Sustainable operations and supply chain management

Subject: Sustainable operations and supply chain management

Assessment task title: Individual assignment

Details of Task: An individually prepared discussion addressing the question:

 “If sustainable operations and supply chain management are so beneficial, why are many CEOs still opposed to the concept?

Using a specific company example, provide key arguments to convince your example firm’s CEO toward investment in sustainable operations and supply chain management”

To answer this question, go beyond the articles set as readings for first two weeks. It is recommended that you consult other recent news, articles and business case studies to support your arguments. Your assignment will be judged on the strength of your arguments and their application in the real world.

Reference: 6 +       Word limit: 1,000 words

DO NOT CHOOSE – Coca-Cola Company

REPORT STRUCTURE:

Introduction: introduce the organisation you selected, briefly mention  its activities from sustainability perspective. You can talk about which stage it is in (as per Lecture 1) etc.

Analysis: answer the question by providing justifications and analyzing the situation, you can also compare your selected company with some other company from the same industry. Use the frameworks or models we discussed in last two weeks

Recommendations: Provide good recommendations.

Reference list: In addition to the list, need to provide in-text references, but these are not counted within the word limit.

NOTE:

The answer should be yes, it’s important – use specific company as example

– Use 5-6 articles to provide argument to support

– You need to talk about both side, give the balance

Argument needs to be very strong – for example: It is very costly, don’t see benefit as quick as possible.

– You can use company annual report to see what the company already do

Reading list (attached):

Why Sustainability is now the Key Driver of Innovation – Nidumolu, Ram 2009

Harvard Business Review, 87(9): 56-64

It’s Hard to Be Good. – Beard, Alison 2011

Harvard Business Review, 89(11): 88-96

Does It Pay to Be Green? A Systematic Overview. – Stefan Ambec, Paul Lanoie 2008-11-1 Academy of Management Perspectives, 22(4): 45-62

Sustainable Operations Management – Kleindorfer, Singhal and Van Wassenhove, 2005 Production and Operations Management, 14(4): 482-492

Sustainable Operations Management Paul R. Kleindorfer • Kalyan Singhal • Luk N. Van Wassenhove The Wharton School of the University of Pennsylvania, Philadelphia, Pennsylvania 19104, USA Merrick School of Business, University of Baltimore, 1420 N. Charles Street, Baltimore, Maryland 21201, USA INSEAD, Technology and Operations Management Area, 77305 Fontainebleau, France kleindorfer@wharton.upenn.edu • Ksinghal@ubalt.edu • luk.van-wassenhove@insead.edu Operations management researchers and practitioners face new challenges in integrating issues of sustainability with their traditional areas of interest. During the past 20 years, there has been growing pressure on businesses to pay more attention to the environmental and resource consequences of the products and services they offer and the processes they deploy. One symptom of this pressure is the movement towards triple bottom line reporting (3BL) concerning the relationship of profit, people, and the planet. The resulting challenges include integrating environmental, health, and safety concerns with green-product design, lean and green operations, and closed-loop supply chains. We review these and other “sustainability” themes covered in the first 50 issues of Production and Operations Management and conclude with some thoughts on future research challenges in sustainable operations management. Key words: sustainable operations; closed-loop supply chains; green products; lean and green operations; environmental management and operations; eco-logistics; competitive advantage Submissions and Acceptance: Accepted by Special Editor, Hau Lee, after one revision. 1. Introduction and Background The Production and Operations Management Society (POMS) was created in 1989, and one of its first activities was to launch Production and Operations Management (POM), with the inaugural issue appearing in 1992. POM’s objectives were ambitious, with an overall objective “to improve practice” (Singhal 1992). We review what the journal has accomplished in its first 50 issues in the context of sustainability. We use the term sustainability to include environmental management, closed-loop supply chains, and a broad perspective on triple-bottom-line thinking, integrating profit, people, and the planet into the culture, strategy, and operations of companies. We start with a brief account of the trends that have shaped the field of operations management (OM) in the past two decades and influenced the mission of the journal, POM. 1.2. Innovations in the 1980s and the 1990s: TQM, JIT, and BPR POM’s launching in 1992 came at an auspicious time for OM, as the 1980s had already underlined the benefits of total quality management (TQM), time-based competition, and just-in-time operations (JIT), imported to Europe and North America from Japan. These philosophies had been refined in the 1960s and 1970s and came to be recognized in Japan as the backbone of the reconstruction of its postwar economy. TQM, JIT, and time-based competition provided both the tools and the elements of the management systems needed to integrate them with company strategy. The locus of control and methodology of these tools and management systems was directly associated with operations. With the growing realization of the impact of these innovations on customers and profit, operations began its transformation from a neglected stepsister needed to support marketing and finance to a cherished handmaiden of value creation. It was becoming a primary focus of strategic importance for companies around the world (Hayes, Wheelwright, and Clark 1988). Building on these early innovations, a wave of change began in the 1990s called business process reengineering (BPR) (Hammer 1990), which provided immense benefits to nonmanufacturing processes by applying the time-based and waste-minimization efforts that TQM and JIT had applied to manufacturing. Gradually, this whole evolution came to be known as PRODUCTION AND OPERATIONS MANAGEMENT POMS Vol. 14, No. 4, Winter 2005, pp. 482–492 issn 1059-1478 05 1404 482$1.25 © 2005 Production and Operations Management Society 482 tapraid4/z3z-pom/z3z-pom/z3z00405/z3z0519d05a mcquaten S5 3/8/06 14:46 Art: 0519 Input-17 process management, a name that emphasized the crucial importance of processes in value creation and management. Process management was given further impetus by the core-competency movement (Hamel and Prahalad 1994), which stressed the need for companies to develop technology-based and organizational competencies that their competitors could not easily imitate. The confluence of the core-competency and process management movements caused many of the past decade’s changes including the unbundling of value chains, outsourcing, and innovations in contracting and supply chains. People now recognize the importance of aligning strategy and operations, a notion championed by Skinner (1969, 1996). 1.3. Focus on Product Development and Supply Chains As companies developed their core competencies and included them in their business processes, the tools and concepts of TQM and JIT were applied to developing new product development and managing supply chains, and they typically involved multiple organizations. Generally, they first incorporated JIT between suppliers and production units, then moved to optimized logistics (including efficient consumer response (ECR)) between producers and distributors, then to customer relationship management (CRM), and finally to global fulfillment architecture and risk management. These supply-chain-focused trends inspired similar trends at the corporate level as companies moved from lean operations to lean enterprises and now to lean consumption (Womack and Jones 2005). We show in simplified form these trends and drivers in Figure 1, based on Kleindorfer and Van Wassenhove (2004). We also show the impact of emerging sustainable OM. As we look back on the first 50 issues of POM, we can see that these trends drive the research published in POM and its application and integration in company strategies around the world. The 1980s’ introduction of TQM and JIT in manufacturing gave rise to the recognition that the principles of excellence applied to manufacturing operations could also improve business processes and that organizations structured according to process-management principles would also improve. The combination of these process management fundamentals, information and communication technologies, and globalization has provided the foundations and tools for managing today’s outsourcing, contract manufacturing, and global supply chains. 1.4. Supply Chains as the Business Model Many successful and innovative companies now formulate their strategies and business models in simple operational terms (for example, Amazon.com, Dell, Li and Fung, Southwest Airlines, Toyota, and Zara). Asked about Zara’s business model, a senior executive said, “At Zara, the supply chain is the business model.” OM has moved from a narrow focus on costs to an appreciation of the customer (service, willingness to pay) and to a closer scrutiny of assets. OM provides the methods for analyzing and improving value drivers at the process level and for measuring and balancing costs, revenues, and assets. These methods include integrated financial and operations-driven metric systems, such as economic value added (Stern and Shiely 2001). 1.5. Sustainability: A Key Element in Supply Chains As the new economic order unfolded, people recognized that profits and profitability were only one element in the long-term success of companies and the economies (Hay, Stavins, and Vietor 2005). Also important are the future of people (internal and external to companies) and the future of planet Earth. These new legitimacy concerns are captured in measures such as the triple bottom line (3BL), the three Ps of people, profit and the planet, and the goal of maintaining viable social franchises (the trust of employees, customers, and the communities) as well as viable economic franchises (the ability to pay from the cash flows it generates for capital and other inputs it uses to produce its outputs). OM is increasingly connected to sustainability, and it now concerns both the operational drivers of profitability and their relationship to people and the planet. The emerging synthesis gives researchers in OM exciting opportunities to make a difference. 2. Roots and Branches of Sustainability Theory 2.1. Convergence of Social Needs and Competitive Advantage The World Commission on Environment and Development (1987) (the Brundtland Commission) defined Figure 1 Locus of Value Chain Restructuring 1980 –2010. Kleindorfer, Singhal, and Van Wassenhove: Sustainable Operations Management Production and Operations Management 14(4), pp. 482–492, © 2005 Production and Operations Management Society 483 F1 tapraid4/z3z-pom/z3z-pom/z3z00405/z3z0519d05a mcquaten S5 3/8/06 14:46 Art: 0519 Input-17 sustainable development as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs.” Criticized by some for its all-encompassing scope, the sustainability movement has nonetheless gained traction because of the evident inefficiency of our current products and production processes in their use of the planet’s resources. This is as true for the industrialized countries as it is for the less industrialized ones and provides huge opportunities for creating new value (Hart 2005; Prahalad 2004). For example, about one percent of all material that originates at the top of the supply chain serving the United States remains in use six months after sale of the products containing it (Hawken, Lovins, and Lovins 1999). Because of these growing concerns, business enterprises are under strong pressure to measure their impacts on the environment and to engage in 3BL reporting to account for the energy and other resources they use and the resulting footprint they leave behind. Primary activities that contribute to their footprint are producing and transporting current products; recycling, remanufacturing, and reusing used products; and designing new products. Naturally OM has contributed to measuring and reducing this footprint. The basic drivers of this movement are evident in Figure 2 below, reproduced from the first special issue of POM on Environmental and Operations Management (Corbett and Kleindorfer 2001a). We begin with the people part of 3BL. Employees need to take pride in their work and need to believe that their companies operate in a prudent and responsible manner and care about employee health and safety. Concerning the planet, aligning sustainability goals with employees and market incentives can be difficult. Community pressures and the threat of liability, however, can drive companies to improve their environmental performance (Snir 2001). Clearly, companies are most likely to improve their environmental performance when public pressure results in strong regulations. Sometimes, companies themselves lobby for regulations if they have developed an environmentally friendly technology and believe that regulations requiring their technology would give them a competitive advantage. Strategy and public-policy experts debate the ultimate cost and benefits of environmental regulations. Many early discussions about sustainable technologies focused on trade-offs between sustainability and economic competitiveness. Parkinson (1990), Porter (1991), and Makeower (1993) challenged the view that trade-offs were inevitable. Porter (1991, p. 96) argued that the “conflict between environmental protection and economic competitiveness is a false dichotomy based on a narrow view of the sources of prosperity and a static view of competition.” He argued that tough environmental standards can trigger innovation and upgrading of sustainable technologies, noting: “Properly constructed regulatory standards, which aim at outcomes and not methods, will encourage companies to re-engineer their technology. The result in many cases is a process that not only pollutes less, but also lowers costs or improves quality. Processes will be modified to decrease use of scarce or toxic resources and to recycle wasted by-products” (Porter 1991, p. 96). Porter and van der Linde (1995a, 1995b) elaborated on this in two later works (Porter and van der Linde 1995a, 1995b) linking this view to the concept of resource productivity and to the environment, innovation, and competitiveness. They used examples from several companies to show that environmental improvements can lead to improved process, products, and profits. Since the early 1990s, this debate on whether synergies exist between profits and sustainable practices has become muted, primarily because the public has been largely indifferent to the economic and policy arguments. Throughout the world, the public and its political representatives have been demanding improved performance on environmental, health, and safety issues. The question for companies has become not whether to commit to a strong environmental, health, and safety record, but how to do so in the most cost-effective manner. We must enlarge our perspective in OM to include people and the planet because companies will be expected to do so. We can expect the opportunities to invest in sustainable technologies, operations, and supply chains to increase rapidly because of the following factors: 1. The costs of materials and energy will continue to grow as the world economy expands and as rapidly industrializing countries, such as China and India, make strong demands on these resources. 2. Public pressure for environmental, health, and Figure 2 Sustainability and the Extended Supply Chain. Kleindorfer, Singhal, and Van Wassenhove: Sustainable Operations Management 484 Production and Operations Management 14(4), pp. 482–492, © 2005 Production and Operations Management Society F2 tapraid4/z3z-pom/z3z-pom/z3z00405/z3z0519d05a mcquaten S5 3/8/06 14:46 Art: 0519 Input-17 safety performance is likely to remain strong, leading to strengthened property rights, additional regulations, international agreements on controlling negative externalities and preserving resources, and reductions in subsidies. 3. Increasing awareness of 3BL issues could increase consumer demand for products made by companies subscribing to 3BL practices. 4. People’s growing antipathy to globalization is leading to strong non-government organization activity regarding businesses’ sustainability performance. 2.2. A Dynamic Framework for Pursuing Sustainability Facing the call for sustainability, how will businesses and operating managers respond? Some researchers published by POM have addressed this question, and early papers concerning the emergence of OM presage the current discussion. Hayes (1992) discussed the emergence of manufacturing in the 1980s as a pillar of strategy rather than a residual cost center. Hayes and Wheelwright’s (1985) framework for the four stages of acceptance of the operations function captured its contribution to creating value and strategic success. Wheelwright and Bowen (1996) developed this idea further. The four stages progress from “internally neutral” (catch-up or reactive mode) to “externally neutral” (matching but not exceeding industry practice and standards) to “internally supportive” (setting appropriate priorities to support the business strategy) to “externally supportive” (providing externally recognized superior operational capabilities for competitive advantage). Hart (2005) suggested that we might expect a similar slow and grudging acceptance of sustainable OM. While he does not use the term “sustainable OM,” the evolution he envisages is similar to Hayes and Wheelwright’s. We reformulate the Hayes-Wheelwright-Bowen framework in the context of sustainable operations: 1. The current internal strategies are to improve internal operations with continuous process improvements related to sustainability, such as, employee involvement, waste reduction, energy conservation, and emission control. 2. The current external strategies are to improve extended supply chains by analyzing upstream supply chains to make trade-offs in the choice of materials and processes and pursuing closed-loop supply chains for remanufacturing and safe disposal. 3. Internal strategies for the future include investing in capabilities to recover pollution-causing chemicals during manufacturing, to develop substitutes for nonrenewable inputs, and to redesign products to reduce their material content and their energy consumption during manufacturing and use. 4. External strategies for the future include developing core capabilities in products, processes, and supply chains for long-term sustainability and pursuing strategies to facilitate it. Assuming that corporations follow this framework, some central OM areas will be reinforced. How particular companies will evolve will depend on company- and sector-specific factors. These changes are already affecting our discipline, as is evident in some contributions to the first 50 issues of POM. 3. Sustainable OM in the First 50 Issues Sustainable OM integrates the profit and efficiency orientation of traditional OM with broader considerations of the company’s internal and external stakeholders and its environmental impact. The evolution towards sustainable OM is clear in three areas that integrate the three Ps of sustainable OM. 1. Green product and process development 2. Lean and green OM 3. Remanufacturing and closed-loop supply chains Although the focus here is on the first 50 issues of POM, we also cover work published in other premier OM journals. 3.1. Green Product and Process Development 3.1.1. Uncertainty, Lead Times, and Investment. As a company moves to long-range strategies and moves beyond its own internal opportunities, the technologies it invests in will involve more money, longer lead times, and greater uncertainties about benefits and outcomes of development efforts. Whether a firm invests in sustainable technologies or not, its competitors may do so. The issues the firm faces are similar to those it would face in developing any new technology, particularly those whose development seems inevitable (Singhal et al. 1987), and it may want to employ game-theoretic models of technology acquisition (Gaimon 1989). Product design is often complicated by the uncertainty inherent in the evolution of environmental trends and regulations; Noori and Chen (2003) developed a scenario-based method for addressing this uncertainty while deciding on product and process designs. 3.1.2. First Mover Advantage. The first-mover advantage for sustainable innovations includes royalties for licensing technology; development of manufacturing capabilities that a competitor would be unable to copy or unable to copy quickly; a head start on the next generation of technologies, including the creation of proprietary information that would provide competitive advantage. Once the firm develops and markets a product successfully, learning effects would Kleindorfer, Singhal, and Van Wassenhove: Sustainable Operations Management Production and Operations Management 14(4), pp. 482–492, © 2005 Production and Operations Management Society 485 tapraid4/z3z-pom/z3z-pom/z3z00405/z3z0519d05a mcquaten S5 3/8/06 14:46 Art: 0519 Input-17 lead to improvements in technology, lower prices, mass markets, and entry of competitors, similar to the well-studied case of the impact of short product-development cycles in the automotive industry (Womack, Jones, and Roos 1990). In the case of Toyota’s hybrid petrol-electric car, Prius, for example, compared to a gasoline powered counterpart, it consumes half as much gasoline, releases half as much carbon dioxide, and lowers the release of smog-forming nitrogen oxides and hydrocarbons by 90 percent. Its competitors, such as Ford Motors, General Motors, Mercedes, and Porsche, which initially focused on a few sustainable technologies and did not pursue hybrid cars, are now rushing to market them, although the idea of a hybrid car is far from new. Piper, an American engineer, first proposed it in 1905. Similarly, when new regulations required a reduction of 90 percent in solvent emissions, 3M simply eliminated the use of solvents by coating products with water-based solutions that were safer (Porter and van der Linde 1995b). It gained a first-mover advantage over competitors who followed the same approach several years later. 3.1.3. Sustainable Product Design. Essential to developing sustainable products is sustainable design. The early history of product design is replete with examples of inefficiency over its total life-cycle. As the ratio of labor costs to material costs went up, it became uneconomical to replace or repair most products’ individual parts, and their designs reflected that. The solution to most malfunctions or breakdowns was simply to replace the entire assembly or subassembly. Manufacturers are now moderating this practice, developing designs that avoid environmentally hazardous components and make it economically possible to save components that have high reuse value. Modular designs increasingly facilitate remanufacturing; automated diagnosis of problems; and repair or part replacements by users, original manufacturers, and third parties (Chen, Navin-Chandra, and Prinz 1994; Ferrer and Whybark 2001; Guide and Van Wassenhove 2001; Krikke, Bloemhof-Ruwaard, and Van Wassenhove 2003). Frameworks for designing conventional products can be modified for designing green products. For example, Singhal and Singhal (2002) developed a framework for analyzing compatibility in modular product design that is analogous to analyzing compatibility of product designs for recyclability and reuse (Di Marco, Eubanks; Ishii 1994). 3.1.4. The Impact of Sustainable Design on Supply Chains. Resources lost in later stages of the supply chain imply dependent losses also upstream, and thus downstream savings lead naturally to higher savings upstream in the supply chain (Lovins, Lovins, and Hawken 1999). Identifying and managing environmental impacts throughout the supply chain is now a focus of OM research (Reiskin et al. 2000; Corbett and DeCroix 2001; Klassen and Vachon 2003). Modular design and easy disassembly also facilitates disposal. According to the World Future Society (2005, p. 3), “The u.s. faces a tidal wave of e-waste. Some three-quarters of all the computers, televisions, and PDAs ever sold in the u.s. are no longer in use and await disposal. These devises all contain substantial amounts of toxic materials and are thus prohibited from most landfills. Disposal cost estimates already stand at $50 billion with no clear solution on how these costs will be covered.” With easy disassembly, it is economical to remove parts that contain toxic materials and making the rest of the product acceptable in landfills. Safe and easy disassembly would ameliorate a scourge inflicted on emerging economies as developed economies dump their toxic waste on such countries as China and India (Brigden et al. 2005). 3.2. Lean and Green Operations OM is attempting to use the tools and concepts of lean operations to add green metrics to the measures of excellence companies use in evaluating business processes. Several POM authors have written about whether the lean and green approach is evident in practice, how best to achieve it, and what its net benefits are. Corporate Image and Profitability. Mitigating environmental, health, and safety impacts of a company is socially responsible and good business. Promoting environmental care can enhance a company’s and an industry’s image (Chinander 2001) as shown by chemical industries’ adoption of codes of responsible care and the rapid spread of ISO 14000 (Angell 2001; Corbett and Kirsch 2001, 2004; Vastag 2004). Kassinis and Soteriou (2003) show that environmental practices in the hospitality industry enhance profitability by improving customer satisfaction and loyalty. Synergies between Lean and Green. Improved environmental, health, and safety performance can aid plant-level productivity efforts (Klassen 2001) and increase revenues and market share (Delmas 2001, 2004). To gain these positive results, the firm must establish management systems and tools that integrate environmental, health, and safety metrics with other process metrics within the company and across the supply chain (Bowen et al. 2001). King and Lenox (2001) and Rothenberg, Pil, and Maxwell (2001) examined the links between lean manufacturing and green manufacturing and found some synergies, but also found that harvesting them is not simple. People generally assume that improving quality practices improves environmental performance. Pil and Rothenberg (2003) Kleindorfer, Singhal, and Van Wassenhove: Sustainable Operations Management 486 Production and Operations Management 14(4), pp. 482–492, © 2005 Production and Operations Management Society tapraid4/z3z-pom/z3z-pom/z3z00405/z3z0519d05a mcquaten S5 3/8/06 14:46 Art: 0519 Input-17 suggest that the causality can also work in the other direction, with improvements in environmental practices leading to improvements in quality. Sroufe (2003) analyzed the link between environmental management systems, environmental practices, and operational performance and found that this link is substantially stronger for some practices than for others. Regulatory Compliance. To comply with regulations, companies must track their use of hazardous substances and emissions of pollutants. Because regulatory scrutiny is costly, many companies are going beyond compliance (XL and 33/50 programs in the u.s. and other voluntary programs elsewhere; Rothenberg, Pil, and Maxwell 2001). By going beyond current regulations, companies reduce the costs of changing technologies and operating policies to comply with new regulations (Woensel, Creten, and Vandaele 2001 and Delmas 2001, 2004). Liability and Negligence. Another factor driving companies to improve their environmental performance is the risk of being held liable or found negligent for accidents or environmental damage, a risk they face even when they act prudently and use stateof-the-art technology. To limit liabilities, many companies implement strict risk-reduction mechanisms, lowering the levels of pollution, biocides, and toxics (P, B, and T) associated with their supply chains and products (Snir 2001; Wolf 2001; Kleindorfer and Saad 2005). Employee Health and Safety. Similar to community concerns, employee health and safety is a key focus of risk reduction and risk communication initiatives (Chinander 2001; Wolf 2001). Employee health and safety is not limited to company workers or onsite exposures, but includes all parties in the supply chain who may be exposed to a company’s product. Improved Tools and Management Systems for Better Product and Process Design. To achieve sustainable OM, companies must integrate employee health and safety metrics with key business processes, measure results, and obtain the commitment of top management. They may use life-cycle analysis, gated DfX screens (where design for X (DfX) includes such factors as environment, safety, disassembly, and recycling), and eco-logistics to promote sustainable products and supply chains. Concerning new management systems to promote employee health and safety excellence and sustainable industrial practices, the papers in POM’s first 50 issues have investigated two synergies with OM concepts. The first is lean production or the process of discovering and eliminating waste that originally focused on time, quality defects, and excess inventory, but is now being used effectively to ferret out environmental wastes (Rothenberg et al. 2001; King and Lennox 2001; Klassen 2001). The second source of synergy is between quality and environmental management systems, focused on the Environmental Management System under the international standards ISO 14000 and the related Eco-Management and Audit Scheme of the European Union (Angell 2001; Corbett and Kirsch 2001; Pil and Rothenberg 2003). ISO 14000 began development in 1991, after the successful deployment of ISO 9000 standards, and the aspirations underlying ISO 14000 were motivated by the experience with ISO 9000. While it is still too early to say whether ISO 14000 and other systemic approaches to managing employee health and safety impacts are effective in a 3BL sense, there are several promising indicators that it may (Klassen 2001; King and Lennox 2001; Melnyk et al. 2003). These include the increasing evidence that process excellence, as embodied in the ISO 9000 quality standard, can be a significant aid to discovering process defects and fixing them. By extension, this same logic of process excellence appears to apply to impacts on employee health and safety and their associated Environmental Management System, and industrial practice is increasingly reflecting this belief (Angell 2001; Corbett 2005; Hart 2005). Several industry-specific studies of sustainable OM have also appeared in POM’s first 50 issues. Forestry managers make extensive use of mathematical models to optimize harvesting patterns. Caro et al. (2003) discuss using these models to take environmental regulations into account and quantify their costs and benefits. Flowers and Linderman (2003) consider how to turn hazardous waste into fuel for cement kilns to dispose of the waste while respecting air-quality regulations. Wolf (2001) and Kleindorfer and Saad (2005) discuss risk methodologies being implemented in the chemical industry to reduce environment, health, and safety related accidents and to promote sustainable operations. POM’s first 50 issues show that lean and green are kin to process excellence. 3.3. Remanufacturing and Closed-Loop Supply Chains 3.3.1. The Genesis and the Architecture of Closed-Loop Supply Chains. As profit margins shrink, product life cycles shorten, and environmental concerns increase, businesses consider product takeback. The increasing costs of handling product returns may offset small profit margins, and short life cycles may increase the costs of obsolescence. Companies are increasingly expected, or legally required, to take responsibility for the entire lives of their products, including proper recycling and disposal (e.g., the European Union’s end-of-life vehicle and waste electrical and electronic equipment directives). Kleindorfer, Singhal, and Van Wassenhove: Sustainable Operations Management Production and Operations Management 14(4), pp. 482–492, © 2005 Production and Operations Management Society 487 tapraid4/z3z-pom/z3z-pom/z3z00405/z3z0519d05a mcquaten S5 3/8/06 14:46 Art: 0519 Input-17 From a business perspective, the reverse supply chain begins when the customer returns the product and ends when the company has recovered the maximum value. Product returns can include packaging returns; recalls and consumer (convenience) returns in the distribution phase; repairs; and end-of-lease, endof-use, and end-of-life returns. Consumer returns may be unused products, and sellers must put time-sensitive products back on the shelves quickly. PCs lose one percent of their value per week and become obsolete very quickly. Their small margins force companies to pay attention to the returns process. End-of-use returns occur, for example, when customers wish to upgrade to newer versions of the product. A customer’s old machine, say, a copier, may still be in perfect working order and, when suitably remanufactured, may start a second life with another customer. Endof-life products typically land in the waste stream. While it may be difficult to recover value from them by reusing modules or components, companies may recover value by recycling materials or recover energy through incineration. Waste disposal is increasingly being regulated and can sometimes be costly. We take a business perspective on recovery of value through the reuse of the entire product, some of its modules, or individual components. We do not pay attention to the end-of-life recovery of materials or energy, nor to proper disposal issues. These green supply-chain issues are important, and a separate industry recycles packaging and other reusable materials, runs wasteto-energy systems, and designs disposal practices. Reverse supply chains include used-product acquisition, reverse logistics (moving to reprocessing facilities), inspection and disposition (determining whether to repair, remanufacture, use of spare parts, or recycle), remanufacturing, and remarketing (Guide and Van Wassenhove 2001). Forward and reverse supply chains form a closed loop when they are managed in a coordinated way toward the common goal of maximizing profits. Companies must proactively pursue value from return streams and coordinate forward and reverse flows, and deal with increased uncertainty as to timing, quantity, and quality of returns and poorly developed secondary markets. 3.3.2. A Multidisciplinary Perspective. Research into closed-loop supply chains (CLSCs) parallels early research in supply chain management. Early researchers focused on the middle part of the process (reverse logistics, disassembly and testing, and remanufacturing) while paying little attention to product acquisition and remarketing. Now researchers increasingly take a broad business process perspective and integrate all steps from product acquisition to remarketing (Guide and Van Wassenhove 2001). In addition, they have shifted from a focus on minimizing costs to creating value. They seek to remove the bottlenecks to coordinating product returns so that the CLSC becomes a profitable business proposition. Researchers understand the importance of design in improving products (Debo et al. 2005) and the process (e.g., designing return networks for rapid response; Blackburn et al. 2004). Designing a profitable CLSC requires careful balancing of product design issues (for example, product durability), product acquisition (for example, the collection rate), the cost of the reverse logistics and remanufacturing processes, and remarketing decisions (such as the length of the product life cycle and the timing of remanufactured product introduction) (Geyer, Van Wassenhove, and Atasu 2005). Early CLSC researchers, focusing on minimizing the costs of such subprocesses as reverse logistics, product disassembly, and remanufacturing, made substantial contributions by using traditional IE/OR modelling. They viewed CLSC research as a natural extension of existing OM research. When they focused on less traditional subproblems, such as product acquisition (Guide, Teunter, and Van Wassenhove 2003) and remarketing (Savaskan, Bhattacharya, and Van Wassenhove 2004), and when they looked at the entire process, they included other approaches, such as economic (e.g., game-theoretic) models. Recently researchers have considered the large strategic issues associated with CLSCs, building on the earlier work on managing individual processes to designing entire systems. This has gone from minimizing costs to creating value and from separate disciplines to a multidisciplinary approach. To design profitable CLSCs, they must understand the underlying accounting issues (for example, valuing recovered products or components) and the related marketing issues (for example, how remanufactured products affect primary markets for those products and how to price them). OM researchers in CLSCs are driving a growing interest in such disciplines as accounting and marketing for studying CLSC problems (Atasu, Sarvary, and Van Wassenhove 2005). 3.3.3. The First 50 Issues of POM. Since POM began in 1992, a strong community of researchers has developed. For a good introduction to this quickly growing field, see a managerial book edited by Guide and Van Wassenhove (2003), a research oriented book edited by Dekker et al. (2004), and a book with business cases edited by Flapper, van Nunen, and Van Wassenhove (2005). POM’s first special issue on environmental management and operations (Volume 10, Number 2, 2001, edited by Corbett and Kleindorfer) featured four articles on CLSCs. Ferrer and Whybark (2001) focused on MRP for a remanufacturing facility facing uncertain supply and demand for used products. Fleischmann et Kleindorfer, Singhal, and Van Wassenhove: Sustainable Operations Management 488 Production and Operations Management 14(4), pp. 482–492, © 2005 Production and Operations Management Society tapraid4/z3z-pom/z3z-pom/z3z00405/z3z0519d05a mcquaten S5 3/8/06 14:46 Art: 0519 Input-17 al. (2001) discussed the use of a location-allocation mixed-integer linear program to examine the impact of product recovery on logistics networks. Majumder and Groenevelt (2001) used game theory to analyze competition in remanufacturing, i.e., the market side of the system. Finally, Guide and Van Wassenhove (2001) advocated a global business process perspective and provided a framework for analyzing the profitability of reuse. They also highlighted the importance of upstream product acquisition and downstream remarketing problems. In a subsequent special issue also edited by Corbett and Kleindorfer (2003), Ketzenberg, Souza, and Guide (2003) discussed mixed assembly and disassembly operations for remanufacturing. This paper is similar to Ferrer and Whybark mentioned above in that it also uses a traditional IE/OR approach (queuing model and simulation) to tackle a new problem arising from assembly of new and remanufactured products on the same line. Recently, Guide and Van Wassenhove asked 15 CLSC researchers to list 10 most influential articles in the field. They named three articles published in POM (Fleischmann et al. 2001, Guide and Van Wassenhove 2001, and Majumder and Groenevelt 2001) testifying to its impact on the field. This influence will continue with the planned publication in 2006 of two special issues on CLSC research being edited by Guide and Van Wassenhove. They will show the richness of problems and approaches, as well as the progress this sub-field has made over the past decade in terms of relevance, quality, and depth of research. 3.3.4. Shifting Paradigm and New Opportunities. In the future, researchers will need to integrate decisions over the life cycle of products. Indeed, for lowmargin, short-life-cycle products it is necessary to carefully integrate the forward and the reverse supply chain and to dynamically maximize product recovery potential over the entire life cycle. For instance, in many sectors, companies can use convenience returns from consumers soon after product launch to replace defective products returned under warranty. That way, new product manufacturing would not be disrupted. Later in the life cycle, companies should probably remanufacture and remarket returned products through secondary market channels. Toward the end of the product life cycle, they can use returns to supply spare parts. Such dynamic optimization depends on designing product and processes carefully and developing marketing, accounting, and performance-tracking tools. CLSCs foster sustainability. Product recovery and reuse reduces the damaging effects on environment of waste disposal, of extracting raw materials, and of transport and distribution. Closed-loop supply chains not only increase profits, but also benefit the planet. Given that recovery operations are typically labour intensive, CLSC can have a positive effect on employment, particularly in less industrialized economies. We expect that closing the loop in supply chains will change business models. One outcome is the increasing trend toward leasing and installed base management, as opposed to selling the product. All this spells new challenges for OM researchers with interests in CLSCs. 4. Conclusions and Directions for the Future The first 50 issues of POM have contributed substantially to sustainable operations management. OM, in both research and practice, can and should contribute to sustainability. In the past, it has been particularly good at helping us to understand and build dynamic capabilities, including the following: • Modeling and measuring action-outcome links; • Designing and managing processes to achieve agility, adaptability, and alignment (Lee 2004); • Executing strategies; • Integrating, conceptually and operationally, the many dispersed activities needed to achieve the goals mentioned above; and • Building bridges with other functions and disciplines, including strong historical links to engineering and, more recently, to economics. These capabilities may be difficult to develop. OM as a profession and POMS as a society for the profession have promoted them and lived them in research, teaching, and practice. These capabilities are the basis for a sustainable OM framework that combines the 3 Ps of 3BL thinking at the operational level of business processes. Indeed, in the spirit of the original Brundtland Commission definition of sustainability, we might define sustainable OM as the set of skills and concepts that allow a company to structure and manage its business processes to obtain competitive returns on its capital assets without sacrificing the legitimate needs of internal and external stakeholders and with due regard for the impact of its operations on people and the environment. We are just beginning to understand and map the territory for sustainable OM. The issue is not “will all of the things we mention happen in the future?” As in global warming, we have passed this stage. The questions are when and how big will the impact be and how fast will the transition be? As the world changes, managers must make some tough bets in deciding how to position their companies for the long-haul on the sustainable OM spectrum, from internal neglect to external advantage, from being reactive to proactive as a company. Whatever their stance, companies need Kleindorfer, Singhal, and Van Wassenhove: Sustainable Operations Management Production and Operations Management 14(4), pp. 482–492, © 2005 Production and Operations Management Society 489 tapraid4/z3z-pom/z3z-pom/z3z00405/z3z0519d05a mcquaten S5 3/8/06 14:46 Art: 0519 Input-17 time to prepare for the uncharted road, especially if they want to be pioneers or early adopters. Sustainable operations management must help companies to become agile, adaptive, and aligned in balancing the people and the planet with profits. The people part is notably absent from OM research to date; the recent renewed emphasis on behavioral OM may bring this element back into focus. The integration of management systems for safety and environmental objectives with ISO 9000, ISO 14000, and other process management systems (Rosenthal et al. 2006) indicates the growing recognition of all three Ps in promoting sustainable operations. OM builds bridges. First, it is where all other disciplines come together as OM plays a central role in executing a company’s strategy. Second, OM constructs bridges with other fields such as economics and game theory, marketing, finance, and behavioral sciences. Sustainable operations will need building further bridges with other fields, such as industrial ecology. To achieve sustainable operations, which covers design, life cycle analysis, and so forth, OM must reinforce its original links with engineering. These bridging exercises will need new approaches to the challenges at hand. For example, as Corbett (2005) suggests, it may be time to look “beyond trade-offs” to derive solutions that alleviate or avoid traditional trade-offs and in the process produce better and stronger outcomes for the company as well as for the discipline. Once companies accept and embrace sustainability, they can rely on OM to apply it and integrate it into the lifeblood of the enterprise and its employees. Finally, the modelers (the OR-based OM population) must revisit the classical models to cope with the people and the planet related issues. For example, one will have to reformulate the objective function and the set of constraints in global production-distribution models in the new context. We have some hard work ahead of us, but we are a strong discipline and we have solid foundations, as shown in the first 50 issues of POM. POMS is well positioned as a professional society to play a key role, and the POM Department of Sustainable Operations and the newly created POMS College for Sustainable Operations speak to our members’ lively and continuing interest. Let the future begin! Acknowledgments We thank the special editor, Hau Lee, and six anonymous reviewers for their comments and suggestions on an earlier draft of the paper. References Angell, L. C. 2001. Comparing the environmental and quality initiatives of Baldrige Award winners. 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ARTWORK Sarah Morris, Black Beetle [Origami], 2008 Spotlight Gloss household paint on wall, installation view It’s Hard to Be Good But it’s worth it. Here are fi ve companies whose success is built on responsible business practices. by Alison Beard and Richard Hornik 88  Harvard Business Review November 2011 SPOTLIGHT ON THE GOOD COMPANY oON THE FOLLOWING PAGES, HBR profiles five “good” companies that do more than just pay lip service to community engagement, labor relations, environmental protection, corporate governance, and supply chain accountability. Neither our editors nor the academics we consulted have voted them the world’s most socially responsible corporations. But each excels in one or more of the areas just listed, and does so by making them part of its internal corporate logic—something that Rosabeth Moss Kanter argues, in another article in this Spotlight, that all businesses should do. These rms have also succeeded commercially—hard evidence that doing the right thing as a company doesn’t con ict with bottom-line imperatives. As Zhang Yue, the founding chairman of Broad Group, says, “The survival and growth of a company is the same thing as its social responsibility.” HBR.ORG November 2011 Harvard Business Review 89 Spotlight on The Good Company The Experts Pamela Hartigan is the director of the Skoll Centre for Social Entrepreneurship at the University of Oxford’s Saïd Business School. She is also a founding partner of Volans. Thomas Kochan is the George Maverick Bunker Professor of Management and a codirector of the Institute for Work and Employment Research at the MIT Sloan School of Management. Christopher Marquis is an associate professor in the organizational behavior unit at Harvard Business School. Roger Martin is the dean of the Rotman School of Management at the University of Toronto. Dan Esty is the Hillhouse Professor of Environmental Law and Policy at Yale University. He is also the director of the Yale Center for Environmental Law and Policy and the Center for Business and the Environment at Yale, and the commissioner of the Connecticut Department of Energy and Environmental Protection. Royal DSM Notable Strength Community Engagement Core Business Chemicals Country Netherlands Year Founded 1902 Employees 22,000 2010 Revenue €8.2 billion 10-year Annualized total shareholder return 9.6% Fact A group of South African primary school children who ate porridge fortified with MixMe, a DSM multi-micronutrient powder, saw their mean store of body iron double over the course of a 23-week company-sponsored clinical study. A decade ago, Royal DSM’s core offerings were petrochemicals, plastics, and base chemicals and materials. Today the Dutch firm is in the same sector, but its output is very different: nutritional supplements, pharmaceutical ingredients, and energyefficient building materials. If the company’s first step on the path to being a good corporate citizen was to develop and sell more-sustainable, healthenhancing technologies and products, the second step is even bolder—and less obviously commercial: giving them away to those who need them most. But both moves are strategic and designed to promote long-term corporate success in an increasingly complex global economy. The biggest initiative is a partnership with the World Food Programme to distribute DSM’s vitamins, nutrient mixes, and fortified food to malnourished people in Nepal, Kenya, Bangladesh, and Afghanistan; 10 million will be served by the end of this year. But the company, which has 250 sites in 50 countries, also participates in many smaller initiatives. For instance, it has contributed lightweight composite modules to a new school in Pune, India, which reduced the costs, time, and environmental impact of construction; the “A lot of companies’ CSR initiatives have nothing to do with their core business. DSM, by contrast, has used its savoir faire, its expertise, and mobilized staff to improve the nutrients in the food given in situations of famine or hunger. If we could clone Feike Sijbesma, the CEO, the world would be a better place.” Pamela Hartigan, Saïd Business School Alison Beard is a senior editor, and Richard Hornik is a contributing editor, at HBR. Heather Wang, Meghan Ennes, Erin Rush, and Samantha Presnal provided additional reporting for this article. Note All total shareholder return figures are as of August 2011 Illustration: Brett Affrunti 90 Harvard Business Review November 2011 It’s Hard to Be Good Southwest Airlines Notable Strength Labor Relations Core Business Airline Country United States Year Founded 1967 Employees 35,000 2010 Revenue $12.1 billion 10-year Annualized Total Shareholder return –6.9% Fact Southwest consistently has the lowest ratio of complaints per passengers boarded of all major U.S. carriers reporting statistics to the U.S. Department of Transportation. school’s students will also be given access to a DSM nutrition program. Elsewhere in India, one of DSM’s anti-infectives units offers free medical services to nearby villagers. And in Mexico, DSM employees hold monthly seminars on safety, health, and the environment for local schoolchildren. Fokko Wientjes, the director of sustainability at DSM, says the company believes that providing aid is both the right thing to do and critical to the future growth of the business. “The benefit isn’t difficult to explain,” he says. “First, in the war for talent, this way of thinking makes DSM an attractive employer. This is a company that’s doing more than just working for shareholders. We have extremely low turnover. “Second, it helps us understand what the needs are in the different countries where an organization like the World Food Programme operates, which helps us innovate. “And third, when you work with these groups you really get the message out on issues like the importance of nutrients. And in the end that will lead to interventions and investments that could be profitable.” The service mentality starts at the top with CEO Feike Sijbesma, who spearheaded the sustainability-focused rebalancing of DSM’s product portfolio. Rank-and-file employees participate by nominating small projects for the company to fund. In the middle, local managers are encouraged to budget for outreach and engagement in their communities. “You look at your environment and think, What can I contribute here?” says Wientjes, whose stints with DSM’s South American and Egyptian operations involved work on safer house construction and environmental cleanup. There’s just one rule: “It needs to be linked to our strategy, to our expertise. We wouldn’t do language lessons for children. But chemistry and math? That suits our company. That’s what we know. “With big projects, you have to find the right partner and the right cause. You have to think, What more can I do with these competencies to build something both for society and for the company?” It’s not just donations. In India, one of DSM’s most important growth markets, the company has a subsidiary tasked with helping local base-of-the-pyramid businesses move toward more-sustainable production, primarily in agriculture (for example, by using better cow feed to improve milk Southwest’s first newspaper ad, published in 1971, promised that its flight attendants—then called air hostesses—would serve from the heart. (Later commercials made it clear they would also wear hot pants.) But what the marketing campaigns didn’t explain was how the company planned to create its energetic corps of customer-loving, costume-wearing employees. The strategy was simple: Southwest would make its staff happy. Customer satisfaction and profits would follow. Today that doesn’t sound new. But back then it was. And the philosophy has paid off. yields) and energy (by providing enzymes to improve the efficiency of gas plants powered by animal manure). Wientjes acknowledges that DSM’s return on its social investment is hard to quantify. “We don’t really put a value on it right now, and maybe we should to have the investor community better understand,” he says. “But shareholders haven’t ever called me and said, ‘Please stop.’” n hbr.org November 2011 Harvard Business Review 91 Spotlight on The Good Company Broad Group “Responsibility is more important than growth.” “Protecting the environment is more important than profit.” “Love is more important than anything else.” You might expect to find those lines in the values statement of a company that makes energy-efficient air conditioners. But would you expect them from one based in hypercompetitive, high-pollution China? From one with industrial customers in more than 70 countries and more than $500 million in sales? From one led by a man worth an estimated $850 million? From one that might soon go public? Broad Group, the Changsha-based business we’ve just described, doesn’t see a trade-off between responsibility and growth. Instead, the company—which makes not only air conditioners but also air filtration systems and prefabricated Southwest is now the largest U.S. domestic air carrier and has been profitable for 38 consecutive years, during which many competitors declared bankruptcy or operated in the red. Last May, on the day the company finalized its $3.2 billion merger with AirTran, Southwest’s management team flew to AirTran’s Atlanta headquarters to throw an air-hangar barbecue for the 6,000 acquired employees based there. CEO Gary Kelly helped serve brisket. The next day the executive group went back to work on a plan that will merge seniority lists in 16 collective bargaining agreements and preserve the job of every manager below the C-suite, though some might be required to relocate. This approach highlights two key elements of Southwest’s employees-first strategy: meaningful interaction between staff and management, and good relationships with organized labor. The company also champions a corporate culture—“warrior spirit, servant’s heart, funloving attitude”—that promotes collaboration. There is a “culture committee,” which is made up of 200 employees from all levels and meets quarterly to plan activities. One favorite initiative is “Delight and Surprise,” when committee members unexpectedly greet the crew of an arriving flight with food and drink and relieve them of plane-cleaning duties. Employee development starts with intense onboarding and continues through the company’s six-week MIT (managersin-training) program. Two poster children for career advancement at Southwest are Mike Ryan, a VP of labor relations who started in the mail room, and Teresa Laraba, senior VP of customer services, who began as a part-time agent in the El Paso airport. Southwest’s pay and benefits are above the industry average. In 1973 it was the first airline to establish profit sharing, and employees now own 5% of company stock. Diversity is a priority, and HR policies allow for small but critical concessions like letting flight attendants trade hours. Much of this is negotiated with the unions, with which Southwest has always worked well. Senior labor relations counsel Joe Harris, who has represented the company since 1972, remembers the initial thinking of founder and CEO Lamar Muse and his legendary successor, Herb Kelleher. “They simply adopted the position that our employees needed an effective voice so we would partner with these organizations,” Harris recalls. Of course, “we’ve had very contentious negotiations over the years. But we’re not like the Hatfields and the McCoys, where we keep fighting after the fight is over. At the end of the day we have a common objective to keep the company healthy and prosperous.” Southwest rei nforces the employee ownership mentality through aggressive internal communication at live events like Kelly’s annual “message to the field” speaking tour and through new technologies. The company offers text alerts for corporate news and has a smartphone app for its intranet, where Kelly posts a weekly audio update and senior managers blog and respond to comments. Will Southwest be able to keep it going and remain a profit leader among airlines even as the economy stagnates, margins tighten, and competitors cotton on to the employees-customers-shareholder continuum? “It’s a tremendous challenge,” Harris acknowledges. “But this philosophy really does still permeate the entire organization.” n “Southwest has been consistently successful by staying true to its values. Other airlines have said, ‘We know we should improve labor relations, but we have 9/11, Asian flu, gas prices…’ It’s always, ‘We’ll get to that.’ Southwest has said, ‘The only way we can turn these planes around quickly is by having committed, problem-solving employees that work together. So what kind of HR practices promote that?’” Thomas Kochan, MIT Sloan School of Management 92 Harvard Business Review November 2011 still significantly higher than those of less environmentally friendly options, making it a harder sell. The company’s earliest successes were in locales with unstable electric systems. Now Broad Group exports to developed markets around the world, supplying airports from Madrid to Bangkok as well as military bases in the United States. It claims to triple the energy efficiency of facilities while dramatically reducing emissions. The company’s other “good” products were developed partly as a response to social and environmental crises: Its air purification systems were designed after the 2002–2003 SARS outbreak in Asia (a cell phone that monitors air quality is on the way); its prefab building system—which allows for fast, zero-pollution construcenergy-efficient buildings—is proof that the two can go hand in hand. “Being good itself is competitive,” says Zhang Yue, who founded the company with $3,000 in 1988 and is now its chairman. “A bad company may be competitive in a market for a while, but it won’t last long. If you offer something of social value, you will survive, and you will prosper.” Of course that wasn’t clear in the 1990s or even the early 2000s, when Broad was trying to persuade industrial customers to switch to its air conditioners. Its technology, which counterintuitively uses natural gas or waste heat to cool, is better for the environment—it avoids the ozone-depleting refrigerants used in electric cooling, reduces the load on power grids, and requires less energy overall. But the up-front costs are Notable Strength Environmental Protection Core Business Industrial Products Country China Year Founded 1988 Employees 2,600 2010 Revenue RMB 3.6 billion 10-year annualized total Shareholder return Undisclosed Fact Broad Town, the company’s one-squarekilometer headquarters, comprises 28 buildings made of recycled packing crates and shipping pallets. Three times a day, employees there are served meals sourced from an on-site organic farm. tion of sturdy, well-insulated structures— followed the 2008 Sichuan earthquake. Zhang sees that system, the BSB (Broad Sustainable Building), as the company’s future. “Buildings consume 40% of the world’s energy,” he explains. As soon as the BSB standards are verified by the Chinese government, the company will tackle its goal of producing 700 million square feet of energy-conserving space by 2020. Working through 100 franchised distributors, it hopes to win a 30% share of the global construction market. “We boldly dream that one day the whole world will cut CO2 emissions by 40% using this technology,” Zhang says. Observers have been impressed by a video showing a prototype 15-story hotel built in 90 hours. But it’s a long way to world domination—hence the desire to raise more capital by taking the company public. A stock market listing will bring new stakeholders, but Zhang thinks he can hold fast to the company’s ethos and culture. Indeed, investors will know exactly what they’re buying into: a company with environmental protection at its core, led by an outspoken tycoon who recently renounced his private jet and who refuses to contribute to overpopulation by having a second child. Zhang really does seem to think he can build a global business on love. “If everybody and every business becomes socially responsible,” he says, “then the earth will become a beautiful hometown for us all.” n “Broad Group continually pushes forward new ideas, products, and services that not only help them meet bottomline objectives but also satisfy their core mission— solving environmental problems in a way that connects to their existing business.” Christopher Marquis, Harvard Business School hbr.org November 2011 Harvard Business Review 93 It’s Hard to Be Good Spotlight on The Good Company Notable Strength Corporate Governance Core Business Fertilizers Country Canada Year Founded 1975 Employees 5,500 2010 Revenue US$6.5 billion 10-year annualized total Shareholder return 27.4% Fact After BHP Billiton launched a hostile takeover of PotashCorp last year, the company’s board of directors met 35 times (compared with eight times in a typical year), with an attendance record of 97%. The bid was eventually quashed by the Canadian government. Potash Corporation A decade ago, after the grand corporate frauds at Enron and WorldCom unleashed a wave of scandal-inspired regulation, the executives and directors of Potash Corporation made a decision. The Canadian fertilizer producer wouldn’t just follow the new rules. It would get ahead of them. “There was this groundswell around governance in the academic, shareholder, and regulatory communities, and that made us stop and take a comprehensive look at what we were doing,” says Joe Podwika, general counsel. “We had established a sustainability committee, and we realized one of the pillars had to be good corporate governance. Instead of adhering to the minimum requirements, we could implement best-practice programs that in the long run would be good for the company.” What started with a core values statement and code of conduct has grown to include a host of shareholder-friendly initiatives, from directors elected by majority vote to “say on pay” for executives—all before such measures were customary or mandated. Most initiatives—such as the stock-option plan based on three-year performance that covers 220 managers and goes up for shareholder vote each year—are taken proactively. But PotashCorp also reacts to outside pressures. Not long ago a big Canadian investor group requested direct contact with board members about executive pay, without management or counsel listening in. “The instinct is to say, ‘We can’t do that,’” Podwika says. “But we looked at it and decided we ought to”—even at a time when CEO William Doyle’s annual package of about $10 million (he also held roughly $400 million in stock and options) was generating controversy. PotashCorp is not without critics. As recently as 1989 it was a debt-burdened government entity. Its mining operations create serious short-term environmental damage, even if it invests heavily in land reclamation. The company also still places “maximize long-term shareholder value” at the top of its key goals, followed by ones related to customers, communities, employees, and the environment (in that order). But when it comes to governance, PotashCorp is by all accounts doing the right thing. What benefit does the company get as a result? “One way to think about the ROI is that it’s like an insurance policy,” says Podwika. “There’s a generally understood principle that the real value of the company is our reputation. I’d say that everybody has it on their consciousness—our CEO, our CFO, and certainly our board. People in every part of the company. We talk about it all the time.” n “Potash shows leadership in the clarity and forthrightness of its compensation disclosure. Rather than giving the minimum required and forcing the investor to try to figure out what the compensation really is, it voluntarily reports how much its executives earn from exercising stock options—even though in recent years it has been an embarrassingly high number. And it does so with a very user-friendly and transparent chart.” Roger Martin, Rotman School of Management 94 Harvard Business Review November 2011 hbr.org Spotlight on The Good Company ing, Unilever identified its top 10 raw materials (as measured by volume, strategic importance, and consumer interest in sustainability) and set out goals for moving to sustainable supply (as measured by 11 factors from soil quality to labor practices). For example, it buys 1.4 million tons of palm oil annually, or 3% of the global yield, but this year more than half of that will come from growers certified by the Roundtable on Sustainable Palm Oil, a group it helped establish. By 2015 the company intends to use sustainable palm oil exclusively. In manufacturing and logistics, the company has set goals for reducing its environmental impact both directly (in factories, distribution centers, and transport) and indirectly (via better packaging and consumer education). Factories are required to submit monthly scorecards on their waste disposal and energy and water use. “We monitor it just as we monitor cost and sales,” Sigismondi says. By 2020 the company aims to reduce CO2 emissions from manufacturing and logistics by more than 40% from a 1995 baseline. So “we know we need to do 4% or 5% a year.” Unilever typically works with governments and NGOs to ensure that its supply chain is following best practices. Though Sigismondi was recently in India visiting vegetable farms, he admits “it’s impossible to do it all on a one-to-one basis.” Suppliers in markets with no certification bodies are told to “self-certify” against Unilever’s Sustainable Agriculture Code; their progress is monitored with software tools and audits. And when activist groups unearth problems, as Greenpeace did in some of Unilever’s Southeast Asian palm plantations, the company responds (in the plantations’ case by revoking their contracts). All this requires investment, and the return is variable. Tea growers certified by the Rainforest Alliance offer higher yields, which reduce product costs, but for sustainable palm oil the balance-sheet defense has yet to materialize. Still, “we’re big enough to afford the premiums, and we believe this is the future of the industry,” Sigismondi says. “Today we’re investing. We’ll see the return in years to come.” There’s more to do. Unilever has not set targets for sustainable sourcing of chemicals, minerals, and packaging other than paper and board. It continues to explore ways to convince customers that they must behave responsibly, too. “Sixty-five percent of our environmental footprint is related to how consumers use our products,” Sigismondi says. “We have to lead beyond our own four walls.” HBR Reprint R1111E To understand the challenge of making Unilever’s supply chain sustainable, consider this: Each year, the company sells 170 billion products across 180 countries, sourcing materials from 150,000 suppliers and operating more than 250 factories. It’s hard to manage that network, much less improve its performance on sustainability. But, according to Pier Luigi Sigismondi, Unilever’s chief supply chain officer, doing better in that area is a strategic imperative. “We have to do business this way to sustain our long-term business goals,” he says. After all, the maker of Lipton tea, Knorr soup, and Dove soap can’t ignore farmland degradation or threats to the world’s water supply. And a leading consumer goods company must respond to consumer demand for sustainably sourced products. Execution rests on a “prioritize and conquer” approach. For agricultural sourcUnilever Notable Strength Supply Chain Accountability Core Business Consumer products Country UK/Netherlands Year Founded 1930 Employees 167,000 2010 Revenue €44.3 billion 10-year annualized Total Shareholder return 4.2% Fact It takes 3.5 million pounds of eggs from 125,000 cage-free hens to make the 30 million jars of Hellmann’s Light mayonnaise sold in North America. “Unilever has developed a pathbreaking framework for looking at products in a cradle-tograve, value-chain-wide way. That represents a real step forward in companies’ taking on a higher burden.” Dan Esty, Yale Law School 96 Harvard Business Review November 2011 hbr.org Harvard Business Review Notice of Use Restrictions, May 2009 Harvard Business Review and Harvard Business Publishing Newsletter content on EBSCOhost is licensed for the private individual use of authorized EBSCOhost users. It is not intended for use as assigned course material in academic institutions nor as corporate learning or training materials in businesses. Academic licensees may not use this content in electronic reserves, electronic course packs, persistent linking from syllabi or by any other means of incorporating the content into course resources. Business licensees may not host this content on learning management systems or use persistent linking or other means to incorporate the content into learning management systems. 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Does It Pay to Be Green? A Systematic Overview by Stefan Ambec and Paul Lanoie Executive Overview The conventional wisdom concerning environmental protection is that it comes at an additional cost imposed on firms, which may erode their global competitiveness. However, during the last decade, this paradigm has been challenged by a number of analysts (e.g., Porter & van der Linde, 1995), who have argued basically that improving a company’s environmental performance can lead to better economic or financial performance, and not necessarily to an increase in cost. The aim of this paper is to review empirical evidence of improvement in both environmental and economic or financial performance. We systematically analyze the mechanism involved in each of the following channels of potential revenue increase or cost reduction owing to better environmental practices: (a) better access to certain markets; (b) differentiating products; (c) selling pollution-control technology; (d) risk management and relations with external stakeholders; (e) cost of material, energy, and services; (f) cost of capital; and (g) cost of labor. In each case, we try to identify the circumstances most likely to lead to a “win-win” situation, i.e., better environmental and financial performance. We also provide a diagnostic of the type of firms most likely to reap such benefits. S ince the publication of the Brundtland Report in 1987 and the subsequent Earth Summits in Rio de Janeiro (1992) and Johannesburg (2002), sustainable development has become one of the foremost issues facing the world. It is recognized that natural systems can be especially vulnerable to human activity because of limited adaptive capacity, and some of these systems may undergo significant and irreversible damage. Furthermore, recurrent smog alerts, acid rain, holes in the ozone layer, global warming, and the loss of biodiversity are among the growing evidence that such a calamity is indeed possible—and occurring faster, in many cases, than scientists originally thought. That is why environmentalists in particular, and the general population more broadly, believe that a business-as-usual approach is worrying. This kind of concern is likely to become more pressing in the future as young generations become even more sensitive to these issues. Managers have long associated environmental protection with additional costs imposed by government, which in turn erode a firm’s global competitiveness. This view relies on a basic paradigm: In general, markets work well to reach optimal use of scarce resources, so that government intervention is useful only for redistributing revenues, or when markets are no longer fulfilling their role effectively. This is precisely what occurs in the case of environmental problems. One of the prerequisites for the adequate functioning of markets is the existence of well-defined ownership rights. In the case of environmental resources available to all, such as clean air and water, these rights are very difficult to assign. Therefore, because air and water belong to no one (or to everyone), economic agents may use them at zero cost, whereas the actual cost of this use for society as a whole is certainly greater. Polluters receive the wrong signal and, because they use these resources without paying the true price, they are encouraged to do so to excess. Left alone, the market mechanism generates too much pollution, and government intervention is legitimate to reduce it to a tolerable We thank two anonymous reviewers for their constructive suggestions, which helped improve the text. We also thank Je´re´my Laurent-Lucchetti for his excellent research assistance. We gratefully acknowledge financial support from INRA and the chair on Sustainable Finance and Responsible Investments. Stefan Ambec (stefan.ambec@toulouse.inra.fr) is Researcher, Toulouse School of Economics (INRA-LERNA). *Paul Lanoie (paul.lanoie@hec.ca) is Professor of Economics, HEC Montreal. 2008 Ambec and Lanoie 45 Copyright by the Academy of Management; all rights reserved. Contents may not be copied, e-mailed, posted to a listserv, or otherwise transmitted without the copyright holder’s express written permission. Users may print, download, or e-mail articles for individual use only. threshold. To that end, government has at its disposal a panoply of instruments, such as regulations, taxation, and pollution permits,1 that may result in the polluters’ receiving the right signal, once confronted with the true cost of their actions. In short, from this perspective, consideration of the environment is necessarily associated with a cost increase for companies that have used environmental resources with impunity. Indeed, the prevailing wisdom is that environmental concerns divert managers from their main responsibility, which should be the maximization of profit (see Friedman, 1970). However, during the last decade, this paradigm has been challenged by a number of analysts (Gore, 1993; Porter, 1991; Porter & van der Linde, 1995). In particular, Porter argued that pollution is often associated with a waste of resources (material, energy, etc.), and that more stringent environmental policies can stimulate innovations that may offset the costs of complying with these policies. In fact, there are many ways that improving a company’s environmental performance can lead to better economic or financial performance, and not necessarily to an increase in cost. To be systematic, it is important to look at both sides of the balance sheet: increasing revenues and reducing costs. In the literature, one can find conceptual or theoretical arguments outlining seven opportunities (described in detail below) companies can make use of to either increase revenues or reduce costs while at the same time being responsible with the earth’s resources (Lankoski, 2000, 2006; Reinhardt, 2000). However, to our knowledge, there has been no systematic effort to provide empirical evidence supporting the existence of these opportunities and assess their scope. In this paper, for each of the opportunities we have identified, we present the economic reasoning involved and provide a systematic review of the empirical evidence available. Furthermore, in each case, we try to identify the circumstances most likely to lead to a “win-win” situation (i.e., better environmental and financial performance) and describe the types of firms most likely to enjoy such benefits. The objective of the paper is not to show that a reduction of pollution is always accompanied by better financial performance, but rather to show that, in many cases, the expenses incurred to reduce pollution can partly or completely be offset by gains made elsewhere. The rest of the paper is organized as follows: First, we sketch our basic analytical framework. Second, we review the opportunities available for improving a company’s environmental performance while increasing its revenues. Third, we present the categories of cost that can be reduced through better environmental performance. Finally, we conclude with a summary and a discussion of future research. Analytical Framework F irms are facing growing pressure to become greener. Various stakeholders (consumers/purchasers, investors, bankers, NGOs, and so on) press companies to reduce their negative impact on the environment. This is now seen as firms’ social responsibility, what businesspeople often refer to as “corporate social responsibility” (Friedman, 1970; May et al., 2007). In various industries, firms must try to cope with these pressures while staying competitive. Management studies (e.g., Aupperle et al, 1985; Folger & Nutt, 1975; Levy, 1995) have argued that environmental corporate social responsibility is generally associated with a reduction in competitiveness. Yet firms can try to reduce their environmental impacts without hurting their economic performance by implementing an ambitious innovation strategy. Such an approach would include one or more of seven strategies that could result in increased revenues or reduced costs. First, better environmental performance can lead to an increase in revenues through three channels: (a) better access to certain markets; (b) differentiating products; and (c) selling pollutioncontrol technology. Second, better environmental performance can lead to reductions in cost in four categories: (a) risk management and relations with external stakeholders; (b) cost of material, energy, and services; (c) cost of capital; and (d) 1 In general, it is considered that “market-based” instruments, such as green taxes and pollution permits, should be preferred over regulation, because they provide incentives for abatement cost minimization and continuous innovation. 46 Academy of Management Perspectives November cost of labor. These mechanisms are summarized in Figure 1. Interestingly, opportunities to increase revenues or reduce costs can reinforce each other, leading to the arrows between both sets of opportunities. For instance, producing greener products through a differentiation strategy may enhance workers’ commitment toward a company, and this could facilitate recruiting and retaining workers. In the same vein, reducing the material or energy costs of a product may facilitate the incorporation of environmental features into the product, helping to develop a differentiation strategy. Increased Revenues Better Access to Certain Markets B etter environmental performance may facilitate access to certain markets. First, generally speaking, reducing pollution and other environmental impacts may improve the overall image or prestige of a company, and thus increase customers’ loyalty or support sales efforts. Although this argument seems pretty straightforward, it is difficult to find strong empirical evidence that customers are influenced by a company’s “green” image. Consumers may be aware of a company’s environmental performance through its offer of green products, but they are less likely to be familiar with its environmental performance as measured by its emissions to water or the atmosphere. Second, more specifically, purchasing policies of public and private organizations may reward green suppliers. It is becoming increasingly common for public administrations to include environmental performance as a criterion for choosing suppliers of goods or services. This phenomenon is known as green public purchasing (GPP). As an illustration, Kunzik (2003) reported that, in general, the central U.K. government, in its Greening of Government Operations policy, aims to: ● Encourage manufacturers, suppliers, and contractors through specifications to develop environmentally preferable goods and services at competitive prices. Figure 1 Positive Links Between Environmental and Economic Performance 2008 Ambec and Lanoie 47 ● Ensure that any products derived from wildlife, such as timber, plants, and leather goods, are from sustainable sources . . . (p. 194). More specifically, for instance, the U.K. Department of Environment, Transport, and Regions has the following objectives: ● Buy a minimum of 10% of electricity from renewable sources. ● Purchase sustainably produced timber products by, for example, specifying that suppliers provide independently verifiable documentary evidence that their timber has been lawfully obtained from sustainable forests managed “to prevent harm to other ecosystems and any indigenous people” (p. 197). In the United States, the Federal Acquisition Regulations provide a detailed code of rules governing procurement by all federal agencies. For instance, these rules specify that “the Environmental Protection Agency (EPA) has to prepare guidelines on the availability, sources, and potential uses of recovered materials and associated products, including solid waste management services; and require federal agencies themselves to develop and implement affirmative procurement programs for EPA-designated products” (Kunzik, 2003, p. 203). Overall, public purchasing is fairly important in the economy. In 1998, it was estimated that government-sector expenditures for consumption and investment were responsible for 20% of GDP in OECD member countries, 9% when subtracting compensation for employees (Johnstone & Erdlenbruch, 2003).2 It can be argued that green public purchasing “can spur innovation by increasing the competitive advantage of greener products in the market, which can then be followed by larger commercialization and diffusion. In particular, public demand may provide “demonstration” effects, giving valuable information to other actors in the economy about potential benefits of newer untried green technologies and products” (p. 12). In addition, private companies have taken steps to “green” their supply chains. Presumably, all plants with ISO 14001 certification pay attention to their suppliers’ environmental performance, as this is one of the criteria to be fulfilled to obtain the certification (Barla, 2007).3 Furthermore, a recent survey of the OECD, covering more than 4,000 facilities in seven countries, showed that 43% of them assess their suppliers’ environmental performance (Johnstone et al., 2007). Some companies’ policies regarding their suppliers’ green performance have been well documented in case studies. For instance, before choosing a supplier, IBM asks potential candidates to do a self-evaluation of their environmental performance, and for those that have a satisfactory score on the self-evaluation, there is an on-site evaluation of practices (Herren et al., 1998). In the same vein, since 1992 Body Shop International has had a strict evaluation system for its suppliers’ environmental performance, the Supplier Environmental Star-Rating Scheme (Wycherley, 1999). Wal-Mart has developed incentive plans and “commonsense” scorecards for its merchandise buyers to encourage innovation and environmentally preferable products.4 Beyond these laudable efforts by companies, is there any research or empirical evidence showing that it pays firms to incur extra expense to improve their environmental performance in order to have better access to certain markets? In other words, is it profitable to be green? There is little evidence to that effect. At best, we can rely on the recent study of Hamschmidt and Dyllick (2006) who provided, to our knowledge, the first costbenefit analysis of an implementation of ISO 14000. In many cases, companies are making the effort to comply with the ISO 14000 requirements in order to improve their image and reach extra customers (Hess et al., 1999). For their sample of 158 certified Swiss firms, they found that the 2 According to Marron (2003), the largest private suppliers of public administration are in the following sectors: construction, energy services, transportation equipment, transportation services, shipbuilding, medical equipment, military equipment (including paper), office equipment, electrical machinery, and clothing. 3 As of January 1, 2006, there were 103,583 plants worldwide that were ISO 14001 certified (http://www.ecology.or.jp/isoworld/english/analy14k.htm). 4 http://www.treehugger.com/files/2006/11/walmart_introdu.php. 48 Academy of Management Perspectives November average payback period of the adoption of ISO 14000 was 2.2 years. Given that most public administrations are now involved in GPP, and that a large percentage of private firms are also paying attention to their suppliers’ environmental performance, it seems that firms selling to governments or other businesses (as opposed to consumers) can actually obtain better access to certain markets by improving their environmental performance. Differentiating Products Along the same lines, it is possible that better environmental performance through greener products or services can allow companies to use a differentiation strategy so as to exploit niches in environmentally conscious market segments. In this case, even if green products or services are more expensive to produce, the extra cost can likely be transferred to consumers who are willing to pay more for more environmentally friendly products or services.5 Ecolabeling can make information about the environmental features of a product or service more credible. The popularity of ecolabeling is increasing, especially in Europe. In particular, sales of products with the European ecolabel went from €51 million in 2000 to €644 million in 2004.6 Consumers’ willingness to buy green products in general is important, although the actual amounts devoted to such purchases may be less impressive. For example, 80% of French adults say they favor the purchase of ecoproducts, while 10% say they actually make such purchases regularly (Guilloux, 2006).7 Specific examples of enterprises that have adopted this differentiation approach are numerous. For some companies, it even became a core strategy. Among the classic examples is Patagonia, an American sport garments company, which in the 1990s launched new lines of clothing made of recycled PET (polyethylene terephthalate) and organic cotton. This was a commercial success in spite of the higher price of these products (Reinhardt, 2000). Swiss chemical company Ciba Geigy in the mid-1990s created a new type of bioreactive dye, Cibacron LS. This new dye had a higher fixation rate, which meant that less dye was required to color textiles. In turn, this meant that rinsing was simpler and less expensive, and that firms’ wastewater treatment costs could be lower. In other words, this dye helped Ciba’s clients reduce their environmental cost. Ciba protected this new dye via a patent. The dye was a commercial success despite its higher price (Reinhardt, 1999). The development of the “biofood” industry (organic food producers and retailers) serves as another example of the success of this strategy, although in this case one can argue that, when buying these products, consumers are also looking at their health attributes8 . This industry is becoming sizable; for instance, the world market for biofood products doubled between 2003 and 2006. This represents almost 8% of the world food market.9 In Europe, the market share for biofood is estimated at 10%. Similarly, sales of organic cotton (produced without chemical fertilizers or pesticides) soared worldwide, from $245 million in 2001 to an estimated $1 billion in 2006.10 It is also becoming more common to see companies emerging in the “green energy” market, i.e., companies that have access to the grid to sell energy from renewable sources, such as biomass, wind, and solar. A well-documented example is the Dutch enterprise PNEM, which generates electricity from a biomass-fired power plant (Hofman, 2005). Here again, we can ask the question: Is it worthwhile for firms to adopt this strategy? There is little empirical evidence available. FGCAQ 5 This differentiation strategy is related to ecodesign, which refers to all the actions taken and activities carried out originating from the incorporation of environmental performance requirements in a product development project. See Johansson et al. (2001), who reported 10 ecodesignrelated commercial success stories. Ecodesign can sometimes also reduce certain types of expenditures, such as the quantity of raw material used, packaging, or transportation. 6 http://www.abgs.gov.tr/tarama/tarama_files/27/SC27EXP_EU%20Eco-label. pdf. 7 See also Carlson et al. (1996) and Willard (2005) on the differences between “intentions” and “actions.” 8 Bonny (2006) showed that environmental attributes are almost as important as health attributes in the decision to purchase biofood in European Union countries (EU-15). 9 http://seme.cer.free.fr/index.php?catfiliere-bio. 10 Les E´chos, November 21, 2006. 2008 Ambec and Lanoie 49 (2004) and Parsons (2005) studied the profitability of farms producing organic milk compared with that of farms producing regular milk, and they concluded that there is no significant difference between the two groups in terms of profits. From these examples, it seems that a differentiation strategy is more likely to work when11 (a) the information about the environmental features of the product is credible (e.g., an ecolabel), (b) consumers are willing to pay for extra environmental features (this is more difficult with lowend products), and (c) there is a barrier to imitation from competitors (such as the patent obtained by Ciba). The variety of the examples available leads us to believe that a wide range of enterprises can actually achieve better environmental performance and obtain more revenues by using this strategy. Even firms producing fairly homogeneous goods that are usually difficult to differentiate, such as agricultural products or energy, can do so. Selling Pollution-Control Technology For decades, solving environmental problems has become a business opportunity for companies that specialize in this area—what we can refer to as the ecoindustry. A detailed description of this industry and its market structure lies beyond the scope of this paper.12 Rather, we are interested in firms that, in their search for better environmental performance, are led to do research and development in the area of pollution-control technologies, so as to optimize their manufacturing or waste management processes. This can lead to technological breakthroughs that potentially can be attractive for others. Companies adopting such a strategy may also enjoy a “first-mover” advantage, and may eventually lobby governments for stricter regulations. For example, as mentioned above, Ciba Geigy patented its new Cibacron LS dye that could be sold to other companies under licensing agreements. Indeed, following its experience with the new dye and wastewater treatment, Ciba in 1998 bought Allied Colloids Group, a U.K. manufacturer of water treatment additives. This was the first step in creating its environmental division. Another example of a large company that has diversified its activity by opening an “environment” division is General Electric. Its Ecomagination division includes 32 clean-technology products, such as wind turbines, and had revenues of $10 billion in 2005 and is forecasting $20 billion in 2010.13 In the same vein, the major aluminum producer Alcan has developed and tested a spent potlining (SPL)14 treatment, the Low Caustic Leaching and Liming (LCLL) process. Up to now, SPL was considered a hazardous waste that had to be stored or landfilled very carefully. With its new process, Alcan will be able to recycle a large part of this waste. The company is building a new plant in Canada to treat its own and eventually other companies’ SPL. Selling pollution-control technology, as one way to turn an environmental problem into an increase in revenues, is probably not a widespread phenomenon. The three examples we found suggest that firms must already have research facilities and a large amount of resources to eventually sell a pollution-control technology they have developed for themselves. Cost Reductions Risk Management and Relations With External Stakeholders B etter environmental performance may make the relations between the firm and its external stakeholders (e.g., government, ecological groups, media, communities) easier and reduce the risk associated with these relations. In particular, as 11 See also Reinhardt (2000) for more discussion. 12 Ecoindustries are industries that produce goods and services to measure, prevent, limit, minimize, or correct environmental damage to water, air, and soil, as well as problems related to waste, noise, and ecosystems. This includes cleaner technologies, products, and services that reduce environmental risk and minimize resource use. In 2005, it was estimated that ecoindustries represented revenues of €180 billion and 500,000 jobs (http://ec.europa.eu/research/briefings/sustain-devel_en.html). 13 http://ge.ecomagination.com/site/. 14 “Spent potlining (SPL) is the main waste residue generated by the electrolysis process in the smelters producing aluminium. It consists of the internal lining of the pots, which is replaced after five to seven years of use. SPL is classified as hazardous waste by many jurisdictions worldwide due to its toxicity and explosive nature” (http://www.publications.alcan.com/ sustainability/2005/en/pdf/alcan_sr05_web_releases.pdf). 50 Academy of Management Perspectives November suggested by Lankoski (2006), less pollution means lower liability costs, avoiding potentially costly litigation and fines. As a concrete example, El Bizat (2006) showed, through a survey of Canadian jurisprudence, that the implementation of a proper environmental management system (EMS), such as that recognized by ISO 14001, can be useful in proving due diligence in court in cases of illegal spills or other environmental accidents. Better environmental performance may also allow a firm to anticipate and reduce the risk associated with future regulation. Firms could even push for tighter standards in order to enjoy a strategic first-mover advantage. For instance, it is well documented that, in the 1980s, Dupont lobbied to ban CFCs and other ozone-depleting substances, because it had the leadership in the research for substitutes (Reinhardt, 2000). In the same vein, firms with a better environmental performance may find it easier to deal with other external stakeholders. For instance, goods that are more environmentally friendly are less likely to suffer from a boycott campaign orchestrated by ecological groups and carried out in the media. Similarly, firms with better environmental performance may obtain approvals from the government and the community more rapidly to extend the size of a new plant or build a new one. Risk management is again facilitated. Finally, learning to deal well with environmental stakeholders may have positive spillover with nongreen stakeholders such as unions or authorities responsible for workers’ safety and health. The companies most likely to benefit from these cost reductions are those that are heavily regulated and scrutinized by the public. One can include in this category firms with toxic emissions, such as the chemical and metallurgic industries, and firms with substantial pollutant emissions, such as the pulp and paper industry and the energy sector. Cost of Material, Energy, and Services15 As mentioned in the introduction, Porter has suggested that pollution is generally associated with a waste of resources, raw material not being fully used, or lost energy. “Pollution is a manifestation of economic waste and involves unnecessary or incomplete utilization of resources. . . . Reducing pollution is often coincident with improving productivity with which resources are used” (Porter & van der Linde, 1995, p. 99). From this reasoning, Porter argued that more stringent and flexible environmental regulations, such as taxes and tradable permits, would be fruitful for the economy, stimulating innovations that might offset the cost of complying with these policies. This is known as the Porter hypothesis (PH). In particular, this line of reasoning implies that reducing pollution can generate a reduction of expenditures on raw material, energy, or services. In the economic literature, the PH has been criticized for its lack of theoretical foundation (Palmer et al., 1995). It rests on the idea that firms systematically ignore profitable opportunities, in contradiction of the standard assumption of profitmaximizing firms subject to competitive market pressure. There are no reasons why regulation would actually be needed for firms to adopt profitincreasing innovations. Walley and Whitehead (1994) argued that, although win-win situations might exist by chance, they are very rare, and, given the magnitude of some investment for regulation compliance, the financial return is likely to be negative. Recent papers have provided a basis for the PH by introducing a market failure (in addition to failure owing to pollution). Environmental regulations, which are devoted to solving the market failure resulting from the pollution externality, prove to mitigate the other market failure to the benefit of the regulated firms. Examples of such market failures include market power (Greaker, 2003; Simpson & Bradford, 1996), specific investments with contractual incompleteness (Ambec & Barla, 2005), asymmetric information within firms (Ambec & Barla, 2002), and spillovers in knowledge (Ambec & Barla, 2005; Jaffe et al., 2004) or learning-by-doing (Mohr, 2002). For instance, learning how to use energy more efficiently or exploit waste and by-products in one production plan might benefit other production plants and improve managerial expertise and, therefore, might entail knowledge spillovers among 15 The services we have in mind here are mainly wastewater treatment, garbage collection, and use of recycling facilities. 2008 Ambec and Lanoie 51 a firm’s divisions (Clemens & Douglas, 2006; Rosen, 2001). Yet such innovation policy might not have been implemented without regulation, owing to organizational failures such as asymmetric information between divisions. Given the objective of this paper, it is relevant to review the rapidly growing empirical literature on the PH. We distinguish between two broad sets of studies. A first set estimates the impact of environmental regulations on the firm’s innovation policy and technological choice measured by investment in R&D or in capital and new technologies or by successful patent applications. These studies test the first premise of the PH that more stringent environmental regulations enhance innovation. Yet more innovation is a necessary but not sufficient condition for the PH. Therefore, they can only invalidate or provide some support for the mechanism underlying the PH without directly testing it. In the second set of studies, the impact of environmental regulations is estimated on measures of firms’ performance, such as productivity and costs. The aim is to test whether more stringent environmental policies can be beneficial to the firms. Yet those papers are silent on the process that leads to higher productivity. Ambec and Lanoie (2007) summarized several empirical papers that fit into these two sets. In the first set of papers, Jaffe and Palmer (1997) estimated the relationship between total R&D expenditures (or the number of successful patent applications) and pollution abatement costs (a proxy for the stringency of environmental regulations). They found a positive link with R&D expenditures (an increase of 0.15% in R&D expenditures for a pollution abatement cost increase of 1%), but no statistically significant link with the number of patents. Restricting themselves to environmentally related successful patents, Brunnermeier and Cohen (2003) found a positive but small relationship with environmental regulations. Both studies suggest a weak but positive link between better environmental performance (through better compliance with regulations) and the firm’s innovation policy. For the firm’s technological choices, Nelson et al. (1993) found that air pollution regulations significantly increased the age of capital in U.S. electric utilities in the 1970s. Gray and Shadbegian (1998) found that more stringent air and water regulations have a significant impact on paper mills’ technological choice in the U.S. However, their results suggest that this tends to divert investment from productivity to abatement, consistent with the standard paradigm. The second set of studies has a long tradition in the economic literature (see Jaffe et al., 1995, for a review). Most papers reviewed in Jaffe et al. (1995) highlighted the negative impact of environmental regulations on productivity. For instance, Gollop and Roberts (1983) estimated that SO2 regulations16 slowed productivity growth in the U.S. in the 1970s by 43%. More recent papers find more positive results. For example, Berman and Bui (2001) reported that refineries in the Los Angeles area enjoyed significantly higher productivity than other U.S. refineries despite more stringent air pollution regulations in the area. Similarly, Alpay et al. (2002) estimated that the productivity of the Mexican food processing industry was increasing under pressure from environmental regulations. They therefore suggested that more stringent regulations are not always detrimental to productivity.17 Relying on an extensive survey from OECD, Lanoie at al. (2007) tested the full causality chain of the PH (from environmental regulations to R&D, and then to business performance). They found that environmental regulation stringency affects R&D spending positively. Yet it has two impacts on business performance: a negative direct impact and a positive indirect impact through environmental R&D, in the spirit of the PH. The net impact of environmental regulations on business performance is nevertheless negative. Although the mentioned studies tend to reject the PH, one cannot conclude that being green harms the firm. Concerning this research, two caveats are worth mentioning. First, it may be 16 The regulations implemented to reduce sulfur dioxide emissions from coal power plants (see Burtraw, 2000, for details). 17 In the same vein, Hoglund Isaksson (2005) looked at the impact of a charge on nitrogen oxide emissions introduced in Sweden in 1992 on 114 combustion plants. Her findings suggest that extensive emission reductions took place at zero or very low cost, and that effects of learning and technological development in abatement were present during the period analyzed. 52 Academy of Management Perspectives November argued that previous studies have not properly allowed for the dynamic dimensions of the PH. Porter argued that more stringent environmental policies will lead to innovations to reduce inefficiencies, and this in turn will eventually reduce costs. This process may take some time. In previous studies on the determinants of productivity, researchers have regressed productivity at time 0 on proxies of environmental regulation stringency at time 0 as well, which allows no time for the innovation process to occur. By introducing lags of three or four years between changes in the severity of environmental regulations and their impact on productivity, Lanoie et al. (2008) found that more severe regulations led to modest gains in productivity in a sample of 17 Quebec manufacturing sectors. Furthermore, they showed that this effect is greater in industries highly exposed to outside competition. Second, most studies rely on command-andcontrol regulatory instruments, such as pollution standards, while environmental regulations are moving to more efficient “market-based” instruments, such as tradable emission permits. The economic theory predicts that emission markets reduce compliance costs by assigning those costs where they are lower. In contrast to standards (that might not be binding after a while), marketbased instruments provide constant incentives to innovate. The PH is therefore more likely to be satisfied in industries regulated with the new market-based instruments, especially tradable emission permits. In this vein, Burtraw (2000) provided evidence that the 1990 switch in environmental regulation of SO2 emissions in the U.S. from a technological standard with emission caps to an allowance trading program considerably reduced compliance cost (40% to 140% lower than projection). It indeed not only enhanced innovation, but also fostered organizational change and competition on the upstream input market. The program left enough flexibility for the firms to select the best strategy for reducing emissions, including a switch to coal with lower sulfur content. The industry also experienced innovation in fuel blending and in the scrubber market.18 In addition, the switch from a technological standard to tradable emission allowances led to a transfer of responsibility from engineers or chemists, typically in charge of environmental issues, to top executives such as financial vice presidents, who are trained to treat SO2 emissions allowances as financial assets. Even if the PH cannot be generalized to the “whole” economy, it is clear that some firms have been able to reduce emissions and costs at the same time. Let us mention a few examples. First, Dow Chemicals is well known for its WRAP (Waste Reduction Always Pays) Award program, which was implemented in 1986. “Since the program began, Dow has given the WRAP Award to 395 projects. Worldwide, the projects account for the reduction of 230,000 tons of waste, 13 million tons of wastewater, and 8 trillion BTUs of energy. The (net) value of all these projects totals roughly $1 billion.”19 Second, when implementing ISO 14001, the authorities of GM’s Flint, Michigan, plant realized that they were using a lot of energy during weekends when the machines were stopped (448,918 kWh during the 1999 Thanksgiving holiday). Shutdown efforts were made very systematically so as to generate savings of approximately $250,000 per year (174,299 kWh were used during the same holiday two years later) (El Bizat, 2006). Third, examples can be found even in the services industry; five changes have been made recently at the headquarters of Adobe Systems (ranging from automatic faucets to motion sensors), which involved an initial investment of around $250,000 for annual savings of around $246,000 (Fortune, 2006). Fourth, Kats (2003) showed with a sample of 33 green buildings that the financial benefits of green design are more than 10 times the additional cost associated with building green. Currently, there is a movement toward “eco-efficiency,” which implies that many changes can be both economical and ecological at the same 18 The former “command and control” did not provide incentives to increase SO2 removal by scrubbers from more than the 90% (for high-sulfur coal) or 70% (for low-sulfur coal) standard. With the new program, the incentives are such that upgrading of existing scrubbers through improvements is likely to occur. 19 http://www.dow.com/commitments/studies/wrap.htm. 2008 Ambec and Lanoie 53 time.20 Lanoie has collected more than 50 examples over the last eight years of companies that were able to reduce both pollution and the cost of resources, energy, and services (Lanoie & Tanguay, 2000, 2004). These companies are very diversified in terms of size, origin, and industry. The actions taken to reach these win-win outcomes are also fairly diversified (reuse of waste, use of waste as a source of energy, more efficient production technology, more efficient energy use, etc.), and this suggests that the set of potential opportunities is fairly broad. It is not always possible to reduce both pollution and the cost of energy, material, and services, but the set of opportunities to do so seems relatively large. These opportunities are more likely to emerge in firms where the production process is flexible, and in industries where market-based instruments (such as pollution taxes and tradable permits) are implemented. Cost of Capital It is also possible that better environmental performance can be associated with a lower cost of financial capital. First, it is becoming quite clear that greener firms have easier access to capital markets through the proliferation of all the green (or ethical) mutual funds.21 Through these funds, green investors can be sure that their money will be invested in firms that meet certain criteria, such as the existence of a proper environmental management system (EMS) or the absence of environmental litigation. Socially responsible investment (SRI) is becoming an important phenomenon. Assets in U.S. socially screened funds increased by 258% between 1995 and 2005, a rate of growth faster than the average of other professionally managed U.S. funds. In France, the increase was 92% between 2002 and 2006. In 2005, nearly one out of every 10 dollars (9.4%) under professional management in the U.S. was involved in SRI (10% to 15% in Europe).22 Portfolio analysis allows one to compare the performance of these socially screened funds with that of conventional funds, as we will see below. Second, firms with better environmental performance can borrow more easily from banks. Most banks now have a team of experts to evaluate the environmental performance of possible borrowers, in particular the size of potential liabilities owing to contaminated assets.23 Furthermore, about 40 international banks have now adopted the Equator Principles to make sure that the projects they finance are developed in a socially responsible manner and reflect sound environmental management practices.24 Third, shareholders in general may be influenced by information on the environmental performance of companies, and their reactions can be perceptible on the stock market. These movements may in turn influence the cost of capital. A large number of empirical studies have tried to identify the stock market reaction to news on environmental performance. Three main approaches are dominant in that literature: (a) portfolio analyses, (b) event studies, and (c) long-term studies using regression analysis. In each case, we will present the methodology used, the main conclusions, and the limitations. Portfolio Analysis25 Portfolio analysis is used to examine whether SRI funds (or indices) exhibit different performance from funds in a more general investment context. Such analysis compares the economic perfor- 20 According to the World Business Council for Sustainable Development, there are seven principles for eco-efficiency: (a) reduce the material intensity of goods and services, (b) reduce the energy intensity of goods and services, (c) reduce toxic dispersion, (d) enhance material recyclability, (e) maximize sustainable use of renewable resources, (f) extend product durability, and (g) increase the service intensity of goods and services. See http://www.wbcsd.org/plugins/DocSearch/details.asp? typeDocDet&ObjectIdMTgwMjc, or Orsato (2006). 21 In general, environmental performance is one of the criteria used to select firms in an ethical mutual fund. 22 http://www.socialinvest.org/resources/sriguide/srifacts.cfm. 23 For instance, the French bank BNP Paribas has a team of 120 professionals in the area of sustainable development (http://www.bnpparibas.com/ en/sustainable-development). Similarly, the American Citibank reported that, in 2004 and 2005, more than 1,500 of its employees were trained on environmental issues (http://www.aeca.es/comisiones/rsc/biblioteca_memorias_rsc/ informes_empresas_extranjeras_4/citigroup_2005.pdf). 24 www.equator-principles.com. One can also refer to the Enhanced Analytics Initiative (EAI), in which members agree to use part of their budget to reward brokers who publish research on extrafinancial issues such as climate change or brand management (http://www.enhancedanalytics. com). 25 See also the discussion in Rennings et al. (2006) and Plinke and Knorzer (2006). 54 Academy of Management Perspectives November mance of portfolios consisting of companies with a higher environmental or social performance with portfolios of companies that have not been screened with these criteria. The comparison is done using such indicators as Jensen’s alpha and Sharpe and Treynor ratios.26 In general, it is expected that ethical funds will underperform over the long run because fund managers are constrained to a subset of the market portfolio. We came across 16 studies of this type, which are summarized in Ambec and Lanoie (2007).27 Eleven of them came to the conclusion that there is no statistically significant difference between the performance of SRI funds and conventional ones, while five of them showed results confirming that SRI funds outperform conventional ones. However, the weaknesses of these studies should be noted. First, the financial success of existing funds depends heavily on the ability of fund management. Portfolio studies cannot easily separate these management effects from social or environmental performance effects. Second, in these analyses, only the average performances of funds are compared. Consequently, the specific form of the influence of environmental performance on economic performance can hardly be separated from other influences such as management of the fund, capitalization, and regional peculiarities. The identification of specific effects requires econometric methods that include all control variables besides the variable of interest (environmental performance).28 Event Studies The event-study methodology is based on the assumption that the capital market is sufficiently efficient to reflect the impact of all new information (events) on the future expected profits of firms (see Fama et al., 1969). The reaction to the announcement of an event is obtained by predicting a “normal” return for each firm during an “event window” (usually the day prior to the event, the day of the event, and a few days after the event), and then subtracting this predicted normal return from the actual return observed on those days of the event window. If there is a significant difference between the predicted return and the observed return (i.e., an abnormal return), one can conclude that the event had a significant influence on the stock price. Normal returns are usually predicted using a version of the Capital Asset Pricing Model (CAPM). Many researchers have examined the effects of environmental “events” on stock market performance. The events considered generally have the character of negative news, such as information about illegal spills, prosecutions, fines, or the emission data related to the American Toxics Release Inventory (TRI). Only a few studies consider the effects of positive news, such as information on environmental awards (Klassen & McLaughlin, 1996; Yamashita et al., 1999). Some authors, such as Blacconiere and Patten (1994), Jones et al. (1994), and White (1996), have considered only one major event, such as the Bhopal explosion or the Exxon Valdez oil spill. We surveyed 14 event studies, which are summarized in Ambec and Lanoie (2007).29 All of them show that stock markets react significantly to good or bad environmental news. Actually, the average daily abnormal returns for bad news represents a loss of 2.22%. Event studies offer strong econometric results of causality when they are limited to one or at most five trading days after the event to ensure that news of confounding events does not interfere with the effect of interest. Can we conclude from such results that poor environmental performance leads to an increase in the cost of capital? The potential reaction of capital markets to new information on companies’ environmental impact can actually be explained by two basic scenarios.30 In the first one, new information on liabilities (potential litigation or fine) or cleanup costs enters the market at time t, causing the stock price to 26 For more details, see Bauer et al. (2005). 27 http://www.hec.ca/iea/cahiers/2007/iea0704_planoie.pdf. See page 17 for a summary table. 28 Bauer et al. (2005, 2007) partly overcame this difficulty through the use of Carhart’s (1997) multifactor performance attribution approach. They also concluded that “any performance differential between ethical mutual funds and their conventional peers is insignificant.” 29 http://www.hec.ca/iea/cahiers/2007/iea0704_planoie.pdf. See page 21 for a summary table. 30 This part of the presentation is based on Koehler (2006). 2008 Ambec and Lanoie 55 drop because investors expect reduced earnings and dividend payments. The return is unchanged if the fundamentals of the company do not change. This is the cash flow news effect, and its existence can be tested using the event-study methodology. Such a short-run negative price movement does not, however, mean that the price of capital is going up. Such price changes do not provide enough substance to formulate buy/sell strategies unless we believe environmental performance to be a matter for day traders constantly arbitraging. We can thus turn to the second scenario, the “green investor effect”31 that may come about through SRI. Learning about bad environmental news, these investors may worry about the quality of the management of the companies involved and decide to sell “dirty” stocks, which reduces their price. Investors’ green preferences are likely to be more long-lived, and thus require multiperiod analyses to be well investigated (using panel data and regression analysis for instance). In this second scenario, as the price of “dirty” stocks falls, investors will demand compensation with a higher return; therefore, the cost of capital for such companies will increase, and it will be more difficult to raise new funds. In the context of our discussion on the impact of better environmental performance on the cost of capital, it will be crucial to find out which of these two scenarios dominates.32 Long-Term Studies Using Regression Analysis In these studies, investigators examine, through regression analysis, the relationship between certain characteristics of companies (including their environmental performance) and their financial performance. In contrast to event studies, the analysis concentrates on characteristics of companies and not on specific news about the companies. In contrast to portfolio analysis, researchers examine not a portfolio of stocks, but single stocks. We identified 12 studies in this category, which are summarized in Ambec and Lanoie (2007).33 Different measures of economic performance (Tobin’s Q,34 return on assets, return on sales, return on equity) and environmental performance (TRI emissions, ISO 14001 certification, the adoption of other international environmental standards) were used in the various studies. Nine studies showed that better environmental performance is associated with better economic performance. Two studies showed no impact, while one concluded that a negative relationship exists. Generally speaking, one can say that these results suggest that bad environmental performance is associated with lower economic performance on a long-term basis, and this implies an increase in the cost of capital. Overall, what can we conclude from this extensive literature regarding the impact of better environmental performance on the cost of capital? It seems clear that a large majority of the portfolio analyses, event studies, and long-term studies show that better environmental performance is associated with better financial performance (or at least not worse). As we have discussed, the longterm studies are the most reliable, and they offer converging evidence to support the hypothesis that lower environmental performance leads to lower financial performance, and thus to a higher cost of capital. Furthermore, it is clear that, in day-to-day life, banks (and insurers) examine the environmental performance of their clients and adjust lending conditions according to that performance. It is also evident that green or ethical mutual funds are becoming more popular, and this is providing green firms with better access to capital. Thus, we 31 Heinkel et al. (2001) demonstrated that the number of green investors is key to affecting stock prices as in the second scenario. They designed an equilibrium model of capital markets assumed to be efficient with two types of risk-averse investors: neutral investors with low sensitivity to environmental concerns and green investors. These investors were faced with opportunities to buy more or fewer “dirty” stocks. After conducting sensitivity analysis on various parameters, they found that a key determinant of the environmental performance of companies is the fraction of green investors. They concluded that it is necessary to have at least 25% green investors to change corporate environmental investment strategy. 32 Other limitations of the event-study methodology have been recognized. For instance, McWilliams and Siegel (1997) and McWilliams et al. (1999) have noted various methodological concerns. They criticized the use of the CAPM model, which is often chosen to predict normal returns. They also questioned the assumption of investors’ rational expectations, arguing that investors could be biased. 33 http://www.hec.ca/iea/cahiers/2007/iea0704_planoie.pdf. See page 25 for a summary table. 34 Tobin’s Q is the ratio of the market value of a firm divided by its replacement cost. 56 Academy of Management Perspectives November can conclude that there is strong evidence that better environmental performance does not lead to an increase in the cost of capital. In fact, there is some relatively convincing evidence that better environmental performance leads to a reduction in the cost of capital. Large firms with shares exchanged on the stock markets are more likely to benefit from these gains. Cost of Labor Some authors have also argued that better environmental performance can lead to a reduction in the cost of labor. As stated by two Ciba Geigy managers: “An improved image of the company results in an improved atmosphere in the workplace and hence in higher productivity. . . . People who feel proud of the company for which they work not only perform better on the job, but also become ambassadors for the company with their friends and relatives, enhancing goodwill and leading to a virtuous circle of good repute. Of course, this is impossible to quantify, but it seems clear that it is true. . . . This is especially important in recruiting talented young scientists, managers, and engineers, many of whom . . . simply would not work for a company with a poor social and environmental reputation. . . . No one wants to work for a dodgy company, and the brightest people obviously have a choice” (Reinhardt, 1999, p. 11). Similarly, De Backer (1999) provided anecdotal evidence that ISO 14001 has significant effects on employees’ morale and productivity, much more than ISO 9000 certification. If this is the case, better environmental performance can indeed reduce the cost of labor by reducing the cost of illnesses, absenteeism, recruitment, and turnover. A few analysts (e.g., Lankoski, 2006) have put forward this argument in favor of labor cost reduction. Even if the argument is fairly compelling, to our knowledge there is no direct empirical evidence supporting it. However, indirect evidence exists from surveys indicating that companies are aiming at better environmental performance to improve the satisfaction of their employees and unions. For instance, Henriques and Sadorsky (2007) found that workers’ pressure is a significant determinant of a firm’s commitment toward a better environment (e.g., implementation of an EMS). Grolleau et al. (2009) showed that improving human resource management is a significant motivation behind the decision to obtain the ISO 14000 certification. What types of companies could potentially achieve labor cost reductions associated with better environmental performance? Basic intuition suggests the following: (a) companies whose emissions can affect their workers’ health; (b) companies that seek to attract young, well-educated workers, such as scientists, MBAs, and engineers; and (c) companies located in areas where sensitivity to environmental concerns is more acute (e.g., the West Coast of North America). Conclusion T he conventional wisdom about environmental protection is that it is an extra burden imposed on companies by government. However, during the last decade, this paradigm has been challenged by a number of analysts who have suggested ways in which improving a company’s environmental performance can be associated with better economic performance. The objective of this paper was not to show that a reduction of pollution is always accompanied by better economic performance, but rather to show that the expenses incurred to reduce pollution can be partly or completely offset by gains made elsewhere. Through a systematic examination of all the possibilities, we also tried to identify the circumstances most likely to lead to a “win-win” situation. These circumstances are summarized in Table 1, in which we introduce examples for each of the seven opportunities to illustrate our point. Table 1 allows us to have in mind a taxonomy of the firms most likely to benefit from better environmental performance. For instance, an energy company located on the West Coast of the United States and selling part of its production to public authorities is very likely to make a financial gain from an improvement in its environmental performance. However, farms, which in general are less scrutinized by regulators, sell homogeneous products, are not on the stock market, and have few employees, may be less likely to benefit 2008 Ambec and Lanoie 57 from better environmental performance (Lanoie & Llerena, 2007). Implications for Future Research As we have seen, there has been significant recent research on the topic of green profitability. However, in many areas, extra effort would certainly be welcome. Regarding opportunities to increase revenues while improving environmental performance, more cost-benefit analyses from a company point of view of strategies to differentiate products are needed. Are the extra costs of producing greener products worth the benefits of reaching new niches of environmentally conscious consumers? Furthermore, we found very few examples of firms being able to sell pollutioncontrol technologies that they developed for their own purposes. More empirical work, digging into licensing agreements for instance, would help provide a clearer picture of this issue. Regarding opportunities to reduce costs, impacts of better environmental performance on the cost of capital and the cost of labor should be better investigated. For instance, one difficulty with the studies on the link between environmental performance and financial performance is determining the direction of the causality. A first plausible mechanism is that environmental perTable 1 Summary of Positive Links Between Environmental and Economic Performance Opportunities for Increasing Revenues Circumstances Making This Possibility More Likely Examples 1) Better access to certain markets More likely for firms selling to the public sector (construction, energy, transportation equipment, medical products, and office equipment) and to other businesses. The Quebec government now cares about the environmental performance of all vehicles it buys, not only about the price. 2) Differentiating products More likely when there is: a) Credible information about the environmental features of the product b) Willingness-to-pay by consumers c) Barrier to imitation. Wide range of possibilities. Toyota has announced that all its models will be available with hybrid engines in 2012. 3)Selling pollutioncontrol technologies More likely when firms already have R&D facilities. Alcan has patented a process to recycle its own spent potlining, and that of other companies. Opportunities for Reducing Costs 4) Risk management and relations with external stakeholders More likely in industries that are highly regulated and scrutinized by the public, such as chemical, energy, pulp and paper, metallurgy, etc. Statoil injects 1 million tons of CO2 a year beneath the seabed of the North Sea, thus avoiding the Norway carbon tax. 5)Cost of materials, energy, and services More likely when: a) Firms have a flexible production process b) Firms are in highly competitive industries where optimization of resources is important c) Firms are in industries where market-based environmental policies are implemented d) Firms already have R&D facilities. BP has reduced its emissions of GHGs 10% below their level in 1990 at no cost by implementing an internal tradable permit mechanism (see Reinhardt, 2001). 6)Cost of capital More likely for firms with shares exchanged on stock markets. The stock value of Exxon went down by $4.7 billion following the wreck of the Exxon Valdez. 7)Cost of labor More likely for: a) Firms whose emissions may affect their workers’ health b) Firms that seek to attract young, well-educated workers c) Firms located in areas where sensitivity to environmental concerns is important. A 2004 survey of Stanford MBAs found that 97% of them were willing to forgo 14% (on average) of their expected income to work for an organization with a better reputation for corporate social responsibility. 58 Academy of Management Perspectives November formance leads to changes in financial performance, as postulated in the studies discussed above. Second, the direction of the causality may be reversed; profitable enterprises can afford to invest in environmental performance. Third, there may be another omitted factor, influencing both environmental and economic performance, that is responsible for the apparent statistical relationship. Apart from Wagner et al. (2002), very few attempts have been made to tackle the question with simultaneous equation models. Another possible criticism is the common use of the TRI as an indicator of environmental performance. In particular, TRI does not provide any information about emissions of nontoxic substances (such as carbon dioxide), or through energy or material use. To provide empirical evidence of labor cost reductions associated with less pollution, one would need a database including observations on proxies of labor cost, such as turnover rates and absenteeism, and data on environmental performance. We are not aware of any database that includes all of these elements, so a new survey would have to be designed to test this hypothesis. Such an exercise would certainly be helpful. Lastly, from a sustainable development perspective that is oriented toward a triple bottom line (economic, environmental, and social), it would also be interesting to examine the social performance of firms and its relationship to economic performance.35 We have deliberately tried to avoid mixing environmental and social performance, although in certain areas, such as ethical mutual funds, this is almost impossible. This is a difficult topic, since there is no clear consensus on the measurement of social performance, but, given the importance of sustainable development in the minds of politicians, NGOs, and academics, it is certainly worth making the effort. References Alpay, E., Buccola, S., & Kerkvliet, J. (2002). Productivity growth and environmental regulation in Mexican and U.S. food manufacturing. American Journal of Agricultural Economics, 84(4), 887–901. Ambec, S., & Barla, P. (2002). A theoretical foundation of the Porter hypothesis. Economics Letters, 75(3), 355–360. 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SUSTAINABILITY INNOVATION+ John Hersey 1432 Sep09 Nidumolu layout.indd 56 432 Sep09 Nidumolu layout.indd 56 7/29/09 6:39:07 PM /29/09 6:39:07 PM hbr.org | September 2009 | Harvard Business Review 57 | by Ram Nidumolu, C.K. Prahalad, and M.R. Rangaswami THERE’S NO ALTERNATIVE TO SUSTAINABLE DEVELOPMENT. WHY SUSTAINABILITY IS NOW THE KEY DRIVER OF INNOVATION Even so, many companies are convinced that the more environment-friendly they become, the more the eff ort will erode their competitiveness. They believe it will add to costs and will not deliver immediate fi nancial benefi ts. Talk long enough to CEOs, particularly in the United States or Europe, and their concerns will pour out: Making our operations sustainable and developing “green” products places us at a disadvantage vis-à-vis rivals in developing countries that don’t face the same pressures. Suppliers can’t provide green inputs or transparency; sustainable manufacturing will demand new equipment and processes; and customers will not pay more for eco-friendly products during a recession. That’s why most executives treat the need to become sustainable as a corporate social responsibility, divorced from business objectives. Not surprisingly, the fi ght to save the planet has turned into a pitched battle between governments and companies, between companies and consumer activists, and sometimes between consumer activists and governments. It resembles a three-legged race, in which you move forward with the two untied legs but the tied third leg holds you back. One solution, mooted by policy experts and environmental activists, is more and increasingly tougher regulation. They argue that voluntary action is unlikely to be enough. Another group suggests educating and organizing consumers so that they will force businesses to become sustainable. Although both legislation and education are necessary, they may not be able to solve the problem quickly or completely. Executives behave as though they have to choose between the largely social benefi ts of developing sustainable products or processes and the fi nancial costs of doing so. But that’s simply not true. We’ve been studying the sustainability initiatives of 30 large corporations for some time. Our research shows that sustainability is a mother lode of organizational and technological innovations 1432 Sep09 Nidumolu layout.indd 57 432 Sep09 Nidumolu layout.indd 57 7/29/09 6:39:17 PM /29/09 6:39:17 PM SUSTAINABILITY INNOVATION+ 58 Harvard Business Review | September 2009 | hbr.org Why Sustainability Is Now the Key Driver of Innovation that yield both bottom-line and top-line returns. Becoming environment-friendly lowers costs because companies end up reducing the inputs they use. In addition, the process generates additional revenues from better products or enables companies to create new businesses. In fact, because those are the goals of corporate innovation, we fi nd that smart companies now treat sustainability as innovation’s new frontier. Indeed, the quest for sustainability is already starting to transform the competitive landscape, which will force companies to change the way they think about products, technologies, processes, and business models. The key to progress, particularly in times of economic crisis, is innovation. Just as some internet companies survived the bust in 2000 to challenge incumbents, so, too, will sustainable corporations emerge from today’s recession to upset the status quo. By treating sustainability as a goal today, early movers will develop competencies that rivals will be hard-pressed to match. That competitive advantage will stand them in good stead, because sustainability will always be an integral part of development. It isn’t going to be easy. Enterprises that have started the journey, our study shows, go through fi ve distinct stages of change. They face diff erent challenges at each stage and must develop new capabilities to tackle them, as we will show in the following pages. Mapping the road ahead will save companies time – and that could be critical, because the clock is ticking. STAGE 1 VIEWING COMPLIANCE AS OPPORTUNITY The fi rst steps companies must take on the long march to sustainability usually arise from the law. Compliance is complicated: Environmental regulations vary by country, by state or region, and even by city. (In 2007 San Francisco banned supermarkets from using plastic bags at checkout; San Diego still hasn’t.) In addition to legal standards, enterprises feel pressured to abide by voluntary codes – general ones, such as the Greenhouse Gas Protocol, and sectorspecifi c ones, such as the Forest Stewardship Council code and the Electronic Product Environmental Assessment Tool – that nongovernmental agencies and industry groups have drawn up over the past two decades. These standards are more stringent than most countries’ laws, particularly when they apply to cross-border trade. It’s tempting to adhere to the lowest environmental standards for as long as possible. However, it’s smarter to comply with the most stringent rules, and to do so before they are enforced. This yields substantial fi rst-mover advantages in terms of fostering innovation. For example, automobile manufacturers in the United States take two or three years to develop a new car model. If GM, Ford, or Chrysler had embraced the California Air Resources Board’s fuel consumption and emissions standards when they were fi rst proposed, in 2002, it would be two or three design cycles ahead of its rivals today – and poised to pull further ahead by 2016, when those guidelines will become the basis of U.S. law. Enterprises that focus on meeting emerging norms gain more time to experiment with materials, technologies, and processes. For instance, in the early 1990s Hewlett-Packard realized that because lead is toxic, governments would one day ban lead solders. Over the following decade it experimented with alternatives, and by 2006 the company had created solders that are an amalgam of tin, silver, and copper, and even developed chemical agents to tackle the problems of oxidization and tarnishing during the soldering process. Thus HP was able to comply with the European Union’s Restriction of Hazardous Substances Directive, which regulates the use of lead in electronics products, as soon as it took eff ect, in July 2006. Contrary to popular perceptions, conforming to the gold standard globally actually saves companies money. When they comply with the least stringent standards, enterprises must manage component sourcing, production, and logistics separately for each market, because rules diff er by country. However, HP, Cisco, and other companies that enforce a single norm at all their manufacturing facilities worldwide benefi t from economies of scale and can optimize supply chain operations. The common norm must logically be the toughest. Companies can turn antagonistic regulators into allies by leading the way. For instance, HP has helped shape many environmental regulations in Europe, and it uses the resulting brownie points IN BRIEF IDEA » Sustainability isn’t the burden on bottom lines that many executives believe it to be. In fact, becoming environment-friendly can lower your costs and increase your revenues. That’s why sustainability should be a touchstone for all innovation. » In the future, only companies that make sustainability a goal will achieve competitive advantage. That means rethinking business models as well as products, technologies, and processes. » Becoming sustainable is a fi vestage process, and each stage has its own challenges. Here’s how to tackle them and emerge from the recession ahead of the pack. 1432 Sep09 Nidumolu layout.indd 58 432 Sep09 Nidumolu layout.indd 58 7/29/09 6:39:23 PM /29/09 6:39:23 PM hbr.org | September 2009 | Harvard Business Review 59 to advantage when necessary. In 2001 the European Union told hardware manufacturers that aft er January 2006 they could not use hexavalent chromium – which increases the risk of cancer in anyone who comes in contact with it – as an anticorrosion coating. Like its rivals, HP felt that the industry needed more time to develop an alternative. The company was able to persuade regulators to postpone the ban by one year so that it could complete trials on organic and trivalent chromium coatings. This saved it money, and HP used the time to transfer the technology to more than one vendor. The vendors competed to supply the new coatings, which helped reduce HP’s costs. Companies in the vanguard of compliance naturally spot business opportunities fi rst. In 2002 HP learned that Europe’s Waste Electrical and Electronic Equipment regulations would require hardware manufacturers to pay for the cost of recycling products in proportion to their sales. Calculating that the government-sponsored recycling arrangements were going to be expensive, HP teamed up with three electronics makers – Sony, Braun, and Electrolux – to create the private European Recycling Platform. In 2007 the platform, which works with more than 1,000 companies in 30 countries, recycled about 20% of the equipment covered by the WEEE Directive. Partly because of the scale of its operations, the platform’s charges are about 55% lower than those of its rivals. Not only did HP save more than $100 million from 2003 to 2007, but it enhanced its reputation with consumers, policy makers, and the electronics industry by coming up with the idea. STAGE 2 MAKING VALUE CHAINS SUSTAINABLE Once companies have learned to keep pace with regulation, they become more proactive about environmental issues. Many then focus on reducing the consumption of nonrenewable resources such as coal, petroleum, and natural gas along with renewable resources such as water and timber. The drive to be more effi cient extends from manufacturing facilities and offi ces to the value chain. At this stage, corporations work with suppliers and retailers to develop eco-friendly raw materials and components and reduce waste. The initial aim is usually to create a better image, but most corporations end up reducing costs or creating new businesses as well. That’s particularly helpful in diffi cult economic times, when corporations are desperate to boost profi ts. Companies develop sustainable operations by analyzing each link in the value chain. First they make changes in obvious areas, such as supply chains, and then they move to less obvious suspects, such as returned products. Supply chains. Most large corporations induce suppliers to become environment-conscious by offering them incentives. For instance, responding to people’s concerns about the destruction of rain forests and wetlands, multinational corporations such as Cargill and Unilever have invested in technology development and worked with farmers to develop sustainable practices in the cultivation of palm oil, soybeans, cacao, and other agricultural commodities. This has resulted in techniques to improve crop yields and seed production. Some companies in the West have also started laying down the law. For example, in October 2008 Lee Scott, then Wal-Mart’s CEO, gave more than 1,000 suppliers in China a directive: Reduce waste and emissions; cut packaging costs by 5% by 2013; and increase the energy effi ciency of products supplied to Wal-Mart stores by 25% in three years’ time. In like vein, Unilever has declared that by 2015 it will be purchasing palm oil and tea only from sustainable sources, and Staples intends that most of its paper-based products will come from sustainable-yield forests by 2010. Tools such as enterprise carbon management, carbon and energy footprint analysis, and life-cycle assessment help companies identify the sources of waste in supply chains. Life-cycle assessment is particularly useful: It captures the environmentrelated inputs and outputs of entire value chains, from raw-materials supply through product use to returns. This has helped companies discover, for instance, that vendors consume as much as 80% of the energy, water, and other resources used by a supply chain, and that they must be a priority in the drive to create sustainable operations. Vendors consume as much as 80% of the resources used by a supply chain. 1432 Sep09 Nidumolu layout.indd 59 432 Sep09 Nidumolu layout.indd 59 7/29/09 6:39:29 PM /29/09 6:39:29 PM SUSTAINABILITY INNOVATION+ 60 Harvard Business Review | September 2009 | hbr.org Why Sustainability Is Now the Key Driver of Innovation STAGE 1 Viewing Compliance as Opportunity CENTRAL CHALLENGE To ensure that compliance with norms becomes an opportunity for innovation. COMPETENCIES NEEDED >> The ability to anticipate and shape regulations. >> The skill to work with other companies, including rivals, to implement creative solutions. INNOVATION OPPORTUNITY >> Using compliance to induce the company and its partners to experiment with sustainable technologies, materials, and processes. STAGE 2 Making Value Chains Sustainable CENTRAL CHALLENGE To increase effi ciencies throughout the value chain. COMPETENCIES NEEDED >> Expertise in techniques such as carbon management and life-cycle assessment. >> The ability to redesign operations to use less energy and water, produce fewer emissions, and generate less waste. >> The capacity to ensure that suppliers and retailers make their operations eco-friendly. INNOVATION OPPORTUNITIES >> Developing sustainable sources of raw materials and components. >> Increasing the use of clean energy sources such as wind and solar power. >> Finding innovative uses for returned products. STAGE 3 Designing Sustainable Products and Services CENTRAL CHALLENGE To develop sustainable offerings or redesign existing ones to become eco-friendly. COMPETENCIES NEEDED >> The skills to know which products or services are most unfriendly to the environment. >> The ability to generate real public support for sustainable offerings and not be considered as “greenwashing.” >> The management knowhow to scale both supplies of green materials and the manufacture of products. INNOVATION OPPORTUNITIES >> Applying techniques such as biomimicry in product development. >> Developing compact and eco-friendly packaging. STAGE 4 Developing New Business Models CENTRAL CHALLENGE To fi nd novel ways of delivering and capturing value, which will change the basis of competition. COMPETENCIES NEEDED >> The capacity to understand what consumers want and to fi gure out different ways to meet those demands. >> The ability to understand how partners can enhance the value of offerings. INNOVATION OPPORTUNITIES >> Developing new delivery technologies that change value-chain relationships in signifi cant ways. >> Creating monetization models that relate to services rather than products. >> Devising business models that combine digital and physical infrastructures. SUSTAINABILITY CHALLENGES, COMPETENCIES, AND OPPORTUNITIES Most companies go through fi ve stages on the path to becoming sustainable. Operations. Central to building a sustainable supply chain are operational innovations that lead to greater energy effi ciency and reduce companies’ dependence on fossil fuels. Take the case of FedEx, which deploys a fl eet of 700 aircraft and 44,000 motorized vehicles that consume 4 million gallons of fuel a day. Despite the global slowdown, the company is replacing old aircraft with Boeing 757s as part of its Fuel Sense program, although it will postpone ordering new ones until 2010. This will reduce the company’s fuel consumption by 36% while increasing capacity by 20%. It is also introducing Boeing 777s, which will reduce fuel consumption by a further 18%. FedEx has developed a set of 30 soft ware programs that help optimize aircraft schedules, fl ight routes, the amount of extra fuel on board, and so on. The company has set up 1.5-megawatt solar-energy systems at its distribution hubs in California and Cologne, Germany. It uses hybrid vans that are 42% more fuel effi cient than conventional trucks and has replaced more than 25% of its fl eet with smaller, more fuel-effi cient vehicles. Following some other pioneers, FedEx recently turned its energy-saving expertise into a stand-alone consulting business that, it hopes, will become a profi t center. 1432 Sep09 Nidumolu layout.indd 60 432 Sep09 Nidumolu layout.indd 60 7/29/09 6:39:35 PM /29/09 6:39:35 PM hbr.org | September 2009 | Harvard Business Review 61 Workplaces. Partly because of environmental concerns, some corporations encourage employees to work from home. This leads to reductions in travel time, travel costs, and energy use. One-tenth of the corporations in our sample had from 21% to 50% of their employees telecommuting regularly. Of IBM’s 320,000 employees, 25% telecommute, which leads to an annual savings of $700 million in real estate costs alone. AT&T estimates that it saves $550 million annually as a result of telecommuting. Productivity rises by 10% to 20%, and job satisfaction also increases when people telecommute up to three days a week. For example, at the health-care services provider McKesson, the group that reported the highest job satisfaction in 2007 consisted of 1,000 nurses who worked from home. Returns. Concerns about cutting waste invariably spark companies’ interest in product returns. In the United States, returns reduce corporate profitability by an average of about 4% a year. Instead of scrapping returned products, companies at this stage try to recapture some of the lost value by reusing them. Not only can this turn a cost center into a profi table business, but the change in attitude signals that the company is more concerned about preventing environmental damage and reducing waste than it is about cannibalizing sales. Cisco, for example, had traditionally regarded the used equipment it received as scrap and recycled it at a cost of about $8 million a year. Four years ago it tried to fi nd uses for the equipment, mainly because 80% of the returns were in working condition. A value-recovery team at Cisco identifi ed internal customers that included its customer service organization, which supports warranty claims and service contracts, and the labs that provide technical support, training, and product demonstrations. In 2005 Cisco designated the recycling group as a business unit, set clear objectives for it, and drew up a notional P&L account. As a result, the reuse of equipment rose from 5% in 2004 to 45% in 2008, and Cisco’s recycling costs fell by 40%. The unit has become a profi t center that contributed $100 million to Cisco’s bottom line in 2008. When they create environment-friendly value chains, companies uncover the monetary benefi ts that energy effi ciency and waste reduction can deliver. They also learn to build mechanisms that link sustainability initiatives to business results, as the Cisco example shows. As a result, environmental concerns take root within business units, allowing executives to tackle the next big challenge. STAGE 3 DESIGNING SUSTAINABLE PRODUCTS AND SERVICES At this stage executives start waking up to the fact that a sizable number of consumers prefer ecofriendly off erings, and that their businesses can score over rivals by being the fi rst to redesign existing products or develop new ones. In order to identify product innovation priorities, enterprises have to use competencies and tools they acquired at earlier stages of their evolution. Companies are oft en startled to discover which products are unfriendly to the environment. When Procter & Gamble, for example, conducted life- cycle STAGE 5 Creating NextPractice Platforms CENTRAL CHALLENGE To question through the sustainability lens the dominant logic behind business today. COMPETENCIES REQUIRED >> Knowledge of how renewable and nonrenewable resources affect business ecosystems and industries. >> The expertise to synthesize business models, technologies, and regulations in different industries. INNOVATION OPPORTUNITIES >> Building business platforms that will enable customers and suppliers to manage energy in radically different ways. >> Developing products that won’t need water in categories traditionally associated with it, such as cleaning products. >> Designing technologies that will allow industries to use the energy produced as a by-product. 1432 Sep09 Nidumolu layout.indd 61 432 Sep09 Nidumolu layout.indd 61 7/29/09 6:39:42 PM /29/09 6:39:42 PM SUSTAINABILITY INNOVATION+ 62 Harvard Business Review | September 2009 | hbr.org Why Sustainability Is Now the Key Driver of Innovation Smart corporations follow these simple rules in their effort to become sustainable. DON’T START FROM THE PRESENT. If the starting point is the current approach to business, the view of the future is likely to be an optimistic extrapolation. It’s better to start from the future. Once senior managers establish a consensus about the shape of things to come, they can fold that future into the present. They should ask: What are the milestones on the path to our desired future? What steps can we take today that will enable us to get there? How will we know that we are moving in that direction? ENSURE THAT LEARNING PRECEDES INVESTMENTS. Top management’s interest in sustainability sometimes leads to investments in projects without an understanding of how to execute them. Smart companies start small, learn fast, and scale rapidly. Each step is broken into three phases: experiments and pilots, debriefi ng and learning, and scaling. These companies benchmark, but the goal is to develop next practices – not merely mimic best practices. STAY WEDDED TO THE GOAL WHILE CONSTANTLY ADJUSTING TACTICS. Smart executives accept that they will have to make many tactical adjustments along the way. A journey that takes companies through fi ve stages – and lasts a decade or more – can’t be completed without course corrections and major changes. Although directional consistency is important, tactical fl exibility is critical. BUILD COLLABORATIVE CAPACITY. Few innovations, be they to comply with regulations or to create a new line of products, can be developed in today’s world unless companies form alliances with other businesses, nongovernmental organizations, and governments. Success often depends on executives’ ability to create new mechanisms for developing products, distributing them, and sharing revenues. USE A GLOBAL PRESENCE TO EXPERIMENT. Multinational corporations enjoy an advantage in that they can experiment overseas as well as at home. The governments of many developing countries have become concerned about the environment and are encouraging companies to introduce sustainable products and processes, especially for those at the bottom of the pyramid. It’s easier for global enterprises to foster innovation in emerging markets, where there are fewer entrenched systems or traditional mind-sets to overcome. A FEW SIMPLE RULES assessments to calculate the amount of energy needed to use its products, it found that detergents can make U.S. households energy guzzlers. They spend 3% of their annual electricity budgets to heat water for washing clothes. If they switched to cold-water washing, P&G reckoned, they would consume 80 billion fewer kilowatt-hours of electricity and emit 34 million fewer tons of carbon dioxide. That’s why the company made the development of cold-water detergents a priority. In 2005 P&G launched Tide Coldwater in the United States and Ariel Cool Clean in Europe. The trend has caught on more in Europe than in the United States. By 2008, 21% of British households were washing in cold water, up from 2% in 2002; in Holland the number shot up from 5% to 52% of households. During the current recession P&G has continued to promote cold-water products, emphasizing their lower energy costs and compact packaging. If cold-water washing catches on worldwide, P&G will be able to cash in on the trend. Likewise, Clorox was surprised to learn that household cleaning products are the second biggest environmental concern – aft er automobiles – in the United States. Its market research also showed that 15% of consumers treat health and sustainability as major criteria when making purchase decisions, and 25% to 35% take environmental benefi ts into consideration. In 2008 Clorox became the fi rst mainstream consumer products company to launch a line of nonsynthetic cleaning products. It spent three years and more than $20 million to develop the Green Works line, delaying the launch twice to ensure that all fi ve original products performed as well as or better than conventional options in blind tests. Clorox had to tackle several marketing issues before launching Green Works. It decided to charge a 15% to 25% premium over conventional cleaners to refl ect the higher costs of raw materials. Green Works products are still cheaper than competing products, which carry a 1432 Sep09 Nidumolu layout.indd 62 432 Sep09 Nidumolu layout.indd 62 7/29/09 6:39:48 PM /29/09 6:39:48 PM hbr.org | September 2009 | Harvard Business Review 63 25% to 50% markup over synthetic ones. Aft er much discussion, the marketing team chose to put the Clorox logo on the Green Works line to signal that it performs as well as conventional Clorox products. The company persuaded the Sierra Club – a leading environmental group in the United States – to endorse Green Works. Although it sparked controversy among activists, this partnership strengthened Clorox’s credentials, and in 2008 the company paid nearly $500,000 to the Sierra Club as its share of revenues from the line. Finally, Clorox struck special arrangements with retail chains such as WalMart and Safeway to ensure that consumers could easily fi nd Green Works products on shelves. By the end of 2008 Green Works had grown the U.S. natural cleaners market by 100%, and Clorox enjoyed a 40% share of the $200 million market. Green Works sales weakened in the fourth quarter of 2008 because of the recession, but they rebounded in the fi rst quarter of 2009. The tailwind has encouraged Clorox to launch more sustainable products: In January 2009 it introduced biodegradable cleaning wipes, and the following June it introduced nonsynthetic detergents, where it will run into rival P&G. To design sustainable products, companies have to understand consumer concerns and carefully examine product life cycles. They must learn to combine marketing skills with their expertise in scaling up raw-materials supplies and distribution. As they move into markets that lie beyond their traditional expertise, they have to team up with nongovernmental organizations. Smart companies like P&G and Clorox, which have continued to invest in eco-friendly products despite the recession, look beyond the public-relations benefi ts to hone competencies that will enable them to dominate markets tomorrow. STAGE 4 DEVELOPING NEW BUSINESS MODELS Most executives assume that creating a sustainable business model entails simply rethinking the customer value proposition and fi guring out how to deliver a new one. However, successful models include novel ways of capturing revenues and delivering services in tandem with other companies. In 2008 FedEx came up with a novel business model by integrating the Kinko’s chain of print shops that it had acquired in 2004 with its documentdelivery business. Instead of shipping copies of a document from, say, Seattle to New York, FedEx now asks customers if they would like to electronically transfer the master copy to one of its of- fi ces in New York. It prints and binds the document at an outlet there and can deliver copies anywhere in the city the next morning. The customer gets more time to prepare the material, gains access to betterquality printing, and can choose from a wide range of document formats that FedEx provides. The document travels most of the way electronically and only the last few miles in a truck. FedEx’s costs shrink and its services become extremely eco-friendly. Some companies have developed new models just by asking at diff erent times what their business should be. That’s what Waste Management, the $14 billion market leader in garbage disposal, did. Two years ago it estimated that some $9 billion worth of reusable materials might be found in the waste it carried to landfi lls each year. At about the same time, its customers, too, began to realize that they were throwing away money. Waste Management set up a unit, Green Squad, to generate value from waste. For instance, Green Squad has partnered with Sony in the United States to collect electronic waste that used to end up in landfi lls. Instead of being just a waste-trucking company, Waste Management is showing customers both how to recover value from waste and how to reduce waste. New technologies provide start-ups with the ability to challenge conventional wisdom. Calera, a California start-up, has developed technology to extract carbon dioxide from industrial emissions and bubble it through seawater to manufacture cement. The process mimics that used by coral, which builds shells and reefs from the calcium and magnesium in seawater. If successful, Calera’s technology will solve two problems: Removing emissions from power plants and other polluting enterprises, and minimizing emissions during cement production. The company’s fi rst cement plant is located in the Monterey Bay area, near the Moss Landing power Companies are often startled to discover which products are unfriendly to the environment. 1432 Sep09 Nidumolu layout.indd 63 432 Sep09 Nidumolu layout.indd 63 7/29/09 6:39:55 PM /29/09 6:39:55 PM SUSTAINABILITY INNOVATION+ 64 Harvard Business Review | September 2009 | hbr.org Why Sustainability Is Now the Key Driver of Innovation plant, which emits 3.5 million tons of carbon dioxide annually. The key question is whether Calera’s cement will be strong enough when produced in large quantities to rival conventional Portland cement. The company is toying with a radical business model: It will give away cement to customers while charging polluters a fee for removing their emissions. Calera’s future is hard to predict, but its technology may well upend an established industry and create a cleaner world. Developing a new business model requires exploring alternatives to current ways of doing business as well as understanding how companies can meet customers’ needs diff erently. Executives must learn to question existing models and to act entrepreneurially to develop new delivery mechanisms. As companies become more adept at this, the experience will lead them to the fi nal stage of sustainable innovation, where the impact of a new product or process extends beyond a single market. STAGE 5 CREATING NEXT-PRACTICE PLATFORMS Next practices change existing paradigms. To develop innovations that lead to next practices, executives must question the implicit assumptions behind current practices. This is exactly what led to today’s industrial and services economy. Somebody once asked: Can we create a carriage that moves without horses pulling it? Can we fl y like birds? Can we dive like whales? By questioning the status quo, people and companies have changed it. In like vein, we must ask questions about scarce resources: Can we develop waterless detergents? Can we breed rice that grows without water? Can biodegradable packaging help seed the earth with plants and trees? Sustainability can lead to interesting next-practice platforms. One is emerging at the intersection of the internet and energy management. Called the smart grid, it uses digital technology to manage power generation, transmission, and distribution from all types of sources along with consumer demand. The smart grid will lead to lower costs as well as the more effi cient use of energy. The concept has been around for years, but the huge investments going into it today will soon make it a reality. The grid will allow companies to optimize the energy use of computers, network devices, machinery, telephones, and building equipment, through meters, sensors, and applications. It will also enable the development of cross-industry platforms to manage the energy needs of cities, companies, buildings, and households. Technology vendors such as Cisco, HP, Dell, and IBM are already investing to develop these platforms, as are utilities like Duke Energy, SoCal Edison, and Florida Power & Light. • • • Two enterprisewide initiatives help companies become sustainable. One: When a company’s top management team decides to focus on the problem, change happens quickly. For instance, in 2005 General Electric’s CEO, Jeff Immelt, declared that the company would focus on tackling environmental issues. Since then every GE business has tried to move up the sustainability ladder, which has helped the conglomerate take the lead in several industries. Two: Recruiting and retaining the right kind of people is important. Recent research suggests that three-fourths of workforce entrants in the United States regard social responsibility and environmental commitment as important criteria in selecting employers. People who are happy about their employers’ positions on those issues also enjoy working for them. Thus companies that try to become sustainable may well fi nd it easier to hire and retain talent. Leadership and talent are critical for developing a low-carbon economy. The current economic system has placed enormous pressure on the planet while catering to the needs of only about a quarter of the people on it, but over the next decade twice that number will become consumers and producers. Traditional approaches to business will collapse, and companies will have to develop innovative solutions. That will happen only when executives recognize a simple truth: Sustainability = Innovation. Ram Nidumolu (ram@innovastrat.com) is the founder and CEO of InnovaStrat, a Santa Cruz– based fi rm that helps companies design and implement sustainability strategies and new business models. C.K. Prahalad (ckp@bus.umich.edu) is the Paul and Ruth McCracken Distinguished University Professor of Strategy at the University of Michigan’s Ross School of Business and a member of the board of directors of the World Resources Institute. M.R. Rangaswami (mr@sandhill.com) is the founder of the Corporate Eco Forum, a global organization of senior executives, and the cofounder of the Sand Hill Group, a San Francisco–based strategic management, investment, and advisory fi rm. 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