How to Evaluate Sustainability Innovations in Construction
I attended a doctoral dissertation defense at Aalto University in Otaniemi on Friday, September 15, 2016. The candidate, Juho-Kusti Kajander, M.Sc. (Econ.), presented his thesis on how construction industry companies can evaluate their sustainability innovations and the economic benefits of innovation investments.
Juho-Kusti’s thesis is titled “Evaluation of sustainability innovations in the construction sector.” In his study, Juho-Kusti suggests the following:
- Construction companies should evaluate sustainability innovations together with clients and the value network to systematically manage the development and adoption of sustainability innovations in the construction sector.
- Construction companies can evaluate the potential monetary benefits of sustainability innovation for shareholders with event studies and for clients and tenants with real-option analyses.
The opponent was Professor Dr. Petri Suomala of Tampere University of Technology. He said he is a layman when it comes to construction. Nevertheless, he seemed to grasp important questions about the construction business and sustainability innovations in that industry.
The research applies a mixed-methods approach combining qualitative and quantitative methods. It features methods and tools to evaluate innovations. Juho-Kusti was also personally involved in some of the investment projects. That is known as interventional research, which, according to the opponent, is no longer a sin.
Need for disruptive innovation
According to Juho-Kusti, construction companies need disruptive or radical sustainability innovations. He argued that urgent global challenges, such as population growth and the demand for a higher standard of living, require fast solutions. Because construction is a big player in the global economy, it can also make a big difference in how sustainable our future will be. On the other hand, the industry can receive substantial financial benefits from being sustainable. For example, buildings with LEED certification enjoy a 5% rental premium and sell for 25% more than non-certified buildings.
Evaluating the shareholder value of innovations
One of the evaluation methods described in the dissertation is an event study. This type of study helps assess an innovation’s impact on a company’s market capitalization, at least in the short term. Juho-Kusti outlined the process for using the tool:
1) Select the kind of innovations and effects to be studied.
2) Collect stock exchange announcements from firms with similar innovations.
3) Calculate whether the announcements had an impact on the market capitalization and how big any impact was.
4) Analyze the results.
5) Follow up on the development of the selected companies’ shareholder values.
The study found that in construction, the positive effect of a sustainability innovation announcement was 0.8%, which is as high as that of a positive profit alert. In other words, sustainability innovations add noticeable shareholder value.
Evaluating the value of innovations for property owners and users
Another tool Juho-Kusti used to evaluate the monetary value of innovations in construction projects was real-option analysis (ROA). He briefly walked us through the process:
- Identify uncertainties in the project, such as changes in the property’s occupancy rate.
- Select innovations that could help manage and mitigate the risks.
- Perform investment calculations with a real-option software tool using three alternative scenarios.
- Calculate the ROI.
- Make the investment decision.
Juho-Kusti mentioned that the feedback he received on the use of ROA during investment projects was very positive. The method makes it possible to analyze a large number of alternatives in a relatively short time. The often-used alternative, discounted cash flow (DCF) analysis, does not address uncertainties, e.g., changing tenant requirements, very effectively. In DCF, uncertainty is usually taken into account by adjusting just one value, i.e., the discount rate.
For example, ROA was used in a health-care center project. The calculated benefits of an indoor air innovation were four million euros. The benefits were mainly due to reductions in employee sick leave. In another project in an office building, the innovation benefits came from a flexible building system. The system rewards the owner and the tenant since unused spaces are easy to lease out. The benefits were around 700,000 euros.
Construction industry pundits often claim that their business is unlike any other. The opponent pointed out that the findings of the dissertation can be applied in other industries with similar traits, such as project orientation and long supply chains. He also reminded us that sophisticated analysis methods are not always required if the initial parameters are well known.
After a careful investigation with several questions for Juho-Kusti, the opponent recommended that Juho-Kusti’s thesis be accepted as a doctoral dissertation. You can download it for free at https://aaltodoc.aalto.fi/handle/123456789/21756.
Juho-Kusti is the CEO of Boost Brothers. You can contact him at juho-kusti.kajander[at]boostbrothers.fi.