Volkswagen and Reductionist Business Thinking

I’ve had some time now to reflect on the Volkswagen scandal having now discussed the topic on TVO here in Canada.  During my interview on the program, I was asked whether I was surprised by their behaviour. Although disappointed as a business professor, there have other egregious examples of this sort of behaviour, equally distasteful in their demonstration of disregard for moral principles and rule of law.  Big bank deliberate manipulation of the Libor interest rates in Europe that affected millions of people, HSBC’s money laundering for drug cartels and here at home SNC Lavalin’s bribery charges come to mind.

The host Steve Paikan asked me to comment on what goes on in the minds of executives of these companies.  I spent some time discussing the shareholder primacy ideology that pervades business decision-making and the business schools that groom these types of decision-makers.  There are several articles that have come out supporting this view (see Fortune Magazine’s article for example). 

But one thing I didn’t get a chance to elaborate on is that if the mandate is shareholder wealth creation and nothing else, why would companies like Volkswagen break the law when getting caught would result in substantial erosion of the very shareholder wealth they were taught to protect?

The cost/benefit analysis I discuss in the interview (the benefit to shareholders of not getting caught far outweighs what is only a potential cost) only explains part of the reason. 

There is a more complex and accurate explanation reason for this paradox.

In a recent book entitled The Shareholder Myth, Lynn Stout explains that there is no evidence that focusing on shareholder wealth maximization actually increases wealth for investors.  In fact, evidence suggests that during the last few decades where the ideology of shareholder wealth maximization pervaded board rooms and business school curricula, the aggregate financial performance of business has actually eroded.  Let me say that again!  During a time when shareholder wealth maximization has been the so-called “religion” of business, profit levels declined.

How could this be? 

Let’s draw on a medical analogy.  It is common knowledge that while medical specialists are experts in highly specific parts of the body, they are limited in their ability to see the patient as a whole.  That is, they struggle to see the patient holistically where the health and well-being is inextricably tied to the complex interactions of hundreds of physical and mental parts that work in unison.  Even general physicians have often been criticized for not seeing how the patient’s physical welfare is highly connected with its psychological, intellectual, and emotional welfare.  The natural tendency for physicians to prescribe drugs is meant to deal with the symptom, for instance, when the patient might need emotional and psychological support.  

You can therefore consider the treatment of patients to fall into two categories.  The first is seeing the patient as the sum of individual and disconnected parts where one can isolate and remedy parts of the patient in isolation.  The second is seeing the patient holistically where the whole is greater than the sum of the parts.  Here, the treatment of a seemingly isolated part of the body has important and often unpredictable implications for other parts of the body just like a person’s emotional state affects and is affected by its physical state in very nonlinear and unpredictable ways.    

There are at least two potential consequences associated with the first reductionist approach.  The first is that treating one part of the patient will likely cause negative consequences for other parts.  We see this all the time when considering the physical and psychological effects of prescription drugs.  Specialists, who work to keep, say the liver in good shape, may end up engaging in behaviour that compromises other vital organs.  In his highly touted book Being Mortal, Atul Gawande explains how the ideology in medicine to keep the patient alive at whatever cost completely ignores the mental and emotional consequences of this ideology to the patient.  Here, the patient may live a longer life but their actual health has completely eroded because, by keeping them alive, they’ve compromised their ability to do the things that kept them fulfilled.  We’re only now seeing a growing awareness of mental health but it is far from being incorporated into a more holistic approach to medicine. 

The second is that treating the patient as a sum of individual parts may produce effects that ultimately erode the very part that was being treated.  This is a very common characteristic of complex systems because it means that the general physician who continues to prescribe prescription drugs to treat a symptom of a more underlying problem will find that the problem might actually grow in intensity and may resort to prescribing a higher dose of drugs. More simply, while an operation might temporarily remedy a physical ailment, the neglect of mental or emotional health in this process, might strongly impact the ability of the patient to fully recover, thereby making the physical ailment much worse.  This happens often with specialists where the treatment of a part of the body impacts others in ways that require subsequent treatments and drugs.    

The relationship between these two consequences is typically chronological.  That is, the doctor’s decisions initially benefit the targeted body part, causing negative consequences for other parts, making it seem like the treatment is working.  But then, over time, as complexity theory would prescribe, the negative consequences to other parts start to compromise the initial body part that received the attention as the physical and mental state itself might start to shut down. 

Now let’s take this analogy and apply it to management.  At business schools, we do not train students to be generalists.  We train them to be specialists.  By that I mean we train them on how to maximize wealth for one stakeholder – the investor.  In the same way that specialists are trained to know everything and anything that is related to the diagnosis and treatment of one specific body part, students coming out of business school are trained on how best to maximize shareholder wealth.  Yet just as the health of any human body is a function of understanding its complexity across multiple body parts physically, emotionally and physiologically, the success of any business is entirely a function of understanding the complexity of the environment in which it operates; that is, the wide range of diverse stakeholders that influence or are influenced by the business. 

Let’s consider the first consequence of reductionist thinking described above and apply it to business.  Focusing on shareholder wealth in isolation has dramatic consequences for other stakeholders like communities, the environment, employees, consumers, and suppliers.  You might say, “but Mike, wouldn’t the manager see that eroding consumer satisfaction or treating your employees negatively adversely affect shareholder wealth?”  Not necessarily.  First, you have to think of variations in the time horizon.  We tend to presume that the time it takes to maximize shareholder wealth is equal to maximizing employee and consumer wealth.  This is not the case.  Shareholder wealth can initially be maximized at the expense of employee and consumer wealth.  I published a paper in Sloan Management Review that looked at the relationship between shareholder wealth maximization and external stakeholders and found that the more the board of directors were compensated with stock (a proxy for shareholder wealth maximization), the more value for consumers, the environment, employees, and communities eroded. 

Second, we need to think about resource allocation.  To a specialist, every dollar allocated to non-shareholders such as consumers and employees means a one dollar loss that could have gone to shareholders.  With this way of thinking, a management specialist is going to search for ways to maximize shareholder wealth in ways that don’t require attention to other stakeholders.  Thinking back to the medical analogy, if the goal is to prolong human life and to therefore trivialize or at least de-prioritize mental and social well-being, physicians would try to convince patients that the obvious choice is to find alternative ways to fulfill their life and to be thankful that they’re still alive. 

Investment banks leading up to 2008 found ways to maximize shareholder wealth without having to meet their consumer needs.  In fact, they found ways to maximize shareholder wealth by undermining the returns of their consumers.  This seems odd doesn’t it?  Goldman Sachs was particularly egregious here when they marketed poor financial securities to their consumers as premium and then made huge bets that these very securities would fail.  So not only do they earn the commission from their duped consumers, they also earn massive payouts when the securities fail.  This creates way more shareholder wealth than if they simply marketed healthy financial securities to their consumers. 

This is not that different from the food and beverage industry, where taking advantage of the addictive qualities of fat, sugar and salt to hook your consumer leads to consumer loyalty and shareholder wealth but an increasingly unhealthy and obese consumer.  We can say the same thing for employees where the obvious question one would have is, “don’t companies know that employees treated well are more productive and loyal to the company”?  But studies show that despite solid science that prescribes specific strategies to improve employee productivity through motivation, job satisfaction and a positive work environment, only 18% of companies use these strategies.    But more importantly, we have to think about how the mindset of the specialist in this case is going to find clever ways to avoid the costs that come with positive employee treatment. 

This then brings us to the second consequence where the specialist ultimately hangs him/herself with their own noose because their efforts to maximize shareholder wealth neglected parts of the environment upon which shareholders were highly dependent.  Because shareholder wealth is highly dependent on understanding the complex nature of multiple stakeholder interests, that wealth is eventually undermined.  But maintaining a focus on shareholder wealth exclusively tricks a manager into a reductionist frame of thinking that overlooks that shareholder wealth is contingent on a manager’s ability to understand and respond to the complexity of a wide range of stakeholders who interact with shareholder wealth in ways that are very unpredictable.  As a consequence, we hear about Lehman Brothers, Volkswagen, and British Petroleum because they fail to understand that shareholder wealth can’t be sustained using a reductionist approach. 

Let me end with Volkswagen.  The reductionist approach of shareholder wealth maximization facilitates decisions that undermine the interests of consumers, the environment, and public health.  Initially, shareholder wealth is maximized as it was from 2005 to 2014.  But eventually, like the physician who continues to ignore the mental and psychological states of her patient for the goal of physical well-being and sees her efforts undermined because of the patient’s mental or emotional condition, executives at companies like Volkswagen failed to see how shareholder wealth was inextricably tied to long-term environmental welfare and public safety (in the form of regulation), consumer trust, and employee loyalty. 

In sum, business schools are still very far from teaching its managers to think about business in a complex way.  We remain committed to a very reductionist approach where we argue that maximizing shareholder wealth will naturally maximize the wealth of other stakeholders.  This is like the general practitioner saying that the well-being of the patient will be maximized if we prolong their life or a skin specialist arguing that if we simply keep your skin healthy, all other parts of your body, including internal organs and mental and psychological health, will improve as well.  The notion that shareholder wealth maximization will naturally improve the welfare of other actors is a façade backed by no evidence. 

It will take some time to convince business school deans that the shareholder value maximization ideology needs to change.  For the time being, these Volkswagen type stories will continue to arise – one out-shocking the other – until we begin to look in the mirror as business schools to consider revamping the ideology that guides our courses, culture, and the mentality of the professors and graduates entering the workplace.

5 Business Strategies for Sustainability

The term sustainability or corporate social responsibility has grown increasingly prevalent in corporate boardrooms and on executive agendas.  In a study of 766 CEOs worldwide, KPMG concluded “that sustainability is truly top-of-mind for CEOs around the world”[i].  Growing pressure to respond to issues of climate change, the financial crisis, environmental degradation, and increasing social inequality have precipitated the diffusion of sustainability in internal business text, company websites, CEO speeches, and company reporting[ii]. CEO action on sustainability issues has shifted from being a discretionary choice to a corporate priority with 93 percent of executives claiming that sustainability issues will be critical to the future success of their business and 80 percent saying that in 15 years a majority of companies globally will have incorporated sustainability [iii].  In a recent study, McKinsey concluded: “the choice for companies today is not if, but how, they should manage their sustainability activities”[iv] with 96 percent of CEOs believing that sustainability issues should be fully integrated into the strategy and operations of a company.

In response, CEOs regularly tout their efforts to “embed” or “weave” sustainability into their operations and culture as the ultimate commitment[v] while scholars and practitioners have offered a number of prescriptions to achieve this objective[vi]. Yet despite the prevalence of sustainability and corporate social responsibility, there is tremendous variation in how companies have responded.  Part of this variation can be explained by the lack of standardized definitions available, leaving the movement open to various managerial interpretations that influence the type of responses by a given firm.  That said, research has shown that companies can be categorized into specific adoption levels of sustainability according to important organizational dimensions. 

Before continuing, let’s define some terms.  Sustainability is defined here as the long-term maintenance of systems according to environmental, economic, and social considerations.  Ecological systems might include water systems, the climate system, biodiversity, or species reproduction.  Economic systems would encompass the global financial system, income equality, the free flow of goods and services while social systems might include things like the proper functioning of civil society, low poverty rates, the education or health systems, social justice, or the food system.  Business sustainability or corporate social responsibility can then be defined as the achievement of economic viability (i.e. profitability and competitiveness) while operating within the capacity, or contributing to the integrity, of social, economic, and ecological systems.  For example, companies that take business sustainability or CSR seriously would be figuring out how to be profitable while preserving biodiversity or, more impressively, contributing to the integrity of existing ecosystems.

Almost all public companies and most non-public companies lay claim to the notion that they are doing something to preserve these systems either by minimizing harm (i.e. negative externalities) or finding ways to reinvigorate and improve these systems.  But any smart student of business would be interested in distinguishing responses that negatively affect these systems.  One of the ways to do this is to consider the relevance of these responses to the core strategy and operations of the firm.  When students of business want to know what makes a business tick, they typically turn to its strategy.  A firm’s strategy can be determined using three factors:  1) its positioning in the marketplace relative to competitors, 2) its core competencies that differentiate it from those competitors, and 3) its underlying culture that clarifies to employees the underlying purpose and identity of the organization, supported by structures, processes and policies.  First, positioning goes beyond marketing and represents a unique value proposition to consumers that distinguishes the firm from its competition.  Wal-Mart’s positioning is the low cost leader while Apple’s positioning is innovativeness and high quality.  Marketing is important in conveying this image to outside actors but positioning is supported by strong evidence that supports these claims (e.g. Wal-Mart’s low prices).  Second, strategy is very much about what the company does really well that is valuable and unique (its core competencies) that competitors find very difficult to imitate or find substitutes for.  This might include particular individuals employed by the firm (e.g. Steve Jobs), specific decision-making processes, unique products, a strong brand, innovation practices, intellectual property, highly valuable machinery or low cost operations.  Finally, external positioning and internal competencies must be supported by an organization’s culture and identity that transcends the worldviews of employees to the point where they see the relevance of the firm’s strategy to their daily activities, making it feel like employees live this strategy on a daily basis.   On what employees are rewarded,how they are trained, how decisions are made, and company policies and mission statements all support culture.

With the above in mind, it is possible to categorize companies into one of five business strategies for sustainability beginning on the one hand with businesses that separate sustainability from strategy and ending on the other hand where sustainability defines their strategy. 

Strategy #1:  Denial

            In the first strategy, sustainability and CSR are highly irrelevant to the firm’s strategy.  Any involvement in social or ecological issues is relegated to philanthropic contributions that have very little to do with the firm’s core operations.  Here the purpose is to build social goodwill to oftentimes combat any negative publicity that might be associated with their core operations.  Any public criticism of the firm is deflected as managers vehemently deny any wrongdoing or responsibility.  The tobacco industry for years denied any responsibility for the link between their products and various forms of cancer in the same way that the food industry today denies responsibility for obesity and other related health issues associated with food.  Associations representing restaurant or food production companies are often heard arguing that the unprecedented growth of food-related health problems is hardly a problem of the food itself but much more a problem of personal responsibility and a deficit in exercise.  Unrelated to food health, the association representing fast food restaurants launched an ad in Times Square denying any responsibility for the growing dependence of their own employees on government assistance and arguing against any need on their part to increase employee pay to a living wage because these employees have no skill or experience and are often lazy.  Nike in the 1990s denied responsibility for the growing instances of labour issues in developing countries because the suppliers making their products were distinct entities and therefore not under the responsibility of Nike.  Ultimately, companies will often say that nothing they are doing is against the law and so they are doing nothing wrong. 

The Denial Strategy omits any use of sustainability or CSR in its competitive positioning and at most would rely on its disconnected philanthropic contributions as part of their marketing strategy to suggest that the company is a good corporate citizen.  In fact, companies adopting this approach are heavily reliant for their success on practices that are particularly corrosive to social, ecological, and economic systems.  Although growing more rare, companies may actually promote this positioning as did low end burger chains like Harvey’s or A&W that went with a positioning that countered any need for healthy food by allowing consumers to indulge to avoid any compromise on taste.  More common though would be a particular positioning that very much relied on the erosion of social or ecological systems where denial of responsibility is oftentimes the only option.  Ashley Madison is an organization whose fundamental premise is based on a service that a majority of society argues erodes social systems.  Cash for money retailers can be classified under this strategy as well because their positioning as a source of capital for those consumers typically unable to get credit naturally positions the firm as an exploiter of vulnerable consumers.  Big banks, at least in Canada, have avoided this low end market because, although legal, they do not want to position themselves in such a way that leads to outcomes that can be perceived by many as exploitative. 

The companies in this category are therefore dependent on unrelated philanthropic initiatives that aim to distract stakeholders from the impact of their core operations.  If they pursued philanthropy for projects meant to counter the negative impact of their operations, they would be admitting guilt to a degree.  McDonald’s children’s charity has attracted substantial criticism due to the claims it makes for improving the lives of children yet ignores the health impacts of their products and the marketing tactics that have historically targeted children.  CIBC’s Run for the Cure, although a worthy cause, ignores how their everyday decisions associated with capital lending might actually be greasing the wheels of those companies making products that have shown linkages to cancer. 

From an internal competence perspective, what distinguishes the firm from its competitors has virtually nothing to do with sustainability.  In fact, their source of distinction represents a key erosion of social, ecological, and economic systems.  Consider gun manufacturers, tobacco companies and weapons manufacturers, all of whom have developed strong competencies related to their products whether it be design innovation, the manufacturing process, or logistics.  But what is unique and difficult to imitate in these organizations are the very things that contribute to system erosion.  Culturally, employees see virtually no relevance of sustainability to their daily operations and at most consider the company’s identity to revolve around some philanthropic endeavors.  Internal processes, reward systems, performance evaluation and employee skill and training have virtually nothing to do with sustainability. 

Strategy #2:  Defensive

            In the second strategy, companies have moved beyond denial of responsibility and have begun to admit that they are partly responsible for the erosion of certain social, economic, and ecological systems.  Unlike the previous strategy where companies feel that there is no need to adjust operations, the companies in this strategy work to lower their impact incrementally but avoid any serious reconsideration of their strategy.  The overarching objective here is to continue with business as usual but with some minor adjustments to respond to upcoming regulation or consumer pressure.  In other words, companies are starting to lose the argument that they are not responsible for system degradation and so want to show that they are responding to pressures of stakeholders, especially consumers. 

            One response is to engage in philanthropic activities that are more associated with the impacts of their operations.  This helps them defend their operations because they can lay claim to the fact that they are at least redistributing some of the profit associated with these operations to various causes that work to stem their effects.  Tim Hortons recently did this.  One has to have a sense of humour to not balk at the company’s initiative to raise money for child food education by selling sugar-laden cookies through their Smile Cookie Program.  This is an excellent example of avoiding changes to their core operations of food and instead launching philanthropic initiatives to show that they care about these issues.  Oil and gas companies have also undergone tremendous criticism for touting their commitment to reducing climate change but have invested substantial resources in lobbying against policies that would support renewable energies such as wind and solar.  The Guardian reported that The European Commission’s outlawing of subsidies for clean energy were largely requested by BP, Shell, Statoil and Total, and by trade associations representing oil and gas companies[vii].

Another very common response in the defensive strategy is for companies to aim for the low hanging fruit; a common expression that refers to those initiatives that represent relatively easy changes that at the same time make obvious business sense.  The most common initiatives are related to reductions in energy and fuel use in manufacturing processes or a reduction in waste through an increase in resource efficiency coupled with an increase in recycling efforts.  Mining companies, for instance, have begun to tout “green mining” to represent incremental improvements in power and fuel use along with reductions in toxicity, emissions, and water use.   Thinking beyond just the ecological dimension, an investment bank might indicate that they have reduced their portfolio of subprime loans from 60% to 40% or a fast-food chain might announce that they are reducing sugar and salt content of existing products by 15% over the next several years.  Companies are therefore positioned as the sustainability leader based on all of the ways that they’ve worked to reduce the impact of their existing operations, products and services on systems.  But the fundamental business practices have not changed. They have merely become more efficient or incrementally less impactful.

            Internally, core competencies remain associated with practices that are associated with system degradation.  That said, some companies might develop competencies in their brand as stakeholders perceive a certain company as a leader in making incremental improvements to their impact.  Other companies may develop expertise associated with resource efficiency that competitors have been unable to replicate.  Culturally, employees are likely unaware of any positioning around sustainability and more directly associate any improvements to representing an important and natural part of business improvement.  So whereas the company may be successful in creating a responsible image to broader society through philanthropic contributions, it's identity internally does not at all reflect sustainability.  Performance evaluations are tied to cost reductions efforts that just so happen to be associated with environmental system improvements for instance, but there is very little in the way of accountability towards social and ecological goals across levels of the business.

Strategy #3:  Isolated

            The third strategy is one where sustainability begins to make substantial inroads into the firm’s strategy and operations.  This typically involves an entire department or product line being positioned according to sustainability.  Remnants of more radical changes to sustainability begin to emerge such as Nike’s green shoe initiative where consumers can design their own shoes using environmental benign materials.  Another example might be a manufacturing firm’s use of a new technology that cuts emissions by 90% such as Vale Inco’s supposed plans to use a carbon sequestration scheme in Sudbury, Ontario that would replace one of Canada’s largest smokestacks.  Another example might be a retail company’s efforts to fuel half of the energy required to operate its stores using renewable energy sources such as wind and solar. 

The important difference from the second strategy is that the company has begun to innovate in ways that have revolutionized a particular product or process resulting in a substantial reduction in social, ecological, or economic system degradation that goes well beyond incremental improvements.  Under the second strategy, improvements are limited by an improvement ceiling because the process or product itself is oftentimes inherently unsustainable.  The third strategy questions the fundamental design of the product/service or the process of interest, thereby sidestepping the ceiling.  Clorox, the consumer packaged goods company, launched a highly popular Greenworks line that represents an isolated brand in the minds of consumers.  In this example, the product category is not associated with Clorox in the minds of the consumer but nevertheless represents an important strategic endeavor by the firm.  We can see similar types of initiatives in the social realm as well. Food manufacturers have either developed their own highly sustainable products or they might purchase healthy brands such as PepsiCo’s purchase of Naked Juice.  A mining company, as another example, might take a much more comprehensive approach to community development surrounding one or two of their mines but relies predominately on donations and philanthropy on the remainder of their mines.  Or they might introduce a technology that dramatically reduces the use of water    An oil and gas company might have a full-fledged renewable energy program, staffed within a legitimate department such as BP that is distinct from its core operations of oil and gas exploration and production that can still result in catastrophic environmental damage.  Finally, Toyota introduced a vehicle part that removed completely the need for a particular toxic mineral.

            A firm’s positioning in the marketplace then represents somewhat of a contradiction because, on the one hand, a part of their operations or a small section of their product line exemplifies sustainability principles but, on the other hand, the remainder of their operations is non-sustainable or continues to be criticized as such.  As a result, companies adopting this strategy will not necessarily lay claim that their positioning embodies sustainability but they will tout their efforts to make this a core part of their strategy by reflecting on the resources allocated to efforts to challenge certain sections of their products/services and operations.  In their attempt to distinguish a firm between strategy 2 and 3, students of business need to examine to what extent these initiatives represent a substantial part of their strategy or, as the second strategy described, do they instead represent a means to mask the system degradation of their traditional operations.  In other words, do these initiatives represent a substantial business endeavor that generates a substantial portion of revenue that positions them relative to competitors (beyond marketing)?  If genuine, managers may position the firm as a leader in sustainability innovation but the innovation, while noteworthy if not groundbreaking, represents a small part of the firm rather than, as will be described in Strategy 4, a key part of the firm’s DNA.  Incidentally, many firms do well with this strategy partly because of a number of third party ranking bodies that tend to be more attracted to key initiatives undertaken by the firm in contrast to the extent to which the firm lives and breathes sustainability. 

            Internally then, firms adopting strategy 3 demonstrate isolated yet highly lucrative competencies that are more typically found in pockets of the firm.  They may have a particular product that is so revolutionary in its benefit for the environment or consumer health that, despite their other operations, represents a highly innovative capability that could be replicated internally in the firm but is hard to replicate by competitors.  When Toyota came out with the Prius as the first hybrid vehicle, they demonstrated a highly lucrative core competency that competitors could not duplicate for quite some time.  The process behind the development of this technology was highly valuable for the firm.  Oftentimes companies, in the absence of core competencies in the area of sustainability, will acquire firms that have these competencies with the alleged intent to slowly integrate this way of thinking into its mainstream product lines (more often than not, this doesn’t actually happen). Common across the acquisition versus greenfield approach to sustainability is that there is potential, however remote,  for these initiatives to gain greater traction in the organization.  Bottom line is that while the core competencies associated with sustainability might be isolated from other competencies that conflict with sustainability, this strategy is the first of the five to show strategic relevance of sustainability. 

From the perspective of employees, strategy 3 creates a very bizarre identity as they might find it difficult to pinpoint just who they are and who they are not.  If sustainability exists in an isolated department, employees not in this department often consider sustainability to be irrelevant to their daily operations. In fact, the existence of a sustainability department has been found to give employees a license to continue on with business as usual or, in some cases, to operate even more egregiously in their degradation of social, ecological, and economic systems.  Business schools themselves have fallen victim to this problem as core business courses were given a license to “stick to the basics” because new departments operating under the label corporate social responsibility and corporate sustainability were meant to sensitize future managers to some of the complications arising from putting these core courses into practice.  Ironically, the influx of specializations in sustainability in business schools inadvertently pushed mainstream professors to avoid thinking more critically about how their course might be partly responsible for some of the system level issues we’ve been seeing.

Other businesses may simply consider sustainability to be one of the many things that they do and don’t hide the fact that there is a contradiction because, in their mind, they are simply responding to the highly diverse set of demands in the marketplace at the time.   From a systems and process perspective, no doubt there are likely job descriptions that relate directly to sustainability initiatives.  This can go as high up as a Vice-President as in the case of Centerra Gold where there is a VP – Sustainability & Environment.  But in most cases, the highest position tends to be at the director role as is the case at Loblaw Companies.  From a performance appraisal point of view, only a selected group of employees, managers and directors would be held accountable for performance indicators related to sustainability.  Decision-making at the organization, at most, will have sustainability as one of its key decision criteria but more often will not consider sustainability in its decisions because, again, a department or group of employees and managers is doing that for them. 

Strategy # 4:  Embedded

The fourth strategy sees sustainability infiltrated throughout the firm where, unlike the previous strategy, sustainability is no longer relegated to a particular department among some isolated die-hard employees or reflected in one or two product lines but is instead present in all aspects of the business across all products and services and among most, if not all, employees.  From a competitive positioning standpoint, sustainability represents THE key differentiating factor among competitors.  While there might be other factors that differentiate the firm in the marketplace (e.g. customer service), stakeholders consider the firm’s primary value proposition to be related to its commitment to sustainability.  That is, consumers are loyal to the company because they can count on the fact that all products and services, and the operations used to support the design, manufacturing, and distribution of those products and services, reflect sustainability principles. 

Many companies adopting this strategy tend to be smaller simply because the market isn’t large enough to support the business.  That said, those consumers who are supportive of these businesses, however niche in nature, are more willing to pay premium prices that support the extra costs that often come with these practices.  The value these businesses create for consumers above and beyond the alternative include health and safety, poverty reduction, the responsibility that comes with environmental conservation and, perhaps less intuitively, a desire to be associated with a company or brand that aligns with their values.  This latter, rather less studied, reason has important implications for competitive positioning because it offers consumers an opportunity to be activists through their purchasing power.  Patagonia, for instance, is a good example of a company that has clearly differentiated itself from competitors like North Face or Timberwolf.  They command a premium price for their products but the philosophical value alignment they facilitate for their consumers justifies the price increase.  Other examples include Ben and Jerry’s, Interface Carpets, and Level Ground Trading. 

On the surface, companies adopting this strategy possess similar capabilities as those companies adopting the third strategy.  That is, their unique products and services might be difficult for competitors to replicate or the processes behind the creation and delivery of these products and services might be inimitable.  But the fourth strategy reveals additional competencies that are higher in levels of complexity.  Complexity is high when there are a large number of interdependent parts or actors that collectively create an unpredictable pattern of behaviour as they respond dynamically to their respective local environments.  Complexity is important when considering internal competencies because the higher the complexity of a given competence, the more difficult it is for a competitor to copy or substitute it.  In fact, the company itself struggles to figure out how they were able to develop these competencies.   One common source of competitive advantage for companies adopting strategy 4 is its culture.  Culture is often defined as a set of values and belief systems that guide individuals in a particular group or organization.  Oftentimes, companies that embed sustainability have a very strong culture where employees, feeling that they are part of something that aligns closely with their values, are more productive and committed to their work.  These companies often refer to how close they are with their fellow employees, how collaborative they are in their work, and how there is very little politics that erode workplace performance. Unlike companies adopting the third strategy where sustainability related capabilities are confined to one department or small group of employees, capabilities are often at the firm level, crossing functional areas as employees, in their daily behaviour, interact in ways that create innovative forms of value for consumers and other stakeholders.. 

The interesting thing about this strategy is that employees of these companies, when asked about what they do in their job that demonstrates their commitment to sustainability, struggle to answer the question because they don’t see sustainability as distinct from their daily routines and activities.  This is an important paradigm shift from strategies 1, 2, and 3 because employees of the company struggle to understand how the business could exist without sustainability filtered through their daily activities just like employees of strategies 1, 2, and 3 struggle to understand how sustainability could at all be relevant to their daily operations.  The identity associated with businesses adopting this strategy tends to revolve around a sustainability leader, consciously distinct from companies that do not take sustainability seriously.  Unlike strategies 1and 2 then, the identity of employees and image to outside actors are aligned.  Most, if not all, levels of the organization have performance indicators related to sustainability and decision-making processes incorporate social and ecological indicators.

Strategy #5: Transformational

            The fifth and final strategy is called transformational because companies adopting this strategy make substantial changes to the external environment in which they operate.  The external environment can be defined here as an industry, supply chain, local community, or even broader society in which the company operates.  Unlike the previous strategy where the focus was on diffusing sustainability within the firm, the focus in this strategy is facilitating more sustainable practices outside the firm.  Many academic scholars and practitioners alike have come to the realization that no organization can single-handedly make substantive strides to sustainable practices.  Wal-Mart, McDonald’s, Starbucks, and Google, no matter how genuine they might be or how embedded sustainability might be internally, can only push the envelope on sustainability if they facilitate change among multiple, highly interconnected actors in their supply chain and industry.  Interface Carpets is a US-based carpet company that has pioneered a number of technologies that have revolutionized the once very toxic carpet industry.  But a key difference from the fourth strategy is that their focus wasn’t just on embedding sustainability, it was about rewriting the regulations associated with the carpet industry by demonstrating that more sustainable modes of manufacturing carpet were possible.  They also constructed new norms in the industry that forced a number of competitors that had no interest in sustainability to jump on board.  That is, the mainstream market, which consisted of large industry government facilities purchasing industrial carpet, now expected that Interface competitors offer a similar portfolio of sustainable products. 

            When done successfully, the strategic benefits become quite lucrative for businesses that adopt this strategy.  Competitive positioning becomes one of leadership where competitors look to the company for the next wave of technological innovation that they too need to adopt or, at least, be mindful of the market’s response to what the company is doing.  Even more lucrative is when government, always uneasy about setting harsh social and environmental regulation that might stifle growth and job creation, establishes regulation that is based on what the company has in fact proven to be possible, without the economic costs governments want to avoid.  SEKEM is an organic conglomerate located just outside Cairo, Egypt that specializes in agricultural commodities for a wide range of industries.  Established in the late 1970s, the company was so transformative in its business model that it single-handedly convinced over 800 Egyptian farmers to transition their practices to organic cultivation in exchange for guaranteed access to the European market.  SEKEM’s own ‘mother farm’ was so advanced in its agricultural practices environmentally and socially that the Egyptian government established regulatory policies in the agriculture sector based partly on what SEKEM proved was possible.  Imagine that, organic farming in the middle of the desert.

Another interesting dynamic associated with competitive positioning for this strategy is that the rivalry among competitors that typically exists in strategies 1-4 is much lower.  Rivalry is lower because for any transformation to take place in an industry, it is easier to have competitors on board for the change.  This sounds counter-intuitive because competitors are supposed to ‘compete’.  But evidence in the last decade suggests otherwise.  Open source innovation is a relatively new practice where multiple competitors join forces to innovate in ways that no individual company could possibly innovate.  This requires the sharing of important intellectual capital.  Patagonia’s business model is predicated on the notion that it is meant to share any of the new innovations they encounter in the development of more environmentally sustainable apparel.  Similarly, leading CEOs, such as Tesla CEO Elon Musk have been quoted as saying that trying to establish a monopoly in their industry is counter to the goals of sustainability because it delays the establishment of a much needed industry standard all competitors can adopt to move forward and leave less sustainable practices behind.  Think about the old BETA/VHS war (for those who are old enough) or the more recent HD-DVD/blu-ray war where the supply chain had to wait to figure out which standard would become dominant.  Companies in the transformative strategy want to avoid these standoffs and establish a common standard that competitors can use as well.  Leading electric car companies could have put forth separate and technologically-specific charging facilities in the hope of being the VHS or Blu-Ray winner.  But at least two leading CEOs have instructed governments in the jurisdiction that they were considering entering that any charging infrastructure must be universal and therefore usable by competing electric car companies.  Another reason why rivalry must be lower is that companies need to collaborate to avoid the tragedy of the commons.  Absent government regulation, natural resources such as a fish species, water or clean air would be depleted if companies behaved independently.  Transforming an entire industry away from unsustainable practices, such as fishing in a remote coastal region, requires collaboration among large groups of fishing companies. 

The transformative strategy then can only be transformative if networks of actors are created. In addition to combining forces to innovate, competitors and players along the supply chain (customers and suppliers)  often come together to self-regulate in ways that governments have struggled. Consider the diamond mining industry where several leading diamond mining companies partnered to impose peer pressure on the industry to stem conflict diamond mining.  The Equator Principles is a similar platform through which major global banks, including CIBC and Royal Bank of Canada, agreed to prohibit any loaning of capital to projects in developing countries of the world that carry substantial social or environmental risks to its citizens.  In the absence of any governing body with the power to develop and enforce such a policy, these banks, through peer pressure, have pushed the industry in a direction that fosters more sustainable lending practices. 

            A critical source of competitive advantage for companies adopting strategy 5 is their ability to foster relationships with key actors in its external environment.  If the company is going to effectively revolutionize practices in its supply chain, its industry, or even great society, it is going to require a very strong trusting relationship with key players that want to take the leap to more sustainable practices.  More importantly, these companies need to understand how to develop a network or ecosystem of actors that are connected and interact in ways that can create the necessary creative destruction that warrant changes in behaviour among all these actors.  Any innovation developed in the transformative strategy is often less valuable than the processes that created the innovation. 

The organization itself starts to be redefined in the 5^th strategy as the lines that once separated its own boundaries become blurred.  That is, in the context of sustainability, managers that think of the company  as a distinct organization is unhelpful.  A more accurate term to define what is needed for strategy 5 is a meta-organization.  A meta-organization are unique networks of organizations in that they organize actions around a system-level goal but are not bound by formal authority relations.  Meta-organizaitons typically possess lead organizations that use their prominence or power to take on a leadership role in pulling together the dispersed resources and capabilities of potential meta-organization participants.  The innovativeness of meta-organizations as alternative forms of organization to traditional hierarchical organizations bestows on them an advantage in coping with the complexity of sustainability.  Meta-organizations are effective at recognizing opportunities through previously unimagined or unavailable participant connections.  The Fair Labour Association, The Kimberly Process and Wal-Mart Labs are examples here.  The organizations involved range from businesses, to non-governmental organizations, to community based organizations and even governmental bodies. 

            Culturally then employees view the organization as one piece of a larger puzzle of organizations who collectively work to achieve sustainability goals.  The identity of the organization is largely tied to the connections it has with key participants of the meta-organization as employees feel that they are part of something much bigger than their own organization can accomplish independently.  In addition to performance appraisal mechanisms of Strategy 4, managers may also be accountable to the networks they create with other participants while decision-making processes within the firm encompass a wide range of external actors. 

In summary, research has shown that companies respond to pressures for sustainable business practices in very different ways, ranging from ignoring and defending against those pressures to aligning the broader objectives of the company and even the supply chain.  One of the ways to understand these differences is to consider them in the context of strategic adoption levels where sustainability in the firm varies according to its role in positioning the company in the marketplace, representing lucrative competencies that are difficult to imitate, and creating a particular culture and identity that aligns with sustainability.  It is important to note that companies will exhibit behaviour that spans some of these strategies.  For instance a company might engage in philanthropic activities that are both related (defensive) and unrelated (denial) to their operations or they may both defend against the impact of their operations while still having a department that contradicts the seemingly careless operations of other departments (isolated).  It’s the job of the analyst to put these initiatives together to pull out a overarching strategy that defines their positioning, core competencies, and internal culture and identity.    

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[i] P. Lacy, T. Cooper, R. Haywood, and L. Neuberger. ‘A New Era of Sustainability: UN Global Compact-Accenture CEO Study’ N Global Compact and Accenture. (2010) p. 10.

[ii] KPMG found that 95% of the top 250 companies report on sustainability.  KPMG International Survey of Corporate Responsibility Reporting 2011:  KPMG International Cooperative (2011); P. Lacy, T. Cooper, R. Haywood, and L. Neuberger (2010) op. cit

[iii] P. Lacy, T. Cooper, R. Haywood, and L. Neuberger (2010) op. cit. 

[iv] Bonini, S. “The business of sustainability”, McKinsey and Company (2011)

[v] For example, Coca-Cola states, “Our next step is to embed sustainability into our strategic planning process”, Nestle explains, “All business units are now encouraged to embed Creating Shared Value and sustainability into their business strategy and consumer communication”; Wal-Mart held a conference on “How to embed sustainability into your organization”; Royal Dutch Shell chairman said, “Under the recognition of Shell that began when I became CEO in July 2009, we embedded sustainable development firmly into our business”; British American Tobacco stated that they are “Working to embed sustainability in the business” while Philips Corporate Communications says “You have to embed sustainability in your organization”

[vi] Examples include I. Andersson, S. Shivarajan and G. Blau, “Enacting ecological sustainability

in the MNC: A test of an adapted value-belief-norm framework,” Journal of Business Ethics, 59/3 (2005): 295-305;  W. Blackburn, The sustainability handbook: The complete management guide to achieving social, economic and environmental responsibility (Washington, DC: Environmental Law Institute, 2007); K. Buysse and A. Verbeke, “Proactive environmental strategies: A stakeholder management perspective”, Strategic Management Journal, 24/5 (2003), 453-470; B. Doppelt,  Leading change toward sustainability. A change-management guide for business, government and civil society (Sheffield, UK: Greenleaf Publishing Limited, 2003); D. Dunphy, A. Griffiths and  S. Benn, Organizational change for corporate sustainability (London, UK: Routledge, 2003); M. J. Epstein, Making sustainability work. Best practices in managing and measuring corporate social, environmental, and economic impacts (San Francisco, CA: Greenleaf Pub, 2008); Ethical Corporation, “How to embed corporate responsibility across different parts of your company”, 2009; S. Bartels, L. Papania and D. Papania, Network for Business Sustainability (NBS), “Embedding sustainability in organizational culture”, B. Willard, The sustainability champion’s guidebook (Vancouver: New Society Publishers, 2009)

[vii] http://www.theguardian.com/environment/2015/apr/16/bp-dropped-green-energy-projects-worth-billions-to-focus-on-fossil-fuels

How to Evaluate Corporate Sustainability Reports

In today’s business environment, there has emerged an unprecedented expectation on companies to provide explicit information on their performance across the triple bottom line.  Consumers, employees, investors, civil society, government, and the media are increasingly interested in knowing how companies shape up when it comes to things like resolving social issues, reversing environmental degrading, and stemming unethical practices in their supply chain.  In response, many companies now publish Sustainability Reports (also called Corporate Social Responsibility Reports or Corporate Citizenship Reports) that, in theory, set out to mimic the highly institutionalized and reliable financial statements by presenting their performance along non-financial indicators. 

In the last decade alone, the number of companies listed on the S&P 500 index publishing sustainability reports increased from 47% in 2005 to 92% in 2015.  According to KPMG, whereas only 25% of the top 250 companies reported on sustainability in 1999, 93% of these companies report on sustainability as of 2013.  The increase has been truly unprecedented.  By region, sustainability reporting has increased dramatically in Asia Pacific over the last 2 years with 71 percent of companies now publishing reports (an increase of 22 percent since 2011 when only 49 percent did so).  Due to an increase in reporting by companies in Latin America, the Americas have now surpassed Europe as the leading reporting region where 76 percent of companies now report, followed closely behind by 73 percent in Europe and 71 percent in Asia Pacific.  KPMG concludes that sustainability reporting “is now undeniably a mainstream business practice worldwide, with 71 percent of the top 100 companies across 41 countries reporting on sustainability.  Whereas in 2011 less than half of the sectors in the world could claim that 50 percent of their companies reported on sustainability, by 2013 all sectors have reported that at least half of all top companies in each sector report on sustainability.  Major gains were seen by the automotive and telecommunications & media sectors with increases of 28 percentage points in both sectors. 

A KPMG survey conducted two years earlier asked CEOs to identify what was motivating them to report on sustainability and found that the primary motivation was reputation and brand (67% of respondents indicated this reason), followed by ethical considerations (58%), employee motivation, and innovation and learning (44%).  Other popular motivations included risk management or risk reduction, access to capital or increased shareholder value (32%) and economic considerations (32%).

But the growth of sustainability reporting has been met with an onslaught of criticism by anti-corporate groups and civil society organizations who claim that companies are using these reports to green wash what is otherwise business as usual, thereby disguising their destructive behaviour.  Some of these criticisms are not necessarily unfounded.  A quick look on the first few pages of mainstream sustainability reports and the reader will be bombarded with large high gloss pictures of the rural poor, for example, smiling ear to ear for all the wonderful things the company has done for them or of green pastures fronted by a farmer and his/her partner with seemingly content pigs and cows enjoying life as they collectively watch the beautiful sunset. 

Yet these same companies find themselves on the front pages charged with complicity in major social, ecological, and governance issues like the death of over 1100 people in the 2011 collapsed Bangladeshi garment factory (Loblaw, Wal-Mart), the mistreatment of animals revealed through undercover videos (Tyson Foods), the contamination of natural ecosystems (DuPont), the laundering of money for terrorist groups (HSBC), or the rigging of centralized interest rates by inflating or deflating their own rates to profit from trades (major banks).  If you look at the sustainability reports of the companies associated with these charges, you’ll find a completely different story, one that conveys the firm as a beacon for corporate responsibility. 

With these inherent contradictions growing in number, there is a widespread need across multiple stakeholders to effectively evaluate a sustainability report to see whether the claims embodied in the report are in fact testament to their commitment to sustainability.  How does an analyst distinguish rhetoric from reality when assessing whether a company is prepared for increased environmental regulation?  How can the consumer figure out which sustainability report is in fact a reflection of a serious commitment to sustainability rather than greenwashing?  How can an investor, concerned about the risk associated with investing in a firm that overlooks social and ecological externalities, figure out which sustainability reporting firm is more or less risky?  And how would an NGO know which firm is legitimately addressing issues?  In the absence of available information, all of these stakeholders want to know how to objectively evaluate a company’s adoption level of sustainability using the information provided in the report.

This feels like a daunting challenge considering the millions of dollars allocated to marketing and brand development that include reporting tactics meant to convince the reader that their commitment to sustainability is genuine.  What is more, unlike the institutionalized nature of financial statements that multiple stakeholders can rely on as a means of comparison, there is virtually no legitimate and substantive equivalent for non-financial indicators.  While there is growing commitment to the Global Reporting Initiative – a standard set of non-financial measures companies agree to provide to be a member – the measures are regularly criticized because they are self-reported and require no substantive basis upon which to demonstrate authenticity in the commitment to sustainability. For instance, one of the required measures under the social dimension is to indicate whether the company provides employees with training on human rights.  A simple ‘yes’ or ‘no’ question means that the company is not obliged to indicate the content of the training, how long it lasts, whether it was provided by professional independent bodies and, perhaps most importantly, whether there is any enforcement of employee behaviour based on this training. 

Despite these challenges, a growing repository of tools is emerging to assist readers in conducting evaluations of companies along non-financial indicators.  Introduced here are four such criteria one can consider when reading a sustainability report.  Incidentally, an important and often overlooked consideration across these criteria is to assign as much value to what is missing from the report as to what is in it.  Let’s look at the four criteria in more detail:

1.  Purpose of Reporting

The reader should begin by trying to uncover the overarching purpose of the report.  This is less difficult than it might seem.  To simplify, imagine a continuum that reflects the purpose of reporting where on one side the main purpose is for marketing and public relations while on the other side the main purpose is organizational development and change towards sustainability where only what is measured can be managed.  These are highly different objectives and there are signals in the report to help the reader position the report on this continuum and simultaneously determine their commitment to sustainability.  Let’s consider the first side of the continuum. Most companies still use the report for the purpose of marketing.  The company’s objective in this instance is to paint a positive picture of their relationship with society and the environment, oftentimes to deflect any negative publicity they might have received.  Signals of this in the report will be obvious, such as the fact that the company doesn’t report on anything negative, doesn’t acknowledge any bad publicity they might have received or, more importantly, on what they are trying to do to rectify issues or criticism they are facing.  The reader will also get the impression that much of what they’re presenting in the report has very little to do with their core business.  Much of the content will discuss their philanthropic endeavors and charity giving.  For instance, a mining company might avoid reporting on its actual relationship with the community but will instead report on the amount of money donated for community causes.  Similarly, a bank will disclose how much they have spent on charitable groups but will avoid presenting the extent to which their daily business decisions that can affect these very charitable groups are considering social and ecological issues, such as whether they are curbing the provision of finance to companies with poor environmental records.  With this in mind, readers of a report that is on the marketing side of the continuum will perceive an alarming sense of hypocrisy in what is presented.  From a stakeholder perspective, the company’s objective in reporting is to appease concerns, to quell criticism, and to defend their behaviour by providing evidence of positive contributions to the groups these stakeholders care about.  Fundamental, like many marketing strategies, the purpose is to divert attention away from relevant social and ecological issues to give investors, consumers and government the impression that the company “can’t be that bad.  After all, look at all the good they are doing”. 

On the flip side, companies may also use the report to facilitate organizational change towards greater performance in sustainability.  Here companies hold employees and managers accountable by reporting on performance levels across non-financial indicators.  Now made public, there is greater pressure by these organizational members to demonstrate improvement.  It also sends an important signal to employees that the company is closely monitoring social and ecological performance as a fundamental attribute of their organizational processes.  At the extreme, companies would use this report as one of many mechanisms to transition the company where sustainability is fundamental to its existence.  With this in mind, the focus of the report is less on philanthropic initiatives and more on the performance along social and ecological dimensions as they relate to the core business of the firm.  Readers therefore get the sense that the company is reporting comprehensively.  That is, rather than presenting small parts of their business that might be doing well, they are reporting across all dimensions of the business.  From a stakeholder perspective, the goal is not to appease stakeholders but instead to engage them.  More progressive reports provide detailed accounts of stakeholder interactions, publishing stakeholder input and providing avenues through which stakeholders can get involved in the company’s performance.  Put another way, the report’s purpose is not to report on the past but to facilitate a platform for discussion in the present.  A fundamental difference between these two objectives is that the second is using this report as a mechanism for change, to hold those in decision-making authority accountable for these issues by explicitly reporting them. 

2.  Metrics and Performance

The second criterion used to evaluate a sustainability report is perhaps the most intuitive of the four.  It asks what the company is measuring and how well they are performing on these measurements.  Again, we can use a continuum to understand the disparity in reporting practices.  On the one hand, companies with poor reports provide stories and anecdotes while listing the many awards they have received related to social and environmental performance.  Importantly, these stories and anecdotes are just that – they are not representative of the performance of the firm more broadly.  The report will be full of ‘feel-good statements’ as proxies for performance levels.  If the company on this end of the continuum did use measures, they would be very vague and ad hoc, likely customized in such a way that they can demonstrate positive performance.  For instance, a product’s environmental footprint encompasses a wide range of components including its carbon footprint, water footprint, materials footprint, among others.  But companies may choose to only report on those components of the environmental footprint that improved while omitting others.  At the same time, measures they are using for one of these footprint components are not provided within any context.  For instance, a company may indicate that its water usage has decreased by 2,000,000 litres or its carbon footprint has been reduced by 25%.  In the first instance, there is no reference point to gauge how much of a drop this represents.  For the second, without the use of a benchmark such as sales or number of employees, both of which are common proxies for company size, this percentage drop is meaningless.  Omitting this information leaves open the possibility that the company got smaller by 30%, indicating that its carbon footprint as a percentage of dollars sold or employees actually increased.  Similarly, companies often fail to provide historical performance levels, from which readers can assess performance over time.   

Companies on the other side of the continuum provide readers with a comprehensive snapshot of their performance over long periods of time (or at least when they starting reporting on these items).  Highly progressive companies will also provide performance indicators on the entire supply chain rather than on the firm exclusively.  Although a more daunting feat, several companies are doing this now to provide readers with the full product life cycle analysis that includes the social and ecological footprint of the raw materials all the way to the disposal of the product.   Apple, for instance, provides the ecological footprint of all components and stages of the product’s manufacturing, including those activities done by contractors used to make the product.  That said, they are not yet able to include the environmental footprint of second and third tier suppliers with any level of accuracy.  More obviously, the reader is easily able to see improvements in the company’s performance over time or, perhaps less ideal, transparency in the areas where they need improvement.  Apparel company Patagonia pioneered an initiative that provided consumers with a detailed breakdown on the carbon footprint of their products.  Incidentally, their honesty was more important to the consumer than any claims that they had the lowest carbon footprint among competitors. 

3.  Future Commitment and Progress

The third criterion readers should consider when evaluating a sustainability report is the extent to which the company provides future targets and reports on progress to these targets.  Because many companies consider sustainability reporting as a marketing initiative, readers are often frustrated with a lack of information on what they plan on accomplishing in future years.  Equally frustrating is when companies provide numerical or qualitative targets but give little or no action plan on how they plan on achieving those targets.  Naturally questions of concern emerge such as how executives are going to make sure that these targets are achieved, how are they being worked into their performance evaluation, who is overseeing these targets, what resources have been expended for the achievement of these targets, how will the firm ensure that employees are involved at contributing to these targets, and what happens if they don’t meet these targets.  With this in mind, targets would need to be incorporated into the existing management systems of the firm.  The reader needs to know how and to what extent these targets are incorporated into executive level decision-making.   Are these non-financial measures prioritized alongside other traditional employee, manager, director, and VP performance expectations or does it reside exclusively with the CSR manager?  These sorts of questions are instrumental and should be laid out in the report because they give the reader some sense of how feasible it will be to achieve these targets.   

In addition, the company often fails to provide detailed summarizes of how well they’ve progressed on targets they’ve set in the past, with details on how and why they’ve struggled to meet their targets and what they intend to do to make up for the failure.  All of this information is pivotal for any reader to make a sound judgment about whether sustainability is being taken seriously by and in the firm.  Oftentimes, employees see progress on non-financial measures in the same sustainability reports read by external stakeholders, meaning that they don’t feel any sense of urgency in the need to achieve these targets in their everyday behaviour.  Although this goes without saying, the targets set out by the firm should be stretch targets that demonstrate that the firm is interested in pursuing radical change towards sustainability.  Incremental changes, while still improvements, are less demonstrative of a company’s commitment to sustainability than those targets that push the company into thinking of radical ways of operating.  That said, the fact that they set targets represents more of a commitment than not revealing any targets at all. 

4.  Legitimacy

The final criterion relates to the legitimacy of the report.  The more obvious indicator of this criterion is whether the report is audited by an external, objective organization.  That said, auditing doesn’t evaluate the performance of the company along non-financial measures, nor does it evaluate the types of measures used.  It only verifies that what the company is saying in its report is accurate.  This is indeed a start no doubt.  But measuring the legitimacy of the report goes beyond whether it was audited.  The reader needs to ascertain whether the company selected its non-financial measures or whether they got their measures from an established source or is using measures that have become standard by external stakeholders.  Too often, readers are fooled by impressive numbers without realizing that the company made up particular measures that allowed them to bend their data in ways that looked good.  Consider an oil and gas company’s efforts to report on their community commitment.  There are a number of social impact indicators out there along with many qualitative indicators the firm could rely on from independent organizations, however many of them use their own made up measures such as the number of children that have attended a particular school they support or the number of patients served at a hospital they support.  For the latter, while having a health facility available is important, there is no indication of whether the community is positively impacted by it partly because it neglects to consider that the increase in patients may not be due to the presence of the facility but instead by the absence of education and preventative measures that are more effectively at improving social welfare. 

Low levels of reporting legitimacy are also associated with high level performance indicators that lack the raw data through which readers can follow the trail of how the measure was calculated.  Readers of progressive companies are able to verify the claims put forward by companies.  Balancing the need for more raw data is an effort to make the report user friendly for the reader.  Believe it or not, some reports are so poorly formatted and disorganized that the reader is unable to find critical information within a reasonable amount of time.  Legitimacy also represents the extent to which external stakeholders are involved in the creation of the report.  Very seldom do companies present data they collected with those critical of their performance.  Although some NGOs are hostile, most are very eager to work alongside the company to collect and measure performance levels.  Their involvement provides a fundamental source of legitimacy.  Finally, as already mentioned, legitimacy stems from the incorporation of reporting measures into the systems, processes, policies, and procedures that already exist in the firm so that it garners as much attention from key decision-makers to those at the front lines as other business activities. 

In sum, sustainability reporting among companies is at unprecedented levels.  Yet our ability to assess these reports in such a way that we can confidently and objectively determine performance levels to compare firms with one another is very limited.  The above four criteria represent a starting point in this direction. 

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i)  KPMG International Corporate Responsibility Reporting Survey, 2011; KPMG:  Accessed July 17th, 2012:  https://www.kpmg.com/PT/pt/IssuesAndInsights/Documents/corporate-responsibility2011.pdf

ii) The KPMG Survey of Corporate Responsibility Reporting 2013:  KPMG.  Accessed August 10th, 2015:  https://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/corporate-responsibility/Documents/corporate-responsibility-reporting-survey-2013-exec-summary.pdf