you've got a great environmental strategy—now what?

You’ve Got A Great Environmental Strategy-Now What?

Marc J. Epstein

L ike most of your competitors, over the past few years you have developed a new corporate mission statement that includes

greater environmental sensitivity. Maybe you have set the tone at the top by committing your company to becoming the most environmentally sensitive in your industry. You might have even done as many others and recently issued your first corporate annual environmental report. But now what do you do? How do you integrate this new environmental sensitivity into product costing, capital budgeting, and product design systems? How do you provide the incentives necessary to motivate employees at all levels to be more sensitive and responsive to environmental issues?

After the recent spate of developments in corporate environmental strategies, companies have been struggling with how to integrate environmental management into their operations to reduce harmful effects and still keep costs down. Corporations are trying to control the skyrocket- ing environmental expenditures that for most large firms are in the hundreds of millions of dollars and, for many, exceed a billion.

Increasingly, business leaders recognize the contrast between the focus on minimizing compliance costs, including pollution control, and the innovation offsets resulting from pollution prevention and source reduction. These innovation offsets can easily exceed the costs of compliance if total costs and benefits are broadly and properly identified and measured. Such a focus on avoiding the production of waste so that money need not be spent cleaning it up is often accom- plished through a combination of capital, process, and product improvements-and often re- sults in “win/win” situations. As former Du Pont

CEO Ed Woolard maintains, “Congress can legislate, envi- ronmentalists can agitate, but only industry can innovate.”

Designing and implementing a new environmental strategy should not depend on changes in government leadership, government poli- cies, or the aggressiveness of regulatory enforcement. It should not depend on whether the federal government begins requiring cost- benefit analyses on new government regulations. Despite some effect from any such changes, the evidence is clear that improved environmental management is good business.

To examine how firms can better manage their impact on the environment, the Institute of Management Accountants initiated a large field study of corporate environmental management practices (Epstein 1996~). Based on an examination of the internal and external documents from more than 100 corporations as well as interviews or field visits to more than 30 of them, (1) the state of the art and (2) best practices of corporate environmental management were examined in each firm. Participants typically included senior corporate executives along with executives and Staff in operations, legal, accounting, finance, engineering, and environment, health, and safety (EH&S). The study concluded that the identification, measurement, monitoring, reporting, and management of corporate environmental effects are critical to the success of many corporations.

You’ve Got A Great Environmentd !%rategy-Now What? 53

Toward that end, tools and techniques are pres- ently available to vastly improve most corporate attempts in this area.

Implementing Corporate Environmentalism For Increased Profits

Corporate environmental costs have grown very large very fast and have caught most major corporations off guard. When costs were minimal, decisions on operating expenses and capital expenditures for pollution control or remediation equipment were made with a view toward regulatory compliance. But with the rapid increase in annual corporate environmental expenditures, companies should have responded by integrating the analysis of environmental impact into management decisions throughout the organization.

Unfortunately, most have not. They continue to relegate EH&S to a department that focuses on compliance and reports to the legal counsel. Environmental costs are still placed in various overhead accounts and arbitrarily spread to facilities and products, thereby masking the source of the expense. Most companies don’t even know their total environmental costs, making effective environmental management impossible. Legal costs related to environmental litigation and permit costs are often placed in corporate general and administrative (G&A) costs. Capital expenditures for pollution prevention and control equipment are often included as general property, plant and equipment (IV&E). which then depre- ciate and are never identified as environmental costs at all. Thus, carefully identifying and track- ing all environmental costs has often produced totals that are four or five times the estimates.

The tools for improved analysis do exist. Commonly used in other corporate functions, they now need to be transferred to the environmental arena. Polaroid has developed an Env- ronmental Accounting and Keporting System as part of a program that monitors and reports the rates of toxic use and waste generation for five categories of materials, including about 1,700 chemicals used at its facilities. The system provides information to assist in measuring progress toward waste-reduction goals. It also provides incentives for employees to reduce toxic waste. By identifying mercury as 3 poisonous material, for example, strong incentives were created to eliminate it from corporate use and redesign the batteries used in film packs. This attention on product and process improvements along with the use of less toxic alternatives has created substantial benefits for both corporate profits and the environment.

To provide incentives for employees to minimize environmental effects. Browning-Ferris In- dustries, the international solid waste disposal

company, has developed an environmental muiti- plier to use in determining bonuses. The amount of an employee’s bonus based on business-unit and other performance variables is multiplied by an environmental performance score. Employees receiving a score of 75 out of 100 on meeting the stated objectives receive only 50 percent of their bonuses. A score of less than 70 is considered unacceptable; a multiplier of zero is assigned and the entire bonus is lost. With such approaches, corporations can effectively transform their cul- tures and heighten the environmental sensitivity of employees at all levels.

In an attempt to move into a position of environmental leadership, Du Pant-which just last year spent $1.5 billion on environmentally related matters-uses a Corporate Environmental Plan to guide resource allocation decisions on the environment. The system measures both the costs and benefits of those expenditures to better allo- cate its resources. The company is trying to move toward a goal in which “environmental performance is truly integrated with business performance.” In doing so, it has been attempting to transfer environmentally successful technologies across business units.

Designing And Managing For Product Take-Back

The well-established Three Rs of environmental management are reduce, reuse, and recycle. But senior corporate executives are now overwhelm- ingly consistent in their recognition and agree- ment that the concept of “take-back” will be a more critical corporate issue in the next few years. This notion that corporations are responsible for ultimately taking ITack and disposing of their products, in addition to their production of waste. is already well established in Europe. Take- back often requires firms to think more broadly about future costs from current production. This often causes changes in product and process designs and substantially increases profitability. Design for disassembly makes it easier to put together and take apart products more cheaply. The returned products can then be recycled or reused for further cost savings.

Coordinating the design stnff and environmental staff at the beginning of product and process designs often dramatically reduces environmental impact. Those companies that have brought together members of the accounting, EH&S, engineering, operations. and legal depart- ments into environmental committees on a regular basis have substantially cut product and process costs and reduced environmental cleanup. It is often the first time EH&S communicates its assessment of the likely future impact of present and pending environmental regulations on com-

pany products and processes. Engineering, design, and operations can then consider design alternatives to reduce harmful effects, while the accounting and legal staff can consider the potential impact on measuring and reporting the environmental liability to external shareholders.

Life Cycle Assessment-A Useful Framework For Analysis

One of the most dramatic improvements in the decision analysis process is an increased use of life cycle assessment (LCA) and life cycle costing to better understand the financial and environmental effects of corporate products, services, and activities. LCA is the attempt to identify all environmental costs and benefits, both internal and external, associated with a process, product, or activity throughout all stages of its life for the company and its stakeholders. The product stages in the life cycle process include (1) raw materials acquisition, (2) manufacturing, (3) use, reuse, and maintenance, and (4) recycling and waste management.

Life cycle costing attaches a monetary measure to every effect of a product and projects likely future costs (and benefits). This is done much like the discounted cash flow (DCF) analyses that are so common in capital investment decisions and financial analysis. It allows companies to expand DCF to include environmental impacts in addition to the commonly included financial impacts.

Until recently, manufacturers were generally not concerned with the ultimate disposal of their products or post-consumer waste. Corporate management delegated to the consumer the task of determining how to dispose of a product safely. But the take-back principle has now shifted this burden back to the manufacturer. So costs must be determined or estimated, assigned to the products that generate them, and formally accounted for to ensure that products can be disposed of responsibly after their useful life. They must be traced properly so that product profitability can be understood and appropriate marketing and pricing decisions can be made.

To manage these costs better, managers must recognize the cost drivers. Using an approach such as activity-based costing, companies can define the activities, processes, and products that generate environmental expense. When the costs are properly identified, traced, recalculated, and arrayed, companies often find that some products have been underestimated and some have been overestimated.

Current environmental costs related to past production, those related to current production, and an estimate of future costs related to current production should all be estimated and included


in product costing and capital investment decisions. Though not all can be measured with pre- cision, managers must acknowledge that they do or will exist and that the number is substantially greater than zero. Including a best estimate of these costs in decisions helps define the likely future costs of present production and may illu- minate possible alternative courses of action available for minimizing present and future environmental effects and their related costs.

A total stakeholder analysis (including employees, suppliers, customers, society, the local community, the environment, and shareholders) should also be completed. This analysis uses a comprehensive impact identification system and various accounting, economic, and social science measurements for its costing. When measurement is considered undesirable or potentially unreli- able, only the effects are identified. Physical measures should be used only when monetized measures are deemed inappropriate.

Bristol-Myers Squibb has been a leader in using LCAs to identify and measure the present and future environmental impacts of their products more broadly. Numerous analyses have been completed, and LCAs are now completed before any new product is introduced. In 1992, Bristol- Myers Squibb embarked on a company-wide pollution prevention program entitled Environ- ment 2000 (see the Figure). It is based on integrating product life cycle (PLC) management into the core of its businesses and thereby integrating environmental protection into all company deci-

Figure Bristol-Myers Squibb: Environment 2000-Product Life Cycle

I Final

I I Product

Disposition Ilevelopment

Packaging

55

sions. According to EH&S vice president Thomas M. Hellman, “Understanding the relationship between environmental quality and product design provides an opportunity to achieve competitive advantage in the marketplace.” The approach drives the consideration of impacts throughout all parts of the company so that all employees can easily see the part they play in reducing environmental damage and increasing profits. Business units now integrate PLC goals in their five-year strategic plans, and PLC reviews are being completed on a regular basis.

One of the first PLCs completed by Bristol- Myers Squibb was on Ban Roll-On deodorant. Through a process that identifies the environmental effects associated with the “formulation, manufacture, packaging, distribution, use, and

ultimate fate,” the PLC team identified more than 20 potential action items for improving the deodorant. Changes were made and savings were eventually realized from this process. By downsiz- ing the package to a snug-fit carton, the company saved 600 tons of recycled paperboard per year and increased shelf

space by about half. This translates into prevent- ing pollution and slashing costs.

Such improved PLC management has also reduced environmental effects by: reformulating products so that chemical solvents can be re- placed by water; using closed-loop technologies to capture and reuse manufacturing chemicals; and extracting oil from metal manufacturing scrap before sending it to a salvage company. In addition, it has promoted extensive recycling efforts, various waste-cutting efforts, and the redesign of products to minimize packaging or to ensure that the packaging is made of recycled or recyclable materials.

LCAs aid companies in evaluating potential risks and opportunities related to a product. Sev- eral years ago, Hyde Tool, a small Massachusetts tool maker with gross revenues of $40 million, set an environmental goal of zero toxic emissions. The company was concerned about the effect of waste water on the community as well as potential environmental fines that, if imposed, could financially devastate the firm. Yet Hyde believed that all improvements should stem from solid. financially based business decisions rather than from environmental concerns alone. So the company began working to devise a cost-effective, closed-loop system to reduce waste water emissions. Floor drains were sealed to avoid flushing waste water into the town’s sewer sys-

tem. Filters were installed to cleanse and recycle polluted water, and chillers were used to control coolant temperatures in the grinding operations and vacuum furnaces. Hyde Tool ended up reducing its annual amount of waste water by 95 percent. Water usage shrank from 29 million gal- lons a year to about 1 million. The cost of the project was about $100,000; the company now saves more than twice that amount each year.

Concerns about post-consumer waste, recycling, reusing, and proper disposal are increasing rapidly. Many companies have found ways to push these through the supply chain and now regularly conduct supplier audits. In 1993, Ford issued design guidelines to its suppliers to improve the recyclability of its vehicles and increase the recycled material content. Nearly 80 percent of the content of its new cars can now be recycled. Ford is also using many other recycled materials in its production. More than 50 million recycled soft drink bottles, for example, have gone into making luggage racks, reinforcement panels, and door padding. Ford has also moved aggressively to reduce solid waste, and is now recycling more than 70 percent of waste material from its plants.

Estimating Future Environmental Impacts

Many companies are using such techniques as option assessments, option screenings, decision trees, and scenario forecasting to help them integrate future environmental costs and benefits into both costing and capital investment decisions. These techniques help generate all available options and select alternatives based on cost effec- tiveness, relevance for decision making, and environmental impact. Next, the options are priori- tized by determining an economic and environmental profile of the effects. These effects are quantified in monetary terms and typically include the net changes in operating and capital costs. The options are then positioned on an “option map” based on the relative weight and importance of the costs and benefits of each option.

The Niagara Mohawk Power Company of Syracuse, New York is among the leaders in measuring and reporting external environmental costs and benefits and using them in capital investment decisions. The company completes a detailed cost-benefit analysis for each proposed capital project and has adjusted the specific monetary values per ton of pollutants determined by the New York Public Service Commission for its cal- culations. According to Niagara Mohawk manager Tom Centore, “We’ve stopped treating waste as a liability. We consider it an asset. When we sell, reuse, or recycle waste, we add value directly to the company’s bottom line.”

Niagara Mohawk implemented a system to identify and measure the options related to both the demand and supply of electric power usage to the year 2019. Using option screening, it deter- mines the optimum mix of demand and supply strategies that provide electrical energy services at the lowest cost within a set of various constraints. Focus groups are used to determine the appropriate options and assign probabilities to the most likely scenarios.

Some firms have been frustrated in their attempts to better estimate and manage environmental impacts. They have become concerned with their ability to estimate adequately the effects-and costs--of the possible changes in environmental regulation and technology. They worry over the long time horizon attached to much of the projected environmental costs and benefits. Nevertheless, many companies are applying these techniques successfully. Using available decision approaches and tools to improve environmental decisions facilitates the move from an orientation of environmental compliance to one of corporate environmental planning. This usually reduces both environmental effects and corporate costs.

Performance Evaluation Systems For Teams, Managers, And Strategic Business Units

Environmental performance indices have been developed by numerous organizations to help them gauge the performance of strategic business units and company facilities. The development is sometimes prompted by external evaluators and sometimes as a part of a comprehensive performance evaluation system that is used, in part, to motivate improved environmental performance. The Kansas City Division of Allied Signal Aero- space Corporation, for example, is operated for the US. Department of Energy. And because a large portion of Allied Signal’s fee is based on a DOE rating of EH&S performance, the company has developed a system to motivate improved environmental performance.

Some companies, such as Niagara Mohawk, have developed an Environmental Performance Index (EPI) whereby targets are developed to focus on consistent and measurable improvements from a baseline of environmental performance. Establishing solid benchmarks against which environmental performance can be measured encourages management and staff to improve regulatory compliance and leads to a de- crease in costly noncompliance issues and correc- tive actions. Niagara Mohawk managers believe that the company’s environmental performance has improved through the application of the EPI.

Among the most explicit integrations of environmental performance into performance evalua-

tion systems is the environmental multiplier used by Browning-Ferris Industries (BFI). When Will- iam Ruckelshaus became CEO in the late 198Os, he realized that the company needed to view society’s changing requirements for corporate environmental responsibility as new opportunities rather than regulations to battle. With an altered view of BFI’s role in society and the de- sire to reposition the company for future growth, in 1990 Ruckelshaus decided that a fundamental change in the corporate culture was necessary.

The decision to become “truly compliant” at almost any cost became an obsession for the firm. Whether the initial impetus for the decision was improved public relations, regulatory pres- sure, concern for the long-term profitability of the enterprise, a new understanding of the concerns of the various corporate stakeholders, or a new mandate from senior corporate executives is not critical. What is important is that such a transfor- mation in corporate culture required a bold implementation strategy to ensure success.

BFI’s senior executives realized that to implement this strategic change effectively they needed to shift incentives and tie environmental performance directly to employee pay. The scoring is an explicit determi- nation that compares actual performance with preset corporate, regional, and district goals. The financial, revenue, and non-financial ’ objectives are multiplied by the environmental multiplier to encourage employees to make the proper trade-offs when authorizing expenditures on environmental projects. The system is intended to encourage managers to plan and budget for environmental responsibility rather than react to crises and be concerned only with minimum compliance.

The advantage of a compound incentive plan such as the one in use at BFI is clear. When mul- tiple performance measures are used, an additive system would permit employees to focus on one or two goals at the expense of the others without severe penalties. Under a compound plan, the multiplicative effect encourages employees to consider all company objectives and goals rather than ignore some performance measures and still receive a bonus. But the weights on each performance measure might indeed focus more attention on one or two goals.

Developing and applying better methods of environmental management is clearly beneficial.

You‘ve Got A Great Environmental Strategy-Now What? 57

Improved environmental costing and capital budgeting do lead to decisions that are better for both the environment and corporate profits. But incentives are often necessary to motivate employees to integrate environmental impact into their decisions. Substantial evidence says that environmental performance can be improved if it is integrated into the performance evaluation system for all employees, teams, and business units. By empowering and rewarding managers and production workers, environmental planning and compliance activities can be improved.

Steps For Implementing A Corporate Environmental Strategy

So how does a company implement a corporate environmental strategy? By following, in whole or in part, these eight steps to better environmental management:

1. Develop an environmental strategy, then organize the corporate structure to effectively implement and measure the success of that strategy. The EH&S department should have direct access to senior corporate officers and directors.

2. Identify and measure environmental effects, including benefits and costs. Think broadly and consider current and future impacts on both the company and society through a total stakeholder analysis.

3. Prepare an inventory of current environmental activities related to pollution prevention and control. Track and accumulate current environmental costs related to current production.

4. Integrate all current and future environmental effects (costs and benefits) into all corporate decisions, including those on product costing, product pricing, product design, and capital investments. This includes taking ultimate responsibility for product disposal.

5. Integrate accounting and financial analysis techniques, including risk assessmen‘t, into environmental decisions. This will permit improved analyses of choices between product improvements, process improvements, and capital im- provemc3Xs. 3s well as better analysis of uncer- tainties related to changing regulations. technology, and the cost of technology. Both voluntary and regulatory projects should be evaluated.

6. Institute a reporting strategy for both internal and external stakeholders and decision mak- ers. EHSiS, legal, accounting, engineering, and operations executives should be involved in an accrual committee to determine liabilities and consider environmental improvements.

7. Integrate corporate environmental performance into performance evaluation systems a- ready in place in the organization and monitor it well. Consider it a variable in evaluating the performance of the total corporation as well as of

individuals and teams. All employees must view corporate environmental performance as critical to the long-term financial success of the company.

8. Collect and provide feedback throughout the firm on the effects of various decisions so that environmental strategy can continuously be updated as corporate impact, regulations, and technology change.

N ot long ago, many corporations were

still viewing environmental expenditures as either responses to unreason-

able government regulations or attempts to ap- pease local community interest groups. But the world has changed and the more progressive corporations have changed with it.

The development and implementation of a corporate environmental strategy is becoming an integral part of overall corporate strategies. A growing number of companies are using life cycle analysis to examine the impacts of their products from cradle to cradle. CEOs are generally recognizing that their companies will likely be held responsible for post-consumer mste through some concept of product take-back and an acknowledgment of their ultimate responsibility for product disposition. Companies now need to consider an estimation of those future costs and bring them into the capital budgeting decisions through full environmental costing or life cycle analysis. Sustainable development is being adopted as a core value among an increasing number of companies, and many are sincerely trying to change a corporate culture that has ex- isted for generations in making their organizations more environmentally sensitive.

All of these companies recognize that there are competitive advantages in the innovations that often result from the examination of capital, process, and product improvements. They see the advantages occurring in the reuse and recycling of materials. They also recognize the benefits in integrating the likely future impact and costs of taking ultimate responsibility for post- consumer waste into current product costing and pricing decisions. Even when the integration is not complete. identifying and analyzing the future costs and benefits of projects and products and performing an LCA has proved extremely beneficial in reducing future costs and rethinking general corporate strategies in addition to a par- ticular environmental strategy.

Such integration of environmental impact into management decisions does not depend on the posture of regulators or which political party is in office. It is good for society and good for business. Those companies that do not no\v be- gin this integration will not only incur higher costs, they will miss out on potential revenues and competitive advantage. 0

References

Srikant Datar, Marc J. Epstein, and Karen White, “Bristol-Myers Squibb: The Matrix Essentials Product Life Cycle Review,” Stanford Business School case, 1996.

An Effective Environmental Strategy (Burr Ridge, IL: Irwin Professional Publishing and Institute of Manage- ment Accountants, 19964.

Marc J. Epstein, “Accounting For Product Take-Back,” Management Accounting, August 1996a.

Marc J. Epstein, “Improved Environmental Management Depends Upon Full Environmental Cost Accounting,” Total Qua1it.y Environmental Management, Fall 1996b.

Marc J. Epstein, Measuring Corporate Environmental Performance: Best Practices For Costing And Managing


Marc J. Epstein, formerly a visiting professor of accounting at Stanford Univer- sity in Stanford, California, is currently the Price Waterhouse Visiting Professor of Accounting and Control at INSEAD, Fontainebleau, France.

59

you've got a great environmental strategy—now what?

Documents