On the flipside: When positive externalities are investment opportunities
Examples of companies with positive externalities are harder to find and more subjective to quantify. Compensation claims, price regulation, and remediation costs are relatively tangible and straightforward compared to the nebulous societal benefits of cheaper healthcare or a decarbonised economy. Many of these potential positive externalities are linked to structural factors like climate mitigation and adaptation, the digitalisation of certain sectors or the growing importance of artificial intelligence, and some will take a long time to play out. They require thorough thematic and company-specific research, but also patience and conviction. Nevertheless, they matter too.
No firm is wholly good or bad, even those emitting serious and persistent negative externalities. Under a capitalist system, increased production of useful goods and services achieves a common good by alleviating poverty and providing opportunities for work, thereby supporting human dignity.
To a certain extent, all companies have positive externalities – but some go far beyond the norm, such as the multinational discount retailer Costco. The company’s co-founder Jim Sinegal laid out a simple formula for this paragon of stakeholder capitalism: “In order to reward the shareholder in the long term, you have to please your customers and workers. You’ve got to get the very best people that you can, and you want to be able to keep them and provide some job security. That’s not just altruism, it’s good business.”5
The average retail employee in the United States makes $12 an hour. Amid talk in Washington of more than doubling the Federal minimum wage to $15, last February Costco announced it was already moving its starting level from $15 to $16 which, including accrued pay rises and typical bonuses, would bump the average to around $24, not including health insurance (a crucial hallmark of entry into mass affluence in America) and the 401k pension plan.
During a recent US Senate Budget Committee hearing debating the issue “Should Taxpayers Subsidize Poverty Wages at Large Profitable Corporations?”, current Costco CEO Craig Jelinek remarked: “At Costco, we know that paying employees good wages makes sense for our business and constitutes a significant competitive advantage for us. It helps us in the long run by minimizing turnover and maximizing employee productivity.”6
The evidence of the benefits of this approach are stark: Costco loses just 0.2 per cent of revenues to ‘shrink’ (theft by employees and disgruntled staff), 80 per cent less than Wal-Mart, and has annual employee turnover of just five per cent, compared to the industry average of 59 per cent.
Trane and Valvoline
Sometimes, external events need to occur before the benefits can be reaped in terms of improved company cashflows and profit outlook, such as a green stimulus package or policy development. A positive externality could result where a company is helping to drive a positive societal change, such as delivering more efficient heating and ventilation to lower carbon emissions.
For instance, Trane Technologies is a global market leader in heating, ventilation, and air conditioning, which can deliver efficiency gains in commercial buildings’ energy consumption. Initiatives such as the European Green Deal may incentivise commercial property owners to think much more about energy efficiency, and investors need to assess what it could mean in terms of upside for the company’s cashflows.
Indeed, engagement is another potential avenue for transforming positive externalities into increased cashflows. Working with companies, investors can encourage them to adopt more sustainable practices that could boost revenues and share prices. Investors can also collaborate with peers and engage with regulators to lobby for stronger environmental and other regulations, supporting the advent of changes that can crystallise a positive externality.
Sometimes, the benefits of the positive externality do not require the catalyst of an exogenous intervention but are reaped endogenously as part of the normal course of business. A case in point would be Valvoline, the operator and franchisor of quick-lube chain Valvoline Instant Oil Change (VIOC) in the US.
A conventional ESG scoring methodology will typically note Valvoline’s four female executive officers and two board members. But the company’s commitment to gender diversity goes deeper throughout the organisation, with women representing 44 per cent of the senior leadership team, and onto the shop floor, where VIOC workers and managers are twice as likely to be women compared to the industry average.
While women drive fewer miles than men, they are responsible for a similar proportion of journeys. In the otherwise male-dominated world of car maintenance, Valvoline represents a refreshing alternative. Anecdotal feedback from female customers highlights they are more comfortable dealing with other women, and more likely to become a source of repeat business.
It is difficult to quantify precisely how much of VIOC’s best-in-class operating metrics are a result of the company’s commitment to diversity, or the extent to which that commitment was driven by a belief it would be good for business.
Whether consciously or unconsciously, the pursuit of gender equality is a subtle, but important, element of VIOC’s sustainable competitive advantage. In a world where consumer choices are increasingly based on personal values, other companies might do well to follow VIOC’s lead in having employees that are more representative of the customers they are targeting.
