The Folly of 100% Compliance

How a myopic focus on compliance minimizes strategic thinking and business value

• By Richard MacLean
• Mar 01, 2006

Environmental, health and safety (EHS) departments were created in response to regulations. For most, it continues to be their raison d'être in the minds of most business managers. Unfortunately, this mindset has typecast EHS professionals into non-strategic roles: service providers who can, at most, add value by cutting regulatory costs. In reality, the opposite is true, but only for those who understand emerging issues and demonstrate strategic thinking. I have interviewed scores of business managers about their expectations and goals concerning EHS and social responsibility (EHS&SR). Usually, these discussions are in conjunction with strategic planning sessions to set the "future state." On a number of occasions their response was proudly, "Excellence!" How commendable. But when pressed on what exactly they meant by excellence, the response was "100 percent compliance."

I am not making this up. This is akin to claiming that the prime measure of an exceptional member of the community is "someone who has never been arrested." I am sure that we all know more than a few boorish, obnoxious, and toxic people who have not received so much as a parking ticket but could hardly claim title to community member extraordinaire.

One hundred percent regulatory compliance has dominated management's thinking in the areas of EHS. Notices of violation (NOVs) and regulatory fines are the gold standard for most company metrics. Beyond this, lagging indicators -- such as accidents and emission reductions -- dominate the scorecard, followed by worker compensation claim reduction and pollution prevention savings. Good metrics all, but hardly strategic, and, with rare exceptions, these metrics do not track issues material to a company (in the Security and Exchange Commission sense).

Does anyone know of a company that was materially impacted because of issues measured by these specific metrics? I'd love to hear about it. Safety is essential; environmental compliance is imperative; low Toxic Release Inventory numbers are important; but how many companies went bankrupt because their stats in these areas were a bit out of whack? Yet, there have been scores of companies that either went bankrupt or made millions over EHS&SR-related issues. What is going on here?

First, real strategic value is all about anticipating emerging issues and responding with selective, competitive positioning to maximum business advantage. This is Michael Porter's (the famous Harvard Business School professor) consistent message on competition.

Second, legislative and regulatory changes move at bureaucratic speed unless there is some massive event to unify and shift public opinion. These events are rare. Companies hire lobbyists to manage the regulatory process, to minimize impact, and/or maximize some other angle to their advantage. Usually, for every Yin (a buck in one special interest's coffer) there is an equal and opposing Yang (in another's coffer). Implementation schedules drag out until the competitive playing field is leveled for routine compliance matters. There are notable exceptions, which I'll get to later.

Similarly, sudden, catastrophic environmental and safety events are relatively rare and seldom rise to the materiality threshold. Bhopal was the most tragic exception, leading to the eventual demise of Union Carbide (Ed. Note: In 1984, the Union Carbide Plant in Bhopal, India, had an accidental release of methyl isocyanate that caused the deaths of more than 2,000 people and adverse health effects in over 170,000 others.). From a business perspective, this means that internal business adjustments can be made (e.g., insurance bought for known risks) to mitigate significant impacts. The net result is that the competitive playing field is again leveled.

Fourth, with relative assurance that the regulatory process will move slowly, and with risk management systems and insurance in place, business managers often grow complacent -- often thinking things are under control. Add a dash of public relations and philanthropy, and "corporate responsibility" issues are covered. Questions to EHS managers become, in essence, binary: "Are we in compliance? -- Yes or No." Are these resources you are requesting needed for compliance? -- Yes or No."

And, finally, after more than a decade of this myopic focus on compliance, many -- if not most -- EHS departments have been reduced to the bare bones; they struggle just to maintain regulatory compliance and keep the latest OSHA numbers tracking downward. The so-called EHS business value question narrows to the usual (and obvious) suspects.

Indeed, EHS&SR managers themselves can become overly focused on tracking these short-term performance issues: They know that there is hell to pay if the "real metrics" by which their performance is measured get out of whack. Longer term EHS&SR issues that can literally bankrupt the company take a back seat in the day-to-day struggle to keep the key performance indicators tracking right. The analogy to CEOs' attention to their stock market price, the subsequent shareholder value meltdown, and the governance scandals of less than a decade ago is troubling.

Timing is everything
Competition is all about timing. Having the right product at the right time is paramount. Likewise, knowing where the landmines are can save a company from disaster. These factors may have little to do with routine regulatory compliance. On the other hand, compliance can have everything to do with competition when government action literally changes the entire paradigm, as U.S.-based electronic manufacturers are now finding out with emerging European Union market restrictions.

When a company engages in some new business activity -- say, making a widget with proprietary materials -- the business can be at the cutting edge of enormous competitive advantage. But products and processes are not static, and, down the road, concerns may develop. No responsible company would knowingly start up some new activity that is clearly in violation of a regulation. But what can happen with time is that concerns may be identified that are eventually brought to the attention of the media, the public, legislators, and regulators that might ultimately result in new regulations. The key is that the company acted in 100 percent compliance with existing regulations since there were no new regulations in effect. Once the issues are sufficiently identified to elicit responses from legislators or regulators, then new rules will define compliance. A company may never be out of compliance during this process, may consistently have acted in accordance with letter of the law requirements, and may have adjusted or even ceased its operations as a result. Is that the end of the story? Not by a long shot.

Sometime thereafter, a company may be rewarded for what amounts to a 100 percent compliance track record with a series of lawsuits and retroactive requirements that may have a material impact or even bankrupt the company. The ultimate example is asbestos, with nearly 80 companies forced into bankruptcy. Polychlorinated biphenyls are another case study in, "We did nothing wrong." Waste disposal and the dawn of Superfund is yet another. Chlorofluorocarbons are at the opposite end of the business spectrum: A profitable new business direction was launched by DuPont that recognized the strategic advantage of supplying substitutes.

What all of these examples share is that, inevitably, there were early warning signs of material gain or loss, yet companies maintained 100 percent compliance at all times. Over and over, we hear the predictable claims by business executives drawn into a public relations or financial mess that they acted responsibly (i.e., were in compliance). These claims ring hollow in 20/20 hindsight when the definitive toxicological and other data come to light, and then the politicians come in to bayonet the wounded companies in front of the media.

To my earlier analogy on the criterion for an outstanding representative of the community, there were hundreds of wife batterers who violated no gun-control laws, that is, until the laws were changed to require retroactively that those guilty of past domestic violence forfeit their future gun rights.

Keeping an Eye on the (Strategic) Prize
For business mangers to whom I have laid out these dynamics of full compliance, there is almost an audible "Uh, Oh" awakening when they view my PowerPoint® slides. EHS&SR strategy is all about this forward-looking examination of emerging issues combined with a retrospective look at the consequences. In other words, real strategic advantage (i.e., material gain) happens when opportunities or threats are identified early on and the company competitively positions itself in anticipation.

These opportunities or threats actually may relate to issues that could eventually develop into regulatory requirements, but the operative term is "emerging issues." In other words, the company with the best crystal ball wins. This applies to EHS&SR as well as any business issue.

On the other hand, business managers (and especially top executives) view compliance -- any form of compliance -- as a cost of doing business. Service departments completing tasks and keeping things in compliance are important, but hardly considered core to the business success. EHS professionals hate to hear this rather dismal assessment of how they are characterized. It comes as no surprise, however, that so many EHS departments are situated within the legal department or shared service group.

This point was driven home in Stewart Hart's recent book, Capitalism at the Crossroads, in which he diagramed the "Shareholder Value Model" and the "Sustainable Value Framework."¹ Compliance was not on it. Programs such as pollution prevention were, but these programs typically yield cost savings that rarely enter the realm of material advantage. There are exceptions, such as when new technologies change the competitive playing field, but these typically are an artifact of the technology rather than any program specifically driven by the EHS&SR group (e.g., the shift to X-ray technology without silver films and the associated pollution).

For many EHS managers, shifting into a strategic role within their company seems beyond their reach. They just do not know how to go about it, what emerging issues to track, what tools to use, what resources it takes, how to communicate these dynamics to management, and so on. They are stuck inside a role defined by their own management's limited perceptions of what can be done. At the same time, they watch companies such as BP, General Electric, Duke Energy, Intel, Nike, and others redefine their core business strategies based on emerging EHS&SR dynamics. "Those are big companies: we don't have the resources," they rationalize.

I exaggerate, of course, but not by much. An unfair generalization? Certainly. I know that my clients are well down the learning curve and I know many others, beyond the aforementioned, that have their eye on the strategic prize. Still, for most companies, the EHS&SR staffs struggle over the compliance game but feel needed because they are just "oh-so busy." Are you busy or strategic? Hopefully, you are both.

References
¹ S. Hart, Capitalism at the Crossroads -- The unlimited business opportunities in solving the world's most difficult problems, Wharton School Publishing, Upper Saddle River, NJ, 2005, pages 60 and 65, respectively.

This article originally appeared in the 03/01/2006 issue of Environmental Protection.