Our recently released research See Change: How Transparency Drives Performance proposes a solution to the stalled state of sustainability reporting and transparency. See Change highlights three key elements that must be addressed in order to gain the most value from transparency and reporting efforts: materiality, valuation of externalities and integration. This is the second in a three-part series, which was originally published on GreenBiz, to explore those elements.
In the first article in this series, we explored how materiality enables companies to focus their transparency efforts and leverage the value of sustainability reporting. The second important element of transparency is valuation of externalities. After identifying and prioritizing the most material issues, companies should account for externalities: the unintended indirect consequences associated with an economic activity for which the costs have not been accounted.
Valuing externalities, such as the full cost of GHG emissions or the upstream environmental benefits of choosing a recycled material, allows a company to understand and present a comprehensive picture of its role in society and the environment.
Despite a dependence on services and resources provided by society and the environment such as access to fresh water, clean air, pollination of crops and thriving communities, to date companies have not yet had to formally recognize — much less account for — those externalities.
Even indirect impacts can be significant
Although there is little incentive to account for indirect impacts associated with good soil health, paying a living wage or switching to recycled materials, for example, a number of drivers including resource scarcity, stakeholder expectations and reporting guidance (such as the IIRC’s Integrated Reporting Framework) are prompting companies to review their indirect impacts.
As a result, this type of evaluation can help companies make more informed decisions, improve performance and thrive within environmental limits. A recent Globescan/SustainAbility survey explores ways to do this.
The good news is that an increasing number of companies have begun evaluating their externalities and using the information to inform their decisions.
For example, the Dow Chemical Company has been assessing some of the indirect impacts associated with its largest manufacturing plant in Freeport, Texas. Dow worked with The Nature Conservancy (TNC) to explore options to improve air quality near its facility. Dow sought to demonstrate that planting trees could be a viable and cost effective complement to conventional air filtration systems such as “scrubbers” on smokestacks. Through modeling, Dow and TNC found that reforestation indeed could be a cost-effective air quality strategy compared to additional conventional control technology.
While the two approaches had similar implementation costs, reforestation had additional benefits: restoration of wildlife habitat, provision of recreational opportunities and carbon storage provided by the trees. “This could be a cost-effective alternative to pollution control devices, which has a potentially big impact for Dow, TNC and beyond. This natural infrastructure solution could be very scalable so the impacts could be quite meaningful,” Glenn Prickett, Chief External Affairs Officer at TNC, noted.
Other companies such as Puma, Kering and Novo Nordisk have produced Environmental Profit and Loss (EP&L) statements to identify where in the value chain the most significant indirect impacts occur and better account for them.
Novo Nordisk examines the value chain
More specifically, Novo Nordisk worked with the Danish Ministry of the Environment to assess the environmental impacts along its value chain. The EP&L revealed that Novo Nordisk’s total environmental impacts amount to $252.33 million, with $38.47 million in water use, $193.49 million in GHG emissions and $20.37 million in air pollution.
The majority (75 percent) of impacts occur in the raw material extraction phase and in the final product phase and are caused by GHG emissions. Anne Gadegaard, program director of Corporate Sustainability at Novo Nordisk, oversaw the EP&L process and noted that the process “has given us data in a way that we have never had before. We will use that as part of the review of the environmental strategy this year.”
Meanwhile, a number of companies have different approaches to increasing transparency on relevant externalities.
Disney, Google and Shell are using shadow pricing, an estimated price of a good or service where the market price doesn’t reflect the full cost, to better account for the indirect impacts associated with GHG emissions.
Natura is tracking the environmental impacts of its suppliers and using this information to inform with whom the company will work.
The Crown Estate is measuring its Total Contribution to the economy, society and environment.
JetBlue evaluated the importance of the Caribbean’s natural ecosystems (PDF) to its vacation-seeking customers and therefore its profitability.
Reduced risks, lowered costs, enhanced brand equity and increased growth are just some benefits that companies receive from this type of valuation. Ultimately, the valuation of externalities can reveal unseen, yet significant impacts that spur a company to explore its fundamental business model and potential innovations.
Despite these benefits, suddenly putting a price tag on every element of society and the environment is neither practical nor necessarily even desirable. As journalist George Monbiot pointed out, applying the same economic approach to solving the problem as the one that created it is a road to ruin.
And yet we are reaching a tipping point where these issues, which carry real costs, will need to be accounted for soon. This type of valuation acknowledges impacts in a market that currently fails to fully account for them.
3 steps to better evaluating externalities
Companies can evaluate their externalities and use the information they’ve gathered to inform decisions by following the guidance in SustainAbility’s See Change report.
- Explore indirect and unaccounted-for impacts associated with material issues and consider engaging a partner organization or existing coalition with access to tools and methodologies for valuing externalities.
- Identify one or two material issues to pilot valuation approaches and assess the externalities, positive and negative, associated with each issue.
- Use the results of the valuation to inform existing corporate strategy as well as internal stakeholders and consider sharing the results publicly to foster evolution in the field.
We expect to see increased attention to externalities valuation in the near future — from value chain approaches that assess impacts, improved valuation methodologies and more effective incentives and regulations on reporting and disclosure — especially in sectors heavily dependent on natural capital such as agriculture, forestry, mining and energy. Greater incentives and regulations, as well as more companies embracing this approach, will make the valuation of externalities a far more common practice.