Environmental Costs Hierarchy

Environmental Costs Hierarchy

Source: adapted from US Environmental Protection Agency (2000) The Lean and Green Supply Chain: A Practical Guide for Materials Managers and Supply Chain Managers to Reduce Costs and Improve Environmental Performance, Environmental Accounting Project, EPA 742-R-00-001.

To produce and make goods available on the market, a hierarchy of environmental costs is concerned, from internal costs that are easy to quantify to external costs that remain vague and complex to assess and even more to quantify. Although managers are keenly aware of the costs involved in managing supply chains, there is commonly a lack of formal methodologies to assess them. This makes environmental accounting a challenging process far from being an exact science since it can be influenced by changing concerns, priorities and even ideology. Still, this endeavor invovles five cost categories:

  • Internal costs are well understood as they concern the inputs costs (materials, labor) related to what has been produced. Most firms have a good level of control over these costs as they directly disburse them. It usually involve an inventory of the processes related to operations, such as energy consumption, materials and other inputs used and wastes discarded.
  • Compliance costs concern an array of expenses that do not contribute to the output but are related to the regulatory framework. Environmental issues, such as emission standards, are common and come with costs assumed by firms to ensure compliance. Compliance can also have some benefits, particularly if it implies subsidies, market access, lower levels of taxation, or lower insurance premiums.
  • Contingent costs. Depending on the sector of activity and the part of the supply chain, there is always a risk of accidents or hazardous materials releases. Although it can almost be certain that such an event will eventually happen, its moment and intensity remain only a probability. Contingent costs thus imply a form of risk management where a low level or a lack of compliance can be weighted in terms of the involved risks, such as being fined.
  • Image and relationship costs. A firm or a product that is perceived negatively from an environmental standpoint can incur significant costs in terms of lower sales, litigation and even market valuation. Public relations on environmental matters are a complex and commonly costly endeavor. If skillfully done, it can also lead to positive impacts in terms of better sales of products perceived as “environmentally friendly”.
  • External costs relate to an array of costs that are externalized, implying that they are assumed by society and not by the firm. Growth often results in a higher level of usage of transport infrastructures, more pollutant emissions, and a higher risk for accidents. All these costs are commonly assumed by the wider economy and can therefore be considered to be outside the firm. They are refered to as environmental externalities.