Risk, CFOs, and the Sustainability Business Case

Risk, CFOs, and the Sustainability Business Case

I’ve been tracking an interesting business metric: the growing number of reports looking at the financial implications of the sustainability challenge, for industries ranging from automotive to electronics.

An analyst at Merrill Lynch, reports the New York Times, “organized a teleconference to address a troubling question for Detroit's automakers: As regulators around the world move to curb global-warming emissions from cars and improve fuel efficiency, what happens if Wall Street adds up the costs?... 'As a U.S. auto analyst, I'm very concerned about the risk side of the equation.'”

A group of institutional investors representing assets exceeding 10 trillion U.S. dollars shows increasing interest in climate change issues, noting that “the future ‘cost of carbon’ is a major headache for energy-intensive FT500 companies,” and that “pressure is growing on financial market authorities, fiduciaries, company directors and officers, and accounting bodies to incorporate climate risk factors into financial statements and offerings.”

And the wild-eyed crazies at Fortune and that socialist rag Business Week have been radically rethinking energy policy, going long on efficiency and renewables and short on petroleum.

These analyses come from a variety of sources -- investment firms, academic researchers, NGOs -- but most interestingly from business leaders.

Dupont CFO Gary Pfeiffer observed, some years ago, that “Dupont has reduced its environmental footprint by 60%, and increased in shareholder value by 340%. Can I prove that those two facts are correlated? No. Do I have any doubt they’re correlated? No.”

This provides an essential business frame to the Dupont sustainability initiatives I’ve described in recent columns -- and for anyone trying to make a robust business case for sustainability strategies and initiatives.

When Pfeiffer keynoted the Conference Board’s 2004 “Business and Sustainability” conference earlier this year, he drove the point home. “Many environmentalists complain that ‘Wall Street’ doesn’t ‘get it.’ I’m here to tell you that they do get it -- and how they get it, and what we do with that.”

Wall Street’s legendary focus on the short term, Pfeiffer asserted, is more precisely a focus on discounted future cash flows. Wall Street is happy if a company will (a) make more money in the future; (b) make money sooner rather than later; and (c) face less risk that could reduce or delay the money they might make.

This is obvious stuff, of course. The key lies in the lenses or filters though which we look at a market landscape, which in turn significantly determines the opportunities we’re able to perceive in that landscape.

A and B argue for using sustainability perspectives to guide the invention of better products and services -- ones that can profitably meet present and anticipated market needs, meet them sooner than the competition, and turn them profitable faster than the competition. One of many examples: selling car painting services instead of the paint itself redirects the financial incentive from maximizing to minimizing the sale of paint (which has been transformed from a revenue source to a cost of production), and drives innovations that reduce VOCs and overspray, since any chemistry that doesn’t adhere to the car adds no value to Dupont’s customers or their shareholders.

The third element, C, demands reducing the risks that could weaken that cash flow – barriers to market entry from future regulatory hurdles, missing shifting market expectations or competitor innovations, facing unanticipated calamities like Bhopal or fully anticipated ones like rising sea levels -- is equally subject to management’s ability to see into that landscape.

We see the same challenges, in industry after industry.

For the auto industry, Grist Magazine observes “...it may be that U.S. automakers will have to take global warming seriously after all. A recent report from financial analysts at the investment group Sustainable Asset Management and the enviro-policy shop World Resources Institute claims that automakers in general, and Ford and General Motors in particular, are at risk from the 'carbon intensity' of their operations. The analysts noted two trends: First is the growing worldwide pressure to cut carbon-dioxide emissions by raising fuel-economy standards, with regulations already underway in Europe, China, and California. The second is pressure inside the U.S. to reduce dependence on foreign energy sources (read: oil). While Honda and Toyota are well-placed to weather the storm, Ford and GM, with their market reliance on gas-guzzling light trucks, are not.” Detroit gave away a third of its market share the 1970s; it remains to be seen whether it’s learned its lesson.

For the electronics industry, “WEEE and RoHS are… like Y2K, but with revenue loss,” according to Agile Software VP Ray Hein. These European Union product take-back and restricted substances directives are rippling through electronics industry supply chains, generating very different responses at different companies. At worst, the directives came as a surprise for some companies, though they shouldn’t have. More commonly, companies ignore them as long as possible and do what’s minimally necessary to comply. At best, companies attempt to guide their product and process design by the biological principles detectable behind the EU directives, in hopes of effectively anticipating where future regulations might be headed.

For the insurance industry, the stark message of actuarial risk analysis precludes waiting for the political debates to resolve, in face of the more pragmatic alternative of acting now to mitigate that potential risk. So we see Munich Re and Swiss Re, among others, alerting their customers to the prospect of climate change related premium increases, or even withdrawal of some coverage from customers who don’t step up to the plate with serious climate change strategies of their own.

The list could go on. As I blogged in May: “Hopefully the point is getting through: This is not a passing phase. It is a serious business, financial and political issue that demands penetrating strategy and focused action from leaders who don't want to be left behind by competitors -- or charged with violation of fiduciary responsibility by their shareholders.”

A significant piece of the challenge is tuning the lenses -- or mindsets -- that managers and investors bring to the table, the diversity and depth of the knowledge bases that support their judgments, and the analytic tools that enable people to perceive risk that others don’t yet see, and to find opportunity in that risk. Pfeiffer’s Finance 101 lesson is clear enough, but without up to date risk literacy education, even the smartest managers will miss clues sitting right in front of them. We see this in the assumption -- still widely held by many environmentalists as well as many business people -- that environmentally sound solutions must necessarily cost more, despite a growing body of evidence to the contrary. (See for example, “The Cost and Financial Benefits of Green Buildings.”)

As good as it is, Pfeiffer’s formula has its shortcomings. Bernard Lietaer, co-designer of the Euro, points out that the very taken-for-granted economic mechanism of discounting future cash flows intrinsically renders the future valueless. How can we use a market system to protect future forests -- or future generations -- if they have no market value?

The numbers, of course, can’t tell you what you should do. They can only tell you how well you’re doing it – and perhaps help you make and defend the case, and sometimes help you recognize an opportunity. As to what you should do, you already know the answer: you should do the right things. What are the right things? Those that bring the greatest good to the greatest number, nurture the regenerative capacity of earth’s living systems, and resonate with humanity’s deepest aspirations.

Woolly-headed, naïve, wishful tree-hugger thinking? Not according to the CFO of one of the world’s largest companies. It might actually be the pathway to greater profit and lower business risk -- as well as the deep personal satisfaction that builds great workforces and makes life worthwhile.

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Gil Friend, systems ecologist and business strategist, is president and CEO of Natural Logic, Inc. -- offering advisory services and tools that help companies and communities prosper by embedding the laws of nature at the heart of enterprise. Sign up online to receive his monthly column via email.

Copyright 2004, Gil Friend. All rights reserved.

[Natural Logic will soon be offering a series of daylong workshops on the theme, “Industry Valuations: Impact of New Global Environmental Requirements.” These workshops, designed for CFOs and investment analysts, will be offered in collaboration with our ally Technology Forecasters. Information on dates and locations is available on the company's Web site.]