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The Return on Sustainability Investment (ROSI): Monetizing Financial Benefits of Sustainability Actions in Companies

Abstract

Practitioners and researchers struggle with valuing the return on sustainability investment (ROSI). We apply a five-step methodology that systematically monetizes sustainability actions to answer a key question: Do sustainable practices lead to a positive financial return for the business? We demonstrate the versatility of this methodology by monetizing potential and realized financial benefits via mediating factors (i.e., financial drivers) across two types of industries: Brazilian beef supply chains that committed to deforestation-free beef and the automotive industry, where companies were working to make manufacturing operations more sustainable. The companies participating in our cases generated substantial value from implementing sustainability strategies. The beef supply chain yielded a potential net present value (NPV) between 0.01 to 12% of annual revenue, depending on the supply chain segment. For one automotive company, the five-year NPV based on realized benefits was 12% of annual revenue. Our ROSI methodology guides managers to better value sustainability’s financial benefits. Ultimately, monetizing sustainability can lead to a competitive advantage and shared value for multiple stakeholders.

Keywords

  • Monetization
  • Corporate sustainability
  • Strategy
  • ESG
  • Financial performance

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Fig. 14.1
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Fig. 14.3
Fig. 14.4
Fig. 14.5

Notes

  1. 1.

    The download link is at the bottom of the page: https://hbr.org/2017/09/how-to-quantify-sustainabilitys-impact-on-your-bottom-line.

  2. 2.

    The Excel download link is available at http://bit.ly/rosi-auto and on the CSB website.

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Acknowledgements

This research was originally published in Atz, U., Van Holt, T., Douglas, E., & Whelan, T. (2019). The Return on Sustainability Investment (ROSI): Monetizing Financial Benefits of Sustainability Actions in Companies. Review of Business: Interdisciplinary Journal on Risk and Society, 39(2), 1–31.

This paper has been selected to receive an honorarium underwritten by Munich Re, a leading advocate of sustainable business strategies.

This research was funded in part by the Investindustrial Foundation and the Gordon and Betty Moore Foundation. We thank Bruno Zappa and Rodrigo Zeidan for their contributions in the deforestation-free beef project. For part of the work, we also received pro bono support provided by AT Kearney.

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Correspondence to Ulrich Atz .

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Appendices

Appendix A: Implementing Monetization Methods Illustrated with an Example

The details of all calculations for the first case study (beef supply chain) are available in a spreadsheet for download (Whelan et al., 2017).Footnote 1 For the automotive industry, we released only the spreadsheet templateFootnote 2 because of the confidential nature of internal company data. To guide practitioners further on how to implement their own ROSI analysis, we walk through one example, conflict materials, from Table 14.3. Risk Reduction Strategies (below).

Excerpt from Table 14.3. Risk Reduction Strategies

Strategy # Benefits Mediating factors Monetization methods
Avoid use of conflict materials 1 Savings from reduced use of conflict minerals Higher operational efficiency Spend reduction on conflict minerals derived from multiplying the per cent reduction in amount of conflict minerals per vehicle by the annual volume of conflict minerals used. Reduction due to less use of conflict minerals multiplied by the weighted average price of conflict minerals
2 Lower costs associated with substitute materials Reduction in conflict minerals due to substitute product multiplied by the conversion rate and by the cost differential in price of material
3 Savings related to lower energy consumption using substitute materials The sum of:
(i) the savings from a reduction in use of conflict minerals derived from multiplying the reduced material used by the weighted average spend on energy used in manufacturing using conflict minerals per ton; and
(ii) the saving from substituting materials derived from multiplying the material substituted by the differential in the weighted average cost of energy per ton using conflict minerals and the weighted average cost of energy per ton using substitute materials
4 Savings related to lower water consumption using substitute materials The sum of:
(i) the savings from a reduction in use of conflict minerals derived from multiplying the reduced material used by the weighted average spend on water used in manufacturing using conflict minerals per ton; and
(ii) the saving from substituting materials derived from multiplying the material substituted by the differential in the weighted average cost of water per ton using conflict minerals and the weighted average cost of water per ton using substitute materials
5 Avoided costs related to supply shortages Better risk management Estimated cost of a short supply incident by the average annual incidents of short supply
6 Avoided costs related to regulatory fines Estimated cost from multiplying the average annual number of incidents of conflict mineral related fines by the average fine per incident less additional compliance costs incurred

The U.S. Securities and Exchange Commission (SEC) had required publicly traded companies to annually report use of conflict minerals (tin, tantalum, tungsten, or gold) in their products (the rule was suspended in April 2017). Regardless, SASB, who standardizes voluntary disclosure, identifies the management of risks associated with critical materials in their materiality map. Automotive companies have worked towards this goal by, for example, signing a declaration of support for the Responsible Raw Materials Initiative or using algorithms to ensure tier 3 and 4 supplier compliance. In the manufacturing process, using less material for achieving the same output has obvious implications for improved resource consumption and using substitute materials may also lead to efficiencies. However, the latter is a less clear financial benefit as the substitute material may cost more or be required in larger quantities.

When companies avoided sourcing and using conflict minerals, they generated value through two mediating factors: operational efficiency and risk management. Operational efficiency benefits were a combination of savings from: (1) reduced use; (2) using cheaper substitute materials—both of which led to (3) lower energy consumption and (4) lower water consumption according to the companies. On the risk side, the benefits were: (5) avoided cost related to supply shortages, and (6) avoided regulatory fines. Above, the monetization method (last column) describes the following calculations. The calculations in Table A1 and A2 follow a similar logic: We gathered the realized inputs for 2015 and 2016, adjusted for vehicle production (so that a change is independent of how many cars were produced), and monetized the changes with average weighted cost.

Table A1 Reduction and substitutes for conflict materials sourcing (1, 2). Cells in yellow are company inputs. Note that substitution was a net loss and so the overall benefit resulted in $14,950,952. Figures were obscured with a random perturbance term to preserve confidentiality that maintained the scale in magnitude
Table A2 Savings for energy and water consumption impact (3, 4). Cells in yellow are company inputs. The overall benefit resulted in $593,181. Figures were obscured with a random perturbance term to preserve confidentiality that maintained the scale in magnitude

Table A1 and A2 show how we simplified calculations by using aggregate data. Other benefits, for instance, managing manufacturing material waste, were also included as a total category (by using the average weighted cost of disposal instead of breaking it down). Some analyses may require an even more granular level of data. If the mix of manufactured vehicles were to have an impact on year-on-year changes, including it would yield more precise estimates. Regardless of the level, however, the framework provides solid directional guidance for forecasting investments and likely outcomes.

Table A3 takes a simplified approach to assessing risk because of the overall complexity resulting from many sustainability strategies. The companies provided estimates for the incident rate and average cost for supply shortage and regulatory fines related to conflict minerals. We postulated that the sustainability strategies would mitigate the potential cost in the long-term. For a risk assessment approach, an extended analysis may choose to model the incident rate and cost as a distribution with, for example, a truncated lognormal distribution. The simulation outputs based on such parameters might then provide more than a point estimate and inform the analyst further on extreme values.

Table A3 Avoidance of short supply and regulatory fines (5, 6). Cells in yellow are company inputs. The overall benefit resulted in $21,321,739. Figures were obscured with a random perturbance term to preserve confidentiality that maintained the scale in magnitude

Tables A1A4 provided the information required to calculate the net financial benefit of the sustainability strategy. The annual additional operating income was $35,944,801 (i.e., $36,865,873 minus the cost of $921,072). Lastly, we wanted to know the value of these benefits if they were to continue over the next five years and calculated the NPV as shown in Table A5.

Table A4 Annual costs and investments for Avoid Use of Conflict Materials. Cells in yellow are company inputs. Figures were obscured with a random perturbance term to preserve confidentiality that maintained the scale in magnitude
Table A5 Net present value (NPV) analysis with an assumed discount rate of 10%. We conservatively assumed that all investments (including so-called one-time spends) accrued every year. The total NPV for this strategy over five years was $125,496,776. Figures were obscured with a random perturbance term to preserve confidentiality that maintained the scale in magnitude

Appendix B: How the Return on Sustainability Investments (Rosi) Framework May Be Applied in the Insurance Industry

Companies that focus on a sustainable business model and related risk management might incur short-term costs and investments, but benefit from mid- and long-term benefits. Some of the benefits materialize right away in reduced insurance premiums as underwriters ought to take the risk management of companies into consideration. Companies and their insurance coverage have similar interests to prevent potential losses, to mitigate losses, and to find innovative solutions. Investments in sustainable solutions have therefore a direct monetary impact as they will be reflected in reductions of insurance premiums. ROSI and its associated data can be used to provide transparency and can be applied in the underwriting process. Identifying, quantifying, and monetizing the value of these sustainability strategies can help insurers further understand how a company is mitigating material risks such as recalls for the automotive industry, which may be used, for example, in assessing price premiums (Table B1).

Table B1 Examples of how metrics captured in the ROSI may be used by insurers for underwriting and asset management

In Table B1, we list three sustainability benefits that were monetized in our study based on the automotive industry:

  • Water use reduction: Insurance companies are already modelling the growing risk of water, its cost implications, and how droughts and floods can both affect operations. We showed how to monetize the automotive companies’ efforts to improve water consumption, which affected the amount of water used, recovered and reused, and disposed.

  • Critical materials: The automotive companies aimed to reduce their dependency on critical and conflict minerals (e.g., tin, tantalum, tungsten, and gold, which have been regulated in the past). The ROSI metrics we used show how companies are either reducing or substituting critical materials, the scale of these efforts, and how they generated a positive net return because of reduced costs associated with the new approaches and the reduced risk from supply chain disruptions (see Appendix A).

  • Recalls: Recalls have been increasing in the automotive industry, and addressing recalls are material to the automotive industry (see the SASB materiality map). The ROSI metrics we used show the scale of the recalls and the associated cost for a recall. For example, in one company, recalls were reduced likely because they incorporated more systems thinking into the manufacturing process, so that the design process spanned multiple departments that were previously isolated in their sustainability efforts. The company’s ability to improve quality in manufacturing along with working closer with their supply chain partners, ought to mitigate the number of recalls. Insurers, during their due diligence, can ask clients about their manufacturing improvements, request that companies begin to track and monetize necessary information, or engage in a collaborative discussion on sustainability strategies that reduce risk exposure.

When a company monetizes its sustainability actions, others can evaluate how they are innovating and investing to minimize risk. People can see, and quantitatively value, robust contingency plans to mitigate future losses, and they can create opportunities for procuring cost-effective insurance coverage. Insurers may be able to capture insights into the long-term prospects of a company that are otherwise hidden. This is useful for assessing risk, gaining customer loyalty, and improving underwriting performance.

Insurance underwriting performance depends on appropriately assessing the risk profile of a company (and industry). The ROSI framework and associated data can enhance analyzing a company’s exposure to risks and the potential impacts of events that they are underwriting, such as catastrophe (floods, hurricanes), business interruption (supply chain disruptions), or product liability (recalls, accidents) losses. These analyses may also open the dialogue on what companies are doing to mitigate these challenges. For example, public company information on manufacturing and other critical locations can be mapped to drought-prone regions. Select ROSI data in our analysis, such as historical incidents in production disruptions or number of recalls along with the associated costs, can be the basis of forecast models that assess the likelihood and severity of losses under various future assumptions. Better assessments of probable outcomes and losses improves underwriting practices for insurers. Measuring the return of sustainability investment can contribute towards these improved practices and more sustainable businesses.

Originally published in: Sezgi, F., & Mair, J. (2010). To control or not control: A coordination perspective to scaling. In G. Dees, P. Bloom, & E. Skloot (Eds.), Scaling social impactNew directions in research (pp. 34–60). New York: Palgrave Macmillan.

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Atz, U., Van Holt, T., Douglas, E., Whelan, T. (2021). The Return on Sustainability Investment (ROSI): Monetizing Financial Benefits of Sustainability Actions in Companies. In: Bali Swain, R., Sweet, S. (eds) Sustainable Consumption and Production, Volume II. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-55285-5_14

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