Post on 16-Mar-2018
Integrated reportingElevating value
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1 Introduction: An evolving view of value 11.1 What is integrated reporting? 11.2 Connectivity and integrated thinking 32 Changing corporate reporting 42.1 Limits of the current corporate reporting model 42.2 Toward integrated reporting 62.3 Background 73 Main aspects of the integrated report 83.1 The business model in an integrated report 93.2 Themultiplecapitalsmodel:beyondfinancialcapital 123.3 Strategy and key performance indicators 163.4 Risk and opportunity management 213.5 Materialitydefined 224 Measuring value creation 244.1 Interactionbetweenfinancialperformance,intangible 25 value and externalities 4.2 Explaining the gap between net book value and 25 intrinsic value 4.2.1 Monetization of intangibles 274.2.2 Monetization of externalities 284.3 Impact of externalities on the value of intangibles 294.4 The value of measuring value 30
Appendices
i Monetization of intangibles in practice: case studies 31ii Externality valuation in practice 38iii Methods of economic valuation 48
Contact 49
We recommend that organizations take into account the guidance of the International Integrated Reporting Council (IIRC) when carrying out an integrated report. This paper gives relevant background for organizations to be able to understandthejourneyofintegratedreportingsofar,thetheorybehindhowitwilloperateandsomedetailsonframeworks,guidelinesandevenregulatoryrequirementsthatareemergingaroundtheworld.Inaddition,weofferourviewofhoworganizationscanutilizeKPIsandmonetization,whichgoesbeyondtheguidanceof the IIRC framework.
Foranotherversionofthispaper,whichincludespracticaltipsonhoworganizationscanimplementintegratedreporting,strategyandthinkingintotheirprocesses,pleasesee our document Integrated reporting: tips for organizations on elevating value.
TheIIRChasreleasedaframeworkforintegratedreporting.Thefullversionofthis,whichismentionedwithinthispaper,canbefoundatwww.theiirc.org.
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Integratedreporting Introduction: an evolving view of value
Inthelast35years,themarketvalueoforganizations has slowly shifted from a price based largely on tangible assets to greater emphasis on intangible assets. The concept of valuehasfundamentallychanged,andwithitthe dynamics of the global economy.1Tocreatevalueovertime,today’sorganizationsneed to actively manage a wider range of resources. Intangibleassetssuchasintellectualcapital,researchanddevelopment,brandvalue,naturalandhumancapital have become as important as tangible assets inmanyindustries.However,theseintangibleassetsarenotuniversallyassessedincurrentfinancialreporting frameworks even though they often represent a substantial portion of market value.
A range of issues combined with intangible assets influencecompetitiveness.Examplesinclude:regulationorderegulation,technologyinnovation,finiteresourcesandconsumersovereignty(thegrowingpoweroftheconsumer),andcomplianceandlegislation.Now,morethanever,creatingsustainable value for organizations depends on two things:
• Adapting to change and the challenges and opportunities in their environments
• Effectively managing intangible assets, which can represent a substantial portion of market value
In this paper we offer our vision on integrated reporting and its role in value creation. We are confidentitwillinformorganizationsthatwanttotaketheirreportingtothenextlevel,aswellashelpthem articulate their unique value creation stories. These stories will ultimately help to attract investors who demand clear performance analysis to assess current and future prospects.
1.1 What is integrated reporting?
Integrated reporting is a concept that has been created to better articulate the broader range of measures that contribute to long-term value and the role organizations play in society.
Central to this is the proposition that value is increasinglyshapedbyfactorsadditionaltofinancialperformance,suchasrelianceontheenvironment,socialreputation,humancapitalskillsandothers.This value creation concept is the backbone
ofintegratedreportingand,webelieve,isthedirection for the future of corporate reporting. In additiontofinancialcapital,integratedreportingexaminesfiveadditionalcapitalsthatshouldguideanorganization’sdecision-makingandlong-termsuccess — its value creation in the broadest sense. (Please see Chapter 3.2 for details.)
Whileintegratedreportsbenefitabroadrangeofstakeholders,they’reprincipallyaimedatlong-term investors. Integrated reporting starts from the position that any value created as a result of a sustainable strategy — regardless of whether it becomes a tangible or intangible asset — will translate,atleastpartially,intoperformance.Marketvalue will therefore be impacted.
Critical to integrated reporting is the concept of sustainable value creation
Today,anorganizationcreatesvaluenotonly for its shareholders but also for the society as a whole by means of a sustainable strategy. This concept requires organizations tofactordecisions,trade-offsandsacrificesintotheirbusinessmodel.Forexample,foran organization to reduce its dependence onnaturalcapital,itmayhavetosacrificefinancialcapitaltoinvestinthehumancapitalcapable of achieving this goal.
An organization may face the choice between protectingitsfinancialcapitalintheneartermandincreasingitsprofitpotentialinthelongerterm.Thesedecisions,ifimportant,shouldbesetoutinanintegratedreportanddefinedintheorganization’svaluecreationobjectives.Thisapproachgoesbeyondthevaluereflectedintheannualfinancialstatementsandincludesthe creation of intangible value and the impact ofanorganization’sactivityonsocietyasawhole.Italsoincludesameasurement,oratleastadescription,ofhowtheseimpactsinfluencelong-termshareholdervalue.
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Integratedreporting
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Sustainable organizations create value by combining a broad range of resources controlled by the organization or third parties. They are increasingly expected to generate positive outcomes for society that go beyond returns for their shareholders or investors — outcomes that can beinstrumentalinimprovinganorganization’slong-termfinancialperformance.Understandingthisco-creation and shared value process is fundamental to integrated reporting. Other considerations include:
1 Anorganization’svaluecreationpotentialdependson its ability to identify all of the resources availabletoit,whethertangibleorintangible,ownedbytheorganizationorthirdparties,andto align them with its corporate strategy
►2 Anyvaluecreated,includingthatwhichbenefits
societyasawhole,hasthepotentialtoimpactontheorganization’svalueandprofitability
►3 An organization that communicates its
strategytothemarketandquantifiesthisbroader contribution may well be stimulating valuecreationinitself.However,toincreasestakeholderconfidencetheinformationmust be credible. (This will be explained further in Chapter 2.3.)
The chart below shows that the only layer of value currently measured consistently by organizations is financialcapital—usuallythroughtheannualreportand accounts. This value is translated into dividends for shareholders or stock price gains.
The second layer encompasses shared value that benefitsstakeholdersdirectlyrelatedtotheorganization(employees,customers,suppliers,publictreasury,etc.).Sharedvaluedependsextensivelyonfactorssuchasemployeeperformance,operatingpermitsandconsumerconfidence.
The third layer describes the value that an organizationgeneratesforsocietyatlarge,evenifit’snotdirectlylinkedtoitsbusinesspurpose.Theseexternalities,astheyareknown,maybeeitherpositive or negative. An integrated report is broader than traditional approaches in terms of scope and timehorizon.Itshouldtelleachorganization’sunique value creation story for each of these areas and include how:► ►• It creates value and for whom
• Itmeasuresandquantifiesthelayersofvalue►• Itidentifiesthevaluecreatedateachleveland
how it may affect future performance
1.2 Connectivity and integrated thinking
Totellacomprehensivevaluecreationstory,integrated reporting requires organizations to identify the interdependency between all elements — internal and external — that materially affect their ability to create value over time. Seeing this connectivity requires integrated thinking as opposed to “silo thinking.” All the operating and functionalunitsofanorganization,aswellasthecapitalsthatitusestocreatevalue,mustbeconsidered. This leads to integrated decision-making and actions. The integrated report is the product of the processes of connectivity and integrated thinking in the organization. Integrated reporting is therefore notjustaboutthereport,butabouttheprocessoftheorganization’suniqueapproachtovaluecreation.To translate integrated thinking into integrated reporting the organization should convey a holistic viewofstrategy,governance,performanceandprospects. The integrated report should also bridge time horizons. Therefore integrated reporting can be used as a governance tool for performance-oriented management.
Page 1
• Layers of Value
Value captured bythe organization
(The only layer of value currently
measured consistently)
Shared value
ExternalitiesValue for society
and the environment
Layers of value
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Integratedreporting Changing corporate reporting
The economy is facing a new value paradigm. Thesechanges,however,arenotreflectedinthe way we measure or report value. Traditional corporate reporting models have failed to adapt to an uncertain economy and account for the increase in intangible assets. Traditional metrics for measuring value and economic progress no longer provide a complete picture.
2A good example of this is gross domestic product (GDP),thecurrentyardstickformeasuringeconomicgrowthand,indirectly,prosperity.However,GDPfails to take into account increasingly important factors such as environmental sustainability or socialinclusionlevels.There’snowgrowingcross-border consensus on the need to enhance GDP measurements with additional data and indicators.
Corporatefinancialinformationfacessimilarshortfalls.Itfailstoreflectallthefactorsthatmayhaveasignificantimpactonvaluecreation.Ittoomust be revised. Tocreatevalue,organizationsincreasinglyrelynotjust on their resources but the scarce resources belongingtosociety.Therefore,thevaluecreationprocess is based on the principle of “shared costs.” Alleconomicactivityconsumes,tosomeextent,resourcesthatbelongtosociety.Consequently,thevalue created by an organization should be shared between its owners and society.
Ifthe“sharedcost”islessthanthe“sharedvalue,”the value created by the organization will show a net positivebalance.Ontheotherhand,ifthesharedcostismorethanthesharedvalue,thiswillshowanetnegativebalance.Inprivateorganizations,assuming that the ultimate measure of the success of a competitive strategy is growth in shareholder value,theequationbecomesmorecomplex.Thekeyis to determine the extent to which shareholder value creation depends on a contribution by society as a whole — and whether that contribution is sustainable inthelongterm.InSection4,frompage24,weelaborate on this theory and provide examples.
With organizations having the ability to create valuebeyondthatcapturedbyfinancialstatements,there’saneedtofindnewwaystomeasureandcommunicate value creation.
2.1 Limits of the current corporate reporting model
Overthepast40years,organizationshavebeendisclosing an increasing amount of information to satisfythedemandsofstakeholders.Specifically,they have offered complementary information to providersoffinancialcapitalwhoincreasinglyviewthesnapshotreflectedbyfinancialstatementsandsustainability reports as inadequate.
Research performed by ACCA1 concluded that investors say:
• Alinkismissingbetweencurrentreporting,
businessstrategyandrisk,andwedonotbelievethatsufficientinformationis providedtoassessfinancialhealth
►• ►Currentnon-financialreportingisnot
sufficientlyrelevant,andnon-financialinformation should be better integrated withfinancialinformation
• Qualitative policy statements are important toassessfinancialmateriality,butquantitativekey performance indicators (KPIs) are viewed as essential
• ►Accountability mechanisms should be part ofnon-financialreporting,eitherthroughnewboardoversightmechanisms,third-partyassurance and/or shareholder approval at annual general meetings
1ACCA and Eurosif; What do investors expect from non-financial reporting?, June 2013
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Page 2, Figure 2
1960 1980 2000 2020 Projected
• Evolution of corporate reporting
Governance and
remuneration
Managementcommentary
Sustainabilityinformation
Financialinformation
Integrated report
Financialstatements
Financialstatements
Financialstatements
Governanceand
remuneration
Managementcommentary
Environmentalreporting
Financialstatements
Governanceand
remuneration
Managementcommentary
Sustainabilityreporting
5
The information needed to evaluate an organization’sabilitytocreatevaluesustainablyover time cannot be gleaned from the prevailing corporate reporting model. A number of arguments support this assertion:► ►• Organizations are publishing a growing variety
ofincreasinglyextensivereports.However,the information provided in them is disjointed. They’reoftengeneratedbydifferentdepartmentswithin the organization and are products of silo thinking instead of integrated thinking
►
• Thecomplexityoffinancialreportingstandardsrequires increasing technical knowledge
►• Thecurrenteconomic,socialandenvironmental
crisesweface(e.g.,recession,theincome gap and climate change) are forcing us to think differently about the world and business
►• The lack of a conceptual and regulatory
frameworkfornon-financialreportsmeansthatinconsistenciesoccur.Therefore,stakeholdersmayfinditdifficulttocomparereportson many benchmarks
►
Source:AdaptedfromIIRC,Towards Integrated Reporting: Communicating Value in the 21st Century, September 2011
*Inthefuture,integratedreportingcouldeventuallyreplaceexistingcorporate reports. Organizations should be able to decide the wayinwhichitwillbepresented—forinstance,asanoverarchingdocumentlinkingtovariousotherreports,orasasingle stand-alone document covering all material aspects.
Evolution of corporate reporting*
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• Financialreportsfailtoreflectanorganization’sabilitytocreatevalueintheshort,mediumandlongtermthroughefficientmanagementofitsstrategic resources
►• Anorganization’svalueisdecreasinglyderived
from the tangible assets on its balance sheet and increasingly from its intangibles. The weight of tangible to intangible assets has inverted over the last three decades as shown below
These arguments illustrate how the current reportingframeworkfallsshortofstakeholders’needsandexpectationsandisinsufficientforinvestment decision-making purposes.
Markets move on information. The more forward-looking and detailed information organizations provide,themoreefficientlymarketsoperate.Therefore,organizationsneedtoexplaintheirvaluecreation goals from a new perspective: a view that accounts for both intangible and tangible assets and quantifies,wheneverpossible,thevaluetheycreatefromabroadereconomic,socialandenvironmentalperspective. The chart on page 7 shows that volatility invaluation,whichcanovervalueorundervalueanorganization,canbeloweredbyincreasingtheamount of information available to stakeholders. The ultimate goal is to enable investors to make moreefficientandeffectivedecisionsandbringanorganization’smarketvalueclosertoitsintrinsicvalue. Integrated reporting does just that. Leading organizations are adopting the concept.
Perspectives on integrated reporting
• ”An integrated report is a concise communication abouthowanorganization’sstrategy,governance,performance and prospects lead to the creation of valueovertheshort,mediumandlong-term.”2
• ”An integrated report is a holistic and integrated representationoftheorganization’sperformanceintermsofitsfinanceanditssustainability.”3
• “Integrated reporting builds on the practice of financialreporting,andenvironmental,socialandgovernance—orESG—reporting,andequipsorganizations to strategically manage their operations,brand,andreputationtostakeholdersand be better prepared to manage any risk that may compromise the long-term sustainability of the business.”4
Integratedreporting
Components of S&P 500 Market Value
• Increasing value of intangible assets
● Intangible assets● Tangible assets
Increasing value of intangible assets
Components of S&P 500 market value
Source:OceanTomo,LLC,“OceanTomo’sAnnualStudyofIntangibleAssetMarketValue—2010,”4April2011
2IIRCframework,“Whatisintegratedreporting?”3InstituteofDirectorsSouthernAfrica,“KingCodeofgovernanceforSouthAfrica2009,”20094ProfessorMervynKing,PressRelease“FormationoftheInternationalIntegratedReportingCommittee(IIRC),”2August2010
2.2 Toward integrated reporting
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The concept of integrated reporting was introduced inSouthAfricain2009throughKingIII,thecodeof corporate governance. The Johannesburg Stock ExchangeadoptedKingIII,andalllistedcompaniesare now required to “apply or explain” the King III principles,ofwhichintegratedreportingisone.
Regulatory requirements around the world and some listing requirements in different parts of the world are heading in the same direction. Requirements are emerging to increasingly disclose non-financialperformance,suchas:
• In Germany,GermanAccountingStandard 15 (GAS 15) includes disclosure requirements withrespecttocontext,KPIs,risksandopportunities,forward-lookingstatements and corporate governance
• In France,GrenelleIIstipulatestheinclusionofexternallyassurednon-financialinformationinannual reports
• In Spain,aregulator’staskforceisworkingon proposals for a new management report format
• In Brazil,theSaoPauloStockExchangerequireslistedcompaniestoreportnon-financialKPIsona
“comply or explain” basis
• In the UK,theCompaniesAct2006(strategicreportanddirector’sreport)extendsthescopeofmandatorynon-financialreportingobligationsforlisted companies
TheIIRC,setupattheendof2010,aimstocreate the globally accepted integrated reporting framework.Ultimately,anintegratedreportshouldexplainthereportingentity’sinterrelatedfinancial,environmental,socialandcorporategovernanceinformation.Itshouldbepresentedinaclear,concise,consistent and comparable manner. And disclosure should be retrospective and prospective to better matchinvestors’needs.Bydoingso,organizationscould improve their ability to access capital.
Page 4, Figure 4
Intrinsicvalue
Zero Low Medium High Full
Organization value
Extent disclosure
Overvaluation
Undervaluation
• Increased firm disclosure improves investors’ estimates of the firm’s intrinsic value
Reduction ofinformation gap
premium
Increased disclosure improves investors’estimatesoftheorganization’sintrinsicvalue
Source:M.Rikanovic,“CorporateDisclosureStrategyandtheCostofCapital—AnempiricalstudyoflargelistedGermancorporations,”basedontheworkofE.F.Fama,30June2005
2.3 Background
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Integratedreporting
3Main aspects of the integrated reportIntegrated reporting is a management and communication tool for understanding and measuring how organizations create value now and in the future. The goal isnottoprovidemoreinformation,butbetterinformation.It’stheinformationthatinvestors are increasingly looking for.
5 Global Reporting Initiative, “The sustainability content of integrated reports — a survey of pioneers,” 2013
InkeepingwiththeIIRCFramework,anintegratedreport should address the following questions:
►►• Organizational overview and operating context: Whatdoestheorganizationdo, and what are the circumstances under which it operates?
►►• Governance:What’stheorganization’s governancestructure,andhowdoesitsupport theorganization’sabilitytocreatevalueinthe short,mediumandlongterm?
►►• Business model:Whatistheorganization’s businessmodel,andtowhatextentisita resilient one?
►►• Risks and opportunities: What are the key opportunities and risks that the organization faces;howdotheyaffecttheorganization’sabilitytocreatevalueintheshort,medium and long term; and how is the organization tackling them?
► ►►• Strategy and resource allocation: Wheredoestheorganizationwanttogo, and how does it intend on getting there?
►►• Performance: How has the organization performedagainstitsstrategy,andwhatare the key outcomes in terms of the capitals?
►►• Outlook: What challenges and uncertainties is the
organization likely to encounter in pursuing its strategy,andwhatarethepotentialimplicationsfor its business model and its future performance and outcomes?
►►• Basis of presentation: How did the organization determinematerialmattersontheircharacteristics,likeKPIs,aspresentedintheintegratedreport?
A number of organizations were already publishing integrated reports before the launch of the IIRC Framework in December 2013. These pioneers incorporate many of the concepts established in the IIRCFrameworkandclearlydefinethefoundationsofhow they create value. Included among them are:
►►• The Crown Estate (UK)
►►• SAP (Germany)
►►• Novo Nordisk (Denmark)
►►• Port of Rotterdam Authority (the Netherlands)
►►• Natura (Brazil)
The Global Reporting Initiative (GRI) conducted a survey5 to assess current practices in relation to integrated reporting and concluded that:
►►• Large private multinationals are driving the year-on-year rise in the publication of self- declared integrated reports around the world.
►►• Countries leading the integrated reporting trend includeSouthAfrica,theNetherlands,Brazil,Australia and Finland.
►►• Globally,thefinancialsectorself-declaresmore
integratedreportsthananyothersector,followedbytheutilities,energyandminingsectors.
►►►• Integrated reporting is still a minority practice.
Onlyoneoutoffiveofthesurveyreportsis self-declared as an integrated report.
►►• About one-third of these reports combine sustainabilityandfinancialinformationtogether.
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• About half of all self-declared integrated reports are two separate publications — an annual report and a sustainability report — published together underonecover,withminimalcross-connection
►►• The rest of the reports are sustainability reports but self-declared as an integrated report without
showing a clear link between sustainability and financialperformance
►►• Over 70% of the reports surveyed exceed 100 pages
Todate,broadacceptanceofintegratedreportinghas been hindered. The delay in universal progress iscausedbyalackofconsensusamongcompanies,industries and even countries as to what an integratedreportshouldcontain.Also,adebateis ongoing as to whether it should replace existing corporate reports. The IIRC Framework could provide greater clarity and align the concept of an integrated report for the vast majority.
Thebusinessmodelisthevehiclethatdefinesandexecutesanorganization’sstrategyandmapsout the process by which an organization creates sustainable value over time. It should assess an organization’slong-termviability,valuepropositionandbusinessstrategy.Itshouldenhancetheentity’sfutureresilience.AccordingtotheIIRCFramework,the business model is based on the theory of multiplecapitals.Thisstatesthat,intheneweconomy,anorganizationcanonlybuildandsustainvalue if it manages the full range of input capitals efficientlyandresponsibly.Theresourcesitusestobuild this value include:
►►• Tangibleitemssuchasfinancialcapitaland manufactured capital
►►• Intangible elements such as relationships withthecommunity,humancapitalandintellectual capital
►►• Other inputs or resources such as ecosystem services derived from natural capital; organizations can draw on these capitals for free or in exchange for payment
The business model should identify the key inputs that contribute to value creation. It should also showhowthesearemanaged,thekeyvalue-addingactivities of the organization and the potential outcomeintermsofvaluecreationovertheshort,mediumandlongterm.Withinthebusinessmodel,value creation encompasses the products and services produced by the organization (including any by-products) as well as the external factors which increase or decrease the value of the capitals usedandaffectedbyit.Valuecreationordestructionoccurs through an increase or decrease in the value oftheorganization’stangibleandintangibleassetsand in the creation of positive or negative impacts forthecommunity(externalities)thatcan,inturn,feedbacktotheorganization’svalue.
3.1 The business model in an integrated report
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• The business model
Source: Business model background for <IR>, IIRC
Society Customer Organization Society
Valueadded by
organization
OrganizationOrganization
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When describing the business model in an integrated report the following series of questions should be considered:
►►• Howdoestheorganizationdefinevalue?► ►►• Whataretheorganization’smissionandvision?
►• What’stheorganization’senvironment?►►►• Howdoestheorganizationdefinestrategy,and what resources does it use? ►►• What are the main opportunities and challenges
faced by the organization?► ►►• What indicators are meaningful in terms of
measuring the extent to which the organization achieves its stated value creation goals?
►►
• Whataretheinputs,i.e,theresourcesorcapitalson which the organization depends? They can beinternalorexternal(e.g.,fundingmodel,infrastructurereliance,people,intellectualproperty,rawmaterialsconsumed,relationshipsor dependence on natural capital).
► ►►• What are the outputs? The products and services
produced by the organization.►• What are the outcomes? Performance in terms
of increasing or decreasing the value of the capitals as a result of product or service production. These outcomes may be internal or external(e.g.,revenueandcashflow,customersatisfaction,taxpayments,brandloyalty,andsocial and environmental impacts).
► • What are the value-adding activities? The key
elementsoftheorganization’sstrategyandthe related initiatives designed to lead to valuecreation(e.g.,strategicinvestments,innovation,planning,design,production,servicelevelagreements,relationshipmanagement,differentiationfactors).
Integratedreporting
The business model
Source:AdaptedfromIIRC,“Interactionofbusinessmodelwithinternalandexternalcapitals”,March2013
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How should an organization define its mission and vision, and the external factors that shape its business model?
Thebusinessmodel,viewedasawebofprocessesdevotedtothecreationofvalueintheshort,mediumandlongterm,needstobealignedwithanorganization’smission,visionandoperatingcircumstances.
The missionsetsoutanorganization’soverarchingpurposeandguidesanorganization’smanagementand employees in decision-making. It answers the questions of what an organization does and how it createsvalue.Oncecreated,itshouldprovidetheframeworkfordesigninganorganization’sstrategyanddefiningitstargetcustomers,productsorservices,anduniquevalueproposition.
SAP’sintegratedreportfor2012includesagoodexampleofmissionformulation.ItrelatesSAP’smission to the role the organization plays in society as an entity that creates value:
“ Our mission is to help every customer become a best-run business. We do this by delivering new technology innovations that webelieveaddresstoday’sandtomorrow’schallengeswithoutdisruptingourcustomers’business operations.”
Visionreflectswhattheorganizationaspiresto in the future.
The Port of Rotterdam Authority formulated the following vision for its Business Plan 2011—2015:
“ The Port of Rotterdam Authority is fully committed to the continued development of Rotterdam’sportandindustrialcomplexsoitcanbecomethemostefficient,safe,andsustainable in the world. The Port of Rotterdam Authority is creating value for customers by developingchains,networks,andclusters,bothin Europe and in emerging markets worldwide. Asanenterprisingportdeveloper,thePortofRotterdam Authority is the partner for world-classcustomersinpetro-chemicals,energy,transport,andlogistics.InthiswaythePortof Rotterdam Authority is enhancing the competitiveness of the Netherlands.”
The operating context and external factors should definetheenvironmentinwhichtheorganizationinteracts. These include:
►►• The macroeconomic situation
►►• The availability of natural resources
►►• The availability of social capital
►►• Market circumstances
►►• The competitive landscape
►►• Technology
►►• Supply chain
►►• Labor conditions
►►• The regulatory environment
An organization needs to continually monitor and analyzethesefactorswhendefiningandfine-tuningitsbusinessmodel.It’simportantthatmanagementtakes the lead in providing required governance andoversightstructures,sincetheintegratedreporting concept of value stems from the notion that the interaction between an organization and its operating environment has become more intense and mutually dependent.
Anglo American plc includes socioeconomic indicators in its operating circumstances and defineshowtheseindicatorsimpactitscorporatestrategies and values. It includes economic growth indicators such as GDP for its various markets,andittrackschangingdemandtrendsin a global environment marked by crisis.
Aegon,inits2012annualreport,outlinedthe trends and new realities of its business inthemacroeconomiccontext,definingtheirimplications and indicating the risks and opportunities implied.
“Trends and new realities described are:
►►• An aging planet
►►• An uncertain economy
►►►• Crisis in the Eurozone
►►►• The way products are bought and sold is changing
►►►• Winning trust
►►►• A new working environment”
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Integratedreporting
Sustainable development requires a balance betweeneconomicprogress,socialadvancesandenvironmentalprotection,whichisthefoundationofthe new value creation vision intrinsic to integrated reporting. This balance is increasingly important because organizations draw from multiple capitals or resources that interact with each other to form a competitive strategy and unique value proposition. This “multiple capitals approach” is the cornerstone of the economic system and development model in the new economy.
The approach provides a new framework for guiding decision-making that is underpinned by a series of principles:
►►• Thelevelofsustainabilityinanorganization’s strategy and business model shapes its future performance
►►• Anorganization’sbusinessmodelandstrategyshould be designed to maintain and protect all stocks of capital over time
• The organization should analyze the impact of its activities on each of its capitals and minimize any unsustainable dependencies►►►• Anyimpactderivingfromanorganization’s activity,internalorexternal,hasthepotential toaffectitsfuturefinancialperformance
Thecapitalsstorevaluethat’sneededbyorganizationstocreatesustainableprofitandprosperity for society. These values can be transformed,increasedordecreasedthroughtheactivities and outputs of the organization. The IIRC Frameworkidentifiessixcapitals:natural,socialandrelationship,human,intellectual,manufactured,andfinancialcapital.Thecategorizationisflexible,andthe IIRC Framework allows organizations to adopt otherclassificationstructures.Forreportingpurposes,anorganizationshouldonlyidentifytheindividual capitals that materially contribute to or affect the value creation process and the long-term viability of its business model.
There are different ways to classify the various forms of capital used by organizations in the value creation process. Access to the capitals may be controlledbytheorganization(suchasfinancialresources,equipment,managementskillsandtheintangibles associated with brands and reputation)
or by society and local communities (environmental services,atalentedworkforceorkeytransportinfrastructure). An organization may have access to these third-party capitals without having to incur anydirectcosts,oritmayhavetoconsumeothercapitals,suchasfinancialcapital,beforeearningtheright to use them.
Capitalsmaybeclassifiedastangibleorintangible.Intangibleassetsaredefinedasidentifiable, non-monetary assets without physical substance. The organization controls and holds these assets for use in the production or supply of goods or services,forrentaltoothers,orforadministrativepurposes. The tangible or intangible assets are purchased or generated by the organization. They may even be owned by third parties. Prevailing accounting regulations seriously limit the ability to recognize internally generated intangible assets on thebalancesheet.Asaresult,theirvaluationsare“backstage”infinancialstatements.Integratedreporting aims to change that by giving intangibles and externalities a place in corporate reporting.
AstraZeneca’s2012reporthighlightsandstatesthecompany’sdependenceontheuseofcapitalsin order to successfully deliver its strategic goals. “Theresources,capabilitiesandskillswehave in the business and how we use them to ensure a focus on:
• Research and development: the discoveryanddevelopmentofinnovative,differentiated and commercially attractive medicines that make a real difference to the health of patients
►►• Sales and marketing: focused on the need ofourcustomers—patients,physiciansandpayers — and undertaken the right way
►►• Supply and manufacturing: a reliable supply and manufacturing operation that ensures our medicines are where they need to be when they are needed
►►• People: a talented and diverse workforce with the right capabilities operating in a high-performance culture”
3.2 The multiple capitals model: beyond financial capital
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Integratedreporting
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The new capitals
• Natural capital: serves as the basis and glue for the entire economic and social system. It provides resources that often cannot be replaced. And it’sessentialforthefunctioningoftheeconomyas a whole. Resources include water or fossil fuels,renewablenaturalresourcessuchassolarenergyoragriculturalcrops,andthecapacityoftheworld’scarbonsinks—i.e.,theair,forestsandoceans — to neutralize or sequester the waste generated by economic activity. When it comes to determining whether natural capital is material to anorganization,relevantfactorsmustbebroughtto bear. These include the level of reliance on naturalresources,theenvironmentalimpactofitsproductiveprocess,andwhattheorganizationhas to do to operate within the limits imposed by the environment.
►►• Social and relationship capital: the stock of
resources created by the relationships between an organization and all its stakeholders. These relationshipsincludetiestothecommunity,governmentrelations,customersandsupplychainpartners.Operatinglicenses,dependenceon the public sector or an unusual supply chain may also be factors
►►• Intellectual capital: encompasses the intangibles
associated with brand and reputation that are critical to the organization. It also includes resourcessuchaspatents,copyrights,intellectualpropertyandorganizationalsystems,procedures and protocols. These can provide significantcompetitiveadvantages.Theycanalsohavedisadvantages,suchasthenegativebrand equity attributed to major polluters or ill-reputed shareholders
►►• Human capital: refers to the skills and know-how
ofanorganization’sprofessionalsaswellastheircommitment and motivation and their ability to lead,cooperateorinnovate.Thesuccessofanorganization is tied to proper management of its teams and care for their motivation and well-being. Excessive employee turnover or inadequate remuneration policies can damage reputations andimpairanorganization’sabilitytocreatevalue
►►• Financial capital: is the traditional yardstick
ofanorganization’sperformance.Itincludesfundsobtainedthroughfinancingorgeneratedbymeansoftheorganization’sproductivity.It’sthe pool of funds available to the organization for use in the production of goods or the provision of services,includingdebtandequity
Financial capital interacts extensively with the
other capitals. Organizations need to understand andreflectthisinterdependenceintheirintegratedreports.It’simportanttoshowfinancialcapitalisconverted into other forms of capital — assigning value to the latter — and explain how these other formsofcapitalwillgeneratefinancialreturnsovertheshort,mediumandlongterm
►►►►• Manufactured capital: mainly comprises physical
infrastructure such as buildings or technology equipment and tools. Manufactured capital may beownedbytheorganizationorbythirdparties,e.g.,portsandotherpublicinfrastructure.Theycontributetoanorganization’sproductiveactivity.Itfollowsthattheirefficientmanagementcanreduce the use of resources and drive innovation thatleadstogreaterflexibilityandsustainability
How do the various capitals contribute to the value creation strategy?
The capitals available to the organization are increased,decreasedortransformedasaresultof its value-adding activities. The connectivity and interdependence among the various capitals orinputs—specificallytheirinfluenceontheorganization’slong-termfinancialperformance—should be communicated in an integrated report.
Moreover,notonlydothecapitalsinteractwitheachother,buttheyarealsoinfluencedbyexternal factors. These include the economic climate,technologicalprogress,socialchangesandenvironmentalissues.Viewedfromthisperspective,anorganization’sabilitytomitigaterisks,adapttochange and interact with its shifting surroundings iskey.What’smore,thecapitalscanbecomeaninternally generated intangible asset.
Tounderstandhowanorganizationusesitscapitals,howtheyrelatetoeachotherandtheinfluenceofexternalfactors,it’svitaltodefinethestrategy,and aseriesofKPIs,tomeasurethestrategy’sprogress.
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3.3 Strategy and key performance indicators
Strategy formulation should describe the process and tools earmarked for the creation of value for shareholdersandotherstakeholders,specificallycustomers,suppliers,employeesandsocietyasawhole. The value created for the community is the result of the production of positive and negative externalities. When the market is aware of the externalitiesgenerated,thelattercanalsotranslateintoanincreaseordecreaseofanorganization’svalue. Strategy must clearly set out the differential value proposition for the customer and the community as a whole.
The strategy must address questions such as:
►►►• What does the organization do to create value for itscustomers,theprovidersoffinancialcapitaland other stakeholders?
►• What outcomes does the organization strive for?
• What capitals does the organization rely on?
• How will the organization position itself in the value chain and in its operating markets?
The strategy should mirror and articulate a balance betweentwothings:first,short-termfinancialperformance;second,thesustainablecreationofvalueinthemediumandlongterm.It’simportantto distinguish the time horizons framing decisions regarding the allocation or consumption of the capitals.Anorganization’sstrategyshouldalsoreflectthechoicesneededwhenitcomestoconsumingresources.Often,theuseofonecapitalcan deplete its value yet drive an increase in the value of other capitals over time.
The strategy should pinpoint the management processes and systems to mobilize and use all the resources (including external resources) within theorganization’sreachasefficientlyaspossible.References to the value creation chain that go beyond elements strictly controlled or owned by the organization can enhance the strategic direction of the organization.
The value of intangibles depends on the extent towhichtheylinkwiththeorganization’sobjectives—orinotherwords,valuecreationthrough connectivity. Any increase in their value mayeventuallymaterializebyimprovingfinancialperformance through interrelated links. This alignment and these interactions are key since the measurement of the value of an intangible canbecost-based,butitcanalsorelyonotherperformance indicators.
Intangible assets have a value potential that depends onhowtheorganizationdefinesitsstrategyandhowthoseassetscontributetotheorganization’svaluecreation goals. An intangible asset unaligned with theorganization’sstrategymayhavenovalue.
Thesuccessofastrategydepends,aboveall,onexecution.Thisrequiresembracingacoretenet:it’sonly possible to manage that which can be measured. In a new economic environment where the ability to adapt to changing environments and intangibles is a focus,thisprinciplerequiresspecificvaluecreationmeasurement metrics.
This is where we believe KPIs can be useful in addition to the narrative portion of the integrated report.KPIsmeasurefinancialandnon-financialperformance against targets and long-term value creation goals. They can also indicate what the organization’soutcomesareintermsoftangibleandintangible value as well as value for society.
KPIs can be used to measure performance and outcomes resulting from the use of tangible and intangible assets as well as capitals the organization doesn’town.Theyrelatetotheorganization’scriticalvaluedriversandtracktheorganization’sperformanceintheshort,mediumandlongterm.With correct KPIs the management team can focus onmonitoringmaterialmatters,andinvestorscan assess value creation. Creating KPIs enables organizations to understand how they can minimize negative externalities and maximize positive ones. Ultimatelythiswillsupporttheperformanceoftheirintangible assets and by extension their value.
It’simportanttoshowhowmeasurableindicators(e.g.,employeeturnover,energyefficiency,mediacoverage)impacttheorganization’stangibleandintangible assets (such as brand and customer relationships).Why?Becauseitdirectlyinfluencesshareholdervalue.Forexample,takeKPIsrelatedto waste reduction generated in manufacturing. The reduction of waste may indirectly measure the creation of external value through enhanced environmental performance. The improvement could result in an improved brand image. This in turnenhancescustomerloyaltyand,byextension,customer relations (an intangible asset).
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Page 6, Figure 5
• Connecting the dots
Source: EABIS Research Project
Humancapital
Employeeengagement
Customer satisfaction
Public perception
Carbonemissions
Product/servicedevelopment
Ethicalintegrity
Boardcomposition
Wastemanagement
Life cycleassessment
Supply chainmanagement
Absence rateStaff turnoverHealth and safetyFair restructuringTrainingPerformance managementEquality and diversityReputationCommitment to customerTalent recruitmentand retention
Customer loyaltyRetentionReputationTrustPrice, product, service quality
Opinion formerperceptionMedia coverageCommunityinvestmentStakeholderdialogueSocial impactLegal/regulatorybreachesInclusion
Energy efficiencyDeployment of renewablesWaste reductionRecyclingEnvironmentalimpactsEnvironmentalbreaches
New productsand servicesValue of patentsCustomerperceptionTalent recruitmentand retentionTrainingR&D expenditure
Numbers ofnon-exec/independentdirectorsEquality and diversityTraining anddevelopmentAudit processesReporting andtransparencyReputationShareholderinterestsAnti corruptionpolicy/practiceCompetitiveness
Increasedsales
Primaryobjective
Financialdrivers
Core non-financialdrivers
Key metrics
ESG factors
Increasedcashflow
Brandvalue
Riskmanagement
Reducedcosts
Customerrelations
Partnerships Environment Innovation Corporategovernance
19
Finally,communicationisacrucialcomponentofstrategyandthevaluecreationstory.Naturally,it’svital that the entire organization is aligned with the organization’sstrategictargets.However,it’salsotrue that the market will only tend to recognize an organization’sintrinsicvaluetotheextentthatitreceivessufficientinformation.Moreover,reportinghow an organization creates intangible value and a value for society may create additional intangible value as long as the communication is credible and consistent. Integrated reports should disclose the measurement methods used by management to calculate KPIs. This information is relevant to enable comparisons between organizations and provide a clear understanding of the organization’sperformance.
Selecting sources of KPIs
TheIIRCFrameworkdoesnotlistspecificindicatorstobeincludedinanintegratedreport.However,there are readily available sources for selecting KPIs in line with the broad concept of value creation. TheseKPIsarenotonlyfinancialmetricsbutalsoESG indicators. They have or are being developed by organizationssuchastheGlobalReportingInitiative,
the European Academy of Business in Society (EABIS) and the Sustainability Accounting Standards Board (SASB).
InSeptember2010,theDVFA(DeutscheVereinigungfür Finanzanalyse und Asset Management/German Association for Financial Analysis and AssetManagement),togetherwiththeEuropeanFederationofFinancialAnalystsSocieties(EFFAS),jointly published a paper outlining the ground rules for integrating ESG considerations into corporate reports. The document includes an extensive list of KPIs for each of the 114 subsectors presented.
These same principles underpin the Global Reporting Initiative’ssustainabilityreportingguidelinesthataredesignedtoenhancethequality,relevance,reliabilityand comparability of the information disclosed in corporate sustainability reports.
Designing or implementing processes and systems to generate input for KPIs requires special attention,especiallyfornon-financialKPIsastheytend to be new to most organizations. Showing connectivity through KPIs often requires links between systems that have not been linked to date. Creating solid processes and systems to get the right information on KPIs requires time and commitment from senior management.
Connecting the dots
Source: Doughty Centre for Corporate Responsibility, Cranfield School of Management, “Sustainable Value EABIS Research Project: CorporateResponsibility, Market Valuation and Measuring the Financial and Non- Financial Performance of the Firm”, September 2009
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Groupstrategicobjectives
Risk-adjustedoutcomes
Apply riskmanagement
process
ReportingGroupstrategy
Page 8, Figure 7
• Risk and opportunity management
Strategicdirection
Compliancemonitoring
Market andcredit risk
Operational andfunctional risk
Investment andproject risk
Manage grouprisk exposure
Risk-relevant control and
response
Risk-basedstrategic choices
Strategy implementation
and operation
Maximize certainty between aspirations, objectives and outcomes
• Considering the group’s strategic direction, we apply the risk management process to inform the strategic choices we make
• Aligned to the group’s strategic objectives, we apply the risk management process proactively to realize the expected outcomes
Source: Adapted from SASOL’s annual integrated report
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Integratedreporting
Risk and opportunity management
Source:AdaptedfromSasol,“Annualintegratedreport–bettertogether…wedeliver,”30June2013
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Page 9, Figure 8
• Compound annual growth rates 2004-2011 by risk maturity level
Source: EY, Turning risk into results2011 Year to date reported as of 18 November 2011
● Top 20%● Middle 60%● Bottom 20%
21
Integrated reporting takes a broader approach to risk and opportunity management than traditional frameworks.Asaconsequence,astrategythatincludestheidentificationandmitigationofrisksagainst the integrated reporting six capitals has a direct impact on performance. It also has an impact on reducing the gap between its market and intrinsic values.
Risks can be placed into four major categories according to the Committee of Sponsoring Organizations of the Treadway Commission (COSO) EnterpriseRiskManagementmodel:strategic,financial,operationalandcompliance.Risksrelatedto natural resources such as scarcity and risks envisioned for the future fall into the category of strategic and operational risks.
Enterprise risk management is seen as important to guaranteeing the viability of any corporate strategy and,byextension,thevaluecreationprocess.Materialrisksthatcouldhaveasignificantimpactontheexecutionoftheorganization’sstrategyandits value creation goals should be incorporated into the decision-making process with the aim of reducing uncertainty with respect to achievement of operating results.
Empirical studies show that organizations with advanced risk management systems create more valueintermsofrevenue,operatingprofitsandresultsagainstequity.Usingaglobal,quantitativesurvey based on 576 interviews with companies aroundtheworld,EYassessedthematuritylevelofrisk management practices and then determined
a positive relationship between risk management maturityandfinancialperformance.
Withriskmanagementaclear-cutvaluedriver,it’simportanttocommunicateitproperlytotheorganization’svariousstakeholdersandrelateittoitscorporatestrategy.Investors,regulators,shareholdersandsuppliers,amongotherstakeholders,areincreasinglycallingonorganizations to enhance their risk management disclosures.However,there’sarecurringdiscussion regarding how much risk information should be disclosed to the market in terms ofriskidentificationandcorporatestrategicresponse,andhowthisinformationcanaffectanorganization’scompetitiveadvantage.
Control over reporting and communication of risk management information can help maximize valuecreation.Internally,it’simportantthattheorganization understands and is familiar with existing risks and stringently applies the related controls. This process should be overseen by its board of directors and audit and control committee. Externally,it’svitalthatthirdpartiesunderstandthekey characteristics of the risk management model and how the organization responds to the most material risks.
Decisionsregardingwhatshouldbecommunicated,andhow,needtobehandledbymanagement.And they must weigh the advisability of disclosing absolutefigures/metricsversustheuseofalternatives such as the percentage achievement of stated key risk indicators (KRIs).
Compound annual growth rates 2004–2011by risk maturity level
Source:EY,“Turningriskintoresults:howleadingcompaniesuseriskmanagementtofuelbetterperformance,”2012
2011 year to date reported as of 18 November 2011
3.4 Risk and opportunity management
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22
Bearing in mind the characteristics of an integrated report,apropermaterialityassessmentisneededtoensure that:►►►►►►• The report is focused on those factors and informationthatsignificantlyimpactthelong-termfinancialperformanceoftheorganization
► ►►• The report is concise and meaningful
Webelievethatamatterismaterialifit’sofsuchsignificancethatitcouldsubstantivelyinfluencetheassessmentsanddecisionsoftheorganization’shighest governing body or the providers of capital. Creatingsustainablevaluefortheorganization’sshareholdersistheultimatefactorthatwillinfluencethe materiality assessment. This analysis needs to factorintheneeds,interestsandexpectationsofitscore stakeholders.
Therefore,thematerialityconceptinthecontextofanintegratedreportdiffersfromthetraditionaldefinitionsusedinfinancialandsustainabilityreportingframeworks.Materiality in integrated reporting spans the entire strategyoftheorganization,notjustthecurrentfinancialorsustainabilityreportingframeworks.Thelatest GRI guidelines encourage a strict approach on determining what is material in a sustainability report and provide a useful starting point for beginning a materiality analysis for an integrated report.6
According to the IIRC Framework the providers offinancialcapitalarethetargetaudienceofan integrated report. But they are not the only stakeholders with a vested interest in assessing the organization’svaluecreationpotential.Forareaderofanintegratedreporttomakesuchanassessment,theorganizationshouldpublishthematerialfinancial,social,economicandenvironmentalinputsthatallowittocreatevalueandthatrevealtheorganization’sability to respond to a changing environment. Other stakeholders’views,besidesinvestors’,shouldtherefore be included in the decision-making process on what is material for the organization so long as they,inturn,haveafinancialimpact.Inaddition,meetingcertainstakeholders’expectationswithregardstospecificformsofcapitalmayimpacttheorganization’svalueandthereforeitslong-termfinancials(seecasestudiesinAppendixi).
The process of determining what is material and would be disclosed in an integrated report should be based on the following criteria:►►►• Relevance: matters that have already impacted the organization’sstrategy,businessmodelorstrategiccapitals,ormaydosointhefuture
• Significance:anassessmentofamatter’ssignificancerequiresevaluatingthemagnitudeof impact(formattersthathaveoccurred,currentlyexist or will occur with certainty) and the probability of occurrence (for matters where there’suncertaintyaboutwhetheritwilloccur)
► ►►• Prioritization: people charged with the organization’sgovernanceneedtoprioritizethe material matters based on their relevance andsignificance
Determining materiality in an integrated report requires the use of the above criteria or instance in a four-step model as depicted on the next page (see page 23).
Topinpointthematerialissuesrequiringdisclosure,anorganization needs to start with a broad list of issues relatedtothevariouscapitals.Thislistisfiltereddownas a function of:
►►• ►Internal factors: bearing in mind the ultimate goal of value creation and the risks emerging from the enterprise risk management system
► ►►• Externalfactors:theneeds,interestsandexpectationsofstakeholders—society,sectorstakeholders or government bodies — by prioritizing these matters
Thiswilldeterminethematerialmattersthatinfluenceanorganization’sabilitytocreatevalueintheshort,medium and long term. Both the material matters and theprocesstodefinethesewillneedtobedisclosedinits integrated report.
Initsintegratedreportfor2012,TheCrownEstatedefinedtheprocessfollowedtoidentifyits material matters. It described its internal andexternalfactors,listingopportunityandriskmanagement,stakeholderrelationsandkeycompany principles and policies as its key internal factorsandindustry-wideissues,legislationandnorms,andtheissuesraisedthroughsectororganizations and panels as its external factors. The Crown Estate concluded that its most material issuesareitssustainedandprofitablegrowth;optimization of the portfolio for long-term total return;attraction,nurturingandretentionofbest talent; attraction of suitable commercial partners; health and safety; maintaining effective stewardship; reputation and successful
“placemaking”; creating amenity value; the effect of climate change; the availability of natural resources; customer focus; organizational and managementstructure;thehealthoftheUKeconomy; and government policy.
Integratedreporting
3.5 Materiality defined
6 Global Reporting Initiative, “G4 Sustainability ReportingGuidelines: Reporting principles and standard disclosures,” 2013
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Page 7, Figure 6
• The steps toward materiality
23
The steps toward materiality
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Page 10, Figure 9
• Environmental impact
Source: Trucost
FishTimber
24
Externalitiesmeananorganization’simpact—positiveornegative—onsocietyasawhole.Generally,they’renotreflectedintheorganization’sfinancialreporting.They only show up on balance sheets to the extent they affect the capitals owned by the organization. Whereas stakeholders (including providers of financialcapital)areincreasinglyconsideringinternalandexternalnon-financialfactorswhenassessinganorganization’slong-termprospects.Moreeffectivecapital allocation decisions can also lead to better long-term investment returns.
Whenexternalitiesarepositive,theycanbecomeasourceofcompetitiveadvantageandfinancialreturninthelongerterm,whichcanhaveaplaceonbalancesheets.Infact,anorganizationcanturntheproduction of positive externalities into an intangible asset or a driver for increasing the value of existing intangibles.Forthistohappen,anorganizationhastodothreethings:identifytheexternalities,estimatetheir value and communicate both to the market.
Externalities can be positive or negative depending on the nature of their impact. They can affect the economyingeneral(economicexternalities),society (social externalities) or the environment (environmentalexternalities).Forinstance,theproduction of renewable energy may reduce a nation’sdependenceonforeignenergy(economicexternalities),creategreenjobs(social)andprotect natural capital by reducing greenhouse gas emissions (environmental).
Withnaturalcapitalincreasinglyscarce,environmental externalities are becoming a key economicissue.Theirsignificancewasclearlyillustratedbyenvironmentaldataexperts,Trucost.Trucost estimated that the environmental costs caused by human activity on a global scale were aroundUS$6.6trillion,or10.97%ofworldGDP,in2008.By2050,thefigurecouldreach17.78%ofglobal GDP.
4
Annual environmental costs for the global economy in 2008 and projections for 2050
Measuring value creation Valueiscreatedordestroyedbyanorganizationwhen it uses and affects the various capitals. Thecapitalsstorevalue.And,althoughchangesinthesestoresarenotreflectedintraditionalcorporatereports,theyhavethepotentialtogeneratefuturecashflowsfortheorganization.Changes in the value of stores translate into increased tangible and intangible asset valuations and into externalities.
Source:TrucostPlc,PRIAssociationandUNEPFinanceinitiative:“UniversalOwnership:Whyenvironmentalexternalitiesmattertoinstitutionalinvestors,”2011
Integratedreporting
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Page 11, Figure 10
• Interaction between financial performance, intangible value and externalities
• The value of the organization is in part defined by intangible value. Therefore, correct communication of this value is also important.
Initiatives aligned with organization’s strategy
Linkages and value-creation cycle*
*Futureeconomic
valueIntangible
value
Value of theorganization
25
Integrated reports enable organizations to tell their uniquevaluecreationstories.Todothat,theyneedto identify and measure the intangible value and the externalities they generate as a result of their business. Organizations also need to assess to what degreetheexternalitiesproducedmayalsoinfluenceintangible value. Some practical examples of this are shown in Appendix i.
Moreimportantly,organizationsneedtobeableto describe the ability of both intangible assets andexternalitiestogeneratefuturecashflows.These can be measured using consistent and generallyacceptedcriteriaandmethodology,themost common of which are listed in Appendix iii. Determining that value and communicating it is imperative to creating additional value. The process of communication can impact market value and can bring it closer to the intrinsic value of the organization,asseeninthegraphiconpage7.
All investment decisions are preceded by an exhaustiveanalysisoffinancialandnon-financialinformation focused on a single question: what monetary value will an investment generate or destroy?
Inthecaseoflistedcompanies,acompany’smarketcapitalization should be a good proxy for its value. However,theinformationcurrentlyavailabletoinvestorsdoesn’ttellthefullstory.Thismaygenerateagapbetweenintrinsicvalue,marketcapitalizationand book value.
Asillustratedinthegraphsonpage27,thegapbetween market value and book value is explained by thefactthatinvestors,throughthemarkets,senseand acknowledge the existence of unrecognized intangible assets and externalities. The market valuealsodiffersfromanorganization’sintrinsicvalue,whichisitstargetvalue.Inaperfectandfullytransparent market where participants had access to thesameinformation,intrinsicvaluewouldcoincidewith its market capitalization. Integrated reporting helps to reduce the gap between intrinsic and market values by identifying intangible assets and externalities and assessing their monetary value.
Interactionbetweenfinancialperformance,intangiblevalue and externalities
4.1 Interaction between financial performance, intangible value and externalities
4.2 Explaining the gap between net book value, market value and intrinsic value
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Integratedreporting
Page 13, Figure 12
• Purchase Price Allocation
Target’s assets and liabilities at ‘fair value’ (after the acquisition)
Target’s assets and liabilities at book value (before the acquisition)
Excess price paid or pre-PPA goodwill
Intangibleassets
Intangible assets
Consideration paidGoodwill
Tangibleassets
Workingcapital
Long-termdebt
Equity market value
Short-termdebt
Tangibleassets
Workingcapital
Long-termdebt
Purchasepriceallocation
Equity bookvalue
Short-termdebt
Purchase price allocation
FairvalueasdefinedbyInternationalFinancialReportingStandards(IFRS)13.
26
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Page 14
• Valuing an organization’s intangible assets
Intrinsic valueMarket capitalizationNet book valueAdjusted net book valuePotential market capitalization
However, if the valuation is not repeated (except for impairment testing), the three values tend to diverge again
This information allowsthe market to adaptcapitalization to the reported value
As with the PPA,book value equals intrinsic value
Valu
e
Time
Page 15
• The effect of greater communication on market capitalization |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||Greater communication leads to a lower perceived risk by investors, leading to higher valuations
Valu
e
Time
Intrinsic valueMarket capitalizationNet book valuePotential market capitalization 27
Measuring the contribution of intangibles to futurecashflowsisfundamentaltointegratedreporting and will help explain the gaps between book,intrinsicandmarketequityvalue.Undercurrentfinancialreportingstandards,organizationsare required to recognize (and if material disclose) intangible assets acquired in a business combination as part of the purchase price allocation (PPA)process.Consequently,theintangibleassetsare only measured once for this purpose.
However,organizationswouldbefreetogofurther in their integrated report and disclose the change in value of an intangible as a result ofanysustainablegrowthstrategyoraspecificinitiative,makingitconvenientincertaincasesto communicate the value of intangibles in an integrated report.
Appendix i includes case studies showing how intangible asset value can be measured and the valuation methodologies used:
►►• Measurement of the increase in brand value as a result of a corporate social responsibility initiative
• Measurement of the increase in the value of customer relationships at a major organization from an environmental initiative
►• Measurement of the increase in the value of anorganization’shumancapitalasaresult of a career development and retention effort
Inpractice,itcanbedifficulttomeasuretheimpact of isolated initiatives on the value of an organization’sintangibleassetsand,byextension,onitsoverallvalue.It’spossiblethat,atthetimeofmeasuringtheimpactofaspecificstrategicaction,therewereinfluencesfromotherinitiatives, positiveornegative,thatmayhaveoccurred in the same timeframe.
However,theprocessofidentifyingandmeasuringintangible assets and communicating the outcome to the market helps investors to:
►►• Recognize,toagreaterextent,thecashflowsthat the organization is capable of generating in the future
►►• Associatethegenerationofthesecashflows with the various intangible assets that create value on a sustainable basis
►►• Perceive reduced investment risk
4.2.1 Monetization of intangibles
Valuinganorganization’sintangible assets
The effect of greater communication on market capitalization
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A wide variety of externalities can be produced as aconsequenceofbusinessactivity.Thefirsthurdlelies with acknowledging or identifying their existence. Whentheexternalityisdestroyingsociety’svalue(e.g.,globalwarming,airpollution,urbancongestionorbiodiversityloss),theorganization’schallengeishowtomitigatetheimpactanddevelopa“profitand loss” approach — identifying mitigation costs and comparing them with the value to society of implementingmitigationactions.Havingdonethat,the organization can communicate its efforts to the market. This may in turn contribute to protecting or increasing the value of its intangible assets or decrease the importance of hidden intangible liabilities. When activities generate positive externalities,thisgivesagoodopportunitytoeffectively communicate the increasing value of the intangible assets to the market.
AccionaandEDP,producersofrenewableenergy,have developed a methodology to monetize the value of renewable energy generation in a numberofeconomiesincludingFrance,Spain,theUKandtheUS.Thescopeoftheworkincludesthe contribution of renewable energy in terms of EDP’sgrowth,greenjobs,energysecurity,CO2 emission reduction and the economic value of energy security. The main goal of this exercise is to protect their license to operate and public policy support in certain markets.
Formula E Holdings has developed a methodological approach to calculate the impact ofthecompany’sactivityinacceleratingthedevelopment of the electric vehicle market globally. This exercise allows the organization to estimate the monetary impact of its role in mitigating global warming or improving air qualityinlargecities,forexample.Byprovidingthisvalue,sponsorsareabletogaugethestrength of the positive environmental attributes theyareseekingtoattachtheirownbrandsto,thus making the company more attractive for sponsors,andthereforeforinvestors.
Untilrecently,mostoftheseindicatorsweremainlytracked for internal purposes. Their oversight was assigned to the business areas with the power to influenceperformance.However,toboosttheorganization’scredibilityamongstakeholders, it’sincreasinglyimportanttocommunicatethemappropriately,transparentlyandfrequently,both within the organization and externally. CommunicatinghowtheorganizationdefinesitsKPIs,theirsignificancetothestrategicobjectivesandhowthey’retrackedandcalculatedwillhelpstakeholdersbetterappreciatetheorganization’sperformance,situationandprospects.
Appendix ii provides some additional examples on monetizing externalities.
4.2.2 Monetization of externalities
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Page 16, Figure 15
ExternalitiesReputation
Health, occupational and environmental risks Resilience
Environmental marketingSocial policy
Enterprisevalue
Product innovation, new market niches, etc.
Retention of the employees and talent
attraction
Brandvalue
Impact value of the
organization in the
environment
How prepared the organization is for an unstable
climate
Environmental due diligence, occupational
risk prevention
• Enterprise value
29
4.3 Impact of externalities on the value of intangibles
Aspreviouslymentioned,tocompletelyunlockitsintrinsicvalue,anorganizationneedstoconvertitspositive externalities and the actions to mitigate negative impacts into intangible value.
Potential approaches to estimate the impact of the externalities produced by an organization on the value of intangibles include:
►►►• The ability to relate the externalities generated with the share price performance► • The generation of customer loyalty or brand equity by means of enhanced consumer perception thanks to the reputation earned by an organization when it generates positive externalities or reduces negative ones►
• Access to more favorable valuations in bidding foroperatinglicensesorpublictenders,paving the way for operating cost savings within the organization as well as geographic and sales growth
►►►►• The sharing of savings along the supply chain when
suppliers manage to enhance their performance► ►►►• Reduced risk of energy dependence and natural
capital depletion/scarcity► • Reduced compliance costs vis-à-vis future
regulations and access to new market niches
The graphic below shows how externalities can bemeasuredtodemonstratehigherrevenues,improved productivity and cost savings.
Enterprise value
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Page 17
• Impact of telecommuting, in addition to savings on fuel, CO2, office space and traveling time
Source: Telework Research Network, 2010
• Potential benefits of video conferencing by 2020 for US and UK businesses, in addition to CO2 emission cuts Source: Carbon Disclosure Project, 2010
• The premium charged for selling “greener” goods
Source: Accenture, Survey of 250 Senior Executives, May 2012
• Qualifying externalities
$19billion
+27% productivity
5% to 20% premium
30
Integratedreporting
4.4 The value of measuring value
Measuring value creation is not so much a theoretical discussion anymore. There is a clear trend toward organizations displaying their value innewways.However,werecognizethattherearechallengesorganizationsmustfirstovercometo effectively measure and monetize their value.Tostartwith,therearemanytechniques,butnoconsensus,onhowtomeasureandmonetizekeyimpacts particularly natural and social capital. This lack of a global monetization guideline therefore limits consistency and comparability of monetized outcomes between organizations. There is however a number of movements aiming to create more globally accepted frameworks for this type of information.Forexample,theNaturalCapitalCoalition is trying to form a standard for valuing natural capital in business.Secondly monetizing externalitiesposesachallengeasit’sheavilybasedon assumptions. That is why organizations should be transparent in explaining their assumptions and what kind of limitations they have in terms of access todata.Anotherchallengeariseswithfinancialreportingrequirementsinmajorfinancialcenters.Insomeregions,theremaybelimitationsonwhatcan be disclosed in terms of monetized value within an integrated report. The IIRC should continue discussions with regulators about these limitations. Finally,revealingexcessivedetailregardingmonetizedvaluecanbeseenasarisk,especially
sincesomeorganizationscurrentlyalsobenefitfrom investors not understanding their full (negative) impact on certain externalities. This is a challenge we believe could be overcome by either reporting improvements or require organizations to communicate negative externalities.
Despitethesechallenges,wesupportmovingtowardamoreholisticpictureofanorganization’svalue,includingmeasuringandmonetizingit.Mostimportantly,monetizationclearlydemonstratesthe extent of the positive or negative impacts on each of the capitals caused by the value-adding activities of the business model. It also assists in the strategic decision-making process of ensuring thatgrowthinone’svaluecapitaldoesn’tdepend(at least excessively) on the destruction of another capital’svalue.Ultimately,italsoservestoprovidestakeholders with a clear and concise answer to their recurringquestion:“what’sinthisforme?”
Quantifying externalities
6509 - EY Int Report v18.indd 30 09/05/2014 13:38
Page 18, Appendix 1
• Brand equity
Bran
d re
cogn
ition
Royalty rate (% over sales)
A-H are comparable brands to the brand being valued
1. We analyze comparable royalties in the industry to determine the correlation with possible value drivers (e.g., brand recognition).
3. By multiplying the royalty rate by the forecast sales of that brand’s products, we can estimate the yearly savings the organization has by owning the brand instead of licensing it. The value of the brand is the present value of the sum of the future royalty savings.
2. We rank the brand we want to value according to its brand recognition, resulting in an estimated royalty rate.
3% 6% 9%
xF G
A
H
B
E
C
D
31
Appendix iMonetization of intangibles in practice: case studies
Case study 1: Increase in brand equity due to higher brand recognition as a result of a corporate social responsibility (CSR) initiative
The“relieffromroyalty”method,themostcommonlyusedbrandvaluationapproach,isbasedon the premise that the owner of a brand obtains abenefitfromholdingitinsteadofhavingtopaya royalty for the use of a third-party brand. Brand value is thus the present value of the stream of future royalty savings. To estimate the stream of royalties,royaltyratesareanalyzedforcomparableindustry brands or trademarks.
The royalty charged for the use of a brand tends tobecorrelatedtothatbrand’smainvaluedrivers.In the example below we see how higher brand recognition on the part of the general public leads to higher royalty charges for its use by third parties and,therefore,higherbrandvalue.
Relief from royalty method
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Page 19, Appendix 1
• Increasing brand equity
Bran
d re
cogn
ition
Royalty rate (% over sales)
F
A
E
B
D
C
G
H
A-H are comparable brands to the brand being valued
The implemented initiative allows for higher brand recognition which, in turn, makes the brand comparable with a brand with a higher royalty rate (all other things being equal)
32
Integratedreporting
Inthiscase,theorgainzationchampionedamerit-based foreign university scholarship program that proved highly popular among young university-goers and their families and peers. The initiative garnered widespread media coverage and was quickly associatedwiththesponsoringfirm’sbrand.
Ayearaftertheinitiative,theorganizationmeasuredits brand positioning in an independent ranking of brands. Recognition levels were used as the KPI.Accordingtotheindependentstudy,theorganization’sbrandhadclimbedfrom28thto10thplace. In a fresh valuation of the brand in the wake of theCSRinitiative,theroyaltyusedtocalculatetheorganization’s“relieffromroyalties”washigherthanthe rate used in the valuation exercise performed priortotheinitiative.Thissuggeststhat,allotherthingsbeingequal,theorganization’sbrandhasincreased in value.
Measuring the value creation in the brand
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Page 20, Appendix 1
• Customer cash flow over time
Cash
flow
s pr
oduc
ed b
y ex
istin
g cu
stom
er re
latio
nshi
ps
As a result of client attrition, cash flows attributable to the existing client relationships tend to drop. The more loyal the customers, the flatter the curve will be, and therefore the higher the cash flows produced by that intangible asset.
As a result of the fall in attrition, the cash flows expected in the future increase.
$
Time
33
Case study 2: Increase in the value of an organization’scustomerrelationshipsthanks to an environmental initiative
The “multi-period excess earnings” method is the most common and widely accepted approach to valuing the intangible assets deriving from customer portfolios. It consists of estimating the present value of the “excess earnings” attributable to the customer portfolio over the useful life of the asset.
Excessearningscanbedefinedasthe difference between:
►►►• Theafter-taxcashflowsattributabletothecustomer base in existence on the acquisition date
►►►• The cost implied by the capital invested in all the
otherassets(tangibles,intangiblesandworkingcapital) used to maintain the customer relationship
►►►The value of the resultant intangible asset corresponds to the present value of this excess of earnings over the useful life of the asset. The highertheriskofthecashflows,thelowertheirpresent value.
Forexample,clientrelationshipsbasedon long-term contracts will have a higher value than those with no contract base.
Inthisexample,theorganizationundertookaninitiative that delivered a 25% reduction in the volume of GHG emissions generated in the production of its core product. The organization communicated this environmental achievement to the media. It highlighted that the initiative made its core product the most environmentally friendly of its class.
Followingtheinitiativeandmediacampaign,theorganization measured customer relationship. Customer loyalty was used as the KPI. The survey results showed that 45% of those polled claimed that theywouldcontinuetousetheorganization’sproduct even “if there were a similar product on the market that cost up to 15% less.”
Withthisinitiative,theorganizationmanagedtoreducethenaturalattritionrateofitscustomerbase,thereby increasing the value of this intangible asset. Inthisexample,aninitiativeaimedatmitigatingnegative externalities has turned into an increase intheorganization’sintangiblevaluethroughthecommunication process.
Measuring value creation in customer relationships
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Page 22, Appendix 1
• Human capital opportunity cost
Recruiting costs
Cost of on-the-job learning and tacit knowledge to reach an employee’s full productivity potential Training expenses
• The more difficult it is to replace a workforce in its current state of productivity, engagement, motivation, etc., the greater its value. This is based on the premise that a quality workforce contributes to the future cash flows of the organization.
34
Integratedreporting
Case study 3: Increase in the value of an organization’shumancapitalasa result of a career development and retention effort program
The most widely used method for valuing human capital as an intangible asset is to measure its replacementcost.Todoso,it’snecessarytoestimate all of the costs the organization would have to incur in order to substitute its existing employees,includingrecruiting,hiringandtrainingcosts,amongothers.
Often,themostsignificantcostitemisthetimeelapsing (measured in terms of wages) between the time a new employee starts on the job and the moment they attain the required level of know-how and expertise.
Ahighlyspecializedworkforce,requiringspecifictraining,willbemorevaluablethanaworkforcewithout any such specialist know-how. This is reflectedinthehigherrequiredtrainingcosts.Similarly,anorganizationwhoseworkforce’smostvaluable contribution is its experience will require a longer period of time (therefore higher costs) to replace if these experienced people move on.
The value of the intangible asset in this case is the sum of all of the costs needed to replace the organization’shumanresourcesasawhole.
Human capital opportunity cost
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Recruiting costs
Training expenses
Page 23, Appendix 1
• Measuring value creation in the workforce
• Initiative
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||| Value of employeesat full productivity potential
Value of the workforce after the initiative
Value of the workforce before the initiative
Value created in the workforce as a result of the initiative
35
Inthecaseathand,anorganizationsustaining an annual employee turnover rate of over 30% (a KPI measured regularly) set in motion a raft of measures designed to enhance employee career development and retention. When this KPI was remeasuredthreeyearsaftertheinitiative,itsannualturnoverratehadfallento19%.Moreover,theinternalpromotionoftheorganization’semployees had given them a command of theorganization’sproductsandmarketsthatsurpassed that of any competitor.
In the year after the organization announced thedeclineinitsturnoverrate,itwasacquiredbyaprivateequityfirmthatmentionedinthepressthat“thequalityoftheorganization’shuman resources was the highest of any of the organizationswelookedat.Wearefullyconfidentthat,withtheirexperienceandmotivation,wewillmanage to bring the organization to the global leadership position it deserves.”
This concept is depicted in the chart below:
Measuring value creation in the workforce
● Valueofemployeesat full productivity potential
● Training expenses● Recruiting costs
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Phase 1 Phase 2
• Qualitative analysis of forces around KPIs
• Quantification of impact of organization’s initiatives on KPIs
• Analysis of quantifiable effects of KPIs (e.g., productivity)
• Cost analysis of organization’s initiatives: how much needs to be spent to improve the KPI by X%?
• Effect analysis of changes in a KPI (e.g., productivity rises by X%, what does this mean in terms of revenue?)
36
Integratedreporting Appendix ii
Externality valuation in practice
The organization’s need
TosupportitsHRstrategy,alargemultinationalwanted to know the monetary impact of social changesintheorganization.Forinstance,itwantedto place a value on changes in employee engagement and retention.
EY’s approach
The approach consisted of two phases:
1. Identifying and quantifying interactions around social KPIs
2. MonetizingchangesinKPIs(e.g.,whatis the$effectofa1%increaseinemployeeretention?)
Business case
Valuing human capital Monetizing the effects of changes in social KPIs
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Effects
Management qualityManager trainingmanager assessment (3600 and associated reward)
Remuneration strategyBonus systemShare ownership, employee participation planFair treatment
Incentives
Career opportunitiesInternal mobilityPromotion
Organization’s key tool to enhance retention rate
Retention rate
Service qualitySales turnover (customer loyalty;recommendations from client)
Productivity rateSales turnover
Key quantitative indicators with direct impact on turnover and operational costs
Employee turnover rateCost of replacement (recruiting; training; temporary loss of productivity)
Sales turnover (recruiting staff renewal and innovation)
Social HR KPI
37
• Ability to leverage available literature on social performance
►►►►►• Innovative use of available HR data from the
organization to identify trends and interactions
►►►►►• Validation of hypotheses through working groups and interviews at every level of the organization
►►►
We used quantitative methods to measure interactionsaroundKPIs,e.g.,therelationshipbetween staff engagement and their productivity.
This approach allows:
►►►• Quantificationofthelinksbetweenpredictorsandoutcome variables
►►►• Measuringifthelinksarestatisticallysignificant
►►►• Identificationofthenatureoftherelationship
(linear,exponential,etc.)
Illustration of qualitative analysis of interactions around a given KPI
Value from our approach
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• Water and energy consumption
• Study of correlations between certification and resource consumption across 300 hotels
• Survey of 230 hotels to measure the costs and workload for implementing environmental certification
• Statistical comparison of customer KPIs of 300 certified hotels versus 200 non-certified hotels
• Environmental opex/capex
• B2C sales
• B2B sales • Interviews with 26 account managers on 46 key accounts
38
Integratedreporting
The organization’s need
An international hotel chain wanted to know the costsandbenefitsofISO14001environmentalcertificationofitshotels.Inparticular,towhatextentdoescertificationattractcustomersandincrease sales?
EY’s approach
Four studies were conducted in parallel to evaluate theimpactofISO14001certification:
Business case
Eco-premium of green products Demonstratingthebenefitsofenvironmentalcertification
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Page 25
B2C customer satisfaction: certified versus non-certified hotels 5 years after certification
Estimation of workload for implementing certification
ª Certified hotelsª Control group of hotels
*=Statistically significant
Total workload in days
ª Before certificationª Additional workday after certification
7,3667,505
Difference of 2.7%*
General satisfaction
6,9527,161
Difference of 3%*
Recommendation
5,7125,849
Difference of 2.3%*
Value for money
7,3667,505
Difference of 2.7%*
General satisfaction
6,9527,161
Difference of 3%*
Recommendation
5,7125,849
Difference of 2.3%*
Value for money
Collect and archiverecords — HR
Environmental training sessions for employees
Preparation and follow up ofenvironmental internal audit
Preparation and follow upof certification audit
Collect and archive records —restaurant and bar
Collect and archive records —maintenance/technical
Collect and archive records —environmental management system
Collect and archiverecords — reception
Information of clients onenvironmental issues
Collect and archive records — room keeping
Environmental trainingand awareness
1 2 3 4 5 6 7
• Demonstrating the benefits of environmental certificationPage 25
B2C customer satisfaction: certified versus non-certified hotels 5 years after certification
Estimation of workload for implementing certification
ª Certified hotelsª Control group of hotels
*=Statistically significant
Total workload in days
ª Before certificationª Additional workday after certification
7,3667,505
Difference of 2.7%*
General satisfaction
6,9527,161
Difference of 3%*
Recommendation
5,7125,849
Difference of 2.3%*
Value for money
7,3667,505
Difference of 2.7%*
General satisfaction
6,9527,161
Difference of 3%*
Recommendation
5,7125,849
Difference of 2.3%*
Value for money
Collect and archiverecords — HR
Environmental training sessions for employees
Preparation and follow up ofenvironmental internal audit
Preparation and follow upof certification audit
Collect and archive records —restaurant and bar
Collect and archive records —maintenance/technical
Collect and archive records —environmental management system
Collect and archiverecords — reception
Information of clients onenvironmental issues
Collect and archive records — room keeping
Environmental trainingand awareness
1 2 3 4 5 6 7
• Demonstrating the benefits of environmental certification
Page 25
B2C customer satisfaction: certified versus non-certified hotels 5 years after certification
Estimation of workload for implementing certification
ª Certified hotelsª Control group of hotels
*=Statistically significant
Total workload in days
ª Before certificationª Additional workday after certification
7,3667,505
Difference of 2.7%*
General satisfaction
6,9527,161
Difference of 3%*
Recommendation
5,7125,849
Difference of 2.3%*
Value for money
7,3667,505
Difference of 2.7%*
General satisfaction
6,9527,161
Difference of 3%*
Recommendation
5,7125,849
Difference of 2.3%*
Value for money
Collect and archiverecords — HR
Environmental training sessions for employees
Preparation and follow up ofenvironmental internal audit
Preparation and follow upof certification audit
Collect and archive records —restaurant and bar
Collect and archive records —maintenance/technical
Collect and archive records —environmental management system
Collect and archiverecords — reception
Information of clients onenvironmental issues
Collect and archive records — room keeping
Environmental trainingand awareness
1 2 3 4 5 6 7
• Demonstrating the benefits of environmental certification
39
Value from our approach
• Demonstration of the impact of ISO 14001 certification: reduction of water and energy consumption,increaseofB2Bsales,B2Ccustomer satisfaction
►►►►► • ROI estimation ofISO14001certification
►►►►►• Recommendations for environmental
management systems►►►
B2C customer satisfaction: certifiedversusnon-certifiedhotelsfiveyearsaftercertification
Estimation of workload for implementingcertification
● Beforecertification● Additionalworkdayaftercertification
● Certifiedhotels● Control group hotels
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• EV scenario analysis
• Translating company impact into measurable externalities (e.g., employment, CO2 emissions, health, consumer surplus)
• Barriers analysis
• Global value created
• Impact on EV market
• Analysis of different EV market share evolution scenarios; consolidation into a vision of three different evolution scenarios
• Analysis of barriers for EV development; measuring the influence of barriers in different EV development scenarios
• Quantifying the extent to which organization’s actions address barriers for EV development, and hence boost EV market share
40
Integratedreporting
The organization’s need
The organizer of an electric racing competition in Europe wanted to measure the potential “sustainabilityvalue”generated,throughsupportingtheelectricvehicle(EV)market.►►►
EY’s approach
A four-stage approach for estimating the organization’spotentialboosttotheEVmarket and translating this contribution into positive externalities.
Business case
Valuing environmental risk and resilience Measuring business sensitivity to environmental factors
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Page 28
• Promoting sustainability impact and “extended value”
20%
24%
22%
15%
19%
• Initial cost of the car• Running costs of the car• Maintenance• Residual value of the vehicle
• The relative influence of each barrier on EV market share is quantified by considering three criteria:
• Charging time• Consumer awareness, “eco-aspiration”• Range anxiety• Safety: noiseless driving electrocution risk
• Climate regulation (CO2)• Air quality regulation (NOx, SOx)• Environmental impacts (Well-to-Wheel)• Uncertain government incentives and support
• Battery capacity• Car performance, especially durability• Charging time• Battery performance (cycles)
Potential impact on the EV penetration success
Complexity and the effort needed to overcome the barrier to achieve mass-production by 2020
Influence of barrier on the other evaluated barriers
• Grid capacity• Charging infrastructure
• Regulatory barrier
• Infrastructure barrier
• Social barrier
• Technological barrier
• Pricing barrier
1
2
3
Page 28
Green growth
77 million
• Promoting sustainability impact and “extended value”
• additional EVs sold
• created in the car industry
€142 billion• extra sales in the car industry
• for consumers of fuel energy (NPV)
€431billionsavings
42,000 permanent jobs
Social
• significant quality of life improvement in cities
• on health care costs from pollution reduction
€25 billionsavings
Quality oflife improvements
Environmental
4.0 billionoil barrels
• equivalent to 2.5 years ofJapan’s current consumption
• on CO2 costs (NPV)
900 milliontonnes of CO2 eq
• equivalent to 2 years ofItaly’s emissions
€13.9 billionsaved
€ Xbillion
Global valuecreation 41
Value from our approach
• New perspective on EV market and organization’srole
►►►►►• Estimation of organization’s potential
sustainability value (fuelsavings,health,employment,CO2emissions,etc.)
►►►►►• Strategic recommendations for organization
to reach its sustainability impact objectives through its actions
►►►
UnderstandingofEVmarket barriers and their relative strength
Theorganization’s“extended value” measured by its economic,socialand environmental externalities
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Micro-analysis: up-front price of each source of energy
• Estimation of capex, opex, fuel cost and CO2 costs• Calculation of the levelized cost of energy in € per kWh
Macroeconomic analysis: economic benefits of each source
Bibliographic analysis
• Computation of the turnover, global value added and jobs created• Direct, indirect and induced economical effects• Additional effects (security of supply, wind integration costs, etc.)
Impact of wind power on electricity spot prices
42
Integratedreporting
The organization’s need
The organization wanted insight into the external costsandbenefitsofrenewableenergypolicymeasures that are not yet accounted for in the decision-makingprocess(jobcreation,GDP, energy security).►►►
EY’s approach
Wind technology was selected as the referencerenewable energy source and was compared to Combined Cycle Gas Turbine (CCGT). For six countriesandtheentireEU27,thefollowing work was done:
Business case
Valuing externalities Measuring the potential externalities of renewable energy policies
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Page 29
2627
UK
1651
France
1133
Spain
1952
Germany
929
Poland
1227
Portugal
ª Windª CCGT
€ ce
nts
tax
retu
rn/€
inve
sted
(le
veliz
ed)
0
20
40
Opex
Windintegration
costsSecurity of supply
GDPcreation
13.1
42.460
80
100
Wind Wind CCGTCCGT
€/M
Wh
(lev
eliz
ed)
Capex
Indirect
Induced
Direct
Opex
Fuel
CO2
Capex
GDPcreation
Indirect
Induced
Direct
Netcosts
Netcosts
• Business Case: valuing externalitiesPage 29
2627
UK
1651
France
1133
Spain
1952
Germany
929
Poland
1227
Portugal
ª Windª CCGT
€ ce
nts
tax
retu
rn/€
inve
sted
(le
veliz
ed)
0
20
40
Opex
Windintegration
costsSecurity of supply
GDPcreation
13.1
42.460
80
100
Wind Wind CCGTCCGT
€/M
Wh
(lev
eliz
ed)
Capex
Indirect
Induced
Direct
Opex
Fuel
CO2
Capex
GDPcreation
Indirect
Induced
Direct
Netcosts
Netcosts
• Business Case: valuing externalities
43
• Insight into socioeconomic effects ofwindenergyforseveralEUcountries
►►►►►• Analysis of the contribution of windpower
toenergysecurityforseveralEUcountries
►►►►►• Comparison of net costs when integrating all external costs
►►►►►• Calculation of impact of wind energy on
electricity cost
Comparison of levelized cost of energy,includingenvironmentalandsocialcostsandbenefits
Value from our approach
Analysis of tax revenues in different countries
● Wind● CCGT
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• Consolidate performance data
Based on interviews with organization relationship managers, score the degree to which each tenantis sensitive to his or her office’s energy performance
Identify risks of losing tenants, in particular tenants who are:• Sensitive to energy performance• Renting office space with poor performance• Close to the end of their lease agreement
• Segment tenant base
• Identify tenants at risk
For each asset in the organization’s portfolio, consolidate performance metrics such as:• Energy consumption per square meter• Energy expense per square meter
44
Integratedreporting
The organization’s need
Arealestateowner,primarilyrentingoffices, wanted to:
►►►►►• Segment its customer base (tenants) according to sensitivity to energy performance
►►►►►• Measure the risk of losing tenants due to poor
energy performance►►►
EY’s approach
EYdevelopedathree-stepapproach:
1. Consolidate available data and establish energyefficiencymetricsforeachbuilding in the asset base
2. Develop a scoring system for segmenting tenants according to their sensitivity to energy performance
3. Identify tenants who are at most risk of cancelling or abandoning the contract
Business case
Valuing environmental risk and resilience Measuring customer sensitivity of business to environmental factors
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10,000m2
5,000m2
1,000m2
Energy performance improvement potential by 2020
Tenant A, building 1
Tenant B, building 2
Tenant C, building 3
Tenant D, building 4
Tenant G, building 7
Tenant E, building 5
Tenant F, building 6
Ener
gy p
erfo
rman
ce (
kWh
Ep/m
2 yea
r)
25%20%
Tenants at risk of beinglost in the near term
15%10%190
290
390
490
590
690
790
Energy performance improvement potential by 2020
Tenant A, building 1
Tenant B, building 2
Tenant C, building 3
Tenant D, building 4
Tenant G, building 7
Tenant E, building 5
Tenant F, building 6
Ener
gy p
erfo
rman
ce (
kWh
Ep/m
2 yea
r)
25%20%
Tenants at risk of beinglost in the near term
15%10%190
290
390
490
590
690
790
45
Value from our approach
• Identification of segments of customers sensitive to energy efficiency and valuation of the risk faced by the organization of having officespacewithpoorenergyperformance
►►►►►• Integration into B2B marketing strategy ►
of energy performance and tenant sensitivity to energy performance
►►►
Identifying tenants at risk of cancelling or abandoning the contract (early adopters who are most sensitive to energyefficiency,butworkinginofficeswith poor energy performance)
End of lease agreement
● Within 2 years● Within 3 years● Within 4 years
Surface
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• Intangible asset inventory
• Identification of intangible resources controlled by the organization (brand, know-how, licenses)
• Identification of external intangible resources (suppliers, customer base, partners, state)
• Study of each intangible component: virtual operating account, balance sheet, cash flow
• Distribution of value created through CSR policy across the intangible asset inventory
• Intangible asset accounting
• Effects of CSR policy
46
Integratedreporting
The organization’s need
The organization wanted to study the sustainable value of its CSR policy and measure the extent to which CSR has enhanced its intangible capital: licenses,technologies,brandreputation, processes,know-how,customerbase,partnerships,suppliers,etc.►►►
EY’s approach
Our approach consisted of delineating the organization’sintangibleassetinventoryandconnectingthebenefitsofCSRpolicywithsharedvalue creation and intangible asset appreciation.
Business case
Valuing impact on reputation Measuring the impact of CSR policy on intangible capital
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Page 27
• Measuring the impact of CSR policy on intangible capital
Mapping and inventory of intangible capital
Economic analysisof CSR policy
Shared value creation
Society(industry, country, world)
Organization(itself and
stakeholders directly
linked to its shareholders)
External resources(shared
values and externalities)
Internalresources(captured
value)
Society(collective
goods and other
stakeholders)
Stakeholders(directly linked)
Organization(intangible
assets)
Intangiblecapital
resources(strategy
without CSR)
Mapping(organization vs. society)
Mapping(internal vs.
external)Benefits Losses Net impact
Intangible capital(strategy with CSR)
Inventory and
measurement
Consolidation and
reporting
Distribution of impact according to
intangible capital
Societystakeholderorganization
47
• Vision of value added through CSR policy and the impact on enhancement of intangible assets
►►►►►• A multidisciplinary team combining
CSRadvisory,HR,stakeholderconsultation and quantitative modeling to achieve the best results
This is underpinned by a SWOT analysis. The analysis included an estimate of the monetized changes in value of intangible assets as mentioned in the SWOT analysis.
Value from our approach
EconomicanalysisofCSRpolicy,intangible capital and shared value creation
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Page 30
• Main valuation techniques
Totaleconomic
value
• Use values • Non-use values
• Stated preferences• Revealed preferences
• Dose — response/production function*
• Benefit transfer
• Market prices
• Avoidance costs
• Hedonic pricing
• Travel cost method
• Contingent valuation
• Choice modeling
48
Integratedreporting Appendix iii
Methods of economic valuation of externatilities
Main valuation techniques used in measuring externalities
*Doseresponse/productionfunctionapproachisnotavaluationtechniqueperse,butitisanimportantelementofseveralofthevaluationapproaches(e.g.,doseresponsefunctionmaybeusedtoestablishthelinkbetweenairpollutionandhealtheffects).
Source:Pearce,Atkinson,Mourato,“Mainvaluationtechniques,”Cost-benefitanalysisandtheenvironment:Recentdevelopments:TheStagesofaPracticalcost-benefitanalysis,February2006
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