Companies come in different shapes and sizes. But at the end of the day, they’re mostly all in business for the same reason: To make as much money as possible for their owners and shareholders. If you’re an EHS coordinator, you have to accept this fact; more importantly, you must recognize what it means to you and your EHS program. Stated simply, it means your effectiveness is directly tied to your capacity to advance the goal of profitability. More precisely, to compete with other parts of the business for resources, you must be prepared to demonstrate that EHS compliance isn’t just a necessary evil or a moral obligation, but is an investment that directly contributes to positive financial performance.
How do you make such a case? Answer: By showing that dollars invested in the EHS program have a positive return on investment (ROI). The good news is that doing so isn’t as hard as you might expect. Most executives do, in fact, recognize that investment in an EHS program generates a positive ROI.
But that fact only gets you so far. Even though CEOs generally recognize the potential economic value of an investment in EHS programs, that doesn’t necessarily mean that you can count on the support of your own CEO. In other words, you still have to show your CEO that the specific investment you’re advocating will have a positive ROI for your company. Here’s how to do that.
What Is ROI?
ROI is a financial measure that business people use to figure out if spending money on a project makes financial sense. In addition to making go/no go decisions, ROI is one of the most popular methods for comparing one investment option to another, e.g., buying new machines or retrofitting old ones.
A positive ROI basically means that the benefits yielded by the investment are greater than the amount of the original investment. A negative ROI means just the opposite. Although there are lots of different variations, the basic, or “simple” ROI equation is this:
ROI = (Net Benefits/Costs) x 100 %
Generally speaking, the higher the ROI, the more desirable the investment.
Here’s a closer look at the different parts of the ROI equation:
Net benefits. Net benefits is the difference between the benefits of the investment and the costs associated with the benefits. So, for example, if spending $100,000 on a new spill prevention system is expected to generate $150,000 per year in reduced spills, the net benefit would be $50,000 (that is, $150,000 – $100,000). As a technical matter, you can calculate net benefits either before or after taxes and depreciation.
Costs. The denominator in the ROI equation is the total costs needed to generate the benefits from the investment.
Time period. There’s also a timing element in the ROI equation. Companies generally want to measure recovery of the investment over a unit of time. In some cases, benefits are shown during the first year of investment—or even within the same fiscal year. In other words, companies want to know if they can recover the costs of the investment in the first year (or fiscal year). Other companies use an ROI formula that spreads out the benefits on a weighted average over the lifetime of the investment.
ROI & EHS Programs—Proposal Building
ROI has historically been used as a decision-making tool for company financial operations. But an increasing number of companies now expect their environmental coordinators to use it to evaluate and justify EHS investments, which poses some tricky obstacles.
As noted above, although the basic ROI equation is pretty straightforward, there are some subtle variations in application. You need to talk to your company’s financial officials to make sure you know which formula your own company uses:
- Are net benefits calculated before or after taxes?
- Are net benefits calculated before or after depreciation?
- What ROI levels does the company expect to approve investments outside safety? If the ROI on your proposed investment isn’t competitive with other proposals within the company, it obviously won’t stand much chance of being adopted.
- How immediate must ROI be? Does your company insist on recouping all costs within the fiscal year? Within one full year? Over the life of the project? The more immediately you can show a positive ROI, the better your chances of winning financial support for the proposal.
Impact on the EHS Program
Using ROI to justify an EHS program may also have implications on how you go about managing it. ROI works best when benefits are easy to identify, measure and manage. Benefits in the EHS realm generally don’t meet these criteria. Or, more precisely, the back-end or “trailing” indicators, such as numbers of reportable spills, that EHS coordinators have traditionally used to measure the success of their EHS programs don’t work well with ROI models.
That’s why using ROI to sell an EHS program might necessitate adopting other “leading” indicators that are more predictive of spills and incidents.
The Procter & Gamble Example
The consumer products giant Procter & Gamble (P&G) is an example of how to use leading indicators to measure the success of an EHS program. P&G identified nine “key elements,” or indicators of success in the EHS realm, including safe practices and effective training sessions, and asked each P&G facility administrators to rate the facility’s effectiveness in each element on a scale of 0 to 20. After four years, all scores were added up and compared to the facility’s injury rates.
Result: P&G identified that a score of 8 or better was a strong indicator of low injury rates. Consequently, all facilities falling below an 8 had to develop an action plan and a time frame for reaching a minimum score of 8.
Conclusion
In 2001, the U.S. insurance giant, Liberty Mutual released what was, at the time, a fairly eye-opening study documenting the positive ROI generated by EHS programs—up to $20 per dollar invested in some cases. Today, most CEOs and CFOs accept that EHS initiatives aren’t mere cost centres but potential profit generators.
But while corporate minds have been opened, EHS coordinators still bear the burden of justifying their particular initiatives in terms of ROI. The challenge is a formidable one. ROI works best with measures that are predictive, rather than reactive. Unfortunately, historical EHS programs have relied on trailing indicators. So, to justify the value of their initiatives, EHS coordinators will have to learn to wean themselves away from the old ways and establish forward-looking, achievement-based (as opposed to failure-based, e.g., recordable injuries) methods to measure the success of their programs.
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