Everybody’s talking about it: the cost of going green

Read the papers, listen to pundits, and you will know that everyone says it costs money to “go green” – and in a recession, it’s a luxury few firms can afford. This is consistent with other things we know – we think of environmental regulations, and we know that regulations often add cost to business. Take waste electrical goods – these now have to be disposed of correctly (WEEE regulations), and you can’t just hide them in the skip with the rest of your trash. So if everyone says it, and it makes sense, the logical conclusion is that it must be true.

Why would lemmings commit suicide?

There is a lovely example in this month’s news from an organisation that should know better: The Carbon Trust. This non-profit organisation has laboured with ingenuity and style for many years to help UK businesses become more cost competitive by reducing their emissions. Yet the first line of their press release says that four public sector organisations will “defy” the economic downturn by reducing their carbon footprints and slashing their energy costs by 25%. How cutting costs by reducing waste energy amounts to defiance in the face of pressure to reduce costs, is not made clear in the article. Could the strategy here be to use a standard prejudice about the cost of going green in order to lure readers in?

Many years ago, I was given a selection of books as a leaving present from a generous boss, of which my favourite was You Know What They Say... The Truth About Popular Beliefs. This book tackled a huge number of well-known “truths”, and examined the evidence for them in detail. These varied from things that just about everyone over five years old will tell you (“No two snowflakes are alike”) to beliefs that have serious consequences (“Rewards motivate people”). In some cases the evidence was mixed or reasonably good, but for most, the real evidence was so poor or non-existent that you wondered how people could go on saying these things (“Lemmings commit mass suicide”).

So what’s the evidence for the cost of going green? It is overwhelmingly in favour of saving money. There are of course rare exceptions – green initiatives that attract nothing but cost. In their excellent book Green to Gold, Winston and Esty describe how “going green” can (accidentally) reduce profits – most notably, through misunderstanding the market, for example by expecting a price premium, or planning on customer tastes fitting your planned innovations. However, the book mainly focuses on the plentiful examples of companies generating huge profits through environmentally sound strategies that are implemented well.

Recent research has continued to support the benefits of pursuing a green business strategy. For example, research published in January showed that firms that report emissions produce a bounce in their share price – especially if they’re small. In a study published last month, ISO 14001 certification in Brazilian firms was shown to correlate directly with improved profitability. There is a rapidly growing literature that looks at “green strategy” from a variety of perspectives, and shows that when executed well, green strategies pay dividends.

So, the next time someone tells you that going green will hurt your profitability, ask them if they know anything about lemmings.

Do more with less – and save £23 billion

That, at least, is the conclusion of a DEFRA study published in March.  It found that for very little cost, UK businesses could produce just as much as they do today, while saving £23 billion in costs.

Given our current economic troubles, it is surprising that this hasn’t been headline news.  The topic is called “resource efficiency.”  The UK government has been trying to encourage firms to improve their resource efficiency by providing advice and grants, and even the European Commission has urged firms on, claiming that “Increasing resource efficiency will be key to securing growth and jobs”.

These claims are entirely realistic.  There are multitudes of case studies available through government agencies and in business school texts, and of course many cases have never been documented.  Just tackling the production of waste products alone – without considering any other efficiency savings – could produce big savings to the bottom line.

The fact is that the funding interventions from the government have so far been very small – less than £100 million per year of the Business Resource Efficiency and Waste scheme.  However, they indicate big potential – every £1 spent by the government achieved an average £1.64 in additional sales and £3.20 in cost savings – and those are the benefits in just one year.  Unfortunately, the budgets for this work are now being cut.

As the ENDS Report has observed, “government will have to depend on businesses stepping up their own efforts independently, without relying on public funds for advice and support.”  Increasing landfill taxes are meant to encourage firms to address their inefficiencies, but waste handling costs represent only a tiny fraction of the true cost of waste.  Moreover, there are many more inefficiencies that have nothing to do with the waste stream.

When so many companies have tackled their waste stream, why have so few put the same energy into efficiencies – that is, into not producing the waste in the first place?  It’s often no one’s job – we assume our employees will identify and eliminate waste if they can, but no one is tasked or measured on this.  And why not?  Well – since the cost of producing waste, or working inefficiently, is almost never measured, those in charge don’t realise it deserves an explicit place in their management structure.

For those companies that grasp the opportunities in resource efficiency, the prize will be higher profits, greater security, and growth.  The government will no longer take the lead, though it is a wonder that it was ever necessary.  Given the size of the prize, it is time more firms put resource efficiency on the CEO’s agenda.

Why your business customers want you to cut carbon

Recent research from The Carbon Trust reveals a potentially unsettling truth for the B2B market: multinationals are not just addressing their own greenhouse gas emissions.  They are also increasingly including carbon in their selection criteria for suppliers.  Within three years, the vast majority will do so – only 10% say otherwise.

Why this move – is it part of these multinationals’ attempts to look green?  The report ascribes the trend to “shareholder pressure”.  Are these shareholders investing in an increasingly ethical way, or are they looking for financial value?  I would suggest the latter - in other words, this isn't a fad.  It's part of a trend towards shareholders actively looking after the value of their investments.  Suppliers should take note.

It is not only shareholders who know that low carbon can translate into good value.  Sourcing professionals look for signs of quality and efficiency to ensure that they are getting the best goods at the best price.  Low carbon emissions signal efficiency – that a supplier is using less inputs for the same output.  That will translate into a sustainably lower cost structure, from which the buyer hopes to benefit.  Multinationals are sourcing low carbon because it’s often cheaper, and is likely to get even more competitive if fossil fuel costs rise further.  Shareholders and management want to know that their companies are managing for value.

A quote from Chris Harrop of Marshalls plc is particularly revealing: “By choosing suppliers of responsibly sourced goods not only do we cut carbon emissions but invariably there are cost and efficiency gains to be had, which all adds up to a strong competitive advantage.”  Perhaps it’s nice to be green, but it’s good business to be cost competitive, and paying attention to carbon in the value chain helps firms solidify this advantage.

So, suppliers now have another reason to address emissions, if cost competitiveness itself were not enough.  Multinationals will be expecting suppliers to report on, and compete on, greenhouse gas emissions.   Their suppliers will be asking the same questions right down the supply chain.  If your business customers are not already asking you to reveal to your carbon footprint, they soon will.

How cash can kill your business

“Cash is bad” said my MBA professor many years ago. This obviously depends on your perspective. But as many business leaders have found to their regret, cash really can be a killer.

The main problem with cash is that it’s fickle – here today, gone tomorrow. Many businesses have run into difficulty when they couldn’t get a loan to cover the difference between cash and profits. That is, they’ve got paper profits, but the expenses need to be paid, and the cash hasn’t come in yet. Businesses like this use cash flow forecasting for two main reasons: 1) to make sure they grow their sales only as fast as that their working capital can match, and 2) to ensure they’ve actually lined up enough working capital, often in the form of a long term line of credit, to be able to pay all their expenses without embarrassment.

A less well known problem faces the business that has a positive cash cycle – the kind of firm that receives the money before they have to pay the expenses. Companies in this desirable position may think they don’t need cash flow forecasting – as long as they keep trading profitably, the cash will always be there. This type of cash flow can also be a killer, and can take business leaders completely by surprise.

The main pitfall for positive cash cycles occurs when a business uses its cash to finance its operations. Why?  Even a business with very thin profits, but growing rapidly, could find itself apparently swimming in cash. Surely it makes sense to use the cash productively, to invest in business improvements and growth? But what if the cash inflows subside, even just for a few months?

Imagine a (highly simplified) business turning over £1m per month. It has a positive cash cycle of 1 month, and razor thin margins. So although profits are essentially non-existent, it sits on £1m of cash at any one time, which has been paid into the bank, but won’t need to be paid out until next month. By that month, another £1m will have come in, so the company will look appreciatively on that money, which always seems to be there, and may think of investing it in something more productive than savings.

Now, imagine that after a couple of months they’ve invested £1m in new equipment, with the intention of growing the business. This is shown as “Month3” in the table to the right – you can see that after a couple of months of sitting on £1m in the bank, they wanted to do something with it, even though their profits are actually zero. Unfortunately bad weather plays havoc on their market (or some other unexpected event occurs) and sales vanish to nothing the next month – “Month4”. Imagine, too, that they feel safe, because they can reduce their expenses by £1m – they have the ultimate in flexible operations, so their margins will stay the same (zero, but at least they’re not losing money).

Unfortunately their cash position is terrible. The £1m buffer that they used to have is now invested in equipment. The expenses from last month - £1m – were going to be paid for with the £1m in cash coming in this month. Regrettably it’s not there, and they need an emergency loan of £1m from the bank in order to pay their debts. The equipment probably cannot be liquidated for £1m, and this is not a profitable firm, so the bank may ask some very difficult questions about this loan request.  Promise of positive cash flow returning next month may sound to the bank like "jam tomorrow", no matter how justified.  They will want to know why you didn't see this coming.

The best way to head off this sort of problem is to incorporate cash flow reporting into the monthly accounts, and to use scenarios to test cash flow forecasts on a regular basis. This will highlight any risks to future cash flows, and should prevent all but the most extreme of unexpected events from taking business leaders by surprise.