Why Transparency MattersSep 10th, 2012 | By Chris Hazen | Category: Sustainability
We’ve all heard references to transparency and the need for more openness in business conduct. This article explores two important and independent trend lines associated with business transparency:
- the cost of acquiring reliable data on business externalities; and
- the willingness of consumers to pay for this information.
The cost of acquiring data continues to fall, while the willingness of consumers to pay for relevant information and insight is rising.
As a general concept, when the cost of an item, including data, falls below the consumers’ willingness to pay for it, it becomes profitable to serve the item to the consumer on a mass scale. In other words, when these two trend lines intersect, the way consumers interact with businesses in that sector reaches a tipping point, causing behavior to be gradually but irreversibly transformed.
This transformation in the relationship between consumers and businesses impacts every practitioner in the world of environmental and sustainability management. For this reason, these two trend lines are likely to be critical determinants of durable business models in the future and need to be much better understood by business leaders and EHS practitioners.
Externality data refers to the class of costs that are defined by economists as external to a given economic activity. By definition, these costs are not required by law or conventional practice to be accounted for in production costs or purchasing costs. Nevertheless, it can generally be agreed that external costs are borne, typically by society as broadly defined and/or the natural environment upon which society depends, in some indirect way.
A simple example of an externality is the legally-discharged air pollution generated by a coal-fired power station. Neither the power station nor the electricity consumer pays for the effects of the pollution, but the effects have costs in terms of diminished visibility, increased air-related health problems in areas affected by the air pollution, etc. As long as the air pollution can be legally discharged at no cost to the generator, it is an externality, and there is, strictly speaking, no incentive for the generator to reduce or eliminate the air discharge.
A Short History of Externalities
Until fairly recently, externalities did not matter in practical or everyday terms to participants in the global economy.
To understand this, and to understand the origins of the change in consumer psychology regarding externality data now emerging, it can be helpful to take a brief journey back in time.
Until sometime in the 1800s, almost all of our ancestors—regardless of where we are from—lived stable lives in rural villages. Few people journeyed more than a few days walk from their village at any point in their lives. They satisfied their basic needs with what was available in their village, including items that might be traded from afar. They grew up, went to school (or not), married, gave birth, grew old, and passed away with only a minute fraction of their economic activity impacting somebody or someplace other than the villages where they lived.
Our ancestors knew the people in their village, and they knew if things weren’t going well in the community. If the shoemaker left a heap of garbage outside his workshop, all the other villagers knew it and might have asked him to clean up his mess. If the butcher screamed at his workers to work harder and faster and without breaks, other villagers might also know it, and some social pressure might have been applied to the butcher to treat his employees more kindly. If the shoemaker or butcher refused to modify their practices, they could lose customers due to their unacceptable behavior.
Today, the modern equivalent of the shoemaker’s garbage and the butcher’s labor abuse are considered “externalities” because they are “external” to our decision to buy shoes or beef at a store. In the absence of information on the social behavior of the companies that manufacture the products that we buy, we are likely to select the cheaper alternative. This can lead to problems if the cost of poor social behavior is not incorporated into the cost of the goods on the market, as can happen in situations with substandard laws or regulations for pollution or social practices.
To bring us up to the present day again, while some of us may still live our whole lives in a single house and village as our ancestors did, this is more the exception than the rule. And even if we do live in the same house all our lives, our economic impact, positive or negative, is certainly global. Small percentages of our economic activity impact every continent as we participate in a well-oiled global marketplace of goods and services.
The United Nations Environmental Program (UNEP) estimates that annual environmental costs from global human activity constituted US$ 6.6 trillion, or 11% of global GDP in 2008 [i], virtually all of it never seen by the people buying or selling the products or services correlating to those costs.
Admittedly…out of sight is still “out of mind” for many people, but thanks to advances in telecommunications fewer and fewer corners of the world are completely “out of sight” any more.
The World is Your Neighborhood
Over the 50 years from 1955 to 2004, the price in tons per kilometer for air freight fell from US$ 3.87 to under US$ 0.30 [ii]. At the same time, average incomes in “rich” countries (east or west) are now 100 times the size of an average income in “poor” countries, a figure that was more like 3 times or 5 times the average in the 1800s. This disparity makes the benefit of labor cost arbitrage across national borders irresistible for consumers and business owners alike.
During the same timeframe, the cost of a one minute local phone call has gone from US$ 0.57 (in 2004 US dollars) to virtually zero depending on your choice of technology to make the call. At the same time, a call from London to New York that once cost US$ 100 per minute is also virtually free. Data transmission has experienced a similar drop in cost.
This year, smart phones will overtake traditional mobile phones as the primary mobile device sold to consumers. Over 2.5 billion of these devices are expected to be sold between 2010 and 2015, many of them to first-time mobile device users in middle-income countries.
In this flat world of international trade, “rich” consumers have benefited from both plummeting prices and proliferating choices that are sometimes overwhelming in their abundance. How can we decide? Brands exist in part to fill the gap in information about products, including quality, reliability, and, some would say, externalities. Most people buy from brands because we trust that brand, and this trust drives the margins that brand products earn above non-brand or low value-brand versions of similar or identical products.
The link from branding strategies used for decades to the value of sustainability data is the concept of “intimacy.” In a very profound way, we are coming full circle. One hundred years ago, we used to know the families who made the things that we bought, and we could see where the things were being made. Then for a long time nobody knew and, frankly, not many of us cared; we relied on the system of international trade and big business to deliver us quality products at low cost in increasingly diverse sizes, colors, shapes and functionalities.
Today, we may not know the families in China who send their daughters to the coastal manufacturing zones to work in manufacturing, but thanks to technology we can feel that we do once again. As a result, labor rights groups, labor unions, news reporters, even governments, all have interests in “reconnecting” us with the world of production in a way that drives higher standards of care throughout the supply chain.
It should be acknowledged here that at least two factors do constrain the generalizable value of sustainability data: First, more externality data is not necessarily better, i.e. there is such a thing as too much data; and, second, not all externality data is valued the same by all consumers. Consumers have demonstrated remarkable diversity when it comes to “sustainability preferences,” for example, they might place a higher value on biodiversity information than on climate change data. However, these are details that individual brand owners can and will need to work out for their own products or services on the basis of market segmentation.
Bargains vs. Intimacy
Let’s admit it, we all like bargains: a bargain stretches our resources and allows us to get “more” out of life. But knowing where your bargains come from and that you need not feel guilty for the bargain appeals to the part in each of us, regardless of race or socioeconomic background, which is humanistically concerned with our neighbors’ well-being—the Golden Rule is found in all world religions.
How far will this intimacy go? A lot probably depends on Maslow’s Hierarchy of Needs. In other words, if my stomach is empty intimacy may be less important to me for the moment.
We’re in a period of change in the relationship between bargain-seeking and community-seeking. Labor around the world wants better treatment, and labor in the developed world wants to keep the manufacturing jobs that are still there.
What’s Next for Brands?
Amidst the shifting sands of global manufacturing advantage and emerging middle classes in China and India, brands want you to trust them above all others. Only that trust can preserve the premium pricing that enables a brand to be a brand. Trust in these terms derives largely from a sense of intimacy between the consumer and the product, and intimacy in this case is associated with the lives and environments of the place and the people who produced the product you choose to buy.
Fundamentally, brands have a vested interest in getting consumers to feel that they know what’s going on in the brand’s manufacturing plant. It creates a stronger bond to the branded product, stronger loyalty, and more willingness to pay a premium to retain that sense of connection. Rather than brands being enemies of human rights and environmental protection, as many activists would have us believe, brands are the best hope in a generation for connecting mass consumer decisions to positive changes in social and environmental conditions associated with manufacturing worldwide.
The concept of externalities helps explain why creating that sense of intimacy, which requires management of a large amount of data in very sensitive ways, will be not just good branding, but fundamentally good business.
Technology Enables “Branding for Good”
Technologies are already being adopted widely to enable smart phones to scan bar code-like images that take the user directly to an internet site through their phone’s browser to access additional information about a product or service. Environmental consulting company WSP is working with retailers who would like to apply this technology to put sustainability data in the hands of any smart phone user who scans the tag of product in a store, for example. This trend has also been noticed by the Harvard Business Review in their February 2012 issue.
We all prefer more certainty when we can get it with only marginal effort or time invested. Many of us now Google the Facebook page and LinkedIn profile of a potential hire, searching for revealing information on their interests, character and extra-curricular activities. As the cost of information drops, a similar sort of background check becomes possible for products. Today, a complete Triple Bottom Line profile for a product is very hard to get, costly in terms of data gathering, and typically not in an easily-digestible or commonly-understood presentation format. It’s so much effort to obtain that buyers often give up. Choosing objectively between this laptop and that one, based on ecological or human rights considerations, for example, is generally dismissed as a non-credible goal by the majority of today’s consumers.
As the cost of information comes down, however—thanks to technology—and as the willingness to pay for information rises along with awareness and a desire for knowledge, at some point the two will intersect. Failure to address transparency demands and expectations—as well as the plummeting cost of meeting those expectations—will put branded products at the same level of trust as generic or non-branded products and there then becomes less reason to choose one over the other. Brands, advertisers and media professionals would do well to prepare themselves and their clients for sudden and unexpected spikes in transparency in the years ahead.
About the Author
Christopher Hazen is the Managing Director of ORIX Energy Services International. Prior to joining ORIX, Chris was a Director and Managing Director at WSP Environment & Energy in the United States and China from 2004 to 2012, and prior to that was a Partner at ERM.
Photograph: Fish by Mario Alberto Magallanes Trejo, Saltillo, Coahuila, Mexico.