BUSINESS SUSTAINABILITY: PRESSING, HARD TO MEASURE, AND IN SLOW PROGRESS1

Dan Cndea
Technical University of Cluj-Napoca E-mail: dcandea@alum.mit.edu Telephone: 0723.322.545 Phone/fax: 0264.44.07.54

Rodica M. Cndea
Technical University of Cluj-Napoca E-mail: rcandea@gmail.com Telephone: 0723.234.368 Phone/fax: 0264.44.07.54

1. Introduction The concept of megatrend was coined by Naisbitt and Aburdene in their 1982 Megatrends book, by which concept they referred to major social and macroeconomic mutations. The evolutions identified by the two authors as megatrends, both in their 1982 book as well as in the revised 1990 edition2, resonate in the business world as deep and lasting changes in the behavior of corporations, stemming from technological advances and business model innovations. According to a recent paper by Lubin & Esty (2010) the orientation towards sustainability in business is a megatrend, which joins other highly influential developments such as globalization, customized mass production or the quickly widening use of IT tools. The drive towards sustainability raises new strategic challenges to the leadership of corporations. Although business sustainability commands attention of many scientists, business leaders and political figures, the concept does not carry the same meaning for all who refer to it. In what follows we will discuss two ways to view business sustainability and, in the context, present some considerations on measuring it. The last part of the paper uses an analogy with the game theorys prisoners dilemma to explain why progress on sustainability keeps being slow.

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Based on a keynote address to the 8th International Conference of the Romanian Regional Science Association, June 24-25, 2011, Cluj-Napoca 2 John Naisbitt and Patricia Aberdene published Megatrends 2000 in 1990, in which ten directions for the worlds evolution were presented for the year 2000 horizon

2. Process-based and end state-based view of sustainability The most widespread meaning of a sustainable business is one that delivers value to investors, customers, and employees; improves the living standards of its employees and the communities it touches; makes wise use of natural resources; and treats people fairly (Cramer & Karabell (2010, p.2)). It is ingrained in the above definition that a company is sustainable if it creates value for its shareholders and, at the same time, shows consideration for a variety of other stakeholders and cares for the environment. Such a company exercises corporate social responsibility supported by the socially responsible investments the company undertakes besides, but desirably tightly related to, its core business investments. A narrower view of a sustainable company is one that is environmentally responsible or green, i.e., it acts in a way that reduces to a minimum the damage to the environment. Both ways of looking at sustainability define it by what the company does to support sustainable development. We call this the process-based view of business sustainability. An alternative way to define the sustainability of a business is to think of its ability to last, of its staying power. If a company can last indefinitely it is sustainable, and we call this the end state-based view of business sustainability. In Candea (2007) we defined the sustainable corporation as one that is capable to offer the shareholders, for the very long term, a fair return on their investment, in order to keep them interested in the corporation. The companys interest is obvious: it cannot survive without the capital brought by investors. In this view securing sustainability is tantamount to achieving very long-term prosperity for the company. Developing an enduring company, implicit in the end state-based view of sustainability, is in agreement with the idea of indefinite perpetuation of humanity, the ideal in the concept of sustainable development advanced by the Brundtland Report. If human society is to develop in a sustained way, it needs enduring companies. The reciprocal is also true: no company can have long lasting prosperity without a durable prosperous society. This parallel suggests that the sustainable corporation should be regarded as the societys partner on the road to sustainable development. The end state-based view of sustainability views both the sustainable development of society and business sustainability as distant targets in time, towards which a continuous journey must be made without actually reaching a state in which nothing more is required to stay sustainable. It is easily understood that the process has to be executed in order to advance towards the end result hence performing the proper process is supposed to raise the prospects for sustainability. We take sustainable as a shorthand for building better prospects for sustainability to refer to companies that undertake socially and environmentally responsible actions.

Almost unanimously the connotation attributed to sustainable is the process-based view, which means that sustainable development is regarded as a voyage, a way of living, and business sustainability is a becoming. As a concluding note we affirm our belief that any perception that the business world and society might have fundamentally diverging interests has no substance. Either partys gain against the other undermines, in the long term, the prosperity of both. Observed socially and environmentally irresponsible corporate behaviors do not stem from some negative characteristics inherent to businesses. There is nothing intrinsic to the construction of a business organization that asks for the neglect of social and environmental considerations. Although companies are for profit organizations, it is not simply the pursuit of profit rather the greed, i.e., chasing high and quick profits, that can turn them irresponsible. In Candea (2009) we were advocating that sustainability-driven companies serve their self-interest. Adopting a long-term thinking framework helps business leaders avoid temporal and spatial myopia, and fend off distant risks or prepare for far-off opportunities by making timely socially responsible investments. Peter Drucker had the vision to recognize the tight interdependency between corporations and society in his book The Industrial Man in 1942: Without a customer today, the enterprise has no purpose. Without a customer tomorrow, the enterprise has no longevity or sustainability. Without a society or community, there is no enterprise. Investment in social assets is a common requirement to all three realities. 3. Measuring business sustainability Business leaders, investors, scientists, politicians, constituents of civil society and individuals are growingly interested in measuring the impacts of economic activities on society and environment. An equal interest is shown by a larger and larger segment of investors and corporation managers for how to measure a corporations prospects for sustainability. Business sustainability can be assessed from two different perspectives: Assessing the dynamics of a companys sustainability over a time span; Comparing the sustainability level of various companies. If we adopt the end state-based view of sustainability, no measurements can be made either of the dynamics or for comparing purposes. Even in the case of very old companies there is nothing to indicate they will continue to last, or if a company is older than other it can be of no help to assuming that the first will outlast the second. In the end state-based view business sustainability is and ideal towards which progress should me made continuously, and measuring the end result is not an issue.

If we look at business sustainability as a process, a preliminary question is: what actions should a company undertake in order to improve its prospects for sustainability? Are company sustainability practices based on the proper causeeffect relationships? If an answer can be found then measuring the intensity and duration of those actions will provide a measure of business sustainability to serve both studying dynamics and making comparisons. There are two issues to consider, which will turn to be strongly related: a) The traditionally dominant preoccupation of companies has been to fight competition. Concern for winning and keeping customers has topped business managers agenda, and planning and budgeting for profit have been a major preoccupation. In this traditional context, the new challenges of incorporating social and environmental objectives into a companys general strategy raise legitimate questions regarding to what extent and in what direction socially responsible investments affect the financial bottom line, both in the short and long term. b) By analogy with sustainable development, with its three pillars: economic and social development, and environmental protection, it is assumed that business sustainability depends on how well a company can balance its triple bottom line: financial performance in equilibrium with social and environmental performance. This implies a cause-effect relationship. If we can answer in a reassuring manner the questions raised in the prior paragraph, the implied cause-effect relationship tells that the higher the companys achievements in the social and environmental domains, superimposed on and balanced with its core business performance, the more sustainable the company is. How can financial performance be blended with socially responsible achievements to measure business sustainability? To address the questions at point a) we acknowledge the numerous studies on the impact of socially responsible investing on the financial performance in business. One source, Gorte Fox, references a research of October 2007 by Mercer, a consulting firm. The research is based on reviewing 20 academic papers, published in peer-reviewed journals, and 10 broker analyses. About half of the results found a positive correlation between the social-environmental performance and the financial performance, about 35% found no differences in the financial performance of the socially responsible companies and the more traditional companies, and 15% showed a negative correlation. Fox Gorte quotes other research papers that demonstrate that corporations with greater social and environmental performance generally enjoy a lower cost of capital because the better management of social and environmental issues induces a lesser risk perception. Wirtenberg, Russel & Lipsky (2008, p.3) assert that In the 21st century, rather than focusing singularly or even primarily on the financial bottom line and the financial assets they posses, the most sustainable companies are looking at themselves and their future through the lens of the five capitals model of natural, human, social, manufactured, and financial capitalAt the same time, evidence

continues to mount that demonstrates that corporate social-environmental performance is strongly associated with financial and marketplace success. We must note, though, that there is no consensus regarding the favorable effect of the socially responsible behavior on business profitability. Lobe, Roithmeier & Walkshausl compared the stock market performance of corporations in sin industries: adult entertainment, alcohol, gambling, nuclear power, tobacco, and weapons with a group of socially responsible companies. Their analysis yielded no significant difference in financial performance between the two groups of firms. And yet, there is ample evidence that the segment of investors who have an interest in companies that manifest social responsibility is continuously growing. This is reflected in the rapidly growing number of indexes that rank sustainable corporations since the first launch of the Dow Jones Sustainability Indexes in 1999. Such a trend is to be expected given the increasing awareness of society about the problems related to sustainable development. An aware society puts pressure on regulators to take tougher and tougher measures against companies that produce negative social and environmental impacts. These major and irreversible social changes bring about the megatrend we mentioned in the introduction as an orientation towards sustainability in business, and raise opportunities and threats, even if more distant in the future, to companies. There are already initiatives of regulatory bodies requiring corporations to identify and disclose future risks and opportunities for investors stemming from social and environmental developments. Such is the ruling of the SEC (Wordpress (2010)) of January 27, 2010; an excerpt from the news release is shown below: The U.S. Securities and Exchange Commission today issued new interpretive guidance that clarifies what publicly-traded companies need to disclose to investors in terms of climate-related material effects on business operations, whether from new emissions management policies, the physical impacts of changing weather or business opportunities associated with the growing clean energy economy. The guidance, the first economy-wide climate risk disclosure requirement in the world, was approved in a formal vote at todays SEC Commissioners meeting in Washington. The lack of specific guidance until now has resulted in weak and inconsistent climate-related disclosure by public companies. Todays decision comes after formal requests by leading investors for the SEC to require full corporate disclosure of wide-ranging climaterelated business impacts and strategies for addressing those impacts in their financial filings. More than a dozen investors managing over $1 trillion in assets, plus Ceres and the Environmental Defense Fund, requested formal guidance in a petition filed with the Commission in 2007, and supported by supplemental petitions filed in 2008 and 2009.

To summarize, spending on socially responsible initiatives may affect the bottom line in the short term but it is very likely that the long-term financial performance is boosted by a socially responsible behavior. Financial performance is the necessary condition for survival, while a balanced mix of financial, social and environmental performance is required for sustainability. To address the questions at point b) above we start by noting that there is no standard method of measuring the success in improving simultaneously the financial, social and environmental capital of a company. The extraordinarily large number of metrics pertaining to the three pillars of sustainability, which include very diverse quantitative and qualitative indicators, explains why we do not have standardized measurement methods and benchmarks, in spite of the outstanding effort that is being made around the world. A good discussion on the measurement frameworks and systems (what and how to measure, and how to report on the result) can be found in chapter six of Wirtenberg, Russel & Lipsky (2008). We have been interested in ways to assess business sustainability as a means to provide guidance to investors who are looking for long-term shareholder value gains. There are a number of indexes that track and rank sustainability-driven corporations worldwide; they are based on a mix of qualitatively assessed criteria that are combined by weighting. The most prominent of the indexes are analyzed in Carciumaru & Candea (2010). Because there in no standardized way of measuring sustainability the various indexes differ widely in what and how they measure. To illustrate, the Dow Jones Sustainability Indexes rank companies by combining criteria that reflect financial performance and good corporate citizenship, while in the FTSE4Good Index ranking, which makes no reference to financial performance, matters how much a company does to protect the environment, the extent to which it treats social aspects and how well it relates with stakeholders. Sustainability indexes are rankings and thus provide comparative information on companies in terms of prospects for lasting success, as defined by the index. At the same time, the dynamics can be followed if one tracks a particular company in its moving in and out of an index or how it changes rank over time. A closing note: while acknowledging the progress made on measuring sustainability we should be aware of the methodological shortcomings of the aforementioned indexes as long as there are no generally accepted standardized method and benchmarks. The results of one index ranking are meaningless for another index. A very critical comment on the issue was made by Porter & Kramer (2006) under the heading of The Rating Game.

4. Why progress on sustainability is slow The business case for a socially responsible business conduct has been convincingly argued by many authors. In their recent paper, Porter & Kramer (2011) reiterated the concept of shared value, which is value created by the corporations that include in their strategies social and environmental objectives inextricably intertwined with their core business objectives. By addressing social and environmental issues a company creates value for society with a return for the company. The companys self-interest is thus served via the value created for society. Creating shared value is the road to business sustainability. Despite this argument many corporations behave irresponsibly by harming the environment and adopting unacceptable social practices, advancing many times the excuse that tough competition prevents them from diverting resources to other than pure business purposes. In what follows we will use an analogy to the prisoners dilemma problem to understand why socially harmful conducts occur. The prisoners dilemma is a fundamental problem in game theory, developed by RAND Corporation scientists Merrill Flood and Melvin Dresher and formalized by a Princeton mathematician, Albert W. Tucker. One statement of the problem is as follows: Two suspects in a bank robbery are placed in two different rooms, and each is asked separately whether or not his partner is guilty. Prison sentences depend on how each suspect responds: if both remain true to each other by keeping silent (i.e., cooperating), they each serve only six months in jail, convicted for some traffic violation. If both betray each other, each receives a five-year sentence. If one testifies against the other and one remains silent, the silent partner serves 10 years while his betrayer goes free. Each prisoner must choose to testify against the other (betray) or to remain silent (cooperate). Each one is assured that the other one would not know about the action of his/her partner. How should the prisoners act? Since the situation is symmetrical for both prisoners, it is sufficient to present the decision tree for just one of them. From the way the problem is framed, it follows that the most likely behavior is that each prisoner cares only about minimizing his time in jail (i.e., maximizing his benefit). It has been proven that rational choice determines both prisoners to betray, which is a Pareto-suboptimal solution. By inspecting the decision tree of figure 1 it is straightforward to perceive why this solution is the rational choice, with both prisoners ending up to serve 5 years in jail each. For the discussion in this paper it is important to notice that the main obstacle to reaching the better solution of 6 month prison terms for each prisoner is the lack of communication between the two suspects. The obstacle to communication is raised by the police. The lack of communication prevents the two prisoners to work together towards their common good. To make the analogy announced earlier, let us examine the case of the environmental impact of some business activities. Consider the following problem:

The people of a planet are concentrated on a large island and are organized as a state. There are two competing logging companies, which supply the wood. The wooded land is owned by the state and periodically re-allotted for cutting down trees by the issue of logging licensing. Competition is keen. Current logging is intensive at a rate at which timber will last for 50 years. If one of the two companies invested in sustainable logging it would experience lower earnings, resulting in a loss of competitive advantage, but timber on the island would last for 120 years. It can happen that an area of wooded land logged sustainably by one
Worst possible outcome for prisoner A

Prisoner A

Prisoner B

Prison sentences

Betray s

Prisoner A 5 years Prisoner B 5 years

5 years

!
Betrays Silent Prisoner A free Prisoner B 10 years

Silent

Betrays

Prisoner A 10 years Prisoner B free

10 years

Silent Prisoner A 6 months Prisoner B 6 months

Figure 1: Decision tree for the prisoners dilemma problem

company be licensed, in the re-allotment process, to the other company that logs intensively. If both companies committed themselves to sustainable logging timber would last indefinitely. What logging policies are the two companies likely to adopt? Again we will structure the problem as a decision tree; it is sufficient to do this for one company. If we assume that each company cares only about its competitive advantage in the short run, then no matter what the other company does, one

company will always gain a greater payoff by intensive logging (see figure 2). Since in any situation intensive logging is more beneficial than sustainable logging, all rational players will choose to continue their intensive logging policy. And similar situations of environmentally and socially harmful acts we can see around us very often. The rational solution to the problem will lead to the demise of the logging industry in 50 years, with catastrophic consequences for the entire island.3 The sustainable development of the society on the island requires that the two companies cooperate for sustainable forestry, which would also help logging business sustainability. Why doesnt that happen? We see two fundamental reasons:
Impact of logging policies on the short-term relative competitiveness

Company A

Company B

Worst possible outcome for company A

Intensive logging

Company A: null Company B: null years No change in competitiveness

Intensive logging Sustainable logging Company A: + Company B:

Sustainable logging

Intensive logging

Company A: Company B: +

Loss of competitiveness Sustainable logging Company A: null Company B: null

Figure 2: Decision tree for the logging companies problem: the short-term aspect

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The formulation of the problem was inspired by the history of the Easter Island, found in Prugh & Assadourian (2003)

 The traditionally entrenched mental model of business competition is confrontational, leading to a zero-sum game. This mental model plays the role of the police of the prisoners dilemma problem because it bars the two companies from communicating. Rather than cooperating the attitude is: Its every man for himself; whoever can get away, good, whoever doesnt, doesnt. The very nature of human beings makes them myopic. People are genetically conditioned to give more weight to events that take place in the immediate temporal and spatial proximity, and to discount the importance of distant possibilities. Because of these two reasons we have left out of the decision tree in fig. 2 the long-term consequences of the logging policies. If the two players managed to break free of the confrontational mental model and also think long-term the rational solution to the problem would change. 5. Conclusion The closing statement of the previous section can be generalized beyond the logging business of the example. In a web posting Moss Kanter (2008), commenting on the worst crisis that hit the USA since the Great Depression, found that a cultureof greed, gorging, and gambling was at the root of it. Therefore changes are needed towards a culture of inclusion guided by a noble purpose. For sustainable business performance: a. Long-term thinking should prevail over the pursuit of large but shortlived profits b. Co-opetition should become a way of working towards the common good c. Informing, listening to and collaborating with stakeholders should be ! used to raise the prospects for sustainable development. REFERENCES Candea, D., 2007. Conjectures About the Relationship Among Business Sustainability, Learning Organization, and Management Systems Integration. Review of Management and Economic Engineering, 6(5), pp. 138-143. Candea, D., 2009. Afacerile !i societatea. In Candea D. ed. 2009. Responsabilitate fa"# de societate !i comportament etic Premise ale sustenabilit#"ii. Cluj-Napoca: UTPRES, pp.1-7. Available at https://sites.google.com/site/organizatiasustenabila/intreprinderea-sustenabila-2009 Carciumaru, R. & Candea, D., 2010. Sustenabilitatea ntreprinderii Practici curente de evaluare !i clasificare. In Candea D. ed. 2010, Dezvoltare durabil# !i responsabilitate social# corporativ#. UTPRES, Cluj-Napoca, 2010, pp.173-202.

Available at https://sites.google.com/site/organizatiasustenabila/home/intreprindereasustenabila-2010. Cramer, A. & Karabell, Z., 2010. Sustainable Excellence. New York: Rodale Inc. Gorte Fox, J., Alpha or Beta? The Financial Value of Sustainability. [Online] Available at: http://www.paxworld.com/viewpoint/2007/10/24/alpha-or-beta-thefinancial-value-of-sustainability-by-julie-fox-gorte-phd-senior-vice-president-forsustainable-investing/ [Accessed May 6, 2011]. Lobe, S., Roithmeier, S., & Walkshusl, C. Vice vs. Virtue Investing Around the World. [Online] Available at: http://ssrn.com/abstract=1089827 [Accessed May 5, 2011] Lubin, A.D. & Esty, D.C., 2010. The Sustainable Imperative. Harvard Business Review, May. Moss Kanter, R., 2008. A Financial Turnaround Requires Cultural Change. [Online] Available at: http://discussionleader.hbsp.com/kanter/2008/10/a-financialturnaround-require.html?cm_mmc=npv-_-LISTSERV-_-NOV_2008-_-FINANCE [Accessed May 10, 2011] Porter, M.E. & Kramer, M.R., 2006. Strategy & Society. Harvard Business Review, December. Porter, M.E. & Kramer, M.R., 2011. Creating Shared Value. Harvard Business Review, January. Prugh, T. & Assadourian, E., 2003. What is Sustainability Anyway?. World Watch Magazine, September/October, pp.10-21. Wirtenberg, J., Russel, W.G., & Lipsky, D. eds., 2008. The Sustainable Enterprise Fieldbook . Sheffield, U.K.: Greenleaf Publishing. Wordpress, 2010. SEC Recognizes Climate Change as A Disclosure Item. [Online] Available at: http://quuh.wordpress.com/2010/01/27/sec-recognizes-climatechange-a-disclosure-item/ [Accessed May 5, 2011]