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Benchmarking: An International Journal

Emerald Article: Using input-output analysis for corporate benchmarking


H. Scott Matthews, Lester B. Lave

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H. Scott Matthews, Lester B. Lave, (2003),"Using input-output analysis for corporate benchmarking", Benchmarking: An
International Journal, Vol. 10 Iss: 2 pp. 153 - 168
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BIJ
10,2 Using input-output analysis for
corporate benchmarking
H. Scott Matthews and Lester B. Lave
152 Carnegie Mellon University, Pittsburgh, Pennsylvania, USA
Keywords Input/output analysis, Benchmarking, Life cycle costing, Social audit, Accounting,
Pricing
Abstract In recent years, cost-effective protection of the environment has become a more
important goal for many businesses. Companies have been striving to reduce the environmental
impacts of their products and packaging, while not incurring costs that put them at a competitive
disadvantage. A key to accomplishing this goal is by benchmarking their performance against other
companies. Benchmarking can be expensive, time consuming, or problematic because detailed
benchmarking requires detailed, specific data that are generally confidential. A screening level
benchmark can accomplish much of the goal quickly and cheaply. Focuses on a tool to make quick,
screening level benchmarks of US industrial environmental performance and discusses how it can
be used to evaluate a plant’s environmental performance. Mentions other tools, notes its
relationship to them, and discusses how it can be more broadly used. Finally, suggests ways that
this type of benchmarking information can be used broadly within a firm for accounting and
decision-making purposes.

Introduction
Companies in the USA and throughout the world face environmental activists
and voters who demand improved environmental performance. Myriad
legislation and regulations require companies to reduce their environmental
discharges and clean up polluted sites. Faced with regulations, fines, consumer
boycotts, bad publicity, and even shareholder and management pressure,
companies have been trying to improve their environmental performance while
not incurring costs that reduce their competitiveness.
In the past, companies focused on product quality and cost, giving little
attention to environmental discharges. Thus firms find that, initially, they can
actually lower costs and pollution discharges at the same time. However, as
they push toward lower discharges costs increase. At some point, continuing to
lower discharges could make the firm less competitive. What are reasonable
goals for a firm that is attempting to be a good environmental citizen? One
answer is that the firm should be performing better than its industry average
and improving its performance over time.
In the absence of benchmarking their environmental performance against
competitors and comparable industries, firms have no idea how they compare
to their competitors or to the industry best practice. In addition, without a
Benchmarking: An International
Journal management information system that enables them to trace the environmental
Vol. 10 No. 2, 2003
pp. 152-167
expenditures and liability for current discharges back to individual products
q MCB UP Limited
1463-5771
and their choices among processes and materials, managers cannot make
DOI 10.1108/14635770310469671 informed decisions because they lack the necessary information.
In this paper we describe a tool that has been developed as a result of field- Using input-
based work with private organizations. The tool is designed to provide output analysis
managers with the information required for making informed decisions. They
are also designed to keep companies from incurring large future liabilities. We
begin with some examples of environmental issues that companies have faced:
.
A plant making automobile supplies was hovering around zero 153
profitability and its disposal costs for scrap seemed high. Our
investigation confirmed that they were producing a great deal of scrap
in the plastic molding process. The result was high environmental
disposal costs. More important was the excessive materials use and the
fact that the plant generally had to work on weekends to fulfill its quotas.
Although the plant had gone to activity based costing (where the costs of
production are explicitly connected with the activities that create them),
the system was implemented so that it understated the effects of
producing and managing scrap plastic by 60-80 percent. The high volume
of scrap was an important indicator of fundamental problems in the plant
that dwarfed the cost of scrap disposal. Thus, managers were looking
elsewhere to find a solution to the profitability problem (Horney, 1998).
.
A few years ago, McDonald’s was faced with environmental protests over
its use of disposable foamed polystyrene “clamshell” containers for
selling hamburgers. While the containers were ideal for insulating and
protecting the food while providing portability, environmental groups
protested that the containers were harmful to the environment. Unless
McDonald’s could find a substitute package that was acceptable to the
environmental groups and served customer needs, they faced a prolonged
battle that would be costly to their public image.
.
Since 1968 American automakers have been required to control the
tailpipe emissions of their vehicles. More recently, California, followed by
states in the Northeast, went beyond this evolutionary approach to
demand zero emissions vehicles (ZEV). This regulation ruled out internal
combustion engines, requiring instead electric cars. Auto manufacturers
found that producing these vehicles was much more expensive than
conventional vehicles and customers found that the vehicles did not have
acceptable range. Regulators insisted that the technology would improve
with more R&D expenditures.
These examples show companies and government agencies facing pressures
from environmental groups, shareholders, and regulators who demand
environmental quality and sustainability. In each case, the company wanted to
be a good environmental citizen and was willing to make at least modest
sacrifices to do so (Lave and Matthews, 1996). In general, companies do not
have the information to respond to these pressures in a timely way that deals
with the issues cost-effectively.
BIJ Setting realistic goals
10,2 A major problem facing a company is what goal to set for current
improvements. Although initially firms can both save money and lower
environmental discharge, within a given technology, the costs start increasing
as they attempt to ratchet down discharges. In many cases, the company can
make a large reduction in discharges, but only at significant cost. What goal
154 should they set?
Environmental demands seem to ask for zero discharges – and even getting
close is expensive. But this cannot be feasible while there is no assurance as to
which level of performance is acceptable. Good companies also have to be able
to sort through environmental demands to see which seem plausible but do not
contribute to environmental quality, and which are most important. Simply
doing what is demanded is likely to be expensive and never ending, and may in
the end be entirely wasteful. We suggest that a reasonable goal is to exhibit
better performance than the industry average and to improve continually over
time. Benchmarking provides a good sanity check. This requires benchmarking
against other companies in the same industry and comparable industries.
Solving these problems is less obvious than it might appear. Unfortunately,
setting goals that have the intention of benefiting the environment have often
turned out to be expensive, or even dysfunctional. For example, many US cities
have had to discontinue all or part of their recycling programs because they
were too expensive; some critics have charged that these programs harm,
rather than help, environmental quality (Zandi, 1991). The 1996 German
package recycling law (“Eco-Cycle and Waste Law” or “Kreislaufwirstschafts
und Abfallgesetz”) cost more than twice what was originally expected; one
result has been warehouses filled with material to be recycled because there are
too few customers for the material. Currently, the recycling authority is willing
to pay firms to recycle the material.
We explore the reason why these are complicated issues and present some
tools for answering them. In particular, we focus on three areas: first, how to
get a quick, first order approximation of the environmental damage done by
discharging pollutants within an industry; second, how to set reasonable goals
for benchmarking across similar industrie; and third, how to provide this
information to decision-makers to help them make informed decisions.

Useful tools for environmental performance analysis


To be useful for environmental analysis, tools must have four attributes:
(1) They must address the whole problem and provide the desired
information. The first attribute requires knowing what information is
required to make informed decisions about packaging fast foods,
comparing an electric car to a gasoline powered car, or choosing which
household waste to recycle. For a battery-powered car, one source of air
emissions is the generation of the electricity used to charge the batteries.
If the electricity were generated by a “dirty” coal fired power plant, air Using input-
emissions are likely to be greater than powering the same fleet of cars with output analysis
low emissions gasoline engines. More important, current electric cars are
powered by about 1,000 pounds of batteries. Mining, smelting and
recycling the battery’s metals will lead to large environmental discharges
of highly toxic metals (Lave et al., 1995a,b; Steele and Allen, 1998). 155
Another example is that making a car of aluminum rather than steel
produces a lighter, inherently more fuel-efficient car. However, a great deal
more energy is required to make aluminum than is required to make steel.
How far would the steel and aluminum cars have to be driven before the
total energy required for manufacturing and use is less for the aluminum
car?
To assess the implications for environmental quality and sustainability
of a product or process, we must examine the full life-cycle of the
alternatives, not just the energy and materials use or environmental
discharges in one phase. Thus, to address the first attribute, life-cycle
information is required to make informed environmental decisions.
(2) The tools must provide that information at the time when decisions are
made (ideally in real time).
(3) The tools must be inexpensive relative to the value of their information.
The next two attributes, time and expense, do not have general answers,
but rather depend on the particular decision. For microelectronics, delays
in bringing a product to market are crucial, particularly because some
products have lives as short as a few months in the market. The designer
needs to make the decision quickly; information available next week is
irrelevant.
(4) They must be reliable in the sense that their information, while even if
uncertain, is good enough to be helpful in making the decisions.
Reliability is a complicated attribute. McDonald’s probably did not
desire to become an environmental exemplar; they simply wanted to sell
hamburgers without bad publicity. To McDonald’s, reliability meant
getting all the relevant environmental groups to agree that a particular
solution was environmentally benign. Conventional life-cycle analysis of
paper versus polystyrene cups generated a great deal of controversy
(Hocking, 1991; Wells, 1991; McCubbin, 1991; Caveney, 1991; Camo,
1991). The analysis indicated that making polystyrene cups resulted in
more air pollution, while making paper cups resulted in more water
pollution. Whether air pollution is better than water pollution is
inherently controversial. The studies also found that the difference
between materials was small relative to the difference among
manufacturers and disposal practices. Materials selection decisions are
inherently comprised of these types of tradeoffs.
BIJ Developing tools requires difficult judgments. The toolmaker must decide
10,2 which of the four criteria to emphasize. For environmental tools, researchers
have tended to emphasize reliability. As a consequence, the tools are time
consuming and expensive to apply – and so are largely of academic interest.
While tools must be reliable to be useful, they will not be used if they are not
relatively inexpensive and produce answers in the relevant time period.
156

An environmental performance screening tool


Now that the relevant screening tool attributes and the issues relevant to firms
have been described, we discuss ways in which tools can be most helpful to
companies. As noted above, firms need to be able to benchmark their
performance against others within their industry. Looking at available
industry-wide data can do this. If the confidentiality of data is an issue,
comparisons against industry averages can be done privately within the firm.
A new tool has been created, building on Leontief’s input-output analysis
(Leontief, 1936; Lave et al., 1995b; Hendrickson et al., 1998). Economic input-
output life-cycle analysis (EIO-LCA, 2002) is based on a linearized model of
production in the US economy supplemented with data on energy use,
materials use, and environmental discharges. The basic assumption of input-
output analysis is that inputs are proportional to outputs. For example,
increasing automobile production by 1 percent is assumed to require 1 percent
more of each of the current inputs. EIO-LCA uses EPA data on discharges of
conventional air pollutants and toxic discharges and the census of
manufactures and department of energy on use of fuels and other materials.
The EIO-LCA tool calculates a wide range of factor inputs, such as bituminous
coal and electricity, and a variety of environmental discharges, such as toxic air
releases and greenhouse gases. It is available free on the Internet (available at:
www.eiolca.net/).
The data used are available to anyone who desires them; they are data
collected by and reported to the federal government by companies and even
individual plants. Thus the data may be over- or under-reporting actual
releases. There are some limitations in terms of data availability, but the
principal limitation concerns the level of aggregation. With only publicly
available data, the tool can compare products by approximating them by the
USA commodity sector in which they are manufactured. This approach is
especially useful as a screening tool. With additional data on the composition of
a product, the tool has been used to compare specific materials and products
(Joshi, 1999). A downside of the wealth of data available is that the input-output
tables are released only every five years (e.g. 1992 and 1997), and with a
significant lag – the 1997 benchmark input-output table will be released in late
2002. This limits comparisons to technology assumptions that are several years
old. However, despite technological advances, purchases in the supply chains
of products are very inertial, with few significant changes over short periods of Using input-
time. output analysis
The EIO-LCA model estimates both direct and indirect effects for the whole
supply chain. By focusing on the direct effects (which come as a result of
production by the manufacturer), a firm can gain insight into the industry
average energy, environmental, or health and safety effects of production. In 157
the previous example of an automobile plastic parts producer, they could
compare their internally tracked data with industry benchmarks. As an
example, Table I shows the direct aggregate sector effects of producing $1
million of automobile parts (from the “motor vehicle parts and accessories”
sector) as estimated by EIO-LCA (the total column will be explained below). Of
course, the estimates in Table I represent a fairly aggregate view of industry
performance. In this case, factories in the “motor vehicle parts and accessories”
sector which also produce brakes and oil filters would also be in this category.
In some cases, firms in very aggregate sectors such as this one will have
difficulty using EIO-LCA for industry comparisons since some of the firms in a
highly aggregate sector will have direct effects significantly higher or lower
than the average.
Once firms have compared their performance against firms within their
industry, they could also benchmark their performance against related
industries. As mentioned, this might arise from the need to find other, more
appropriate, sectors to be used for comparison. In the case of the plastic auto
parts plant mentioned previously, this could mean against other manufactured

Effect Direct Total

Electricity used (Mkw-hr) 0.18 0.96


Energy used (TJ) 0.93 16.8
Conventional pollutants released (metric tons)
Sulfur dioxide (SO2) 0.1 4.3
Carbon monoxide (CO) 0.07 5.8
Nitrogen oxides (NOx) 0.12 2.9
Volatile organic compounds (VOC) 0.2 0.92
Lead 0.0 0.01
Particulate matter less than ten microns in diameter (PM10) 0.0 0.45
OSHA safety (fatalities) 0.00004 0.0006
OSHA lost workday cases 0.38 0.89
Greenhouse gases released (metric tons CO2 equivalents) 58 1,210
Fuels used (metric tons) 21 467
Ores used (metric tons) 0 535 Table I.
Hazardous waste generated (RCRA, metric tons) 6.8 50 Direct and total
Toxic releases and transfers (metric tons) 0.8 2.8 coefficients of
Weighted toxic releases and transfers (metric tons) 8.1 21.7 releases for
Note: Assumes $1 million of production of SIC 3-714 “motor vehicle parts and accessories” automobile parts
Source: EIO-LCA (2002) production
BIJ plastic products industries. Table II shows a summary comparison of the direct
10,2 effects across several similar plastic products manufacturing sectors. This
comparison highlights the issues that arise when benchmarking firms even
with similar materials and processes. While the direct energy use is similar
across the four sectors, the environmental, health, and safety effects vary
widely. This is a familiar result of benchmarking.
158 As seen in Table II, these sectors vary widely in performance benchmarks.
Conventional pollutant releases and fatalities are an order of magnitude
difference. Energy use and greenhouse gas emissions are more similar. These
differences can be explained by technology, regulation, or other effects. In
addition, using a simple measure such as $1 million of product might not be a
fair comparison.

Product stewardship, supply chain and life-cycle analysis


Product stewardship has motivated companies to consider the “downstream”
implications of their products. For vertically integrated firms, that is the entire
life-cycle. If the firm’s environmental management scope goes beyond the
factory gate, then data across the production supply chain are needed for

Miscellaneous Hoses and


Effect Auto-parts Footwear products belts

Electricity used (Mkw-hr) 0.18 0.16 0.35 0.26


Energy used (TJ) 0.93 1.07 1.04 2.07
Conventional pollutants released (metric tons)
Sulfur dioxide (SO2) 0.1 0.01 0.06 0.12
Carbon monoxide (CO) 0.07 0.00 0.01 0.00
Nitrogen oxides (NOx) 0.12 0.01 0.03 0.04
Volatile organics (VOC) 0.2 0.73 0.92 0.53
Particulate matter less than ten microns
in diameter 0 0.00 0.02 0.01
OSHA safety (fatalities) 0.00004 0 0.00024 0
OSHA lost workday cases 0.38 0.84 0.5 0.70
Greenhouse gases released
(metric tons CO2 equivalents) 58 159 49 135
Fuels used (metric tons) 21 22 17 47
Hazardous waste generated
(RCRA, metric tons) 6.8 0.2 0.37 0.2
Toxic releases and transfers
(metric tons) 0.8 0.6 0.7 1.3
Table II. Weighted toxic releases and transfers
Comparison of (metric tons) 8.1 0.1 0.4 5.4
performance Note: Assumes $1 million of production of the following sectors: motor vehicle parts and
benchmarks for four accessories, rubber and plastic footwear, misc. plastic products, and rubber and plastic hoses and
plastic product belts
sectors Source: EIO-LCA (2002)
comparison. Certainly, most firms are only concerned with the operation and Using input-
management of their own facilities. output analysis
Life-cycle analysis (LCA) is the key to making informed decisions about the
implications for environmental quality and sustainability of choosing among
materials, product configurations, and processes. EPA and the Society for
Environmental Toxicology and Chemistry (SETAC) have developed the most
159
widely used LCA method (Keoleian and Meneray, 1993; Vigon et al., 1993; Fava
et al. (1991)). The first step is to scope the problem, defining the boundaries of
the analysis. The second step is a life-cycle inventory where the environmental
discharges of all processes within the boundary are calculated. The third step is
estimating the implications for the environment of these discharges. The final
step examines ways of reducing the environmental damage by reducing the
discharges or changing the materials, product configuration, or processes.
SETAC-EPA analysis has proven controversial (Portney, 1993). It is time
consuming and expensive to determine the energy and resource inputs to a
process and the resulting product output and environmental discharges. Hence,
the boundaries are drawn tightly, including only the largest supplier or two at
each stage. Since changing the boundaries changes the results of the analysis,
often there is disagreement about where to draw the boundaries. The time and
expense of getting data on each process also leads to using out of date data.
Perhaps the most important problem is that few plant owners are willing to
share proprietary data on their energy and material inputs, outputs, and
environmental discharges. Thus, the individual plant data are rarely seen by
anyone other than the LCA analyst. As a result, it is impossible for anyone
other than the analyst to know the quality of the data. There are inherent
difficulties in relying on the person collecting the data for quality assurance of
that collection process. Unless the data are open to scrutiny, there is little
reason to have confidence in the LCA results.
As an example of LCA, Table III displays the results of a comparison of
producing paper and polystyrene cups using EIO-LCA. In both cases, the
manufacture of cups is approximated by the input-output sector in which the
cups are manufactured. As seen below, there is no obvious “winner” in the
comparison between plastic and paper cups. For example, while emissions of
conventional pollutants are uniformly higher for paper cups, RCRA hazardous
waste is more problematic across the board for plastic cups. It is not socially
obvious which environmental effect is more problematic. However, one result
of such an analysis is a better, more systematic understanding of the
magnitude of impacts for the two types of cups.
For product use, such as an automobile, the inputs could consist of fuel used
over the vehicle lifetime, service estimates (parts and fluids replaced and labor)
and fixed costs such as insurance, depreciation, etc. (Maclean and Lave, 1998).
These inputs are approximated by their input-output sectors. As a result of its
economy-wide boundary, EIO-LCA often leads to more complete results than
BIJ
Description Units Polystyrene cup Paper cup
10,2 Final demand $ million 0.300 0.600
Economywide output $ million 0.745 1.463

Energy consumption
Bituminous coal MT 100.04 232.6
160 Natural gas MT 79.72 63.6
Light fuel oil MT 9.18 25.1
Heavy fuel oil MT 4.67 24.8
Electricity Mk Wh 0.37 0.51
Total energy TJ 9.27 13.9
MT
Non-renewable ore consumption
Iron ores MT 8.84 13.94
Copper ores MT 85.64 33.79
Toxic releases
Air MT 0.35 0.51
Water MT 0.04 0.05
Land MT 0.04 0.03
Total releases MT 0.6 0.62
Releases and transfers MT 1.7 0.92
Conventional pollutants
Sulfur dioxide MT 1.7 4.2
Carbon monoxide MT 1.4 4.4
Nitrogen oxides MT . 1.5 3.5
Volatile organics MT 0.76 1.1
RCRA hazardous waste
Generated MT 155 41
Managed onsite MT 151 40
Shipped out MT 4 2
Summary indices of emissions
Global warming potential MT CO2 eq. 566 984
Table III. Notes: Polystyrene cups are approximated by the “plastic materials and resins” sector. Paper
Selected summary cups are approximated by the “paperboard containers” sector. The price of a polystyrene cup is
environmental 3 cents and a paper cup is 6 cents.
impacts from MT = metric tons; MkWh = million of kilowatt-hours; TJ = terajoules; MT CO2 eq. = metric tons
production of 10 of equivalent CO2 emissions (using IPCC weights)
million cups Source: EIO-LCA (2002)

other LCA methods. EIO-LCA estimates some discharges or resource uses that
are not typically associated with the product.
For automobile parts manufacturing, suppliers use more energy than the
assemblers. As an easy example of the difference between including just the
direct effects of production, Table I shows the total (direct plus indirect) effects
of producing $1 million of automobile parts. The total estimate further
considers all purchases across the supply chain needed to produce the auto
parts, as opposed to just those direct purchases made by the final
manufacturer. With this expanded scope, it is possible to see several orders of Using input-
magnitude more effects across the supply chain. output analysis
This life-cycle perspective can also enhance benchmarking activities within
a firm. Taking a life-cycle perspective of automobiles suggests that driving the
automobile uses much more energy than producing the vehicle, servicing it, or
disposing of it (MacLean and Lave, 1998). Incorporating the life-cycle
perspective could facilitate a benchmark of competing vehicle designs (or
161
materials choices, e.g. steel vs. aluminum). It could also show a specific vehicle
design versus a generic (sector average) vehicle design over the life-cycle.

Social cost accounting and pricing for environmental management


A revolution has taken place in accounting in recent years to provide managers
with better information. Unfortunately, the applications of activity-based
accounting that we have seen neglect important aspects of a firm’s
environmental costs and so lead to bad decisions.
In our work with a number of Fortune 500 companies, we have not found a
single company that has been able to compute the environmental costs and
liabilities of individual materials, processes, products and designs. In addition,
companies focus on their environmental expenditures, rarely attempting to
quantify the extent of future liability from their disposal and other practices.
Unfortunately, they have no direct information about how their costs and
liabilities would change if they switched materials or processes, or changed
their product configurations and disposal methods.
A company’s accounting system does not provide good information
concerning these costs. Unfortunately, the accounting system is the
management information system (MIS) for many companies. The accounting
system is designed to satisfy the Internal Revenue Service (and state and local
taxing authorities) and the Securities and Exchange Commission. Depreciation,
the valuation of property and treatment of liabilities satisfy tax standards; only
in the most remote sense can these accounting values be said to approximate
current market values. Rather, accounting assumptions about depreciation,
length of life of equipment and building, and values for capital goods are
determined by tax authorities with little attempt to relate the assumptions to
current market values. We stress that accounting systems are not designed to
provide the sort of information that is needed to make informed decisions about
products, production, and disposal.
An MIS should provide executives with the information needed to make
design, production, and disposal decisions. A reasonable MIS tabulates current
environmental costs and likely future liabilities and traces them to the material,
product, and process generating them, allowing decision-makers to assess their
current status. A good MIS would give decision-makers information about how
environmental costs and liabilities would change if there were a change in
materials, design, or process. While enterprise resource planning (ERP)
BIJ systems are becoming more pervasive within corporations, few are being used
10,2 to fully support environmental, health and safety missions.
We have been working with several companies on improving their MIS. A
companion paper details some results and lessons learned from these
investigations. In many cases, we find that a company would increase its profit
162 by changing design and practices to lower environmental costs and liabilities.
For example, a plant doing injection molding for plastics seemed to have few
environmental problems. It proudly displayed its equipment for recycling scrap
polyethylene plastic. A closer examination revealed that the plant had a high
scrap rate that increased its costs dramatically and increased its waste
material, including the material that could not be recycled. The accounting
system valued scrap parts at the cost of materials, understating the costs by the
amount of labor and machine time going into each part, as well as disposal
costs. Furthermore, the system credited them with the value of the recycled
plastic without charging them for the labor and machines required for the
recycling. Thus, it saw scrap as almost costless. In fact, scrap parts were three
to ten times more expensive than the accounting system estimated. Faced with
the real costs of this scrap, it saw that decreasing scrap rates was the most
important short-term priority of the plant.
We find that few firms attempt a quantitative assessment of their possible
liabilities from environmental discharges. They assume that satisfying current
environmental laws and regulations will protect them from future liability. Our
history indicates this assumption is not prudent. Many Superfund sites
resulted from companies that satisfied all applicable environmental laws and
regulations – or even went far beyond these regulations. A more prudent
assumption is that any discharges of toxic materials into the environment
could result in future liability.
The MIS described so far attempts to help firms increase their profits by
generating better information about their costs and liabilities. However, a firm
can be fully in compliance with all environmental regulations and still impose
large costs on society. For example, a paint company in Los Angeles that was
in compliance with its permits might have emissions of volatile organic
compounds that were a major contributor to ozone levels.
The next step in constructing a better MIS would be to use the social, rather
than private, costs of discharges. If a company calculated its costs on the basis
of social costs, it would see where it was imposing large costs on society and
perhaps where it is likely to be regulated in the future. Using social costs would
show the firm where corporate citizenship could contribute the most to
environmental quality. Having social costs substantially greater than private
costs indicates a possible problem. In our judgment, a firm should have this
information to make informed decisions about its design, processes, and
materials.
By applying known estimates of the damage associated with air pollution, Using input-
firms could account for the social costs of air pollution associated with a output analysis
product or process. Tables IV and V show the comparative external air
pollution costs of producing paper and plastic cups (using the same
assumptions as in Table III). The values in Tables IV and V display a range of
social cost valuations resulting from air pollution emissions, and are found by
multiplying these valuations by the tons of conventional pollutants and
163
greenhouse gases emitted for the 485 sectors in the US economy. They are
given in percentage terms and represent a valuation of how much society might
be willing to pay to avoid these air emissions. See Matthews and Lave (2000)
for details on the valuation method.
The values suggest that the social air pollution costs of manufacturing paper
cups are roughly twice the social cost of an equivalent number of plastic cups.
If only the social costs of air pollution are important, then plastic cups should
be chosen. The values estimated only consider social costs of air pollution, and
none related to water or release of toxins. Including these would further
increase estimates of social costs.

Low Median High

Total 0.6463 2.9785 9.0536


Paper and paperboard mills 0.2181 0.9188 2.9466
Electric services (utilities) 0.1867 0.7151 2.0225
Pulp mills 0.0534 0.2035 0.751
Crude petroleum and natural gas 0.0259 0.1677 0.3396
Paperboard containers and boxes 0.0223 0.1571 0.3165
Trucking and courier services, except air 0.0186 0.1519 0.5585
Railroads and related services 0.0154 0.0743 0.4139 Table IV.
Industrial inorganic and organic chemicals 0.0145 0.0682 0.2164 External air
Natural gas distribution 0.0122 0.0764 0.1407 pollution costs for
Coal 0.0115 0.0789 0.1348 paper cups (percent)

Low Median High

Total 0.3076 1.4912 4.3139


Electric services (utilities) 0.1128 0.4319 1.2216
Industrial inorganic and organic chemicals 0.0557 0.2618 0.8311
Plastics materials and resins 0.0346 0.1865 0.5264
Crude petroleum and natural gas 0.0337 0.2184 0.4423
Natural gas distribution 0.0091 0.057 0.1049
Railroads and related services 0.0064 0.0309 0.1721 Table V.
Trucking and courier services, except air 0.0061 0.05 0.1837 External air
Coal 0.005 . 0.0345 0.0589 pollution costs for
Other repair and maintenance construction 0.0045 0.0145 0.0839 plastic cups
Nitrogenous and phosphatic fertilizers 0.0042 0.02 0.052 (percent)
BIJ Finally, we offer a more radical suggestion. To an economist, environmental
10,2 pollution arises because companies do not face the social costs of
environmental discharges. Environmental discharges are an externality and
so lead to market failure. As Pigou suggested in 1918, the most straightforward
way to deal with an externality is to impose a tax equal to the external cost to
society (Pigou, 1918). If firms face the correct prices for their discharges, they
164 will have incentives to make the right decisions regarding these environmental
discharges. In this case, there would be no need for regulatory agencies to
compel firms to modify their behavior – the combination of the market system
and social cost pricing would lead to the right behavior.
The notion of social cost accounting and pricing is both attractive and
frightening to executives. It is attractive to think about getting away from EPA
control. However, the pollution charges could be large, adding to costs and
reducing sales. We think social cost pricing is worth serious attention even
though firm costs would be increased in the short term.
Social cost pricing would force society to clarify its environmental goals and
set priorities. Is the social cost of emitting a pound of sulfur dioxide one cent,
one dollar, or $100? How important is abatement of sulfur dioxide compared to
abating emissions of nitrogen oxides (NOx) or emissions of a carcinogen such
as benzene?
Setting these values would unleash market incentives. Firms would find
ways to abate environmental discharges in order to lower their production
costs. Entrepreneurs would search for new technologies to abate discharges or
technologies that are naturally low polluting. These incentives lowered the cost
of abating sulfur dioxide under the 1990 Clean Air Act by more than two-thirds
(Burtraw, 1995).
Social cost pricing would give better information to consumers about the
environmental costs of their purchases. The market price would reflect the full
social costs. Customers would not need recommendations from consumer
groups about which products to buy, since the product price would embody its
environmental costs.
Finally, social cost pricing would give greater stability to firm decisions.
Currently environmental legislation and regulation are subject to chaotic, often
punitive behavior. For example, automobile companies have a difficult time
predicting new emissions regulations. They also point out that they are subject
to much more stringent NOx emissions controls than are stationary sources.
Under social cost pricing, cars and electricity generation plants would face the
same marginal costs for NOx emissions control, leading to lower total costs of
NOx abatement.
Social cost pricing would not replace regulation. For discharges that lead to
global or regional rather than local problems, social cost pricing would be
sufficient. For greenhouse gases, CFCs, and, to a lesser extent, the precursors of
acid rain and ozone, social cost pricing would be expected to lead to the desired
level of abatement, the only issue. For suspended particulate matter and toxic Using input-
emissions, emissions can cause local “hot spots” that could result in output analysis
unacceptably high local risks, even though the overall level of abatement is
achieved. Regulations would still be needed to deal with these hotspot
problems.
In the paper versus plastic cup example, given public outcry about air
pollution, consumers would face a “fully costed” price of paper cups that was
165
between 0.6 and 0.9 percent higher, and 0.3 to 0.4 percent higher for plastic
cups. A social cost analysis can aid benchmarking activities within the firm by
showing dollar-valued social cost comparisons of environmental discharges
against production cost. If air pollution damages are the primary concern, then
the method used would give social cost benchmarks of the two alternatives.
The firm could use the benchmarking data to minimize the total cost of
production with air pollution damages included.

Conclusion
The first step in improving environmental quality and sustainability is to
clarify social goals. The environmental legislation of the 1970s set out
environmental goals, although Congress was far from clear as to the precise
goals. The next step is to fashion tools that allow firms to calculate the
implications for their profitability and social goals of their decisions regarding
product design (choice of materials and product configuration), processes,
materials, and disposal practices. To be useful, these tools must address the
firm’s problems, must be quick, inexpensive, and sufficiently reliable to be
worth using.
We have described a tool that can help to improve this decision making, both
for the private sector and for government. EIO-LCA can provide good estimates
of impacts for industries, especially if the time and resources are not available
for a detailed analysis. It can be used to help firms benchmark their progress
broadly within an industry or across common industries. Finally, social cost
accounting and pricing provide information so that executives can make
informed decisions.
These tools enable environmentally-conscious companies to examine the
implications of their decisions and track future performance or efficiency gains.
They also create a demand for better data on composition of a product or
component and of the materials use and environmental discharges associated
with a particular manufacturer. Many of the companies purchasing
components of consumer products are now demanding this information from
their suppliers. Environmental management tools, such as ISO 14000, require
this information. Although they have complained about providing these data,
much of the confidential information (e.g. TRI and RCRA) has already been
disclosed. The required reporting has led to large reductions in environmental
discharges to the benefit of the environment and society more generally.
BIJ Local, state, federal, and international law is requiring firms to evaluate and
10,2 improve their environmental performance and look forward to sustainable
operations. Companies that fail to comply with the letter and spirit of these
laws will be censured by stockholders, employees, and the community, and
fined by regulatory agencies. Until now, companies thought of compliance as a
painful, costly process. The tools we describe can help firms to lower their
166 costs, better understand the implications of their products, and predict future
social and regulatory concerns.

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