Why your business customers want you to cut carbon

Recent research from The Carbon Trust reveals a potentially unsettling truth for the B2B market: multinationals are not just addressing their own greenhouse gas emissions.  They are also increasingly including carbon in their selection criteria for suppliers.  Within three years, the vast majority will do so – only 10% say otherwise.

Why this move – is it part of these multinationals’ attempts to look green?  The report ascribes the trend to “shareholder pressure”.  Are these shareholders investing in an increasingly ethical way, or are they looking for financial value?  I would suggest the latter - in other words, this isn't a fad.  It's part of a trend towards shareholders actively looking after the value of their investments.  Suppliers should take note.

It is not only shareholders who know that low carbon can translate into good value.  Sourcing professionals look for signs of quality and efficiency to ensure that they are getting the best goods at the best price.  Low carbon emissions signal efficiency – that a supplier is using less inputs for the same output.  That will translate into a sustainably lower cost structure, from which the buyer hopes to benefit.  Multinationals are sourcing low carbon because it’s often cheaper, and is likely to get even more competitive if fossil fuel costs rise further.  Shareholders and management want to know that their companies are managing for value.

A quote from Chris Harrop of Marshalls plc is particularly revealing: “By choosing suppliers of responsibly sourced goods not only do we cut carbon emissions but invariably there are cost and efficiency gains to be had, which all adds up to a strong competitive advantage.”  Perhaps it’s nice to be green, but it’s good business to be cost competitive, and paying attention to carbon in the value chain helps firms solidify this advantage.

So, suppliers now have another reason to address emissions, if cost competitiveness itself were not enough.  Multinationals will be expecting suppliers to report on, and compete on, greenhouse gas emissions.   Their suppliers will be asking the same questions right down the supply chain.  If your business customers are not already asking you to reveal to your carbon footprint, they soon will.

Carbon offsets vs carbon reduction – which is the better investment?

Carbon prices are at an all time low.  What does this mean – and should a business thinking of buying carbon offsets be worried about investing in them?

Carbon offsets are purchased by individuals or firms to offset the emissions they produce in their activities.  The emissions aren’t being taken away of course; the idea here is that somewhere in the world, a project to reduce emissions by the equivalent amount will go forward because this money has been granted to it.  That is supposed to put the project into the black – the UN will only approve offsets if the project would not be financially viable without the money the offset brings in.

Offsets can include landfill methane power generation. Photo: D'Arcy Norman /
Creative commons

The problem right now is that offsets are in low demand, at least partly as a result of the recession.  At the same time, supply of offsets is rising, as more and more projects are approved by the UN.  There is no shortage of companies willing to propose projects, but at current prices, most of these will barely cover their costs.   High supply and low demand have made this one of the worst performing commodities this year.

However, this is not a problem for the buyers of offsets.  In fact, if you are buying in order to become carbon neutral, it has never been cheaper to do so.  So should every firm that aims for carbon neutrality start focussing on offsets to accomplish this?

This is not necessarily wise.  Carbon offsets cost money, and provide no direct return – you have to buy them again next year.  Carbon reductions – for instance reducing waste, energy consumption, and so on – does provide a return, as the cost reductions come year after year.  Like offsets, they may cost money, though many are free or have a payback period of months.  However, even the costly investments do at least have a return, which carbon offsets do not.

On the other hand, some environmental investments will never be profitable.  To take an extreme example, solar panels on a north-facing roof in the UK are unlikely to turn a profit.  How can a firm decide which investments to make, and whether to pursue offsets as well?

A popular tool for selecting green investments is the marginal abatement cost curve.  The vertical axis shows the net present value or cost of the project per Kg of emissions reduced, while the horzontal axis has the total amount of abatement per year.  Investments are ordered by value, with those that create the greatest financial benefit per unit of carbon reduction on the left.

Those projects with a positive net present value are the obvious priority. As for the projects with negative net value, some will be attractive to firms that will gain sufficient indirect value from carbon reductions (morale, reputation, etc).  Those opportunities with a net cost lower than carbon offsets should clearly be favoured next. For projects with a greater net cost than offsets, the strategy should switch to purchasing these instruments instead.  The chart on the right summarises the decision process.

Offsetting is most valuable to firms that have already have a powerful programme of continuing carbon reductions, and who will benefit from the reputation effects of achieving full carbon neutral status.  However, if a firm’s emissions per unit of sales or output are not falling, then there are almost certainly direct carbon reduction options waiting to be uncovered.  In addition to being environmentally sound, these projects are financially more sustainable than offsets.

Reporting and green tourism – what happens when consumers know?

Emissions from tourism matter – they account for around 5-14% of total global emissions.  Developed countries produce considerably more GHG emissions per capita than developing nations, and one reason among many is the availability of time and money for leisure. 

Carbon emissions from leisure pursuits is a sensitive issue.  On the one hand, denying people air travel or even the experience of a heated swimming pool would be politically unrealistic.  On the other hand, consumers themselves are becoming increasingly interested in their personal impacts, and consumer goods companies from Puma to Unilever have been quick to respond, by reporting their impacts and showing annual improvements and innovations.

The same cannot be said of the leisure industry.   Few report on their emissions at the corporate level – but the rare leaders who do suggest some interesting conclusions.  Figure 1 shows emissions from a selection of firms in transport, holidays, casinos and hotels.   Two dimensions are relevant: emissions per customer, and per unit of spend.

For an individual trying to reduce their discretionary carbon footprint, the emissions-per-customer metric is highly relevant.  For example, a luxury hotel stay (measured on a room-night basis – HKS and Intercontinental) is clearly less green than a stay at a holiday park (Centre Parcs and Holidaybreak).

For a company looking to produce a more efficient product and deliver more value to their customers, the dimension of emissions per unit of revenue is most relevant.  For example, compare the two hotel groups, Intercontinental and HKS (Hong Kong and Shanghai), both targeting the high end of the market.  HKS is likely to keep costs low by reducing energy consumption relative to revenue, presumably without changing the quality of the experience.  This will help them boost their financial surplus, which can be invested in services their guests actually value.

At the moment, consumer tools like GoodGuide.com focus on goods rather than services.  Given the importance of leisure to global emissions, change cannot be far off.  When these tools are available for holidays, travel, and other leisure experiences, those companies that have already invested in their own sustainability – and reported transparently – will be the first to benefit. 

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.