Beyond the green corporation

/ Source: BusinessWeek Online

Under conventional notions of how to run a conglomerate like Unilever, CEO Patrick Cescau should wake up each morning with a laserlike focus: how to sell more soap and shampoo than Procter & Gamble Co. But ask Cescau about the $52 billion Dutch-British giant's biggest strategic challenges for the 21st century, and the conversation roams from water-deprived villages in Africa to the planet's warming climate.

The world is Unilever's laboratory. In Brazil, the company operates a free community laundry in a São Paulo slum, provides financing to help tomato growers convert to eco-friendly "drip" irrigation, and recycles 17 tons of waste annually at a toothpaste factory. Unilever funds a floating hospital that offers free medical care in Bangladesh, a nation with just 20 doctors for every 10,000 people. In Ghana, it teaches palm oil producers to reuse plant waste while providing potable water to deprived communities. In India, Unilever staff help thousands of women in remote villages start micro-enterprises. And responding to green activists, the company discloses how much carbon dioxide and hazardous waste its factories spew out around the world.

As Cescau sees it, helping such nations wrestle with poverty, water scarcity, and the effects of climate change is vital to staying competitive in coming decades. Some 40 percent of the company's sales and most of its growth now take place in developing nations. Unilever food products account for roughly 10 percent of the world's crops of tea and 30 percent of all spinach. It is also one of the world's biggest buyers of fish. As environmental regulations grow tighter around the world, Unilever must invest in green technologies or its leadership in packaged foods, soaps, and other goods could be imperiled. "You can't ignore the impact your company has on the community and environment," Cescau says. CEOs used to frame thoughts like these in the context of moral responsibility, he adds. But now, "it's also about growth and innovation. In the future, it will be the only way to do business."

A remarkable number of CEOs have begun to commit themselves to the same kind of sustainability goals Cescau has pinpointed, even in profit-obsessed America. For years, the term "sustainability" has carried a lot of baggage. Put simply, it's about meeting humanity's needs without harming future generations. It was a favorite cause among economic development experts, human rights activists, and conservationists. But to many U.S. business leaders, sustainability just meant higher costs and smacked of earnest U.N. corporate-responsibility conferences and the utopian idealism of Western Europe. Now, sustainability is "right at the top of the agendas" of more U.S. CEOs, especially young ones, says McKinsey Global Institute Chairman Lenny Mendonca.

You can tell something is up just wading through the voluminous sustainability reports most big corporations post on their Web sites. These lay out efforts to cut toxic emissions, create eco-friendly products, help the poor, and cooperate with nonprofit groups. As recently as five years ago, such reports—if they appeared at all—were usually transparent efforts to polish the corporate image. Now there's a more sophisticated understanding that environmental and social practices can yield strategic advantages in an interconnected world of shifting customer loyalties and regulatory regimes.

Embracing sustainability can help avert costly setbacks from environmental disasters, political protests, and human rights or workplace abuses—the kinds of debacles suffered by Royal Dutch Shell PLC in Nigeria and Unocal in Burma. "Nobody has an idea when such events can hit a balance sheet, so companies must stay ahead of the curve," says Matthew J. Kiernan, CEO of Innovest Strategic Value Advisors. Innovest is an international research and advisory firm whose clients include large institutional investors. It supplied the data for this BusinessWeek Special Report and prepared a list of the world's 100 most sustainable corporations, to be presented at the Jan. 24-28 World Economic Forum in Davos, Switzerland.

The roster of advocates includes Jeffrey Immelt, CEO of General Electric Co., who is betting billions to position GE as a leading innovator in everything from wind power to hybrid engines. Wal-Mart Stores Inc., long assailed for its labor and global sourcing practices, has made a series of high-profile promises to slash energy use overall, from its stores to its vast trucking fleets, and purchase more electricity derived from renewable sources. GlaxoSmithKline discovered that, by investing to develop drugs for poor nations, it can work more effectively with those governments to make sure its patents are protected. Dow Chemical Co. is increasing R&D in products such as roof tiles that deliver solar power to buildings and water treatment technologies for regions short of clean water. "There is 100 percent overlap between our business drivers and social and environmental interests," says Dow CEO Andrew N. Liveris.

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Striking that balance is not easy. Many noble efforts fail because they are poorly executed or never made sense to begin with. "If there's no connection to a company's business, it doesn't have much leverage to make an impact," says Harvard University business guru Michael Porter. Sustainability can be a hard proposition for investors, too. Decades of experience show that it's risky to pick stocks based mainly on a company's long-term environmental or social-responsibility targets.

Nevertheless, new sets of metrics, which Innovest and others designed to measure sustainability efforts, have helped convince CEOs and boards that they pay off. Few Wall Street analysts, for example, have tried to assess how much damage Wal-Mart's reputation for poor labor and environmental practices did to the stock price. But New York's Communications Consulting Worldwide (CCW), which studies issues such as reputation, puts it in stark dollars and cents. CCW calculates that if Wal-Mart had a reputation like that of rival Target Corp., its stock would be worth 8.4 percent more, adding $16 billion in market capitalization.

Serious money is lining up behind the sustainability agenda. Assets of mutual funds that are designed to invest in companies meeting social responsibility criteria have swelled from $12 billion in 1995 to $178 billion in 2005, estimates trade association Social Investment Forum. Boston's State Street Global Advisors alone handles $77 billion in such funds. And institutions with $4 trillion in assets, including charitable trusts and government pension funds in Europe and states such as California, pledge to weigh sustainability factors in investment decisions.

Why the sudden urgency? The growing clout of watchdog groups making savvy use of the Internet is one factor. New environmental regulations also play a powerful role. Electronics manufacturers slow to wean their factories and products off toxic materials, for example, could be at a serious disadvantage as Europe adopts additional, stringent restrictions. American energy and utility companies that don't cut fossil fuel reliance could lose if Washington joins the rest of the industrialized world in ordering curbs on greenhouse gas emissions. Such developments help explain why Exxon Mobil Corp., long opposed to linking government policies with global warming theories, is now taking part in meetings to figure out what the U.S. should do to cut emissions.

Investors who think about these issues obviously have long time horizons. But they encounter knotty problems when trying to peer beyond the next quarter's results to a future years down the road. Corporations disclose the value of physical assets and investments in equipment and property. But U.S. regulators don't require them to quantify environmental, social, or labor practices. Accountants call such squishy factors "intangibles." These items aren't found on a corporate balance sheet, yet can be powerful indicators of future performance.

If a company is at the leading edge of understanding and preparing for megatrends taking shape in key markets, this could constitute a valuable intangible asset. By being the first fast-food chain to stop using unhealthy trans fats, Wendy's International Inc. may have a competitive edge now that New York City has banned the additives in restaurants. McDonald's Corp., which failed to do so, could have a future problem.

Rising investor demand for information on sustainability has spurred a flood of new research. Goldman Sachs, Deutsche Bank Securities, ubs, Citigroup, Morgan Stanley, and other brokerages have formed dedicated teams assessing how companies are affected by everything from climate change and social pressures in emerging markets to governance records. "The difference in interest between three years ago and now is extraordinary," says former Goldman Sachs Asset Management CEO David Blood, who heads the Enhanced Analytics Initiative, a research effort on intangibles by 22 brokerages. He also leads Generation Investment Management, co-founded in 2004 with former Vice-President Al Gore, which uses sustainability as an investment criterion.

Perhaps the most ambitious effort is by Innovest, founded in 1995 by Kiernan, a former KPMG senior partner. Besides conventional financial performance metrics, Innovest studies 120 different factors, such as energy use, health and safety records, litigation, employee practices, regulatory history, and management systems for dealing with supplier problems. It uses these measures to assign grades ranging from AAA to CCC, much like a bond rating, to 2,200 listed companies. Companies on the Global 100 list on BusinessWeek's Web site include Nokia Corp. and Ericsson, which excel at tailoring products for developing nations, and banks such as hsbc Holdings and abn-Amro that study the environmental impact of projects they help finance.

Some of Innovest's conclusions are counterintuitive. Hewlett-Packard and Dell both rate AAA, for example; market darling Apple gets a middling BBB on the grounds of weaker oversight of offshore factories and lack of a "clear environmental business strategy." An Apple spokesman contests that it is a laggard, citing the company's leadership in energy-efficient products and in cutting toxic substances. Then there's Sony Corp. vs. Nintendo. Wall Street loves the latter for a host of reasons, not least that its Wii video game system, the first to let users simulate actions such as swinging a sword or tennis racket, was a Christmas blockbuster. Sony, meanwhile, has a famously dysfunctional home electronics arm, and was embarrassed by exploding laptop batteries and long delays in bringing out its PlayStation 3 game console. Nintendo's stock has more than tripled in three years; Sony's has languished.

Viewed through the lens of sustainability, however, Sony looks like the better bet. It is an industry leader in developing energy-efficient appliances. It also learned from a 2001 fiasco, when illegal cadmium was found in PlayStation cables bought from outside suppliers. That cost Sony $85 million, says Hidemi Tomita, Sony's corporate responsibility general manager. Now, Sony has a whole corporate infrastructure for controlling its vast supplier network, helping it avert or quickly fix problems. Nintendo, a smaller Kyoto-based company focused on games, shows less evidence of the global management systems needed to cope with sudden regulatory shifts or supplier problems, says Innovest. A Nintendo spokesman says it meets all environmental rules and is "always reviewing and considering" the merits of new global sustainability guidelines.

Here's another Rorschach test. Which is the best investment: ExxonMobil, BP, or PetroChina? Exxon, one of the best-performing energy biggies of the past five years, seems like the obvious stock pick. PetroChina Co. is riskier but also alluring. It's a prime supplier of fuel to booming China, has seen revenues and profits rocket, and has been a hot stock for two years. Analyst Shahreza Yusof of Aberdeen Asset Management PLC rates the company a buy. Because of its access to China's market and new reserves, he writes, one day it will be as big as today's major oil giants—"if not bigger."

By contrast, BP seems to disprove the sustainability thesis altogether. CEO John Browne has preached environmentalism for a decade, and BP consistently ranked atop most sustainability indexes. Yet in the past two years it has been hit with a refinery explosion that killed 15 in Texas, a fine for safety violations at a refinery in Ohio, a major oil pipeline leak in Alaska, and a U.S. Justice Dept. probe into suspected manipulation of oil prices.Browne has recently announced his retirement. BP's shares have slid 10 percent since late April. Exxon's are up around 12 percent.

Innovest still rates BP a solid AA, while labeling Exxon a riskier BB. And PetroChina? Innovest gives it a CCC. Here's why: BP wins points for plowing $8 billion into alternative energies to diversify away from oil and engages community and environmental groups. Exxon has done less to curb greenhouse gas emissions and promote renewables and has big projects in trouble spots like Chad. "I would still say Exxon is a bigger long-term risk," says Innovest's Kiernan. Petro- China is easier to justify. Begin with its safety record: A gas well explosion killed 243 people in 2003; another fatal explosion in 2005 spewed toxic benzene into a river, leaving millions temporarily without water. PetroChina has been slow to invest in alternative energy, Innovest says, and its parent company has big bets in the Sudan.

Do Innovest's metrics make a reliable guide for picking stocks? Dozens of studies have looked for direct relationships between a company's social and environmental practices and its financial performance. So far the results are mixed, and Kiernan admits Innovest can't prove a causal link. That's little help to portfolio managers who must post good numbers by year's end. "The crux of the problem is that we are looking at things from the long term, but we're still under short-term review from our clients," says William H. Page, who oversees socially responsible investing for State Street Global Advisors.

Yet Kiernan and many other experts maintain sustainability factors are good proxies of management quality. "They show that companies tend to be more strategic, nimble, and better equipped to compete in the complex, high-velocity global environment," Kiernan explains. That also is the logic behind Goldman Sachs's intangibles research. In its thick annual assessments of global energy and mining companies, for example, it ranks companies on the basis of sustainability factors, financial returns, and access to new resource reserves. Top-ranking companies, such as British Gas, Shell, and Brazil's Petrobras, are leaders in all three categories. For the past two years, the stocks of elite companies on its list bested their industry peers by more than 5 percent —while laggards underperformed, Goldman says.

Still, BP's woeful performance highlights a serious caveat to the corporate responsibility crusade. Companies that talk the most about sustainability aren't always the best at executing. Ford Motor Co. is another case in point. Former CEO William C. Ford Jr. has championed green causes for years. He famously spent $2 billion overhauling the sprawling River Rouge (Mich.) complex, putting on a 10-acre grass roof to capture rainwater. Ford also donated $25 million to Conservation International for an environmental center.

But Ford was flat-footed in the area most important to its business: It kept churning out gas-guzzling SUVs and pickups. "Having a green factory was not Ford's core issue. It was fuel economy," says Andrew S. Winston, director of a Yale University corporate environmental strategy project and co-author of the book Green to Gold.

The corporate responsibility field is littered with lofty intentions that don't pay off. As a result, many CEOs are unsure what to do exactly. In a recent McKinsey & Co. study of 1,144 top global executives, 79 percent predicted at least some responsibility for dealing with future social and political issues would fall on corporations. Three of four said such issues should be addressed by the CEO. But only 3 percent said they do a good job dealing with social pressures. "This is uncomfortable territory because most CEOs have not been trained to sense or react to the broader landscape," says McKinsey's Mendonca. "For the first time, they are expected to be statesmen as much as they are functional business leaders." Adding to the complexity, says Harvard's Porter, each company must custom-design initiatives that fit its own objectives.

Dow Chemical is looking at the big picture. It sees a market in the need for low-cost housing and is developing technologies such as eco-friendly Styrofoam used for walls. CEO Liveris also cites global water scarcity as a field in which Dow can "marry planetary issues with market opportunity." The U.N. figures 1.2 billion people lack access to clean water. Dow says financial solutions could help 300 million of them. That could translate into up to $3 billion in sales for Dow, which has a portfolio of cutting-edge systems for filtering minute contaminants from water. To reach the poor, Dow is working with foundations and the U.N. to raise funds for projects.

Philips Electronics also is building strategies around global megatrends. By 2050, the U.N. predicts, 85 percent of people will live in developing nations. But shortages of health care are acute. Among Philips' many projects are medical vans that reach remote villages, allowing urban doctors to diagnose and treat patients via satellite. Philips has also developed low-cost water-purification technology and a smokeless wood-burning stove that could reduce the 1.6 million deaths annually worldwide from pulmonary diseases linked to cooking smoke. "For us, sustainability is a business imperative," says Philips Chief Procurement Officer Barbara Kux, who chairs a sustainability board that includes managers from all business units.

Such laudable efforts, even if successful, may not help managers make their numbers next quarter. But amid turbulent global challenges, they could help investors sort long-term survivors from the dinosaurs.