Last week, Wal-Mart announced that it will be creating a new sustainability index. The discount retailer wants its products to get sustainability scores, so that consumers can have greater information to decide which products to purchase. After all, in today's world more matters to some people than price. I applaud the effort, but had several concerns that I outlined in a blog post, the day before their announcement. After that announcement, I sought additional detail regarding those questions. A spokesperson from Wal-Mart responded.
Will Anyone Care?
Naturally, without some really good prophets, it's hard to be sure how people will react. But I pointed out that the biggest issue that could lead people not to care would be if products with high scores turn out to be more expensive. In response to that possibility, a Wal-Mart spokesperson said:
We believe the index will help lower costs, raise quality and bring transparency to the supply chain. Energy is a cost, water is a cost, excess packaging is a cost. As the amount of energy or water used the manufacture, shipment or use of a product or the amount of packaging used on a product is reduced, so is the cost.
If Wal-Mart is right, then I agree. However, if it's right, then I'm not sure why all companies wouldn't already have perfect sustainability scores already -- wouldn't they naturally want costs to be minimized? Is using recycled packaging more expensive? Are cheaper chemicals used in production not as good for sustainability? I can't know all the costs involved for each company, but if the lowest costs result in the best sustainability, I'm not sure why Wal-Mart's index would need to drive them to that end. That would just be smart business.
Producers Have Reason Not To Participate
Will producers participate? Wal-Mart tells me that compliance is not mandatory. But their spokesperson also referred me to the New York Times article that I mentioned. In that article, the Times quotes a few large producers, including Unilever and Procter & Gamble. They're on board. But that makes sense: if these measures turn out to be costly, the bigger the firm, the less that cost will be felt.
Putting a sustainability index like this in place is essentially like non-government imposed regulation. It forces companies to behave in a certain way. If they don't and others do, they will look bad. And like most regulation, it will favor the bigger firms who, given their high production levels, can more easily bear the cost of a few sustainability-driven tweaks here and there. Some of the smaller producers Wal-Mart works with will not be as excited.
Auditing Producers' Claims
I also worried about how Wal-Mart could be sure that its producers honestly answer the surveys it provides in order to determine their sustainability scores. After all, there would be an incentive to lie. Would it conduct audits to ensure veracity? A Wal-Mart spokesperson responded:
We expect our suppliers to answers these questions honestly. We will have ways to verify, both internally and through independent third parties, the responses to our questions, but we don't plan to audit every answer from every supplier.
It sounds like Wal-Mart is working on a sort of web of information verification through third-parties within the supply chains of firms. That's good news. This might not plug every potential hole, but it will keep producers on their toes. Will there be producers that stretch the truth a little? Probably some, at times. But if that's the exception, and not the rule, then I don't see this as a major problem for the index.
Will Competitors Follow?
Clearly, Wal-Mart can't be sure about this, and neither can those competitors. They'll be waiting to see how the index comes together, customer reaction and other factors needed to evaluate it. For this one, only time can tell.
I'll do my best to keep my eye on the progress of the index. I certainly hope it turns out to be a success. If everything works out the way Wal-Mart hopes, it sounds like it could be.
This seems oddly naive. Business process change, industrial process change and cultural change are hard. Companies in general do not operate anywhere close to optimal efficiency despite the fact that doing so would save them money (aka "smart business"). They never have. Real corporate organizations do not remotely resemble theoretical perfect markets and in particular are rarely perfectly rational about decisions that have short term costs and long term returns.
There are many examples of this: US car companies are getting better and some plants are competitive, but if you compare most US car plants over the last 30 years with Toyota they are materially less efficient in their use of materials, energy, space, labor. The key elements of the Toyota production system ("lean manufacturing") have been well known for all of that time--numerical process control, JIT manufacturing, long term relationships with suppliers that locate close by, workers organized in teams with incentives for process improvements, "kaizen", etc. Yet for a long time the US car companies despite clear evidence that they could deliver more profit by adopting similar practices did not (as of today, some have, to some degree).
Why not? Wouldn't that just be "smart business"? Well of course it would, but corporations are not fluid entities that easily respond rapidly to adopt best practices unless they are forced to. US Companies didn't adopt such practices for a long time because (a) they had other strategies for profit and were fairly secure in there market share and it just wasn't a priority to optimize that part of their business even if doing so would be "smart business"; (b) organization structure, corporate cultures, work rules made such process change very difficult.
Dramatic losses in share and profitability slowly forced change on the US auto companies and forced many to adopt or try to adopt some of the best practices of Toyota, and I expect we will see more of that as they come through the current crisis. But that was forced by crisis. Not because it was just "smart business" and corporations are good at optimizing their business when not faced with crisis (which can be market crisis or impositions by government or near monopolies like Walmart).
I worked for years in a large super successful corporation with way above industry average profitability for our sector in the software space. Changes in the competitive market structure (emergence of companies like Google with different business models) made clear to many of us that we would need to change many things to continue to thrive over time. We were not blind or stupid, all of us on the exec team knew this, and we had lots of great strategy discussions about what to do, but investing in the changes required just never had enough urgency because we were making tons of money and change is hard--operating differently required different DNA and real changes in corporate culture. By the time the urgency was there, it was too late. "Smart business" had nothing to do with it.
Thanks for the perspective. If companies regular ignore attempting to achieve the lowest production costs, then that's certainly grim news for business. It completely escapes all logic why businesses would seek higher revenues but not lower costs. After all, either effect will increase profits.
Daniel,
Thanks for the reply. A bit more:
Don't overgeneralize. Many companies are great at optimizing costs and their core essence is about grinding out every last penny of cost. Others are great at innovation. Or brand differentiation. Great companies are good at multiple things. But not even great companies are great at everything, it is very hard to change what you are great at or to become great at fundamentally new things, and companies have to prioritize and can't simultaneously optimize all aspects of their business. So if you take the typical company making consumer goods that sells to Walmart, they obviously have figured out a lot of things and may even be great at some. But it is very unlikely that they have optimized for sustainability even if it could save them money. Because (a) it isn't in their DNA, (b) they probably are not organized and instrumented to even know what their end to end costs are in this regard (their costs are organized in different buckets) (c) they probably have other ways of lower costs (or raising revenues) that they understand better or are a higher priority (eg, optimizing energy and water use might save X, but moving a factory to Malaysia might save 5X. In a perfect world they might do both, but in the real world that would be unlikely.) So an exogenous factor like a new "regulation" from Walmart could be a very powerful catalyst for both sustainability and cost savings that they would not have pursued simply because of "smart business".
A similar story that might help one relate: Almost every homeowner in the US could save 20% (or a lot more) of their ongoing energy costs with some pretty simple changes like replacing incancesdents with CFLs and some low-tech weatherizing. With current common State rebates, a typical "retrofit" would cost somewhere between almost nothing and $500 and payback time would be as short as 1 year or maybe a few years, but with really significant cash savings for the homeowner over 5-10 years. Yet only a trivial percentage of homeowners have done this. Why not? Isn't that just "smart business" and "logical"? Well, it turns out (a) many people value cash in hand more than future savings whether that is in their best interest or not (b) people are really bad at understanding payback models and don't trust them, even if they are pretty well documented (c) people often really don't understand how much they are spending for what, as relates to their energy use (d) 20% savings is pretty material on a percentage basis, and over time adds up to a lot of money on an absolute basis, but for a lot of homeowners still doesn't hit the bar of the top +/- 5 expenses they worry about, and therefore just gets ignored.
dm makes several good points. but, as an environmental consultant let me just point out that costs related to water, energy, packaging, etc are frequently not appropriately internalized.
for instance, you will frequently pay less the more water you use. where is the incentive to decrease use?
what company assumes the cost of disposing of/recycling/composting/re-using the product packaging they use? they don't, so all the cost calculations reflect cost to purchase/use, costs associated with shipping and someone else assumes all the back-end costs.
what wal-mart is doing is attempting to begin to identify and internalize those costs.
adam smith said, "waste is a tax on everyone". unfortunately, most of us don't realize how much we pay for it.
Notchris makes good points. You can add that water is generally not subject to market pricing but is often a fixed/low cost divorced from supply and demand. So there is (relatively) little incentive to reduce water use. In addition to what Walmart is doing, we would all benefit from reforms that would put a true price on water that considers externalities (as Waxman-Markey however feebly are trying to do with Carbon).