Here’s yet another concern for investors: sustainability risk management, or SRM. While the basic concept has been around for years, emerging market forces are creating a new strain of investor sustainability risk: point-of-purchase reputation risk. Disruptive systems are on the verge of revealing ecological impacts of products that could sink some brands — and boost others.
Regulatory and litigation risks have become familiar, and most companies have learned to avoid or manage them. The new kid on the block — reputation risk — may grow to be the most important for many businesses. One big reason? With Wal-Mart’s announcement in July that it is working with an academic consortium to develop a sustainability index for rating products, a never-seen-before level of transparency seems headed for their stores. Other retailers like Safeway and Best Buy are showing interest in adopting a similar rating.
Here’s the way the ecological transparency index seems likely to work. Wal-Mart’s house brand division is already piloting seven existing products, asking suppliers to assess those products on four dimensions of sustainability: resource use, including nonrenewables; impact on climate change; impact on ecosystems throughout the product’s supply chain; and impact on human health. Data like this, apparently, will become the basis for sustainability ratings that will be posted so shoppers can compare brands in the store aisles.
One model for such point-of-purchase comparisons already exists: www.GoodGuide.com, which aggregates more than 200 such databases to rate companies and products on environmental, health, and social impacts. These include not just the greenhouse gas outputs of the company but also dozens of registries of “chemicals of concern” like BPA and phthalates (both of which are on the recent list announced by the EPA of industrial chemicals that will no longer be allowed in consumer products). More than 60,000 personal care, food, and toy products are now rated on a ten-point scale, standing as proof-of-concept for Wal-Mart’s sustainability index.
Unveiling the ecological impacts of products to consumers will likely create instant winners and losers. Signs in store aisles would be much more effective than online systems, and this point-of-purchase comparison sets the stage for what psychologists call the “contrast effect.” The discovery that your child’s toy contains a toxic substance like lead activates disgust — and the toxin-free toy you are comparing it with looks all the better.
Investors can predict how shifts in brand preference could quickly scale, hurting some brands and improving others.
“Just as consumers have had myopia on the ecological impacts of products, investors do regarding these risks,” says Mark Tulay, director of People4Earth, a nonprofit organization. Tulay’s group has begun to establish a global standard for investors to assess sustainability-related risks and opportunities. The ratings include product health and safety, labor practices, the impacts of operations on the environment and biodiversity, and output of greenhouse gases.
Businesses vary widely in their preparedness for reputation risk. As one Wal-Mart executive told me, “I wonder about the future of companies who, when we tell them we want data on their carbon footprint, answer, ‘Carb-what?'”
The dilemma for most companies is that the standard industrial platforms, processes, and chemicals in daily use were developed in the era before companies and consumers were aware of the ecological dangers they could cause.
Adapting to reputation risk will require a new mindset. Take a paper company that has excellent practices in its mills — lower chlorine use, good wastewater systems, alternative energy use, and the like. But the company still sources its wood from virgin forests — a practice that will make it a laggard if its competitors no longer use virgin wood.
To become less susceptible to this new risk, investors might favor companies that use life cycle assessment to identify the impact profile of their products, benchmark those scores against industry averages, and find innovative solutions that raise their ecological scores in the marketplace. One useful tool in development is Earthster, a supply chain management tool designed to help companies do just that — including identify new suppliers with the needed ecological solutions.
Wal-Mart is already working with Greg Norris, developer of Earthster, on pilot analyses of the seven house brands I mentioned earlier. Earthster aims to create an open source information commons that sets sector-by-sector standards for sustainability scores. Companies will be able to use Earthster to compare their own goods to industry averages, diagnose their worst impacts — and then focus R&D or suppliers to improve where it will help their overall sustainability ratings the most.
Lowering sustainability risks that in turn can affect long-term profitability and growth potential has become a mandate at an increasing number of companies. The Sustainable Investment Research Analyst Network (SIRAN) reported in July that annual reports from 86 of the 100 largest publicly traded U.S. companies include sustainability initiatives, and 34 report measurable goals.
Investors are taking note. The Investor Network on Climate Risk has 80-plus members representing over $60 trillion (including BlackRock and CalPERS). While climate concerns have been at the forefront for investors like these, social sustainability — such as how workers are treated — has been an additional focus of late. And as new ecological transparency systems come online, that focus will most certainly broaden.
Investors can minimize their exposure to the risk of supporting companies more likely to lose in this reputation battle. “What’s been missing is what we are all working towards: meaningful metrics on the climate impacts at the product level,” says People4Earth’s Tulay, adding that this is what life cycle assessment systems like Earthster and GoodGuide seek to capture and quantify. Tulay adds, “Investors should demand ecological transparency from companies.”
Full article originally posted at harvardbusiness.org