Determining the right price for your products is one of the first lessons entrepreneurs learn. In a market economy, the price is the mechanism to reconcile demand and supply. If an entrepreneur sets prices too cheaply, (s)he will not make any profit. If prices are too high, demand will disappear. Finding the right price is consequently essential.
But what happens if a price in the market doesn’t adequately reflect all (production) costs?
What mechanism leads to the situation that sustainably produced goods often are sold for higher retail prices than conventional peers, or pears if you like? At Soil & More Impacts we argue for a closer look towards current price setting in the food market. With our expertise at the farm level, by researching global food value chains and applying more inclusive standards, we discovered that prices in the current food markets do not fully reflect all costs involved with producing the food. Often, large parts of the costs are hidden.
Incentivized to push past our planet’s limits
Not accounting for all costs makes a firm’s profit look better. Capital providers would have surely applauded here for. But it also triggers adverse behavior. Driven by insightful reports from scientists, NGOs, governments, and businesses, we have learned that the currently predominant systems for food production, distribution, retailing and consumption are causing significant damage to the planet and its people. The system pushes us through planetary boundaries and enhances social inequality.
As an example: The agriculture and forestry sectors, directly and indirectly, contribute to about 24% of the global greenhouse gas emissions. Half of it occurs through the energy-intensive manufacturing and application mainly of nitrogen-based fertilizers as well as general agricultural practices. The other half happens through deforestation in order to expand the arable land. Increasing production in such a system is logically unsustainable.
A view from a wider angle, based on monetizing impacts
By applying a broader lens to prices and value creation, other outcomes become logical: By implementing a system in which we account for profit, people, and the planet. Indeed, companies do not only have responsibility for generating economic value, but also for creating environmental and social value.
This broadened view echoes the idea that companies need to earn their stakeholders ‘willingness to support’ to achieve long-term continuity. The business world is increasingly recognizing its responsibility towards all stakeholders, recently underlined by BlackRock- the world’s largest asset manager. Using a wider lens reveals information about the future perspectives of a company, an essential determinant of creditworthiness. Insights into real costs of producing are therefore well received by capital providers assessing food & farming companies.
An important step from stakeholder - supported production to creditworthiness is internalizing externalities. Externalities can be both positive and negative impacts (costs and benefits) of the company’s economic activity experienced by unrelated third parties. In the current production system, associated costs are not included in prices. In many cases thus not borne by parties who cause them. Not including negative externalities leads to market imperfections. And so, consumers (and society) pay for cheap food in many ways - not just at the checkout.
Walk the talk
Transparency and the ability to talk in a common, well - understood monetized denominator (€ or $) about externalities would help stakeholders to make better decisions. Accurate cost accounting (TCA) enables stakeholders to understand more about the scale and nature of these externalities. From a business perspective decreasing negative and increasing positive impacts of a company raises revenues, reduces risk and saves costs.
Together with our partner Eosta, Europe’s leading organic fruit & vegetables distributor, we have applied the TCA concept on their business. In a pilot we calculated a Profit & Loss (P&L) account based on estimated actual costs; together with other value chain actors in food, farming, and finance. Besides Eosta, also GLS and Triodos Bank embarked on this journey, as well as the organic tea brand Lebensbaum and NGO Hivos.
Together with EY, we have used FAO numbers and the Natural Capital Protocol for monetizing the use of soil, water and the impact on climate change and biodiversity, as well as social aspects as education and health in several fruit and vegetable categories, coffee, tea, and herbs.
To calculate we based our modeling on existing and business - proven, accessible tools, e.g., Cool Farm Tool (cCO2E), ClimWat and CropWat (water) and RUSLE (soil erosion). All these variables can be used - based on international standards to monetize impacts.
What is more expensive?
The results from this pilot are in line with other research in the food industry on country or meta company level. The current, efficiency-driven, ‘conventional’ way of producing has many hidden costs. But even ‘just’ implementing the EU organic standard is not good enough to avoid all external costs.
We argue that if in the future the sector has to internalize part of these external costs, may be due to upcoming legislation around COP21, P&L accounts of Food companies will show significant declines. Now players still hold the helm for positive change themselves, and the planet has some time left. Rather soon boundaries will limit the sector’s ability to prosper; say hello to Cape Town April 22nd! Doing business and making investments needs to be done based on true prices for resources we depend on.
Volkert Engelsman, Eosta’s CEO concluded after the pilot “… a more realistic assessment of risk in food and agriculture is also purely in the self-interest of the financial sector. If banks want to ensure a long-term profit, they can no longer ignore the fact that True Cost Accounting is in the best interests of the planet and its inhabitants.”
Soil & More Impacts are more than happy to discuss with you how to effectively incorporate sustainability issues into the corporate decision-making processes. By managing, measuring, monetizing and marketing impacts a company puts itself on a higher path of creating long-term, ongoing values.
More info at www.soilandmore.com