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Sustainability Challenges Shaping Competitive Advantages in Technology and Innovation

  • Hakan LuciusEmail author
Living reference work entry
Part of the Sustainable Development book series (SD)

Abstract

How do sustainability challenges shape the competitive behavior of corporations? Does investing in sustainability actually pay off? The chapter studies the current state of the world in terms of its environmental limits, reaching from climate change to biodiversity. It highlights population growth as the main driver for exceeding some environmental planetary boundaries and makes the link to the type of technologies currently used. The case is made that no country which enjoys high standards of living appears to be living within its environmental limits. Given forecast rapid population growth and the legitimate drive to raise standards of living for all, the need for technological change and innovation is presented in a new dimension. The traditional approach to innovation and competitive advantages is analyzed and the necessity to integrate sustainability into the methodologies is stressed. It is shown that the integration of sustainability into the core business strategy of a corporation is becoming a determining factor for future competitive advantage. Two examples, one from the automotive sector and one from the consumer goods sector, are provided. Furthermore, the key challenge in measuring environmental and social performance is highlighted and current developments presented. The integration of the materiality aspect by the Sustainability Accounting Standards Board is crystallized as a key milestone in sustainability accounting. Finally, the case is made that sustainability does create financial outperformance.

Keywords

Corporations that integrate sustainability into their core strategy are the winners of tomorrow Technological change and innovation is absolutely necessary to tackle the sustainability challenge Measuring the sustainability performance of a corporation remains a challenge Sustainability accounting standards based on materiality are a promising way forward Sustainability outperforms financially Corporate responsibility Carbon-free economy 

Introduction

The objective of the chapter is to highlight the connection between current technologies and the environmental limits of the planet while demonstrating how sustainability shapes competitive advantages. The sustainability challenge is explored in part 1. The planetary limits are outlined, and climate change and biodiversity are provided as examples. Sustainability is then defined as a common denominator guiding the entire chapter. Part 2 demonstrates that it is not possible with today’s technologies to live within environmental limits and to enjoy high standards of living at the same time. The consequences of this finding are transposed into the model of technological change and innovation in part 3, with the implications for competitive advantages of corporations. Two cases further underpinning the argument are provided for in part 4.

Given that management requires measurement, the measurement challenge of environmental and social performance lies at the heart of part 5. A way forward through Sustainability Accounting Standards is proposed thereafter, in part 6. The case of financial outperformance through sustainability is concludingly made in the past part, 7, before wrapping up the encouraging findings in the conclusion. Corporations that have sustainability at the heart of their business strategy are best placed to become the winners of tomorrow.

The Sustainability Challenge

The key driver to today’s sustainability challenge is the size and growth of the world’s population. With more than 7 billion inhabitants, the planet is populated with more people than ever before in human history. One hundred years ago, the total world population was estimated around 1.8 billion people. Quadrupling in only about three generations, the world has experienced the largest absolute growth ever in the number of people populating the planet. We have grown by more than five billion in only one century. This has never happened before. And the growth is set to continue, albeit with a flattening out over the next 100 years or so. The United Nations population forecasts are clear. The current world population of 7.3 billion is expected to reach 8.5 billion by 2030, 9.7 billion in 2050, and 11.2 billion in 2100 (United Nations 2015).

With this unprecedented number of people living on the planet, the rate at which we use resources to sustain our living is equally unprecedented, albeit very unequally distributed around the globe. The rate at which we altogether consume water, be it for home use, agriculture, or industry, the amount of space we take up for our living, and the rate at which we altogether utilize energy, just to name a few, are higher than ever before. We utilize resources at a high pace and have an unprecedented impact on our environment, on our planet. The use of resources and their impacts are multiple and complex; they go well beyond water, land use, and energy. The impacts on the climate, inducing a gradual and clear change, have reached higher levels of awareness among the larger public, but the effects on, for example, biodiversity, ocean acidification, or the nitrogen cycle are much less widely known. Yet, we may have reached rates of utilization, which could be above those which the planet is able to regenerate. And we may have surpassed those limits in some areas. The State of the World Atlas (Smith 2012) gives a good overview, including those aspects for which we do not have measurements, such as for aerosols or chemical pollutants. However, for those areas for which we do have estimates, it is clear that, altogether, the human population has surpassed the “limits of safe operating levels” in the areas of climate change, biodiversity, and also the nitrogen cycle. On local level, effects such as water shortages or others compound the sustainability challenge even more.

Climate Change

Climate change is driven by the amount of greenhouse gases that we emit at a rate into the atmosphere that is higher than the ecological systems’ ability to absorb these. As we are emitting faster than the planet’s capacity to absorb, the absolute amount of greenhouse gases in the atmosphere rises. As the amount of greenhouse gases rises, these trap more and more of the radiation that comes from the sun and enters the atmosphere. At current levels the amount of greenhouse gases, measured in CO2 equivalent in our atmosphere, has surpassed the 400 parts per million (ppm) mark (NASA 2017). This level is much higher than any level that could be measured for the past tens of thousands of years. While levels were fluctuating in preindustrial times as well, they seem not to have exceeded 280 ppm. The most current measurements at some 405 ppm are a category higher than any level measured, such as through borings in Antarctic ice, since any moment of the existence of the Homo sapiens, the modern human.

The effects of the elevated levels of greenhouse gases are very tangible. It is calculated that the rise in the average world temperature since 1880, which is when we started to have reliable worldwide data, is at 0.94 °C, or 1.7 °F. This rise has most visibly led to a melting of glacial and polar ice. The arctic ice sheet has shrunk to its smallest surface in 2012 with less than 4 million square kilometers, which is well below the minimum levels of 6 million square kilometers measured before 2000. The average reduction of the arctic ice coverage is calculated at 13.3% per decade. As glacial ice and Antarctic ice are also melting and getting less, a rise in the sea level can equally be observed. The total rise of the average, global sea level since 1970 is 17.8 cm, and the rate of rise is 3.4 mm per year, with a margin of error of 0.4 mm, since 1993 (NASA 2017). The impacts are already felt. Cities such as Miami and Florida, USA, have to deal with water coming out of the stormwater collection systems and with inundations of some roads during high tide. The city of Arles, at the Bouche de Rhône in France, located at sea level where the Rhône river flows into the Mediterranean Sea, has already changed its building code and requires that all new buildings have to be built higher than before. A building built today is most likely to stay for some 50 and 100 years or even more. At that time, it should be able to withstand the higher sea level, given today’s measurements and trends.

Melting ice and increasing sea levels are only two of the direct effects of climate change; many more direct and indirect effects take place. These range from increased frequencies of extreme weather events, hurricanes, floods, heat waves to changing patterns in agriculture, higher risk of disruption of supply chains, to the need to recalculate insurance premiums. The necessity to adapt to the effects of climate change and to mitigate its causes is imminent.

While there are numerous sources of greenhouse gas emissions, a major one is the use of fossil fuels. Our economic activity is closely tied to their utilization. Any modern commercial transport uses fossil fuels. Any commercial plane that flies uses kerosene, any truck that runs uses diesel fuel, and any commercial ship that crosses the seas uses fossil fuel. Electricity production is also heavily based on fossil fuels, despite the steadily increasing share of renewables. Coal is a major source of energy for electricity production, gas equally so. While we utilize fossil fuels pretty much whenever we turn on the lights, or have any goods transported, the use of fossil fuels is even more far reaching. In areas which do not directly appear to be linked to fossil fuels, we do depend on them. For example, the price of bread is influenced by the price of oil. This is due to the fact that the use of fossil fuels is part of the agricultural cycle. In today’s world the growing of wheat and the production of bread require machinery, not least agricultural machinery and trucks to transport these. The use of fossil fuels is very tightly knit into our current economic fabric.

We are clearly utilizing fossil fuels, creating greenhouse gas emissions, at a rate higher than can be absorbed by the planet, causing a net increase in the levels of these gases in the atmosphere. In answering the question up until which level we can go to while keeping the planet relatively safe, with foreseeable and manageable climate change effects, the consensus is that this level is one of an increase of 2 °C of the average global temperature, compared to preindustrial levels. This is the temperature increase that is expected when approximately 1000 gigatons of CO2 equivalent of greenhouse gases are added to the atmosphere. Currently, some 500 gigatons have already been emitted, leaving another 500 gigatons that can be emitted without significantly exceeding the 2 ° warming threshold. This logically requires that no more greenhouse gases are added to the stock in the atmosphere thereafter, requiring a very low carbon or even carbon-free economy in the future.

Given the dependency on fossil fuels of most of our current technologies, and of our economic activity, becoming carbon-free will necessitate significant technological change . While some technologies already exist and only require further rolling out, such as electric vehicles powered from renewable energy supplies, numerous others need major development. Any aerial transport, maritime shipping, or heavy goods’ transport is waiting for feasible technological advances, if not breakthrough technologies, together with their related diffusion and widespread utilization, displacing the fossil fuel-based ones.

Biodiversity

The world is rich in diversity of species. The total number of species is hardly known, and numerous new ones are being discovered. Yet, it is possible to track many of the known ones. The World Wide Fund, WWF, is closely watching our biodiversity. It has developed the Living Planet Index, which is a “composite indicator that measures changes in the size of wildlife populations to indicate trends in the overall size of biodiversity.” The index allows to track the number of terrestrial, marine, and freshwater species since 1970 and covers species of mammals, birds, amphibians, reptiles, and fish. In the period from 1970 to 2008, the index for terrestrial species has decreased by 25%, for marine species by 22%, and for freshwater species by 37% (WWF 2012). Many species have become extinct, with the current rapid loss of species being estimated by experts to be between 1000 and 10,000 times higher than the expected or “natural” extinction rate (IUCN 2017).

The variety of species and the ecosystems play an important role and provide many economically beneficial services to us. These cover most obvious benefits such as pollination, water cycling, soil formation, nutrient cycling, and many others. If these were not provided by nature, they would have to be provided for in the form of services, assuming that humans can replace these services effectively. To give an order of magnitude of the value of these services provided for free of charge by ecosystems, the International Union for Conservation of Nature (IUCN) in Gland, Switzerland, has estimated their economic value. The estimate is that these services would have a monetary value amounting to some 33 trillion US dollars per year. This is more than twice the GDP of the United States of America, or roughly equivalent to half of world GDP (Worldbank 2017).

The loss of biodiversity due to human activity poses a major sustainability challenge. The strongly elevated rate of loss of species and the reduction of wildlife population, together with the degradation of ecosystems, are a major risk. The long-term effects on the wider economy in general and for corporations’ operations in particular are just starting to emerge. And the magnitude of the impact could be most significant.

Defining Sustainability

The concept of sustainability can be understood within differing frameworks by varying actors. A common understanding of the term on a global scale was set by the United Nations World Commission on Environment and Development. The commission was set up in 1963 and gathered the views and opinions of very many stakeholders from around the world. Its work culminated in its final report in 1987, Our Common Future.

Chaired by the former prime minister of Norway, Gro Harlem Brundtland, the commission fundamentally determined in its report that “Many present efforts to guard and maintain human progress, to meet human needs, and to realize human ambitions are simply unsustainable - in both the rich and poor nations. They draw too heavily, too quickly, on already overdrawn environmental resource accounts to be affordable far into the future without bankrupting those accounts. They may show profit on the balance sheets of our generation, but our children will inherit the losses. We borrow environmental capital from future generations with no intention or prospect of repaying. They may damn us for our spendthrift ways, but they can never collect on our debt to them. We act as we do because we can get away with it: future generations do not vote; they have no political or financial power; they cannot challenge our decisions.”

The report further determines sustainability as meeting “… the needs of the present without compromising the ability of future generations to meet their own needs” (United Nations 1987). This seminal report defined the term sustainability in an unequivocal way and paved the path for its widespread utilization. The term is coined from a resource utilization point of view; it is rooted in the environment. Yet, it is equally intertwined with the people that use those resources; it has a clear social aspect. Very often sustainability and social responsibility are used interchangeably. In a corporate context, the terms Corporate Social Responsibility, CSR, or just Corporate Responsibility, CR, as well as Sustainability, or Sustainable Development are used almost as synonyms. For those who evaluate or analyze corporations, the aspect of governance is often added to the environmental and social considerations. Putting the environment, social, and governance aspects together is then referred to as ESG and is similarly used in an interchangeable manner with the term sustainability and its related terms: CSR , CR, and Sustainable Development .

Living a Good Life, Sustainably and Altogether

The aspiration to live a decent life, in good conditions, can fairly be assumed to be a general wish of all people. Such a good life need not only be dependent on a high income; its dimensions would also be of nonmonetary nature. In its Human Development Index, the United Nations Development Programme has addressed this question and has put together the Human Development Index . The index classifies countries not only according to their per capita income but also according to nonmonetary measures, such as longevity or levels of knowledge. The index ranges from zero to one, with zero being the lowest and one the highest level of human development. No country is at zero or one, but all are in between, ranging from 0.19 to 0.94. One could reasonably assume that being at an index level of 0.8 or higher can be seen as a good, decent life at higher living standards. Figure 1 below gives an overview of the world according to the Human Development Index. The darker the green color, the higher the level of the Human Development Index (United Nations Development Programme 2016).
Fig. 1

The world mapped according to the Human Development Index (Source: United Nations)

The key question is whether attaining the higher level of the Human Development Index is possible while living within environmental limits. To answer this question, we need not only know whether or not the people in a given country are enjoying a higher level of living standards and thus are at a higher level of the Human Development Index but also whether they are living within environmental boundaries, within sustainability limits. Is their ecological footprint above or below the corresponding biocapacity limits of their country? We therefore need a proxy measure of the limits of sustainability, i.e., the equilibrium between the ecological footprint and related biocapacity, per country. This measure is provided for by the Footprintnetwork and is based on the unit measure of the global hectare. Specifically, “The Ecological Footprint is the only metric that measures how much nature we have and how much nature we use. Ecological Footprint accounting measures the demand on and supply of nature. On the demand side, the Ecological Footprint measures the ecological assets that a given population requires to produce the natural resources it consumes […] and to absorb its waste, especially carbon emissions. […] on the supply side […] biocapacity represents the productivity of [a country’s] ecological assets. These areas, especially if left unharvested, can also absorb much of the waste we generate, especially our carbon emissions. Both the Ecological Footprint and biocapacity are expressed in global hectares—globally comparable, standardized hectares with world average productivity” (Footprintnetwork 2017).

On a worldwide level, the global hectares available per capita were around 4 global hectares in 1961. By 2007 this had decreased to 2 global hectares per capita. This reduction is mainly due to population growth. In 1961 the world counted some 3.1 billion inhabitants. By 2007 this number had more than doubled to 6.6 billion, accounting for the best part of the reduction by half of the availability of global hectares per person. The fact that it had not gone down fully proportionally to the population growth, and therefore by more than half, is due to technological improvements and efficiency gains, allowing for better use of resources.

To see the correlation between the level of human development and the ecological footprint of a country’s population, one needs to plot these two dimensions against each other. This provides us with a superb proxy of sustainability per country. Figure 2 depicts countries’ consumptions versus their Human Development Index.
Fig. 2

Countries’ consumptions measured in global hectares versus their Human Development Index (Source: European Environment Agency, Footprintnetwork, UN)

There are a number of countries that have a human development level higher than 0.8, which can be considered a good life. There are also many countries below 0.8, ranging as low as 0.19. In terms of living within sustainable limits, a significant number of countries’ consumption is below the worldwide average of 2 global hectares available for each person on this planet. A significant share of countries, however, consume much more than they can replenish, even four to five times more.

The first striking insight is that all countries that live within their environmental limits are below 0.8 on the Human Development Index scale. The second striking insight is that all countries which are above 0.8 on the Human Development Index are exceeding their environmental limits. The green rectangle which depicts the area of high living standards within environmental limits is completely empty. No country lives within environmental limits and enjoys high standards of living! It appears that with our current economic model based on our current technologies, we are unable to conduct a good life and to live sustainably at the same time. This has profound implications, for both, those at a higher Human Development Index levels and those who would like to achieve them. Going back on living standards is no option. We need to further progress and enable higher standards for all while respecting environmental limits. This can only happen through technological change and innovation.

Implications for Technology and Innovation

Let us recall that the world population is set to increase further from today’s unprecedented levels to some 9.7 billion by 2050. At the same time, a higher share of that population is set to enjoy higher standards of living. Especially the middle class is a keen consumer of goods and services. At the end of 2016, it is estimated that there were about 3.2 billion people in the middle class, and this number is increasing significantly: “… in two to three years [from 2017] there might be a tipping point where a majority of the world’s population, for the first time ever, will live in middle-class or rich households. The rate of increase of the middle class, in absolute numbers, is approaching its all-time peak. Already, about 140 million are joining the middle class annually and this number could rise to 170 million in five years’ time” (Kharas 2017). The increase of the middle class and the related higher standards of living enjoyed by those people are, by itself, a welcome development. And it would be even better if everyone were to enjoy better living standards and poverty were eradicated.

However, catering for higher standards of living for more and more people, while respecting the planetary boundaries without “compromising the ability of future generations to meet their own needs,” is not possible with today’s technologies. No single country currently lives within its limits of sustainability and enjoys a high level of human development at the same time. To enable the further progress of all people, whether more or less developed, whether current or future, there must be further technological development and innovation that enables the current and the next generations to live well. Exceeding our natural limits is a constraint, but it also is a clear opportunity. For those who see the challenge, it is an opportunity to drive technological change and innovation through sustainability.

Competitive Advantage

The traditional approach to competitiveness and industrial policy views technological change as the main driver for innovation and growth, while market forces determine the competitive strategy and positioning. Technology is driven by discoveries and research. First, base technologies are discovered, such as the electricity, the combustion engine, the semiconductor. These base technologies lead to developments based on that technology. The semiconductor allows for miniaturized electronic switches that allow computational technology, which over time spread through the world and through innumerable applications from almost any mobile device, machine to telecommunications and smartphones, transforming our lives. Such base technologies’ discovery and subsequent spread are long-term phenomena and may take decades and generations (Lucius 1995). Their effect is lasting; if not replaced by another technology, they remain for centuries. The combustion engine invented at the end of the nineteenth century replaced the steam engine due to its higher efficiency and technological superiority, providing for economic gains, but has remained unchallenged since then. At the beginning of the twenty-first century, it is still omnipresent and is the single most used source of propulsion and transport. No new technology has replaced it (Porter and Kramer 2003; Scherer 1986).

Rivalry and free market competition are seen as main engines for innovation and industrial development. In its seminal work, Porter outlines fives forces that determine the competitive advantage of companies (Porter 1990). Intra-industry rivalry is at the center of the model, which is the first of the five forces. Bargaining powers of suppliers and of buyers (forces two and three) further add to the forces shaping competitive advantages. Furthermore, there are threats. One major threat is that of new entrants into the industry, new competitors (force four), and another is the threat of substitutes (force five), be it product substitutes or process substitutes, which can change or even disrupt the competitive positioning of the industry’s players. This approach does not take sustainability into account, however. It presumes that business as usual is possible, without ever reaching environmental limits. With the current unsustainable consumption of resources, many industries will not be able to maintain business as usual. Their own activity and their use of resources will cause a shift over time requiring technological change due to the sustainability challenge. A fossil fuel company cannot maintain its position in the industry, even if all other factors remain the same. Either its wells or mines will run dry, necessitating exploration of new sources, or the impact of the fossil fuel consumption will render the sector unfeasible because the consumption itself has changed our environment. What has worked well for an industry 30 years ago may not work in the next three decades. The operating environment changes because of the industrial activity itself; and those players in the industry that innovate and adapt their technologies accordingly will be the winners of tomorrow. It is them who will gain competitive advantage; and they will do so by mainstreaming sustainability into their business strategy.

Case 1: Automotive

The automotive industry relies on the consumption of fossil fuels. Its main product, the automobile, is based on the technology of combustion engines as a means for propulsion. It is evident that this means for propulsion is not sustainable. Yet, the reactions of various players in the industry vary. A good example can be drawn from a major Japanese manufacturer. Back in the mid-1990s, this manufacturer started with the development of a hybrid technology for its vehicles. This technology combines combustion engines with electric ones, saving the otherwise wasted energy when braking or driving downhill in a battery, which in turn supplies the electric engine. Such an approach brings significant energy savings and reduces the consumption of fuel. At the time of the development of this technology, oil prices were at 10 dollars per barrel, much lower than the levels of 50 dollars seen 20 years later, and not to speak of 100 dollars or more which had been reached in between. At the time of the development, the technology appeared misplaced, but did prove to be highly appropriate within a sustainability context, giving the manufacturer a major competitive advantage (Toyota 2017).

Today, the same manufacturer has developed a hydrogen car, which does not consume any fossil fuel at all. It is based on the technology of the fuel cell, converting hydrogen from the vehicle’s tank and oxygen from the air into water only. It runs completely free of greenhouse gas emissions and is based on a sustainable technology. However, as of today there are barely any hydrogen fuel stations around the world to refuel the vehicle, and for that reason, it can hardly be sold. As a seemingly economic failure, to some the development may indeed appear as misplaced today, as did the hybrid technology appear 20 years ago. The same manufacturer however “plans to all but stop making carbon emitting cars by 2050” (BBC 2015). This corporation depicts a very good example of integrating sustainability into its operational strategy. It drives technological change and innovation with sustainability at its heart, thereby gaining a clear competitive, long-term advantage.

Case 2: Consumer Goods

A major Dutch-British transnational consumer goods company co-headquartered in Rotterdam, and London is serving some 2.5 billion people around the world daily. Its products include food, beverages, cleaning agents, and personal care products. The company is perfectly aware of its impacts on the environment and the people, as well as the resources that it consumes to satisfy its customers’ needs. The increasing resource scarcity and lack of sustainability are high on its agenda. The company acknowledges that “Increasing resource scarcity means it is more urgent than ever to be efficient with packaging and find solutions (…).” It has embarked on a large-scale effort to reduce its use of resources per product produced by about 2008. At the same time, it has also taken into account the waste side of its operations and products. By 2016 it stated, for example, that “Water abstraction reduced by 37% per ton of production compared to 2008” and that by February 2016 over 600 of its sites around the world had achieved zero nonhazardous waste to landfill. Going forward it aims at sourcing 100% of its energy used within its operations from renewable sources by 2030 and to generate more renewable energy than it consumes. It now states: “By 2030 our goal is to halve the environmental footprint of the making and use of our products as we grow our business” (Unilever 2017). The corporate’s approach to sustainability is embedded in its business strategy, and its product and process innovations are centered around sustainability considerations, providing the corporate with a long-term competitive advantage.

The Measurement Challenge

“No management without measurement” is a common management maxim. It requires that good management is based on measurement of outputs and/or inputs, to be able to allocate resources effectively. Measuring and accounting environmental and social outputs and impacts of a company’s operations is particularly challenging. In today’s corporate world, financials are well measured. We have financial statements, or consolidated financial statements if it is a group of companies, we have profit and loss statements reflecting the financial flows of a company over a defined period of time, and we have the balance sheets which state the financial position of a company at a given point in time, most often at year end, and even cash flow statements. In the history of accounting, many strides have been made to develop these measurements. Accounting standards and systems have been developed; the entire industries of professionals in the accounting, standard setting, and auditing areas have grown and thrived. Financial statements are an essential and integral part of corporate life. Yet, all these systems measure financial performance only. Despite their complexity and intricacy, they solely give information about the financial situation of a corporation; they do not divulge any meaningful information about the state of the company’s performance in terms of its effects on the environment or on people. These two areas lag hugely behind the measurement of that of financial performance .

There are international efforts to address the issue. The Global Reporting Initiative (GRI 2017), a voluntary set of environmental and social standards for the reporting of nonfinancial statements, has been developed to guide companies in the disclosure of their environmental and social performance. The Social Performance Task Force is a voluntary gathering of microfinance professionals, who have come together exactly for the purpose of developing a common set of reporting standards in the social area (SPTF 2016). The United Nations Principles for Responsible Investment have put together the reporting requirements in terms of environmental and social reporting for financial institutions. Set up in 2005, the UNPRI have gathered more than 1200 signatories in only a decade, reflecting the momentum gathered in the area (UNPRI 2016). Also, on the regulatory side, developments are remarkable. The French Law on Energy Transition (Loi sur la transition énergétique), in its article 173, requires that all listed companies shall disclose, in their annual reports, financial risks related to the effects of climate change and measures adopted by the company to reduce those risks. It specifies that the report issued should also include an aspect on the risks and impacts of the company linked to climate change, not only concerning its own operations but also concerning its services and products. Furthermore, institutional investors such as asset managers, public institutions, and public pension funds shall include in their annual report information on how their investment decision-making process takes environmental, social, and governance criteria into consideration, and the means implemented to contribute to the financing of energy transition, as well as the climate change risk exposure and the carbon emissions of their portfolio/assets. The law was enacted in 2015, and came into force as of 2016, with the first reports to be issued as of 2017 (French Law 2015; Lucius 2013).

All these developments bode well for the future; they depict an accelerating trend toward reporting on nonfinancial aspects by corporations and financial institutions. Yet, we are far away from having a comparable set of indicators and measurements, which allow evaluating and, most importantly, comparing economic actors’ performances in the environmental and social areas.

Sustainability Accounting Standards

The lack of comparable and comprehensive accounting standards for the nonfinancial aspects of economic actors’ activity is recognized as a major hurdle in tackling the sustainability challenge. A promising initiative to overcome that challenge is the sustainability accounting standards, developed by the Sustainability Accounting Standards Board (SASB 2016). A not-for-profit organization, based in California, the SASB was established in 2011 with the aim of establishing a comprehensive set of measurements, which could be applied to all major sectors of economic activity and which would enable cross-company comparison. A methodology was devised capturing nonfinancial performance within five areas: (i) the environment, (ii) human capital, (iii) social capital, (iv) business model and innovation, and (v) leadership and governance. This division largely follows the more generally accepted disaggregation of nonfinancial aspects into the environment, social, and governance, i.e., ESG, aspects, mentioned earlier. The methodology of SASB does, however, go a step further than the ESG approach by subdividing the social and the governance aspects. The social dimension is split into two: the human capital, which captures a corporation’s own staff, its human resources, and the social capital, which refers to all other persons related to the corporation, i.e., the stakeholders in general, including all those that are affected, positively or negatively, by the actions of the corporation. The governance aspect is equally subdivided into two, the business model, which captures the operational, workflow-related aspects of the corporation and leadership and governance, that refers to the higher-level managerial approaches, strategies, and general orientations decided by top management. The environmental aspect is not further subdivided and remains as one single area. All these five areas and their more detailed subheadings, covering a total of 30 issues, ranging from greenhouse gas emissions to supply chain management are applied equally to all sectors. Sectors are defined around larger categories, such as transportation, financials, renewable energy, services, etc., with a total of ten sectors. Each sector is then further disaggregated to account for the variety of different industries. For example, renewable energy distinguishes between solar, wind, biofuels, fuel cells and industrial batteries, forestry and logging, and pulp and paper. A total of 79 industries are defined.

The major innovation in the approach of the Sustainability Accounting Standards Board is the distinction between material and immaterial issues. It recognizes that not all issues are equally material for all industries and that some issues that may be material for one industry may well be immaterial for another. For example, the emission of greenhouse gases is highly material for the cement industry or for the automobile industry. Both are energy-intensive sectors. However, in the services sector, for the operating of hotels, for example, the emission of greenhouse gases is not material. Hotels would not emit significant amounts of greenhouse gases, and their supply of energy would be more dependent on the offer of available utilities rather than their own choices. The greenhouse gas emission issue would therefore be immaterial for hotels. However, hotel operators’ relationship with their own staff, being a labor-intensive industry, would be material. The issues are mapped accordingly, across sectors and related industries, reflecting whether they are material or not for each industry. This approach enables to focus on what is important in terms of environmental, social, and governance aspects for each industry and provides for a major step forward toward a common framework to establish meaningful sustainability reporting standards.

Sustainability Outperforms

The concept of materiality guides us in determining whether sustainability outperforms financially. In their research “Corporate Responsibility : First Evidence on Materiality,” Serafeim et al. from Harvard Business School have taken materiality as the basis for their analysis of corporations’ financial performance. They have analyzed more than 1000 corporations over a period of 10 years, and some 200 over a period of 20 years, depending on data availability. The underlying tool was the materiality map of the Sustainability Accounting Standards Board, which determines which aspects of a corporation’s sustainability performance are material with respect to their industry. The performances of material and of immaterial aspects are then evaluated and categorized as strong or poor. Having conducted the research in 2015, the study covers the health care, finance, communication and technology, nonrenewable resources, transportation, and services sectors, as at that stage materiality maps were only available for those (Serafeim et al. 2015).

The findings are encouraging. Corporations that have demonstrated a poor performance on both material and immaterial aspects have equally had a poor financial performance in terms of their stock market returns, reflected in a negative alpha of minus 2.90%. Those corporations that showed a strong performance on their immaterial aspects while poorly performing on material aspects had a slightly positive alpha of 0.60%, demonstrating that a good sustainability performance even if only for immaterial aspects had no negative effect on the stock performance. A strong performance on, both, material and on immaterial aspects, however, was better, with an alpha of 1.96%. However, a strong performance on material aspects only, i.e., with a poor performance on immaterial aspects, identified the companies with the strongest financial returns with an alpha of 6.01%. These companies were focused; they were placing their efforts on issues that were material to them and yielding a strong performance. Sustainability was at the center of their business operations, leading to superior financial returns.

Conclusion

Many current technologies are unsustainable. It is not possible to remain within environmental limits while enjoying high standards of living as in some countries that have a high Human Development Index. We are meeting our current needs while compromising the ability of future generations to meet their own needs. Technological change in innovation is therefore indispensable to tackle the sustainability challenge. Growing worldwide population is further accelerating that need. Industrial policy and models for innovation and competitive advantage have to be adapted accordingly. Those corporations which have embraced the sustainability challenge and have integrated it into their core business strategy are gaining a competitive advantage and are best placed to be among the winners of tomorrow.

Measuring sustainability performance remains difficult, and a comprehensive framework allowing for comparison among companies and sectors is needed. The Sustainability Accounting Standards based on materiality by the Sustainability Accounting Standards Board are most promising. Going forward policymakers need to integrate sustainability in industrial policy while simultaneously furthering and mainstreaming the related measurement accounting framework. Finally, latest research based on materiality demonstrates that companies which have strongly performed on material sustainability issues have also financially outperformed.

References

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Copyright information

© Springer Nature Singapore Pte Ltd. 2017

Authors and Affiliations

  1. 1.European Investment BankLuxembourg CityLuxembourg
  2. 2.INSEADLuxembourgLuxembourg
  3. 3.SciencesPolitiquesParisFrance
  4. 4.Welch College of BusinessSacred Heart UniversityFairfieldUSA

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