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April 10, 2009

Avoiding Pitfalls on the Sustainability Path to Shareholder Value

Peter Capozucca
Principal
Deloitte Consulting

Doing good for the environment and society has long differentiated consumer product companies, like Patagonia. The ROI associated with its closed-loop recycling system for polyester, which cuts energy use by 76 percent and reduced emissions by 71 percent compared to using virgin polyester, is clearly understood by board members and outsiders alike.

But when Patagonia pulled the popular Nalgene polycarbonate-constructed water bottles from its store shelves over worries about the chemical bisphenol A in 2005, it became evident that more than an ROI analysis is needed to understand how being sustainable can build shareholder value.

Whether driven by consumer interest, retailer requirements, or pending legislation, senior executives are beginning to make sustainability a top agenda item. The markets agree – according to a 2008 study by the Economist Intelligence Unit, companies that embrace sustainability have achieved the highest share price growth over the past three years whereas companies with the worst performance focused less on sustainability.

It is clear the cost of doing nothing is too great, but what pitfalls exist for companies on the path to sustainability? Below are five items companies should consider to ensure their sustainability efforts are delivering shareholder value.

Pitfall #1: Confusion from the start

Sustainability is often left open to interpretation as it remains a broad and complex concept that has not been consistently defined. The United Nations Brundtland Commission developed one of the first definitions of sustainability: “Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs.”

However, the commission’s definition has not been consistently adopted by companies, thus complicating the sustainability landscape. Corporate philanthropic efforts to protect the environment or improve the conditions of local communities often get cited as examples of sustainability. Less obvious components of sustainability are efforts to mitigate raw material shortages or to improve corporate governance and transparency.

Despite the confusion, it is becoming commonly accepted that sustainability encompasses the triple bottom line, including environmental, social and economic factors. The strategic opportunity for sustainability is at the intersection of all three – considering both the environmental and social implications while continuing to build shareholder value and ensuring the long-term viability of the enterprise. Where this may become tricky is when the environmental or social benefits outweigh the short-term financial bottom line.

Nonetheless, defining sustainability is a critical first step to leveraging it as part of an enterprise’s strategy. Employees need to clearly understand what it means – and does not mean – to help the sales force, product managers, and public relations departments speak to external parties in a meaningful way. It also can help product engineers and operations managers design products and processes while considering the triple bottom line. Though many organizations have used the Brundtland Commission’s definition as a starting point for their sustainability definition, a more narrow definition may be required depending on a company’s culture.

Pitfall #2: The missing link-organizational DNA

Defining sustainability is a critical first step, but a definition alone is incomplete. A sustainability vision statement should also be developed in order to serve as a guidepost for decision-making related to strategic issues, such as capital projects or merger/acquisition targeting, as well as tactical issues including supplier requirements for back-office supplies. By having an inspiring, action-oriented sustainability vision statement, a company can further engage its employees and stakeholders. Such engagement is the first step in embedding sustainability within the company’s culture.

A company’s mission statement commonly defines the organization itself – so important, that it is sometimes referred to as the company’s DNA. With something so central to a company’s being, it is critical that the sustainability vision statement aligns closely with the company’s mission statement. For example, SC Johnson’s mission statement and sustainability vision share an unmistakable “family values” link making it clear to both employees and external stakeholders that sustainability is a natural extension of SC Johnson’s core mission.

Pitfall #3: Pursuing without priorities

Sustainability is a large, strategic issue that can impact multiple areas of an enterprise. Taking one large environmental challenge head-on, such as water consumption and quality, can require significant resources. Taking on many challenges on a smaller scale can dilute the desired environmental benefits or worse, and it can also confuse key stakeholders about what is really important to the enterprise. Developing clear priorities helps decision-making when the ROI is foggy or the payback appears further out.

Hybrid vehicles, for example, can improve fuel efficiency and reduce greenhouse gas emissions for large fleet owners. However, these vehicles can cost over $70,000 – at least 75 percent more than conventional vehicles – sometimes requiring over a 10-year payback for the fuel savings differential. The investment in these vehicles may not meet a company’s payback period, but the long-term cost of not taking sustainability seriously may be as considerable as the short-term cost of adopting sustainability initiatives.

Defining priorities requires analyzing the enterprise’s inputs and outputs at the operational level. In assessing its inputs, a company may consider its top spend categories for raw materials. Accordingly, as some commodities experience increasing levels of volatility, companies may elect to make them a higher priority for both environment and economic benefits. For example, our oil-based economy presents challenges for almost every sector and the proven cost volatility of oil may spur on a company to place energy management at the top of its strategic priorities. From an output perspective, consumers are becoming increasingly aware of the negative impacts of greenhouse gas emissions, escalating the pressure on companies to reduce their emissions levels. As such, reduction of emissions has emerged as a top priority for many companies as well as the related causes of emissions, such as energy and transportation.

Social issues need to be considered as priorities as well, especially for consumer businesses which have brands to build and protect.

Pitfall #4: Baseless progress

About 85 percent of leading consumer businesses have pursued some sort of sustainability-related initiative – whether to streamline production processes to reduce raw material inputs or retrofit lighting fixtures to use lower energy bulbs. What is critically lacking, in many cases, are established baselines against which year-on-year benefits can be measured. It is one thing to tell the board of directors that sustainability is an integral component of the company’s strategy or that $10 million was invested in energy saving technology; however, it is another and far more powerful message to communicate that manufacturing waste was reduced by 45 percent since 1998 like Nike delivered.

Generally speaking, baselines should be established for each key sustainability priority. On the consumption side, this might include water, energy, pulp, recycled or agricultural inputs, while the disposal side might include greenhouse gas emissions, waste water, scrap waste and recycled waste.

A more difficult baseline to establish involves measuring greenhouse gas emissions, an issue that has been garnering increased public attention.

Pitfall #5: The Lone Rider

Going it alone when it comes to tackling sustainability challenges can be arduous, if not impossible. Companies must keep up with changing technology, which provides not only a better understanding of environmental and social effects of an enterprise’s operations, but also new potential solutions to sustainability challenges. However, companies cannot take full advantage of technology’s benefits without collaborating with external organizations to help them navigate the ever-changing sustainability landscape. Companies should collaborate with non-profit organizations, academia or industry groups to develop a more comprehensive understanding of the issues, to identify more innovative tactics or technology to address the issues, and to engage potential stakeholders, such as NGO’s, to achieve their sustainability goals.

For example, faced with a shrinking global supply of fish, Unilever collaborated with the World Wildlife Fund to establish the Marine Stewardship Council in 1997 to ensure the long-tem sustainability of the fish supply and the integrity of the marine ecosystem. The council established a global environmental standard for responsible fisheries using a two year consultation process with stakeholders, and in 1999, the council became an independent non-profit organization.

Given increasing pressures from a multitude of stakeholders, including consumers, retailers, regulators and non-profit organizations, it is clear why so many companies are marching down the sustainability path. What will differentiate those organizations who realize environmental and social benefits while delivering shareholder value is the strategic foundation they rely upon to avoid the pitfalls.

Peter Capozucca is a principal with Deloitte Consulting and the consumer business leader of Deloitte’s Enterprise Sustainability group.

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