Full Cost Accounting in the Circular Economy
“What we obtain too cheap, we esteem too lightly”
Thomas Paine. Inventor, pamphleteer, revolutionary and founding father of the United States.
Economics often refer to markets as arbiters, notably – but not only – when it comes to the allocation of resources, bearing in mind the whole process is a complex interplay of factors such as materials, energy and information.
Within this framework, the discourse generally involves notions such as ‘level playing field’, the need to ‘minimise distortions’, and the idea that prices act as messages which inform decisions made by stakeholders. In that logic, it seems crucial for the aforementioned prices to reveal the full costs (of any activity) if the lowest level of distortion possible is to be achieved: that implies taking into account not only the monetised aspect of a process – e.g. extraction costs, wages or energy – but also the hidden costs of activity-induced negative impacts such water quality degradation, harmful emissions, etc.
Which currently raises more questions than it brings answers, because if one takes the latter example, putting a price on a loss of air quality amounts to putting a price on air itself… and if one pushes that a bit further the question extends to all natural assets and ecosystem services. That debate isn’t exactly new and in a founding article titled “The Value of the World’s Ecosystem Services and Natural Capital” published in Nature in 1997, Robert Costanza (University of Maryland) and his team of scientists estimated that the services provided by the ecosystems amounted to $33 trillion per year – a figure exceeding the annual gross national products of all the world’s economies combined. By putting a “price tag” on nature, Costanza wanted above all to emphasise the real costs resulting from a value creation mechanism based on the consumption and/or degradation of ‘free’ services and finite resources:
The depletion of the natural capital base has often been counted as profits, because these external costs are miscounted as profits. Are we making bad management decisions because we’re not considering all of our capital base? If you were the CEO of Earth, you would have been fired long ago, and replaced with someone who can take that stuff into account.
Views that at the time were considered both marginal and radical are gradually making their way into a relatively mainstream discourse, with an increasing realisation that there is a need for reporting processes that extend beyond sheer financial considerations. Progress remains slow and one could argue that short of attaining consensus on a compulsory mechanism at global scale there is little hope for change… yet this shift in mindsets runs in parallel with a growing interest, from business leaders and policymakers alike, for circular economy practices. By their very nature, these entail a system view, which in corporate terms amounts to considering the whole value chain – a planetary jigsaw puzzle in today’s globalised economy. As some pioneering efforts have proven, Full Cost Accounting (FCA) practices or Environmental Profit and Loss (EP&L) reports provide such a view, and challenge the common conception which has it that such initiatives only result in a quantification of negative impacts for transparency’s sake.
It was notably revealing for sportswear brand Puma (Kering group), who in 2011 published the first major EP&L report with consulting companies Trucost and PWC, to realise that the bulk of its impact happened at raw materials production level, more than during manufacturing phases. Having a better view of the “where” led to interrogating the “how”: if a value is put on the damage done by cotton production, for example, there is a strong incentive to rethink these processes and move towards regenerative systems which enhance natural capital… since it’s now an asset category. As the Puma report highlighted, EP&L is a tool addressing issues around strategy, risk management and transparency which, rolled out at group level can help change the relationships with suppliers. Such practices reveal the complexities of material flows and highlight chains of causality that the linear model, whose performance is measured in terms of throughput, generally overlooks – or limits to a mere CSR box-ticking exercise.
The question remains: why would a business, in the absence of coercive legislation, start internalising externalities, running the risk of self-inflicting a competitive disadvantage? The forward-looking companies who experiment with FCA do it for a variety of reasons, yet these all revolve around a sound economic rationale. Anticipating resource-related issues by understanding precisely the factors at play allows resilience-building mechanisms to be put in place. That can be working with raw materials suppliers to develop regenerative agricultural processes to ensure a steady and price-stable feedstock (whilst reducing chemical fertiliser costs, for example), or in the case of technical materials develop take-back mechanisms to address the leakage and associated environmental damage that regulation will eventually address through taxation. In this instance, FCA can be seen as a cost-avoiding preventive measure.
By revealing the interconnectedness of factors throughout the supply chain, methodologies acknowledging externalities provide the big picture view that the circular economy relies upon to optimise systems and move away from the halfway solutions which consist of making ‘better’ products in isolation… regardless of what it actually took to source materials, or where they will fit once the end of their useful life has been reached. Granted, the movement is only just beginning, but efforts made to publish results, share methodologies and develop expertise are important when it comes to gradually getting to scale, normalising these practices.
To go further, watch our interview with Kering’s Sustainability Director Michael Beutler, part of the DIF 2014.
Notes and Sources
 As an example, the European Union has amended its Directive 2013/34/EU on reporting in October 2014 to give it more scope.
Robert Costanza et al., “The Value of the World’s Ecosystem Services and Natural Capital,” Nature, vol. 387, no. 6230 (May 15, 1997)