With a bold stroke of courage and transparency, PUMA announced the completion of its first Environmental Profit and Loss (EP&L) Account (PDF, 2.1M) in the fall of 2011. This commendable advance toward mainstreaming the accounting of our planet’s natural capital provides other businesses (competitors, take note…) a possible road map to follow in suit.
How might your organization depend on open space? What are the opportunity costs of land use conversion for your business operations? What are the shared costs to society? As businesses begin to consider the risks and opportunities posed by diminishing “free” ecosystem services provided by open land and natural ecosystems, it becomes critical to answer these questions in financial terms. PUMA has taken the first step.
PUMA was honored as the overall winner of the Guardian’s 2012 Sustainable Business Awards and also won the biodiversity category for its release of the EP&L Account. The EP&L Account has made a tremendous splash in sustainability news and discourse. So how did they do it? Seeking a practical, repeatable, and robust approach to natural capital accounting, I investigated the land use valuation methods and assumptions that PUMA employed. You might be surprised to hear what PUMA found: their impacts to land cost society €37 million in diminished human welfare. In other words, society bears this cost of PUMA’s land use impacts.
How did PUMA arrive at this €37 million figure? And how and why should we come to terms with our businesses’ dependencies on open space and land (of which I’m sure there are many)? Read on for the BioResilience take.
The Big Picture
In developing the EP&L account, PUMA assessed impacts from their direct operations as well as suppliers all the way down the value chain (categorized as Tiers 1 through Tier 4 suppliers). Then, “the changes in human welfare which result from PUMA’s environmental impacts” were put into monetary terms–net costs of PUMA’s impacts to society are a loss; net benefits are a profit.
The calculated costs of their land use impacts to biodiversity and ecosystem services as they contribute to human welfare totaled €37 million (about 25% of the total EP&L account). The costs of greenhouse gas and water use impacts accounted for €47 million each (each comprising 33% of the account).
The 2010 EP&L account balance is a €145 “loss” (in externalized costs to society). This figure is substantial, especially when you consider that PUMA’s reported 2010 net earnings were €202 million (which does not incorporate the loss reported in the EP&L account).
Putting a Value on Land Use Impacts
The flow of ecosystem services from natural areas accrues to society every year and, as the extent of natural areas decreases as a result of land conversion, so the annual flow of public ecosystem services is reduced.
(And so too does the value of the ecosystem services increase in proportion to their increasing rarity/diminishing returns, which PUMA acknowledges.)
In discussing their impacts to land, PUMA states that agricultural production of cotton, rubber and cattle (for leather) causes the greatest land use change across their supply chain. These activities are within Tier 4, raw materials production–the supply chain tier furthest from their direct operations. To evaluate their impact, PUMA conducted a detailed analysis of the value of the ecosystems converted for these agricultural production activities.
PUMA states a “more simplified” methodology was used to determine impacts from their direct operations and Tiers 1 through 3 of the supply chain (manufacturing, outsourcing and processing, respectively), which are much smaller than those of raw material production.
Calculating the Area of Impact
PUMA acknowledges that specific areas used for Tier 4 production are unknown. Thus, to estimate the total area of impact associated with Tier 4 activities they first identified the total, government-tracked areas used for cattle, cotton and rubber production in the states they source from. Then, they estimated their proportional share of the total production and associated land used for raw material production in each nation
Once they had an estimate of the total area associated with Tier 4 activities by nation, the entire areas used for cotton and rubber production were incorporated into the land use impact calculations. However, only a portion of the areas used for cattle production were incorporated, as leather is but one output of cattle production (some argue it could be considered a by-product in the production of meat).
PUMA states that because the hide is valued at up to approximately 15% of the value of meat (and thus contributes to the growing demand for cattle rearing and the associated land conversion), they incorporated into their land use impact calculations a fraction of the total area used for cattle production based on the proportion of the value of leather to the total value of a head of cattle (by nation).
Finally, PUMA identified the general terrestrial ecosystem types associated with the estimated areas of production based on the World Wildlife Fund’s terrestrial ecoregion delineation. The following table portrays the results:
PUMA states that studies and methods published by The Economics of Ecosystems Biodiversity (TEEB) and others were used to calculate appropriate per hectare values for each ecoregion and each country where impacts occur. Based on a review of the included reference list, it appears the TEEB Valuation Database (Van der Ploeg, DeGroot & Wang, 2010) was instrumental, although the precise methodology is not disclosed.
PUMA conservatively assumes that all ecosystem services are lost following land conversion to cotton, rubber, and cattle production.
And as previously introduced (and to PUMA’s credit), they state:
Most underlying ecosystem valuation studies were performed recently and consider the cost of losing an additional hectare ‘today’, while PUMA is also interested in the cost of past conversions. To overcome this challenge the values from these studies have been adjusted to take into account the fact that ecosystem value per hectare increases as the extent of remaining natural areas diminish. PUMA makes the conservative assumption that ecosystem value is directly proportional to scarcity of the given ecosystem (rather than increasing more rapidly as scarcity increases which would give a lower average value over time) and an average value over time is developed based on this assumption.
This seems reasonable, although I certainly question its accuracy. A lengthy footnote in the EP&L account justifies the decision and acknowledges the drawbacks. In terms of the drawbacks to assuming a directly proportional relationship and then extrapolating an average, positive convex exponential relationships often more accurately reflect the relationship between ecosystem services and land conversion. These exponential curves denote the tipping points of many ecosystems beyond which a certain level of damage triggers ecological collapse. PUMA states that they decided to assume directly proportional relationships as a “strongly” conservative alternative due to lack of data. Fair enough.
Regarding the use of average values, they state:
Using the average is the most appropriate approach because today each converted plot contributes equally to the prevailing scarcity of ecosystem services, such that it would be inappropriate to assign them different values.
So, PUMA calculated an average value through time and arrived at per hectare average values for each country they sourced from ranging from €63 to €18,653, with an average weighted value of €347.
The weighted average values were multiplied by the areas of land use impacts caused by Tier 4 production to arrive at the EP&L account “loss.”
In future updates to the account, I would like to see a bit more transparency (perhaps in an attachment to the report). For instance, it would be worth disclosing the total areas of impact by nation and by type of impact (i.e., production of cotton, rubber, or cattle); specific discussion of the sources, studies and/or methods used to extrapolate the monetary value of ecosystem services provided by open land as well as key assumptions; and more information regarding the general assumed timeframe of land conversion and value curves used to calculate the average value per hectare by country.
PwC and Trucost helped PUMA prepare the EP&L account and I wonder if they are hesitant to disclose all of their magic. I can’t say I would blame them, but these disclosures would further contribute to the development of a robust, consistent, and comparable methodology that other organizations may employ.
What else would you suggest including? What methods would you change?
In recent news, Executive Chairman, Jochen Zeitz, stated PUMA will “soon” stop using leather in all of its athletic shoes. I do wonder if the EP&L account helped illuminate the potential value of this decision, as it will provide a notable cost reduction in the EP&L account across many of the impact categories and supply chain tiers, including land use.
Overall, this is a commendable, groundbreaking effort that shows PUMA is taking seriously its externalized costs to society and is working to reduce them. I predict it is only a matter of time before many others follow in stride by accounting for their impacts to nature as they relate to human welfare. Bravo.Tweet