DRIVING PROFIT, BOOSTING SUSTAINABILITY

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Bryce Stanley
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1 DRIVING PROFIT, BOOSTING SUSTAINABILITY 02/03 VIEW Magazine

2 Our View This article looks at the sustainability imperative within the food industry. Historically, many businesses approached sustainability as something that had to be done to keep stakeholders content but many privately believed that the more sustainable they became the more they eroded their competitiveness. Thus, in many cases it was delivered through practices undertaken not to deliver bottom line financial benefits to the organisation but to appease stakeholders and to protect reputation. Yet in recent years the tide has started to turn. More and more companies in the food supply chain are waking up to the fact that proactively managing sustainability challenges actually makes good commercial sense. Indeed, the work that EFFP has undertaken as a partner in Project SCALE is demonstrating that, when viewed through the telescope of the triple bottom line, sustainability provides many opportunities to improve profitability and performance. The question should not be whether food businesses adopt this approach but how best to do it to drive real benefits for the company and for wider society. Issue 13/Summer 2014

3 90 % INCREASE IN UK AGRICULTURAL PRODUCTIVITY BETWEEN THE EARLY 1950s AND THE EARLY 1990s 04/05 VIEW Magazine

INTRODUCTION It would seem that even the most ardent climate sceptics can no longer deny that the overwhelming body of scientific evidence points to the reality of climate change and that mankind is

4 INTRODUCTION It would seem that even the most ardent climate sceptics can no longer deny that the overwhelming body of scientific evidence points to the reality of climate change and that mankind is largely responsible. Indeed, the recent Fifth Assessment reports by the UN s Intergovernmental Panel on Climate Change (IPCC) are based on several thousand peer reviewed scientific papers and make stark reading, particularly for anyone involved in the business of producing food. Scientists are now confident that the effects of climate change will be severe, pervasive and irreversible. With respect to food production it will negatively impact on the quality and quantity of water resources and generate more frequent extreme weather events placing crops under stress with adverse effects for yields. As we have seen over recent years the consequence has been fluctuations in crop yields and much increased price volatility for agricultural commodities leading to greater uncertainty, less affordable food and even hunger. And, of course, this set of circumstances is not happening in isolation. Population growth and economic development means that the demand for food is expected to rise by at least 70 per cent over the next 35 years. What is more, consumption patterns are changing as incomes in developing markets grow, resulting in higher consumption of protein, particularly meat and livestock products, altering resource requirements. If agricultural production is to meet this rising demand, food producers will have to find an affordable response; not only to climate change but also to the limited potential for any expansion in the land devoted to crop production and the pressures that global economic growth are placing on non-renewable resources such as oil, minerals and fresh water. The post war model of agricultural production is based on increasing input use eg fertilizers, energy and irrigation but now a new green revolution is needed whereby natural resource productivity rises exponentially. In essence the agricultural industry will need to employ the fruits of scientific and technological advance including management science in order to raise output not only per unit of land but also per unit of energy, minerals and water. The perhaps hackneyed expression more from less has never been more relevant. Issue 13/Summer 2014

6 UNDERSTANDING NATURAL RESOURCE PRODUCTIVITY From the perspective of sustainability a good starting point is Total Factor Productivity (TFP) growth which is defined as the aggregate quantity of outputs produced divided by the aggregate quantity of inputs used. It is this overall measure of productivity rather than partial measures such as yields or labour employed that matters from the viewpoint of natural resource sustainability and it should be a matter of serious concern that on this basis, the growth of agricultural productivity has slowed markedly in recent years. Defra statistics show that UK agricultural TFP increased by more than 90 per cent between the early 1950s and the early 1990s: the product of a doubling in the volume of output and a modest increase in the volume of inputs of less than 10 per cent. FIG 1: UK AGRICULTURE TOTAL FACTOR PRODUCTIVITY Index UK Agriculture: Total Factor Productivity Underlying rate of Total Factor Productivity: 1.5% ( ) 2012 The slowdown in TFP is illustrated in Figure 1 which shows how TFP has broadly plateaued since 2002 since when it has grown at only around 0.3 per cent per annum. Issue 13/Summer 2014

Farming is only one stage in the food chain but the productivity performance of all stages downstream of farming displays similar slowdowns over recent years.

7 Farming is only one stage in the food chain but the productivity performance of all stages downstream of farming displays similar slowdowns over recent years. In retail and catering, for instance, Defra estimate that TFP is actually marginally lower in 2012 than it was in From the stance of social welfare the slowdown in TFP growth should be a matter of concern because unless the post war trend shown in Figure 1 is re-established, the cost of food is likely to be significantly higher, than it otherwise would be. But this raises another concern. Much of the post war growth in agricultural production was achieved by a combination of increasing the volume of inputs and labour productivity as farming and food manufacture adopted more capital intensive production techniques: see Figure 2. We are now in the foothills of a new green revolution which will continue the long term trend of replacing labour with capital but the focus must now shift markedly to improving natural resource productivity with particular emphasis on nonrenewable resource productivity. 08/09 VIEW Magazine

8 A new approach to the sustainability agenda, embedded in real commercialism, suggests that if sustainability is approached in the right way it can deliver significant value for businesses as well as for society at large. FIG 2: COMPONENTS OF TOTAL FACTOR PRODUCTIVITY Total level of output Contribution to output from volume of physical inputs used Contribution to output from input productivity growth Consumption of physical capital employed Purchased intermediate goods & services Natural resources: land, fresh water & non-renewables General and firm specific human capital Technological focus for sustainable productivity growth External focus for sustainable productivity growth Primary internal focus for sustainable productivity growth Internal routines for sustainable productivity growth All food businesses now need to really care about global sustainability challenges even if they operate within a tight geographic area, with a defined supply chain and customer base. Some change is likely to be required as a response to the demands of customers and society at large, if only to protect reputation. But there is much more at stake. A new approach to the sustainability agenda, embedded in real commercialism, suggests that if sustainability is approached in the right way it can deliver significant value for businesses as well as for society at large. This poses an interesting difference from what has become the accepted norm that is to say that big business is bad and that sustainability solutions come from NGOs and non-profit organisations. It is probably fair to say that we are at a low point in the public regard for large businesses but things are changing. Renowned Harvard business school professor, Michael Porter, talks of the awkward reality that shows that non-profits are not making sufficient progress to meaningfully address sustainability challenges because their activities are inherently impossible to scale due to a lack of resources. He argues that resources are always created in businesses, and suggests that it is this that allows businesses to drive solutions that are infinitely scalable and, therefore, self-sustaining. Porter calls this shared value the concept of addressing social issues with a business model to deliver social value and economic value and he suggests that if businesses change the way they see themselves, as well as the way others see them, then real progress can be made. It is a compelling argument and it is increasingly accepted that if society is going to materially change practice to deal with the major sustainability challenges we all face, then businesses will need to lead this change. Issue 13/Summer 2014

FIG 3: SUSTAINABILITY AND OPERATING PROFITS Economic (operating profits) Minimum legislative environmental standards C Represents a rise in the terms of trade B (output prices rise relative to input

9 FIG 3: SUSTAINABILITY AND OPERATING PROFITS Economic (operating profits) Minimum legislative environmental standards C Represents a rise in the terms of trade B (output prices rise relative to input prices) E Output rises in response to a short-term market opportunity: revenue exceeds cost of some decline in productivity-efficiency Assumes output remains constant but productivity has lowered production costs: close to point of maximum efficiency The economic-environment frontier shifts in response to investment in not only plant and machinery but also employee competencies and supplier relationships that significantly increases the productivity of natural resources A D Environment (natural-resource productivity) The exciting part for businesses operating in the food supply chain is that a focus on sustainability is not detrimental to economic performance. Indeed, it can improve performance, enhance longer term survival and reinforce a reputation for doing good. In short, placing a greater emphasis on non-renewable resource productivity delivers a win-win outcome for both a business and society. Figure 3 illustrates the relationship between two elements of the triple bottom line: economics and the environment. We define economics as operating profits and the environment as natural resource productivity. Starting at point A our representative firm s use of natural resources more than conforms with current legislation eg concerning pollution. Any move along the curve from A to B is an unambiguous gain in efficiency and operating profits as output has not increased but the firm has reduced the volume of natural resources used in its production. The shape of the curve from A to C reflects diminishing returns ie given the prevailing knowhow and technology; point B represents maximum efficiency. It is reasonable to assume that the growing weight of scientific evidence regarding climate change and natural resource depletion will result in more regulation and legislation; thus in terms of Figure 3 the minimum legislative environmental standards line will, over time move to the right. It is also extremely likely that business strategy will be strongly influenced by the scientific evidence. Indeed, in his interview in the last issue of VIEW the CEO of Greencore, Patrick Coveney, referred to the need for businesses to focus on effective resource utilisation, not just within their own sphere of operations but right the way through the supply chain. More broadly, EFFP is currently involved in a large project where a survey of a number of European food chain businesses revealed that the number one reason for adopting more sustainable business practices was the expectation of cost reductions and better utilisation of assets ie economic performance. Other reasons featuring prominently for investing in sustainability were reputation, compliance with customer requirements and legislation as well as being seen to do the right thing. 10/11 VIEW Magazine

It is however the combination of R&D and investment that has the potential to really improve performance. The key to progress is research and innovation.

competitive advantage. Curve DE in Figure 3 shows the effects of such investment.

10 It is however the combination of R&D and investment that has the potential to really improve performance. The key to progress is research and innovation. Investment in fixed capital embodying science and technological advances in natural resource productivity alongside the development of competencies will create both a unit cost benefit and a competitive advantage. Curve DE in Figure 3 shows the effects of such investment. A firm already operating at maximum natural resource productivity ie a firm already successfully capturing the competitive advantage inherent in such a strategy, will move from point D to point E. As implied by the diagram the firm not only improves its sustainability but also it further improves its economic performance as investment leads to a shift to the right in the production possibility frontier. Thus, in contrast to a widely held belief that the more environmentally friendly a company becomes the more it erodes its profitability, the reality is that it is more profitable in the longer term to strive to achieve the highest levels of natural resource productivity ie sustainability. Issue 13/Summer 2014

11 HOW MIGHT AGRI-FOOD BUSINESSES CAPTURE THE BENEFITS? 12/13 VIEW Magazine

12 FIG 4: THE SUSTAINABILITY JOURNEY Positive demand supporting prices and sales growth Awareness of imperative and benefits of natural resource productivity reinforced by compliance and decisions Reputational benefits brand, trust creating scope for product differentiation Competitive advantage: Higher profits, reduced exposure to natural resource shocks and climate change Develop a growth-sustainability strategy embracing research and innovations Financial benefits from reduced unit production costs Increased natural resource productivity initially through engaging employees-suppliers then reinforced by investments We have established that sustainability provides opportunities and should not be seen as something that has to be done but as something that drives both economic and social value. Easily said, but where do you start? Figure 4 provides some guidance. The first stage is to get the vision right. Even if the first actions are to do no more than reduce waste it is important for senior managers to have in their sights the goal of a new business model; that is a strategy that can be developed and enhanced to transform the business. Underpinning the vision must be an acceptance to redesign processes and products so as to prioritise natural resource efficiency across operations. This can only be done by firstly, making employees and key suppliers aware of the imperative and benefits and secondly, by building commitment through reinforcing decisions. In developing a new strategy to transform the company s approach to sustainability the vision will expand to embrace innovations and investments capable of delivering significant improvements in natural resource productivity. Initial productivity gains can be sought by the engagement of employees and suppliers; indeed, the scope offered by new relationships with key suppliers might be considerable. But these gains will necessitate investments in physical and human capital if they are to overcome diminishing returns and provide a trajectory for growing natural resource productivity. The capture of increased profits through natural resource productivity should be viewed as only part of the potential value embodied in the new business model. Once established and on an improving trend the new model offers a means of reputational enhancement and thereby scope for differentiation and positive demand. Exploiting the new model as a source of differentiation redefines or reinforces its competitive advantage. Food supply chains are highly complex and experience suggests that many of the sustainability issues (and therefore benefits) are found either at the production or consumer ends of the supply chain. This means that to realise the overall benefits supply chain partners need to work collaboratively for mutual gain. In our VIEW food businesses now need to drive further and faster in the direction of sustainability. The rate and scale of change required cannot be addressed through incremental developments businesses will need to develop new ways of working, be prepared to educate both internal and external stakeholders and deliver technical innovations at all levels to meet the challenges ahead. A proactive and collaborative approach is what s required. Food supply chains are highly complex and experience suggests that many of the sustainability issues (and therefore benefits) are found either at the production or consumer ends of the supply chain. This means that to realise the overall benefits supply chain partners need to work collaboratively for mutual gain. Working in partnership up and down the supply chain requires lateral thinking about the wider issues associated with the triple bottom line of people, planet, profit. It also requires a mind-set shift from short-term gain for one party to longer-term benefits for all. Issue 13/Summer 2014

13 END PIECE As mentioned in a previous edition of VIEW, EFFP is a partner in Project SCALE, a European initiative that sees us working alongside DHL, Cranfield University School of Management, Wageningen University and the University D Artois to deliver a step change in food chain sustainability. The project is part-funded by Interreg IVB and aims to deliver a number of tools and frameworks that the agri-food sector can use to improve the efficiency and sustainability of food and drink logistics throughout the supply chain. Yet, while the focus of Project SCALE is logistics, the approach applies equally well to any sustainability drivers and has the potential to help food businesses explore the challenges ahead, developing solutions that have environment and social benefits at their centre. At the heart of the SCALE project is a framework that takes a business from the development of a sustainability strategy to building a case for change through implementation and then evolution a continuous process of review, innovation and development. Whilst collaboration isn t going to be for everyone, for those more enlightened businesses it can and will offer real opportunities to create value for all those involved across the triple bottom line. As set out above, collaboration is an important component of tackling the sustainability challenges ahead whether this is within a single supply chain (vertical collaboration) or between businesses operating in different supply chains (horizontal collaboration) or a combination of both. Whilst collaboration isn t going to be for everyone, for those more enlightened businesses it can and will offer real opportunities to create value for all those involved across the triple bottom line. Thus another key component of the SCALE project has been the development of a partnership model to help businesses identity the most appropriate form of collaboration to meet their collective needs. 14/15 VIEW Magazine

Response to Ofwat s consultation on outcomes

January 2017 Response to Ofwat s consultation on outcomes The Thames Water Customer Challenge Group s response to Ofwat s consultation on the outcomes framework for PR19 The Thames Water Customer Challenge