“For years now we’ve treated the land like a piggy bank, to be raided“
John Christopher (The Death of Grass, 1956)
The sustainability of profit – what’s useful?
Profit is one of the main indicators we use to assess company success. It’s not the only one, but it is a totemic and universal measure. Profit is the driving force of capitalism; profit warnings can bring down companies.
So why isn’t it useful for measuring sustainability, or even for telling us much about economic viability? Because profit is a lagging indicator and sustainability is inherently about long-termism. Assessing and delivering sustainability requires forward-looking indicators.
Paying it backwards
A lagging indicator tells you something about past performance. However, its power to predict future performance is limited, especially if conditions are changing. With increasing ecological, economic and social uncertainty, how useful is profitability in indicating true sustainability? I would say not much.
Firstly, profitability doesn’t really (nor was it designed to) tell you anything useful about the sustainability of an activity or enterprise. Secondly, there are other good reasons why we need forward looking indicators for company performance which reflect the resources and processes which enterprises depend upon.
A sustainable future requires healthy and resilient stocks and flows of non-financial resources (which in turn provide the fundamental basis of financial value). These have been conceptualised as complementary multiple capitals: natural, social, manufactured, human and financial.
Companies depend upon different stocks and flows from these capitals, such as the following:
- ecosystem functions, such as biological productivity, raw materials and resources, water management and natural flood defence
- social infrastructure, the generally accepted rule of law, education, ‘social security’, health care);
- an educated and economically capable consumer base;
- manufactured capital, such tools, technology and built infrastructure.
Given these requirements, the performance and future prospects of an organisation, viewed through the lens of sustainability, would be better understood by assessing its relationship to these multiple capitals.
My heart goes forward but my head looks back
Of course, it’s not completely illogical that profit is such a powerful metric. It reflects (to varying degrees of accuracy – depending upon the veracity of the accounting process behind it) the financial performance of an enterprise in the recent past.
The value of a listed company under generally accepted accounting principles and investment processes lies in both its track record of making profit and/or its potential to make profit. The latter is assessed through an analysis of strategy, competencies, existing and potential market, competitive status and other mainly market-based measures.
Recent years have also seen some adjustments to company value based upon issues that have traditionally been viewed as externalities (outside the company’s balance sheet), such as carbon, slavery, supply chain management, ethics, governance and water. However, these are largely still marginal adjustments. They are often made without thorough consideration of a company’s relationship to the sources of value which may support success (or indicate impending failure) into the future, especially over the long term.
To use a personal metaphor, you could point to the number of miles you have run in the last week as a (lagging) indicator of how fit you are now. However, if you don’t also consider how much you may drink and smoke it doesn’t necessarily tell you that much about how fit you will be in the future. Past and current achievements do not, as financial advertising consistently tells us, guarantee future success.
So, we have a paradox. Accounting and valuation systems look backwards to judge success, but investments make judgements about future profitability, which require looking forwards.
Paying it forwards
Truly useful indicators for assessing the sustainability of a company would be those that relate to the contribution that it makes to the health and resilience of natural and social capitals. Does a company with a dependence upon a biological supply chain have a net-positive effect upon the preservation, protection and enhancement of productive soils? Does it contribute towards the strength and resilience of the communities in which it operates and how are those measures understood in supporting an assessment of the enterprise as a going concern over the long term (or at least 10 years)?
Others are also focussed on the idea that we should be interested in extending the time horizons for considering what constitutes a healthy (and sustainable) business. For instance, the High Level Expert Group on Sustainable Finance (established by the European Commission) released its Final Report at the end of January 2018. The Report contains a very wide range of recommendations for evolving the sustainability of finance, infrastructure and to mobilise capital towards sustainable development priorities and challenges. It also had the following recommendation (p40) for developing the responsibilities of corporate directors:
“To act in a way the director considers in good faith is most likely to promote the success of the company for the benefit of its owners and other stakeholders. This includes: The likely consequences of any decision in the longer term (beyond three to five years).”
Profits of Doom
Without significant attention to the way that we understand value, and evolve or contextualise profit, we will continue to ignore ‘profit warnings’ for the planet from earth and systems scientists.
The 9 Planetary Boundaries (originally developed by Johan Rockström et al in 2011), identify and quantify aspects of the Earth’s natural systems that present close-to-absolute thresholds we should not cross. Of these, 2 boundaries are already exceeded, 2 are close to the safety thresholds, for 2 ½ we lack the data and understanding to know what our situation is. Still, 2 ½ out of 9 isn’t bad is it? (for a more specific description of the Boundaries and our current status, go to the Stockholm Resilience Centre).
Scant profit in a bankrupt world
Not only is profit unhelpful for assessing sustainability, it is also little use for assessing longer-term economic viability. If resources become scarce and societies struggle then profit may be the least of our worries, unless a Mad Max style theft and barter future appeals to you. Putting Max and Furiosa to one side for a moment, ultimately, it will be proof of how a company contributes to, balances and invests in the capacity and health of nature and societies that will be a true measure of both economic success and sustainability.
A piece of the puzzle…
We are planning to write more about this and balance the references to Mad Max and the breakdown of society with a more temperate and useful analysis of some of the thinking on leading measures which already exist, as well as proposing a few of our own.