Return on Climate and Environment: a new ROCE metric for the next 2,000 years

Products, profits and returns have been the language of business for decades. And rightly so; the provision of compelling goods at a competitive price remains existential for business success. These fundamentals haven’t changed.

But society has – and the search for an alternative to the traditional criteria for assessing business performance, Return on Capital Employed, is assuming a new significance. A new type of ROCE, Return on Climate and the Environment, is evolving.

ROCE has always been a favoured metric for understanding business performance holistically, across all parameters. Unlike return on equity, for instance, ROCE measures the return on all the capital invested in an enterprise, not merely through its shares, but also other sources of finance such as loans, grants and contributions (beyond equity), as well as any asset depreciation that has gone into ‘fuelling’ operations during the period in question.

Unlike the simpler net income ratio – revenue minus costs – ROCE also considers the volume of inputs employed to realise a certain profit. This is why its evolution towards Return on Climate and the Environment makes so much sense – a straightforward metric that records the manner in which an enterprise is using all the resources at its disposal.

Today, such considerations extend well beyond the domain of finance. Society (and, increasingly, investors, employees and consumers) are applying a new set of criteria to business, reflecting not merely the quality of their products and services, but their use and impact on all the resources at their disposal.

Such ‘new’ ROCE criteria will have huge implications not just for what and how businesses produce, but how they are valued in both financial and societal terms. There is overwhelming evidence to suggest a clear correlation between environmental consideration and business performance.

My favourite example is as compelling as it is simple: in 2014, Harvard Business School calculated that a dollar invested in a select portfolio of public companies whose stated objective was growth, 20 years earlier, that dollar would be worth $14.46 at the time of the research. A significant return, certainly. However, if that dollar had been invested in companies focused on the most environmental and social issues while growing their businesses, that same dollar would’ve grown to $28.36!

This is new ROCE in action; and it’s perfectly compatible with the traditional acronym of the same letters.

In common with many other businesses, my own firm – The Mahindra Group – is already applying some of these principles to our operations. It’s a learning and evolving process, but significant milestones have been reached.

Our Formula E team, Mahindra Racing, for instance, has been pioneering this new idea of ROCE. The team has been achieving net zero emissions across its entire operations since inception – an experience which will prove fundamental to our Group as a whole as it works to attain carbon neutrality by 2040.

This experience underpins our commitment to all aspects of sustainable transport. We have implemented more than a 100 ESG projects since 2014, which have generated an average return on capital of 24% over a period of just two years. Energy represents 12-15% of overall manufacturing costs for vehicles (cars and tractors). Over the last three years, with the adoption of renewable energy and energy efficiency improvements, we have reduced energy costs by around $6.5 million a year.

Traditional ROCE metrics have been in common use since the Greek and Roman times, so we’ve had a lot of time to get used to them. By contrast, the idea of a new type of ROCE, Return on Climate and the Environment, is still in its infancy.

Let’s hope these new principles last, and help shape and define business for as long as the original ROCE. That’s 2,000 years and counting!