KPMG INTERNATIONAL A New Vision of Value Connecting corporate and societal value creation kpmg.com Contact KPMG Sweden Daniel Dellham Head of Sustainability Consulting Phone: +46 8 723 96 63 Mobile: +46 70 580 70 40 E-mail: [email protected] Helena Mueller Sustainable Business Expert Phone: +46 723 95 40 Mobile: +46 73 327 22 54 E-mail: [email protected] 2 | A New Vision of Value: Connecting corporate and societal value creation CONTENTS FOREWORD 4 INTRODUCTION: about this report 6 EXTERNALITIES: the age 9 THREE KEY DRIVERS: 15 01 of internalization is here 02 increasing the rate of internalization KPMG’S TRUE VALUE 39 CASE STUDIES: applying the 57 METHODOLOGY: building KPMG True Value methodology in 03 corporate and societal value 04 practice Step 1: Assess the company’s ‘true’ earnings 42 Underground gold mine, Witwatersrand, South Africa 60 Step 2: Understand future earnings at risk 48 Brewery, Maharashtra, India 69 Step 3: Create corporate and societal value 51 LDPE plastics plant, Texas, US 76 Holcim/Ambuja Cement Limited, India 83 AN AGENDA FOR CHANGE: 89 BIBLIOGRAPHY 106 accelerating progress towards 05 a new vision of value ACKNOWLEDGMENTS 110 ABOUT KPMG’S TRUE VALUE SERVICES 114 © 2014 KPMG International Cooperative A New Vision of Value: Connecting corporate and societal value creation | 3 FOREWORD FOREWORD RECONNECTING WITH WHAT WE VALUE Companies have always created value, namely revenues, costs and societal value in the course of doing risk. It is the phenomenon that we at business. They provide people with KPMG describe as ‘the disappearing the goods and services they need. disconnect’ between corporate and They contribute taxes to the economy. societal value creation. They create jobs and wealth, and by doing so, they have played a significant Berkshire Hathaway’s Chairman part in helping to lift hundreds of Warren Buffet described it well in a millions out of poverty. recent company report: “Today our world is changing faster than ever Yet that positive contribution to society before –economic, geopolitical and comes at a price. In the course of doing environmental challenges abound. business, companies also draw on the A company must invest in the key natural resources of the planet and can ingredients of profitability: its people, have negative effects on people and communities and the environment.”1 John Veihmeyer the environment. Global Chairman, Yet this investment entails far more KPMG International As a result, the role of business is than corporate philanthropy, CSR increasingly being scrutinized, debated projects or ‘green’ initiatives—worthy and challenged. This is happening all and important though these may the more as the world globalizes and be. To do well in today’s business people become wealthier and more environment, you increasingly have to connected. As a business community, measure, understand and proactively we need to be aware of this trend and manage the value you create, or reduce, respond to it. for society and the environ ment as well as for shareholders. We also need to be aware of the social and environmental megaforces at work, To do so, companies need to better including our growing global population, understand their so called ‘externa lities’. the increasing scarcity of water and That is because what was ‘external’ other resources, and changing weather is rapidly being internalized, whether patterns. through regulation such as taxes or pricing, changing market dynamics 1 http://www.jm.com/content/dam/jm/global/ A company’s creation, or reduction, of including resource shortages, or more en/general-documents/sustainability/ 2011JMSustainabilityReport.pdf societal value increasingly has a direct frequent and impactful stakeholder Retrieved 25 August 2014. impact on the drivers of its corporate pressure. 4 | A New Vision of Value: Connecting corporate and societal value creation © 2014 KPMG International Cooperative FOREWORD What executives need is a method Ultimately, we need a standardized to understand and quantify their approach to measure societal value externalities and the likelihood they creation. While there is still work to be will affect their company’s earning done, I believe we have broken new capability and risk profile in the ground in providing a way for executives future. to better understand externalities and the opportunities and risks of As the old adage goes, what you internalization and to take more can’t measure, you can’t manage. informed decisions that help build both KPMG firms—with their experience in corporate and societal value. accounting, tax and other business advisory services—can help. In this As corporate and societal value creation report, we introduce a methodology, become increasingly interlinked, I hope called KPMG True Value, to help this report provides executives with businesses combine financial earnings useful food for thought and a means to data with monetized externality explore the implications for their own data and quantify the likelihood and organizations. potential impact of the latter coming to influence the former. © 2014 KPMG International Cooperative A New Vision of Value: Connecting corporate and societal value creation | 5 INTRODUCTION INTRODUCTION: ABOUT THIS REPORT Value creation is the goal of all companies, but corporate value creation is not always aligned with value creation for society as a whole. Historically, externalities have had little Globalization, digital connectivity, the Business leaders and investors need or no impact on the cash flows or risk financial crisis, population growth, the to understand these new dynamics profiles of most companies. Companies explosion of the global middle class, and their consequences in order to have not been fully rewarded for their climate change and other economic, unlock value creation opportunities. positive externalities and have also not social and environmental megaforces They need to identify and quantify paid for much of the damage they cause are transforming the operating externalities, recognize what is driving through negative externalities such as landscape for business. internalization, and understand the carbon emissions or the social effects potential effects on corporate value. of poor working conditions. As a result, externalities are increa - Equipped with this understanding they singly being internalized, bringing will be in a stronger position to develop For this reason, externalities have been new opportunities and new risks with effective response strategies that largely excluded from the measurement significant implications for corporate protect and create value, both for of corporate value. But this disconnect value creation in the 21st century. shareholders and for society. between corporate and societal value is In short, externalities are now part of disappearing. every company’s value creation story. Readers of this report will learn: • how new regulations, growing stakeholder influence and changing market dynamics are driving the internalization of business externalities at an increasing rate • how companies can protect and create both corporate and societal value in the age of internalization using the KPMG True Value methodology • what is needed from investors, business leaders and policy makers in order to achieve closer alignment between the creation of corporate and societal value. 6 | A New Vision of Value: Connecting corporate and societal value creation © 2014 KPMG International Cooperative INTRODUCTION TERMS USED IN THIS REPORT The following terms are used widely in this report. While there is a general understanding of these terms in the business and financial worlds, precise definitions vary and are debated. In this report, they are taken to mean the following: CORPORATE VALUE Shareholder value (i.e. market capitalization) and/or enterprise value (i.e. total business value) SOCIETAL VALUE Economic, social or environmental value created or reduced for society in the course of doing business POSITIVE EXTERNALITY An economic, social or environmental benefit that a company creates for society for which it is not directly or fully rewarded in the price of its goods and services NEGATIVE EXTERNALITY An economic, social or environmental cost that a company inflicts on society for which it does not directly pay a price INTERNALIZATION Processes through which a company’s externalities become internalized (i.e. through which a company is more fully rewarded for the societal benefits it creates and/or pays for more of the costs it inflicts on society). Regulation, such as pricing, is one driver of internalization, with direct effects on corporate value creation. However, other interconnected factors, including stakeholder action and market dynamics, are also at work (see page 15). © 2014 KPMG International Cooperative A New Vision of Value: Connecting corporate and societal value creation | 7 8 | A New Vision of Value: Connecting corporate and societal value creation © 2014 KPMG International Cooperative 01 EXTERNALITIES: the age of internalization is dawninghere © 2014 KPMG International Cooperative A New Vision of Value: Connecting corporate and societal value creation | 9 CHAPTER 01 Externalities xternalities have existed for as long as business itself. population growth and wealth growth drive consumption ever Throughout history, companies have both created higher. An example of this is the extreme level of air pollution benefits for society for which they have not been in many Chinese cities, which a senior Chinese scientist