FOR GOOD MEASURE
Downturn or not, CFOs should heed a new regime of corporate reporting - the triple bottom line of social, environmental and financial accounting.
By Adam Lincoln

With a solemnity befitting marriage vows, Wipro, the Indian IT outsourcing star, opens its annual report with a nod to its corporate mantra: "With utmost respect to human values, we promise to service our customers with integrity, through a variety of innovative, value for money products and services, by applying thought, day after day." Across the continent at Japanese conglomerate Hitachi, the motto "Inspire the Next" commands pride of place in the company's environmental report, where talk is of a loop-based society that recycles and reuses resources for both environmental preservation and economic growth. Further south in Hong Kong, at the regional headquarters of German leisure goods leader adidas-Salomon, "the brand values of the company - authenticity, inspiration, honesty and commitment - are derived from sport." Not far away, in the industrial heartland of Kowloon, privately held Carven Circuits, a maker of printed circuit boards, is "trying to maintain the shape of our earth."

Nice words, lyrical even. But what do they really mean - and what are they really worth? Suresh Senapaty, Bangalore-based CFO of US$660 million Wipro, puts it this way: "Sustainable profit for a company is dependent on its brand. We have taken up socially relevant initiatives that help build the brand. This attracts human talent and customers to the company - it creates a certain feeling of warmth." When CFOs talk of warmth, the conversation usually leads to money. And Senapaty's reported results are positively cosy. Wipro posted a 106 percent rise in net profits to US$138 million in March on revenues of US$662 million and a 101 percent increase in the first quarter through June. Not bad given the worldwide downturn in the high-tech service industry.

Like Wipro, a handful of other Indian IT service companies, including Satyam, HCL Technologies and Infosys, are profitable even in a rocky period for their business. At the same time, these companies support and broadcast internal programs to develop human capital through education and community services.

Their wish to do good is hardly altruistic. Wipro has alliances with global powerhouses like SAP, IBM, Nortel and Cisco. It also counts among its clients NEC, Nokia and BT, all companies that adhere to a comprehensive set of guidelines for socially responsible disclosure recommended by the Global Reporting Initiative (GRI). An international effort convened by the Boston-based Coalition of Environmentally Responsible Economies in 1997, the GRI creates a common framework for voluntary reporting of economic, environmental and social impacts.

To remain competitive as an Asian offshore vendor to the powerful multinationals, the 'green' component of the brand is far more than a philanthropic whim. It means maintaining a standard that makes them more presentable to major clients, because those clients' shareholders contain a rigid component of investors that consider such initiatives mandatory to corporate responsibility.

It means staying in the race in a sector of fierce competitors as a supplier of services in a market that's shrinking, because the rest of them are doing it, too. On the strategic side, it means building a brand. On the defensive side, it becomes a major component of risk management. No Asian supplier can afford to lose business because its multinational client cuts it out of the supply chain due to unsafe or exploitative labor conditions, murky finances, or destruction of the local environment.

It all boils down to this: the best Asian companies, uniquely, stand between an exploitable low-cost labor base and the heavy-hitting multinationals of the first world. Do they go for cheap labor and slack conditions, shoddy transparency and murky financial relationships with banks, or do they differentiate themselves all down the reporting line? The choice, increasingly, makes a difference. Wipro, for example, boasts three board-level committees: auditing, compensation and benefits, and investor grievances. It has five independent directors on a board of nine - a ratio unthinkable for most Asian companies. Its financial disclosure is every bit as scrupulous as that of IBM, one of its clients. Its employee benefits are legendary.

For Western executives who have their audit and compliance committees to deal with, Wipro makes the choice of hiring an Asian service partner a lot easier. And by Senapaty's own admission, Wipro pays attention to social responsibility to maintain the integrity of its brand. The company follows the pattern of the growing number of Asian companies that have adopted a high level of transparency and installed programs to promote social responsibility. These companies disclose for their own benefit, plus the glow that these policies lend to brands.

That glow represents real money. Look twice at investment numbers and you begin to get the idea what corporate responsibilities mean to Wipro's brand - and market value. The Association for Sustainable and Responsible Investment in Asia says that only US$2.5 billion worth of socially responsible investment (SRI) funds are committed to Asia - most of it in Japan and Australia. That's a mere pittance. But some US$2 trillion of SRI money, or about 13 percent of funds under management, is committed to US companies. Since Wipro is listed on the NYSE and serves dozens of US multinationals, the influence of these US SRI investments has a tangible affect on company policy. To win acceptance as a major supplier, Wipro needs to be green.

"A company that reports with a high level of transparency and makes the effort to install and report socially responsible policies," says Robert Eccles, partner at PricewaterhouseCoopers, "has a real opportunity to gain the attention of global markets and lower its cost of capital." Says Al Gula, chief investment officer of Franklin Templeton, a Boston fund: "Wipro is better in at least two ways than the competition; commitment to quality management and financial strength, and the infrastructure they've put in place."

Are You Sustainable?

The whole welter of green issues - labor, the environment, shareholder rights and human capital development - intertwined into one idea dubbed sustainability. Companies attain this magical quality, the theory goes, when they create value on three fronts: economic, social and environmental. "Put another way," writes Eccles, "they must deliver acceptable results along a triple bottom line." This phrase is more a guideline that dictates the scope of reporting needed to demonstrate sustainability rather than a hard and fast method.

Skeptics argue that the idea of sustainability has not been around long enough to prove investor reward. Even a study by the US-based Ethical Investment Research Service in 1999 found that annualized returns on SRI funds were a shade below those of traditional funds. But Margaret Chin-Wolf, principal and portfolio manager of Singapore-based Nexus Asia Investment Management, says there is a good reason why companies, and fund managers, must look for ways to make sustainability pay. "We are unloved as a region; more money left Asia last year than any other market," says Chin-Wolf. "It is vital that sustainability is embraced by the financial community here," she says.

There is strong evidence that this isn't just emotion talking - that investors who place their faith in "sustainable stocks" over the long haul are smart. For instance, the US-based Domini Social Index (DSI), a capitalization weighted market index of 400 common stocks screened according to broad social and environmental criteria, has outperformed - albeit narrowly - the S&P stock index on a total return basis since it went live in May, 1990. Through January 31, 2001, the DSI's five year annual average return was 20 percent, compared to the S&P 500's 18.4 percent. Whether members of Asia's nascent shareholder advocacy movement are moved by such figures remains to be seen.

The formation in 1999 of the Dow Jones Sustainability Group Index and, earlier this year, the comparable FTSE 4 Good index, undoubtedly lends weight to the cause. But both skeptics and proponents agree that if the triple bottom line is to fulfil its promise - that a business will ease its cost of capital by illustrating sound prospects for long term sustainability - the clarity and credibility of financial reporting must somehow be replicated.

A number of groups actively promote this goal, the most prominent being the Global Reporting Initiative. The GRI focuses on the triple bottom line's "front end". Members of the steering committee include the Association of Chartered Certified Accountants (ACCA), India's Centre for Science and Environment, and US auto giant General Motors. AA1000, brainchild of the London-based Institute of Social and Ethical Accountability, is intended to support GRI goals from the "back end". The two overlap on several fronts, but AA1000 clarifies the strategic and tactical issues that companies must address before reporting.

Other initiatives collectively aim toward enhancing companies' sustainability. Most familiar are the benchmarks of the International Standards Organization (ISO), which focus on the development and certification of management systems. Companies that meet the criteria are rewarded with a formal seal of approval. One part of the ISO series, ISO14001, addresses many of the AA1000 processes, but with a specific focus on environmental issues. Another standard with close links to AA1000 is the Council on Economic Priorities Accreditation Agency's Social Accountability 8000 (SA8000), which looks at workplace conditions in supply chains.

Clean Bill of Health

There is no paradigm yet formed for the perfect triple-bottom line company. The GRI says about 60 companies have acknowledged using its guidelines. One of the largest to embrace it as a reporting goal is Shell. The oil giant's motive was obvious: hit hard by labor troubles in the 1990s as a result of bad publicity over its activities in Nigeria, it made a worldwide push to demonstrate social responsibility. No company in Asia has adopted reporting for sustainability in such a comprehensive fashion. The best examples have emerged in Japan, where a regulatory push for greater financial transparency has been accompanied by greater pressure for environmental disclosure.

Hitachi, the electronics giant, has responded to the pressure on both fronts, overhauling its internal audit system, increasing its number of independent directors, and - in one fell swoop - introducing one of the most comprehensive eco-reporting systems yet to emerge. The electronics giant made the decision to start an environmental accounting system in 1999, and demonstrated its commitment by funding it partly through the R&D department and devoting 33 billion yen to the task in the first year. It drew together a team of employees from its finance and environment divisions to push the initiative forward.

The size of the problem bore a fleeting resemblance to Hercules at the Augean stables. Hitachi is a huge multinational that counts some 335 overseas companies among its subsidiaries, making US$68 billion in consolidated net sales and US$842 million in profits last year. At first the team faced a problem of internal transparency. "Data was insufficient and it was not easy to encourage a recycle-oriented mindset," recalls Shunkai Horiyasu, general manager of Hitachi's corporate environmental policy division.

One element working in Horiyasu's advantage, however, was that Japan was preparing for a massive regulatory shift that required companies to consolidate their books, fighting the old practice of hiding accounting for sales and costs, including such items as waste disposal, as if each unit were an unrelated economic entity from the parent company. Hitachi's board bought into this shift early, and it gave Horiyasu an internal advantage by giving him greater access to the numbers.

By 2000 Horiyasu and his team were able to eke out data from an increasing number of group companies, but only came up with a year-end report from 21 subsidiaries. But that was only the beginning. Under increasing pressure from non-governmental organizations (NGOs), the team was finally able to break through internal barriers - this year its report included data sourced from 310 group and affiliated companies. The result is a pioneering example in environmental accounting, giving careful tallies on the progress of such elements as plant emission activity and the number of kilowatt hours that Hitachi uses in energy to make products.

Measuring Green

Horiyasu and his team discovered that careful environmental auditing was beginning to yield year-on-year cost savings. In one area, the report showed that new designs of products had led to a 722 million kilowatt hour reduction in energy by consumers when they used the products, or five times the size of the reduction in 1999. Horiyasu reckoned that the auditing effort and the conservation efforts that emanated from it added 9.4 billion yen to net income for the group, following a reduction of 32 billion yen in expense. Publishing these figures represented one of the first times that a company has fixed a hard number to the environmental portion of the triple bottom line.

The company issued guidelines in March for green procurement and began to collect information on the environmental credentials of its vendors and business partners, such as details on chemical substances contained in procured items. While the Internet was a valuable research tool, Horiyasu says cooperation with these vendors and business partners was crucial. A database was created that can be accessed by users involved in product design and materials procurement. "The supply chain is thus effectively used to develop green products," Horiyasu says.

Rules of Engagement

One of the residual benefits of greening the supply chain is that it seems in everyone's interest to collaborate. Hitachi shares information down the supply chain. Germany-based adidas-Salomon is even willing to share information about suppliers in Asia with its competitors, including Nike. The thinking behind the information-sharing is straightforward: the companies lose nothing and gain everything by keeping an eye on which suppliers comply with international standards, and which violate them.

The experience of Nike, which came under fire from international human rights groups in the 1990s for child labor and other transgressions at its contracted factories, has proved a powerful catalyst for many companies, including adidas-Salomon. The company has launched one of the most tightly organized efforts to ensure compliance of socially responsible conditions in its factories among any company in the region.

Aside from its joint venture factory in China, adidas-Salomon outsources all production to facilities across Asia. To ensure that none of those factories are exploiting underage workers or committing similar crimes, it began to set up a new standards of engagement (SOE) division in 1998 to oversee social and environmental compliance. The SOE's corporate social responsibility program, as it is known today, replaced pre-existing programs. Jobs in this division are not window-dressing. The team includes 18 experts in Asia alone - the largest such team in the company's global network - that report directly to the company's legal section in Germany.

William Anderson, head of standards and engagement for adidas-Salomon Asia Pacific, presides over this regional team. "We're quite technical, we're not spin doctors," Anderson says. The team members make sure that workers are aware of their rights and that there is two-way communication between employees and management in all plants that make the brand's products.

"Most countries have signed on to international conventions. If they are legal locally, they are meeting many of our standards," Anderson says. When they don't, the company formulates a program of remedial action to bring a factory into line. The factory nominates who will be responsible for specific actions, and the parties negotiate an appropriate timeframe. "As long as they demonstrate commitment and achieve certain milestones of improvement, the relationship will continue," Anderson says. And if they don't? "We have terminated business relationships," he says. This doesn't happen often, but the frequency is increasing - 2 percent of factories have lost their contracts this year.

Anderson admits to an element of 'carrot and stick', but points out the real long-term benefit for factories if they get their acts together. "We deal with factories across Asia, we know who the leading lights are, the exponents of best practice. We can say, ÔOthers can achieve this so why can't you?'" he says. The result is that these companies have a chance to become "an international-standard business, which may bring opportunities with other brand buyers," he says.

Thinking Ahead

That line of thinking surely occurred to Majorie Yang, the chairman and chief executive of Esquel, a privately owned textile and apparel manufacturer based in Hong Kong. Yang began working in the company's management after graduating from MIT in the 1970s. Last year, Esquel, which employs 43,000 people in ten countries, earned revenues of US$500 million by making items for world-famous labels such as Tommy Hilfiger and Polo Ralph Lauren. The company's main factory is in a small town three hours from Hong Kong, which uses water from the Western River, a tributary of the Pearl River. Yang recalls that ten years ago when she'd visit the family dying mill and say to factory bosses that she didn't think they should be killing fish next to the factory, "they would look at me like I was ga-ga."

Yang was among the first in Hong Kong to raise her company's profile by overhauling its environmental practices. Recognizing that the brand-name buyers would eventually press for better working conditions, she looked for ways to clean up operations. "Our buyers say we have to do it, but that shouldn't be the only reason," she says. This realization meant that investments were required - most significantly, 30 million renminbi (US$3.6 million) was spent on water treatment technology developed in China. The new system helped reduce the volume of water used in piece dying, which reduced the amount of chemicals used in the process - and cut costs on both chemicals and fuel. Other tactics focused on a smarter approach to existing processes. Yang made the decision to deviate from the standard width of fabric rolls used by most fabric mills, a move she said significantly reduced packaging costs. That year, the mix of great and small measures amounted to total operational savings of US$1.4 million.

Unlike Esquel, Carven Circuits, a privately held partnership that makes printed circuit boards (PCBs), entered into the push for sustainability without an added nudge from its customers. It has done so because of the private convictions of Albert Mok, its managing director, who believes that striving for tougher standards than local regulations required for a company its size - the company employs 80 people - is good business sense.

PCB production is a notoriously dirty activity that relies on astringent chemicals. Mok has seen the advantage of going the benchmarking and certification route, which has made Carven highly visible in its peer group. In 1997 it was the first Hong Kong company to achieve the quality standard QS9000. The following year, it was the first among its peers to meet the ISO14001 environmental benchmark. Earlier this year came the Hong Kong Eco-Business Gold Award for best environmental reporting. The company also won the 2000 Hong Kong Best Managed SME Gold Award, reflecting the findings of a study by US-based Assetbet, which found companies that do a good job on the environment are likely to be well managed generally.

Without revealing how much, Carven's quality assurance manager Thomas Lau says the company paid a large sum to invest in equipment to back its effort to meet the international benchmarks. But as with Esquel, the new techniques have translated into savings. "We see demonstrable benefits in areas such as electricity consumption, water usage and reusing resources within the process," says Lau. "This streamlines chemical treatment, which is very expensive in Hong Kong," he says.

Cost of Virtue

Savings aside, the cost of benchmarking to world standards for an SME can be forbidding. To achieve ISO14001 status, for example, most companies need to hire environmental consultants to guide them through the process. Andrew Thomson, CEO of Hong Kong's Business Environment Council, says this costs between US$30,000 and US$60,000. An ISO14001 audit usually takes three days, followed by a "surveillance audit" at a cost of US$6,000 to US$12,000 a year. Certificates last three years, after which another audit is required.

That's nothing compared to the ongoing costs for advisory on a comprehensive program to report across a triple bottom line. The Big Five charge a lot to verify such reports. Tim Fisher, group environmental manager of London-based shipping company P&O, told a conference in London that the lowest quote he could get last year was US$74,000 - more than twice the cost of actually producing his report. The next year he asked an environmental campaigner to provide written comment on his report's content. Likewise, Kirin Breweries in Japan asked an NGO, to give feedback on the back page of the document. Such moves save money but they don't impress ACCA, which says environmental and social reports are "simply not acceptable" without verification.

The ultimate question for the green bottom line - whether verification will forge a measureable link between green reporting and a lower cost of capital - is hard to pin down. Imelda Willamson, manager of sustainability advisory services at KPMG in Sydney, observes: "There is not a generally accepted way to marry environmental performance with an economic metric so the market says, ÔYep, that result is equal to this many basis points advantage.'"

But movement is afoot. In 2004 the Basel-based Bank of International Settlements will ratify changes to the International Capital Accord, which will change the way banks assess risk. Banks will be less reliant on credit ratings from agencies like Moody's, which are affected by the strength of national currencies. The new regime should reward companies that reduce their operational risk by paying attention to social and environmental strategy, as well as financials.

Earlier this year, British consultancy SustainAbility, working for the United Nations Environmental Partnership, spoke with experts from the sustainable development and financial communities to channel current thinking into a digestible format. One outcome was the Sustainable Business Value Matrix, which helps executives map the connection between ten areas of social and environmental performance and ten conventional measures of business success, such as shareholder value, access to capital and risk profile. A table of 100 color-coded cells shows whether the supporting evidence for a particular course of action is strong or, indeed, just wishful thinking. For instance, SustainAbility says there is "strong evidence" that commitment to the triple bottom line has a "weak positive impact" on access to capital.

Perpetual Motion

Wipro's Senapaty is convinced of the relationship. "The cost of capital, or the debt that a company accesses," says Wipro's CFO, "is dependent not only on its present profitability but also its estimated profitability over the period. In our industry, human capital has significant importance for an organization's ability to generate profit." No surprise then that the company aims to be among the top ten preferred employers in the world, "by creating an environment of empowerment, intellectual challenge and wealth sharing," says Senapaty.

It seems to be on track. Wipro pioneered share options for staff in India in 1984; today more than 6,000 so-called "Wiproites" are included in the scheme. The company is pursuing PCMM (people capability maturity model), an international HR benchmark, with success. Its Silicon Valley-style campus in Bangalore boasts tennis courts, a swimming pool and a gym.

"How you treat your human capital affects attrition and morale, which has an impact on scalability - the ability to train and retrain people based on the latest technology," says Senapaty. "If one can demonstrate scalability on a year-in, year-out basis, it gives robustness to profitability generated quarter after quarter. The moment you do that your cost of capital drops," he says.

Or, put another way, the thin green line connects directly to the bottom line.

Adam Lincoln is executive editor of CFO Asia, based in Hong Kong