How to measure the true costs of profit

The mandatory report for listed companies requires an integrated assessment to determine true sustainable value creation. But how is it calculated?

How do you value SA’s fresh air or water supply, the grasslands, rhinos, oceans, the impact of CO² emissions, investment in staff and community or spending on corporate social investment (CSI)? How is sustainable value calculated?

It is mandatory for all listed companies to produce integrated reports in line with the International Integrated Reporting Council. Though there have been improvements in how companies report, each of the people-planet-profit dimensions are still reported separately by most companies. This is not integrated reporting, nor is it an accurate measure of good performance. King IV clearly sets out the required principles for such reports.

Principle 4, for example, states: “Appreciate that the organisation’s core purpose, its risks and opportunities, strategy, business model, performance and sustainable development are all inseparable elements of the value-creation process.”

Integrated reporting requires an integrated assessment to determine true sustainable value creation. This means, for example, showing how much profit a company makes in relation to the water it uses or greenhouse gases it emits. These integrated, combined measures — rather than siloed calculations — reveal very different portraits of sustainable value.

The concept of sustainable value was developed by researchers at the Euromed Management School in Marseilles, France, and the Institute for Future Studies and Technology Assessments in Berlin, Germany, mainly to assess corporate sustainability performance.

These researchers define sustainable value as “integrating the economic, environmental and social dimension of sustainability. Sustainable value integrates environmental and social dimensions into financial analysis and investment decision-making”, and they have been conducting this analysis for the vehicle sector for some time.

Their website elaborates how sustainable value has come into its own, “building on decades of financial market research to finally assess and manage environmental and social resources similar to economic resources. Using opportunity cost thinking, it avoids most problems that have prevented us from truly integrating economic, environmental and social aspects in everyday decision making.”

Unlike financial reporting, reporting on environmental and social measures in integrated reports are extremely varied, which makes comparisons of the integrated performance of companies in the environmental and social dimensions of sustainability more difficult.

It requires standards — and headway has been made, notably with the publication of the Global Reporting Initiative standards. They feature a modular, interrelated structure and represent the global best practice for reporting on a range of economic, environmental and social impacts.

A range of other initiatives, such as The Economics of Ecosystems and Biodiversity, have put considerable effort into “making nature’s values visible”. They describe their principle objective as: “to mainstream the values of biodiversity and ecosystem services into decision-making at all levels.

“It aims to achieve this goal by following a structured approach to valuation that helps decision-makers recognise the wide range of benefits provided by ecosystems and biodiversity, demonstrate their values in economic terms and, where appropriate, suggest how to capture those values in decision making.”

MBA students at Rhodes Business School were recently set the task of interrogating a range of South African integrated reports to determine how many companies have been doing the kind of integrated analysis that delivers an accurate portrait of sustainable value. Their verdict: hardly any!

However, the students concluded that such reporting can be done. Dino Giovannoni, Cornelia Blignaut and Victoria Shiimi examined two companies from the retail clothing sector: Mr Price Group and TFG.

From their 2017 integrated reports, the students could obtain the revenue, CO² emissions and spending on CSI. These measures can be compared directly, from which it can be deduced that Mr Price Group is performing better than TFG.

“We can, for example, construct an indicator incorporating the financial measure, revenue, with the environmental measure, CO² emissions, giving an ‘FE-indicator’ as the ratio of CO² emissions (in kilograms) to revenue (in rand). This CO²-R ratio is an indicator that is easy to relate to,” the students reported.

“We can also construct a social-financial indicator, as the ratio of spending on CSI to revenue (which again we multiply by 1,000).

This CSI-R ratio confirms how much money is invested in social development for every R1,000 spent at the store.

“In comparing the two retailers, TFG has about 50% higher CO² emissions for each R1 of revenue earned and is spending about a third of what Mr Price Group is spending on CSI.”

Some argue that this kind of approach is too instrumentalist; that it doesn’t take into account intrinsic value and falls short of the complexity required for ecosystem services and biodiversity. The counterpoint is that if this is not done, it will lead to the demise of the natural environment and fail to assess the real measure of the social impact of business.

Writing about the economics of valuing ecosystem services and biodiversity, researchers at The Economics of Ecosystems and Biodiversity state: “In economic terms, quantifying and valuing ecosystem services are no different from quantifying and valuing goods or services produced by humans.

“In practice, however, valuing ecosystem services is problematic. There are reasonable estimates of the value of many provisioning services — in cases where well-developed markets exist — but there are few reliable estimates of the value of most nonmarketed cultural and regulating services.

“The problem is that since most ecosystem services and biodiversity are public goods, they tend to be overconsumed by society.”

This needs to be rectified, by bringing together transdisciplinary teams of accountants, economists, scientists, lawyers, sociologists and anthropologists to agree on the integrated standards and measures of sustainable value.

Let us not pay lip service to achieving effective integrated reporting. Proper integration of the six capitals — financial, manufacturing, human, social and relationship, intellectual and natural — for sustainable value creation is within the grasp of companies.

First published in Business Day, on Wednesday, 16 April 2018.