Most people don't get excited by accounting concepts. But according to Peter Drucker, Chairman of the World Business Council for Sustainable Development, we actually should. He claims that accountants are going to save the world. After all, they can help companies integrate sustainability issues into their report and reporting is crucial for companies for getting capital. So the concept of materiality is key here. In the previous video, we argue that sustainability is crucial to business models and corporate strategy. But what sustainability exactly? Sustainability is a very wide concept with potentially hundreds of issues to consider, and it would be foolish to take all those issues equally seriously. One simply doesn't have the time or resources to do that. So focus is warranted, focus on those issues that matter the most. But how do you determine what matters most? It also begs the questions, what matters most to whom, in what situation, in what context, and to what stakeholders. So let's take an example here. The material issues of pharmaceutical company are very different from those of a mining company. In pharma, material issues tend to be innovation, human capital, product safety, and ethical pricing. In mining is more likely to be about health and safety of labor, environmental issues, and the management of local stakeholders. But even within mining, material issues can differ a lot depending on the type of product being mined, its labor intensity, and its location. So it's a lot more risky to do manual copper mining in a place like Congo than to do mechanized iron ore mining in Australia. Let's look at some of the alternative definitions of materiality. First of all, there's accounting materiality, which refers to the financial statement implications of an issue. This is a rather narrow concept as it depends on strict criteria [inaudible]. Second, there are stock market materiality, which refers to anything that moves stock price often instantaneously. Third, there's business materiality, which is about anything that affects the company operationally, and these three materiality concepts, they may or may not overlap with each other at various instances and over time. So for example, a labor issue in a mine. It can evolve over a few months time from a business material issue as the company risk losing production to one as marketing material, as the stock price drops to one that's accounting material as it shows up in lower profitability. Materiality is the basis for deciding whether to report on an issue or not. But it's not the only criterion for deciding whether to act or manage on an issue. Issues might also be immaterial from all three above perspectives. For example, if it concerns only a small operating units in a large company. But if it's material to stakeholders and if it's basic decency to take responsibility then a company had better fix it. Because if it doesn't, it effectively shows it's not in control or doesn't take such things very seriously and then it may become material after all. In practice, we use these different types of materiality interchangeably and there are typically maps in a so-called materiality matrix. For every company, you can draw a different materiality matrix. In the picture you see the materiality matrix for Novozymes, an enzyme maker that replaces petrochemicals with enzymes and these enzymes help clients operate more efficiently and also help them emit less greenhouse gas emissions. This is great, and to keep on delivering those superior products, the company has to be superior on innovation, compliance, and partnerships. They are all crucial to the success of the company, but also to its stakeholders. For a mining company, this matrix will look completely different with, for example, much more emphasis on the management of the local stakeholders and worker safety. Companies typically devise such materiality matrix by having stakeholder dialogue. So they invite a lot of people to give their opinions. But another way to do is, and you can also do this from the outside, is to build a stakeholder impact map. By listing the main stakeholders and their goals, one can get a nice overview of the tensions in a business pool. For example, at pharmaceutical companies, there is the conflicting goals of affordable products on one end, and company pricing on the other. In social media companies, the users, they're not clients which means that users get products supposedly for free, but the data are sold to the real clients and social media companies have an incentive to act in the interest of clients rather than users. Doing such an analysis can help discover additional risk or opportunities. It may change your view on the attractiveness of a company. So my call to action is simple, do a materiality analysis, don't be blind. As an investor, I've seen too many list of companies who hadn't thought this through properly and they got into trouble. Trouble that could be easily have been avoided and perhaps even worse, many companies miss great opportunities. So please do a materiality analysis.
