Why natural capital asset management becomes critical across the business as sustainability moves beyond the boardroom

By: David South, Alison Patelski, and Alex Frank

As sustainability moves beyond the boardroom, natural capital asset management becomes critical across the business.

Capital is a commonly understood term; it represents the physical assets used to produce a good or service. Capital must be amassed, maintained, and properly valued for a business to prosper. But recently, there has been a growing view that the traditional notion of capital misses a key component of economic value: natural resources.

“Natural capital” is actually a very simple idea rooted in the concept that natural resources represent dynamic systems that have real impacts to an economy. Natural capital is a way of describing the value that ecosystems provide and the services upon which people and businesses depend. Natural capital can take the form of a large variety of assets—from clean water and fertile soils to a stable climate and natural barriers to disease spread.

The rise of ecosystem services
Since at least the time of Plato, when he worried about the effects of deforestation on natural springs, we have understood that ecosystems provide resources that we all need for survival. This concept became more formalized during the growing environmental movement in the 1940s, when the idea of ecosystem services became a hot topic of discussion and scientific research. Ecosystem services are the functions that ecosystems perform, such as cleaning the air or water, that people utilize. The field of ecology grew to encompass large studies of a variety of ecosystem services and how these sometimes obscure functions (e.g., bats eating moths?) that result in very important outcomes on which people depend (e.g., a reduction in common agricultural pests!). Yet what these studies often identified were important services suffering from a “tragedy of the commons.” That is, individuals and corporations, acting independently and rationally, were exploiting a shared resource to the detriment of the long- term interest of the community. This concern is now embedded in the “triple bottom line” and being monetized through natural capital.

Not a new concept
Outside of academia and the environmental movement, the idea of natural capital has actually been embraced for some time. In 1889, Seattleites voted to purchase the forested Cedar River Watershed to naturally filter the city’s water supply. Also, New York City maintains and protects the Catskill Watershed to secure its drinking water (and to ensure its pizza and bagels taste so good). At their face these seem like very straightforward decisions, but in both instances communities have agreed to spend money to maintain a natural area because they needed what the ecosystem provides.

Now, clean water may be a straightforward example of natural capital, but all businesses, public and private, in at least some way depend upon it. Manufacturing may require raw material inputs such as lumber, minerals, or water. Retail businesses rely on packaging derived from trees or oil. Even hedge fund managers have increasing concerns over natural capital when making investments because without considering natural capital impacts they could put future returns at risk. And finally, at its most basic level, all business requires healthy people, and if you want healthy people you need clean air, clean water, and a stable climate--all part of any business’ natural capital.

But, new attention to managing it
Of course not every business will need to purchase forested land or protect clean rivers to preserve its natural capital, but simply ignoring natural capital isn’t always the right answer either. There is a new push for businesses to begin documenting, valuing, and assessing their natural capital.

As the paradigm for evaluating capital shifts, companies will change both how they evaluate their business processes and how they are evaluated from an outside perspective. This shift in the evaluation will include natural capital. Going forward, a company’s success no longer will be measured by its financial growth alone, but also by its ability for sustainable growth. The environmental impacts of businesses (e.g., air pollution, biodiversity loss, ecosystem degradation, and water scarcity) affect natural capital, and the risk of depletion or extinction of these resources from over consumption prevents the ability to deliver sustainable growth.

Understanding and quantifying the impact
In order for companies to achieve sustainable growth, they need to achieve financial growth while reducing their environmental impact; but in order to do so companies need to understand the environmental impact and associated risks. Companies need to understand how their current business operations affect the environment around them as well as the impact a lack of these natural resources would have on their daily operations and long-term viability.

A number of companies are beginning to put a “shadow” price tag on things like carbon emissions, water use, and land conservation to help them manage these resources more effectively. The shadow price is the estimated price of a good or service for which no market price exists or where the market price doesn’t reflect the full replacement cost. By including a shadow price, companies are starting to understand how the impacts on natural capital may affect the bottom line.

To put this in context, let’s use a water example. If a production site lost access to water for one month, what would happen to the business? General Motors calculated that a one-month disruption at one of its production facilities in Mexico, hard hit by drought, could result in a loss of $27 million in net income.1

Another way to evaluate natural capital extends into the supply chain. Most companies focus on production from the minute raw materials enter the facility to the moment they leave as a finished good. More and more, companies are becoming responsible for the extended supply chain, which include the sourcing of raw materials. Evaluating where a company sources these raw materials as well as the available supply is often overlooked, but this could have a severe long-term impact on a business.

The life sciences industry, for example, may face these issues. GlaxoSmithKline reviewed its use of raw materials, identifying concerns over long-term sustainability and availability of palm oil, fish oil, and paper products. Through this analysis, the company intends to source palm oil and paper packaging only from sustainable sources.2 Additionally, MillerCoors has shown a growing concern about its dependencies on water throughout its supply chain. Sustainable sources of water to grow barley and hops are critical to its product and financial viability, so it is investigating strategies to reduce water usage and secure water rights in the agricultural supply chain.

This understanding helps drive decisions for a company to look into alternative solutions and how it can change their current operations to de-couple its natural capital impacts and revenue growth, which directly correlates to the company’s future viability.

Natural capital asset management
As corporate sustainability grows and expands beyond the boardroom, issues like natural capital asset management will become broader reaching, affecting multiple areas of the business—from the operations team up to the Chief Financial Officer. By incorporating natural capital asset management, a company will better understand its business and can implement changes to minimize risk while planning for long-term growth and success.

For additional information on natural capital, please reach out to David South at dsouth@westmonroepartners.com, Alison Patelski at apatelski@westmonroepartners.com or Alex Frank at afrank@westmonroepartners.com.

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Sources:

1 The State of Green Business 2014: http://info.greenbiz.com/rs/greenbizgroup/images/sogb14-1.pdf?mkt_tok=3RkMMJWWfF9wsRolv6vNZKXonjHpfsX57O0oWqCylMI%2F0ER3fOvrPUfGjI4CTsBmI%2BSLDwEYGJlv6SgFSLHEMa5qw7gMXRQ%3D

2 Biodiversity and ecosystem services: http://www.naturalvalueinitiative.org/download/documents/Publications/Biodiversity%20and%20Ecosystem%20Services%20report%20July%202011.pdf