Expect the Unexpected
KPMG has recently published a new report – Expect the Unexpected: Building business value in a changing world. Dealing with the unexpected should be what good businesses try to do all the time, but the focus of this report is specifically on the impact of what the authors call ‘sustainability megaforces’. They identify ten of these: climate change, energy and fuel, material resource scarcity, water scarcity, population growth, wealth, urbanisation, food security, ecosystem decline and deforestation. One suspects that they could have condensed this to seven or eight, but round numbers always seem a more attractive way to convey messages: why else would the EU have set the 20:20:20 targets, for example?
The concern central to this study is that businesses are vulnerable to a range of factors outside their control, although KPMG give this a positive spin by suggesting that those organisations which are well prepared can continue to be successful. The message is that there are external environmental costs which are doubling every 14 years; as pressure grows to include these external costs in the final prices of goods and services, this will become a significant factor hitting companies’ bottom line. In this analysis, it is reckoned that pre-tax profits across a range of sectors (airlines, motor manufacturing, beverages, chemicals, electricity generation, food production, industrial metals, shipping, mining, oil and gas production and telecoms) would have been reduced by 41% in 2010 if all environmental costs had been accounted for.
In the case of food producers, this calculation suggests that the extra costs would be more than double the actual profit! By this analysis, the conclusion is also that food and beverage production are not only at high risk, but they are also among the sectors least prepared to meet the challenge. If true, this is very concerning, since a secure and affordable food supply is one of the basis essentials of life.
This study illustrates the crucial nature of the debate about sustainability and environmental economics. Commodities, goods and services are priced according to supply and demand. Scarcity of raw materials, all things being equal, should be reflected in their price, and this will have an inflationary effect on downstream products. However, environmental factors such as losses of biodiversity or deforestation have no direct economic cost (hence the term ‘externalities’, beloved of economists).
This means that prices have to be derived in a more artificial way. For example, the ‘willingness to pay’ method is essentially a consumer survey which asks people to put a price on conserving natural habitats for recreation etc. In a similar way, forests can be priced based on their capacity to retain carbon dioxide, but this in turn depends on a carbon price being set, predicated on the modelled negative impact of climate change caused by burning fossil fuels.
Societies through the ages have always had to deal with resource scarcities. Before farming, welfare was limited by the availability of game animals and wild nuts, seeds and fruit. After the introduction of agriculture and the establishment of permanent settlements, the vagaries of the weather and water availability would have been the primary constraints. These are still important factors today and we can also add energy to that list.
In one sense, energy has always been a constraint. Firewood is needed by less developed societies for cooking and warmth, and large areas have been effectively denuded of trees (a process which occurred much earlier in Europe as forests were cleared for farming, building and fuel), but this is used only intermittently. In the industrialised world, we now take for granted that energy is constantly on tap and, not surprisingly, sometimes get concerned about security of supply. In many ways, our sophisticated lifestyle is uniquely vulnerable; localised power cuts can cause real problems for people in the short term, but national or regional blackouts would soon cause chaos as IT systems went down.
But in most ways our interconnected, globalised world makes much better use of resources than ever before. Historically, civilizations were constrained by the availability of relatively local resources, but today raw materials can be sourced where they are abundant and sent where they are needed. This is what has enabled rapid development, which has benefitted so many people. Figures compiled for the KPMG report show the following global changes over the last 20 years: a 163% increase in GDP, with a 21% reduction in resource intensity and 23% lower CO2 emissions per unit GDP, a 19% improvement in the UNDP human development index, an 18% reduction in undernourishment, and a 31% drop in average annual population growth rate.
Not that everything is so rosy. There is still plenty of real deprivation in the world, often caused or compounded by poor governance. But the real progress, which is driven by value-creating businesses, could be slowed or halted if the external environmental costs highlighted really were to be rolled in to the price of goods and services. Much of the additional cost is derived from emissions reduction policies. After all, energy, material resources and water, for example, are already priced on a conventional economic basis, and we continue to use resources more efficiently, albeit in greater quantities overall.
Experience shows that developed countries are the ones which care most for the environment. Logically, encouraging development should get a much greater proportion of the world’s population into this category sooner, while slowing it down with additional costs could result in more environmental degradation in the longer term. Any further costs would be due to government intervention, and this seems uncalled for. Businesses should continue to expect the unexpected, but ideally not in the form of unnecessary additional costs.