« View All Blog Posts

Pricing Externalities: Redefining Profit to Reflect Reality
By Holly Testa, Director, Shareowner Engagement

According to Webster's dictionary, profit is defined as "the excess of the selling price of goods over their cost." Simple definition, yes, but complex to calculate when the cost is uncertain or hard to measure.

Some costs, such as the depletion of natural resources or the health impacts of polluted air and water, are all too often assumed to be zero when in reality they may be high. So high, in fact, that the “profit” reported by some industries may not be profit at all—but instead, a loss of irreplaceable resources essential to our future well-being and economic prosperity.

Defining the Indefinable

A new report authored by Trucost in conjunction with The Economics of Ecosystems & Biodiversity Coalition (TEEB) is a notable attempt to quantify the monetary value of natural systems and determine the impact of incorporating business "externalities" into company balance sheets.

Natural Capital at Risk: The Top 100 Externalities of Business ranks the top 100 impacts in each sector, broken down by region, and evaluates the value of unpriced natural capital. While authors acknowledge that the methodology has limitations and can only provide a “high-level” indication of natural-capital risk, the findings are sobering:

  • Primary production and processing industries may cost the global economy around $7.3 trillion a year in terms of the economic costs of greenhouse gas emissions, loss of natural resources, loss of nature-based services such as carbon storage by forests, and air pollution-related health costs.
  • Coal-fired power in Eastern Asia and in Northern America rank first and third, respectively, in terms of impact—estimated at $770 billion annually. These consist of the damaging impacts of GHG emissions, and the health and other damage caused by air pollution. In both instances, these social costs exceeded the production value of the sector.
  • Other high impact sectors include agriculture in areas of water scarcity and in areas of high production and land use. Cattle ranching in South America and wheat/rice production in Southern Asia also rank high in terms of impact.
  • The majority of environmental externality costs are from greenhouse gas emissions (38%) followed by water use (25%); land use (24%); air pollution (7%), land and water pollution (5%) and waste (1%).

Several organizations are working on the challenge of incorporating these real but difficult to quantify costs into corporate accounting. As reported in the most recent issue of Affirmative Thinking, the non-profit Sustainability Accounting Standards Board (SASB) is working to develop clear and measurable sustainability standards-similar to what the Financial Accounting Standards Board (FASB) has been doing for the past forty years.

Posted: May 13, 2013