A company wanted to better understand the financial value of its Corporate Social Responsibility efforts. We found that CSR is greatly appreciated by the employees but adds little or no revenue from the customers. Investors need to consider CSR as an insurance premium that lowers the business risk and thereby indirectly increases the value of the company.

Context

ValueMetrix AB is a small R&D firm in the management field. It is located in Stockholm, Sweden, but draws on many years of experience from consulting work and management positions in various industries and companies across Europe and the US.

ValueMetrix has the cause-and-effect methodology, software and experience for reliably quantifying the linkages between actual financial performance and the responses given by customers, employees and other stakeholders in surveys. The quantitative part of the methodology uses factor analysis and structural equations. The methodology is a combination of competencies from survey analytics, controllership, management consulting, and pure business management. It is described in further detail in the “Capturing Trends, Managing Attitudes…” document, also published on the MIX site.

A ValueMetrix analysis typically reveals that the linkages between financial performance and survey responses greatly differ from conventional wisdom: Efforts to improve survey scores are often a profitability trap.

Instead companies need to address the attitudes of their stakeholders in an innovative, holistic manner where the driving forces of several stakeholder categories are combined into coordinated actions with long-term financial success as the goal.

This story illustrates this.

The new CFO of a state-owned company managing vast forests in Sweden, below referred to as “the Company”, was concerned about the span and level of resources that the Company allocated to actions under the Corporate Social Responsibility banner. ValueMetrix was asked to help him review to what extent these resources were creating financial value to the owner.

Triggers

Already in 1970, after my first year in business school, I helped the Italian sales subsidiary of a Swedish steel company improve profitability by redesigning their sales management system.

Ever since, I have been intrigued by the drivers of business performance:

As a business controller and assistant to the CEO of an international trading company
As a McKinsey strategy consultant
As the CFO of a European consumer products company
As a member of the Swedish management team of Digital Equipment Corporation
As a management consultant linking various kinds of stakeholder attitudes to financial performance

In the latter role, I was originally attracted to Customer Satisfaction because of the positive message and as an appealing way to improve corporate financial performance.

I sold Customer Satisfaction successfully to leading European companies for several years as a partner in CFI Group, the consulting business of Prof. Claes Fornell at the University of Michigan. Prof. Fornell is also the founder of the American Customer Satisfaction Index (ACSI) and similar national satisfaction measures.

However, despite many serious attempts during these years, neither Prof. Fornell nor my own analyses of client data convinced me of the universal financial blessings of Customer Satisfaction.

So I continued exploring how attitudes can be linked to financial performance, extending and modifying the cause-and-effect methodology used in the ACSI and by CFI Group.

I invested in efficient software to be able to evaluate alternative linkages quickly and to directly see the results and the associated reliability measures in graphs; otherwise the linkage testing would have been too cumbersome.

As part of this development work, I had the opportunity to apply the ValueMetrix approach successfully to such measures as customer satisfaction, supplier attractiveness, and employee satisfaction and motivation.

When asked to help estimate the financial value created by the Company’s CSR efforts, I was attracted by the challenge to clarify some of the mysteries around the vividly discussed but vaguely defined CSR concept and its many promises.

Several academic researchers have used publicly available information about companies’ efforts in the CSR arena and compared them with publicly available profitability and market value data for the same companies, claiming that the positive correlations prove that CSR creates value.

Such analyses are insufficient and misleading. The conclusions have been drawn without eliminating the possibility that there are external factors, such as the business cycle, that explain the correlations.

Just consider this: During good times, many costs tend to increase; when times get tough, the costs are cut back again. Had the researchers had access to company-internal cost data, they would probably have found similar correlations between financial performance and such items as travel expenses, advertisements, product development, HR training programs, bonuses etc.

There are also reporting issues to keep in mind. As CSR got increasing public attention, companies tended to expose actions that previously had been hidden among other costs and actions. This further strengthened the business cycle-driven correlations.

To anyway get an up-to-date view of CSR experts’ thinking and methodologies, I began my assignment for the Company by contacting some 20 CSR-labeled organizations around the world. Could they suggest a methodology for estimating an optimal level of CSR costs? None of them could.

So we went ahead with the methodology, software, and experience of ValueMetrix. It has been designed to solve this kind of challenges. It is equally applicable to the attitude-behavior linkages of all stakeholders, be they investors, customers, employees or indirect stakeholders. If the Company’s CSR efforts do have a measurable financial value, it should show up in our analyses.

Key Innovations & Timeline

The key innovation of this story is to establish a direct linkage between the Company’s CSR actions and the value of the entire company as determined by investors.

This is an orthodox definition of value creation, but it is the only definition that avoids sub optimization and it is holistic as it takes all aspects of the Company’s actions into consideration.

It also incorporates the Company’s competitive situation, a necessity in today’s complex, international business world.

Had the Company been listed on a major stock exchange and tracked by many financial analysts, we would have included their assessments of the Company’s present and future operational performance in an investor survey. From here we would have derived a direct measure of the value of the Company’s CSR efforts.

However, such a survey is not possible for 100% state-owned companies. There are no external analysts who systematically evaluate these companies and the ministers and their representatives can hardly be interpreted using surveys and quantitative analyses.

So instead we needed to consider how companies generally are valued by investors on the financial markets, namely as a function of the companies’ likely future profitability and risk.

This meant that we had to draw our conclusions based on estimates of how the Company’s CSR actions would impact on the behavior of its customers, employees, and selected indirect stakeholders and thereby on the Company’s profitability and risk.

Obviously this is a much bigger engagement than just surveying the investors.

Initially, I thought this engagement would take some two to three months to finalize. In reality, the timeline for the entire engagement – from the first idea until the complete results had been delivered – extended over one year.

It took roughly three months to write proposals and get acceptance from first the CFO and then the CEO. It took another three months to get hold of the raw data of existing surveys, re-analyze them, interpret them, and get the approval from the rest of the management team to carry out additional surveys for those stakeholders from whom we had insufficient data. It took yet another three months (including summer holidays) to agree on new questionnaires and get access to e-mail addresses to all the stakeholders to cover in new surveys. The last three months were needed for data collection, the analyses, and preparing and presenting conclusions.

The actual time I spent on this assignment was much shorter, or about the two to three months I had in my original estimates.

Challenges & Solutions

In ValueMetrix I already had the methodology, software, and experience needed to link stakeholder attitudes to financial performance. (You can read about in my MIX document called 'Capture Preferences, Manage Attitudes for Success in an Ever-Changing World'.) Our challenge now was to adapt this approach to the CSR concerns experienced by the Company.

The Company had measured stakeholder attitudes before, but without co-ordination and without attempting to do any financial linkages. We began by reviewing these surveys to see if they could be re-analyzed to get a grip of the CSR issues.

To catch the customer perspective, we accepted to use a recent customer satisfaction survey which also included several CSR-related questions.

Here our challenge consisted of adding profitability measures per respondent. The Company’s financial reporting system allowed us to extract volumes, average prices, and two levels of contribution margins per product category and customer. With a bit of luck and patience, we could tie the individual survey responses back to each customer, a basic requirement for properly doing the financial linkages.

For the employees and the indirect stakeholders, we needed to start from scratch.

First we selected the indirect stakeholders to include in the analysis. The stakeholder categories to which we had e-mail addresses and that were sufficiently large to analyze using surveys were:

Local politicians in communities where the Company had operations
Hunters renting hunting grounds from the Company
Orienteers competing with map and compass on grounds managed by the Company

Next our challenge was to define CSR in simple, practical terms, to be understood also by people who never heard of the expression before and possibly only had limited personal experience from the company.

We decided to divide the questionnaire into three main sections.

The questions in the first section were a practical definition of CSR as an Overall Evaluation:

How responsibly do you think that the Company acts

In general terms
Compared with other large forest managers in the country
Compared with how you believe that a large, forest-managing company should act

Note that this becomes a key Responsibility metric that explicitly includes a competitive comparison. Indirectly the other ratings also include competitive elements, but seeing it as a direct comparison is often an efficient way to attract management’s attention to the results of the analyses.

The questions in the second section dealt with the three key areas that most academics think of when discussing CSR, namely the environmental, societal and ethical issues.

The environmental area was specified with questions regarding four aspects:

Managing forests in a sustainable manner
Maintaining biodiversity
Limiting damages to water and ground eco systems
Curbing the emission of greenhouse gases

The social responsibility area was covered from five perspectives:

Create forestry-related economic growth
Create opportunities for other forestry-related businesses
Develop the economic, ecological and social values of the forests
Run an efficient forestry operation
Improve the conditions for an active outdoor life

The ethical area was explored using questions about how well the Company treats the stakeholders in regard to:

Integrity
Professionalism
Respect
Honesty

We made no references to legal or other externally enforced requirements. Some stakeholders may know them, others not. People have their opinions anyway, their ratings show what these are, and this is what they base their preferences and actions on.

To make the scores more vivid and actionable, we also included open questions per CSR area. This is a valuable help for those managers who prefer text over numbers.

There is also a risk that “outliers” disappear in the quantitative analyses. Important messages from individual stakeholders with early signs of mismanagement may best be explained in plain text and not as a rating on a scale from 1 to 10.

The questions in the third section dealt with the Desired Behavior, defined as the willingness of the stakeholders to recommend the Company to friends in various situations:

How likely are you to recommend one of your best friends to:

Sell wood to the Company
Buy products and services from the Company
Accept a job offer from the Company

These are weak indicators of future financial performance – who takes notice of the recommendations? – but we found no facts or other behavior that could strengthen the analyses, at least not without jeopardizing personal integrity.

We anyway included them in the questionnaires as they are essential when quantifying the importance of the various factors per stakeholder category.

Once these joint CSR questions had been defined, we made stakeholder-specific additions for the employees regarding their job situation. Here we included eight conventional questions about employee satisfaction plus three questions about their views on how they would like to see their tasks and responsibilities develop over the next few years.

Now we could send e-mails with links to the correct questionnaires on an independent data collector’s servers.

Benefits & Metrics

When the survey and financial data had been collected, we ran the factor analyses and built structural equations to identify and quantify the linkages.

Several of our findings challenged conventional wisdom:

Neither the customers nor the local politicians, nor the orienteers considered the environmental, social, and ethical aspects to be sufficiently important to have a significant impact on their behavior

Neither did the CSR components have a significant impact on Customer Satisfaction, particularly not for those customer that also buy wood from other companies than the Company
The overall CSR score of the employees and the indirect stakeholders had a strong impact on their willingness to recommend the Company. However, the CSR score was primarily driven by how efficiently the stakeholders felt that the Company was managing the forests, not by the environmental, social, and ethical issues
The employees even felt that managing the forests efficiently was more important than their own job situation

These findings are illustrated in a simplified manner in the attached document called 'Observations of CSR Attitudes in Stakeholder Surveys'.

Thus, there was no indication that additional CSR efforts would generate enough additional revenue to improve the Company’s profitability.

Customer Satisfaction is typically a strong driver of loyalty and thereby of the risk in the business. However, as the Company’s CSR efforts had no significant impact on Customer Satisfaction, additional CSR efforts would not be likely to lower this risk.

In fact, the logical conclusion for the Company was to reduce its CSR efforts as the “no impact” works both ways; profitability would go up as neither the revenue nor the risk would change.

However, this reasoning is true only for on-going operations without major, negative events. Scandals and accidents can overthrow it in hours – just think of BP!

The risk aspect is extra sensitive for a state-owned company as it also includes a political risk. Governments typically want to develop the state-owned companies into role models so environmental hazards, sexual harassment, bribes etc. must by all means be avoided.

Thanks to the new insight into the Company’s CSR efforts and its linkages to value-creation, the Company’s owner and management could objectively discuss and agree on how to allocate the CSR resources to best support the ambitions of the owner.

CSR is a dynamic concept that probably will change in substance and importance over the years to come. Our analyses show that the Company presently is doing what its stakeholders are expecting but this may change as people gradually mature in regard to CSR.

With this in mind, the Company’s survey scores for CSR in general as well as for the individual environmental, social, and ethical issues are important metrics that should be tracked over time. This is a cheap, fast, and reliable way to ensure that the Company detects if and when changes in its CSR efforts are needed.

Special outlier analyses may also serve as an early warning system. By extracting the responses with particularly low scores and any accompanying open answers, signs of mismanagement or negligence can be detected before becoming a reputation problem that risks damaging the Company’s financial value and political correctness.

Lessons

Managing forests in Sweden is a very special, low-risk operation. It has been controlled by law since over 100 years, new product development takes at least 75 years, there are no serious environmental hazards, and there is no child labor or unacceptable work conditions in distant countries to consider.

Yet this story describes results that are in line with what I have seen when analyzing the attitudes of various stakeholder categories for other companies. They indicate valuable linkages to look for and some of the biggest surprises to expect when linking attitudes to financial performance:

In the public debate, “stakeholders” are often referred to as a homogenous group. There is nothing in our data that supports this. There is no uniform interpretation of what CSR is, and the drivers of the CSR scores are not the same for owners, customers, suppliers, employees, and such indirect stakeholders as local politicians, hunters and orienteers
Investors pay much more attention to risk than what management and employees often realize. Look in the financial pages, and you will see that risk is a hot topic in company valuation. Look inside companies, and you will find that risk often is neglected, disregarded, or expected to be taken care of by an insurance policy or by somebody else. Those investors who regard CSR as an insurance premium will find that CSR creates value by lowering the risk, not by increasing profitability, just like an insurance
Customers are much more sensitive to price than what they appear to be in surveys. This may seem trivial and obvious as customers by definition have accepted the prices, yet many companies are organized and act as if prices and pricing were unrelated to Customer Satisfaction and financial performance
Employees may well feel that improving job satisfaction isn’t worth the money it generally costs. Job security and higher pay could be more important. And increasing job satisfaction tends to make the employees complacent and less willing to take on added responsibilities
Local politicians do not seem to be particularly interested in having companies play an important role in proactive local business and environmental initiatives. If you need the support of local politicians, you should probably let them get some of the glory – and make sure that none of the bad will spills over on them if your company would run into trouble
Other indirect stakeholders may only be looking for support of their personal preferences, not for companies to do well in a general sense

With such experience as a solid and inspiring foundation, the approach described in this story is ready to be applied on a larger scale and in more challenging environments , helping companies do both good and well.

You can read about additional consequences for corporate leadership in my “Empower, Relax, and Perform...” contribution on the MIX site.

Credits

The methodology described above builds on the methodology developed by Prof. Claes Fornell at the University of Michigan for the American Customer Satisfaction Index (ACSI) and similar national satisfaction indices.

I am also thankful for the input of Dr. Marc Orlitzky, Ass. Prof. at Penn State and a prominent researcher in the field of linkages between CSR and financial performance.

Materials

You can read more at www.valuemetrix.net or contact me directly for additional documents. Just send me an e-mail, using the standard format for Anders Magnusson at valuemetrix.net.

Documents

Observations of CSR Attitudes in Stakeholder Surveys.pdf

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July 29, 2010 at 9:55am

David Sims

So, Anders, I'm trying to parse this. Is your finding generally that you were not able to see much benefit from the company's CSR efforts?

October 5, 2010 at 8:55am

Anders Magnusson

David,

I sent you an e-mail response before but let me clarify this also on the MIX site:

The benefit of CSR efforts has to viewed from the investors' perspective, starting from the fact that the value of a company is a function of both profitability and risk.

So far it has not been possible to verify any generic, substantial sales increases as a result of investments in CSR. I have not seen it in my research, and I have not seen it elsewhere either. If you then consider the costs for the CSR actions, it is obvious that they generally reduce profitability.

Another (far too well-known!) fact is that major CSR mistakes may result in substantial volume reductions, enormous costs, and staggering financial losses for the investors. This means that investors look at CSR expenditures as a way to reduce risk, almost like an insurance premium. Thus, the CSR costs may reduce profitability but actually increase the value of the company thanks to the reduced risk.

This was shown in an academic paper already some eight years ago by Prof. Marc Orltizky, nowadays at Penn State.

I am now spending a couple of days trying to upgrade my three MIX documents and finalizing a fourth one. One of my changes will certainly be to try to make the true benefit of CSR efforts easier to find.

Best regards,

Anders