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5 ways to apply natural capital valuation in your business

Shadow pricing, designed to reflect future market value of underpriced natural resources, is one major way companies incorporate sustainability.

Natural capital is a new way for business to think of the environment — a way that overcomes the current disconnect between economic growth and nature.

To grow revenue, all companies depend on the Earth’s support systems such as a stable climate or clean water, as well as natural resources such as land and timber. Most natural assets are grossly underpriced in the market, which results in companies' using them at an unsustainable rate. Natural-capital valuation prices these natural assets so that companies can see their true value to their business.

As the population grows and businesses compete for a fixed supply of natural assets, the risk of companies having to pay natural capital costs increases due to regulation, scarcity, pollution or extreme weather events that cause business disruptions.

As a practitioner of natural capital valuation for over 14 years, Trucost has pioneered many approaches for corporations and financial institutions to apply it. One question Trucost is frequently asked is: “How can my company act on and apply natural capital valuation in day-to-day, practical operational decision-making?” Here are five suggestions to make natural capital valuation work for your business.

1. Shadow pricing

Shadow pricing is one way to account for risk and natural capital costs. A shadow price is an estimated monetary value that is used internally to account for risk or profitability. A natural capital shadow price or valuation might be factored into actual operational costs in a profit and loss statement, included in a discounted cash flow statement for a capital investment or considered alongside a capital asset on balance sheet.

For example, some 150 companies including Microsoft, Dow and retailer Canadian Tire disclosed to CDP that they are using a shadow price for carbon to inform business decisions.

Trucost develops shadow prices by taking into account such variables as current market prices, resource availability, timing of impacts and the likelihood of risks. Valuing water is more complex than carbon, as its impact is local. The Water Risk Monetizer, a free online tool developed by Ecolab and Trucost, looks at the amount of water available at a specific location, the amount of water used by a facility and the full value of the water to the business and community. The tool provides a monetary water risk premium, or shadow price, that can be used to pinpoint high-risk facilities that should be priorities for water efficiency.

2. Sourcing, procurement and supply-chain management

For companies in sectors such as technology, apparel and food and beverage, over three-quarters of environmental risks reside in their supply chain rather than in the company’s own operations (see figure).

Natural capital valuation, by Trucost.

Practical ways to apply natural capital accounting can be with supply-chain risk assessments, strategic sourcing or hedging of commodities, supplier relationship management, or sustainable procurement strategies and guidelines for buyers and suppliers.

The starting point is to conduct a risk assessment and quantify environmental performance to see which impacts are material to the business where they occur. Trucost not only quantifies the impacts in physical terms (such as tons of greenhouse gases or gallons of water), it also calculates the monetary value to enable impacts to be compared and prioritized.

Armed with this information, a company can begin to build a more risk-resilient supply chain. This could involve requesting data on suppliers’ carbon emissions or water use, and offering training to carbon- or water-intensive suppliers. The company even could consider screening suppliers that do not want to engage, or which fail to disclose how they manage risks such as water scarcity, which can cause major disruption. Companies could switch to more sustainable suppliers for commodities such as timber or cotton produced under an independently certified scheme.

General Mills worked with Trucost to conduct a supply-chain risk assessment and understand the impacts of 17 commodity and product categories. This revealed that carbon emissions and water use in the agricultural production and processing of ingredients were the dominant impacts. The results informed a new goal to sustainably source 100 percent of its 10 priority ingredients by 2020.

3. Product design

Another way to operationalize natural capital valuation is in the product development and design process. Many forward-thinking companies already use lifecycle analysis (LCA) to quantify and reduce impacts associated with sourcing, manufacturing, using and disposing of products.

Natural capital valuation can enhance LCA data by converting physical impacts into monetary values, which are more readily understood by business people. Different environmental impacts also can be compared in a way not previously possible. A business also can understand the impact in relation to the amount of the resource actually available, as its value reflects its scarcity. Water, for instance, will be more valuable in an arid region of the world compared to a water-rich region.

Interface is just one of the companies that has applied Trucost’s natural capital valuations to LCAs of its carpet tiles. The results showed that carbon from the raw materials was the biggest impact, validating the company’s strategy of switching from virgin raw materials towards low-carbon recycled materials. Putting a monetary value on the impacts also helped Interface simplify its internal communications and drive improvements by creating a global metric of its products’ carbon footprint.

4. Scenario planning

Companies can use natural capital valuations to inform decisions such as where to grow and invest capital, or withdraw and divest assets, or how to weigh environmental constraints for different business models such as on-line retailing versus conventional stores.

For example, a large brewing company may want to expand production in cities where it already has a number of breweries and where population growth is skyrocketing, but where water scarcity is an increasing problem. By assessing the future natural capital costs of water, the company may gain insight into where best to expand, and can feed valuation data into other calculations such as site-development costs.

Another organization might value natural capital to consider the feasibility of vertically integrating operations as a way to source alternative agro-materials or fibers, or to compare the costs of different technologies. Natural capital valuation helped make the case for Utilyx’s (PDF) low-carbon solution that might require a larger capital outlay, but which in the longer term could reduce operating costs and other risks, leading to a net saving.

Monsanto and Natura, through a collaboration with Conservation International and Trucost, measured the net environmental and financial cost benefits of sustainable soy and palm oil through conventional and alternative production scenarios.

5. Enterprise management software

Many companies use business management systems, including enterprise resource planning software, to keep track of all the data a company generates on its finances, human resources and business performance.

Yet many firms keep sustainability data separate, despite its being crucial for long-term success. One reason is that environmental impacts conventionally are measured in physical terms such as tons of air pollution, while business data is measured in monetary terms. Natural capital valuation overcomes this barrier.

As Thomas Odenwald, senior vice-president of sustainability at SAP, recently noted: “Including natural and social capital accounting and optimization in our mainstream business processes could help business go beyond just monitoring negative impacts in separate satellite systems, and start making informed, data-driven decisions about how to achieve positive ones.”

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