MIPS for SRI
How Ethical Investment can Drive Sustainability in Business (and Society)
Abstract
In spite of steady growth in SRI throughout the world, including spectacular growth in Australia, global environmental services and social welfare continue to deteriorate. In this respect, SRI has not delivered on its potential to drive companies to make significant sustainability-related improvements to their core business practices. As a result, there is now a growing concern that even if SRI continues to acquire assets, its impact will not be enough.
The most recent sustainable development research suggests that most of the gains in corporate sustainability performance over the last decades have been outstripped by “rebound effects”. This means that money saved through cleaner or less energy intensive production has been reinvested to scale up operations or the volume of products sold and has resulted in increased consumption. Current indices used to screen SRI funds do not address rebound effects, and therefore neglect a significant factor indicating the overall sustainability of a company’s performance. In this context, ethical investment analyses could be encouraging businesses in inappropriate ways.
To this end, the major recommendation from this recent research is to rethink the unit of ethical investment analyses. A new “leading” indicator is required that identifies companies that are not simply reducing costs through waste minimisation strategies, but instead finding revenue sources from sustainability. One such indicator, currently being explored in Europe, is MIPS.
Introduction
Recent SRI growth in Australia has been among the most dramatic in the world. The Ethical Investment Association’s 2003 Socially Responsible Investment Benchmarking Survey reports that in the two years since its first survey, SRI in Australia has more than doubled. During that time, private SRI portfolios managed by financial advisers have increased by 61%; and over the past three years, total assets of SRI managed funds in Australia have experienced an astounding growth rate of 625%.
There are a number of forces driving this impressive growth:
§ SRI money managers are achieving competitive, and often superior, returns (relative to conventional investments) even though they limit their investments to those that pass social and environmental screens.
§ SRI has grown during Bull and Bear markets.
§ SRI shareholder concerns have changed corporate behaviour and led to meaningful reforms.
§ SRI now offers a sufficiently wide range of investment choices that allow investors to diversify across many asset types.
However, in spite of these great achievements, our world continues to remain on an unsustainable path. Although SRI has contributed to general improvements in corporate behaviour, in terms of sustainability, these improvements remain marginal. For this reason, many are concerned that even if SRI continues to grow and acquire more assets, it may not be leading us towards an ecologically sound, equitable world.
Ethical investment analyses are designed to:
a) drive businesses toward more sustainable ways of working, and thereby
b) drive societies toward more sustainable ways of living.
Are current modes of analysis adequately driving businesses toward sustainability?
Rebound Effects - SRI and the Existing Gap to Sustainability
Many of the gains achieved in business through sustainability-focused efficiency improvements have been outstripped by “rebound effects”. This means that money saved through cleaner or less energy intensive production has been reinvested to scale up operations or the volume of products sold and has resulted in increased consumption. Consequently, in many cases overall corporate sustainability performance, in terms of its net environmental and social impacts, has not improved.
Rebound effects can also be observed in domestic consumption patterns. For example, although consumers may now acquire energy-efficient appliances, they often end up buying and running many more of them.
ABS’s March 2003 Environmental Issues: People’s Views and Practices indicated that:
“While there was widespread penetration of some energy saving measures, for example insulation, fluorescent lights and use of cold water in washing clothes, there was also an increase in the number and usage of energy using household appliances.”
Rebound effects are visible through a wide range of lagging indicators[1], from increasing greenhouse gas emissions (environmental impact) to increased consumption (social impact) and alert us to the need for change.
Unfortunately, current indices used to screen SRI funds do not address rebound effects. Under the current SRI framework, companies are rewarded if they exhibit more efficient ways of working, such as cleaner, more environmentally friendly production. Yet, these micro efficiency improvements do not necessarily result in a net improvement in sustainability performance of the overall business, nor do they lead to less materials intense consumption. Therefore, there is an urgent need for indicators that encourage businesses not just to conduct standard (unsustainable) operations less harmfully, but rather, to proactively implement new sustainable business strategies that enable less materials intense and less ecologically damaging societies.
The Problem: Lagging Indicators
The major problem with current SRI screening indices is that they largely promote business “add-on” activities focused on harm minimisation. These activities, such as pollution control, waste remediation and clean up, tend to address lagging indicators. Consequently, rebound effects of the overall business impacts are missed. In this respect, the existing SRI indices do not always identify organizations that are moving us in the direction we want to go. A closer look at the two major screens now applied to SRI portfolios highlight this reality.
Negative Screens
The exclusionary approach to screening is insufficient as it does not directly address or assess the sustainable nature of the companies that are included in the investment-opportunity set. Many feel that these types of screens should really become a minimum requirement for all investments.
Positive and “Best of Sector” Screens
The next step in the current socially responsible investing framework is the positive screen, along with the budding “best of sector” screen. These “active” investment strategies go well beyond the “exclusionary” approach of the negative screen by evaluating the companies that will be included in the portfolio; however they fall short in their efforts to combine profitability with sustainability.
These screens endeavor to select organizations with environmentally progressive policies, thorough Triple Bottom Line reports, or established Environmental Management Systems. Unfortunately, companies that possess one or more of these qualities do not always characterize businesses that are making measurable gains in sustainability performance, nor do they create value for shareholders through sustainable growth[2].
In socially responsible investment, what does it mean to have “good environmental and social performance”? Today, it means that a company might include clean up procedures, waste management policies, or pollution reduction strategies, to their core business operations. All of these business activities are focused on end-of-pipe solutions; reactions to environmental problems that have already occurred. This is not to say that these activities are not valuable. In fact, they are extremely important considerations and should be a minimum requirement. However, they are inadequate if the objective of SRI and of CSR-minded businesses is to achieve absolute improvements in sustainability, because these “reactive” activities only serve to minimize the state of existing impacts.
Best of sector screens attempt to select a diversified portfolio of leading firms (based on environmental and social performance or sustainability) in every business sector. This is a strategy currently employed to find the balance between profitability and sustainability. It attempts to mitigate financial risk (and ultimately achieve profitability) through portfolio diversification; however in doing so, this strategy often compromises environmental and social quality. For example, “where necessary, Westpac selects companies with lower sustainability ratings to manage the overall risk of the portfolio.” (Trog, 2001)
SRI will always be faced with the challenge of finding diversified, financially sound investment-opportunity sets that deliver on exceptional sustainability performance. In order to do so, an indicator with the ability to identify innovative companies that are finding revenue sources from sustainability is required.
The Need for a Leading Indicator
Those who ascribe to the business case for sustainability argue that successful companies in the future (and those that will create the most reliable long term value) will not be focused on cleaning up their activities, as their operations will be waste-benign and ultimately begin to regenerate environmental and social systems. These companies will have core business strategies that embrace sustainability, leading to truly sustainable growth. They will do this by closely monitoring the resources and energy going into their business and thus have greater control over the types of outputs their operations deliver. This approach leverages information provided by leading indicators[3]. In order for SRI to accurately identify these types of businesses, a new leading indicator is required that will alter the current SRI benchmarks by identifying businesses that are implementing corporate strategies that create value for shareholders without coincidental environmental and social impacts. A leading indicator with the ability to address these concerns is MIPS.
The MIPS Concept
At the moment, enormous quantities of natural materials are dislocated to provide us (particularly those of us who live in industrialized countries) with a relatively high level of material prosperity. (Schmidt-Bleek MIPS on one page) This reality highlights the existing link between wealth generation and environmental degradation. In order for us to achieve significant improvements in sustainability, our “prosperity” must become far less material-intense.
What is MIPS?
MIPS stands for materials input (including energy) per unit of service. It is a sustainability indicator that calculates the materials input per total unit of services delivered by the product over its entire useful life cycle (including resource extraction, manufacturing, transport, packaging, operating, re-manufacturing, recycling, and the final waste/disposal). (Schmidt-Bleek Bridging Ecological, Economic, and Social Dimensions with Sustainability Indicators) The MIPS value includes material along with energy inputs by counting the material fluxes associated with energy inputs.
MI/S
“The lower the value of MIPS, the better the ecological quality”
Looking at the equation, it is evident that there are two critical aspects to the concept; materials input (MI) and service (S). Although both considerations are important concepts on their own, when combined, the ratio becomes a powerful indicator of sustainability by evaluating resource productivity.
Ecological Rucksack = MI
The ecological rucksack can be defined as the total quantity (in kg) of natural material disturbed to generate a product (cradle to grave) minus the weight (in kg) of the product itself. All products and services carry an ecological rucksack. In today’s world, most of the ecological rucksacks are much heavier than the finished products themselves. (Schmidt-Bleek, Lehner, 1999) For example, 500 tons of non-renewable natural resources are dislocated from its natural place for 1 ton of copper to be made. (Fani, 1999) Therefore, the ecological rucksack of copper is 500 tons input/ton copper.
Have a good look at the computer on your desk. It doesn’t take up too much space on your desk, does it? Consider its ecological rucksack and you might think differently. The latest research has found that around 1.8 tons of raw materials are required to manufacture the average desktop PC and monitor! (Computers and the Environment: Understanding and Managing their impacts, edited by Ruediger Kuehr & Eric Williams, Kluwer, Dordrecht, 2003.)
Service = S
The value for S in MIPS is defined as the number of units of service (utility) delivered by the product during its entire lifetime. (Schmidt-Bleek) The reason this idea is so profound is that it forces us to think of products in terms of their utility. In fact, in the MIPS concept, products are not thought of as products (material things) at all. Instead, they are considered “service delivery machines”. By thinking of products in this way, the MIPS concept takes into account the consumption of products (how and to what degree the product is being used). This is a revolutionary way to view end-products and will be critical in driving innovations in business that promote extended producer responsibility (EPR)[4] and improved sustainability performance.
Material Intensity (MI) VS Resource Productivity (RP)
There are two ways to look at MIPS, each telling the same story, but from a different perspective.
1. MIPS = MI/S
We have always been taught to think of a product as a material entity. Therefore, when the idea of material intensity per unit of service is introduced, the first thing that comes to mind is the use of less material (dematerialization) per “product”. This is partly correct, but by neglecting to understand that MIPS relates material intensity to “service provided by the product”, a vital part of the equation is omitted.
The reason the service aspect must not be excluded is the rebound effect. When thinking of MIPS only in terms of the materials input, the rebound effects that occur when more efficient (less materials intense) products are consumed in greater quantities (thereby outstripping product efficiency gains), are not addressed.
In my opinion, the critical component of the MIPS equation is service. To this end, it might be more useful to think of MIPS in terms of “resource productivity”.
2. RP = S/MI
Resource productivity is a measurement of how many service units one can get from a given amount of material. Both MIPS and RP include the ecological rucksack of all materials for the product; however resource productivity highlights the critical role that increased service units can play in improving sustainability. With this in mind, we are encouraged to think about the consumption or utility of the product relative to the materials input and therefore the obstacle of rebound effects can be avoided.
Improve Sustainability Performance – Reduce MIPS / Increase RP
With the MIPS concept, there are two ways to design a more sustainable product, service or system.
1. Lower materials input (MI) for a given service (dematerialization)
2. Increased service (S) for a fixed quantity of resources (resource productivity)
These changes can be achieved through a number of different improvements, such as technological, managerial (corporate strategy), and/or social innovations. (Schmidt-Bleek) Technological improvements can often lead to reductions in materials input for a given service, resulting in lower-MIPS goods and services. However, dramatic increases in service units (without a corresponding increase in materials input) can be achieved simply by changing the way we use goods and services. For example, by increasing the longevity of goods, leasing rather than selling products, and/or by sharing equipment, building space, infrastructures, and vehicles, we can achieve significant increases in resource productivity.