When Seeking Long-Term Profit, Consider Long-Term Environmental Risks

15th in a series of excerpts from the book The HIP Investor (John Wiley & Sons, 2010). See other articles in the series here.

This last management practice category focuses on including HIP criteria in every decision-making process. Alcoa (NYSE: AA) provides the perfect example.

Despite its heavy industrial processes, Alcoa is actually one of the few companies to implement a triple-bottom-line evaluation in its decision-making. Alcoa analyzes financial profit, environmental aspects, and social factors as an immediate next step after defining a project. To this end, the company systematically evaluates all capital projects and operational improvements according to a HIP (Human Impact + Profit) type of framework.

Let’s walk though an example of Alcoa’s triple-bottom-line thinking. For years, the spent lining of aluminum smelting pots was regarded as industrial waste. But by looking at this “waste” in a different way, Alcoa developed the ability to turn the smelting pot linings — which include carbon — into a raw material for other industries. At year-end 2005, 28 percent of the spent linings were no longer waste but raw material for new products, and Alcoa had turned trash into cash. What used to be cost turned into new revenues and profits — and Alcoa was two years ahead of its seven-year goal to reduce landfill waste by 50 percent.

Very recently, Dow has taken on the responsibility of valuing ecosystem services.  They saved $38+M in CapEx (-95%) where they had planned $40M to build water treatment facility, yet chose project to invest $1.4M to build a wetland that naturally cleans the water that treats 5MM gallons daily, and serves as habitat for multiple uses.

This systematic approach of reviewing criteria beyond pure financials is also used by United Technologies (NYSE: UTX ) for its product designs and capital spending reviews. This forward-looking approach systematically evaluates all types of risks, including the volatile prices of oil- and pollution- pricing regulations.

“Environmental criteria are integrated with capital projects here at Ford,” says Thomas Niemann, of Ford Motor Company’s (NYSE: F) sustainable business strategies group. “If you are only altruistic, then you might go out of business.” But a lifecycle analysis that includes the long-term costs of all the materials and labor required contributes to a deeper understanding of the best course for both human impact and profit. In Michigan, Ford’s 10.4 acres of “green roofing” did cost up to 25 percent more to install, but it will cost 50 percent to 65 percent less over its full life when compared to the maintenance required for a soft-membrane tar roof. The green roof also reduces water runoff, recaptures gray-water and contributes to lower costs. “Mr. Ford is focused on the human impact,” Niemann says. “Environmental and economic responsibility are not exclusive from each other, but supportive of each other.”

At Shell Oil (NYSE: RDS) and Marathon Oil (NYSE: MRO), the planning and capital spending processes have included a forward-looking estimate for a range of potential carbon prices. These influence the prospective designs of new and refurbished plants, pipelines and infrastructure. At Chevron (NYSE: CVX), all capital projects and enhancements valued at more than $5 million must be evaluated for environmental and social concerns, according to Maria Pica (Chevron). “We must evaluate the emissions profile, seek to reduce it and how we can use carbon credit to offset the remaining profile,” she says. All projects over $50 million have mandatory considerations of the risks and benefits of sustainability issues.

While investment banks have typically financed whatever clients request, the Equator Principles developed by the World Bank have set environmental and social guidelines that have taken hold because they also address and mitigate investment risk. For project finance, which includes $315 billion of annual debt and equity going to new energy or infrastructure developments worldwide, the Equator Principles are applied in nearly 75 percent of those transactions, many of which happen in emerging economies (Project Finance; Environmental Data Services 2008). These principles have gradually spilled over into the everyday financings of some investment banks. Morgan Stanley (NYSE: MS ) says it has “adopted explicit limitations on financing or investing in projects that would, among other things: significantly degrade a critical habitat; support companies engaged in illegal logging; support extraction or logging projects in World Heritage sites; or violate local and World Bank pollution standards” (Morgan Stanley Web site).

Less than 10 companies of the top 500 have reported systematically integrating HIP criteria into their decision-making processes. This long-term, lifecycle approach can add business value to a range of decisions. Product development could yield more innovative products. Capital spending would evaluate more risk factors — and factor in the cost of unexpected energy and environmental scenarios. Managerial reporting would include a broader set of measures beyond just financials.

These leading management practices can be embedded in the DNA of the company, and can be clear predictors of future positive impact, leading to higher financial performance.

HIP Management Practices: a predictor of impact?

It is surprising that companies like Coach (NYSE: COH), the maker of leather accessories, dispute that environmental factors affect their businesses. Here’s how Coach spokesperson Andrea Shaw Resnick responded to a 2007 request from the Carbon Disclosure Project, a not-for-profit organization that collects corporate climate change information: “Upon review of the document, we have decided not to complete the questionnaire given the fact that it really has nothing to do with our type of business and unlike the Gap, we do not have the internal capability to complete it.” Coach has declined to participate in the 2008 and 2009 CDP surveys as well.

What doubters need to recognize is that these factors affect every company. Leaders who seize the opportunity and initiate programs to increase human, social, and environmental impacts, realize higher financial performance.

In our earlier article on using HIP metrics, we showed how the HIP Scorecard published in Fast Company in April 2007 demonstrated higher HIP management practices correlated with higher human impacts. Does the relationship hold for the S&P 100 and the S&P 500? A HIP analysis of both indexes shows that integrating sustainability more deeply into how companies are run (management practices) leads to a higher level of quantifiable Human Impact.

Linking impact and practices to profit

Leading companies are very systematic about being sustainable and seeking human impact and profit. A compelling vision with a timeline and a target focuses the enterprise. Then, a scorecard of leading indicators quantifies the impacts that can be linked to profit. Accountability is ingrained in the enterprise and decisions are judged by HIP criteria. Leaders who embed these management practices tend to correlate with, and drive, higher impact. These impacts link to higher business value.

Next week, we show how a HIP approach that equates impacts to the financial statements can increase profit on the income statement, boost net worth on the balance sheet, improve overall cash flows, and stimulate higher demand from investors—especially those that are HIP.

To navigate this series, please use this table of contents.

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HIP Investor supports Spring of Sustainability.  For three months, the Spring of Sustainability will feature 100 “stars” of sustainability, from Jane Goodall to Bill McKibben to Van Jones, in free interactive teleseminars throughout the spring of 2012. Live events will also be held in cities across the globe.

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R. Paul Herman is CEO and founder of HIP Investor Inc. Herman is the author of “The HIP Investor: Make Bigger Profits by Building a Better World,”  published by John Wiley & Sons in 2010. Herman is a registered representative of HIP Investor Inc., an investment adviser registered in California, Washington and Illinois.

NOTE: This feature, excerpted and adapted from the HIP book, is not an offer of securities nor a solicitation. The information presented is for information and education purposes, and is not an investment recommendation. Past performance is not indicative of future results. All investing risks losing your principal. The author may invest in the companies mentioned above, and several are included in the HIP 100 Index portfolio. Details and full disclosures are at www.HIPinvestor.com

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