Should Companies Invest in Sustainability?- Juniper Publishers
Civil Engineering Research Journal- Juniper Publishers
Short Communication
In April 2018, MIT Press published my book, Balancing Green: When to Embrace Sustainability in Business (and When Not To). The book was a result of five years of primary research interviewing hundreds of executives in industry, government and NGOs. My original intent was to argue, as did others, that business should take the lead because many governments are paralyzed by discord and political calculus. Industry, I thought, being the source of most environmental impacts, can and should lead the way (Figure 1).
Over five years and over 500 pages later, I now realize that not only business is not taking the lead -it really should not do it. To understand this viewpoint, we have to think about what role industry plays in society. Vast supply chains span the globe to deliver goods and services to humanity. Through advances in information and communications technology, companies have lowered their costs and vastly enhanced their levels of service so that more people can afford and enjoy more goods whenever and wherever they desire. These advances have enabled new business models, such as electronic commerce and omni-channel, allowing delivery of many products in a day or two or even in hours, at affordable prices.
Three of the most revealing results of the research that led to my book are that
A. Companies cannot control most of their emissions even if they wanted to
B. Most consumers are not willing either to pay more or incur slight inconveniences in the name of sustainability, and
C. Jobs and economic development are more important than sustainability.
1. It’s Outside the Four Walls
For almost every company, most of its environmental footprint of a company’s products is not in its own operations. Instead, it comes from either its upstream supply chain (the deep-tiered network of suppliers, sub-suppliers, sub-sub-suppliers, and so on) or from downstream in the use phase (when consumers use and discard the product). Examples of use-phase impacts include exhaust emissions from automobiles; electricity-related emissions for consumer electronics; the footprint of making hot water when using laundry detergents, shampoos, and soaps; and many others. This is important to remember as one judges corporate claims of environmental achievements.
Every product is based on a bill-of-materials (BOM), specifying the components of the product, their sub-components, and their sub-sub-components. Some electronic products have 15-20 echelons in their supply chain. Their intricate composition is based on materials and minerals that must be extracted from the earth, yet the companies making and selling the electronic product is not likely even to be aware of who the deep-tier suppliers are. While companies know who their “Tier 1” suppliers are - those are the suppliers they buy from and pay -they typically don’t know who the suppliers of these suppliers are. Most suppliers regard the identities of their sub-suppliers are as a trade secret and a source of competitive advantage. In addition, in some cases they fear that the manufacturer will bypass them and buy directly from their sub-supplier. Even if a manufacturer identifies a sub-supplier buried deep in its supply chain, it has no leverage over it and therefore no ability to convince or pressure such a supplier to become more sustainable. The reason is that the manufacturer has no commercial relationship with such a supplier. Furthermore, the sub-supplier may not even know that its own product ends up used by the manufacturer.
The issue with use-phase environmental impact can be even more difficult. For some products it is simply a new design with no behavioral change required. A more energy-efficient refrigerator or computer might be identical in performance and operating instructions to the less-efficient model it has replaced; it simply uses less energy (yet it may cost more). Others, such as a cold-water detergent, might involve some modest change to an otherwise familiar practice. Finally, some changes, such as electric vehicles, might demand both behavior changes (e.g., learning to manage the range of the vehicle and find charging stations), as well as concomitant consumer investments (e.g., installing charging facilities at home).
In addition to designing products for efficient downstream usage, companies may have to influence and educate consumers on the benefits and efficacy of new, environmentally responsible products, and how to use the product in a sustainable fashion. For example, dry shampoo110 is a specially formulated spray or powder that absorbs excess oil from the hair and scalp, allowing for a longer period between wet hair washes. Unilever claims that it can replace a wet wash 60 percent of the time. Consumers, apparently, do not believe the product has the same efficacy, value, or appeal; dry shampoo accounts for only 3 percent of the global market.
Because of such difficulties, companies focus on their own operations and report on their efforts in glossy brochures and triumphant press releases. For example, Coca Cola tout the reduction in their water use. It reduced its water consumption in its own operations from 2.7 liter of water per liter of beverage to 1.96 Liter per liter of product. Meanwhile, the sugar beet farmers deep in its European supply chain that supply the company guzzle 28 liters of water per liter of Coke. And, while McDonald’s is working to scrap the use of plastic straws in its restaurants - an inconsequential initiative -- it keeps serving beef, despite the fact that cattle is responsible for about 10 percent of all global GHG emissions, mainly through its emission of methane, a greenhouse gas 28 times more potent than carbon dioxide in its impact on global warming. The point of this section is that in most cases companies cannot really have a significant impact on sustainability because they have no control and little influence over their deep tier suppliers or customers. Consequently, most do what they can within their own operations, but are not putting it in the context of their actual supply chain-wide environmental impacts.
Say vs. Pay.
In many polls and surveys, consumers claim they want more sustainable products and are willing to pay more to for them. But retail data shows that very few actually do. Faced with a choice at the supermarket shelf, the vast majority of consumers choose the least expensive products regardless of its environmental characteristics. Furthermore, consumers are not willing to tolerate lower product performance or less convenience. When McKinsey, the management consulting company, surveyed 1,000 consumers in Europe and the US, it found that less than 10 percent of consumers said they were willing to pay a 25 percent higher price for green goods. Realistically, such surveys overestimate the impact of eco-labels: Survey participants tend to respond the way they think the survey creator wants them to respond, or they may want to appear progressive and caring. Data from actual product sales experiments, in contrast, show lower premiums for sustainability labels and sometimes no premium. British researchers, using an ordinary least squares model based on dozens of indicator variables, found the premium for Fair Trade coffee already on the market to be only 11 percent. A New England study of 26 grocery stores found that eco-labels had mixed effects on sales and price premiums.
When a Fair-Trade label was added to two previously unlabeled coffee varieties (one selling for $10.99 and the other $11.99 per pound), sales volumes of both increased by about 10 percent. When the prices of both coffees were raised by $1 per pound, sales volumes of the higher priced coffee remained elevated, whereas sales of the lower-priced coffee dropped by about 30 percent. This result suggests that wealthier consumers may be willing to pay a premium for sustainable products, while more frugal consumers might use sustainability attributes only as a tiebreaker among equally priced products, rather than an inducement to pay more. Finally, in an on-going study by the MIT Center for Transportation and Logistics, consumers were simply observed while making buying choices between clearly-marked sustainable products (soaps, detergents, paper products, etc.) and regular products in several Boston area supermarkets. Early results show that only four percent of consumers choose the sustainable products.
These and other observations of actual behavior (rather than questionnaires) suggests that the majority of consumers in developed countries refuse to pay more for sustainable products. The situation is even more alarming because for the vast majority of consumers in developing markets, sustainable products are a “luxury good.” In other words, if they will attain the standard of living of Western consumers, including air conditioning, concrete buildings, and automobiles, no amount of sustainability initiatives by consumers and companies will bring a reduction in the rate of carbon emissions growth.
Finally, for readers who think they are willing to pay more or be somewhat inconvenienced in the name of sustainability, I pose the following questions:
i. how many of you or your fellow consumers refuse to purchase items from Amazon (or other e-commerce sites) because of the wasteful item packaging which ends up in landfills?
ii. How many Amazon consumers consolidate their purchases and order only once every week or two in order to save on transportation and packaging?
iii. Finally, how many of Amazon consumers forego the free two days (or two hours in many cities) delivery in favor of longer deliveries, even in the face of “$1 off” from Amazon? The answer to all these questions is very few!
The moral of these observations is that companies should not invest heavily in environmental initiatives until their customers will be willing to pay for these investments by preferring sustainable products. The last part of this paper argues what companies can and should do.
People vs. Planet
Companies provide not only goods and services, but also jobs. Agriculture, mining, transportation, manufacturing, warehousing, distribution, retailing, and the many other businesses involved in global supply chains provide jobs for people across the world. When environmentalists or regulatory agencies threaten these jobs, the response can be fast and furious. Consider the case of the oil sands of Alberta, Canada. Alberta, Canada, has the world’s third-largest reserves of oil, behind only Saudi Arabia and Venezuela. But those 166 billion barrels of viscous crude oil lie locked in sandy formations that make extraction difficult and environmentally impactful. This results in open pit mines that scar the land where shallow layers of black oil sands can be dredged. To extract deeply buried oil sands, miners burn large quantities of natural gas to generate steam that is injected into the ground to mobilize the thick gooey bituminous deposits. The process consumes significantly more of energy and water than does extraction of more liquid crude reserves. “The most destructive project on Earth” is what the NGO Environmental Defence Canada, called these oil sands fields. In 2010, the NGO ForestEthics launched a campaign against US brand-name retailers and consumer goods companies, pressuring them to boycott fossil fuels derived from Canadian oil sands. ForestEthics started publishing a growing list of companies that seemed to have agreed to its demands. The list included green companies such as Patagonia, Seventh Generation, and Whole Foods, as well as more mainstream companies, including Levi Strauss, The Gap, and FedEx (apparently without many of these companies’ knowledge or consent).
In rebuttal, the Alberta government published facts about the large economic benefits and modest environmental impacts of the industry, which provided 30 percent of the GDP of the province. Most importantly, the industry is the number one employer of indigenous (First Nations) people. They also pointed out that the industry mines only 1.3 percent of Alberta’s boreal forest; recycles 80-95 percent of the water used; has reduced emissions by 26 percent since 1990; and that miners had already planted 12 million seedlings as part of required land reclamation efforts. The Canadian people were less measured in their reaction. “We invite Levi Strauss, The Gap, and the affiliates (as well as any other American/international company currently marketing their products in Canada that does not want to accept our ‘dirty’ money) to NO LONGER do business on Canadian soil. By all means, purchase your oil from regimes that provide NO human rights or environmental stewardship. Don’t let the door hit your ‘behind’ on the way out,” said a reader commenting on the story. A nonprofit called Alberta Enterprise Group (AEG) launched a counter-boycott campaign on Facebook, urging Canadians to boycott the boycotters of Alberta’s oil.
Faced with heightened media coverage, some companies, who apparently did not consent to their inclusion in the ForestEthics list, clarified their position. Levi Strauss, The Gap, and Timberland criticized ForestEthics for including them on the NGO’s anti-oil sands list. “We do not take a position opposing or supporting any fuel or energy source from any country or geography,” said a Levi Strauss spokesperson. The morale of this story is that environmental slogans such as “Profits vs. Planet” are missing the mark. In reality, it is people vs. people, or some people vs. other people. On one side are people who wish to prevent or reverse the effects of climate change and pollution to ensure a better environment for themselves and future generations. On the other side are people who wish to have affordable goods and services as well as jobs to ensure a better economy and living standards for themselves and future generations. And while both sides vilify each other, both sides are “right.” Only such recognition can lead to reasonable solutions which do not reduce standards of living while moving towards a more sustainable environment.
So, What Should Business Do?
Many countries have enacted a slew of regulations aimed at curbing carbon emissions. On September 17, 2015, German Chancellor Angela Merkel was pictured with top Volkswagen officials at the opening of the Frankfurt auto show. The next day the US EPA issued a notice of violation to VW over emissions cheating; the company’s market value dropped 45 percent in short order. By 2017, the scandal spread to include all the big German automakers. In the ensuing weeks, Daimler, VW, Porsche, BMW, and Audi were found to have manipulated nitrogenoxide emissions from some of their diesel cars and issued mass recalls. On the heels of the scandal, many German publications uncovered the cozy relationships between the industry and the German government. These range from ignoring bogus emission testing, to the revolving door between government officials, lobbyists, and industry executives. Not only were the German car companies colluding to weaken pollution standards, the government was there to help. Germany’s Chancellor Angela Merkel lobbied the EU to relax emissions standards, and her government threatened other European countries with economic sanctions if they would not vote for relaxing regulatory oversight by the EU on the German auto industry.
There are good reasons why Berlin stands by its car companies. The industry employs over 750,000 people in Germany, has been a poster child for German engineering prowess and dwarfs other sectors of the economy. The state of Lower Saxony even holds a 20 percent stake in Volkswagen. The result is that the German government sees its role being to protect the industry from tough regulations and where regulations exist, to help the industry evade them by, for example, allowing each car company to hire its own emission testing company. This paper, however, is not about how to cheat and circumvent regulations. Most companies comply with all regulations because it is the law. However, complying with regulations is not leadership. The question is what companies beyond what should do is required under penalty. Beyond compliance, companies should justify certain sustainability initiatives based on the following three criteria:
Eco-efficiency: it helps the business;
Eco-risk management: it mitigates certain risks; and
Eco-hedging: it is a protection against certain changes in the market.
These three criteria align economic and environmental objectives.
Eco-efficiency
The easiest business case for sustainability involves initiatives that are aligned with the corporate main profit goals. The most common one is cost reduction, most of which is associated with reduction in energy and raw material consumption. Such reductions - whether changing to LED bulbs in the office, regulating truck speeds, or installing solar panels - can all reduce a company’s energy bill and reduce its carbon footprint at the same time. It is straightforward to calculate ROI for such projects and they can be justified in most cases based on standard financial metrics. Most companies have harvested these changes which are, in the vast majority of cases, marginal, but easy to justify.
In 2006, Staples, the giant office supplies retailer, changed the control software in its delivery trucks to limit their top speed to 60mph. The result was that average gas mileage climbed from 8.5mpg to 10.4, a nearly 20 percent reduction in fuel consumption. Changing the vehicle’s engine management software cost only $7 per truck. The change immediately paid for itself in $3 million of fuel savings annually. Staples did not even suffer any lost driver productivity because the time lost to slower speeds was offset by fewer fuel stops, a finding confirmed by studies in Europe and Japan.
Eco-risk management
Eco-risk mitigation initiatives are those activities that explicitly aim to reduce the likelihood and magnitude of business disruptions caused by environmental issues. Thus, they can, in principle, be evaluated in the same way as insurance or other business risk-reduction initiatives. Sustainability initiatives can mitigate a variety of risks including: NGO attacks (leading to business disruptions); unfavorable media coverage (causing reduced sales); investor actions (triggering changes in the board and senior management); and disruptive government regulations (resulting in higher costs, direct business restrictions, and even plant closures).
Unfortunately, unlike the case of insurable events such as natural disasters and accidents, risk managers have scant reliable actuarial data for quantifying the likelihoods and impact of NGO strikes, consumer preference changes, or adverse regulatory changes. Even the possibility of physical damage from environmental impacts involves speculative extrapolations. As a result, the few available insurance policies have limited scope and high costs. Thus, companies are left to manage these risks themselves using “just-in-case” or scenario-based justifications for risk mitigation. Exposure to environmentally motivated actions by activists or the media is particularly acute for brandname consumer-facing companies that rely on brand equity. Because consumers seldom perform their own due diligence, they rely on NGOs and the media, who know that readers will identify with stories about brands they know, leaving these companies vulnerable to NGOs’ antics and media campaigns.
The decision by brand-sensitive companies to invest in ecorisk mitigation has a relative dimension: NGOs are more likely to target environmental underperformers. NGO and media environmental performance scorecards can give rated companies some indication of their risks relative to their peers, which can influence a company’s materiality assessment (prioritizing dimensions of sustainability) and eco-risk mitigation priorities. In essence, brand name companies want to avoid being the “nail that sticks up” for publicity-eager NGOs. Such analysis can provide guidelines for minimum-required and maximum-reasonable investment (assuming that eco-risk mitigation is the sole green investment criterion). It is usually beneficial for companies to participate in and subscribe to industry standards for codes of conduct. Such standards institutionalize performance metrics and reduce auditing process overhead. Such standards may satisfy corporate eco-risk goals in that the company can cite its compliance with standards to defend against criticism of its sustainability practices.
Eco-hedging
Eco-hedging strategies focus on experimentation with green products. Such green products may have an existing market. For example, Paul Polman, CEO of Unilever said, “Our experience is that brands whose purpose and products respond to that demand- ‘sustainable living brands’-are delivering stronger and faster growth.” On the other hand, as Gregory Unruh, a professor of Doing Good Values at George Mason University, suggested: “Green marketers have known this for a long time. Consumers will consistently tell surveys that they are willing to pay more for socially and environmentally superior products. But when they are alone in the shopping aisle and it’s just them and their wallet, they rarely fork out more for ‘green.’” A 2014 study by the European Food Information Council confirmed this by concluding that although consumers understand sustainability, this understanding does not yet translate into changes in food choices. Even though mainstream consumers were not buying green products in volume, surveys found that millennials (those individuals born in the 1980s and 1990s) may be more willing to pay for sustainable products than older consumers. Yet, survey responses do not sales make. Until retailers’ sales data corroborate environmentalists’ survey data, companies may be reluctant to invest in large-scale changes or incur higher operating costs for environmentally sustainable products.
But, as the famous physicist Niels Bohr is quoted as saying “Prediction is very difficult, especially about the future.” Consequently, some companies are hedging their bets in the face of uncertain shifts in future regulations and consumer behavior. In 2008, Clorox launched Green Works—the first new product line in two decades for the 95-year-old company. Green Works included 17 green cleaning products designed with natural active ingredients that compete with Clorox’s main line of cleaning products. Buoyed by a $25 million-a-year advertising push in 2008 and 2009, the Green Works product line sales brought in $58 million a year in 2009. However, its price premium and doubts about its efficacy caused sales to fall to just $32 million in 2012.
Green Works may have been a money-losing proposition for Clorox, given the R&D costs, the marketing campaigns, the specialized supply chain involved, and the meager sales. For a company the size of Clorox, with $5.6 billion in annual sales, the Green Works product line can be considered “an experiment.” “What’s really exciting is that we’re building knowledge and confidence within the rest of the company so that we can do the same things with a lot of our other product lines,” said Jessica Buttimer, director of marketing for Green Works. Such corporate experiments allow the company to learn about the technology, the supplier eco-system, the distribution channels, and the green consumer market. In that sense, such eco-hedging efforts include eco-risk management elements, ensuring that the company is not caught unprepared if government regulations or consumer preferences shift to require more sustainable products and services.
Conclusion
Given the difficulties companies face in reducing environmental impacts in their supply chain; the reluctance of consumers to pay for sustainable products; and governments’ preference for jobs and economic development both in the developed world and certainly in the developing world, companies cannot make significant investments and increase costs in the name of sustainability. Yet, NGOs, environmental activists, some investors, and most of the media in the West is exerting pressure on companies to lead in sustainability efforts. This is particularly true in the face of the inability of government to provide significant market-based solutions, such as carbon taxation or tough regulations. The 2018 “Yellow Vest” riots in France, in response to a 2.5 percent suggested increase in gas prices; the defeat of the carbon tax proposal in Washington State in 2018; the repeal of carbon tax in Australia, demonstrate that people are not willing to pay more in the name of sustainability. What companies are doing is what many governments are doing. They “talk a good game” but not taking significant steps because consumers are not ready for such steps that might increase costs, upend business models, and reduce employment in existing industries and professions. Thus, companies should take incremental steps, such as the ones outlined above. More importantly, they should present initiatives which they were going to take anyway as environmental initiatives.
In 2011, UPS, the supply chain behemoth, launched a new service for consumers called My Choice. The digital tool alerts consumers when a package is coming and allows them to control the timing and location of the delivery. While obviously beneficial for consumers as an added service, it also helps UPS reduce costs (and environmental impacts). The reason is that UPS incurs significant costs in making redelivery attempts if the recipient is not home to sign for the delivery. Having the consumer specify location and time for delivery reduces the problem significantly - packages are likely to be delivered on the first attempt and not have to be redelivered (UPS attempts to deliver three times) or returned. The result is not only significant cost saving for UPS but reduced carbon footprint owing to the elimination of multiple delivery attempts and sending the package back to the shipper. Such an initiative, while clearly developed to improve customer service and reduce costs, can be presented to the media and NGOs as an environmental sustainability initiative. This, among other initiatives, can help the company avoid being the “nail that sticks up” [1-27].
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