Environmental Costs Hierarchy

Cost TypeImplications
InternalMaterial, labor, other expenses, and revenues that are commonly allocated to a product or process. Can easily be quantified (internalized).
ComplianceExpenses incurred by and benefits to the firm that are not related to products or processes. Mostly concern compliance to regulations.
ContingentPotential liability or benefit that depends on the occurrence of a future event. Assessed as a risk.
Image / relationshipCosts/benefits related to the subjective perceptions of a firm’s stakeholders.
ExternalCosts/benefits of a company’s impacts upon the environment and society that do not directly accrue to the business. Difficult to quantify (externalized).

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 methodologies available to assess them formally. This makes environmental accounting a challenging process far from being an exact science. Still, this endeavor concerns 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 for these costs as they directly disburse them.
  • 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 all come with costs assumed by firms to ensure compliance. Compliance can also have some benefits, particularly if it implies subsidies, 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 its 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 and litigation. 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 emissions of pollutants, 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.