After having explained what sustainability is in the first post, the next step in line is to discuss sustainability risk. Sustainability risk refers to the¬†uncertainty¬†in being able to sustain the growth of a given system (a corporation, household, community or economy) because certain practices may have negative externalities which result in the dilapidation of value chain of the system over a period of time or impact other related systems. In this post, I will discuss the sustainability risk as it applies to the businesses.
The starkest example that illustrates this scenario is rising sustainability risk across sectors of an economy to varying degrees because of climate change. Whether or not climate change is leading to significant disorders is not even a point of debate. Innumerable agencies, including the¬ plus importante¬ Intergovernmental Panel on Climate Change (IPCC) have well established the adverse impacts that range from rising temperature to increase¬†occurrences¬†of extremes condition of flood and drought. These climatic disturbances have already been directly impacting the profitability of corporations. For example, floods in the most important coal basins of the world, Queensland, Australia, led to an estimated loss of $6 billion, according to Forbes. Up to 40% of the global coke supply was impacted and supply disruptions caused coke contract prices to rise up to 30%. This led to delays in the production of steel and within three weeks after the flood, the steel prices had risen more than 10%. According to JP Morgan’s senior economist¬†Helen Kevans, the flood impact on production and demand could have shaved around 0.4% points off the Australian GDP. Such can be the economic impact of a flood. As the frequency of such events rise, we can very well imagine what the quantum of loss could be.
Whether they are aware or oblivious, but large number of companies are facing sustainability risk, which is seated deep in the value chain of the firm. It is in this respect that sustainability risk is akin to other risks like financial risk, political risk, investors risk etc.
There is another way sustainability risk bothers corporations. Because the ever deteriorating ecosystem needs serious attention and governments come up with policies that may not be in the best interest of the corporations where non-compliance may amount to worse outcomes for the firms. Governments these days are very active making ‘green policies’, and it is a matter of concern for many as to how the policies will affect the profitability, and thus a source of risk.¬†For example, Government of India levied coal cess of about $1 per tonne of coal¬†produced, giving a blow to the profit margins of coal producers and raising¬†prices for power companies. In anticipation of such a regulation, forward-looking companies may seek to improve plant efficiencies, look for fuel substitutes, upgrade technologies, or expand their portfolio to¬†renewable energies.
Be it power, manufacturing or automobile sectors, sustainability risks are growing for all and is increasingly getting more attention.¬†Additional trends in sustainability risk include risks to financial performance from volatile¬†energy prices¬†and risks from product substitution as¬†customers switch to more sustainable alternatives.
It therefore has become imperative that sustainability risk well gauged so that appropriate and timely planning can help the company adapt to the changing environment and avoid losses. The focus is increasingly being laid on finding out¬†how,¬†when and by how much will these risks impact corporations. Sector-wide, people may have a general perception of the sustainability risks, but that is not credible enough. To take any effective action towards sustainability risk mitigation, it is important that companies carry out exhaustive risk assessment exercise, designed with as much scientific approach as possible.¬†Business decisions are critically contingent upon speculations and a robustly designed Sustainability Risk Assessment tools will help carry out such speculations with greater precision. Risk assessment may differ from one firm to the other depending upon the purview of analysis. However, there are a few considerations that should be consistent across the board. Sustainability Risk assessment should be able to quantify the risk so that a clear picture of expected damage because of looming risks of climate change and unsustainable practices emerge. Further, it is vital to gauge the degree of impact in different scenarios. Another critical dimension that any SRA should focus on is the estimation of time line as to what kind of risk causes the damage when.
Sustainability risk assessment techniques and methodologies are being designed and used by companies at an ever increasing rate. It should help them quantify the risk so that a clear picture of expected impact of climate change and unsustainable practices emerge. Given the rapid fluctuation in domestic and global scenarios, risk assessment can help gauge the degree of impact in different scenarios across a short, mid, and long term. According to a study by Wilbury Stratton, large firms will spend $59 billion on six categories of sustainability projects in 2012 alone. See below.
Large corporations have already been engaging in risk assessment and management. For example, PepsiCo has invested ahead of the curve¬†to manage sustainability risks linked to water scarcity. As a a critical raw material, water impacts input costs, competitiveness, and the ability to maintain production as well as influencing community relations and brand image. In 2009 PepsiCo announced 15 global goals and commitments focused on the sustainable use of water, land, energy and packaging. The firm aims to reduce¬†water usage intensity by 20% between 2006 and 2015¬†across all manufacturing operations. It’s high time that even medium and small scale companies follow suit and start paying serious heed to the sustainability risk, assess it and make plans to manage the risk if they want to ensure that growth takes place at an accelerated rate.