Following on from last week’s article that looked at the first of Porter & Kramer’s three main activities for creating shared value – reconceiving products and markets – this week I look at their second one: Redefining productivity in the value chain.

First of all, this is a big topic! The value chain includes all of the value-add stages in the production of goods or services. Their thesis is that societal problems create costs in the value chain, and that reducing these costs can be a source of competitive advantage and financial value.

Therefore, we need to look at the way we source materials, purchase components, use energy, manage employees, distribute products and so on.

For example, Wal-Mart smartened up its use of packaging, which led to significant savings in landfill costs. It also re-routed its trucks and cut 100 million miles from delivery routes in 2009, saving US$200 million. In the process it has addressed societal problems – waste disposal and transport emissions – and created value in forming the solution.

What’s driving this approach?

There is nothing intrinsically new about reducing costs in the value chain as a strategy. What we are talking about here, though, is an appreciation that businesses often push costs onto society. In many cases they exist because that’s the way it’s always been done, the “cost” is not highly visible or because there is no direct financial impact resulting from it.

In the case of Wal-Mart, its transport emissions carry little direct cost – when we look at the risks posed by climate change, we don’t trace the problem back solely to Wal-Mart.

Porter & Kramer argue that a proactive approach to addressing these issues – which often exist in a social or environmental form – are a source of financial opportunity, through productivity improvements, for companies.

Staying with environmental issues for the moment, Nyrstar was able to unlock significant value in its zinc smelting operations at Port Pirie in South Australia. When the government introduced legislation for the mandatory reporting of energy usage, the company saw an opportunity to better understand energy use and wastage in its one hundred year old plant.

Through a comprehensive analysis of its site, it has identified 17 short-term opportunities that will yield $5.5 million in annual savings. Because these are permanent, annual savings achieved at a relatively lost cost, the value of this zinc smelting operation has probably increased by something of the order of $50 million and reduced energy-related emissions at the same time.

At the Novotel Hotel (part of the Accor group) in Wollongong, Australia, its management instigated a range of community related activities to increase the engagement of its staff. As a result, its employees have become the major source of business innovation, leading to cost reductions and / or improvements in the customer experience. They also have a low absenteeism rate. [Follow this link and go to page 4 if you would like to learn more about how Novotel did this.]

This example of engaging with the community as a way of building financial value fits neatly into Porter & Kramer’s value chain category.suppl

Another form of value creation is in our dealings with suppliers, such as raw materials, services or intermediate goods. Traditional business practice has often been to focus on screwing down supply costs. Porter & Kramer contend that this is short sighted, as marginalised suppliers will be less likely to invest in quality improvements and innovation.

Consider companies like Nestle and Pepsi that regularly work with suppliers on a quasi-partnering basis. They work with farmers to share technology and facilitate access to finance in order to improve crop quality and yields. In turn, the extra investment leads to increased prosperity for the famer and the region as a whole.

These examples show how financial returns can be co-created with positive societal outcomes in many different ways in the value chain.

Deconstructing the strategy

The types of activities we are familiar with that fit into this category are ones that we would traditionally call sustainability initiatives. Porter & Kramer highlight the following sub-categories:

1. Environmental factors: environmental impact, energy and resource use
2. Employee productivity: skills, development, workplace safety, health
3. Supplier access, viability and distribution practices

 
Their sub-categories seem a little limited and clunky for mine, but the intent is sound.

Investors and financiers, as the primary suppliers of capital to publicly owned business, are starting to ramp up their understanding and analysis of environmental and social factors. Only five years ago, the practices of companies like Wal-Mart, Accor, Nyrstar, Nestle and Pepsi went relatively unrewarded, meaning that investors were not factoring in the value created into their financial models. A lot of it was filed under sustainability which, in the investment world, has often been a metaphor for “things that companies do with non-commercial outcomes”!

With the advent of initiatives like the Principles for Responsible Investment, which has attracted signatories who control more than US $30 trillion of global investments, rest assured that the market is already developing more sophisticated ways of analysing companies and rewarding them for what they achieve in the value chain. Likewise, they will punish those who are ignorant or poor managers on the basis of risk.

Porter & Kramer are not the only ones to begin recognising that value creation that is going on here, however, they come at it from a very bottom-up competitive strategy angle, which is a useful perspective and can only serve to increase discussion and raise the bar on these practices. Another perspective can be garnered from (David) Blood and (Al) Gore, who run Generation Investment management, in a recent Wall Street Journal piece.

The successful firms of the future will be those that possess the management ability to:

• Understand and evaluate societal issues in the context of their business
• Put the consideration of environmental and social factors at the centre of their strategic thinking rather than at the periphery; and
• „Be able to take strategic initiatives from idea to execution, and attain the financial returns that come with it.

 
Most of all, having a sufficient level of intuition, strategy formation, leadership, and execution skills will continue to be a rare commodity in business. Those firms that manage to do it and do it well may enjoy the spoils on offer as their competitors struggle to close the gap.

In next week’s piece, I’ll look at the third, and in some ways most interesting, of the three strategies: enabling the development of business “clusters”.