Embedding Sustainability into New Enterprises 184.0

New Zeitgest, tools and metrics are making CSV for enterprise the new norm
Businesses are starting to embed sustainability into their strategy rather than just do it as a separate project under corporate social responsibility (CSR).  They are starting to do this because it is beginning to make business sense.

The Sagip Pasig Movement (SPM) invited me, as one of three speakers, to talk on this new approach before an audience of Green and other student scholars at Polytechnic University of the Philippines (PUP) on Saturday, March 6.

This new approach that I think will become a trend is still seeking a name – the consultants’s usual game – but is variously called Creating Shared Values (CSV) – the label I use here as set right by Ms. Susan Steinhagen, thank you! (in 3/25/10 comments) – by Nestle and hybrid strategies at Ayala Corporation.

Two reasons. I think this trend will become the norm. Firstly, it is confirmed by the Zeitgeist or the sign of the times even as firms are now able to use new green technologies to design sustainability into new projects. And, secondly, because new metrics are being developed that will make it easier to measure sustainability as part of a business’s bottom line.

The invitation to share from Sagip Pasig Movement came about because of a post I wrote here in SYNTHESiST on January 17.

Direct Descendant of the ‘Invisible Hand.’ In one sense, CSV is more a linear descendant from pure capitalism – that we represent here with Adam’s Smith’s invisible hand – than CSR that treats socially responsible action like sustainability as projects on the side to be funded out of a percentage of profits, i.e. after the bottom line.

CSR, therefore, may have the affiliated Foundation as the dispenser of funds drawn from annual grants out of profits. CSV, on the other hand, will have a different set of stakeholders that are within the internal organization as sustainability is made part of internal business processes that, consequently,makes sustainability an integral part of business management.

CSR was a quick detour in historical time though CSV will not replace it completely as many firms will continue to find it more convenient to burnish the corporate escutcheon through formalized charity than do the harder task of internalizing sustainability.

CSV is the Firm’s adaptation to new capitalism into a more social enterprise that is (a) demanded by the Zeitgeist and (b) allowed through design for sustainability by new tools and technologies and by new metrics.

Changing external conditions. External conditions have changed sufficiently to also change the business Zeitgeist:

• There is a universal acceptance that many natural resources are finite and flagrant use can lead to higher commodity costs;
• There is common agreement that pollution and climate change, for example, are costly – though as economic externality or on public goods – to the world community at-large or future generations;
• Agreement has been reached – that the USA as major player has not ratified – among the community of nations to define a formula for this high cost through such modes as ‘carbon credits’ determined through schemes like cap-and-trade or carbon taxes (and inversely, green incentives).

Also, internally among firms, there is now acceptance that pollution, for example, is a form of inefficiency or under-recovery of inputs like waste heat, unburnt fuel represented by smoke exhaust, and the like.

With incentives from government for R&D and for commercialization – as best exemplified by our introduction story on the bloombox – new technologies now allow firms to adopt or adapt newly developed technologies and embed them into new projects in an application I label as design for sustainability.

(Note: Thanks variously to CBS 60 minutes and National Geographic for photos on the first slide. A video of the bloombox introduced on February 24, 2010 can be seen on You Tube.)

Quickly, as an aside, I still remember the time in early eighties when the paradigm was that one cannot have high quality and low cost at the same time. It took the success of Japanese manufacturing and the tools they introduced in that era like Quality Function Deployment (QFD) and concurrent engineering that both high quality and low cost can be done in an approach that I can label design for quality – as lead-in into the concept of design for sustainability I introduce here – rather than adding quality features in the more traditional stage-gate process of product development.

As we noted in a previous post, the IDEO design thinking model even extends this paradigm shift farther upstream in the product development process by combining rapid prototyping with market research to further improve productivity and reduce time to market.

Note: I teach a course on Product Development at the Asian Institute of Management in Makati, Philippines.

CSV examples.The bloombox is an example of new technology that will drive sustainability. Other examples are:

• Industrial tree plantations. New Zealand plantations have improved viability with additional incomes from traded carbon credits.
• Wind farms. The Bangui wind turbine farm in Ilocos Nortereceived incentives from Denmark’s aid agency, Danida, and also gets revenues from carbon credits under the CDM.
• Methane from biogas from landfills and animal farms. Sanitary landfills and animal farms now routinely build bio-digesters into their operations
• LED vs. LCD and traditional lamps. Local governments now install LED traffic lights than traditional incandescent type
• Green community by design like Ayala’s Nuvali

. Other than leading the Philippines in CSV through hybrid strategies, Nuvali as a real estate product is designed with green as a a major selling point

New and Modern-day Facilitators. A major proponent of CSV or hybrid strategies is HYSTRA, a new consulting firm headed in the Philippines by Jim Ayala, that helped Ayala Corporation in their ‘embedded and for profit’ efforts. This re-direction has already been announced late last year though public details are still scarce. HYSTRA, composed of ex-McKinsey consultants, is closely associated with Ashoka, that is the leading proponent of social enterprise in the world and founded by ex-McKinsey consultant, Bill Drayton.

CSV and Social Enterprise. As I have foretold (I think that is the best word, indeed) elsewhere in SYNTHESiST in a post on Jeffrey Sach’s book Common Wealth on 6/28/29, I believe that all firms will eventually become social enterprises with degrees of triple bottom line proportions in near historical time.  The Zeitgeist, or the more catholic sign of the times, commands it.  In a sense Ayala Corporation is just continuing its traditional leadership in local business by jumping into the still unstill waters of CSV and social enterprise.  It does exercise CSR through the Ayala Foundation and will continue to do so.  I am an eager watcher about what they will do next.  Community sewerage with Manila Water, Nuvali with Ayala Land, covered walkways and green buildings, …

Elsewhere in SYNTHESiST, we have also written about Philippine leadership in social innovation through social enterprise. The Institute for Social Enterprise in Asia (ISEA) led by Lisa Dacanay and hosted, quite smartly, at the Ateneo’s School of Government (ASoG) with Dean Tony La Viña at the helm is actively supporting social enterprise. Dean Tony happens to be the Country Representative of Ashoka: Innovators for the Public. In September 2009, ISEA published a booked on triple bottom lines for social enterprise via monetization.

Peter Drucker as we described in another SYNTHESiST post believes that social innovation together with technical innovation has been crucial in moving the world forward. W Brian Arthur accepts innovation can come from non-natural phenomena, the source of technical innovation and calls it Purposed Systems.

The New Metrics – Triple Bottom Lines. Traditionally, businesses in pure capitalism had only one bottom line, its objective function in optimization theory – profit. Profit, in this math, can also be represented by a point in X-Y space as return on equity,

In contrast, the goal of the modern social enterprise is to meet the triple bottom lines of Profits, Planet and People as shown in the slide with Planet taken to mean sustainability and People to mean equity. These bottom lines are well drawn in a Venn-diagram like sketch that I downloaded from Wikipedia and installed two slides above and repeats in bigger detail below.

From the point of view of business math, the triple bottom line is problematic to derive with traditional methods of accounting since a good performance for each one often goes in opposite directions to the others.

This is why the consideration of incentives that can be deducted from investment and of carbon credits, as new metrics, that can be added to returns corrects the situation and still allows the traditional measurements like Discounted Cash Flow – Internal Rate of Return (DCF-IRR) to be used to measure performance.

I have shown a typical format of DCF-IRR in a slide above with its mirror metric, NPV or net present value.

Triple Bottom Lines – Monetization. The current state of the art in measuring strategic performance still uses the traditional DCF-IRR formula, that accounts for the present value of money, by monetizing and netting on top of the regular business cash flows the incremental investments and the marginal returns for sustainability activities.

Monetizing first involves estimating this incremental and marginal investments and returns. This estimation requires the use of assumptions that make this adaptation of a traditional technique, DCF-IRR, not really ideal for use. Though DCF-IRR does have the advantage of almost universal acceptance, as method, by investment managers and business leaders all over the world.

Triple Bottom Lines – New Metrics for the Future. Consistent with the adjective “triple’” I see an opportunity to migrate metrics for social enterprises (and similar businesses with multiple goals) in techniques from optimization theory that have been used in operations management since the 1950s.

Here, I would like to thank Viking, a friend from the past who is a mathematician, for pointing out a quirk of these more difficult mathematics.

Profits have been used as the proxy and the sum of all goals for a business – the objective function. In having profits measured in terms of money, it allows the mathematical summation as the language of business.

Optimization, on the other hand, involves the achievement of an objective function.

As Simplex algorithm. For social enterprise, I propose that this objective function ought not be profit but the original and organic goal of the enterprise using as metric the fairly old (from the 1950s) Simplex algorithm typically used in solving complex transportation problems.

For example, if the business goal is to extend credit then the value to society of such activity ought to be measured and expressed as the objective function – in its success in extending credits – rather than, by proxy – as profits.

The triple bottom lines – that are difficult to measure as one – are then considered as the triple constraints in the optimization matrix to achieve this objective function in a balanced way. In this case, for example, profits can be expressed as a constraint line, say, as equivalent to a desired return in equity. Sustainability and equity can be expressed as other lines of constraint equations, too.

As shown in the Simplex algorithm diagram at right in blue as feasible region, simplex algorithm can be used to define the space that can be used as a measure of performance. Thanks to Wikipedia for the diagram shown in the slide above.

As a Simplex Tetrahedron Solid. Alternatively for future research and development after which the math becomes more accessible, a social enterprise can be described as a solid, say a Simplex tetrahedron (or an apple! instead of as a flat space in the optimization above) with math techniques combinatorics (for discrete planes) or topology (for continuous surfaces). The description of a social enterprise here, say as a desirable apple versus another that looks like a pineapple, LOL and Hahah, can become the metric of choice for the future.

Thanks to Wikidpedia for the illustrative drawing shown on the slide of a Simplex tetrahedron.

Like their true fruit cousins, markets for social enterprises described and measured as solids using this new match can likewise be established, a new stock trading places.

This is not as improbable as it sounds.  Calculus is now taught in third year high school after Isaac Newton and Gottfried Leibniz invented it.  Options pricing was embedded in TI financial calculators and in use in stock trading floor within ten years after Fischer Black, Myron Scholles and Robert Merton wrote about it circa 1973.  And many new users do not even need to understand the fine assumptions behind these new tools.

Already there are buyers for such multi-objective enterprises especially among foundations and social funds, i.e. those who invests only in dolphin-safe investments and the like.

Then, the market can create real choice. And the Zeitgeist who desire such investment is fully satisfied.

Conclusion. New technologies and tools will allow design for sustainability supported the present Zeitgeist. The continuous work on developing new business metrics being done in the Philippines by groups like ISEA at ASoG will facilitate the conversion of traditionally profit-centered businesses into social enterprises.

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