Claims about the impact of sustainability initiatives – or the lack thereof – on a company’s financial performance are prevalent in media. Claims cover the spectrum from crippling, through negligible, to transformative. Articles making these claims target audiences ranging from corporate executives to non-industry activists, politicians, and regulators. Likewise, the articles cite vastly differing sources to support claims.
These articles are often rife with unsupported claims and inconsistencies, are poorly sourced, poorly written, and dripping with bias. The most egregious are often rewarded with “likes,” “shares,” and additional “reporting” by equally biased purveyors of “the word.” These viewpoint warriors create a fog of war that makes navigating the mine-laden battlefield of stakeholder interests incredibly treacherous.
The fog of war is penetrated by stepping outside the chaos to collect and analyze relevant information. To do this in the sustainability vs. profitability context, a group from NYU Stern Center for Sustainable Business have developed the Return on Sustainability Investment (ROSI) framework. ROSI ends reliance on the incessant cascades of conflicting claims, providing a structure for investigating the impacts of sustainability initiatives on an organization’s financial performance.
The NYU team have identified nine “drivers of corporate financial performance,” dubbed mediating factors. Financial drivers are relevant to all forms of management, but the nine mediating factors identified have been found to be particularly powerful in sustainability management.
Each of the nine mediating factors is presented below, illustrating links between an organization’s sustainability efforts and its financial performance.
Operational Efficiency. Operations managers are in perpetual pursuit of efficiency improvements; the desire to “do more with less” is never sated. A focus on sustainability reveals opportunities for efficiencies that may be overlooked in “traditional” analyses. For example, reducing the amount of process water required lowers costs of supply and consumption, processing, recycling and disposal. Another example is the installation of efficient equipment reducing energy costs. In both examples, lower demand for the commodity (water, electricity, gas, etc.) results in a subsequent reduction in required capacity of equipment and infrastructure, further enhancing operational efficiency.
Innovation. Interest in sustainability shifts focus from creating new features to serving required functions more efficiently. This can be achieved through design (e.g. materials, specifications), processing (e.g. methods, quality assurance), delivery (e.g. packaging, logistics), order processing, scheduling, or any component of a product or service offering, be it tangible or intangible.
Sales and Marketing. Highlighting the “greenness” of a product or service attracts attention from the increasingly environmentally-sensitive marketplace, leading to increased sales. Effective marketing of a sustainable product or service could increase market share, open new markets, or justify premium pricing. If executed exceptionally well, the provider’s marketing may be supplanted by word-of-mouth and social media attention; reduced marketing effort is a direct benefit to the bottom line.
Customer Loyalty. Establishing a reputation for sustainable quality spurs repeat purchases by environmentally-conscious consumers. Loyal customers become advocates, “spreading the word” to encourage others to consume sustainably. The dedication of these customers limits promotional expenses required of the provider to maintain, or even increase, market share.
Employee Relations. Employees tend to feel a deeper connection with employers that demonstrate commitment to environmental and social responsibility. This often manifests in higher morale and lower turnover that increases organizational performance. Lower recruitment and training costs, fewer quality issues, higher productivity, and fewer labor shortages contribute to improved financial performance.
Supplier Relations. People like to associate with those that share their values. This doesn’t change when individuals are grouped into companies; organizations prefer to do business with other organizations that share their collective values. Relationships are strengthened by a shared commitment to sustainable practices, reducing sourcing costs and increasing opportunities for further development of efficiencies.
Media Coverage. Media exposure is an extension of marketing efforts. Organizations aim to manage the message to the extent possible, maximizing their “good press” and minimizing detrimental effects of any negative attention they may receive. If the media coverage received is overwhelmingly positive, the credibility it lends facilitates relationship-building with employees, customers, suppliers, and other stakeholders.
Stakeholder Engagement. Sustainability initiatives “open doors” to the communities in which organizations operate. Demonstrating a commitment to stakeholders’ safety, prosperity, and longevity weakens resistance to operations and presents opportunities for collaborations that yield benefits for the organization and the community at large.
Risk Management. A focus on sustainability places an organization in a proactive stance. Managers are more likely to recognize risks and develop strategies to avoid or minimize them and to mitigate the effects of occurrences. Proactive measures provide financial benefits before issues occur (e.g. consistent operations, lower insurance premiums) and during disruptions (e.g. contingency activation, rapid recovery). Proactive organizations are also better positioned to respond to changes in market conditions and regulatory schemes than less forward-thinking competitors, reducing the financial impacts of these inevitable incidents.
Each of the nine mediating factors provides a context in which sustainability initiatives can be evaluated. These are drivers of financial performance and, as such, should be referenced when evaluating projects and translating intangibles into monetary terms as part of the ROSI methodology.
The Return on Sustainability Investment (ROSI) methodology developed at NYU Stern Center for Sustainable Business is a five-step iterative process. Discoveries in each step may require previous steps to be revisited in order to produce a thorough, accurate, and useful analysis. An overview of the Return on Sustainability Investment (ROSI) Framework is presented in Exhibit 1.
Each of the five steps of the ROSI methodology is presented below. Descriptions are necessarily generic, as circumstances for unique organizations are highly diverse.
Identify sustainability strategies. Compile a comprehensive list of sustainability-related activities in which the organization is engaged or is considering. Activities may be explicitly aimed at sustainability (e.g. zero landfill solid waste target) or other objectives may have prompted activities with sustainability components (e.g. delivery route optimization). Both types of activities contribute to sustainability objectives and, therefore, should be included in the analysis. Advocacy groups publish reference materials and standards that can be used to guide this effort. These include:
Quantify costs and benefits of sustainability strategies. To evaluate current activities, collect performance data to compare to previous practices. Strategy proposals rely on estimates of performance derived from information acquired from industry reports, supplier recommendations, academic studies, or other sources. Each of the nine mediating factors must again be considered; some creativity may be required to develop a consistent method of quantifying intangible or nonmonetary benefits.
Document assumptions and estimate uncertainties. Uncertainty is inevitable. Ignoring it is unacceptable. By documenting assumptions that led to the conclusions drawn, estimates and strategies can be modified should flaws in those assumptions be discovered. Defining ranges of likely values – for inputs or outputs – permits sensitivity analysis and scenario-based planning. Without documentation of assumptions and uncertainty, deviations from anticipated results are inscrutable.
Calculate monetary value of sustainability strategies. Various metrics can be used to evaluate the financial performance of sustainability activities. Of course, a return on investment (ROI) percentage can be calculated. Similar projects can be compared on the basis of earnings before interest and taxes (EBIT) or other standard accounting measure. To compare projects that are vastly different in duration, scope, or size of investment, the best approach may be to calculate the net present value (NPV) of each. Whatever metric or method of comparison is used, decision-makers must agree that it is valid and instructive.
Repeat the process, incorporating revelations from previous iterations, until the information is stable. A completed ROSI analysis can be used to make decisions on investments and to implement or refine sustainability strategies. The scope of decisions can range from the management of a single process to corporate policy.
Challenges and Caveats
Many of the articles mentioned in the introduction cite a correlation between organizations’ financial performance and their sustainability efforts. This correlation is inferred to be positive, but is often unstated. Allusions to a causal relationship are also common, though the direction of it may be the reverse of that implied. Is it possible that the case study companies are able to implement broad-based sustainability strategies because they have been financially successful?
Failing to explore – or even acknowledge – this possibility is not the only crime against journalism frequently committed. There are too many bad examples to critique them all; instead, readers are simply urged to be vigilant. Critical thinking is crucial to successful strategy implementation; putting analysts in this mindset is what makes the ROSI methodology valuable.
Operations management cannot focus on sustainability to the exclusion of all other matters. There are many other factors that influence decisions and complicate analysis. These may include the organization’s financial position, local or global market conditions, supply chain stability, labor disputes, geopolitical turmoil, or any number of other factors, many of which can be difficult to define. Without a complete picture of the environment in which a business operates, an outsider’s assertion that a sustainability program is an “easy” choice lacks merit.
A significant factor complicating decision-making is that sustainability is not a purely technical matter. It is heavily influence by economics and psychology. The economic influences are more straightforward; some of them have already been presented. Psychology enters the frame in the form of behaviors, particularly in the disparities between stated and revealed preferences.
When asked to choose between two hypothetical options (say, paper or plastic straws), many respondents will declare a preference for the socially acceptable option (paper straw). When faced with an actual choice, however, the socially acceptable option is often forsaken because it is inferior (functionally unacceptable). The revealed preference is for plastic straws. When this occurs, strategies must be reconfigured to address the realities of consumer behavior.
Another psychological factor that should be considered is consumers’ perceptions of cost and quality of “green” products and services. A reputation for higher quality or cost can increase sales and improve margins, whether or not the perceptions are accurate. Hence, the danger consumers face of “greenwashing” – the practice of claiming environmental stewardship in excess of actual practices. The opposite perception may warrant an education campaign, a component of the sales and marketing mediating factor.
Analysts must be aware of traps to avoid falling victim. A common trap is overstating benefits or underestimating costs by shifting responsibility or effects to a new location. Converting a fleet of delivery vehicles from internal combustion to battery electric vehicles does not eliminate emissions. Emissions are transferred from tailpipe to generating plant, but must still be accounted for. This is a rearranging effect (see “Revenge ON the Nerds” for a discussion of rearranging and other revenge effects).
The Return on Sustainability Investment (ROSI) methodology can be used in two ways. As a backward-looking analysis, performance of current or past practices can be evaluated. This is useful for testing the validity of assumptions and accuracy of estimates used to make prior decisions in order to apply lessons learned to new project decisions. As a forward-looking analysis, ROSI aids effective decision-making, improving forecasts of financial performance related to proposed sustainability initiatives by ensuring a more comprehensive review of relevant information.
A ROSI analysis may reveal that a net negative financial impact on the organization can be expected for a particular implementation. This does not preclude project execution, however; the implementation may not be optional due to safety, regulatory, or other issues. The completed analysis informs managers of the magnitude of the financial impact and is the starting point for the development of recovery plans. It is important to remember that ROSI and other analyses inform decisions, they do not make them. Judgment, intuition, and creativity must still be applied to make effective decisions. Without these human contributions, IBM’s Watson may as well be CEO.
If an organization is actively engaged in lean practices and regularly prepares financial justifications for projects, executing the ROSI methodology is a natural extension. It builds on existing skills by providing a lens through which attributes of sustainability are focused. As such, ROSI is less a new method of analysis than an adaptation of existing analysis methods for a specific purpose. Implementing an adaptation, rather than a new method, facilitates the selection of metrics to be used for assessment and comparison of alternatives. ROSI can be executed within most existing organizational structures, including information systems, departmental boundaries, and resource allocations.
For additional guidance or assistance with Operations challenges, feel free to leave a comment, contact JayWink Solutions, or schedule an appointment.
[Link] “The Return on Sustainability Investment (ROSI): Monetizing Financial Benefits of Sustainability Actions in Companies.” U. Atz, T. Van Holt, E. Douglas, and T. Whelan. In Sustainable Consumption and Production, Volume II: Circular Economy and Beyond. R. Bali Swain and S. Sweet (eds.). Springer Nature Switzerland AG, 2021.
[Link] “How to Talk to Your CFO About Sustainability.” Tenise Whelan and Elyse Douglas. Harvard Business Review, Jan/Feb 2021.
[Link] “Does Environmental Management Improve Financial Performance? A Meta-Analytical Review.” Elisabeth Albertini. Organization & Environment, 2013.
[Link] “Most manufacturers say cost pressures are 'restricting' green strategies.” Will Phillips. Supply Management, 24 November 2022.
[Link] “Choosing Sustainability Is Easier Than You May Think.” Michael Xie. Forbes, 28 November 2022.
[Link] “Why industry is going green on the quiet.” Cassandra Coburn. The Guardian, 8 September 2019.
[Link] “Resource efficiency: Can sustainability and improved profit go hand-in-hand?” The Manufacturer, 11 June 2019.
[Link] “5 Reasons It Pays to Implement Sustainable Manufacturing Practices.” Thomas Insights, 30 October 2019.
[Link] “The incompatibility of benefit–cost analysis with sustainability science.” M. Anderson, M. Teisl, C. Noblet, and S. Klein. Sustainability Science, 13 September 2014.
[Link] “Financial Valuation Tool.” GLOBAL VALUE tool showcase.
[Link] “Going Green to Make Green: Harnessing the Power of Sustainability in Business.” Kristin Manganello. Thomas Insights, 5 July 2018.
Jody W. Phelps, MSc, PMP®, MBA
JayWink Solutions, LLC
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