Most major corporations have adopted public reporting to communicate their performance in moving to sustainable management of their business. These reports reveal the companies’ total impact in terms of resource consumption and waste generation as well as normalized versions that attempt to convey corporate improvement in using resources and reducing wastes.
Companies strive to reduce their overall environmental footprint regardless of their overall growth, but the normalized version of the metrics are used to portray their actual efficiency. A growing company might increase its total water consumption but still claim improved efficiency by showing a reduction in water consumption per unit output. The claims based on this type of metric (overall average intensity) generally have been accepted at face value.
Closer examination, however, reveals that overall average intensity seldom, if ever, provides an accurate measure of corporate improvement in efficiency.
Average intensity ≠ efficiency
Corporate sustainability reports tend to equate change in average intensity to change in efficiency. If a company reports that it is using less total water per unit of product produced, or per million dollars of revenue, the conclusion is that the company is using water more efficiently, and the magnitude of the change reflects the degree of improvement. While intuitively attractive, this assumption is false.
An actual improvement in efficiency indeed will result in an improvement in overall average intensity, but many other factors that have nothing to do with the efficient use of resources can and will affect this metric. In particular, we will discuss changes in partial outsourcing (or “in-sourcing”), changes in facility use and changes in product or service mix.
1. Partial outsourcing (or in-sourcing) will affect average intensity
Partial outsourcing (or in-sourcing) can have an obvious impact on average intensity. If outsourced activities are not included in company reporting systems (as is often the case), these practices result in a simple manipulation of the metric’s numerator, denominator or both.
For example, if a manufacturing step using water is moved to a third-party (outsourced) while the final production remains on site, average intensity will decrease. Outsourcing an activity that is water-intensive will have an even more dramatic effect.
Partial outsourcing, and in-sourcing actions, can result in significant changes in average intensity without any measured change in true efficiency. The change in average intensity results from nothing more than a change in what is being accounted for in the numerator, the denominator or both.
2. Change in facility use will affect average intensity
Facility use is an issue familiar to cost accountants and this principle applies to sustainability parameters as well. Resource consumption and waste generation, like costs, tend to have a fixed component (independent of production quantity) and a variable component (directly related to the amount of production). For example, the water used at a manufacturing plant might include both fixed components (irrigation water, potable water for office facilities) and variable components (water added as an ingredient to the product, water used to clean equipment, or to cool or heat product).
When production is increased, average intensity will decrease because each unit of production will receive a smaller allocation of the fixed water use. Similarly, when production is decreased, average intensity will increase. In neither case does this change result from any actual change in efficiency; the change results from a change in facility use.
Facility use generally reflects anticipated product demand, which is often a function of overall economic conditions. Therefore, changes in facility use often will move in the same direction across most of a company’s product lines, resulting in a systemic shift in the average intensity. A declining economy creates significant headwinds for the average intensity metric just as an improving economy provides a helpful tailwind.
3. Change in product or service mix will affect average intensity
Most companies are fairly diverse: they have a variety of products, services and activities that contribute to the company’s overall resource consumption or waste creation. For each sustainability parameter, every activity has its own unique rate (or intensity), and some activities are far more resource intensive than others.
If the relative mix of these activities changes, the company’s overall average intensity for all relevant sustainability parameters also will change even if all the individual intensities for those activities remain unchanged. This is a subtle impact, but not difficult to comprehend.
If a company’s mix of products shifts toward those that are less resource-intensive, the average intensity will reflect this shift by declining. If the shift occurs toward more resource-intensive products, the opposite will occur. The company’s overall average intensity will become less, or more, resource-intensive and that change typically will be brought about by changes in market preferences or by company business strategies — not by any real change in management efficiency.
Real efficiency changes can be measured
Overall average intensity is a metric of limited usefulness, and serves as a very poor proxy for corporate efficiency. Large corporations that rely on this metric do so at their own peril: They may be misled into believing their management policies are achieving efficiency improvements when in fact they are not, or they mistakenly may abandon effective practices.
Companies that wish to accurately measure changes in their overall corporate efficiency, however, can do so using a method developed using sound managerial accounting principles.
A method based on flexible budgeting was jointly developed by Bacardi Limited and North Carolina State University and has been in practice by Bacardi for several years. The method is able to effectively eliminate all of the distortional effects discussed in points 1 through 3 above, providing an accurate measure of a company’s overall performance for each sustainability parameter.
A case study sponsored by the Institute of Management Accountants highlights how Bacardi Limited reports its environmental sustainability performance. It includes examples of the application of efficiency metrics and solutions to minimize sustainability reporting distortion.