In today’s ever-changing world, businesses are facing new, non-financial challenges related to the environment, society and upholding human rights. Changing weather patterns increasingly damage business properties. Exogenic shocks like COVID and the Ukraine war are jeopardizing global value chains and have significant economic and social impacts.
Global transformations like these have shaken the principles that businesses have long believed in. Businesses are now required to answer fundamental questions, such as: How do we measure the various non-financial impacts of our business on society? How do we reflect these externalities in business decisions? How do we redefine corporate success?
To answer these questions, a new language is needed. A common language that can describe diverse non-financial topics such as climate change, biodiversity, training, health and safety. Now more than ever we need a language that integrates financial value with these topics. How should this new language look?
Approximately 150 years ago, the “periodic table” appeared as a new language in the areas of chemistry and physics. It described diverse chemical elements based on their chemical building blocks – ‘atomic numbers’ and presented them in one picture. It is useful to compare different elements, easily understand relations among them, and to predict chemical reactions of elements. This new language not only changed the way we think about the world, but also functioned as the ultimate canvas for innovation. It contributed significantly to shaping modern industries from chemical, energy, semiconductor, pharmaceuticals, and battery.
Now the business world also needs a customized language. A solution that explains diverse non-financial topics and connects them with financial discussions. This is required for businesses to better understand and manage their impacts and dependencies on society and nature, deal with changing ecosystems and contribute to solving pressing issues. Disclosing information in this new language would enable investors to move from the traditional risk-return perspective of investments to a risk-return-impact perspective. With a new language, governments would be able to better facilitate partnerships with the private sector to fulfill public goals such as the Sustainable Development Goals (SDGs) and the Paris Agreement.
Impact measurement and valuation (IMV) fits the needs of this new language. IMV is an approach that places a monetary value on the impact of companies in non-financial areas across the whole value chain. Many leading companies already apply this approach to transparently evaluate their sustainability performance, embed ESG considerations in their business steering, and make better decisions.
By applying IMV, company decision makers have the following benefits:
Integrate sustainability into core business
Sustainability performance can be translated into a language which is readily understood by business leaders and investors – USD, Euro, or Yen. This enables easy integration of sustainability with financial decisions. Placing sustainability topics into business language via valuations enables companies to better understand their sustainability performance in line with financial performances.
For example, in the IMV language a business steering discussion about water consumption might include this statement, “water consumption for this course of action would result in social costs of 1 million USD.” In a traditional context, without IMV the statement would be, “this course of action requires 1,000 liters of water consumption.” It is more likely that companies will include sustainability topics in their business steering discussions and decision-making processes regarding product development, sourcing, supplier management and so on when sustainability valuations are implemented.
Promote decisions on trade-offs among varied impacts
A monetized unit makes it easy to facilitate difficult decisions and discussion on the trade-offs between impact indicators. Different units such as m3 (water usage), tons (CO2 emissions), hours (training) and the number of accidents (health & safety) can be translated into a common unit (“$”).
Sometimes tensions arise between sustainability indicators and different options. For example, building a factory for electric vehicles enables reduced carbon emissions, but at a particular site also increases the risk of endangering sand lizards. As more sustainability topics enter the discussion it becomes more difficult for companies to understand and compare their relevance. In these instances, IMV enables comparison and comprehension from decision makers that are not environmental experts by providing information in a language all business decision makers and stakeholders understand.
Importantly, IMV must not be used to net negative and positive impacts. For example, a large positive tax value cannot balance a negative air pollution value. In contrast, monetary valuation can help demonstrate the magnitude of negative impacts that a company should address, as well as the positive impacts a company should aim to further increase.
Identify material topics
Monetized impacts provide a clear picture of material topics for corporates. For instance, quantifying and monetizing identifies which impacts (e.g., air pollution, water consumption) are relatively more material to the business and thus pose a higher risk to the business model and society. Based on IMV, the whole value chain of a company can be assessed, which allows stakeholders to see where material impacts occur throughout the value chain in a consistent and objective manner.
The real impact of corporate activities depends on the environmental, social, and economic contexts of the locations where the company operates. For example, impacts from the same amount of water consumption can create more negative values in a water-stressed region compared to a water-abundant one. To reflect this, IMV uses different valuation coefficients for different countries and contexts.
Risks and opportunities often vary depending on the region, market and industry where companies operate. By monetizing business impacts with differentiated valuation, IMV provides a new tool for enterprise risk management, investors, and other stakeholders who assesses the company’s ESG performance.
For IMV to be widely accepted, one common methodology is needed to ensure credibility and comparability. In 2019, a group of global companies formed the Value Balancing Alliance (VBA) to start a discussion on building this new business language – a harmonized methodology for IMV.
The VBA is a non-profit organization with the ambition to change how company performances are measured and valued. At this moment, 25 global companies are participating in the Alliance and cover many industries and geographies. Trailblazing companies in Asia, such as Mitsubishi Chemical, are among those that have joined this journey to provide insights from Asian perspectives.
The VBA methodology includes two perspectives – Value to Society and Value to Business. Value to Society (insideout perspective) assesses how a company impacts external society and the environment. Value to Business (outsidein perspective) assesses how external sustainability elements, such as climate change, impact a company’s enterprise value.
With support from global accounting firms Deloitte, EY, KPMG, and PwC, the VBA developed a draft methodology which all member companies pilot annually to prove its applicability and relevance in day-to-day business operations. Following each piloting round, member feedback is collected to further improve the methodology.
Beginning in 2023, to combine forces developing a common, standardized methodology, the VBA partners closely with the International Foundation for Valuing Impacts (IFVI), a newly formed spinoff from the Impact-Weighted Accounts project at Harvard Business School. The partnership enables complementary perspectives for wellrounded methodology development. IFVI focuses on the investor perspective of methodology development with academic rigor and the VBA provides practitioner perspectives to ensure that the methodology is useful in a management accounting and corporate disclosures.
The current methodology covers economic, environmental, and social impacts and the entire value chain (Upstream – Own Operations – Downstream) which enable calculation of the total positive and negative value that a company creates.