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Environmental Shareholder Value 9 Earnings: sales growth and operating profit margin9.1 Competition in the sector In order to create Shareholder Value, the company must be able to create earnings. In this connection, the important factors are: sales growth, operating profit margin and tax on income. In this section however, we will only look at sales growth and operating profit margin, since tax on income is not relevant in an environmental context. This is because Danish income taxation has no direct relation to the environment, so there is no tax-related benefit or penalty for companies with regard to environmental initiatives. However, it is possible to save on specific taxes as mentioned in the investments section. Sales growth is an important parameter to create a free cash flow, since this is the way greater amounts of money can be earned. However, growth is not an objective in itself if it does not create a greater profit. It is therefore important to compare sales growth with the operating profit margin. In order to achieve the greatest possible earnings, we basically need to sell as much as possible (sales growth) at a given price, which should preferably be as high as possible. Of course, this requires that the company's product is attractive to customers - and preferably more so than the competitors' products. As a basis for the further analysis of the relationship between earnings and the environment, we have decided to take as our point of reference the competitive situation of the company as described in Michael E. Porter's Five Forces model (1980, 1985). According to Porter, there are five overall parameters that decide the competitive situation of the company.
Figure 6: Porter's Five Forces model The five factors of the model give rise to the following general questions (Lægaard & Vest, 2003, p. 60-61):
The rationale of the model is that the earnings potential of the sector decreases the stronger the five forces are. However, companies may be positioned very differently within a sector, and the company that is strongest with regard to the five forces "wins" the earnings. In the following sections, the five forces will be described and we will assess how the environment can push the forces in different directions. 9.1 Competition in the sectorThe level of competition within the sector depends, amongst other things, on how many competitors there are and their size in relation to each other. Moreover, it is important if the sector is experiencing growth and the market is increasing, or if there are internal battles over a stagnating market. In addition, it is significant for competition if the products of the sector are very similar and where it is easy for customers to change from one product to another. Very homogeneous products lead to a higher risk of price competition and reduce the loyalty of customers because it is easy for them to switch to a competing supplier. Some of these parameters are not immediately possible to change, but the company basically has two options to improve its competitiveness in relation to the other companies: competition on price or product differentiation. Here, environmental conditions may have a significant influence. With regard to competition on prices, the production costs can be reduced as a consequence of making environmental performance more efficient and thus give rise to reduced prices. Legislative environmental requirements requiring environmental investments may, on the other hand, make production more expensive and thus place the company in a less favourable competitive position. However, this disadvantage is not important if the same legislation applies to competitors as well. Over the years, some companies have reduced costs by "dumping" the environment. However, since this poses a great risk for the company's reputation and since more and more countries now apply the "polluter pays" principle, such a strategy could backfire. It is also possible to differentiate products environmentally. The company may market its product as environment-friendly and will thus give it an advantage over products that are less environment-friendly. Of course, this requires that the company can document that the products or the production is more environment-friendly. Some companies do this through environmental certification of production or by having their products ecolabeled. Other companies choose to make an environmental information label that talks about the product's environmental impacts, or they provide more general information about their environmental performance in environment or sustainability reporting. 9.2 Threats from new competitorsThreats from new competitors depend particularly on the access barriers and how the established companies are generally expected to react to a new company in the sector. Environmental conditions may form access barriers for new competitors. If a country has restrictive environmental legislation, it may be difficult for companies from abroad to meet these requirements and thus enter the market. For example, this has been pivotal in the Danish debate on the return system where legislation on the use of glass bottles kept companies out of the Danish market. Established companies may also form barriers by having a certain environmental standard and by having created expectations of this among consumers. 9.3 The bargaining power of the customersThe more dependent the company is on individual customers, the greater the bargaining power of those customers and thus the possibility for them to put pressure on the price and make requirements for the product. As described in the section about competition in the sector, the bargaining power of customers is also dependent on the extent of product differentiation in the sector and how easy it is for customers to switch to a competitor. Again, the environment could be a parameter that could strengthen the company's product in relation to the customers. According to information from the European Commission on the eco-label, the Flower, four out of five consumers are willing to pay more money for a product, provided that it is checked by an independent organisation. The company could thus stand stronger in relation to certain customer groups if it has an environment-friendly product. 9.4 The bargaining power of the suppliersThe bargaining power of the suppliers depends on how easy it is for the company to switch suppliers and whether the supply risks becoming a restriction of the development of the company. If a company commits itself to environment-friendly purchases, this may increase the bargaining power of the suppliers because the choice of suppliers is reduced. The environmental product itself may also be limited. For example, this applies to FSC labelled wood that guarantees sustainable forestry, because there are relatively few suppliers in relation to the total market. 9.5 The threats from substitute productsSubstitute products include products from other sectors that may cover the same need and thus displace the company's product from the market. This consideration is very relevant with regard to the environment. One example could be energy generation being substituted by the production of insulation materials. It could also be car production being substituted by public transport or similar. In view of this, the company must be aware of the environmental trends and assess whether its product has an environmental profile that makes it likely that some customers will try to find substitutes. Some companies start at their own initiative. Years ago, a company like Royal Dutch Shell redefined itself from being an oil company to being an energy company, and the company now also works with alternative types of energy. The focus on the environment could thus contribute to business innovation which is very important to create long-term Shareholder Value. 9.6 SummaryEnvironmental conditions may entail both risks and opportunities for the company when it comes to earnings. It will vary from company to company whether the environmental initiatives lead to a more or less expensive product. In some sectors, environmental concerns will be a minimum requirement from customers so that there is no benefit to be gained by living up to them, but in fact a risk is taken if the company does not live up to them. In other sectors, a green image or a product that is environmentally advantageous has a competitive edge in relation to current and future competitors. Likewise, the threat from substitute products could be smaller if the company has an environmentally sound alternative. It could, however, entail a risk if the company is dependent on special environmentally certified suppliers. Conversely, a company that has less control of its environmental conditions or is not optimising its products environmentally could run a risk of being driven out of competition by new, more environment-friendly products or substitute products. It may also face customer requirements that could be difficult to meet. The risks may not be great at the moment, but any company must consider possible future risks. Thus, it is not possible to say that environment-friendly companies will generally have higher or lower earnings than less environment-friendly companies. This would require an analysis of the competitive conditions of the individual company.
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