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The apparel industry: An improbable leader in True Cost Accounting

Full Cost Accounting

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One of the basic principles of being a responsible company is to manage risk and create value for the long-term sustainability of the corporation. True Cost Accounting (TCA) is an approach whereby businesses – or governments – understand in monetary terms the full scope, impact and risks of their operations, financially, environmentally and socially, on the short, mid and long run.
TCA requires, hence, the quantification of not only the environmental services of our ecosystem, but also the social benefits corporations rely their activities on.

Of course, the magnificence of nature and human society is priceless. But the unfortunate effect of seeing these inputs to well-being and economic prosperity as incalculable has been that they are normally treated as free. But, as these presumably ‘free’ resources are neither limitless nor indestructible, that mind-set creates problems.
Just as with any other resource, the rule is: incapability or unwillingness to put a price on them, makes it difficult to evaluate trade-offs, which again are invariably part of any decisions relating to sustainability. For decisions to be taken in a well informed manner, all components need be assessed on comparable terms – in practical terms this means a cash equivalent value.

Pricing environmental and well as social resources is essential to this process, although admittedly a challenging task. Not the least because, at this stage, the data needed for complete true cost reporting is not readily available. Yet – with the right methods and experts at hand, it is possible to develop (crude) estimates at the very least. An example is the erosion and avalanche control provided by Alpine forests: How much would it cost to achieve the same control by other means? Or the pollination that bees perform: What is it worth to agriculture? How much are we already spending in the present to perform these tasks ourselves, and how much more will we be spending still in the decades to come?

TCA methods have already been discussed by academics, strategists and hard-nosed economists (1996; 1997; 2001) for the better part of two decades. And with the recent publication of Puma’s Environmental Profit and Loss Accounts (Puma E P&L), the topic suddenly hit, not quite unexpectedly, the headlines of all major economic news outlets, from the Financial Times to the Harvard Business Review and Bloomberg‘s.

In fact, Puma’s achievement, while far from perfect and still work in progress, cannot be underestimated, and was as a consequence rightly awarded the 2012 Guardian Sustainable Businesses Award:
For starters, the E P&L is the first public effort by any sizeable corporation to put a financial value not only on their internalised costs and risks, but also explicitly and systematically so on their externalised ones. In addition, the result of the exercise was made publicly available rather than just discussed behind closed doors – the commitment to transparency and future improvement was made explicit. Also, and to the world’s surprise, Puma owned up to the fact that were they to be charged accurately for all the resources they consumed in their current operations, they’d be in the deep reds and bleeding money. And last, but certainly not least: with the E P&L’s publication, Puma’s mother company PPR pledged to roll the E P&L out across all of its holding’s brands, and Gucci, Stella McCartney, Ives Saint Laurent or Alexander McQueen are now scheduled to have their first E P&L completed by 2015.

The apparel industry and TCA: Leading by example

Puma’s initiative, radical as it may seem in an otherwise risk averse and conservative industry such as apparel, has neither been undertaken lightly, nor without precedence, or at least peers. In the course of two short years, Puma’s E P&L is already the third initiative launched in apparel with TCA as the core principle. The E P&L is complemented by

  • the EcoIndex, developed by the American and European outdoor industry associations, assesses product impacts within six life cycle stages: Materials; Packaging; Product Manufacturing and Assembly; Transport and Distribution; Use and Service; and End of Life.
  • the Higgs Index measures the environmental and social performance of apparel products and the supply chains that produce them. It enables companies to evaluate material types, products, facilities and processes based on a range of environmental and product design choices, and is developed by the Sustainable Apparel Coalition (SAC), a conglomerate of the world’s largest retailers and manufacturers, launched by Patagonia and Walmart, and with multi-national such as Inditex, H&M or Cotton Inc. among its members.

That all three of these initiatives take place within the realm of apparel is of course not a coincidence, but rather are the direct consequence of continued scrutiny by activists, NGOs and the media ever since the Nike Scandal in the mid 1990.

A further interesting detail: While the EcoIndex and the Apparel Index are both developed by consortia of companies and hence represent, more or less, an industry consensus, Puma/PPR’s approach is entirely geared towards their own needs. The three approaches are as consequence complementing, not competing with, each other, and cover both the breadth of the industry as a whole, as well as the depth of a single corporation. Taken together hence, they represent a 360 degree application of the TCA concept to decision processes of businesses, hands-on as well as strategical.

Conclusion and Outlook: Beyond apparel – Cross-sector impacts

While there are of course differences in theory and practise among the three mentioned TCA approaches, they all illustrate that TCA is gaining momentum, most lately at the Rio20+ conference far beyond apparel alone. TCA is a first and necessary step to come to spell out what it means ‘to do business responsibly’ in financial terms.

Let’s revert back to what TCA boils down to: the recognition, and therefore opportunity for mitigation, of operational and strategical risks – and the related future financial losses. It therefore allows investors to take externalized costs and benefits into account, and gain assurance that a company is managed well in all aspects of operations, not just over the next quarter but with a long-term view.

We further know that during the most recent financial crisis, from 2007 to 2010 – at a stage when TCA was largely unheard of – the overall universe of professionally managed assets remained roughly flat while Social Responsible Investment (SRI) assets enjoyed healthy growth. As a result of this growth, today nearly one out of every eight dollars under professional management in the US is involved in some strategy of socially responsible investing. In numbers: 12.2% of the $25.2 trillion in total assets under management tracked by Thomson Reuters Nelson.

The logical consequence of the above data is that responsible management practise – including the calculation of the costs of externalities – and the developments in the investing world go hand in hand.

Initiatives to value ecosystem services will therefore without a doubt gain further relevance and traction. In practise this means that with growing social and increasing legal pressure, investors and fund managers will gradually shear away from in-transparently – possibly irresponsibly – managed companies, towards those that are strategically and operationally better aligned with what the big challenges of the upcoming decades are.
This has absolutely nothing to do with ‘being good’, but rather makes hard-nosed economic sense: Investments are made into companies that are expected to encounters the least problems in their operations, and deliver the largest averaged benefits over a specific time period. Responsibly managed companies, hence, with the risks known, controlled and actively addressed, are the best guarantor for a revenue oriented, low risk investment.

Accidentally, this development goes hand in hand with what we already know from consumer markets where over 75% of consumers are suspicious of corporation’s sustainability pledges, but would be willing to pay more if certain that the extra money went to where promised. For a corporation’s customer relationship management, finally, TCA offers a not to be underestimated opportunity to engage with consumers over a product’s true – financial, environmental, social – costs, and the direct implications on the product price.

Puma, EcoIndex and Higgs Index are only the early adopters of a new era of how companies, and their profitability, will be evaluated in a not too far off future. Other industries (e.g. agriculture and construction) will be under pressure to follow suit whether they want or not.

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