approaches to quantify value from business to society - … · 2018-06-13 · data sources for the...

Approaches to quantify valuefrom business to societyCase studies of KPMGs true value

methodologyBernd Hendriksen, Jeroen Weimer and Mark McKenzie

KPMG, Amsterdam, The Netherlands

AbstractPurpose This paper aims to present an approach to quantify in financial terms the value thatcompanies create and reduce for society, based on the KPMG true value methodology. Thismethodology was developed to quantify the socio-economic and environmental value created andreduced by businesses in a format that can easily be understood and used by business leaders to affectkey business decisions based on quantitative data. The paper looks at the business drivers for thedevelopment of the methodology and the implications and initial results for companies adopting it.Design/methodology/approach Following a brief introduction of the methodology, and thefactors leading up to its development, this paper will present three recent cases of companies that haveapplied the methodology, their motivation for using it and what some of the initial results have been.The authors led the development of the KPMG true value methodology and have been involved in theapplication of the methodology across various sectors and companies. Other consultants involved in theimplementation of the methodology within the companies in the case studies (below) were alsointerviewed for this paper.Findings The three cases above represent very different companies from various sectors. Althoughthe approach and implementation of the KPMG true value methodology was similar across all threecompanies, the results, application of the results and subsequent benefits to the company in questionwere divergent. To date, only a handful of corporations have measured and publicly disclosed theirsocietal value creation, but momentum is building, and, in this age of internalization, more and morecompanies will likely follow suit. Corporations that choose a methodology and apply it in a consistentfashion can only stand to benefit from the insights the experience brings.Research limitations/implications This paper provides insight into the KPMG true valuemethodology and how it has been applied within several large companies from different sectors.Because of confidentiality issues, the companies have been anonymised, and some specific quantitativedata have been omitted. This paper does not look in detail at how indicators are calculated, because ofspace limitations. Given the fact that the methodology has only relatively recently been introduced,long-term results are not yet available. As the methodology further develops over time, there will beconsiderable opportunities for academic research around the methodology, for example, looking at howthe creation of value for society relates to shareholder value or environmental, social and governanceperformance over time.Practical implications This paper provides examples of how companies have integratedsocio-economic and non-financial metrics with standard financial metrics and some of the implicationsthis can have on corporate decision-making processes.Originality/value The KPMG true value methodology was introduced in 2014 with the publicationof the 2014 KPMG report A New Vision of Value: Connecting corporate and societal value creation(available on-line). This paper is one of the first publications in an academic journal on this topic. Inwriting this paper, the authors do not assume that readers have previous knowledge of themethodology, and, as such, have borrowed extensively from A New Vision of Value in explaining the

The current issue and full text archive of this journal is available on Emerald Insight at:www.emeraldinsight.com/2040-8021.htm

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Sustainability Accounting,Management and Policy JournalVol. 7 No. 4, 2016pp. 474-493 Emerald Group Publishing Limited2040-8021DOI 10.1108/SAMPJ-07-2015-0062

http://dx.doi.org/10.1108/SAMPJ-07-2015-0062

methodology. This paper, however, goes on to highlight and reflect on the experiences of some of thefirst companies from different sectors to use the methodology since its launch more than two yearsprior.

Keywords Sustainability, Risk management, Shareholder value, Stakeholder value, Externalities,Corporate finance

Paper type Viewpoint

IntroductionCan societal value be quantified in financial paradigms?

A plethora of standards, covenants, reporting initiatives and methodologies exist forreporting, measuring and managing a companys societal and environmental impacts.Examples include GRI, ISO 26000, Social Return on Investment (SROI), Sustainabilityaccounting Standards Board and The UN Global Compact. The number of corporationsusing these tools has also increased considerably during recent years, and themethodologies have become increasingly sophisticated. Nonetheless, no singlemethodology has as yet emerged as a universal standard of comparison as, for example,USA GAAP, has within financial accountancy.

One of the reasons why environmental, social and governance (ESG) issues may notbe routinely taken account in business-critical financial decisions is that there is acurrent disconnect between standard accounting and financial measurements on the onehand and ESG metrics on the other. KPMG developed its true value methodology withthe intention of helping to bridge this gap. Specifically, the methodology seeks to find away to measure, in financial terms, the value that a company creates or reduces forsociety through its most significant environmental and socio-economic impacts and importantly to provide a means of understanding the comparative order of magnitudeof those impacts and the resulting value creation/reduction for them to be understoodand addressed. It was important that the societal value creation/reduction should beexpressed in financial metrics that could be considered in relation to P&L and othercompany key performance indicators, enabling societal value creation/reductionconsiderations to be brought into risk analysis and strategy and investment planning.The methodology and its outputs had to be sufficiently concise for decision makers notto be overwhelmed with excessive detail and also had to be presented in a familiarformat and language and, therefore, easily understood.

Although this paper identifies a number of potential benefits related to themonetization of societal value, the authors also recognize the inherent limitations ofmonetization. Whether it is human health, environmental impacts or any of the otherissues that can be monetized through the methodology, it is important that oneremembers that the resulting numbers are just a proxy for the actual impact that theseissues have on individuals, society and the planet. It remains essential for businesses toconsider and address these issues within the actual context in which they occur.

Bridging the disconnectThe sustainability and innovation studies performed by the MIT Sloan ManagementReview and the Boston Consulting Group are among several reports that provideevidence of a disconnect between sustainability and finance professionals withincorporations. Data from these studies show the percentage of companies thatestablished a business case for investing in sustainability resources and initiatives grew

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only 7 per cent from 30 to 37 per cent during the period 2008-2013. The percentage ofcompanies that tried but failed to build a business case increased from 8 to 20 per cent.More than half of respondents of the 2013 study had either failed to establish a businesscase or had not even tried to create one (Kiron et al., 2013).

This disconnect is perhaps only to be expected if one considers that the two groups speaklargely different languages. The language of finance has developed over centuries and isbased around accounting and financial reporting measures that have changed little in thelast 100 years or so. Chief financial officers and chief executives all speak and think in thiscommon tongue, most having learned it in their studies and throughout their career.

The language of corporate sustainability, by contrast, is less established and not aswidely understood, having evolved over the past 20-30 years. It is spoken primarily bya new breed of corporate executive the chief sustainability officer. It tries to capture avery wide range of issues: consider the fact that the key framework for sustainabilityreporting the GRI G4 guidelines offers some 150 metrics covering sustainabilityissues from conservation habitats to diversity to human rights. Furthermore, thelanguage of corporate sustainability continues to evolve at a rapid pace. Its earlyvocabulary was based around responsibility, citizenship and philanthropy, but thelanguage is now morphing to include more familiar management terms such asstrategy, risk and opportunity. With this in mind, it is perhaps unsurprising that thelanguage of corporate sustainability can struggle to engage those who functionprimarily outside the professional sustainability field.

This historical disconnect between societal and corporate value creation and betweensustainability and finance has meant that many corporations, along with investors andgovernments, have arguably lacked both the motivation and the means to factorsustainability issues meaningfully into investment decisions. It is with this disconnectin mind that KPMG member firm professionals from both corporate finance andsustainability disciplines worked together to develop a common methodology that hadthe potential to link sustainability performance with financial performance.

Given a widespread failure (Kiron et al., 2013) within corporations to factor social orenvironmental externalities into considerations of corporate value in any systematicway, the chosen approach was to take traditional corporate finance techniques andapply them in a sustainability context. The resulting methodology is based on thediscounted cash flow techniques that are already well understood within corporationsas measures of financial performance and corporate value creation but have not yet beenwidely extended to sustainability.

Externalities and the age of internalizationCompanies create and reduce value for society largely through their externalities, i.e.the benefits they create for society for which they are not fully compensated (positiveexternalities) and the costs they impose on society which they do not fully bear (negativeexternalities).

Externalities have always existed, and, although most finance professionals havebeen aware of them, externalities have, for the most part, been perceived as having littleor no impact on the key drivers of corporate value, namely, revenues, costs and risk.They have, in short, been external to the business. This, in large part, explains whycorporate value creation and societal value creation have been largely separate concepts.

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However, this status quo is now changing for a number of reasons. First, the effectsof negative corporate externalities such as pollution, carbon emissions and ecosystemdamage are becoming impossible to ignore, as population growth and wealth growthdrive global consumption ever higher. An example of this is the extreme level of airpollution in many Chinese cities, which has been described as being at an unbearablestage by a senior Chinese scientist (HNGN, 2014).

Second, public awareness and understanding of corporate externalities and theireffects is growing. More information is becoming available to more people, and thatinformation is spreading more widely and more rapidly than ever before, thanks todigital connectivity and social media.

Third, a number of drivers are at work that are internalizing corporate externalitiesat a rapid rate. These drivers are increasing the costs and risk associated with negativecorporate externalities, for example, carbon markets or fines for non-compliance withsocial or environmental regulations.

Three key drivers of internalization are greater levels of regulation; actions taken bystakeholders, including workers, communities, non-governmental organizations(NGOs) and consumers; and market dynamics, including changing operatingenvironments, resource pressures and market disruptions (KPMG, 2014) (Box). Thesedrivers are interlinked and have always existed. What is different currently is thatcorporations are seeing rapid acceleration and intensification of them on multiple frontsand, as a result, find that their externalities have increasingly significant implicationsfor their ability to create corporate (financial) value.

Negative externalities are generally internalized more directly than positive ones,often through regulatory action prompted by stakeholders with a direct interest inmaking corporations pay for their negative externalities.

However, the same drivers are also reducing risk and increasing the commercialopportunity associated with positive externalities, for example, access to tenders thathave requirements around levels of ESG performance. As a result, more corporationsfind that they can grow revenues, cut costs and reduce risk by increasing their positiveexternalities and the value they create for society while reducing the negative (KPMG,2014). The true value methodology aims to assist the development of the business caseby translating ESG performance into traditional or better understood measures of value,risk and return.

The methodology for linking corporate and societal value creationA three-step methodology was developed by finance and sustainability professionals toassist corporations in linking their corporate and societal value creation and bringingsustainability considerations into the financial decision-making process.

The methodology has been piloted successfully by a number of corporations indiverse sectors, including food retailing, transport, telecom, private equity andconstruction. Case studies from the cement, automotive and transport sectors areincluded later in this paper. The three steps of the methodology are as follows:

Step 1: identify the value the corporation creates, and reduces, for society. The valuea corporation creates and reduces for society is calculated by identifying its mostmaterial externalities and expressing them in financial terms. Data sources for themonetization of environmental and socio-economic externalities are many and varied,even for common indicators such as the social cost of carbon emissions. In practice, this

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Box. Three drivers of internalization

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Energy & fuel

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Population growth

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Urbanization Food security

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Three key drivers are increasing the rate of internalizationDriver 1: regulationLegislation and other forms of regulation, such as industry self-regulation, increasinglyrequire corporations to pay more of the costs they impose on society (negative externalities)but can also improve the rewards corporations received for providing benefits to society.Pricing mechanisms, such as carbon pricing, are the most direct and perhaps the mostfamiliar regulatory driver of internalization. When there is a direct price on a negativeexternality, corporations have no choice but to internalize the cost of that externality, at leastin part.There are also other forms of regulation that aim to reduce negative impacts on society.Examples of this type of regulation include increasingly severe limits on the advertising andbranding of alcohol and tobacco, taxes on unhealthy products such as sugary drinks andmandatory investment in corporate responsibility initiatives (e.g. as recently enacted by theIndian Government) (Mondaq, 2014).Although the outcomes of such regulations suggest that some policies are more effectivethan others, the general trend is clear, namely, for increasing levels of regulation thatprovide incentives for companies to increase the positive value they create for societyand reduce the negative.

(continued)

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means that a certain amount of bespoke research and analysis is inevitably required toidentify the monetization factors that are most applicable to the organization inquestion, its sector and the geographic location of operations being analyzed.

Monetization factors for common environmental and social indicators are oftensourced from well-known sources such as The Economics of Ecosystems and

Box.

Driver 2: stakeholder actionPublic scrutiny of corporations is on the rise, as people worldwide become more aware of thenegative effects of business on society and have access to more information via digitalsources and social media. Furthermore, as wealth and living standards improve across muchof the world, more people feel empowered to take action to protect their own interests.Some action, such as strikes over wage levels or working conditions, can be costly forcorporations.Community protests can also threaten a corporations social license-to-operate and havedirect impacts that can halt production, prevent projects from proceeding and deter investorsfrom providing capital. For example, community protests are on the rise in China, with some90,000 recorded each year over issues such as corruption, pollution and illegal land grabs(Reuters, 2014).In addition, corporations face ongoing pressure from NGOs and civil society campaigners toreduce their negative externalities and increase their societal value creation. Manytechnology companies, for example, have encountered pressure to increase their use ofrenewable energy to power their data centres (Greenpeace, 2014). At the same time, manyglobal brands are imposing more stringent requirements for their suppliers to address theirown externalities. Efforts are going deeper into the supply chain, beyond primary suppliersto suppliers of raw materials at the start of the value chain.

Driver 3: market dynamicsMarket dynamics can be seen as drivers of internalization in that they offer corporationsfinancial incentives to increase their positive externalities and reduce their negative ones. Forexample, companies can tap into profitable new markets for products and services thatcreate societal value. These include the market for circular supply chains which, according tothe World Economic Forum and Ellen Macarthur Foundation (2014), have the potential togenerate over US$1tn per year by 2025 and create 100,000 jobs by 2020. Similarly, the globalmarket for smart city solutions and the services required to deploy them has been valued atover US$400bn by 2020 (UK Department for Business, Innovation and Skills, 2013), and themarket for energy-efficient retrofits of commercial and public buildings is expected to growby almost 90 per cent to US$127.5bn by 2023 (Navigant Research, 2014).At the same time, market dynamics such as commodity scarcity can increase the cost tocorporations of behaviour that reduces societal value. For example, over-exploitation of wildfish stocks has meant that global supply of fish oil is struggling to keep up with demand,leading to soaring prices (Starling, 2013). As a result, fish oil could become an economicallyunviable input for many products, leading to financial risk for corporations that produce andmarket such products. On the other hand, scarcity of the commodity presents opportunitiesfor corporations that innovate to develop secure supplies of alternative inputs.The potential stranding of oil and gas assets in a future low-carbon world is another, muchdebated, example of how market dynamics may compel corporations to internalize negativeexternalities.

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Biodiversity for environmental externalities and SROI network for social externalities.Environmental agencies such as the US Environmental Protection Agency are also arich source of data.

However, the most robust and appropriate data for monetizing environmental andsocio-economic externalities is often to be found in less well-known studies fromindustry organizations, government departments, academic institutions, think tanksand other organizations.

Step 1 of this process builds on quantification techniques established by PUMAspioneering environmental profit and loss account published in 2011. It takes thesetechniques a step further by quantifying social value and economic value-add, as well asenvironmental value.

It also differs by illustrating the information in a value bridge or waterfall chart,a form of data visualization that is familiar to finance professionals and widely used tounderstand the cumulative impact of sequentially introduced value creation and valuereduction.

In the true earnings bridge, the monetized externalities are classified as eithereconomic, social or environmental and as either positive (value created) or negative(value reduced). The monetized externality data are then combined in the value bridgewith the corporations financial earnings data.

The result illustrates in a graphic form what the corporations true earnings wouldbe if its economic, social and environmental value creation were taken into account. Itshows, at a glance, where a corporation is creating, and reducing, the most value forsociety and where future value creation initiatives may be directed (Figure 1).

Step 2: understand future earnings risks and opportunities. In Step 2 of themethodology, the material externalities identified in Step 1 are analyzed to understandhow likely it is that they will be internalized in the future. Where the risk ofinternalization is found to be high, financial modelling techniques are used to assess thepotential impact on the corporations revenues and costs. In a typical project, between 10and 15 of the companys most material indicators are selected for further analysis. Theobjective is to cover the most significant part of the companys societal impacts whilekeeping the number of indicators manageable.

The analysis focuses on the three key drivers of internalization new regulations, thethreat of stakeholder action and changes in market dynamics. This can be done under avariety of future scenarios when the levels of uncertainty and complexity require it. Asin Step 1, the results of the analysis are typically shown in value bridge or waterfallchart format (Figure 2).

Step 3: develop business cases to build and protect future value. Step 3 uses a variationof another tool already familiar to finance professionals the marginal cost curve tobuild and analyze business cases for potential investments.

Using the cost curve in a true value context enables executives to understand not onlythe direct financial returns from an investment but also the likely additional returnsfrom internalized externalities and the value the investment will create for society. Thisprovides a broader, more holistic basis on which to analyze potential investments.

For example, projects which are not viable when assessed on direct financial returnsalone may deliver more attractive returns when the likely internalization of externalitiesis factored in. The societal value axis of the curve enables corporations to prioritizeprojects that deliver similar financial returns according to the value they create for

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EarningsCostRevenue Trueearnings

Socialpositive

Socialnegative

Environ-mentalpositive

Environ-mental

negative

Economic positive

Economicnegative

EARNINGS ECONOMIC SOCIAL ENVIRONMENTAL TRUEEARNINGS

Source: KPMG (2014)

Figure 1.A generic trueearnings bridge

Cost of COemissions through carbon pricing

Lost production caused by labor unrest over pay and working conditions

Increase in cost of raw materials due to resource scarcity

Cost reductions through energy and water efficiency

Profit potential from new goods or services

$$

EBITDA Remaining EBITDA

Source: KPMG (2014), Introducing KPMG True Value

Figure 2.Example analysis of

internalizedexternalities

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society. This enables the corporation to enhance its own true earnings and increase itspositive contribution to society, thereby potentially enhancing its reputation, influenceand license-to-operate and reducing the risk of stakeholder action over its negativeexternalities (Figure 3).

Key challenges and limitations of monetizing societal value creationTypical challenges faced when delivering this type of analysis include:

Availability of data on an organizations environmental and social externalities.Environmental and socio-economic externalities cannot be monetized unless theorganization can provide the necessary input/base data. Successful true value analysis,therefore, relies on the availability of quality data from the organizations existing datacollection, monitoring and reporting processes and systems. If the required base datacannot be sourced from the organizations existing reporting, the organization needs tobe committed to conducting further analysis of its environmental and socialperformance data as necessary. Success requires co-ordination and collaborationbetween multiple divisions and departments and clear leadership from the top of thecompany.

Identifying the most material externalities for analysis. Identifying and agreeing uponthe most material externalities and the corresponding societal value creation indicatorsusually requires bespoke analysis for each organization or sector.

Selecting robust monetization factors. As discussed earlier in this paper (under Step 1of the methodology) there are numerous potential data sources that could be used toapply a financial value to the organizations material externalities. This is true even forrelatively common indicators, such as the social cost of carbon emissions. Bespokeresearch and analysis is usually required to identify the most robust and relevantmonetization data for each organization and each analysis. There is not yet a commonagreement among practitioners on standard monetization factors.

Because of the wide range of monetization factors, the financial values applied toexternalities should be considered as indicative and not absolute in the same sense asfinancial data generated by traditional accounting processes. For this reason, unduefocus on the numbers themselves should be avoided. Rather, the value of this type of

NPV including returns from internalized externalities

Direct financial returns

Business case is improved when returns from internalization are taken into account

Horizontal axis enables value created for society to be brought into the decision-making process

Returns from internalization of externalities can transform a negative or break-even investment into positive NPV

NP

V (

$)

Societal value (NPV)

Source: KPMG (2014)

Figure 3.Marginal true valuecurve

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analysis lies in providing a means to understand the relative magnitude of anorganizations environmental and socio-economic externalities and to drawcomparisons of scale between them. This helps to identify which externalities are mostmaterial both to the business and to society and to inform future activity and decisionson strategy and investment.

Lack of comparability between organizations. The huge number and variety ofpotential monetization data sources, combined with differences in input data betweenorganizations, means that this methodology cannot yet be easily used to provide aconsistent comparison of societal value creation between one organization and another.Current analyses typically focus on single organizations, and standardized approachesare still in development.

Complexity of attributing proportions of societal value creation. Because of thecomplex nature of the current global value chains, it is widely debated whether a singleorganization can be held entirely responsible for all the value created or reduced forsociety by its operations. Take, for example, a smartphone manufacturer. Can themanufacturer claim responsibility for all the value provided to society by thecommunications capability the smartphone provides, given that manufacturers ofcomponents, the retailers, the network providers, the consumer who buys the phone andothers all also play a part in delivering that value to society?

The same challenge applies to the value reduced for society by negative externalities.For example, if there are sub-optimal working conditions in component factories deep inthe supply chain, to what is extent is the smartphone manufacturer responsible for that,and what proportion of responsibility should be taken by the component suppliers, thephone retailers and others in the value chain?

These issues must be taken into account during the analysis to reach a fair andreasonable view on the proportion of societal value creation and reduction that can beattributed to a single organization.

Case study 1: quantifying societal value creation at a leading global building materialmanufacturerOne of the first companies to use the methodology was a global building materialsconglomerate headquartered in Europe with global revenues of approximatelyUS$20bn. In 2013, the firm was one of the worlds top five producers of cement byrevenue, and, in 2014, it announced an ambitious sustainable development strategy withaction focused on three pillars: climate, resources and communities. The company hasset sustainable development targets to 2030 and is committed to generate one-third of itsrevenues from its portfolio of sustainability-enhanced solutions.

One of the companys key sustainability challenges is that the significantexternalities of its resource-intensive manufacturing process are not fully factored intoproduction costs. The firm recognized that a clearer understanding of its externalities,and the societal value they create and reduce, would enable it to have a more balanceddialogue with stakeholders, including policy makers and communities, based onquantitative data representing its societal value creation. It would also enable the firm tomaximize future profitability by understanding the likely financial impact if thoseexternalities were to be internalized in the future and by taking investment decisionsthat would reduce financial risk while simultaneously increasing the value the firmcreates for society.

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To enhance its understanding of these issues in relation to its business, the companyengaged KPMG member firm professionals to apply the true value methodology. Priorto implementing the methodology on a global scale in 2014, the company piloted themethodology with its Indian subsidiary starting in 2012. This specific case study willfocus on the initial work done with the Indian subsidiary (the subsidiary accounted forbetween 5 and 10 per cent of the groups 2013 revenues). At the end of the case, theresults of the global activity will be briefly referenced.

In line with the methodology, the subsidiary went through three steps:Step 1: the firm delivers positive true earnings. The project team constructed a

true earnings bridge for the company which combined the firms financial profits withthe societal value it created and reduced (i.e. its monetized positive and negativeexternalities). The calculation showed that in 2012, the company generated net-positivesocio-environmental value; in other words, its true earnings, including its societalvalue creation, were greater than its financial earnings alone.

Examples of societal value created by the company through its positive externalitiesinclude:

harvesting more water than is used in its manufacturing through check dams,river linking and turning former quarries into manmade lakes or wetlands;

using waste from other industries in its manufacturing process, thereby avoidingthe need for landfill disposal; and

supporting income-generating activities for members of the local community.

Examples of societal value reduced by the firm through its negative externalitiesinclude:

emissions of greenhouse gases; other emissions such as fine particles; and extraction of groundwater.

The true earnings bridge enabled the companys finance executives to easilyunderstand the firms most material positive and negative externalities in an engagingand familiar visual format (Figure 4).

Step 2: assessing the potential impact of internalization on profitability. In Step 2, adetailed analysis of the companys material externalities was conducted to assess howlikely it would be for those externalities to be fully or partially internalized throughfuture regulation, stakeholder action or market dynamics.

Where the likelihood of internalization was found to be high, the potential impact onthe companys future profitability was modelled.

The analysis was applied under a number of future scenarios. It revealed that thefirms negative externalities were more likely to be internalized than its positiveexternalities. The key drivers of internalization for the company were found to be:

new regulations (such as laws, subsidies or taxes) to address water scarcity,industrial energy efficiency and greenhouse gas reduction;

stakeholder action by communities, NGOs and the media over water scarcity; and market dynamics including increased water prices due to drought and water

scarcity (Figure 5).

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$$

Human health

GHG emissions

Water extraction

Landdisturbance

Rainwater harvesting

Alternative materials and fuel

Quarry restoration

Reduced water use

Social and economic value-addto society from CSR

Financial Profit

Environmental Externalities

SocialExternalities

True Value

$

+ +

Figure 4.True earnings

bridge for Indiansubsidiary of global

building materialscompany based on

2012 data

Profit NegativeExternalities

Positive Externalities True Value

Highly Likely Likely Unlikely

+$

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Figure 5.Analysis of company

externalities bylikelihood of

internalization

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Step 3: prioritizing future investments. The analysis enabled the company to bring a newlens to its decision-making on investments. The firm has been able to assess NPVreturn-on-investment not only on the basis of direct financial returns but also taking intoaccount the potential financial effects of new regulation, stakeholder action andchanging market dynamics.

For example, in anticipation of rising water costs, the company is investing toreplenish five times its annual water footprint by 2017 by phasing out groundwaterconsumption and increasing its reliance on rainwater harvesting.

The analysis has also enabled the firm to prioritize investments that provide similarfinancial returns according to the value those investments would create for society. Bymaximizing its societal value creation and by quantifying previously intangiblemeasures, the company is in a stronger position to have a dialogue with policy makers,communities and other stakeholders about its positive contribution to society. Thecompany can also further reduce the risk of financial losses caused by stakeholderaction over its negative externalities.

Following the successful pilot in India, the company rolled out the methodologyacross its global group. The results, based on 2014 data, were published in June 2015 inits first Integrated Profit and Loss Statement. The calculation showed that in 2014, theglobal group of companies generated net-positive socio-environmental value ofapproximately US$4.8bn compared with a retained value of approximately US$2.4bn; inother words, its true earnings, including its societal value creation, wereapproximately twice its financial earnings alone.

The greatest positive societal value created by the company is in the area ofstakeholder value. This calculation shows that the companys contribution to localeconomies through the multiplier effect of salaries and direct and indirect taxes issignificant. In the markets where it operates, it creates jobs, raises living standards andcontributes taxes to local economies.

The analysis showed that, of the companys negative externalities, CO2 emissionsfrom the supply chain and the companys own operations reduced the most value forsociety. Because of the relatively high likelihood that this externality will be internalized(e.g. through carbon prices or carbon taxes), the group has made addressing CO2emissions a priority for its sustainability action plan. The methodology has also helpedit to identify a number of positive climate-related benefits of building with cement thatare not yet quantifiable. Examples include long-term durability and the use of cement inprojects related to climate adaptation.

Case study 2: public transport, a European national railway companyThe second case presented in this paper is that of a major railway company in amedium-sized European country. The company, or actually group of companies (whichincludes passenger transport, train maintenance and station management), employsover 20,000 people and has a revenue of approximately 3.3bn (US$3.7bn); 86 per cent ofrevenue comes from passenger transport. It is one of the busiest rail networks in theworld with over 1one million journeys a day. Although the company has operated as aprivate company for more than 10 years, the national government retains 100 per centownership of shares, and, through the ministry of transport, it is involved in a number ofareas of key decision making.

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As the largest rail company in a country that makes extensive use of public transportby rail, the company recognized the important role it plays in terms of mobility withinthe country. With this in mind, the company felt it was important to take stock of thevalue it creates and reduces for society. A key driver for the true value assessment wasthe opportunity to build quantitative measures into discussions with stakeholders aboutthe companys societal impacts and trade-offs. For example, the company is one of thelargest single renewable electricity consumers in the country, and any decision it takesin this area, for example, the purchasing of renewable energy, can have a considerableimpact on other sectors, in this case the energy sector.

The rail company chose to apply the KPMG true value methodology, because it wasable to capture both the creation and reduction of societal value, leading to a more robustand balanced discussion. As the CFO stated: The methodology helped us to articulateour economic, environmental and social impacts much more clearly and to explain howthese impacts interact. As a company that positions its core service as a safer and moreenvironmentally friendly alternative to the private car, it was hoped the methodologywould support this positioning with easy-to-understand quantitative data.

The first step in the process was to identify and quantify where the company creates,and reduces, the most value for society. Value creation was categorized in four key areas,mobility, safety, corporate expenditure and environment, and was quantified infinancial terms using various internal and external data sources. For example, themethodology was used to quantify the positive value of mobility and the negativeimpacts of travel time, waiting time at stations, travel to and from stations and delays(Figure 6).

The methodology also allowed the company to explore some of the complexitiesaround its environmental footprint, looking, for example, at the CO2 emissions fromelectricity used both to operate and manufacture the trains. These data were then usedto calculate the emission savings generated when travelling by train compared withtravel by car (Figure 7).

Figure 6.Analysis of the railcompanys societal

value creation inmobility and safety

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The methodology enabled the company to analyse its societal value creation in agranular way, as well as allowing top line analysis that compared the different impactswith a common financial metric.

Application. The results of the analysis have helped the company to develop newstrategic initiatives and take investment decisions, based on a clearer understanding ofits societal value creation.

Case study 3 leading European automotive manufacturerOne of Europes leading automotive manufacturers recently applied the KPMG truevalue methodology to build the business case for fully electric buses. This company ispart of a larger group that manufactures conventional buses, trucks, boat engines andconstruction equipment, as well as providing related financial services. Global groupsales in 2014 exceeded US$30bn. A global player, the group of companies operates in 180markets and has approximately 100,000 employees globally.

The electric bus market is currently small but is expected to grow quickly in thecoming decade. The technology faces challenges in terms of gaining market share in thecity transport market space. Barriers include the relatively high purchase or lease pricecompared with diesel or other longer-established technologies and the requirement foradditional infrastructure such as charging stations.

On the other hand, electric buses offer attractive benefits when compared withtechnologies such as diesel, including lower operating costs, zero tailpipe emissions andless noise. These benefits are appealing to municipalities that have goals of providingcitizens with cleaner, more liveable cities. However, one of the challenges for the

Avoided emissions (compared with car travel)Emissions: trainsEmissions: busesEmissions: electricity use in buildings and stationsEmissions: electricity use by rail infrastuctureEmissions: manufacture of trainsEmissions: passenger travel to and from stationsWaste incineration, water use, noise pollutionEcosystem impacts of land use (tracks, etc)

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Figure 7.Analysis of the railcompanysenvironmental valuecreation

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company in building the business case for electric buses is the lack of quantifiable dataon the full range of benefits they provide to society.

To present a more holistic view, the firm worked with KPMG member firmprofessionals to develop an approach called true cost of ownership. This is based on thetotal cost of ownership management accounting technique that estimates the total costof acquiring and operating an asset across the entire period of ownership. In the case ofa bus, the total cost of ownership typically includes the cost of the vehicle lease, fuel,driver costs, garaging and maintenance.

True cost of ownership, however, provides a broader picture, because it usesquantification techniques to bring the social and environmental costs to society into theanalysis. For example, the true cost of ownership of buses also includes the effects ofnoise and pollution on public health, the environmental impacts of manufacturing thefuel, contributions to climate change and travelling time for passengers.

Applying the true cost of ownership approach in this case resulted in a dramaticallydifferent result from the traditional total cost of ownership analysis. Under total cost ofownership, electric buses are more costly than diesel vehicles, primarily because thetechnology is new and more expensive, meaning that lease costs are higher. However,the picture changed significantly when financial indicators were applied to the social,environmental and economic benefits brought by electric buses, such as lower impactson public health and climate change and reduced travelling times.

When these values were included in the cost of ownership analysis, the true cost ofownership of electric buses was some 200 per cent less than the total cost of ownershipand significantly less than the true cost of ownership of equivalent diesel vehicles.

The true cost of ownership analysis has proven useful not only for the manufacturerto build the business case for its product but also for its potential customers, namely, citymunicipalities that need to make decisions on how to develop their public transportsystems. It enables cities to understand and communicate the broader value that aprocurement decision creates for society.

FindingsThe three cases above represent very different companies from diverse sectors.Although the approach and implementation of the methodology was similar across allthree companies, the results, application of the results and subsequent benefits to thecompany in question were different.

For example, quantification has enabled the cement company to quantify the societalvalue reduced by its carbon emissions and water use and to assess the risk to its futureprofitability from regulation, stakeholder action and changing market dynamics relatedto these social and environmental impacts. These risks would not have been visible ona standard balance sheet but have served as a useful guide for future investment.

By applying the analysis, the company has been able to shift perceptions ofsustainability within the firm, most notably among management and financeprofessionals. Quantification of societal value creation has helped to createunderstanding of how sustainability issues directly and indirectly affect bottom linefinancial performance and how the three pillars of the triple bottom line (people, planetand profit) are interconnected. Also, focusing on the firms material socio-environmentalissues has helped to direct the sustainability conversation towards materiality andperformance and make it relevant to goal-setting and decision-making.

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At the railway company, quantifying societal value creation has enabled businessmanagers to quantify and compare a diverse array of impacts on the environment,society and the well-being and happiness of its passengers. It has served as a usefulreference tool for internal discussions and prioritization of activities and investments. Ithas also helped to provide a fact-base for the company to explain its decisions both to thebroad gamut of its stakeholders and to its sole shareholder (i.e. the nationalgovernment). The process has also helped those working within the company to gain abetter understanding of their own business and the value it creates for society.

For the electric bus manufacturer, the methodology has enabled a transformation ofthe business case for its product by building quantified social and environmentalbenefits into its analysis and incorporating it into one of the most commonly usedmetrics in the area of purchasing, total cost of ownership.

ConclusionThe true value approach and other methodologies that attempt to monetiseenvironmental and social impacts are not without controversy. It is well argued that andunderstanding of context and complexity is essential when addressing challengingsocietal issues. We must, however, not be lured into a false dichotomy wherestandardization and quantification are seen to preclude systemic thinking and analysisof issues and solutions in all their complexity. Although monetization methods arguablyrepresent a simplification of complex problems, they also provide the languageunderstood in the corporate boardroom. If corporations are to benefit from bringingsustainability considerations into the heart of decision-making, then more needs to bedone to bridge the current gap between the sustainability and finance disciplines

The quantification of externalities and societal value creation in financial terms israpidly gaining ground as a means to do so. KPMGs true value approach is not the onlymethodology of its kind. Important work is also being done in this area by otherorganizations, including the Natural Capital Coalition, The World Business Council forSustainable Development and other professional services and accounting firms.

The methodologies are by no means perfected; yet, flaws and challenges remain, andthe ultimate goal must be to achieve a standardized approach that will enablebenchmarking and comparison between corporations and sectors and effectivelyincorporate sustainability issues into the corporate decision-making process.

As outlined in the challenges and limitations section, monetization of societal value isstill in an early phase of development. The methodology is also more difficult to apply incertain industry circumstances than in others. For example, it is easier to apply themethodology to companies that have physical products compared to ones withnon-tangible products and services. More abstract areas of value creation (e.g.happiness and wellbeing) are also more difficult to quantify. Attribution also remains akey challenge both where value is created and where it is reduced. Furthermore, it isimportant to keep in mind that when societal value is created, this value is notnecessarily evenly spread across society.

Moving forward, academia and scientific inquiry will have a key role to play indeveloping the standardized monetization values and protocols that are required.Beyond that, academia can help to explore how effective different monetization modelsare both in reflecting the societal value created and reduced by businesses and thebenefits to business of identifying and acting on these indicators. An important area for

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future academic exploration is to understand how these models actually affect businessdecision-making and to what extent those decisions result in societal impacts. Also ofinterest would be an analysis of financial performance of companies before and aftermonetizing societal value.

Although the methodology will continue to be refined, corporations that take apioneering approach to the quantification of value have much to gain. They can improveperformance by reducing costs and risk, increasing revenues and increasingcollaboration between the sustainability and finance functions. They can informstrategy with analysis using financial metrics and build broader business cases forinvestments. Importantly, they can increase their influence by demonstratingleadership, deepening the conversation with investors and engaging in a quantifiedvalue-creation dialogue with stakeholders of all kinds, including policy makers andNGOs. The authors further hope that as these methodologies are further developed andrefined, they will provide improved business paradigms that create both business valueand societal value. Over time, a more complex and multi-lensed approach to accountingfor societal value creation may emerge that aligns more closely with the double-entryfinancial accounting system and the six types of capital identified by the InternationalIntegrated Reporting Council: financial capital, manufactured capital, intellectualcapital, human capital, social capital and natural capital.

It could be argued that financial currency cannot adequately reflect all types ofcapital. For example, can dollars and cents fully reflect the experience, skills, values andmotivation of employees that make up a companys human capital? The methodology isnot intended as a substitute for more detailed analysis and discussion of social andenvironmental impacts of business, but rather as a complement.

Although the end goal for the methodology may be for companies to account moreaccurately for each type of capital, it is a complex and long-term vision. After all, theprocesses of financial bookkeeping have evolved over hundreds of years.

The authors believe that quantification and monetization in its present form offers auseful means to inform the corporate decision-making process by drawing comparisonsof scale between a companys various externalities and identifying which of them aremost material both to the business and to society. It is, in our opinion, the best approachcurrently available and will remain so for the foreseeable future while continuing toevolve and refine.

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KPMG (2014), Report: a new vision of value: connecting corporate and societal value creation,available at: www.kpmg.com/global/en/topics/climate-change-sustainability-services/pages/a-new-vision-connecting-corporate.aspx (accessed 15 July 2015).

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Starling, S. (2013), GOED chairman: Serious omega-3 supply issues lie ahead as demand rockets,NutraIngredients, available at: www.nutraingredients.com/Markets-and-Trends/GOED-chairman-Serious-omega-3-supply-issues-lie-ahead-as-demand-rockets (accessed 25February 2015).

UK Department for Business, Innovation & Skills (2013), The smart city market: opportunities for theUK, available at: www.gov.uk/government/uploads/system/uploads/attachment_data/file/249423/bis-13-1217-smart-city-market-opportunties-uk.pdf (accessed 15 July 2015).

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Further readingBBC News (2014), South Africa platinum strike over, available at: www.bbc.com/news/

business-27981977 (accessed 25 February 2015).

Bosley, S. (2014), Mexico enacts soda tax in effort to combat worlds highest obesity rate, TheGuardian, 16 January, available at: www.theguardian.com/world/2014/jan/16/mexico-soda-tax-sugar-obesity-health (accessed 25 February 2015).

Campbell, D. (2014), Plain cigarette packaging regulations to be announced by ministers, TheGuardian, 26 June, available at: www.theguardian.com/society/2014/jun/26/plain-cigarette-packaging-regulations-announced (accessed 25 February 2015).

Ensor, L. (2013), Department to assess effects of mooted alcohol ad ban, Business Day BD Live,24 December, available at: www.bdlive.co.za/national/health/2013/12/24/department-to-assess-effects-of-mooted-alcohol-ad-ban (accessed 25 February 2015).

KPMG (2012), Report: expect the Unexpected: Building business value in a changing world,available at: www.kpmg.com/global/en/issuesandinsights/articlespublications/pages/building-business-value.aspx (accessed 15 July 2015).

Maylie, D. (2014), South Africa platinum miners consider new union offer to end strike, The WallStreet Journal, 4 June, available at: www.wsj.com/articles/south-africa-platinum-strike-continues-as-union-rejects-latest-offer-1401867774 (accessed 25 February 2015).

About the authorsBernd Hendriksen is a Partner at KPMG in The Netherlands, where he leads the SustainabilityServices practice that comprises around 40 sustainability professionals. In this role, he leads thedevelopment of KPMGs true value methodology in collaboration with Jeroen Weimer, Head of

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http://www.kpmg.com/global/en/topics/climate-change-sustainability-services/pages/a-new-vision-connecting-corporate.aspxhttp://www.kpmg.com/global/en/topics/climate-change-sustainability-services/pages/a-new-vision-connecting-corporate.aspxhttp://www.mondaq.com/india/x/302204/Corporate+Commercial+Law/Corporate+Social+Responsibility+Now+A+Mandated+Responsibilityhttp://www.mondaq.com/india/x/302204/Corporate+Commercial+Law/Corporate+Social+Responsibility+Now+A+Mandated+Responsibilityhttp://%20www.navigantresearch.com/research/energy-efficiency-retrofits-for-commercial-and-public-buildingshttp://%20www.navigantresearch.com/research/energy-efficiency-retrofits-for-commercial-and-public-buildingshttp://www.reuters.com/article/2014/05/10/us-china-protests-idUSBREA4904320140510http://www.reuters.com/article/2014/05/10/us-china-protests-idUSBREA4904320140510http://www.nutraingredients.com/Markets-and-Trends/GOED-chairman-Serious-omega-3-supply-issues-lie-ahead-as-demand-rocketshttp://www.nutraingredients.com/Markets-and-Trends/GOED-chairman-Serious-omega-3-supply-issues-lie-ahead-as-demand-rocketshttp://www.gov.uk/government/uploads/system/uploads/attachment_data/file/249423/bis-13-1217-smart-city-market-opportunties-uk.pdfhttp://www.gov.uk/government/uploads/system/uploads/attachment_data/file/249423/bis-13-1217-smart-city-market-opportunties-uk.pdfhttp://www3.weforum.org/docs/WEF_ENV_TowardsCircularEconomy_Report_2014.pdfhttp://www3.weforum.org/docs/WEF_ENV_TowardsCircularEconomy_Report_2014.pdfhttp://www.bbc.com/news/business-27981977http://www.bbc.com/news/business-27981977http://www.theguardian.com/world/2014/jan/16/mexico-soda-tax-sugar-obesity-healthhttp://www.theguardian.com/world/2014/jan/16/mexico-soda-tax-sugar-obesity-healthhttp://www.theguardian.com/society/2014/jun/26/plain-cigarette-packaging-regulations-announcedhttp://www.theguardian.com/society/2014/jun/26/plain-cigarette-packaging-regulations-announcedhttp://www.bdlive.co.za/national/health/2013/12/24/department-to-assess-effects-of-mooted-alcohol-ad-banhttp://www.bdlive.co.za/national/health/2013/12/24/department-to-assess-effects-of-mooted-alcohol-ad-banhttp://www.kpmg.com/global/en/issuesandinsights/articlespublications/pages/building-business-value.aspxhttp://www.kpmg.com/global/en/issuesandinsights/articlespublications/pages/building-business-value.aspxhttp://www.wsj.com/articles/south-africa-platinum-strike-continues-as-union-rejects-latest-offer-1401867774http://www.wsj.com/articles/south-africa-platinum-strike-continues-as-union-rejects-latest-offer-1401867774

Corporate Finance. Bernd has over 15 years experience in advising clients on sustainabilitystrategy.

Jeroen Weimer is Head of Corporate Finance at KPMG in The Netherlands and Head of KPMGValuation Services for Europe, the Middle East and Africa. As leader of the Valuations Practice inThe Netherlands, Jeroen engages in many different types of value analyses, ranging from publicfairness opinions, to valuations of intangible assets such as brands and patents, to valuations foraccounting purposes. He is a lead partner on a number of major KPMG clients and a core teammember of the Executive Master of Business Valuation post-doctoral education program at theUniversity of Groningen, The Netherlands.

Mark Mckenzie is the Global Director of Sustainability Thought Leadership at KPMGs GlobalCenter of Excellence for Climate Change and Sustainability, based in Amsterdam, TheNetherlands. He has conceived, co-authored and produced over 15 KPMG thought leadershipreports. These include A New Vision of Value: Connecting corporate and societal value creation(2014); Expect the Unexpected: Building business value in a changing world (2012), whichexplores the impacts of social and environmental megaforces on business; The KPMG Green TaxIndex (2013), which analyses green tax systems across 21 major economies; and The KPMGSurvey of Corporate Responsibility Reporting (biannual, last edition 2015), which is widelyacknowledged as one of most authoritative views of the global state-of-play in non-financialcorporate reporting. Mark McKenzie is the corresponding author and can be contacted at:[email protected]

For instructions on how to order reprints of this article, please visit our website:www.emeraldgrouppublishing.com/licensing/reprints.htmOr contact us for further details: [email protected]

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