• by Michael Martin , November 10, 2010

There is a giant problem in the room the size of a planet. No one is talking about it but it is something that all CEOs and CMOs need be aware of. It is a little thing called full-cost accounting.

I'm not going to talk about the kind of cost accounting many of us had to take (and didn't like) in college or grad school. I'm talking about a fundamental, game-changing issue in business.

A corporation's financials are their report cards, yet corporations are being graded on a curve. Celebrated reporter and author Thomas Friedman succinctly put it this way: Profits are privatized and the externalities are socialized.

In this context, externalities are costs borne by society as a result of corporate action. As an example, according to the American Lung Association, reducing emissions (ozone and particulate matter) from coal-fired power plants in the U.S. would save 14,000 - 36,000 lives each year, prevent 26,000 admissions to hospitals and emergency rooms, eliminate 23,000 non-fatal heart attacks and prevent 240,000 asthma attacks and 440,000 cases of acute bronchitis.

The externality is the cost of medical care required for all the people who get sick. Government and individuals pay for that healthcare, not the utility. That social impact is not on the utility's balance sheet and there are hundreds of examples where these externalities exist.

I am not saying capitalism is bad or that businesses should not produce products or make a fair profit. Quite the opposite; we believe business innovation is the engine that ultimately drives solutions to these problems. The reality is, under current accounting methods, we aren't capturing the full cost of products/services and, therefore, may ultimately be making the wrong economic choices for the long-term.

As our growing population consumes more finite resources, today's cheap inputs will eventually dry up. The end point is in sight for many fossil fuel deposits. Stores of rare minerals used in computers are becoming so depleted that China has been accused of stockpiling. Clean water is becoming a limited resource.

Many companies are sustaining pricing models on an eroding input base and current accounting does not accurately factor this in. This is a short-term perspective that threatens the corporation's sustainability and ultimately the world economy. Eventually, the collective we have to pay the total cost. Somehow, some way, sometime, the bill will come due.

Will full-cost accounting become law? I doubt it. Will it become a standard that industries adopt? Probably not. What's more likely is this: Businesses serious about sustainable competitive advantage will realize that they can make more money long-term by building people and planet explicitly into their business models.

How would you change your business model and product positioning if you had to account for externalities?

Dealing with externalities isn't just about expenses; it is also about revenue generation. Consumers are starting to ask questions like:

• How come the cost of disposal of most consumer goods packaging is born by communities via landfills?

• Why do electronic manufacturers and retailers not pay for the cost of reclaiming heavy metals in the computers and TVs they sell?

• Why does a battery maker not deal with recycling the toxins in their batteries?

• Is my coffee company treating their workers fairly? Are they cutting down rain forests?

According to Natural Marketing Institute, since 2005, the number of consumers who avoid buying from companies whose values don't align with their own has increased by 17%. People want to support companies doing the right thing so a company sincerely operating in the best interest of the people and the planet will sell more products.

Think about it. If you're serious, there is an opportunity for true brand leadership.

When Method introduced highly concentrated soaps and detergents, which have a much smaller environmental footprint, it rocked the category while building its brand name. It was the right thing for the planet, it reduced its externalities and it built its business. Others have followed suit, so now it's becoming a de facto industry standard.

Similarly, Nature's Path has reduced its packaging, eliminating the cardboard box for some SKUs and the Toyota Prius has started to usher in a new future for the auto industry.

All these companies changed how they operated by taking an enlightened view of their business and asking how they could reduce their externalities. In the process, they created competitive advantages for their brands.

When my company works with clients, we tell them to imagine how their business model would be different if full-cost accounting were a legal requirement. Suddenly, everyone starts re-examining the product, packaging, distribution, marketing and more. Given a valid incentive, managers turn from caretakers to creators, just as conscious consumers seek out more sustainable alternatives.

Full-cost accounting breeds respect -- for the business, for the brand, and for managers themselves. In a conscious world, loyalty and therefore revenue and profits ultimately follow.