Puma, a sportswear company, has created a stir with its ‘environmental profit and loss’ (EPL) account. It is a praiseworthy initiative, but the results should be used with care.
Environmental reporting by companies is not new. Puma’s innovation is to place monetary values on its environmental impacts, enabling them to be compared and summed. It estimates the net loss of welfare due to its environmental impacts in 2010 at EUR 145M, the main contributors being greenhouse gas emissions (EUR 47M), water use (EUR 47M) and land conversion (EUR 37M). Much of the impact is well down its supply chain in the production of raw materials such as cotton and leather (1).
‘Environmental profit and loss’ is a catchy name that may have helped Puma gain publicity, but it could mislead. The reported environmental impacts are virtually all negative, the only ‘profit’ relating to energy recovered from waste incineration (2). ‘Profit and loss’ suggests that what Puma has done is accounting when it is really economics. The crucial step of placing monetary values on various physical units relies heavily on the economic literature on environmental valuation, notably a review by Tol (3) of the economics of climate change, and The Economics of Ecosystems and Biodiversity (TEEB) (4). A more accurate term for what Puma has measured would be ‘net external environmental cost’.
What can be done with these figures? Some uses Puma suggests (5) are:
- To indicate where its efforts to reduce environmental impacts can best be directed.
- To identify environmental issues that pose emerging risks to shareholder value.
- To increase transparency to stakeholders regarding the company’s environmental impacts.
- To assist employees in taking account of environmental impacts in day to day business decisions.
These are all valid points. One caveat however is the importance of equity as well as overall scale in evaluating environmental impacts. Any impacts that threaten livelihoods, even of small groups, need to be taken particularly seriously. Another is the dependence of the figures on the particular economic valuation techniques used and assumptions made. For example, the value placed on water use relates only to indirect effects on ecosystem services. It is assumed that the direct reduction in water availability for consumption by others is already reflected in the price paid for the water (6). This is questionable, since in many parts of the world water is priced well below its full cost (7).
Another use that might be attempted is this. Profit as conventionally measured is not a good measure of a company’s net contribution to welfare, so why not try to improve it by making a deduction for environmental externalities? One might observe that if Puma’s EPL cost (EUR 145M) is deducted from its accounting profit (EUR 301M in 2010 (8)), the result is still a net profit (EUR 156M). This is I think slightly reassuring: imagine the outcry if environmental impacts had been much larger than accounting profits.
However, it would be wrong to place too much weight on such a figure, since it is a hybrid based partly on accounting and partly on economics. Externalities are just one welfare-related issue recognised by economics but not by conventional accounting. Others are:
- consumer surplus: the welfare implicit in the difference between the maximum price consumers would be willing to pay and the price they actually pay;
- opportunity cost: the value of resources to society in their best alternative use;
- the need to adjust prices paid for market distortions such as indirect taxes and over-valued exchange rates.
A proper measure of a company’s net contribution to welfare would require a kind of cost-benefit analysis allowing for all these issues, albeit with its scope the entire operations of a company and its supply chain, rather than a particular project. What a company could perhaps do is prepare conventional accounts for accountability to shareholders together with a cost-benefit analysis for accountability to society (and to identify risks to shareholder value). One part of such an analysis would be to value its environmental impacts, and this would require just the sort of assessment that Puma has done.
Notes and References
- Puma (2011) Environmental Profit and Loss Account 2010 p 6 & 8. http://about.puma.com/wp-content/themes/aboutPUMA_theme/financial-report/pdf/EPL080212final.pdf
2. Puma, as above p 22
3. Tol R. (2009), “The Economic Effects of Climate Change” Journal of Economic Perspectives Vol 23 : (2) http://www.aeaweb.org/issue.php?journal=JEP&volume=23&issue=2
4. TEEB (2010) The Economics of Ecosystems and Biodiversity: Mainstreaming the Economics of Nature: A synthesis of the approach, conclusions and recommendations of TEEB. http://www.teebweb.org/TEEBSynthesisReport/tabid/29410/Default.aspx
5. Puma, as above pp 4-5
6. Puma, as above p 17
7. Comprehensive Assessment of Water Management in Agriculture (2007) Water for Food, Water for Life: A Comprehensive Assessment of Water Management in Agriculture London: Earthscan, and Colombo: International Water Management Institute p 378
8. Puma (2011) Annual Report 2010 p 137. EUR 301M is the pre-tax profit, described as Financial Result. http://ir2.flife.de/data/puma/igb_html/index.php?bericht_id=1000004&index=&lang=ENG
Economic Droplets 