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This page explains how Upright’s approach to understanding companies' costs and benefits differs from related frameworks.
Among existing approaches to measuring companies' value creation, Upright's methodology is most closely related to those of the Impact-Weighted Accounts Framework (IWA), the Value Balancing Alliance (VBA), and the International Foundation for Valuing Impacts. Namely, the approaches share the following principles:
- Indirect impacts within the value chain must be taken into account.
- Impacts are valued in monetary terms to make them comparable.
Upright's methodology differs from those of IWA and VBA in three material ways:
- Impacts are attributed top-down within the private sector to avoid double-counting of impact. (See the info box below for details)
Top-down vs. bottom-up
Upright measures value creation with a top-down approach: it estimates the costs and benefits created by companies using a model of the whole private sector, encompassing all products and services traded in global markets. The results of the model are used to allocate shares of costs and benefits within different categories to each company.
The alternative approach would be to work bottom-up, conducting e.g. LCA-style analysis of each specific product.
The main downsides of such a top-down approach are:
- 1.Initial inaccuracy: Results of the first iterations are inaccurate. Upright's result accuracy has been and will continue to be improved iteratively.
- 2.Large initial workload: A sizable initial workload is needed to develop and validate the model and cover the whole private sector in terms of products and services.
The main upsides of such a top-down approach are:
- 1.Comparability: Upright creates comparability between impact categories by estimating the share of global impact within each category. This is made possible by the fact that Upright models the whole private sector: calculating a share of a cost or benefit is only possible with a model that understands the global whole. That would not be possible with a bottom-up approach.
- 2.Avoidance of double counting: Given that the Upright net impact model attributes impact from a global total, it effectively avoids both double counting and undercounting of impacts.
- 3.Understanding indirect impacts: The Upright net impact model understands value flows between products and services. This enables the model to determine how companies create impacts indirectly in their value chains, besides just the direct impact of the company and its operations.
- 4.Scalability: Upright’s top-down approach has a low marginal cost for adding new companies to the model. That makes it possible to cover a large number of companies and answer macroscopic questions that relate to the aggregate impact of tens of thousands of companies.
Besides IWA and VBA, multiple established and emerging approaches exist to assess the value creation of companies. All these approaches differ in their objectives, and consequently, they aim to answer different questions and produce different answers.
A common way to assess the value creation of a company is to look at its earnings using a figure like EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization). Given that earnings are a net of costs and gains, it seems at first sight like a good measure for net value creation. There are, however, two problems:
Firstly, using earnings as a measure of value creation is not compatible with the fact that individuals have different values. Value creation can be reduced into a single number only after an individual’s view of value has been taken into account, not before.
Secondly, even if every individual decision-maker had the same values, earnings would be an accurate measure of value creation only if all of the following assumptions were true:
- Consumers perceive the private costs and benefits associated with its products and services accurately and make “rational decisions”.
- Governments estimate the external costs associated with its products and services correctly and set up corresponding taxes, marketable permits, or emission charges.
- Governments estimate the external benefits associated with its products and services correctly and set up corresponding subsidies or vouchers.
- Consumer surplus is negligible.
It is, of course, well known that consumers don’t always make optimal choices for themselves, and that activities of companies are associated with considerable external costs and benefits, such as greenhouse gas emissions or knowledge.
Sustainability metrics and LCA are ways to quantify to what extent companies use resources in a way that can be sustained over time. They can provide insights into the nature of the external costs associated with a company’s activities.
They are not particularly useful for understanding net value creation since they do not state anything about the relationship between the costs to the benefits that are created by them. In order to do that, it is necessary also to measure the benefits that companies create.
A less fundamental problem with sustainability metrics is that in practice they typically cover only a small part of the costs and benefits created in a product’s value chains, and fail to quantify costs consistently and comparably.
The EU taxonomy of sustainable activities is intended to explain what share of the revenue, operational expenditure (OpEx) or capital expenditure (CapEx) of a company meets the criteria of sustainable activities as defined by the Taxonomy regulation. The aim of the Taxonomy regulation is to funnel investment into companies and activities to reach the objectives of the European green deal.
The criteria for sustainable activities as defined by the regulation are specific and completely omit societal benefits. Therefore while taxonomy alignment is often evidence of the sustainability of activities, the lack of alignment cannot be used to judge whether an activity is not sustainable or net positive.
The table below summarizes the above-mentioned approaches to understanding how companies create value and the questions they aim to answer.