Sustainability is smart…smart business! Businesses that are smart enough to develop and implement sustainability strategies will gain the green advantage – making more green by being green.
For decades, most business leaders would say their corporate mission was to maximize profits for shareholders and owners.
That was the primary success metric for businesses around the world. If you look at a generic business model, you can see that the typical business converts various forms of capital to a differing amount of the same types of capital, with a goal of maximizing the output amount of financial capital (in the form of revenue (and hopefully profit).
Business begins with value creation. It is the purpose of the institution: to create and deliver value in an efficient enough way that it will generate profit after cost.
The purpose of a business is to create value (through work), sell or trade it to customers, and capture some of that value as profit.
In theory, the value of an asset (in this case, a business) is the present value of its future earnings. This means that there is more of a long-term focus, a focus on the future, and not just on today’s profits. A business that values continued existence into the future must focus on both short-term profit and long-term value.
Value is created, changed or destroyed by an organization through its business model. The Business Model Background Paper for the Integrated Reporting (IR) initiative (www.integratedreporting.org) defines the term business model as “the chosen system of inputs, business activities, outputs and outcomes that aims to create value over the short, medium and long term.”1 Therefore, within the context of IR, the process of value creation is explained as follows:
“Value is created through an organization’s business model, which takes inputs from the capitals and transforms them through business activities and interactions to produce outputs and outcomes that, over the short, medium and long term, create or destroy value for the organization, its stakeholders, society and the environment.”
The capitals from which the business model takes inputs are identified in the Capitals Background Paper for IR as financial, manufactured, intellectual, human, social and relationship, and natural capital
- Financial capital includes the pool of funds that is available to an organization for use in the production of goods or the provision of services, and is obtained through financing, such as debt, equity or grants, or generated through operations or investments.
- Manufactured capital includes manufactured physical objects (as distinct from natural physical objects) that are available to an organization for use in the production of goods or the provision of services, including buildings, equipment, and infrastructure (such as roads, ports, bridges and waste and water treatment plants). Manufactured capital is often created by one or more other organizations, but also includes assets manufactured by the organization when they are retained for its own use.
- Intellectual capital includes organizational, knowledge-based intangibles, including intellectual property, such as patents, copyrights, software, rights
and licenses; “organizational capital” such as tacit knowledge, systems, procedures and protocols; and intangibles associated with the brand and reputation that an organization has developed.
- Human capital includes people’s competencies, capabilities and experience, and their motivations to innovate, including their alignment with and support for an organization’s governance framework and risk management approach, and ethical values such as recognition of human rights; ability to understand, develop and implement an organization’s strategy; and loyalties and motivations for improving processes, goods and services, including their ability to lead, manage and collaborate.
- Social and relationship capital includes the institutions and relationships established within and between each community, group of stakeholders and other networks (and an ability to share information) to enhance individual and collective well-being. Social and relationship capital includes shared norms, and common values and behaviors; key relationships, and the trust and willingness to engage that an organization has developed and strives to build and protect with customers, suppliers, business partners, and other external stakeholders; and an organization’s social license to operate.
- Natural capital includes all renewable and nonrenewable environmental stocks that provide goods and services that support the current and future prosperity of an organization. It includes: air, water, land, forests and minerals, biodiversity, and ecosystem health.
The capitals represent stocks from which value is released when the capitals are combined, transformed and leveraged through an organization’s business activities and interactions in order to produce outputs and outcomes that represent value creation or value destruction for stakeholders depending on their interests and perspectives. However, the use of these flows should not be taken to imply that the stocks should be drawn down in the process. On the contrary, the stock should be maintained or increased, like the corollary concept of principal and interest. We should only be using the interest on the stocks of available capital. The concept of maintaining or increasing the stocks – the principal, in financial terms – is sustainability.
The actions of the business model upon the various forms of capital has both positive and negative impacts on the business, society and the environment, in both short- and long-term time scales. Value creation for the business is obvious, but estimation of overall value creation for society is more problematic, and relates to dependencies between the company, communities, stakeholders, supply chains, and the environment.
In addition to the flows of capital upon which the business depends to build value, there are also external pressures on the business model. The business model does not exist in a vacuum. Michael Porter, a well-known Harvard professor known for his theories on economics and business strategy, recognized that there are five primary forces that make up the competitive environment, and which can erode profitability. According to Porter, these five forces are the key sources of competitive pressure within an industry. He stressed that it is important not to confuse them with more fleeting factors that might grab your attention, such as industry growth rates, government interventions, and technological innovations. These are temporary factors, while the Five Forces are permanent parts of an industry’s structure. The Five Forces are the following:
- Industry rivalry
- Threat of new entrants
- Threat of substitutes
- Bargaining power of suppliers
- Bargaining power of buyers
Porter has also postulated that there are four generic competitive advantage strategies that apply across the board, and across time, as shown below. These strategies can be used to achieve lasting competitive advantage in the face of the Five Forces.
Porter’s concept of “sustainable competitive advantage” has been considered to be the “holy grail” of strategy since 1979.
These theories have come to be seen as applicable in what is a relatively stable state of affairs (business-as-usual), where small changes are made in order to stay ahead of the competition and maintain a competitive advantage. It is usually characterized by a consistent output produced from consistent inputs, and a dependable situation, where businesses are reluctant to take risks and invest in change.
Unfortunately, the world is not “usual” anymore. Many things are changing, and the speed of change is faster than ever before. Given this, what is the value of using old assumptions to inform future scenarios? If we only use reference scenarios that include social, technological and policy norms that have already happened, we may miss the changes that will significantly alter the trajectory of the future system. Business is now anything but usual, much less predictable. The world is changing at unprecedented rates. Investments in innovation and efficiency are no longer a luxury to ensure greater returns.
According to the theory of transient competitive advantage (Rita Gunther McGrath, The End of Competitive Advantage: How to Keep Your Strategy Moving as Fast as Your Business, 2013), business needs to move away from the heavy reliance on a single strategic framework and tool which advocates that the purpose of strategy is to achieve a sustainable competitive advantage. According to McGrath, competitive advantage is not a viable and sustainable proposition anymore because it is transient. Thus, for a firm to survive in a fast-changing economy, it needs to fully comprehend how this new era functions and the assumptions behind that understanding.
“The firms should be able to move from wave to wave of competitive advantages, trying not to stay with one too long because it will become exhausted, and always looking for the next one. The list of once-storied organizations that are either gone or are no longer relevant is a long one. Their downfall is a predictable outcome of practices that are designed around the concept of sustainable competitive advantage. The fundamental problem is that deeply ingrained structures and systems designed to extract maximum value from a competitive advantage become a liability when the environment requires instead the capacity to surf through waves of short-lived opportunities. To compete in these more volatile and uncertain environments, you need to do things differently.”
According to the theory of transient advantage, cycles such as the one shown above actually overlap with the next one – with the next wave of innovation.
In the past, firms have relied on two assumptions resident in Porter’s theories, which are that industry forces matter most, followed by the assumption that competitive advantage is sustainable. This is not to say that the competitive advantage theory is no longer viable. According to Prof McGrath,
“There are indeed examples of advantages that can be sustained, even today. Capitalizing on deep customer relationships, making highly complicated machines such as airplanes, running a mine, and selling daily necessities such as food are all situations in which some companies have been able to exploit an advantage for some time. But in more and more sectors, and for more and more businesses, this is not what the world looks like any more. Music, high technology, travel, communication, consumer electronics, the automobile business, and even education are facing situations in which advantages are copied quickly, technology changes or customers seek other alternatives and things move on.“
What can be drawn from this is that innovation is crucial to the long-term success of a company. Companies that do not innovate will quickly be bypassed by those who do and will lose their competitive advantage and possibly their business.
According to the ImagineNation blog,
“organizations who see and act upon the opportunities and possibilities for change through innovation in the current volatile and uncertain, business environment will not only survive; they will successfully compete and even flourish in the face of the range of emerging adverse and fluctuating business and economic conditions. They will use innovation as a strategic, systemic & technological lever for developing agile innovation cultures, accountable business management processes, and global industry eco-systems. This enables them to achieve a range of key business outcomes including; engaging and inspiring people to tap into the power of the internal crowd, and empower people to create, invent and innovate new products, processes and services; increasing their ROI to shareholders; achieving business growth goals and improving bottom-line results; increasing business value making the business attractive to shareholders, mergers and acquisitions; making productivity and efficiency gains to increase profitability; competing successfully to respond to industry disrupters, increase market share and extend product lifecycles; and responding quickly by developing the internal capability in both human and technology resources to change direction and do things differently.”
So what can drive business toward this sweet spot of intersection between our interest in sustainability and their business interests? We argue that development and implementation of a sustainability strategy is a significant form of innovation, capable of achieving most, if not all, of these core business benefits.
It’s interesting to ask people whether they view sustainability as a risk or an opportunity. The answer is usually a risk. Acknowledging that business-as-usual cannot go on is daunting, but the alternative view is that a fundamental shift in how we operate throws up various opportunities for growth. From a business perspective, why wouldn’t you be undertaking the tasks required to improve your sustainability anyway? Lowering resource consumption, establishing robust, resilient supply chains and building a reputation as a good corporate citizen is unlikely to have a detrimental impact on your business, so why not view sustainability as an opportunity to achieve the following business goals in an innovative way?
- increase revenue flow
- reduce costs
- improve customer’s ROI
- set yourself apart from the competition (product differentiation)
- serve the customer mission
- underpromise and overdeliver
- reduce risk
- build your brand
- increase resiliency
- attract, retain, and engage employees
In summary, a little math…Sustainability is innovative…innovative is smart business…therefore, by the transitive property, sustainability is smart business!
If you are a business that would like to explore the road to sustainability, please get in touch with us using any of the methods shown below!