This is a reproduction of a project Thom and I did for our Strategy and Sustainability class. We got an “A”, so I thought it was worth sharing our thoughts on the Sustainability Index to highlight the difficulty in quantifying sustainability across industries.
Part I: An evaluation of the Global 100 Sustainability Index
1. The Global 100 claims to be the definitive global sustainability benchmark
- This is not a universally accepted index, unlike the stock market itself and is therefore not subjected to the same rigorous processes
- The index is static and does not reward year on year improvements (ideally include both)
- Index covers only public companies, though private companies lacking shareholders to answer to may have more freedom to pursue innovative sustainability strategies
- The methodology was changed in 2010, making previous years’ indices less useful. A metric needs to stay consistent otherwise it has no value since conclusions on progress cannot be drawn. A good example of this is that GE was not even ranked in the top 100 in 2009 and was placed 1st in 2010 – an unlikely reward for instant performance?
2. Global Sustainability Research Alliance (GSRA) compiles research
- GSRA covers 95% of equities in N. America, Europe and Korea and 30% of equities in emerging markets, and is thus biased toward developed countries.
- There is a possible conflict of interest with bank-based research as the alliance likely picked from its clients and would miss any external companies; also banks stand to benefit from their clients making the list
3. GSRA isolates from this research the top 300 performers out of 3,000
- The methodology used to distill these 3,000 is not fully disclosed, but we are told that credit and solvency are considered as are security market valuation. We believe that financial strength should not be “married” this early with sustainability leadership because it confounds the true sustainability metrics from the beginning and precludes innovative sustainability practices at smaller firms from gaining attention.
4. CKRG assesses these 300 against 10 ESG KPIs
- Not all of these factors deserve equal weight, and therefore the winners are “average winners”, and successes in one area will drift to the bottom. Many measures reduce the effectiveness of any one measure.
- More detailed metrics should consider net “greenness” for the world and reward specific efforts (Should oil companies be allowed in?)
- It is not explained how sector weightings from the MSCI ACWI were used, but MSCI covers financial information and not sustainability factors, so this does not address the previous concern (2).
- KPIs were identified after numerous reviews by finance specialists, and not scientific or sustainability-related experts. Only a survey of investors and interviews of asset managers were sited in an ESG context, as well as the experts sited on the Global 100 site, but their relative importance is not clear. (4)
- Data was not available in all cases and neutral scores could cover up for extremely negative scores that companies simply did not report.
5. Inflection Point Capital Management provides a final round of vetting
- The proprietary model is a black box and appears to be open to subjectivity
6. Resource indicators are forward-looking
- The majority of resource data is unaudited
- We don’t believe sustainability rankings should reflect the future.
7. This analysis relies heavily upon the research stating that successful programs must support the dual objective of stabilizing atmospheric greenhouse gasses and maintaining economic growth
- Perhaps economic growth should be replaced with competitiveness
Interpretation of the 10 KPIs
Energy/Carbon/Water/Waste Productivity: Since the measure uses revenue per unit of energy/carbon/water consumed it is natural that larger, resource-intensive companies will benefit from economies of scale. This does not seem to consider whether these companies are using innovative solutions to deal with the output of these resources (i.e. carbon capture/trading, selling the waste) or if their companies are naturally greener in these areas.
Leadership Diversity: Reverse anti-discrimination measure should not be used to reward companies. Promoting women in business is great but it should be on merit and not part of any sustainability measure with equal weighting to environmental destruction factors
CEO-Worker Pay Ratio: Different industries will have different structures (some autocratic, some democratic and some meritocratic) and this should not be used as a consistent metric. It is not clear if the data includes bonuses and it is only 30% complete.
Tax Paid: This is a legal requirement and not a sustainability matter and will unfairly bias companies in different regions where laws differ and c0rruption may play a role (See Ex. 1 for a comparison of tax factors by region)
Sustainability Leadership/Remuneration: There is no numerical distinction between companies and how they measure/reward sustainability incentives.
Innovation Capacity: This KPI does not include a) any measure of effectiveness or productivity of investment made and b) a stipulation of investment in sustainable products. For example, a company could be highly ranked even if they spend a lot of money on R&D to create more and unnecessary products that create additional waste (New disposable cleaning products made with hazardous chemicals, for example)
Transparency: Whilst it is important to have transparency, this should implicitly be a necessary condition for the reporting not a measure used to weight its outcome.
Conclusion: The methodology is biased toward large publicly traded companies from developed countries and, despite it’s claims of transparency and simplicity, introduces arbitrary gateways in the process undermining the measure itself. The majority of review is done according to financial results and there are no significant areas in the process requiring scientific rigor and third-party verification. It attempts to do too much (to become the ‘definitive’ measure) and because of this loses the ability to be particularly insightful in any one place; indeed, the equal weighting rewards mediocrity and brings the overall measure into disrepute (see Exhibit 2 for an example of how Nokia outperforms GE at nearly all criteria despite being ranked 4 places lower). It is our belief that it would greatly benefit by narrowing the focus of its analysis by considering only the first four consumption criteria and leaving the less tangible social factors to a different index. The problem with ‘sustainability’ as a buzzword is that it is too encompassing and lacks a concrete and implementable factor – something that this index exacerbates.
Part II: Strategic Opportunities for Inditex, a Global 100 Company
To look at the links between financial and sustainability performance, we first compared the other listed retail companies: H&M and Kingfisher. From the graph, Ex. 3, it can be seen that though many of the data are missing on H&M, it ranks higher than the other two with only one solid gain in carbon productivity over the others. Energy, water and waste productivity were not listed. From preliminary evidence, it appears that a lack of data, rather than financial performance could be the biggest factor in positioning on the list.
As for Inditex, the links between sustainability and financial performance are notably related to the unique strategy of the company. Shipping intensive and with lots of retail outlets, Inditex is understandably low in energy and carbon ratings, but these elements of their fast-fashion model are tied directly to strategy. Inditex scored high in water and waste productivity likewise because of its well-tuned logistics, high-tech machinery and production strategy. Clothes are often cut and styled on a last-minute basis, which removes the uncertainty of sales, and decreases waste and makes efficient use of machinery.
Inditex’s poor performance in carbon consumption (according to our calculations, Inditex emits as much CO2 as a small African country – see Exhibit 5) comes, by large part, from their shipping costs and fast product cycles. A core part of their business model, this will prove difficult to change. This represents another fundamental flaw in the Global 100 rankings. The areas in which the strategy align – water and waste specifically – along with some of the less environmentally rigorous KPIs allow companies like Inditex to seem sustainable despite their highly destructive levels of carbon and energy.
However, Inditex seems to be interested in strategically improving their sustainability ranking with actionable and aligned projects. Their Carbon Footprint Project includes many initiatives like greener transportation and energy efficiency in stores (6). The eco-efficiency measures aim to reduce electricity use in their stores by more than 30%, which is estimated to reduce CO2 emissions by 36 tonnes of CO2 per year (5). The company also plans to use biodiesel for transportation, and will train drivers in efficient driving techniques. Inditex is also developing an analytical tool to help identify the carbon footprint of factories and products for comparison across locations. (6)
To the extent that Inditex implements these projects, there is potential to lighten their carbon emissions and energy efficiency. Improvements in transportation efficiency and store energy usage are feasible and attractive. Analyzed with the criteria of improved financial return, improved energy and carbon efficiencies, acceptable implementation cost, manageable risk and strategic alignment, these projects appear to fit. The highest cost of implementation will come from the development of the monitoring system, but once in place promises to lower costs in other areas by helping managers identify problem areas. Happily for Inditex, the problem areas are in their stores and their transportation, which while necessary for their strategy are areas they can improve on with minimal cost to the benefit of their reputation and with potentially very high financial benefit.
- Global 100, Criteria and Weights: The Definitive Global Sustainability Benchmark.
- The MSCI All Country World Index, http://www.mscibarra.com/products/indices/international_equity_indices/definitions.html#ACWIASIAXJP
- Thomson Reuters Extel and UKSIF 2009 Socially Responsible Investing Y Sustainability Survey Results, 28 July, 2009.
- Massimo Dutti receives the first “A” Energy Rating awarded in Spain to a retail store http://www.inditex.es/en/press/other_news/extend/00000754
- Strategic Environmental Plan 2007-2010
- 2010 Global 100 List spreadsheet download
|Exhibit 4: Inditex Scores|
|Global 100 Rank||12|
|Energy Productivity (US$)||$4,839|
|Industry Group Percentile||64%|
|Carbon Productivity (US$)||$39,934|
|Industry Group Percentile||31%|
|Water Productivity (US$)||$44,170|
|Industry Group Percentile||100%|
|Waste Productivity (US$)||$1,224,073|
|Industry Group Percentile||88.8%|
|CEO-to-average worker pay||33:1|
|% Tax Paid||100.00%|
|Innovation Capacity||No disclosure|
|Exhibit 5: CO2 Emissions calculations|
|Carbon Productivity (US$)||$39,934|
|=> Carbon Emissions (tons)||260,430|
|Carbon Output of Guinea-Bissau||279,000|
|* Taken from 2008 Annual Report on http://www.inditex.com|