The truth about imports and emissions

Back in April and May there were a lot of headlines about how the UK isn’t really reducing emissions at all – we’re just transferring emissions to the developing world by importing energy-intensive manufactured goods.  A report by a respected institution, the National Academy of Sciences of the USA, has been cited as solid evidence.  It is solid – but people are drawing the wrong conclusions.

The data does indeed show that when we look at consumption rather than production, emissions in the developed world have indeed grown rather than fallen – by 0.3% per year on average.  Moreover, the fact that global emissions continue to increase is undeniable.  However, we are not simply transferring our emissions to the developing world.  The authors state this – the emissions intensity of trade is actually falling, even as trade grows.   Since 1990, international trade has grown at more than twice the rate of the emissions embodied in that trade. The problem is that we continue to consume more, and we have failed to reduce the emissions of our consumption enough to compensate for our increased appetites.

The real question is this – what should we do about it?  There is a danger that, based on the headlines, policy-makers will conclude that reducing energy-intensive imports is the way forward.  In short, protectionism will become fashionable again.

Of course, as most mainstream economists will tell you, protectionism tends to lead to slower growth – good for emissions, but bad for jobs and wealth.  Fortunately, The Economist, a respected international news and opinion journal, throws cold water on the idea that tariffs could help.  It argues instead that green investment in the developing world is the way forward.

However, all commentators appear to neglect the point that stares at us out of the data – the big emissions opportunities that we in the developed world can tackle are from production destined for domestic consumption.  While it is very difficult to regulate emissions in other countries (tariffs are a very blunt and potentially divisive instrument), it is perfectly possible for countries to regulate the emissions from their own production, most of which is destined for internal markets.  Since this is the largest figure, and the one most conducive to management, it makes sense to focus attention here.

Of course, there is still a strong argument for measuring national emissions based on consumption, not production.  This gives us a more realistic picture of the environmental impacts of our national lifestyles.  Nevertheless, when it comes to making reductions, we should be looking at the big wins that come from production to meet our own needs – this is where we will have the biggest positive impact.

Is micro-generation a good business investment?

The UK government yesterday announced its strategy for microgeneration of renewable energy.  It is aimed at businesses and individuals who want to produce energy on their own property, rather than energy companies or investors.  In my 16^th May article I pointed out that small businesses may be able to invest in renewables profitably if they have an idle resource that can be turned into energy cost effectively.  Does the UK government’s strategy make this any easier?

It will.  The government has already put financial incentives in place to promote small scale renewables, most notably the Feed-In Tariffs (FiTs).   These incentives work, yet not every suitable business is installing solar panels on the roof or a wind turbine on vacant land.  Why not?  One major obstacle is the lack of knowledge, and uncertainty about whom to trust.  The government’s strategy will address this by taking a stronger lead in establishing standards, quality marks and the like, to give decision-makers more confidence in choosing systems and services.

Will this strategy overcome all the major obstacles to the development of microgeneration?  No – the missing piece of the puzzle remains planning permission.  Although the government’s strategy mentions the issue in relation to community energy projects, they describe it as essentially a work in progress.  However, approval rates do vary widely, as the National Audit Office has reported, with Scotland taking the strongest lead in application approval rates.

A longer term consequence of regional variations in micro-generation approvals will be that business decisions about new site location may be influenced in part by planning attitudes to renewable energy.   This will be particularly attractive to those firms in energy-intensive industries, or where carbon footprint is important to the buying decisions of their customers.

Of course, the difficulties in obtaining planning permission do not make renewable micro-generation less attractive in terms of financial returns.  Instead, these obstacles increase the business risk associated with considering renewables, as it becomes more likely that the management time and pre-planning investments will come to nothing.  Businesses are no strangers to this problem – tenders, pitches, and investments in unproven markets all suffer from this sort of risk.  The secret to managing them is to make these efforts many and small, so the firm can afford to fail with most of them.

 

Translating this to micro-generation, the approach should be similar.  Look at all resources that could be converted to energy.  Plan to put in applications for any renewable installations that have a positive financial value.  Do this over a period of time that does not put excessive burden on management.  Expect to lose most of them, unless your business is located within an authority that is friendly to renewables, so keep the up-front investments low unless there is good reason to think your application will succeed.  Use independent, specialist consultants to evaluate the business case and advise on planning.   Micro-generation can be profitable, and approaching it with the same attitude taken to any business investment will bring good financial returns, as well as environmental benefit.

Finally, keep an open mind about micro-generation opportunities, because government policies, carbon pricing, and fuel costs will continue to alter the landscape in which businesses have to make their choices.

The Anthropocene

We had got used to being insignificant.  Copernicus showed that we were not at the centre of the universe.  Darwin found an explanation for the variety of species that did not involve them being created for our benefit.  But just as we had got used to being unimportant, it turns out that things are changing.  The Economist is amongst the latest to note the view that we are living in the Anthropocene age – a geological time in which the development of life on earth is dominated by mankind.

This change of perspective reflects our increasing recognition of the impact we have on our planet.  As individuals, our impact is normally insignificant, but as the number of our species has grown and our individual impacts have increased, these multipliers have added up to an unimaginable impact on the planet’s ecosystems.

As we wait for legislation, the markets, or scientific innovators to solve the problem for us, the costs are beginning to mount.  Insurance costs are on the rise.  Speculators, investors and consumers drive up commodity prices in ways that are proving hard to predict.  It is difficult to know what to do in the face of such uncertainty and change.  However, standing still looks like a poor strategy.  Businesses need to be flexible, to learn and to adapt continually.

The traditional approach to learning is to rely on experts.  Unfortunately, in times of rapid change, experts have only a part of the picture.  What is most needed are experimenters – people who can combine thinking about what is known with speculation, turning it into testable hypotheses.  They will then run fast, inexpensive experiments to inform business decisions.  How do you know whether these experiments lead to success or failure?  As Columbia professor Rita Gunther McGrath observes, you don’t – so you need your experimenters to be expert in learning from all outcomes – including failures.

The current crop of entrepreneurs is doing exactly this.  As sustainability author Andrew Winston has blogged for HBR, both new business leaders and venture capitalists are making bets on businesses that solve sustainability problems.  These aren’t first-time-right ventures, but resilient enterprises that have kept going until they found a solution.  For example, third place winner PK Clean has based its business on technologies that are the fallout from many inventions and innovations tested and redesigned over decades.

But how do we decide what sorts of experiment to run?  The answer comes from a good understanding of the organisation’s impacts and vulnerabilities.  Your experiments will aim to reduce these.  From this point of view, the experts are not the external change consultants, but your internal experts who know full well what your firm does to the environment (even if they don’t know how much), and who have a pretty good idea of your firm’s critical needs – those things you cannot do business without.

The key factor for success is straightforward: manage your changes as experiments, not just “pilot projects”.  In other words, the aim should be not to “prove” that they are a success, but to evaluate them critically and learn from the results.

We humans are coming to dominate our planet in a way we did not anticipate.  The coming decades will favour those firms that acknowledge this, and deal with the changing environment with ingenuity and open-mindedness.  The winners will accept that the answers may not yet be “out there” – they’ll use sound methodologies to find the answers that really work... if only until the next change.

How much is this waste costing us?

Nowadays, waste disposal costs usually have a place in the accounts.  Standard landfill tax costs £56 per tonne (set to rise to £80 per tonne by 2014), and waste disposal services have their fixed and variable fees on top.  Recycling may provide some relief, but still typically involves some cost.  However, waste has hidden costs as well, and these can be considerably more than the disposal or recycling cost.

There are two big hidden costs in waste: the materials, and the production cost.  The first is easier to spot – if you purchase a tonne of steel, and sell products containing 990g of steel, you know you have wasted 1% of the material.  Production managers are usually aware of this, but the finance department may not be.

The second cost is less obvious – the cost of the facility.  Let’s say that a manufacturing firm has operating costs of £100m per year, and is working fairly near its current capacity, so waste products displace products that could be sold.  If the reject rate is 0.1% of products, then the operating cost of producing that waste is £100K per year (0.1% of £100m).  Alternatively, consider this from a time perspective.  If a typical production line in our hypothetical facility spends just 10 minutes of a 16 hour day producing product that can’t be sold, that would be 1% of the time – or £1m cost per year.  Move to another perspective: the opportunity cost of the goods not produced because the line is at capacity.  If gross margins are just 10%, then waste at 1% of production is equivalent to £100K of foregone profit, displaced by waste.

These hidden costs of waste are rarely part of any management accounting system, and may be difficult to pin down.  However it’s worth the effort – keeping track, even at the “guestimate” level, can help companies work out the value of investing in waste elimination initiatives.  Putting a price on waste helps to focus attention on a big win for both the environment and the bottom line.  Recycling may deal with the waste that can’t be eliminated, but the biggest win comes from avoiding waste entirely.

What to do about high energy prices

As oil prices reach a new sterling high, and experts cast doubt on a significant price fall in this decade, there are few words of comfort for British businesses. The low oil prices in the 1990s now look like a temporary reprieve.  Electricity prices are likely to rise as coal plants close and the UK invests in new capacity.  What does this mean for UK business? 

The UK faces the combined threats of inflation and a return to economic recession.  This is “stagflation”, and can occur when inflation due to commodity price rises (like energy) result in lower productivity in the economy.  There is no certainty about what energy costs and productivity will do, and this uncertainty is far from reassuring.

Small businesses can be particularly hard hit because they lack buying power, often cannot risk buying fuel on long term forward contracts, and face having their increasingly price-sensitive customers consolidate their purchases with the “big box” stores (for B2C) or with large suppliers who can reduce their transaction costs (B2B).  However, this is also a time of opportunity for agile SMEs who can negotiate the uncertainty of these economic conditions.

The solution to the energy squeeze is clear: reduce dependency on energy and increase productivity.  Britain is already doing this, though the 5% drop from 2000 to 2008 hides wide variation between firms, even in the same industry.  As a second option – become an energy producer.

Office space can consume energy when not in use.

The first solution, reducing dependency on energy, essentially means eliminating waste.  If a firm reduces its use of unneeded resources – anything from heating empty office space  to producing goods and services too poor to sell – then it reduces its consumption of energy.  Firms often have unnoticed waste, from the unused space mentioned above to the waste of material that is considered “just part of the way this industry does business”.  Successful waste reduction efforts start by identifying all the resource consumption that does not create value for customers, and then working with employees, suppliers, customers, and other organisations to find ways to eliminate this waste.

The second solution – becoming an energy producer – works best when a firm identifies a resource it already has in excess which can be turned into energy.  As a simple example, some firms in suitably windy locations install wind turbines.  Others turn their waste into energy, either directly (for example wood waste becomes biomass), or indirectly, by selling their waste to a firm that can produce energy from it.  It is often surprising how many waste streams contain energy that can be released cost effectively as a fuel.

The critical message for SMEs is not to stand still.  Although no one can predict future energy prices, recent history does not encourage complacency.  To avoid being trapped between rising energy costs and downward pressure on margins, firms should act to cut waste in all its forms – this is a tried and tested route to reducing energy consumption.  With whatever excess resources are left, look for smart ways to turn these into energy.

How deeply should you cut your energy consumption?

This week’s Economist argues that decarbonising developing economies matters much more than reducing emissions in the developed world.  Although emissions from production in developing countries is now greater than in the industrialised nations, there is in fact no excuse for complacency about energy use in the wealthier economies.  Just over a month ago, DECC released their provisional estimate for UK greenhouse gas emissions for 2010.  They showed the first year-on-year increase in two decades.  As major consumers of energy, businesses need to play their part in turning this around, both because it’s right and also because it makes business sense.

The ideal energy consumption for any company is zero – in a perfect world we would have no energy costs at all.  But putting aside idealism, how do we set an emissions target for our business that is both desirable and realistic?

One way for a firm to set a target is to look at the governments' targets in the countries in which it operates.  For example, the UK has an emissions target for 2020 of 34% below 1990 levels.  In 1990, emissions were much higher than today – as of 2010, emissions were down by about 25%.  That leaves another 9% to go – or to put it another way, about 11% of 2010 emissions need to go by 2020.  This has to happen even as the economy grows – in other words, emissions per unit of output need to fall even faster.  A company that can cut its emissions by 11% over the current decade while growing at the same pace as the economy can feel that it has done its bit to help meet these targets.

But is this a good target for your company?  It’s a fair share in UK terms, but what about global terms?  If we are trying to be equitable, and just use our fair share of global emissions, we need to aim higher.  A UN Environment Programme report estimates that the world needs to peak at 44GT of greenhouse gas emissions in 2020 to avoid exceeding 2 degrees C of global warming.  If we take into account the estimated populations of the UK and the world now and in 2020, we’d need to reduce our emissions by 34% from 2010 levels in order to be making only our share of emissions.  In other words, we need to cut emissions by about a third over the coming decade in order to be equitable.

Is it realistic to cut a firm’s emissions by 11-34% by 2020?  In a word... yes.  Others have managed it.  For example, Interface Inc, a maker of commercial carpeting, reduced absolute GHGs by 71% from 1996 to 2008, while increasing sales by two thirds.  They didn’t do this by moving into a less energy intensive line of business.  They accomplished this remarkable reduction principally by reducing waste.

This is not to say that massive reductions in emissions are easy.  They need belief and determination.  However, the payoff is substantial – in good profits, good morale, and good reputation.  In the words of Ray Anderson, CEO of Interface Inc, “sustainability... has proven to be the most powerful marketplace differentiator I have known in my long career”.

How cash can kill your business

“Cash is bad” said my MBA professor many years ago. This obviously depends on your perspective. But as many business leaders have found to their regret, cash really can be a killer.

The main problem with cash is that it’s fickle – here today, gone tomorrow. Many businesses have run into difficulty when they couldn’t get a loan to cover the difference between cash and profits. That is, they’ve got paper profits, but the expenses need to be paid, and the cash hasn’t come in yet. Businesses like this use cash flow forecasting for two main reasons: 1) to make sure they grow their sales only as fast as that their working capital can match, and 2) to ensure they’ve actually lined up enough working capital, often in the form of a long term line of credit, to be able to pay all their expenses without embarrassment.

A less well known problem faces the business that has a positive cash cycle – the kind of firm that receives the money before they have to pay the expenses. Companies in this desirable position may think they don’t need cash flow forecasting – as long as they keep trading profitably, the cash will always be there. This type of cash flow can also be a killer, and can take business leaders completely by surprise.

The main pitfall for positive cash cycles occurs when a business uses its cash to finance its operations. Why?  Even a business with very thin profits, but growing rapidly, could find itself apparently swimming in cash. Surely it makes sense to use the cash productively, to invest in business improvements and growth? But what if the cash inflows subside, even just for a few months?

Imagine a (highly simplified) business turning over £1m per month. It has a positive cash cycle of 1 month, and razor thin margins. So although profits are essentially non-existent, it sits on £1m of cash at any one time, which has been paid into the bank, but won’t need to be paid out until next month. By that month, another £1m will have come in, so the company will look appreciatively on that money, which always seems to be there, and may think of investing it in something more productive than savings.

Now, imagine that after a couple of months they’ve invested £1m in new equipment, with the intention of growing the business. This is shown as “Month3” in the table to the right – you can see that after a couple of months of sitting on £1m in the bank, they wanted to do something with it, even though their profits are actually zero. Unfortunately bad weather plays havoc on their market (or some other unexpected event occurs) and sales vanish to nothing the next month – “Month4”. Imagine, too, that they feel safe, because they can reduce their expenses by £1m – they have the ultimate in flexible operations, so their margins will stay the same (zero, but at least they’re not losing money).

Unfortunately their cash position is terrible. The £1m buffer that they used to have is now invested in equipment. The expenses from last month - £1m – were going to be paid for with the £1m in cash coming in this month. Regrettably it’s not there, and they need an emergency loan of £1m from the bank in order to pay their debts. The equipment probably cannot be liquidated for £1m, and this is not a profitable firm, so the bank may ask some very difficult questions about this loan request.  Promise of positive cash flow returning next month may sound to the bank like "jam tomorrow", no matter how justified.  They will want to know why you didn't see this coming.

The best way to head off this sort of problem is to incorporate cash flow reporting into the monthly accounts, and to use scenarios to test cash flow forecasts on a regular basis. This will highlight any risks to future cash flows, and should prevent all but the most extreme of unexpected events from taking business leaders by surprise.