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Ken Tysiac
Ken Tysiac

Sustainability can be justified with proper valuation

Expanding shareholder value framework can help executives determine the true benefits and costs of sustainability initiatives, new report says.

June 7, 2012
by Ken Tysiac

Sustainability initiatives can be difficult for companies to sell to shareholders.

Investors want to make money, and sustainability initiatives can be costly. The benefits aren’t immediately obvious to shareholders who focus on the earnings and expenditures described in businesses’ quarterly financial reports.

In challenging economic times, it may be difficult to justify spending for solar energy panels, stormwater management systems or infrastructure that improves energy efficiency.

But a PwC report released last month says sustainability strategies and shareholder value need not be at odds. The report, Sustainability Valuation: An Oxymoron?, advocates expanding the shareholder value framework in two ways to determine whether sustainability initiatives are worthwhile even though they are difficult to quantify.

The report describes direct and indirect methods of accounting for the value of sustainability measures. Sustainability practices can include actions such as implementing green energy, fuel efficiency and recyclable materials, and even policies encouraging diversity in the workplace and nurturing relationships with local communities, said report author Hervé Kieffel, a PwC principal whose expertise is sustainability valuation and project portfolio optimization.

The report was triggered by thinking about sustainability in a broad way--beyond energy, waste packaging and water management, Kieffel said.

Direct vs. indirect

Probability is at the core of the direct method of sustainability valuation. It calls for estimates on ranges of potential growth in market size, market share, or cost savings as a result of sustainability initiatives. The direct method acknowledges and quantifies the risks and uncertainties of these possible financial benefits.

Kieffel said businesses have used probability models for years in the oil and gas industry when considering reserves, and in the pharmaceutical industry when considering clinical trials whose results are uncertain. Factors can be analyzed in the same way with respect to sustainability, he said.

The report says using recycled material, for example, can have an immediate, negative financial impact as manufacturing processes are upgraded. But sustainability can be good for a business if consumers favor products sold by responsible companies, and the report says falling behind competitors in “green” initiatives is not a good way to increase market share.

Clients implementing sustainability practices have asked Kieffel if they are the first in their industry to act.

“They realize that they have to keep up with what the competition is doing,” he said. “And they have a very clear intuition that there is a value in that. What’s difficult for them is to quantify that value.”

The direct method doesn’t make sense in all situations. So the indirect method can demonstrate sustainability benefits while not connecting them directly to the profit and loss metrics, the report said.

Rooted in a methodology called multi-attribute analysis (MUA), the indirect method aims to measure the impact of sustainability initiatives against specific performance measures for different objectives. It then creates trade-off models to obtain a total impact in dollar terms.

PwC’s government clients have been using MUA analysis for more than 30 years; the report says it has been applied at the Department of Energy and the Environmental Protection Agency. Kieffel said that if taking into account whether to subsidize solar energy, for example, a government might take into account a lot more than the cost savings.

The benefits offsetting the cost could include stimulation of the economy, reducing dependence on foreign oil, and improving the environment. In businesses, Kieffel said, CFOs and other senior executives know how much financial performance they are willing to sacrifice in order to improve other objectives such as brand image.

“We can think about these sustainability issues the same way we think about R&D efforts or advertising,” Kieffel said. “We have a way to think about this, not just because it’s a cost saver or it’s the right thing to do. It’s something that creates value, and we can quantify that.”

Showing the results

As those values get quantified, some companies are choosing to report them. Sustainability has become an important part of a growing desire for businesses to report—and investors to be able to examine—nonfinancial value.

German sports apparel maker Puma was first major company to quantify and report the monetary cost of its environmental impact in a formal profit and loss statement. Puma published its first “E P&L” in 2011, after chairman and chief executive Jochen Zeitz decided “to bring transparency to something that is hard to grasp when you are still stuck in the old paradigm, where natural resources and the environment have no limits.”

Coca-Cola, one of a number of companies reporting on their strategic water use plans, made a pledge in 2007 to become water neutral in its global operations. The company releases an annual “water stewardship report” that describes its progress in reducing use of, recycling and replenishing water, as well as an overall yearly sustainability review.

Applying valuation strategies to their entire portfolio of initiatives, rather than just individual sustainability projects, is the next step for companies, Kieffel said.

“We’re beginning to see some of our clients going in that direction,” he said. “To me, we’re at a very interesting turning point.”

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Ken Tysiac is a senior editor with the AICPA Magazines and Newsletters team.