Proving the economic value of sustainability

In terms of social impact, up until Covid, it was thought that big initiatives are often the ones that have the largest impact. With the pandemic, we realized how important the individual behavior is and how it can impact at a global scale.

These days more than ever, companies are called to adopt and advance acting upon different types of social and environmental causes. Organizations pledge to sustainability goals and then figure out a way to monitor impact. Initially, these types of initiatives were developed to build an image and influence public opinion. Today, the aim is to directly link them to long-term profitability, risk mitigation, and strategic perspective. The word pledge has a clear meaning: a solemn promise or undertaking. It represents an agreement, a bond, an oath to commit to a given cause or purpose. But what does this mean for a company when it comes to delivering on it? In most cases, companies set goals, activities, and projects that do not have a clear performance indicator or fail to establish a cause-effect relationship between social and environmental impact, and real economic effects. It is true that efforts in this direction are constantly made. But they fall short of proving or even linking, social and environmental impact to business outputs. In most cases, the evaluation is limited to costs savings (with more or less rigor) and a monetary allocation to risk mitigation.

Let’s take the Sustainability Development Goals (SDG) proposed by the United Nations in 2015, for instance. While they have been broadly adopted and pledged for, companies still struggle to realise them. The Inter-Agency and Expert Group on SDG Indicators (IAEG-SDGs) is the UN Statistical Commission in charge of setting the performance indicators (KPI’s) that define whether or how those goals are achieved. Consider SDG #15, for example: “to protect, restore and promote sustainable use of terrestrial ecosystems, sustainably manage forests, combat desertification, and halt and reverse land degradation and halt biodiversity loss”. Lots of companies are committing to this goal for which the UN has set the following KPI’s:

·       Forest area as a proportion of the total land area.

·       Proportion of land that is degraded over total land area.

·       Proportion of countries adopting relevant national legislation and adequately resourcing the prevention or control of invasive alien species.

·       Proportion of important sites for terrestrial and freshwater biodiversity that are covered by protected areas, by ecosystem type.

How are these KPIs linked to the business bottom line? What is the economic impact of these initiatives on the P&L of a business that has committed to them? The lack of a performance standard made organizations set their own diverse ones. Sustainability reports show social and environmental impact but fail to prove impact on business (at least in a credible way to shareholders). Consulting firms and other organizations have been trying to set such a standard for decades already. The “Virtuous Circle” in 2002 in London or even John Elkington’s book “Cannibals with Forks: The Triple Bottom Line of 21st Century Business” in 1998 are known as the early origins of Environment, Social and Corporate Governance (ESG) factors, a first attempt to define the causality (rather than correlation) between environmental and social standards and financial performance.

What would we need to do if we want to achieve such a slippery metric in a credible way? It is necessary to generate a mind shift from monitoring only impacts on costs and saving to analyzing the overall impact on costs and revenues.

The approach to cost savings has already been defined and it is somehow generally accepted. I would erase any monetary valuation of risk allocation from the econometric assessment as this is not a real cash flow. In order to prove that corporate social responsibility projects are an investment (not only in social and environmental equity but in real economic terms), we need to show money inflows and money outflows. Real money, not just value. Saving costs is a real cash flow interaction. On the other end, we need to prove how those initiatives affect actual revenues. The traditional approach to revenues calculation usually takes two directions: static financial analysis and dynamic financial analysis. The static financial analysis works using the control group technique, you define two scenarios: one without your sustainability project implementation and one influenced by it. Check both scenarios gains or losses in operational or financial terms during the monitored period and the difference can be allocated to the project. While this approach is scientifically rigorous it attributes one hundred percent of the effect to the project which is always questionable and seed doubts on the validity of the conclusions. The dynamic approach is a static approach monitorization that incorporates the use of another mathematically rigorous model: discounted cashflows. This way the value generated by your sustainability project is calculated based on the present value of the project’s future cash flows. Again, not a real cash flow measurement that is questionable also in terms of the selected discount rate and the lifetime of the project.

How can we solve this Gordian knot? By building a robust attribution model. A robust attribution model that can finally determine the real economic value of the net revenues generated by a project is one that can isolate two things: the number of acts of purchase or revenue sources that have been impacted by the project (even if it is just knowing that it exists) and the influence of the project in the decision-making process of clients and or revenue sources. The first parameter is achieved through traceability methods (coupons, links, redemption, near field communication, radio frequency identification, and a myriad of technologies now available) and the second one through quantitative research that can give you statistical relevance, hence credibility.

Now it is not only the variance that is considered but the influence of the project on the overall business reflecting the actual impact of the sustainability initiative on the bottom line of organizations and finally proving in a robust and credible way, its return on investment.