Natural Capital: Assessing Organisational Risks and Uncovering Opportunities
Natural capital — the stock of natural resources that yield a flow of benefits to humans, companies and economies — is under pressure. Globally, we use volumes of renewable natural capital resources such as timber and fish equivalent to those provided by approximately 1.8 Earths every year.1 Additionally, we are reaching or have reached the maximum production rate in terms of additional units mined for certain non-renewable natural capital resources, such as gold, silver and copper. This overexploitation, alongside other factors such as climate change and pollution, has driven us into a state of natural capital deficit.
Why does this deficit matter? It is easy to see what may be at stake when natural capital diminishes: natural capital is a source of inspiration, relaxation, spirituality, education and aesthetic pleasure. Beyond these social benefits, natural capital is a crucial economic resource, and its decline will have far-reaching consequences for businesses and economies.
But natural capital risk is also inherently a business risk. According to the World Economic Forum, around half of the world’s gross domestic product is highly to moderately dependent on nature either directly or indirectly. Given supply chain dependencies on natural capital, the World Bank estimates that organisations will face significant operational risks, such as increased costs or the inability to access inputs of production, as a result of a diminishing natural resource base.
Beyond operational risk, organisations can also be susceptible to reputational and regulatory risks, from both their use of and their impact on natural capital. On the flip side, organisations may find opportunities through successfully mitigating their natural capital use and impact. Focusing on these risks and opportunities will become increasingly important to ensure a long-term competitive advantage. As scrutiny from scientific, public and regulatory stakeholders grows, expectations about the responsibility organisations have towards natural capital are also set to increase.
In this edition of Executive Insights from L.E.K. Consulting’s Sustainability Centre of Excellence, we highlight the risks that organisations face as a result of the decreasing quantity and quality of natural capital, as well as the opportunities that come from mitigating their natural capital use and impact. We also lay out key questions that organisations can consider to assess their exposure and to develop a natural capital strategy.
Figure 1 (below) depicts the three main types of natural capital: planetary system resources (e.g. sunlight, water, wind, air and fire), geological resources (e.g. minerals, metals and fossil fuels) and ecosystem resources (e.g. forests, coral reefs, coasts, lakes, open ocean and grasslands). Economic value can be derived from each resource group through means such as solar, wind and hydropower; oil; natural gas; batteries; plastics; wood; paper; food (e.g. plants or animal byproducts); natural medicines; pollination; and tourism, among other examples.
All organisations use or rely on these different types of natural capital as inputs to production, even though this may differ depending on their unique requirements and position along the value chain. Organisations may also impact natural capital as a byproduct of production or of other organisation activities (e.g. via disposal of waste). Furthermore, use and impact are almost always connected.
An organisation’s use of and impact on natural capital have inherent risks, such as negative public perceptions, lawsuits and disruptions to supply chains due to dependence. The extent of risk an organisation may face is in part determined by three key characteristics of the natural capital — whether it is (1) depletable, (2) non-renewable and (3) ownable.
The risk to an organisation from using or impacting planetary system resources is the lowest because planetary system resources are non-depletable and non-ownable and therefore are inherently more sustainable. By contrast, ecosystem resources are depletable and ownable and therefore their use presents more risk to an organisation. Lastly, geological resources, which are not only depletable and ownable but also generally non-renewable, expose organisations to the highest level of risk.
Because of this risk hierarchy between the types of natural capital, there is a logical desire to replace more at-risk resources (i.e. geological or ecosystem resources) with those less at risk (i.e. planetary system resources). However, not all natural capital is equally suited for or of equally high quality in its contribution to production (e.g. although wind is non-depletable and non-ownable, it is not as energy dense and is highly intermittent compared to fossil fuels for power generation). Therefore, organisations face a complex set of decisions as they seek to use or impact natural capital with the lowest risk and in the most effective way possible.
The particular risks that organisations face as a result of leveraging different natural capital resources can be categorised into three types: (1) market, (2) legal and regulatory, and (3) supply chain (see Figure 2). Failure to mitigate these risks can have significant financial implications and can cause organisations to fall behind competition. Alternatively, improvements in an organisation’s use of and impact on natural capital can provide opportunities in these same categories that can ultimately lead to differentiation and business longevity.
By focusing on limited or fair use and reduction of impact in their strategy, organisations have been able to mitigate risks and unlock opportunities across the three categories.
Organisations that limit or optimise their use of and reduce their impact on natural capital may unlock market opportunities such as reputational gains, market share gains, an increased ability to attract or retain talent, higher valuations, and access to capital from impact investors.
Unilever have woven the protection and regeneration of nature into their strategy, committing to a deforestation- and conversion-free supply chain by 2023. As a result, Unilever have seen positive feedback from nongovernmental organisations, investors, consumers and suppliers. For example, in their 2020 Sustainable Living Brands report, Unilever reported that their sustainable living brands had grown 69% faster than the rest of their business and delivered 75% of their overall growth. Furthermore, Unilever have been awarded the CDP Forest A List for several years for their leadership in environmental transparency and performance on combatting deforestation, a qualification which is increasingly assessed by investors seeking to understand companies’ environmental impact.
Likewise, organisations may unlock opportunities related to legal and regulatory factors, such as clearance of proposals to enter new markets or operate in specific areas.
Deep Yellow Ltd.’s approval to mine Australia’s Mulga Rock, one of the largest uranium resources, was predicated partly on a requirement to prepare a conservation plan to protect sandhill dunnarts, a species listed as “vulnerable” under Australia’s Environment Protection and Biodiversity Conservation Act 1999.
Lastly, organisations may unlock supply chain opportunities, improve financial performance and gain sustained benefit against competition by diversifying towards more renewable, less depletable or depleted, or less ownable sources of natural capital.
Wild Planet, a canned fish company, expanded their product offerings beyond tuna to include canned sardines and anchovies. Tuna is a relatively unsustainable choice of canned fish, as populations have been overfished in the past and take relatively longer to reproduce. Sardines and anchovies, on the other hand, live relatively lower on the food chain and thus have a quick growth cycle and high repopulation rate. As tuna stock continues to decline and becomes increasingly harder to access, Wild Planet are well positioned because they have diversified towards other, more renewable sources of natural capital.
Focusing on fair and/or limited use of natural capital inputs as well as on reducing negative impact from byproducts of production is key to avoid the above-mentioned risks and capitalise on opportunities. Organisations that assess and optimise their use of natural capital, and proactively seek to have a positive impact, can unlock opportunities — for innovation, operational improvements, improved margins and business longevity.
As a starting point, organisations should ask themselves the following key questions today:
What are our natural capital dependencies and/or how do we impact natural capital? How does this put our organisation at risk?
What are the potential financial consequences of these risks?
What are the mitigating steps we can take to reduce these risks?
What are the costs of taking these mitigating steps (including costs of replacing natural capital types that pose the most risk to organisations with lower quality but more sustainable types)?
What opportunities can we unlock by improving how we use and/or how we impact natural capital?
What are the costs of capitalising on these opportunities?
What are the strategic implications of taking action on our relationship with natural capital and how do they impact the longevity of our business?
The world we live in is our most precious shared resource, and how we use it has an impact not only on our own lives but on the lives of generations to come. But beyond this, the business imperative is unarguable. Those businesses that are able to use natural capital the most sustainably will be the most successful. Yet the corporate world’s understanding of and actions to address natural capital are still nascent; given this, organisations have the opportunity to differentiate by improving their use of and impact on natural capital. Over time, as the importance of natural capital to organisations continues to increase, thoughtful use of natural capital will become a table stake.
1The World Counts https://www.theworldcounts.com/challenges/planet-earth/state-of-the-planet/overuse-of-resources-on-earth; The Global Footprint Network; Our current rate of resource usage per year is approximately 1.8 Earths. In other words, we have already used more resources than the Earth can provide in any given year. For the remainder of the year, we are in deficit and are ‘drawing down’ resource stocks that were produced in past years. Once those resource stocks are depleted, we will require much more at our current rate of use than the Earth can actually reproduce for us.