Building business value in a changing world

Businesses today are operating in an ever more interconnected and globalized world. Supply chains stretch across continents and are vulnerable to disruption. Customer demands and government policies are changing rapidly and threaten to impact bottom lines if businesses do not respond. Against this background of complexity we face a new set of challenges. For 20 years or more we have recognized that the way we do business has serious impacts on the world around us. Now it is clear that the state of the world around us increasingly affects the way we do business.

In a recent report^[1], KPMG has explored the challenges, risks and opportunities faced by businesses as a result of the massive environmental and social changes taking place in our world. We analyzed dozens of forecasts to identify the changes that will have the greatest effects. The result is a set of ten environmental and social megaforces that KPMG professionals believe will impact every business over the next two decades. They are:

1. Climate Change:

Climate Change is the one global megaforce that directly impacts the other nine. According to the 2006 Stern Review, predictions of annual GDP losses from climate change range between 1 percent per year, if strong and early action is taken, to at least 5 percent a year if policymakers fail to act.

2. Energy & Fuel:

Fossil fuel markets are likely to become more volatile and unpredictable because of higher global energy demand; changes in the geographical pattern of consumption; supply and production uncertainties; and increasing regulatory interventions related to climate change.

3. Material Resource Scarcity:

As developing countries industrialize rapidly, global demand for material resources is increasing dramatically. Business is likely to face increasing trade restrictions and intense global competition for a wide range of material resources that become less easily available. On the flip side, scarcity also creates opportunities to develop substitute materials or to recover materials from waste.

4. Water Scarcity:

It is predicted that by 2030, the global demand for freshwater will exceed supply by 40 per cent.^[2] Businesses will be vulnerable to water shortages, declines in water quality, water price volatility, and reputational challenges. Growth may be compromised and conflicts over water supplies may create a security risk to business operations.

5. Population Growth:

The U.N. predicts global population to be 8.4 billion by 2032 in a moderate growth scenario. This growth will place intense pressures on ecosystems and the supply of natural resources such as food, water, energy and materials. Businesses can expect supply challenges and price volatility as a result.^[3] This is a threat, but there are also opportunities to grow commerce, create jobs, and to innovate to address the needs of growing populations.

6. Wealth:

The OECD predicts the global middle class (defined by the OECD as individuals with disposable income of between US$10 and US$100 per capita per day) will grow 172 percent between 2010 and 2030. The challenge for businesses is to serve this new middle class market at a time when resources are likely to be scarcer and more price-volatile. The advantages many companies experienced in the last two decades from "cheap labor" in developing nations are likely to be eroded by the growth and power of the global middle class.

7. Urbanization:

In 2009, for the first time ever, more people lived in cities than in the countryside. By 2030 all developing regions including Asia and Africa are expected to have the majority of their inhabitants living in urban areas; virtually all population growth over the next 30 years will be in cities, according to the UN Habitat report. These cities will require extensive improvements in infrastructure including construction, water and sanitation, electricity, waste, transport, health, public safety and internet and cell phone connectivity.

8. Food Security:

In the next two decades the global food production system will come under increasing pressure from megaforces including population growth, water scarcity and deforestation. Global food prices are predicted to rise 70-90 percent by 2030. ^[4] In water-scarce regions, agricultural producers are likely to have to compete for supplies with other water-intensive industries such as electric utilities and mining, and with consumers.

9. Ecosystem Decline:

Historically, the primary business risk of declining biodiversity and ecosystem services has been to corporate reputations. However, as global ecosystems show increasing signs of breakdown and stress, more companies are realizing how dependent their operations are on the critical services these ecosystems provide. The decline in ecosystems is making natural resources scarcer, more expensive and less diverse; increasing the costs of water and escalating the damage caused by invasive species to sectors including agriculture, fishing, food and beverages, pharmaceuticals and tourism.

10. Deforestation:

Forests are big business. Wood products contributed US$100 billion per year to the global economy from 2003-2007 and the value of non-wood forest products (mostly food) was estimated at US$18.5 billion in 2005.^[5] Yet, the OECD predicts forest areas will decline by 13 percent from 2005 to 2030, mostly in South Asia and Africa. The timber industry and downstream sectors such as pulp and paper are vulnerable to potential regulation to slow or reverse deforestation. Companies may also find themselves under increasing pressure from customers to prove that their products are sustainable. Opportunities may arise through market mechanisms and incentives to reduce the rate of deforestation.

Systems thinking

Existing predictions provide us with some insights about what the future might look like in a world buffeted by these megaforces, but we should not rely on them to tell the whole story. Many predictions extrapolate current rates of change without taking full account of the fact that megaforces reinforce, compete with, or balance the effects of each other. For example, increasing wealth and the growth of the global middle class will accelerate demand for consumer goods and services, putting further pressure on the natural and material resources needed to produce them. Regional freshwater availability could struggle to keep pace with the agricultural production necessary to feed the growing population. Urbanization predictions generally do not account for the potential impacts of climate change refugees migrating from areas where water and food scarcity hit hardest. Similarly, food production projections rarely factor in deteriorating soil quality and the competing demands for agricultural land.

Strategic business decisions

Projections that do not consider the entire system of megaforces cannot provide an adequate basis for strategic business decisions. For example, a company may understand its direct dependency on water, but may not have thought about how the supply of its material resources could be impacted by increasing water scarcity in the supply chain. That is why KPMG member firm professionals encourage their clients to adopt systems thinking around sustainability - to consider the entire structure of megaforces, rather than individual constituents. This is an important way to assess and manage new risks, and uncover existing risks that were previously unidentified.

Megaforces: A sectoral view

Over the next 20 years there is likely to be increasing pressure for the price of resources, products and services to reflect the full cost of their production including the cost of environmental and social impacts. This pressure is likely to grow as governments address the effects of megaforces. Possible futures include the removal of subsidies on input commodities (such as fossil fuels and water) and the wider introduction of mechanisms to increase the cost of environmentally damaging outputs (such as emissions trading systems and higher water pricing). It is therefore prudent for companies to expect to pay in the future a rising proportion of their external environmental costs, which today are often not shown on financial statements.

Costs environmental impacts doubling every 14 years

Our analysis suggests that the external environmental costs of 11 key industry sectors (including upstream supply chain) rose by 50 percent between 2002 and 2010, from US$566 billion to US$854 billion.^[6] This suggests that the external environmental costs of business operations, and by implication the environmental impacts of business, are doubling every 14 years. This is a rate that is unlikely to be sustainable even in the medium-term. The sectors analyzed were: Airlines; Automobiles; Beverages; Chemicals; Electricity; Food Producers; Industrial Metals & Mining; Marine Transportation; Mining; Oil & Gas and Telecommunications & Internet, all defined in line with the Industry Classification Benchmark system.

Using the same Trucost dataset, we also compared the external environmental costs of these sectors with their level of earnings (EBITDA) and found that these costs, as yet mostly unpaid, could account for a considerable proportion of earnings and therefore represent significant business value potentially at stake. Across the 11 sectors, the average external environmental costs per dollar of earnings would have been approximately 41 cents in 2010. Food producers had the largest external environmental cost footprint of the 11 sectors in 2010 at US$200 billion, followed by electricity at US$195 billion and oil and gas at US$152 billion. Strikingly, the external environmental costs of Food Producers could outweigh the sector's entire earnings. For five other sectors (Electricity, Industrial Metals, Mining, Marine Transportation and Airlines) environmental costs could account for more than half of earnings.

Sectoral risks

The risks that megaforces pose to business range from the physical, such as damage to assets or supply chains from extreme weather events, to the competitive, such as volatility in commodity prices and rapidly changing market dynamics. Other risks include reputational damage, increasing exposure to legal action, complex and rapidly evolving regulation involving sustainability and carbon reporting, and the growing threat of civil unrest and even international conflict driven by environmental and social issues.

It is a mistake to label these risks as "medium to long term". They are not. They are impacting businesses here and now. For example, Japanese car makers took a hit running into hundreds of millions of dollars after the 2011 floods in Thailand disrupted the global supply of auto components. Clothing companies saw profits drop significantly, also in 2011, after droughts and flooding affected cotton supplies and prices.

New opportunities

Along with the risks, environmental and social megaforces also provide nimble and innovative businesses with new opportunities. These include opportunities to cut operating costs and increase efficiency; to develop profitable new partnerships with governments, NGOs and other businesses; to innovate new products and services, and to tap into new markets such as the US$5 trillion "base of the pyramid" market: the four billion people living on less than US$3000 per year. This is why the likes of Unilever, Philips, Puma and many others are putting sustainability at the center of their strategies.

In this context, it seems inconceivable that narrow and traditional notions of company value can persist indefinitely. With potentially far reaching impacts on the horizon as a result of environmental and social megaforces, it is crucial that businesses and policymakers together take strategic decisions now and promote changes in long-term thinking. Without action and planning for the complex future that lies ahead, risks will multiply and opportunities will be lost.

Sustainable growth requires action from both economic sides: supply and demand. The supply side must make more with less, increasing resource efficiency and minimizing the environmental footprint of processes and operations. The demand side must make less do more, managing growing demand for goods and services, while addressing pressure on dwindling natural resources.

The essentials of business action

To understand and assess risks, KPMG recommends businesses to use Enterprise Risk Management tools and sustainability systems thinking to a) assess and understand future risks from sustainability megaforces and b) define responses to deal with them through efficiency, substitution or adaptation. Strategic planning for sustainability requires the involvement of senior management and should encompass a wide range of corporate functions. These strategic plans must then be transformed into ambitious targets and actions: Bold targets can drive energy and resource efficiency, sustainable supply chain management, innovation and access to new markets for greener products and services.

Reporting on sustainability

Sustainability reporting, although largely still unregulated, is becoming increasingly important and is already mandatory in some countries. Integrated reporting, where sustainability information is included in the full picture of the company's business performance, is a growing trend. For integrated reporting, companies need to build a framework for sustainability reporting processes, stronger information systems and appropriate governance and control mechanisms on a par with those currently used in financial reporting.

Build partnerships

Seek collaboration with business partners on sustainability issues, KPMG recommends. This will be critical to increase leverage and improve the cost-benefit ratio of action. It is also vital to seek opportunities for genuine dialogue with governments and demonstrate new and innovative approaches to public-private partnerships. Dialogue should focus on economic instruments that could reduce market barriers and make sustainable business operation easier.

Good business sense

In conclusion, the transition to a sustainable economy is possible, but it needs widespread global support from businesses, governments and civil society and innovative solutions that address both how and which goods and services are produced. The public and private sectors both have a vital role to play and a coordinated approach holds the key to success. The bold, the visionary and the innovative recognize that what is good for people and the planet can also be good for the long-term bottom line and shareholder value. Competitive advantage can be carved out of emerging risk. We can never be certain about the future. But it is good business sense to be prepared for the possibilities: to expect the unexpected.

References

This is a shortened version of the article Yvo de Boer wrote for The Sustainability Yearbook 2013 published by RobecoSAM and KPMG International.

This article may be reproduced according to our terms of use with attribution (and link, if online) to www.tias.edu. To be cited as: “ Building business value in a changing world”, Yvo de Boer, www.tias.edu, April 24, 2013.

1. KPMG International's report, Expect the Unexpected: Building business value in a changing world can be downloaded via the link above to the left.
2. 2030 Water Resources Group. (2009). Charting Our Water Future: Economic frameworks to inform decision-making.
3. 2030 Water Resources Group. (2009). Charting Our Water Future: Economic frameworks to inform decision-making.
4. Oxfam International. (2011). Growing a Better Future: Food justice in a resource-constrained world.
5. Food and Agriculture Organization of the United Nations (FAO). (2010). Global Forest Resources Assessment 2010.
6. Dataset provided by Trucost, an independent environmental research agency, on the operations of over 800 companies between 2002 and 2010 and representing 11 sectors. Trucost converts 22 environmental impacts into financial value, drawing upon current environmental-economic research.

Read more

The Sustainability Yearbook 2013
KPMG Report: Expect the Unexpected

Author(s)

Yvo Boer
KPMG Global Advisor on Climate Change &Sustainability