Changing Corporate Strategies

Industrialization brought tremendous benefits, but came at a time when resources seemed limitless.

The externalities -- the costs to the environment, to people and to the way corporations managed their businesses -- were under reported until they became dangerous to public health or safety, resulting in regulations. In this day and age, companies are finding that taking steps to manage these externalities is good business. On the value creation side, companies see cost savings, better outcomes from supply chains, worker safety and breakthroughs in resource efficiencies.  On the risk side, they see water scarcity and energy volatility, carbon regulations and reputational risk. 

As activist investors, pensioners and customers push boardrooms, businesses are looking at fundamental changes in the way they make decisions about a wide range of corporate practices. While some are investing heavily in energy sources and efficiencies, others are using new measurement and mitigation tools to develop fiscally appropriate short and long term strategies. One approach, highlighted by Carbon Credit Capital, as the name implies, places value in measuring carbon and using strategies to offset emissions, while another, Malk Sustainability Partners, prioritizes ESG: Environmental, Social, Governance.

Monetize Carbon

Carbon has become a major topic in corporate boardrooms for two reasons: risk mitigation and efficiency. A PwC report estimates that climate risk cost the US manufacturing and services sector $21.7 billion in 2014.

Add to that the cost of managing adverse health impacts of atmospheric carbon, loss of worker productivity and municipal spending on a resilient infrastructure, and the figure becomes larger by many multiples.

Investing in offsets is a direct and immediate way of reducing carbon output. This is done by buying credits from carbon reduction efforts in the voluntary offset market. In Europe, the offset market is supported by strict emission reduction regulations with which companies must comply. In the US, carbon offset markets are varied in the absence of any federal emission reduction policies, and only a few regional programs, like California’s Cap-and-Trade and RGGI, have any regulatory power. This leaves a huge carbon pricing and purchasing gap for companies that are not part of any of these regulatory compliance mechanisms. Carbon Credit Capital (CCC), a company that specializes in selling voluntary offsets, however, sees drivers for such markets and provides new options, as some companies:

  • Actively chose to be stewards of the environment for various reasons. This can be due to their industry.  One example would be packaged food manufacturers that are dependent on a productive environment.
  • Have a global presence in countries that have carbon reduction targets. Even though their products may be made in areas without such regulations, selling those products into regulated markets can be harder without a corporate policy.
  • Face increased pressure from external stakeholders.  Fortune 500 companies are especially mindful of any initiatives that lower their environmental impact.

Since the starting point for any carbon strategy is measurement, CCC has launched a service, called Carbon Neutral Checkout™, where they estimate greenhouse gas emissions of an organizations’ products. CCC then helps the organization offset its carbon footprint using the highest quality carbon offsets to neutralize carbon emissions. CCC follows the same protocols that audits require, such as the Green House Gas protocol or the Global Reporting Initiative, but has lowered costs by estimating emissions based on company responses to simple sets of questions, and by cross checking answers against existing data from industry specific databases, like one on wool production in New Zealand or pulp mills in Canada.

By breaking down outputs at the division and supplier level, the company finds that offsetting most products is a matter of cents, and that it can be incorporated into the price of the product without losing market share. CCC then helps the company advertise and market their efforts through interactive QR codes on a product tag, alerting consumers that the product they are purchasing is carbon neutral, leaving zero carbon footprint.

One of the hidden benefits of emissions reporting is that it enables companies to develop long term carbon strategies that ultimately become integrated into day to day activities as they become familiar with practices. The carbon offset strategies that CCC offers, based on their estimate of total company footprint across all sectors, doesn’t alter the supply chain, manufacturing process or final product. However, a carbon estimate is an invaluable tool for corporate leaders developing a plan to lower costs by reducing carbon through efficiencies or generation.

Carbon Credit Capital has seen growth in the US voluntary offset markets, even in the Midwest and South. Moreover, many believe that some form of carbon pricing is inevitable. Those companies that are measuring and strategizing now stand to be winners in the future.

Value Creation

Another approach measures intangibles. Calculating the value of intangibles--such as the corporate brand, consumer attitudes or good management-- so that they can be reported on corporate balance sheets has been the subject of countless studies by CFOs as well as their actuaries and accountants. As the Security Exchange Commission ups the anti by requiring reports on climate threats, new factors are showing up as material for companies across the US. 

While there are several approaches, Malk Sustainability Partners works with Private Equity to protect company valuation by addressing ESG management, which plays a key role as a supplement to the investment process of assessing how well the company will perform into the future. ESG is a broad term used by the investment community to describe a range of investment considerations related to environmental stewardship, social equality, and ethical governance. Common objectives of ESG management include energy savings, waste diversion, improved labor practices in the supply chain, employee health and safety, and fair business dealings. Malk Sustainability Partners is very skilled at creating value by finding the intangibles that can affect the worth of the company, and measuring the impact on earnings.

The growth in demand for ESG is partly attributable to General Partners (GP)--those who control how the money is spent—who are motivated by a new breed of Limited Partners (LP)--the investors. Malk Sustainability Partners finds that these new investors are evaluating the potential for returns by asking questions about how GPs will evaluate ESG factors. The GPs are incentivized by low hanging fruit, such as energy efficiencies with attractive paybacks. As these paybacks grow, investors seek to expand their scope, finding savings as well as actions that reduce a broad range of political, social and resource risks. Management leaders like KKR, TPG, Carlyle and Blackstone were pioneers in this area, finding that being a major shareholder is the path to increasing the company's ability to compete in the marketplace by impacting the corporate energy, water and transportation profile.

For companies that may not have ESG metrics at the top of their concerns, many find that during major strategic actions, such as a merger or acquisition, ESG suddenly becomes relevant as a way to value the effects of good-or bad-management, risk mitigation and resource efficiencies on the bottom line. Since such actions impact future earnings, ESG is also critical when a General Partner is trying to exit a company. As investors and managers focus on ESG as core investment considerations during transaction diligence, companies that are unprepared to answer such questions are increasingly at a disadvantage. 

In a new investment horizon, accounting practices and due diligence have been impacted by  legislation such as Dodd Frank, anti-corruption and pending anti-money laundering; increased pressure to monitor corporate supply chains; and a more active NGO, press and internet. With greater transparency, there is a higher chance of something getting picked up that will have an impact on earnings as external stakeholders react. From this point of view, reputational risk is a 'new normal', making investors eager for any data that can avoid finding the company they just purchased being flashed across the blogosphere or becoming a meme for bad governance.

As recently as three years ago, ESG was primarily an investment tool for nonprofits and large pension funds such as CalPERS. Now companies like Malk Sustainbilty Partners are making such considerations normal, especially for companies in transition: those seeking private equity for expansion or acquisitions, or merging with another entity. Those that are not thinking now about ESG may find themselves on the sidelines.

Staying ahead of the Curve

Going forward, both companies expect these trends to continue. More will be asked of fund managers and corporate boardrooms, and the criteria established by protocols, such as the UN PRI, will become more stringent. At the same time, more companies are learning about value created from ESG management and carbon reduction, and are taking actions to capture that value. For all these reasons, new and innovative measurement strategies are becoming a must-have for companies looking to advance in a carbon centric world. One thing is certain: if companies do not assimilate to these strategies, they will be left in the dark.