Why Should an Organization Report on Sustainability?
Sustainability reporting is not a legal requirement in many countries, but there are many important reasons to do it. Organizations can use their reports to help determine if their operations are reaching a more sustainable level. How they use these reports depends on several factors. In the normal course of operations, organizations select relevant information for decision making based on their mission, strategy, and organizational form. The organizational form (e.g., public or private companies, nonprofit organizations, government agencies) often influences how information is used. In privately held companies that choose to become more sustainable for ethical reasons, sustainability reporting can assist them in their efforts. If sustainable development becomes a part of their mission and strategy, the companies can use sustainability accounting and reporting as a managerial tool to assess their progress. It can be incorporated into other nonfinancial management systems such as the balanced scorecard to help align business operations to the mission and strategy of the organization. Sustainability reporting is also relevant for nonprofits and governmental agencies that are committed to sustainable development. These groups may be even more inclined to show by example that they are behaving in sustainable ways. This can be especially helpful to better manage resources in times of budgetary constraints. As more countries pass climate change legislation, sustainability reporting can help organizations comply with these laws. By the end of 2014, 99 countries, which produced 93 percent of the world emissions, had passed 804 climate change laws.1 The enactment of these laws has doubled every five years since 1997. For public companies, sustainability reporting is useful not only for internal communication of progress toward sustainable development but also for external communication. All organizations can use their reports to help determine if their performance is reaching a more sustainable level, which benefits everyone.
Internal Benefits
Unifying Internal Management
As organizations seek to address sustainable development, one benefit is establishing a unifying approach to management. When organizations incorporate sustainability into their mission and strategy, they have the opportunity to link the entire organization’s activities to this theme. For example, Interface Inc. has made sustainability a major theme of its business. Its mission, Achieving Mission Zero, is dedicated to sustainability: “Our promise [is] to eliminate any negative impact Interface Inc. has on the environment by 2020.”2 To fulfill this mission, the company continually improves its products and processes to reduce its environmental and social impacts. Its approach is to foster a culture of innovation that permeates the entire company. By incorporating life-cycle analysis into the management of its products’ development, production, and disposal, the company has devised an interesting model for its carpet tiles. When portions of the carpet become worn, Interface Inc. replaces only those tiles. In this way, Interface Inc. has control over the disposal of its used product. Instead of going to the landfill, the worn tiles are either remanufactured or, in some cases, composted. In 2014, 49 percent of Interface’s raw materials were from recycled or renewable sources.3 The carpet that can be composted is made from a corn-based material (polylactic acid), hemp, flax, and wool.
Many performance indicators for sustainability are nonfinancial and can be adapted to a particular organization. The use of a sustainability balanced scorecard is one way of linking an organization’s strategy to its activities and ensuring that environmental, social, and economic dimensions are covered.4 This adaptation of the balanced scorecard created by Kaplan and Norton is based on cause-and-effect relationships that tie sustainable development measures to the organization’s overall strategy for sustainable development.5 The four perspectives of the balanced scorecard—financial, customer, learning and development, and internal business processes—can be designed to incorporate a sustainable development strategy. It could serve as a planning tool to determine a sustainable strategy and a strategy map to implement it. One of the proposed advantages is better internal acceptance of the sustainable strategy.
Operational Benefits
Improving operations is one benefit of sustainability reporting. Major improvements can come from focusing on energy, materials, and water. Energy use has a major environmental impact, and improving energy efficiency can be a significant cost savings. There are many ways to identify where energy use can be reduced. Looking at accounting information can help to identify energy costs. Evaluating the details of various invoices, processes, and compliance costs is also a useful approach.6 Energy usage meters should be analyzed for energy consumption patterns and ways to reduce consumption. As a means to assure accountability, an employee should be assigned responsibility for energy reduction initiatives. In addition, employees in the different business functions (sales, marketing, operations, and purchasing) can provide valuable information about energy use in their respective areas. In effect, this approach puts the spotlight on energy consumption patterns that need improvement and the cost savings from improving those patterns.
If an organization is unable to conduct energy audits and institute cost-saving initiatives, management should consider engaging an energy service company (ESCO) to perform this function. An ESCO provides energy efficiency and other services where performance contracting is a major part its services business.7 The U.S. ESCO industry began in the 1970s as a response to the oil shortages of the time. The industry grew at 20 percent a year from 1990 to 2000 and slowed down to a 3 percent growth rate from 2001 to 2004. The slowdown was due to a variety of factors, such as industry consolidation, the Enron scandal, and the expiration of federal legislation affecting the industry. The industry has come back and increased 9 percent a year from 2009 to 2011 and is expected to continue to grow. In terms of revenues, the industry earned $6 billion in 2013, and in 2020, the revenues were estimated to be $11 to $15 billion.8 According to the National Association of Energy Service Companies, ESCOs not only save energy costs for clients, but they also contribute to the U.S. economy by creating new jobs within ESCOs, through contractors, and in other indirect supporting roles. ESCOs are businesses that usually assume the role of project developers for projects intended to increase energy efficiency and decrease maintenance costs. These companies develop and install energy-efficient projects for their clients. Examples often include high-efficiency heating and cooling systems, high-efficiency lights, and centralized energy management systems. Because many of these projects involve a substantial initial cost for their clients, ESCOs often secure financing from third parties (e.g., banks). The clients also benefit from performance contracting that is a critical part of the energy efficiency business. Performance contracting requires that the ESCO provide costs savings for their clients in order to be compensated for their work. Their fees are contingent on how much they save their clients. Energy savings are usually directly tracked as part of the monitoring and verification system that is based on approved engineering protocols.
Energy savings can also be obtained by recapturing waste heat from manufacturing plants, utility companies, and university power generators. There are several companies that have found this business to be profitable. Recycled Energy Development (RED) is one that provides this service. The company is able to produce both heat and energy from energy that is wasted from industrial facilities or other large institutions. In a factory, the heat or steam produced in a manufacturing process can power a factory’s electrical needs. Since 1986, Turbosteam, a wholly owned subsidiary of RED, has set up over 180 energy capturing systems. The company estimates a reduction in CO2 emissions of more than 4 million tons with energy savings to its clients well over $200 million.9 Thermal energy is another source of power. For example, excess heat from the production of steel can be captured and put to another use. Numerous industries—chemical, wood, petroleum, food processing, pulp and paper, textile, automotive, and lumber milling and drying—have found this approach to be advantageous. Institutions such as colleges, hospitals, military bases, prisons, and municipal steam plants have benefited from this technology. A few of Turbosteam’s customers include Wright-Patterson Air Force Base, Carnegie-Mellon University, and Kimberly-Clark.
For manufacturing firms, managers have the opportunity to systematically assess what materials they are using and how they are processed. They should seek to replace raw materials that are not sustainable. This includes substituting nonhazardous materials in place of hazardous ones. This action can reduce waste and risks. Waste reduction cuts down on disposal risks. If the eliminated waste is from hazardous materials, the rewards are twofold—elimination of expensive hazardous waste disposal and elimination of the potential liability from spills. Improving the efficient use of resources can increase productivity. Time spent on disposing of wasted resources can be more effectively used in the production process. As a result, cycle times can be reduced. Attention to improving production processes can lead to innovations in the product or processes. New technologies can be developed or acquired to improve production. Waste reduction with sustainable materials should also be a priority.
Water usage is another environmental concern with substantial cost implications for companies. Fresh water is a scarce resource that needs protection from waste and contamination. Evaluating water use and reducing its use can cut costs. Organizations pay for both the use and disposal of water. As a means to conserve water, many car washes have instituted systems that reclaim their rinse water to be reused in the initial wash cycle. In some systems, all water is reused by reverse osmosis, where solid materials are removed by a filter. If the water cannot be reused in car washing, it can be used in landscape irrigation. Another way that water can be conserved is through a routine evaluation of the equipment and system. Water valves and nozzles should be checked for leaks and wear. In the example of the car wash, timers can shut off the spraying of rinse water in between cars. The conveyor system can be set up to allow more time to recapture the rinse water as it drips from the cars. The car wash can acquire high-efficiency washers to clean towels and can create rules for efficient use, such as only running full loads. In general, water efficiency can be obtained by small measures. At relatively minor costs, companies can install flow regulators on faucets, waterless urinals, and water-efficient toilets. Growing native plants that are tolerant of local weather conditions reduces landscape watering.
Financial Rewards
Direct cost savings from more efficient uses of materials can result in financial rewards. One approach to efficient use of raw materials is a closed-loop manufacturing system where the same materials are constantly recycled in the system. Some manufacturing processes can be designed to recapture chemicals that are used in production. In the 20th century, most manufacturers followed the “cradle to grave” model where the end of a product’s life was at a landfill. In an era of mass production and consumption by billions of people, this model is not sustainable. The closed-loop system is often described as a “cradle to cradle” system. If closed-loop systems are designed properly, very little material escapes into the environment. What does escape is in quantities that can be absorbed by the natural environment without damaging it. If materials cannot be recaptured or scrap cannot be avoided, innovative ways to utilize waste materials in the production process can save costs. Scrap materials can be the source of additional revenue by selling it to other companies as is or making new products. An example would be a drapery manufacturer that uses scraps or seconds to make paint drop cloths to be sold in paint or hardware stores. Disposal costs are reduced, and revenues are increased. Financial rewards occur also when companies prevent the violation of environmental laws. “Compliance-only” is a short-run strategy that is not cost effective. Legal fees and fines can be reduced when a proactive approach is instituted. A proactive approach leads to a much less confrontational relationship with regulators.
Organizational Rewards
Organizational rewards can be obtained from sustainability reporting because it provides a framework of accountability that can be used to implement an integrative strategy of sustainability.10 This enables an organization to integrate long-term economic, environmental, and social aspects in its business strategies while maintaining its brands and keeping competitive. The integrative strategy should include the participation of all employees in the effort to achieve sustainability. Employee satisfaction is likely to rise when the entire organization is working toward sustainability. Workers want to work for a company they believe is doing the right things for the environment and society. They are more motivated to act in the best interests of the company if they believe that the company is doing good things. Working conditions also affect workers’ productivity. Workers need to feel respected and protected from harm. Safe working conditions, protection of human rights, and appropriate job training are among the activities that can help a company become more sustainable. This long-term approach to doing business provides a stable work environment that is less likely to have high employee turnover. Companies that perform well on sustainability dimensions can attract talented people.
Sustainability reporting provides managers with a better tool for sustainability risk management. The report describes the company’s sustainability risks, sustainability efforts, and risk-control systems. The sustainability risks that companies face include damage to the ecosystems (ocean, fresh water, forests, land, air), climate change, and resulting lawsuits. In order to prepare the report, companies have to gather the information that can help set benchmarks.11 This information is useful for setting and achieving internal goals along with providing information to compare to the progress of other companies.
External Benefits
An organization that seeks to become more sustainable for ethical reasons can set an example for other organizations. It can be recognized for its leadership by taking an active role in promoting sustainability through its actions. In addition, the organization can influence the development of standards for reporting and support platforms for engagement in sustainability efforts for others. Interface Inc. has assumed this position as a leader in sustainability. It declares it is committed to sharing its approach with other companies. It is actively using its innovations in sustainable manufacturing to inspire others to do the same.
Enhancing an organization’s reputation is one of the major benefits of sustainability reporting. Reputation and brand value are intangible assets that bring the value of a company above the value of its physical assets. As companies establish the quality of their products and services, stakeholders come to view the company as trustworthy. This trust can be enhanced when the company engages its shareholders and reports how it is protecting the environment, its workers, and its financial health.
The financial benefits of sustainable development come from a variety of sources. A better-managed company has better access to investor capital. Investors will view sustainable companies as more attractive if the companies are concerned about the environment, employees, customers, and economic criteria. In a quest to be sustainable, organizations can develop new markets for their innovative processes or products that address sustainability issues. In striving to become sustainable, companies can create processes that could be marketed to other companies. The risk of ignoring sustainable development can be a loss of competitive edge. Competitors that can make the same products at a lower price and in an environmentally and socially friendly way are more apt to have a loyal customer base in the long run. They also are less likely to have environmental compliance problems.
Sustainability reporting encourages engagement with stakeholders. Communication with stakeholders allows interested parties to express their interests in and expectations of the organization. Organizations can use this opportunity to improve their relationship with their stakeholders. For the organization, a dialogue with stakeholders can help it address corporate governance, product safety, economic risks and opportunities, human rights, labor rights, and environmental protection. Reporting on the dialogue and the effects of this communication provides transparency that is critical to achieving trust with stakeholders. Governance is enhanced because the organization must provide details about how it protects against corruption and conflicts of interest. The organization has the opportunity to examine its anticorruption policies and ways to improve them. By publicly disclosing their policies and practices, organization officials can be held accountable for adherence to their policies. Discussions about product safety can help an organization examine its systemwide approach to safety, which affects both workers and consumers. Workers and consumers can weigh in with their concerns. Investors can incorporate information from these reports into their investment analyses of the organization’s risks and opportunities. Sustainability reporting can reveal how well the organization is poised to assess and address the risks that they face. Organizations can provide their sustainability progress to external rating groups to provide external assessment of their performance. Awards for sustainability reports enable an organization to be rewarded for the quality of their reports and performance. Public recognition adds greatly to their reputation.
Risks of Ignoring Sustainability
There are several risks of ignoring sustainable development. One important risk is that of missing the opportunity to do the right thing for people and the planet. With many serious worldwide problems such as climate change, depletion of resources, and poverty, organizations are in a unique position to do something to mitigate their contribution to these problems. Putting off finding solutions to these problems to another generation may be too late. A quote attributed to Rabbi Hillel, influential Jewish scholar of the first century, seems apt: “If I am not for myself, then who will be for me? And if I am only for myself, then what am I? And if not now, when?”12
There also are the tangible risks that organizations confront on a daily basis. In industrial accidents, the loss of human health and lives are tragic events. Without safety precautions to prevent such tragedies, organizations are taking a large risk. When environmental accidents occur, they can result in medical costs, cleanup costs, and legal fines that are sometimes substantial. Public relations problems associated with environmental damage can be costly. If companies are sued, the legal fees and damage awards could be large. Another risk of ignoring sustainable development is failing to comply with federal regulations. Failing to comply can result in substantial fines and negative publicity. Companies’ reputations are often hurt by the revelation of their lack of compliance. Negative news stories are hard to overcome. News reports often refer to a company’s past environmental or social problems when discussing a current event.
The cost to repair the environmental damage can exceed the costs of prevention and monitoring. The grounding of the Exxon Valdez on Prince William Sound, Alaska, on March 24, 1989, demonstrates the huge cost of environmental damage. Eleven million gallons of crude oil spilled into the ocean along 1,200 miles of Alaska’s coast. As the tanker was leaving Prudhoe Bay, Captain Joseph Hazelwood was intoxicated and let an inexperienced pilot navigate the tanker through a difficult passage of the bay. One of the issues in the case was that Exxon had knowledge of the captain’s history of alcohol abuse. Cleanup efforts did little to stop the environmental damage to wildlife and their habitat. Crude oil can still be found on the beaches of Alaska’s coastline. Cleanup costs for Exxon were $3.4 billion along with compensatory damages of $507 million paid to 33,000 Native Alaskans, landowners, and commercial fisherman. The environmental damage has lasted for over 20 years and has had a profound negative effect on the fisheries. The fishing industry (commercial and sport) has suffered a severe economic downturn.
Twenty years after the accident, the case for punitive damages was still in the courts. Thirty-three thousand commercial fishermen, landowners, and others whose livelihoods were harmed by the spill filed suit against Exxon for punitive damages of $5 billion. In 1994, a jury in Anchorage awarded $5 billion in damages to the plaintiffs, but a federal appeals court reduced the award to $2.5 billion in 2006.13 The case went to the U.S. Supreme Court, and on June 28, 2008, they ruled that ExxonMobil should be held accountable for approximately $500 million. The Court ruled in ExxonMobil’s favor by substantially reducing the punitive damage award, but the company incurred legal expenses and negative publicity for over 20 years.
Another risk of ignoring sustainability is inadequate disclosure of environmental risks and the resulting litigation threat. The risks and damage from climate change are significant. Major weather events (i.e., severe local storms, flooding, drought, tropical cyclones) in the U.S. have been increasing between 1980 and 2014. There have been 178 disasters each costing over $1 billion in damage and costs; the total exceeds $1 trillion.14 Tropical cyclones make up 47.4 percent of the damage. Severe weather events disrupt businesses and affect investors’ risks. Companies are required by the Securities and Exchange Commission (SEC) to disclose their environmental risks in published financial statements. The disclosure involves information regarding climate change issues and potential material financial costs and liabilities from a company’s environmental damage.15 SEC regulation S-K 101 requires information on compliance with environmental laws and their material effects on earnings, competitive position, and capital expenditures. A good example is a company with facilities in European Union countries where greenhouse gas emission controls are required to meet various countries’ environmental regulations. Expenditures for these controls are likely to be material and would have to be disclosed. Another SEC requirement, S-K 103, is the disclosure of legal proceedings involving environmental and health issues. S-K 103 states that any climate change litigation against individual companies must be disclosed. Proceedings that are pending or potential claims under administrative or judicial proceedings are to be included. S-K 303 requires a disclosure in a company’s financial statements titled Management Discussion and Analysis that includes major trends, events, or uncertainties that are known to the company as potentially having a material effect on its financial condition. In an SEC Interpretive Release (17 C. F 11989), this has been interpreted to include environmental trends and uncertainties. In 2010, as a response to a formal request by investors representing $1.2 trillion in assets, the SEC issued an interpretive guidance document to clarify what was defined as material climate-related information in an effort to improve climate change reporting.16
Another risk of ignoring sustainable development is the danger of allowing human rights abuses to persist in an organization. Human rights abuses hurt individuals and society. The tolerance of abuse diminishes the moral fabric of society. For an organization, it can have a pernicious effect on everyone connected with it. In addition, the revelation of abuses can hurt a company’s reputation and future business prospects. This was the case with Nike, the sportswear and equipment corporation. In the 1990s, the company hired contractors that employed child laborers in Pakistan and Cambodia to manufacture its sportswear and equipment. When this information was revealed, public reaction was negative. Many consumers boycotted Nike’s products, and the company has had to work to win back its customers’ trust. Nike suffered the consequences of what its suppliers were doing. As a result, Nike publishes periodic sustainability reports in part to report how it is managing its human rights issues and to restore trust with its stakeholders. The company wants to be judged on its actions, not on perceptions. Nike’s management considers transparency to be essential to rebuilding trust. Management continues to work to counter the perception that child labor is used in manufacturing its products. To that end, Nike was one of the first companies in the sports clothing industry to publish the locations of over 700 of its contracted factories.17
Competitive advantage can be lost if a company does not engage in sustainable behavior. If other companies are producing products with fewer resources and in more environmentally friendly ways, then companies that do not are at a disadvantage. Increased costs along with reduced profit margins can prevent companies from expanding and developing new products. Companies behaving in sustainable ways are able to use their sustainably innovative products and processes as a means to differentiate themselves from their competitors.