Supply Chain

Green Is the New Lean

Doing more with less is what many sustainability initiatives are all about. That&spamp;rsquo;s why CFOs are embracing them.
Alix StuartJune 15, 2012

Before Jeff Piccolomini joined Henkel Corp. in 1997, he was dubious about corporate efforts to address environmental concerns — a “typical skeptical CFO,” as he puts it. A CPA by training and a longtime finance executive, Piccolomini wasn’t accustomed to dealing with the kind of green goals that the German-owned personal-care company had set in motion, such as reducing carbon emissions.

Today, as Henkel releases its 21st annual sustainability report — which details plans to become three times more efficient in energy and water usage by 2030 — Piccolomini has changed his mind. “I’ve really become a convert,” he admits. As president and CFO of Henkel’s North America unit, he now believes that sustainability “is a very positive thing, and the right long-term view that all companies should have.”

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To be sure, sustainability is still largely about doing good, and making customers and employees feel good about that good. But as saving the planet takes on an increasingly practical focus, many finance executives find themselves in the midst of sustainability efforts at their companies, and explaining their own conversions. “We’re good folks and we care about our neighbors,” says Art Hicks Jr., CFO and chief operating officer of exercise-equipment manufacturer Cybex International. “But quite honestly, we get paid to run a successful business, and environmental issues have become bigger business issues in the past few years.”

Piccolomini says that Henkel’s customers usually appreciate green-oriented changes, such as reduced packaging. Plus, he adds, “I can’t think of a time when we were faced with a project that was a candidate for sustainability but didn’t make good business sense,” he says.

European companies like Henkel are generally ahead of their U.S. peers in terms of their sustainability efforts, in part because of tighter environmental regulations on the continent. But American businesses are catching up. Close to 80% of large U.S. companies now have a sustainability function, if not a chief sustainability officer. (The main reason for these new positions — ahead of customer and employee expectations — is to address energy costs, according to recent research by Ernst & Young.) Sustainability reports are becoming nearly as common as 10-Ks, and environmental issues are one of the top categories in proxy proposals this year.

Finance has little choice but to embrace the movement, and many CFOs are doing just that. According to E&Y’s research, 65% of finance chiefs at companies with $1 billion or more in revenues said they were “somewhat” or “very” involved with sustainability initiatives. That shouldn’t be surprising: going green is generally in harmony with the traditional CFO mantra to do more with less. In fact, it’s ripe for the rigorous analysis that finance does so well. Here, we examine three areas of sustainability in which finance executives and their staffs are playing major roles: capital expenditures, sustainability reporting, and investor relations.

Capital Expenditures: Return on Green Investment
Given the attention paid these days to building methods and manufacturing processes, CFOs can barely sign a lease without considering the environmental impact. The big question: Will investing in greener materials and processes pay off within an acceptable time period?

When Cybex built a new manufacturing plant in Minnesota five years ago, the $1.4 billion company decided that it would benefit from making the facility as green as possible. “We have adopted lean manufacturing practices, and we find that they go hand in hand with sustainability efforts, particularly when you’re talking about eliminating excess materials and reducing hazardous materials,” says Hicks.

To that end, Cybex invested in a $3.5 million painting system that minimizes the energy used in coating its products. The Minnesota facility also recycles the water used for painting several times, reducing wastewater, and then keeps it in holding ponds to cut down on pollution. At the same time, Cybex installed machines that laser-cut steel used in its products to decrease waste, and spent $70,000 on energy-efficient lighting.

The return on investment from such large projects can be uneven, though many CFOs say they track it rigorously. At Cybex, Hicks says the lighting paid for itself in less than two years in the form of lower energy costs and tax incentives, but he is still waiting for the plant to show a return, thanks to the drop-off in sales volume that accompanied the recession. Meanwhile, he is now considering installing a wind turbine to generate some electricity for the plant, with an expected payback period of two years or less (though he is mindful of the potential disruption to bird migration patterns the turbine may pose). “I’m kind of a skeptic, so I make sure we revisit projects one to two years later to ensure we got the projected results, and to learn for future projects,” Hicks says.

Most companies (close to 70%) require sustainability projects to clear the same payback hurdles as other kinds of projects, according to E&Y research. Only 20% permit a longer payback time. UPS is one company that is willing to relax the hurdle rate for projects that generate a sustainability benefit, says Kurt Kuehn, CFO of the $53 billion shipping and logistics giant — particularly when it comes to the new vehicles that the company is trying out, including all-electric trucks, hydraulic and electric hybrid trucks, propane trucks, composite “plastic” trucks, and trucks fueled by liquefied natural gas.

“We see vehicles as a rolling laboratory,” Kuehn says. The goal is to build and maintain a portfolio of truck options for different driving conditions, economies, and climates. Over time, he expects those options to help minimize costs and bolster the company’s reputation. In its latest sustainability report, UPS proudly noted that it reached a milestone in 2010 of 200 million miles driven in alternative fuel and advanced-technology vehicles since 2000.

State and federal tax incentives can go a long way toward shifting the ROI calculation. In fact, guiding the tax department to explore such options may be one of the biggest ways a CFO can contribute to the sustainability agenda, says Steve Starbuck, leader of E&Y’s climate change and sustainability services for the Americas. Tax incentives “can make a very significant difference to payback models, so it’s important that the CFO make the connection between tax and sustainability,” he says.

Some companies may be able to tap alternative energy sources with little or no investment, thanks to incentives. Spice-maker McCormick & Co. recently struck a deal with Constellation Energy to have the utility install solar panels on the roof of one of its Maryland manufacturing facilities, with no up-front investment from McCormick. McCormick’s only obligation is to buy all of the facility’s energy from Constellation over the next 20 years, with rates starting at below-market levels.

The deal makes sense for Constellation because of deep subsidies that come through state and federal tax incentives, says Mike Smith, the utility’s vice president of solar and energy efficiency. “In some states we can make the economics work for the customer, in others we can’t,” Smith says, noting that the “sweet spot” states right now are Arizona, California, Maryland, Massachusetts, and New Jersey.

Sustainability Reporting: Getting Serious
For large companies, producing an annual sustainability report has become almost mandatory. “Being a sustainable company is good business, and it’s also good business to help your key stakeholders understand your sustainability efforts,” says Mary Rhinehart, senior vice president and CFO of Johns Manville, the building-materials manufacturer. The company published its first sustainability report in March, called We Build Environments. “To remain competitive, it is important that our customers are aware of what we are doing in this area,” says Rhinehart.

While the contents of sustainability reports still vary widely — some are little more than glossy brochures, with few unique metrics — many are gaining in rigor. Kuehn says UPS’s report has evolved over time. “Our environmental footprint wasn’t something we had thought explicitly about,” recalls Kuehn, who helped create UPS’s first sustainability report about 10 years ago when he headed investor relations. “But we did have a rigorous metrics and analysis environment, including a lot of activity-based costing. So we took one of those models, and instead of creating an output of cost, we created an output of carbon. For me, it was an ‘Aha!’ moment.”

Now, UPS’s report catalogs an impressive array of metrics, including gallons of fuel used per ground package delivered, carbon emissions by business segment, and miles logged with alternative fuel. To make sustainability this quantitative, finance must be heavily involved, experts say.

While most firms are tracking environmental metrics in spreadsheets outside normal accounting systems, “a lot of the information comes out of the accounting record,” Starbuck notes. For example, measuring greenhouse-gas emissions likely entails looking at the amount of electricity purchased, while other metrics might draw on data about how much water was used or the amount of employee travel.

Taking it one step further, some companies are now getting their financial auditors to sign off on their sustainability reports. “Globally, about half of companies get a third-party audit,” says Starbuck. “In the U.S., that has historically been much lower, around 15%. But I can tell you that we’re seeing a lot more interest in it.” While the third party has often been a boutique firm specializing in environmental concerns, more companies are looking to their auditors for a review, says Starbuck, “because Wall Street has confidence in them.” Last year Kuehn hired Deloitte, UPS’s financial auditors, to provide assurance on the company’s sustainability report, in order to enhance the credibility of its data. “They’re already familiar with our systems, so they can hit the ground running,” he says.

Investor Relations: From Fringe to Mainstream
On the face of things, investors are more riled up about environmental issues than ever before. Nearly 50% of shareholder proxy proposals this year relate to environmental and social issues, up from 40% in the 2011 proxy season, according to Institutional Shareholder Services. Proposals range from general requests, such as those pressing companies to set more-quantitative goals around energy reduction, to highly specific demands, including several asking energy companies to improve the composition of fluid used in hydraulic fracturing, or “fracking.”

Historically, these types of proxy proposals have come from fringe investor groups that are tightly focused on environmental issues, but lately they seem to be gaining more support from mainstream investors. The average shareholder support for such proposals reached 21% last year, with five resolutions garnering more than 50% of shareholder votes, according to E&Y’s data. That widespread interest suggests it is not just fringe groups that are voting yes.

For example, while financial services provider TIAA-CREF, a fairly traditional investor, is not in the vanguard of filing shareholder proposals on environmental or social issues, it is looking for “reasonable” ones to support, says John Wilson, director of corporate governance. “There’s a lot of data showing that commodity prices are rising, and it’s beginning to be better understood that scarcity of natural resources is becoming a bigger risk factor,” he says. “We are not prescriptive — we’re not going to tell a company to invest in renewable energy — but we’re looking for disclosure about your strategy and performance on meeting your goals.”

One area close to finance that investors have addressed with tenacity is the supply chain. Last year, for example, Apple bowed to shareholder pressure and released an unprecedented amount of data about its suppliers’ adherence to human-rights standards and environmental regulations. Close to 80% of firms surveyed by E&Y are now working with their suppliers on obtaining similar data. CFO Hicks says Cybex is already reporting details for its European customers, such as how hazardous materials in its products are disposed of at the end of the products’ useful lives. “That certainly makes us think about how to design products in order to reduce the hazardous materials used,” he says.

When it comes to face-to-face meetings, though, most CFOs say investors are asking few if any questions on sustainability. Addressing the topic, therefore, involves a delicate balance between saying enough and saying too much. “You can get pumped up about this, but if you play it too strong, a lot of investors’ eyes kind of roll back in their heads,” says Kuehn. “What I’ve learned is to pitch this to investors as part of long-term brand investment, a sign of innovation, and part of long-term risk-management strategy.”

No matter how companies may characterize them, sustainability efforts are increasingly about efficiency and growing the bottom line. “We set goals for water usage and energy usage because you can’t really hit those while pursuing only economic benefits,” says Henkel’s Piccolomini. In the end, though, “cost reductions will flow out of using less water and less energy — they almost have to.”

Alix Stuart is a contributing editor of CFO.

A Customer Service
UPS now offers carbon offsets to shippers.

Some companies, particularly smaller ones, are still blissfully unaware of the carbon emissions they may be generating or how to reduce them. Last year, UPS decided to help enlighten its customers. The shipping and logistics giant rolled out a “carbon calculator” that tells customers exactly how much of an impact shipping their packages will have on the climate. Then, for as little as a nickel a package, they can pay to erase that impact, through the purchase of an offset that will help fund high-quality and third-party-reviewed projects that sequester carbon.

UPS CFO Kurt Kuehn is quick to note that the product is not a moneymaker, at least not yet. “In no way has that calculator generated an ROI; we just think it’s a great way to help our customers adapt to the future, and a positive brand attribute,” he says.

It’s also a useful way for Kuehn to engage his treasury staff in the company’s sustainability agenda. Treasury employees screen the offsets that customers indirectly purchase, setting stringent guidelines to help avoid disreputable projects, like funding a reforestation site that could become a parking lot five years later. “Treasury groups in most companies are pretty black and white, and they were at least a little skeptical at first about getting involved,” says Kuehn. “But, with some time, it’s been exciting for them to see how they can add value, too.” — A.S.