When you buy a can of beans, you can read the label and know exactly how many grams of protein, fat, and calories you are consuming. Robert “Bob” Kaplan and Karthik Ramanna have applied the same principle to measuring greenhouse gases (GHG).
“When you purchase a car, for example, you’ll see how much CO2 was created in producing that car, which you can think about amortizing over the life of the car along with the GHG from the fuel you burn, based on the car’s fuel efficiency,” explains Bob. “If companies can start reliably reporting their GHG numbers, and their customers and consumers begin looking for this type of information, it can create lasting, realistic changes in behavior across the economy to address climate change.”
Bob and Karthik have won the 63rd Annual HBR McKinsey Award, which honors the best Harvard Business Review article of the year, for their story outlining a new rigorous approach to measuring greenhouse gases. It integrates basic financial and cost accounting practices with advances in both blockchain technologies and in calculating direct emissions. Using their approach, companies can produce auditable and contractible corporate climate accounts in their pursuit of more sustainable growth.
Most companies report their emissions using the GHG Protocol, the authors explain, established 20 years ago and updated several times since. It outlines 3 types of emissions: Scope 1 which are direct emissions from sources that are owned or controlled by a company, such as its production equipment; these are about 15 to 20 percent of a typical company’s total GHG footprint. Scope 2 covers emissions at facilities that generate electricity bought and consumed by the company. Scope 3 includes all other indirect emissions that occur in a company’s value chain including end users.
Bob and Karthik focus on Scope 3 emissions. “As currently defined, they are almost impossible to measure,” says Karthik. “A car maker or aerospace manufacturer would have to reach out to tens of thousands of suppliers and suppliers’ suppliers, and say, ‘Tell us how many greenhouse gases are in every one of the tens of thousands of components we buy from you.’ As a result, companies are allowed to substitute industry-standard metrics for actual numbers, and carbon reporting becomes riddled with guesstimates. Scope 3 eliminates the incentives for companies to invest in reliable and auditable climate data.”
In addition, the GHG Protocol requires multiple counting of the same emissions by the many companies in a supply and distribution chain, creating redundancy and reducing accuracy. So, many companies don’t even report Scope 3 emissions. “The largest part of a company’s carbon footprint goes unaccounted for, and this was the measurement problem we set out to solve,” Karthik adds.
Bob describes himself as a “quant guy” and is a senior fellow and professor emeritus at Harvard Business School. Trained in electrical engineering and operations research, he learned to teach accounting at Carnegie-Mellon’s Tepper school and has written on healthcare, strategy, and risk management, winning his previous HBR McKinsey Award in 1984.
Karthik is a professor and director of the Master of Public Policy Program at the University of Oxford’s Blavatnik School of Government. A graduate of MIT and an expert on accounting, business-government relations, and organizational trust-building in society, he is also a prolific writer of case studies, for which he won three international awards. “We work well together,” says Bob, “we finish each other’s sentences.”
As Bob and Karthik delved into the research, they independently realized, ‘Actually we know how to solve this.’ It’s basic accounting—but applied to the physical measurements of gas rather than physical quantities of cash. In the article, they illustrate their new approach to GHG measurement using the example of a car-door manufacturer and its supply chain.
As a first step, the company records the quantity of GHG in the products and services it buys from its tier-1 suppliers. Then, environmental engineers estimate a company’s Scope 1 emissions from its own production and distribution processes. Both these data are entered into a new E-liability account, and, using activity-based costing, are assigned down to all of its outputs of products and services. For example, a steel sheet’s E-liability would include its share of the on-site greenhouse gases generated in its production, plus the accumulated greenhouse gases from all the input products that had been purchased and used in its production process (including a depreciated share of GHGs from its capital equipment).
The E-liability attaches to the steel sheet as it moves through the value chain, adding up or subtracting down along the way, depending on the emissions and offsetting activities of various intermediary companies. For example, when it is transferred to a shipping company for transport, each ton carries its share of accumulated E-liabilities—starting with the mining company, through the plant production process—and now includes emissions from the shipping itself. If one of the intermediaries along the way has engaged in carbon-abatement activities such as reforestation, the E-liability metric may be reduced to reflect this.
“This approach is simple, even elegant,” says Karthik. “It leverages the existing accounting system by adding a second field for GHG, alongside the currency field. The E-liability information travels with the product. As you go from stage to stage, you could put it on a blockchain so auditors can go in and check on it, providing both transparency and integrity. The key insight was to measure and transmit GHG information at the output level, exactly the way inventory accounting works—not at your enterprise or facility level.”
Since Scope 3 emissions were impossible to measure accurately, companies didn’t have much incentive to reduce them. “We basically lost 20 years of corporate innovation because we had an accounting system that didn’t recognize decarbonization winners, and prospective customers couldn’t trust the numbers,” points out Karthik. “Now, we have a rigorous and low-cost method of measurement, which we hope will take off and align the power of competitive markets to address climate change.”
As a next step, Bob and Karthik will be piloting their approach with a number of companies, and have been reaching out to regulators. “We think this is a critical missing element for companies undertaking net zero pathways,” says Bob. “Because if you don’t measure it well, you can’t manage it and improve it.”