Corporate Social Responsibility and Environmental Management Corp. Soc. Responsib. Environ. Mgmt.

19, 114128 (2012) Published online 23 January 2012 in Wiley Online Library (wileyonlinelibrary.com) DOI: 10.1002/csr.292

Assessing Trade-Offs in Investments for the Environment The Case of a VOC-Reduction Investment at AUTO Group
Tobias Hahn,1* Frank Figge1 and Andrea Liesen2
2

Euromed Management, Marseille, France Sustainability Research Institute, University of Leeds, UK

ABSTRACT This case focuses on the assessment of trade-offs between different environmental features of investments. Using the example of a VOC-reduction investment at a car maker, the case applies an innovative approach for the assessment of environmental investment projects. Since it is unusual that all environmental performance characteristics of investment projects will be in harmony, decision-makers need to ascertain the overall environmental effect of different investments. This case transfers the logic of nancial investment appraisal to the environmental assessment of investment projects. The analysis shows, in monetary terms, by how much each investment option outpeforms or underperforms environmental efciency targets. With monetary gures, decision-makers can balance conicting environmental performances and identify the investment option that supports a companys environmental strategy best. The case provides a step-by-step explanation of the assessment approach and offers students and decision makers a novel perspective on the assessment of trade-offs in environmental investments. Copyright 2012 John Wiley & Sons, Ltd and ERP Environment.
Received 10 June 2010; revised 3 April 2011; accepted 14 July 2011 Keywords: environmental investment; trade-offs; sustainable value; automobile industry; VOC emissions; investment appraisal

Foreword
these targets, companies need to dene measures to implement environmental improvements. However, improvements in one particular environmental area (for instance, reducing VOC emissions) will oftentimes have other environmental effects (for instance, increasing energy use or waste generation). There can thus be considerable trade-offs between an intended improvement in one environmental area and unintended, deleterious environmental impacts in other areas (Hahn et al., 2010b). When decision-makers in companies can choose between different environmental investment options, they need to take these trade-offs into account in order to avoid situations where some environmental improvements are overcompensated by unintended side-effects.

ORE AND MORE COMPANIES SET THEMSELVES QUANTITATIVE ENVIRONMENTAL PERFORMANCE TARGETS. TO REACH

*Correspondence to: Dr Tobias Hahn, Associate Professor of Corporate Sustainability, CSR and Environmental Management, Euromed Management Marseille, Domaine de Luminy BP 921, 13288 Marseille Cedex 9, France. E-mail: tobias.hahn@euromed-management.com
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Tools to balance conicting aspects of environmental projects (Lawrence et al., 2002), such as life cycle assessments (Labuschagne et al., 2005), often follow a technical and natural science rationale that is alien to many corporate managers. Therefore, this case offers insights into the application of a novel appraisal tool for environmental investments that is based on a strong analogy to standard nancial investment appraisals and value-based management (Feibel, 2003). Methodologically, the case brings well-established capital assessment tools to the eld of environmental assessments. Because of its fundamental role for the understanding of this case, Box 1 sketches out the logic of value-based assessments of nancial and environmental resources.

Box 1. Value-based management of nancial and environmental resources.

In traditional nancial management, the value-based perspective represents a well-established standard for the assessment of investments (Feibel, 2003). An investment is said to create value when its anticipated return is above its cost of capital as determined by its opportunity costs. The average market return is the appropriate measure of the cost of capital (Modigliani and Miller, 1958) and thus the hurdle rate for value creation. Oftentimes, companies set an internal hurdle rate strategically as the minimum return on capital that should be achieved by investment projects. To compare different investment options traditional investment appraisals discount future revenues to their present value (using the internal hurdle rate). According to this standard management approach (Graham and Harvey, 2001) only investment projects with a positive net present value will be considered. Until recently, this standard value-based perspective has only been applied to economic capital. From a sustainability perspective, companies need also environmental resources next to economic capital to create a return. The sustainable value approach applies a value-based logic to the use of environmental resources (Figge, 2001; Figge and Hahn, 2004; 2005). Analogously to the logic of standard investment appraisal, an environmental resource is used in a value-creating way, when the resource efciency is above the hurdle rate. In an investment appraisal context, companies can strategically set the hurdle rate to dene the targeted environmental resource efciency.
Corporate performance Waste efficiency 10 per t Hurdle rate

8 per t

Efficiency spread

2 per t

Waste generation

10 t

Value creation

20

A positive (negative) sustainable value shows how much more (less) return a company creates with its environmental resources compared to the required hurdle rate. A company producing 10 tonne of waste to create a prot of 100 has a waste efciency of 10 per tonne of waste. If the hurdle rate is set at 8 per tonne of waste, the company creates 2 value per tonne of waste and 20 value overall. Here value is not equal to nancial value but an environmental value expressed in monetary terms. It describes the outperformance of the use of environmental resources compared to a resource efciency target.

Introduction
Helen Grant, the head of corporate sustainability at AUTO Group,1 a world-leading premium automobile manufacturer, is very proud of working for her company these days. She has nally succeeded with implementing quantitative
1 Due to condentiality reasons the company and the specic investment example had to be anonymised and adapted. However, the core approach and the very nature of the logic used by the company are preserved. Any similarities with existing companies are unintentional and none of the statements in this case directly reect the position of any specic car manufacturing company.

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sustainability targets at the strategic level of the company. AUTO Group has taken the strategic decision to increase the efciency of the use of environmental resources by 30% until 2012 compared to 2006. In this context, it has been decided that environmental efciency will be measured in terms of operating prot per environmental resources or emissions. As a consequence, every major project and investment will need to be assessed against these targets before being approved by top management. The adoption of quantied top-level strategic environmental performance targets marks a milestone for the systematic integration of sustainability issues into strategic decision making of AUTO Group. Environmental targets will now be implemented at the same level as nancial performance targets, i.e. on a par with the minimum rate of return on capital that AUTO Group has been using for a long time according to its value-based management philosophy. As part of this new strategy, Helen and her team are now involved in the assessment of investment decisions for Auto Groups production facilities. Looking back, the rst investment that Helen was involved in was the replacement of the existing solvent-based paint shop at AUTO Groups Townsville site. The investment was scheduled for 2008. From an environmental perspective, the main goal of the investment was a substantial reduction of emissions of volatile organic compounds (VOC). The company had identied two low-VOC technology options for the new paint shop at Townsville. However, while both options promised a considerable reduction of VOC emissions, the bigger picture was mixed: while Option 2 had a better prole for VOC emissions, wastewater and waste generation, Option 1 looked more promising in terms of energy savings. Helen and her team thus faced a trade-off situation. They had fought so hard to be included in investment decision processes and they now had to deliver. They needed to identify the one option that provided the strongest contribution to AUTO Groups overall environmental efciency targets.

Background
AUTO Group was founded in the 1920s and produces automobiles in the premium segment worldwide. Including production facilities in its European home market, AUTO Group operates production and assembly plants in 13 countries including the USA and China. In 2006, AUTO Group sold 1.4 million cars. This generated a turnover of 49 billion and an operating prot of 4 billion. Roughly 100 000 people worked for AUTO Group in 2006. Environmental issues have gained increasing importance in the car manufacturing sector. On the one hand, this refers to the emissions of cars as car manufacturers face regulatory and public pressures in Europe to reduce CO2 emission levels of new cars to 120 g of CO2/km on average (Plotkin, 2001). On the other hand, even if less in the public eye, production processes of automobiles bear considerable environmental impacts. For instance, the coating and painting processes of vehicle bodies and parts still represent a considerable source of VOC emissions (Geffen and Rothenberg, 2000; Biller, 2006). A comparison of the VOC efciency in the car manufacturing sector worldwide reveals surprisingly large differences between the leaders and the laggards with regard to VOC performance (Hahn et al., 2010a). As Table 1 illustrates, the most efcient car manufacturers outperform the industry average by a factor of up to 6.5. These gures and this case therefore do not focus on the environmental impacts of the use phase of cars but on the environmental efciency of car production. To translate the abovementioned resource efciency strategy into stringent management procedures, AUTO Group requires every plant to improve environmental efciency by 5% per year compared to 2006. This comprises four environmental key performance areas: energy use, waste generation, wastewater generation, and VOC emissions. AUTO Group systematically records all these performance gures at all locations worldwide on a monthly basis.

Development of Strategic Efciency Targets

AUTO Group developed its target of 30% efciency increase based on a detailed analysis of the environmental performance in the car sector worldwide. For this purpose, the sustainability department conducted an analysis of how much operating prot, i.e. earning before interest and taxes (EBIT), 16 car companies generated with different environmental
Copyright 2012 John Wiley & Sons, Ltd and ERP Environment

Corp. Soc. Responsib. Environ. Mgmt. 19, 114128 (2012) DOI: 10.1002/csr

Trade-Offs in Environmental Investments The Case of AUTO Group

Company BMW Group Daihatsu DaimlerChrysler Fiat Auto Ford GM Honda Hyundai Isuzu Mitsubishi Nissan PSA Renault Suzuki Toyota Volkswagen Industry average Average VOC efciency 20012005 [EBIT per VOC emissions] 1,159,346 per t 95,030 per t 400,795 per t - 64,751 per t 134,299 per t 49,139 per t 330,964 per t 166,026 per t 594,086 per t - 5,651 per t 449,774 per t 98,449 per t 110,456 per t 114,367 per t 447,860 per t 175,222 per t 179,404 per t

117

Efciency factor relative to industry average 6.5 0.5 2.2 N/A 0.7 0.3 1.8 0.9 3.3 N/A 2.5 0.5 0.6 0.6 2.5 1.0

Table 1. Average VOC efciencies of 16 major car manufacturers between 2001 and 2005 (Source: Based on Hahn et al., 2010a)

resources over the period from 2001 to 2005. Figure 1 shows that the different manufacturers deviate considerably from the ve-year industry-average VOC efciency of 180 000 EBIT per tonne of VOC emissions. In addition to these performance trends, the sustainability department analysed environmental regulatory requirements and policy targets. According to the NEC-Directive (European Communities, 2001), the EU15 member states needed to reduce overall VOC emissions to 6 510 000 tonnes by 2010. The sustainability management of AUTO Group applied this regulatory scenario to the situation of the car manufacturing industry. If the car industry wanted to maintain its prot levels and at the same time reduce VOC emissions in accordance with the EU target, the average VOC efciency of the car manufacturing sector would have to increase by 4.6% p.a. to reach about 225,000 EBIT per tonne of VOC emissions in 2010.
VOC efficiency 2001-2005
1,600,000 Isuzu

1,400,000 BMW Group 1,200,000

1,000,000

VOC efficiency [ /t]

800,000

600,000

Toyota Honda Nissan DaimlerChrysler

400,000

200,000

Industry average Ford Daihatsu PSA Fiat Auto Mitsubishi GM

Volkswagen Hyundai Renault Suzuki

0 2001 -200,000 Year 2002 2003 2004 2005

Figure 1. VOC efciency in the car manufacturing industry (Source: Hahn et al., 2010a)
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AUTO Groups sustainability management decided it would at least need to keep pace with regulatory requirements to keep the edge it currently had over its competitors. Consequently, a yearly improvement target of 5% with regard to 2006 efciency levels was set.

Putting AUTO Groups Environmental Targets into Action: The Case of VOC Reductions
Establishing such sophisticated strategic environmental performance targets was a long and hard process for Helen and her team. After the new targets had been approved by top management, Helen and her team started to put these targets into action. One particular focus was on the reduction of VOC emissions through the replacement of the old solvent-based technology in the paint shop at AUTO Groups Townsville site. Helen needed to identify the investment option with the strongest contribution to all of AUTO Groups environmental efciency targets. This meant that Helen needed to take into account not only the VOC performance but also the three other environmental key performance areas, namely energy use, waste generation, and wastewater generation. What if the technology with the strongest VOC reduction had an inferior waste or energy performance? How could Helen recommend one investment option in the presence of such trade-offs? And how should she communicate her judgment of such trade-offs to colleagues that were not experts in environmental issues? Traditionally, painting and coating technologies in automobile manufacturing were solvent-based with high levels of VOC emissions. There are different layers of a modern automotive coat: an electro-deposition coating for anti-corrosion, a primer/anti-chip coating, a base coating giving the vehicle its colour, and the clear coat for durability, UV protection, and a high gloss nish (Prendi et al., 2008; Brun et al., 2010). With solvent-based technologies, solid particles of the different coating layers are sprayed onto the car body in an organic solvent environment, which leads to signicant environmental impacts (Geffen and Rothenberg, 2000; Barberich, 2004; Prendi et al., 2006; Prendi et al., 2008). The organic solvents evaporate causing VOC emissions and the solid particles remain on the car body. The drying and baking in ovens after each layer is sprayed leads to considerable energy consumption. Other environmental issues include wastewater (e.g. pretreatment chemicals and paint overspray), and waste issues (e.g. waste paint solids from overspray in sludge). AUTO Group had so far mainly focused on powder-based and waterborne low-VOC technologies. However, at its Townsville site AUTO Group still operated a solvent-based painting and coating plant. Continuing with solvent-based technologies was no longer an option for AUTO Group. In recent years, some car manufacturers had introduced innovative powder-based technologies not only for primer coats but also for the clear coat (Biller, 2006; US Auto Parts Network, 2007; Box 2). The quality of the clear coat is essential as it gives the car its look and appearance and determines the durability of the coating.

Box 2. Principles and advantages of powder-based clear coat technology

With powder-based clear coating, high-tech powder is applied through electrostatic charge through which the powder particles stick to the earthed body. Powder-based clear coating offers highest possible standard of quality in terms of looks and functionality. The powder-based clear coat technology is also benecial in terms of an environmentally friendly production: No emissions caused by solvents. No consumption of water so no wastewater. No use of purifying agents. The utilization ratio of the material is almost 100%. There is hardly any waste. No paint sludge.

In conventional clear coating systems the bodies are sprayed on with 1 to 1.5 kg of solvents in a wet coating process. The clear coating remains on the body, whereas the hydrocarbon compounds escape. The powder-based clear coating consists of dry solids, which does away with the need to use solvents. Based on: US Auto Parts Network (2007)

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A combination of different waterborne and powder-based technologies represents the state-of- the-art for European and US-based car manufacturers. Some Japanese competitors have developed the wet-on-wet technology where the topcoat is applied on the primer coat while it is still wet, saving energy by eliminating one baking process. Together with the use of high-solids paints, it also reduces VOC emissions by 65% (Barberich, 2004). A combination of powder primer, waterborne base coat, and a powder topcoat achieves even higher reductions of VOC emissions of 75% or more (Barberich, 2004). However, this technology combination is still characterised by high levels of energy consumption. Helen was asked for her assessment of two technology options for the new paint shop at Townsville in the light of the strategic environmental targets: (1) The wet-on-wet technology with the use of high-solid paints and a closed-loop water management system and (2) the combination of powder primer, waterborne base coat, and a powder topcoat. Given that the capital requirement for a new paint shop site usually represents 3050% of the capital investment in a new car manufacturing plant (Barberich, 2004), this was not a small project.

Assessing Two Investment Options for VOC Reductions

To meet this challenge and communicate her decision to colleagues, Helen followed a stepwise approach to assess the two investment options with the sustainable value approach (see Figure 2 for an overview of her assessment procedure that will gradually be developed in this section). First, Helen needed to assess how well the two investment options would perform in the future if they were to be implemented with respect to both nancial and environmental performance (Steps (1) and (2) in Figure 2). She had a closer look at the environmental performance of each of the two investment options. Based on the documentation

(1) Determine anticipated yearly return of the investment

(2) Determine anticipated yearly use of resource of the investment

(3) Calculate anticipated resource efficiency

(4) Define target efficiency for environmental resource

Repeat for each year

(5) Calculate efficiency spread

(6) Calculate yearly out-/underperforman

(7) Discount out-/underperformance to present value

(8) Calculate net present value of the investment for each environmental resource by summing up discounted out-/ underperformance of each year

Figure 2. The assessment step-by-step

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provided by the technology suppliers and the expertise of her colleagues, she estimated that Option 1, the wet-on-wet technology option, would reduce VOC-emission levels by 65% compared to the existing technology. At the same time, she expected the closed-loop water management system to reduce wastewater by 10%. For waste generation she expected a reduction of 5% and for energy consumption she estimated a 25% reduction as one of the baking and drying processes would be eliminated. With Option 2, she found that even higher reductions of VOC emissions, 75% compared to the existing technology, could be expected. In addition wastewater levels could be reduced by 30% and waste generation by 40% due to the relatively strong usage of powder-based technologies. However, for energy consumption she was only expecting a slight reduction of 10% for Option 2. She summarised the actual performance and the anticipated environmental performance features of the two options in a table to have a better overview (Table 2). As the environmental targets of AUTO Group were efciency targets, she also needed the nancial performance features of the two investment options. Fortunately, this was not very difcult as AUTO Group had been managing production sites as prot centres according to their value-based management philosophy. Thus, she could easily get the estimates for the nancial performance of the two investment options from her colleagues in the nance department (Table 2).

Past performance 2006 VOC emissions Wastewater generation Waste generation Energy consumption Yearly prot 420 t 230,000 m 5,600 t 6,200 MWh 65% 10% 5% 25% Option 1

Anticipated performance Option 2 75% 30% 40% 10% 105 t 161,000 m 3,360 t 5,580 MWh 13,000,000

147 t 207,000 m 5,320 t 4,650 MWh 15,000,000

Table 2. Anticipated performance of the two investment options

Now Helen had all the elements she needed to estimate the environmental efciency of the two investment options for waste generation, energy use, wastewater generation and VOC emissions. She simply had to divide the anticipated return (Step (1) in Figure 2) of the respective investment option by the anticipated resource use (Step (2) in Figure 2) to obtain the anticipated efciency for each investment option for all four environmental aspects (Step (3) in Figure 2). For instance, to estimate the VOC efciency of Option 1 in 2008, the rst year in which the new investment was expected to be operational, she divided the anticipated prot of 15 million by the anticipated VOC emissions of 147 tonnes which results in 102,041 of EBIT per tonne of VOC. Option 2 looked even more VOC efcient than Option 1 with an anticipated VOC efciency of 123,810 per tonne of VOC. As both investment options had stable prots and stable VOC emissions over the ve years in question, she could use these gures for all of the years. Table 3 provides an overview of the anticipated yearly efciency gures for both options.

Anticipated yearly resource efciency Option 1 VOC efciency Wastewater efciency Waste efciency Energy efciency 102,041 per t 72 per m 2,820 per t 3,226 per MWh Option 2 123,810 per t 81 per t 3,869 per m 2,330 per MWh

Table 3. Anticipated efciencies of the two investment options

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Helen looked at what she had found so far and was puzzled because there was no clear winner. The environmental performance prole of the two options looked mixed with Option 2 having a better prole for VOC emissions, wastewater, and waste generation, but Option 1 promising more energy savings. In addition, Option 1 was apparently more protable than Option 2 because of lower investment costs. Helen was stuck in a trade-off. How should she now proceed to nd out which of the two options was better overall? Should she advise opting for the more protable Option 1 that has also a more favourable energy performance or Option 2 because of its more benecial VOC, wastewater, and waste prole even if anticipated prots were lower for this option? And would colleagues understand what she was saying? She reected how they had convinced the top management to adopt the environmental targets in the rst place: We should treat environmental aspects just as any other strategic target in the investment decision process. This had been their main message. Well, she thought, why not actually treat and assess the environmental performance like nancial performance? Such a traditional investment appraisal had been run for the two options by the nance department. AUTO Group used a standard net present value approach to assess their investments. In this context, the internal rate of return and discount rate was usually set at 15%. Only investments that met this target return on capital over their lifetime would be considered. Analogously, Helen said to herself, from an environmental point of view only those options that meet the target efciencies should be implemented. She liked this idea and tried to gure out how she could actually calculate which of the two investment options on the table was making a bigger contribution towards meeting the environmental target efciencies. As she had worked as a production plant manager before becoming Head of Corporate Sustainability, she was quite familiar with the way standard investment appraisals work at AUTO Group. If she wanted to assess the two investment options against the target efciencies, the next step was to determine the environmental efciency targets for the Townsville site (Step (4) in Figure 2). For this purpose Helen could fall back on strategic environmental targets set out above. She extracted the actual environmental performance of the Townsville paint shop site for the year 2006 from the group-wide greenfacts database. Based on these gures she could then easily calculate the target efciency for each year until 2012, based on the 30% efciency improvement strategy of AUTO Group. Efciencies had to increase every year in line with the environmental targets of AUTO Group to achieve the 30% improvement targeted for 2012. In other words, the environmental efciency hurdle an investment had to clear to comply with Auto Groups environmental strategy became more demanding every year. The actual efciencies of the paint shop site in Townsville for 2006 and the target efciencies for wastewater generation, waste generation, VOC emissions and energy consumption for the Townsville site for the period 20082012 are shown in Table 4.

Past performance 2006 VOC emissions Wastewater generation Waste generation Energy consumption EBIT 420 t 230,000 m 5,600 t 6,200 MWh 17,220,000 Past performance 2006 2008 41,000 per t 45,100 per t 75 per m 82 per m Target performance 2010 2011 49,200 per t 51,250 per t 90 per m 94 per m

VOC efciency Wastewater efciency Waste efciency Energy efciency

2009 47,150 per t 86 per m

2012 53,300 per t 97 per m

3,075 per t 3,383 per t 3,536 per t 3,690 per t 3,844 per t 3,998 per t 2,777 per MWh 3,055 per MWh 3,194 per MWh 3,333 per MWh 3,472 per MWh 3,611 per MWh

Table 4. Past and target environmental performance of the Townsville paint shop site
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Now that she knew which performance the site would have to achieve according to AUTO Groups strategy, she could start comparing the estimated performance of both investment options with the target efciencies. Starting with VOC emissions, she was now able to ascertain whether the respective anticipated VOC efciencies for the two options were above or below the targeted levels for each year. For this purpose she calculated the efciency spread between the anticipated and the targeted VOC efciency of each investment option (Step (5) in Figure 2). For instance, Option 1 was expected to achieve almost 49,000 more EBIT per tonne of VOC than required by the VOC-efciency target for 2012 (anticipated VOC efciency of 102 041 per tonne minus the target VOC efciency of 53 300 per tonne). She found that both options had a positive VOC efciency spread in all years and thus outperformed the targeted VOC efciency in all years (Table 5).

Investment Option 1 2008 2009 2010 2011 2012 2008

Investment Option 2 2009 2010 2011 2012

Anticipated VOC 102,041 102,041 102,041 102,041 102,041 123,810 123,810 123,810 123,810 123,810 efciency per t per t per t per t per t per t per t per t per t per t Target VOC 45,100 47,150 49,200 51,250 53,300 45,100 47,150 49,200 51,250 53,300 efciency per t per t per t per t per t per t per t per t per t per t 56,941 54,891 52,841 50,791 48,741 78,710 76,660 74,610 72,560 70,510 Efciency spread per t per t per t per t per t per t per t per t per t per t Table 5. VOC performance of both investment options

However, she was still not happy with the results. When imagining that she needed to explain the results in this format to non-environmental colleagues, she was not sure they would be convinced. Would a colleague from the nance department really understand what it means that in 2012 investment Option 1 would probably achieve almost 49 000 more prot per tonne of VOC emissions than required by the VOC-efciency target for 2012? Would this colleague really understand that the same analysis could be used analogously for the other resources and for all years? Again she drew upon her experience from being a plant manager and how they valued capital investments back then. Following the value-based approach of the nancial management at AUTO Group, they had compared the anticipated return on capital of an investment with the required return as dened by the internal hurdle rate. This showed how much more or less prot per invested euro could be expected compared to the hurdle rate. But in a nal step this spread was multiplied with the overall investment to come up with a monetary gure of the outperformance or underperformance of the investment. This was what she needed. So she proceeded in the same way for the VOC efciencies. She rst took the efciency spread as calculated in Step (5), showing her how much more or less prot per tonne of VOC emissions the investment would generate compared to the target. As she was interested in the absolute effect, she then multiplied the efciency spread with the anticipated amount of VOC emissions for the respective year (Step (6) in Figure 2). While the efciency spread for Option 1 in 2012 showed an outperformance of roughly 49 000 per tonne of VOC compared to the efciency target, the anticipated use of 147 tonnes of VOC with Option 1 resulted in an overall outperformance of about 7.2 million (147 tonnes 49 000 per tonne). As a result she could see how much more or less prot in absolute terms the future use of a given amount of VOC emissions would generate compared to the efciency target. In other words, this calculation gave her the monetary value of the outperformance or underperformance of an investment option relative to the targeted efciency level (Figure 3). This step was crucial because she had now moved from some rather complicated efciency gures to simple Euro terms. This was much easier to communicate as she was now using something her colleagues were used to: euro. A negative result showed her by how much an investment falls short of meeting the required efciency level, and a positive result indicated how much more prot than required by the efciency target is achieved through the future use of a resource. For instance, with its VOC emissions, Investment option 1 would generate 7.2 million more prots than prescribed by the environmental strategy (Figure 3). With its anticipated VOC emissions of 147 tonnes,
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Corp. Soc. Responsib. Environ. Mgmt. 19, 114128 (2012) DOI: 10.1002/csr

Trade-Offs in Environmental Investments The Case of AUTO Group

Anticipated performance for 2012 VOC efficiency 102,041 per t Target performance for 2012 53,300 per t

123

Efficiency spread

48,741 per t

Anticipated VOC emissions in 2012

147 t

VOC outperformance in 2012

7,164,900

Figure 3. VOC outperformance of investment Option 1 in 2012

Option 1 would need to achieve a prot of at least 7.8 million (147 tonnes of VOC times target efciency of 53 300 per tonne of VOC). With its anticipated prot of 15 million, Option 1 outperformed this hurdle rate by 7.2 million. Helen thought this was a much better way to assess if and by how much the two investment options for the new paint shop site would contribute to the achievement of the environmental efciency targets. So she ran the same calculations for the three other indicators wastewater, waste, and energy as well. She started to see more clearly now how the two investment options performed with regard to the different environmental efciency targets. The only problem left was that the investment was scheduled for 2008 but the outperformance or underperformance she had calculated referred to future periods of 2008 to 2012. Was an outperformance in 2008 as valuable as an outperformance in, lets say, 2012? Once again looking into standard investment appraisal was helpful: Because people prefer to receive a prot sooner rather than later, a future prot is not equal to a present prot. In nancial assessments, future earnings are therefore discounted to their present value to make them comparable. AUTO Group discounted future prots to their present value by using a discount rate of 15%. Helen just applied the same logic to the gures she found for the out- or underperformance with respect to the different environmental targets: She divided the monetary gures by 1.15 for each year to arrive at the present value of the yearly anticipated out- or underperformance (Step (7) in Figure 2). As a result she obtained the present values of the monetary out- or underperformance of the two investment options for all years. The remaining nal step was easy (Step (8) in Figure 2). In standard investment appraisals the discounted prots from all periods are added up to come up with the net present value of an investment. Helen just had to do the same thing in her case and sum up the discounted yearly values for the two investment options. As a result she came up with a net present value for the performance of the two investment options for each of the four indicators (Table 6).2 This showed her the overall performance for the different environmental aspects for both investment options over the entire duration. A positive (negative) net present value indicates if and by how much an environmental resource is used more (less) efciently than required by the efciency targets over the lifetime of the investment.

Reading the Results and Balancing Trade-offs

The overall performance of the two investment options across all indicators now became much clearer. Option 1 outperformed the VOC targets but fell short of meeting the targeted efciencies over its investment lifetime for the three other indicators. This can be seen through the net present values for wastewater, waste, and energy use that are all negative in Table 6. Especially for waste, the performance targets were clearly missed, as reected in an underperformance of -17 million. In other words, with the same amount of waste, the site would need to create
2

An XLS-spreadsheet for the calculations is available from the authors upon request. Corp. Soc. Responsib. Environ. Mgmt. 19, 114128 (2012) DOI: 10.1002/csr

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Investment Option 1 2009 2010 2011 2012 2008 2009 2010 2011

Investment Option 2 2012

2008

Anticipated VOC efciency Target VOC efciency

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Efciency spread 8,068,950 7,016,478 30,265,935 72 per m 72 per m 72 per m 72 per m 81 per m 81 per m 5,873,422 4,909,181 4,096,555

102,041 per t 45,100 per t 56,941 per t

102,041 per t 47,150 per t 54,891 per t

102,041 per t 49,200 per t 52,841 per t

102,041 per t 51,250 per t 50,791 per t

102,041 per t 53,300 per t 48,741 per t

123,810 per t 45,100 per t 78,710 per t

123,810 per t 47,150 per t 76,660 per t

123,810 per t 49,200 per t 74, 610 per t

123,810 per t 51, 250 per t 72, 560 per t

123,810 per t 53, 300 per t 70, 510 per t

8,370,300

7,767,600 7,466,250 7,164,900 8,264,500 8,049,250 7, 834, 000 7, 618, 750 7, 403, 500 8,264,500 6,999,348 5, 923, 629 5, 009, 452 4, 232, 975 30,429,904 81 per m3 81 per m3 94 per m3 - 9 per m3 - 259,400 - 259,400 81 per m3 97 per m3 - 13 per m3 - 17 per m3 - 862,100 - 1, 464, 800 - 2, 067, 500 - 2, 670, 200 - 749,652 - 1, 107, 599 - 1, 359, 415 - 1, 526, 696

8,370,300

72 per m

82 per m 86 per m 90 per m 94 per m 97 per m 82 per m 86 per m 90 per m3

- 10 per m - 14 per m - 17 per m - 21 per m - 25 per m - 2 per m - 5 per m

- 2,047,800 - 2,822,700 - 3,597,600 - 4,372,500 - 5,147,400

- 2,047,800 - 2,454,522 - 2,720,302 - 2,874,990 - 2,943,043

Out-/ Underperformance Net present VOC value per period Net present VOC value Anticipated wastewater efciency Target wastewater efciency Efciency spread Out-/ Underperformance Net present wastewater value per period Net present wastewater value - 13,040,657

- 5,002,762

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Investment Option 1 2009 2010 2011 2012 2008 2009 2010 2011

Investment Option 2 2012

2008

Anticipated waste efciency Target waste efciency

Copyright 2012 John Wiley & Sons, Ltd and ERP Environment

Efciency spread

2,820 per t 3,383 per t - 563 per t

2,820 per t 3,536 per t - 717 per t

2,820 per t 3,690 per t - 870 per t

2,820 per t 3,844 per t - 1,024 per t

2,820 per t 3,998 per t - 1,178 per t

3,869 per t 3,383 per t 487 per t

3,869 per t 3,536 per t 333 per t

3, 869 per t 3, 690 per t 179 per t 601, 600 454, 896 2,871,164

3, 869 per t 3, 844 per t 25 per t 85, 000 55, 889

3, 869 per t 3, 998 per t - 128 per t - 431, 600 - 246, 769

- 2,994,900 - 3,812,850 - 4,630,800 - 5,448,750 - 6,266,700 1,634,800 1,118,200 - 3,501,550 - 3,582,642 - 3,583,006 1,634,800 - 16,977,619 3,226 per MWh 3,226 per MWh 3,226 per MWh 3,226 per MWh 2,330 per MWh 2,330 per MWh 972,348

- 2,994,900 - 3,315,522

Trade-Offs in Environmental Investments The Case of AUTO Group

Out-/ Underperformance Net present waste value per period Net present waste value Anticipated energy efciency Target energy efciency 3,194 per MWh 32 per MWh 147,750 - 498,000 - 376,560 - 1,229,768 128,478 3,333 per MWh - 107 per MWh 3,472 per MWh - 246 per MWh 3,611 per MWh - 385 per MWh 3,055 per MWh - 725 per MWh

3,226 per MWh

2, 330 per MWh

2, 330 per MWh

2, 330 per MWh

Efciency spread

3,055 per MWh 171 per MWh

3,194 per MWh - 864 per MWh

3, 333 per MWh - 1, 003 per MWh

3, 472 per MWh - 1, 142 per MWh

3, 611 per MWh - 1, 281 per MWh

793,500

- 1,143,750 - 1,789,500 - 4,047,800 - 4,822,700 - 5, 597, 600 - 6, 372, 500 - 7, 147,400 - 752,034 - 1,023,152 - 4,047,800 - 4,193,652 - 4, 232, 590 - 4, 190, 022 - 4, 086, 549 - 20,750,613

Out-/ Underperformance Net present energy value per period Net present energy value

793,500

Table 6. Environmental investment appraisal of the two investment options

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17 million more prot over the ve years of the investments lifetime to meet the waste efciency target. For energy consumption, this investments performance was still in line with the energy efciency targets for 2008 and 2009. It was only from 2010 on that investment Option 1 was expected to fall below the expected energy efciency levels due to the required improvement of 5% per year. Accordingly the anticipated yearly outperformance/underperformance for energy was expected to fall below zero in 2010. The energy performance of Option 1 still looked a lot better than the energy performance of Option 2. Here the target efciency was clearly missed and this investment option was 20.75 million below the targeted performance (discounted to 2008 values). At the same time, the waste performance of Option 2 was positive. Over the lifetime of this investment option, the net present value of the waste performance was 2.9 million above the targeted levels. While wastewater performance was negative (albeit less negative than with Option 1), the VOC performance of Option 2 was strongly positive with a net present value of the VOC performance at 30.4 million above the target level. This meant that of the ve years of the investments lifetime the VOC efciency of Option 2 was strong enough to generate 30.4 million more prot than required by the VOC-efciency target. Helen could see that both investment options provided a mixed picture with areas in which performance targets were achieved and areas where the anticipated performance of the investment fell short of the targets for the paint shop site. Compared to her initial situation where she had only physical gures of the two alternatives performances, she now had one decisive advantage. She had euro gures for all environmental aspects, which facilitated the task of balancing the positive and negative performance aspects considerably. She could now easily see for both options if the underperformance for some environmental aspects could be compensated by the outperformance of some other aspects. For both options, she just had to add up all negative net present value gures and compare this to the sum of all positive net present value gures. As soon as the balance was positive she could recommend this investment option for implementation, because a positive balance indicates that overall the outperforming aspects outweigh the underperforming areas. Her assessment had allowed her to deal with the environmental performance trade-offs inherent in both investment options. She could now see for which investment option the trade-offs were acceptable as overall, the positive effects outweighed the negative ones. At the same time she could clearly identify the weak points of both options. Table 7 shows the balance of the performance trade-offs of the two investment options for the new paint shop site in Townsville. Overall, with Option 2 that combines powder-based and waterborne technologies the outperforming aspects outweigh underperforming areas so that overall strategic support for the environmental targets of the Townsville site was evident for Option 2.
Investment Option 1 Outperforming aspects VOC emissions Underperforming aspects VOC emissions Waste generation Energy consumption Sum - 31,248,044 Balance negative Table 7. Balancing performance trade-offs of the two investment options Investment Option 2 Outperforming aspects VOC emissions Waste generation Sum 33,301,068 Balance positive Underperforming aspects Wastewater generation Energy consumption Sum - 25,753,375

Sum 30,265,935

Helen was happy that she could now give a clear and well-founded recommendation that from an environmental viewpoint investment Option 2 should be implemented. But even more than that: she now had a tool at hand that looked into the environmental performance of investments using the same logic as the nancial performance of investments were usually assessed. The environmental investment appraisal matched the logic of the value-based management philosophy of AUTO Group. In a way she was looking at environmental performance from a value-based perspective (Figge and Hahn, 2004; 2005): Only those investments that overall support the minimal rate of return in terms of a targeted environmental efciency should be undertaken. The environmental performance of investments could now be assessed analogously to nancial performance. A positive value is attributed when the anticipated return
Copyright 2012 John Wiley & Sons, Ltd and ERP Environment

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Trade-Offs in Environmental Investments The Case of AUTO Group

127

exceeds the targeted return on the use of an environmental resource. What was new to Helen was to look at the environmental performance of different investment options in terms of being an investment of environmental resources to generate future returns. Especially from the viewpoint of natural science or life cycle assessment that many environmental specialists are most familiar with, this seemed rather unusual and almost at odds in the beginning. But it turned out to be a very strong way to come up with an assessment tool that helped in the internal communication and that could deal with the environmental performance trade-offs that are inherent in so many environmental activities.

Questions
1. Imagine yourself in the role of Helen Grant who has to present the results of her assessment to top management. Prepare a 15-minute presentation in which you describe the analysis and explain the results in order to substantiate your recommendation for one of the two investment options. 2. Imagine a reassessment of the situation has provided improved information on the anticipated performance of both investment options. With Option 1, Helen now anticipates a 10% increase of waste generation; while with Option 2, the energy consumption is now considered to remain unchanged compared to the actual performance situation. Redo the assessment and readdress the recommendation of Helen for which option to choose. 3. Imagine top management readdresses the strategic environmental targets for AUTO Group and puts particular emphasis on the energy targets while lowering the targets for VOC emissions. Energy efciency is now expected to increase by 8% per year while for the VOC efciency a yearly 2.5% increase is now considered sufcient. Redo the assessment and readdress the recommendation of Helen for which option to choose.

Further readings and resources

There are a number of additional resources on the value-based approach to the assessment of environmental and social resources in strong analogy to standard nancial assessment tools. References to related academic papers, surveys and practical tools are available on www.sustainablevalue.com or upon request from the authors.

Acknowledgements
We would like to acknowledge the helpful comments and suggestions of two anonymous reviewers and the special issue editors. We would also like to thank the people at AUTO Group and other industry partners for their collaboration and willingness to share their practice. Finally, funding from the German Federal Ministry for Education and Research for the International Research Network on Social and Environmental Aspects in Business and Management (SEABUS; grant number 01UT1005) as well as of the MISTRA Foundation is gratefully acknowledged.

References
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Corp. Soc. Responsib. Environ. Mgmt. 19, 114128 (2012) DOI: 10.1002/csr