In the previous chapter, we discussed how the policymakers and regulators might attempt to reduce pollution, or internalize unpaid social costs by affecting the behavior of business firms. In this chapter, we look at the same set of issues, but from the point of view of producers of goods and services, and how they might contribute to sustainable development.
For any process of development, business has a critical role to play, in conjunction with markets, government, and society. On one hand, business is responsible for creating demand for different goods and services through advertising and marketing, and thus can affect the consumption of resource-intensive products. On the other hand, production of goods and services can result in negative environmental externalities in the absence of government regulations or social sanctions that have been discussed in the previous chapter. Thus, business uses the (free or non-priced) natural resources as both a source (as raw material) and sink (to release wastes), and through promoting further consumption, can be responsible for an increasing rate of use of ecosystem services over time. There is a commonly held perception that for a firm to adopt a sustainable (environment and socially friendly) strategy, it has to incur a relatively high cost, in terms of current profitability. This tradeoff is often considered irreconcilable, arising out of a departure from business as usual. This need not be necessarily true, as is demonstrated in this chapter.
Here, we explore the different drivers of firm behavior in the context of sustainable development, given their constant interplay with regulatory institutions and other stakeholders. After discussing the different enablers that make a corporation go green, we examine the alternative strategies a typical firm may adopt toward this goal. This could include substituting raw materials, changing the production process, innovating to introduce new products, or managing the complete value chain of a service to minimize its environmental externalities. We then discuss the possibilities of green-washing, as there are large information asymmetries between different stakeholders and the firm. We conclude by trying to identify whether there are any key ingredients that can ensure that a firm behaves in a sustainable manner.
What Makes a Company Green?
Firms are often described as a nexus of contracts. They exist because of a complex set of explicit or implicit understandings among the owners of the firm, its employees, its suppliers, customers, competitors, investors, and several other institutions. Regulators, chambers of commerce, civil society organizations, the judiciary, and educational institutions are some of the key institutions that can affect corporate sustainability strategy. We examine the role of some of these stakeholders in influencing firm behavior, keeping in mind that, much like any other business strategy, sustainability strategy is viewed by the manager as a means of furthering her fiduciary responsibility to maximize shareholders’ wealth.
Of the many drivers of corporate sustainability, the one that has been the most prominent historically has been government regulation and its enforcement. These include both prescriptive norms for minimizing pollution, providing a safe and healthy workplace, or to restrict discrimination of any form and market-based mechanisms to encourage environmentally responsible firm behavior. The nature of regulation, its stringency, efficiency of implementation, and changes in the approach of regulators over time are some of the parameters that affect how managers in a firm decide to manage the environment.
As discussed in the last chapter, regulations have evolved from being command and control to more market based, and regulators have started viewing businesses in a more collaborative role, setting standards and policy, as well as monitoring and inspection mechanisms in consultation with them. Hybrid systems of regulations combining elements of public regulation; government-supervised corporate self-regulation, mandatory information disclosure, and green procurement are being developed to promote the current trend of strategy toward sustainable development (Eisner 2004).
One of the key sustainability challenges for firms worldwide has been the availability of natural resources as inputs. Resource scarcity is becoming more and more acute as production levels increase. Firms respond to this challenge either by substituting away from scarce resources or by more efficient use of existing inputs and minimizing wastage. Not only does this make more business sense, but it also contributes to sustainable development reducing the pressure on the ecosystem. The other resource drivers for business are its suppliers, financers (including shareholders, investors, and banks), customers, and insurance firms. Linking sustainability attributes, such as good work practices and compliance to national regulations, to supplier and buyer relationships can reduce overall costs. It can also promote organizational learning as it is shared among partners, reduce environmental risk and liability, and provide cheaper financial resources for sustainable projects. The diffusion of learning and experience helps minimize adverse environmental and social impacts through process, product, and organizational changes. This diffusion constitutes a key benefit of developing good supply chain1 relationships.
Risk management2 can become a key driver of a firm’s sustainability strategy, as was evident when consumers worldwide boycotted Nike when it was found that its suppliers were responsible for employing children who worked in poor conditions for unfair wages (Beder 2002). Insurance companies equate socially (gambling, for example) and environmentally risky (coal mining, for example) operations with increased financial risk and apply these criteria in their underwriting process. Sustainability considerations are used for business ratings of credit, customer, pricing, and investment for companies, which are, in turn, deployed by the financial industry to enable better risk profiling. Past practices and records of corporations are examined by banks along with the merits of the actual proposal before approval of loans or other financing mechanisms for firms. Such pressures from the sources of capital that increase the cost of borrowing strike at the core of corporate decision-making.
Shareholders and investors are powerful change agents within the firm. The concept of socially responsible investing, starting with the formation of the Coalition for Environmentally Responsible Economies (CERES), which comprises investors who subscribe to a list of principles of environmental protection, has resulted in firms choosing their portfolios more cautiously. While CERES champions the use of investor voting to change corporate behavior, investment funds may influence behavior through moderating the flow of capital based on social and environmental criteria. Exclusions or negative screening refers to an investment strategy where certain companies or sectors are eliminated from the portfolio of industries to be considered for investment. These could include adult entertainment, gambling, nuclear power, tobacco, weapons, fossil fuel-based power generation firms, and mining firms with poor reputations.
Corporate strategy of a firm is influenced by customer demand and changing tastes and preferences along with information about current trends from consultants, trade associations, and even competitors. The effect of changing consumer preferences in favor of sustainable practices on business strategy can be quite complex. These effects can range from green washing (where firms project a sustainable image without actually doing anything) to business as usual (as consumers often do not pay a premium for products with sustainable attributes, although they claim they are willing to do so), to making actual changes in their activities to become more sustainable. The strategies adopted by the firm would depend on the extent of consumer awareness and its ability to convey to society its position on sustainability in a clear and credible manner. Of course, sustainable consumerism has led to the development and growth of new market segments such as organic foods and ecotourism. As with any other business strategy, the plans and actions of competitors could influence a firm’s sustainability strategy so as to stay ahead of or at least keep pace with the competition. Firms compete over the extent of influence in changing the form and content of regulations depending on their state of preparedness and competence. Such influence may result in creation of barriers of entry for new firms and/or an unsustainable drain of resources for smaller competitors. Firms benchmark themselves against their competitors and are in constant search of improving the industry’s best practice. Trade associations and consultants are conduits through which rules of thumb, standard operating procedures, and best industry practices are transferred among firms. By being the first mover or emerging as leader in setting standards and industry norms that other competitors seek to emulate, a firm benefits from a satisfied public (consumers and social stakeholders) and green investors while simultaneously putting pressure on competitors to catch up with it.
In today’s connected world, the power of civil society organizations and media to mobilize social opinion and influence legislation is immense. In addition to legal consent to operate, firms also need social consent, for which close communication with social drivers, including the community is critical as part of a firm’s sustainability strategy. Civil society organizations influence corporate operation directly or indirectly through diverse means including undertaking scientific research, conducting public protests, engaging in corporate alliances, influencing press coverage, and mobilizing public opinion. Of these, the pervasive effect of non-governmental organizations (NGOs) in changing societal norms and beliefs is probably the most potent and sustainable driver of superior environmental performance for firms, as it influences every firm employee, including senior management in the long run. Community and media have brought environmental issues to the fore of public and industrial concern informing and directing public debate.
Sustainability Strategies
Business strategies obviously aim to increase the long-term profitability and growth of a company, given the context in which it is operating. Sustainability strategies are very similar to business strategies, as they have a long-term focus, take into account current and future resource constraints and the business environment to steer the firm in a direction where it can improve its business operations. Thus, these strategies need to focus on either reducing costs or increasing revenues or both. Another set of strategies may focus on non-monetary business goals of a firm such as becoming a market leader, getting ahead of the competition or strengthening brands, the reputation effects of which also lead to increased long-term value of the firm. As environmental and social issues start occupying greater mind space of society, regulators, and consumers, firms will perforce be more concerned about weaving sustainability concerns into their business strategy.
A focus on sustainability could lead to the adoption of cost reduction strategies. The first approach in this context would be for the firm to embrace the concept of eco-efficiency and implement it. This would include a reduction in the material and energy used per unit of goods and services produced. Improved recyclability, reduced dispersion of toxic wastes, greater use of renewable content, and increased life cycle (in terms of durability) and service intensity (usefulness) of products are all features of eco-efficiency. Improving operational efficiency through process or product modifications could lead to reduced wastage, better output quality, and lower rejection rates, all of which contribute to falling costs of production. An indirect benefit from pursing eco-efficiency measures relates to better risk management, including better safety records, expedited permitting, and improved relations with regulators. A comprehensive corporate sustainability policy goes a long way in avoiding litigation, legal claims, and accident expenses (See Box 8.1). Further, such a policy, coupled with a strong reputation, results in reduced recruitment and retention costs, as employees are more willing to work in companies that are committed to social and environmental concerns. This allows the firms to attract the best and brightest potential employees, as well as to access new, local pools of labor. Improved employee morale can also result in greater productivity, thereby driving costs downward. Firms with strong reputations enjoy improved access to capital, as they are less prone to environmental and social risks, improving their creditworthiness. Further, with the advent of socially responsible investing and green financing, firms that are not focused on sustainability may face much higher costs of capital.
Strategies aimed at innovating products or processes as a response to sustainability challenges result in an expansion of the topline of a firm, as it identifies new markets and is able to charge a premium on prices for the additional sustainability attributes of its product or service. These strategies could use tools such as involving stakeholders to come up with new product or service ideas (crowdsourcing3 is an instance), which, in addition to improving brand loyalty, also reduces the development costs of innovations. Many consumers take an organization’s reputation and social contributions into account when making decisions to purchase its products.
Box 8.1 Enablers of sustainability strategies
For a firm to engage in sustainability initiatives, there could be several enablers that have to come together. To start with, the power of human agency is paramount, whether it is in the form of managerial leadership or demands from stakeholders. Thus, in Alcoa, an aluminum-producing firm, a fifth of executive cash compensation is tied to safety, diversity, and environmental stewardship, which includes greenhouse gas (GHG) emission reductions and energy efficiency. Exelon, an energy-producing company, has introduced an innovative long-term performance share scheme that rewards executives for meeting non-financial performance goals, including safety targets, GHG emissions reduction targets and goals engaging stakeholders to help shape the company’s public policy positions. PepsiCo identifies and discloses climate change, water scarcity, and public health issues as core sustainability challenges in its annual financial filings. GE attempts to integrate sustainability into the company’s culture, ranging from hiring practices and training to employee wellbeing programs through its human resource department. The global water technology provider has both a sustainability steering committee and an enterprise risk committee. It identifies senior executives who are held accountable for sustainability performance.
Another enabler is to focus on one or two key initiatives and setting goals and roadmaps for them. For example, Coca-Cola has improved its efficiency of its water use by 20 percent, and is open to third-party evaluation of its water stewardship. Ford Motor Company and Walmart have focused on supply chain sustainability. PG&E’s (autility company) environmental policy explicitly references habitat and species protection, and the company publicly reports detailed findings on its efforts. Adobe is using renewable energy technologies, including hydrogen fuel cells and solar arrays, and is also focused on reducing energy needs by improving the cooling efficiency of its data centers and virtualizing many of its systems, platforms, and devices to reduce GHG emissions. Bank of America has committed to increasing its portfolio of Leadership in Energy and Environmental Design (LEED) certified buildings, while Johnson and Johnson has focused on implementing a detailed policy that incorporates the Universal Declaration of Human Rights (UDHR), International Covenant on Civil and Political Rights, and International Covenant on Economic, Social, and Cultural Rights. It applies these principles not just in its overseas operations and supply chain, but also to all its workplaces.
Innovation in design and process using crowdsourcing is another way forward, as demonstrated by Nike. It has created the making app in 2013, where data on its materials sustainability is publicly available, enabling designers from the industry and beyond to design products with lower material and environmental impacts. Dell has been integrating alternative, recycled, and recyclable materials in its product and packaging design, improvements in energy efficiency, and design for end-of-life, and recyclability. Procter and Gamble has been developing and selling sustainable innovation products, that is, products that provide a greater than 10 percent reduction from previous or alternative versions in one or more of the following: energy use, water use, transportation, material used in packaging, and use of renewable energy or materials.
As a key element of sustainability strategy revolves around building and nurturing relationships with stakeholders, sustainable firms have an improved ability to attract and build effective and efficient supply chain relationships (See Box 8.2). Profitable long-term business relationships are forged with partners across the value chain and the firm assists its partners in improving their production standards, thereby reducing risks for the partners, as well as itself. Further, improving the depth of engagement with consumers and society may result in an enhanced ability of the firm to better anticipate and understand trends to proactively plan for the longer term. This could be in the context of new regulations, heightened social expectations, and improved technologies. This enables the firm to strategically plan for the longer term, which, in turn, would result in increased revenue and market share. A proactive firm that has sustainability as one of its primary goals could also gain a first-mover advantage among its competitors by correctly anticipating and responding to social pressures.
Box 8.2 Walmart: Leading with supply chain sustainability
Walmart started on its sustainability journey over a decade ago under the leadership of Lee Scott, the then CEO. Being a retailer, its focus was on supply chain sustainability, that is, the extent to which the procurement, manufacturing, and logistics departments within the company could directly impact sustainability targets. Their targets revolved around both environmental and social issues such as reduction of GHG emissions, waste reductions, more responsible hiring, and community development.
Through better routing and truck loading, driver training focused on minimizing idle time and progressive shifting, improved truck aerodynamics, fuel-efficient tires, and increased purchase of compressed natural gas powered trucks, they achieved an 84.2 percent improvement in fleet efficiency over the 2005 baseline by 2014. They also reduced the extent of the total waste generated.
The true success of Walmart is in influencing its suppliers (both small and large) to adopt more sustainable practices. For example, in 2007, Procter and Gamble agreed to start selling smaller, more concentrated bottles of detergent. This was good for fleet efficiency, good for the store (more shelf space for products), and reduced landfill waste. Walmart created a sustainability index scorecard through which they ranked their suppliers. They were able to create such scorecards for more than 700 categories of products. Attention was given in the area of sustainable chemicals to ensure that chemicals used in the products they sourced were not hazardous to humans.
Corporate responsibility may well go beyond considerations of direct profitability and core business goals. Walmart’s efforts on economic and environmental sustainability would clearly give them a competitive advantage because they would be able to reduce costs. Contributing on the social front may not be profitable directly, but there would be goodwill generated by the company’s contribution to the local community. Walmart committed 25 million dollars over five years to improve the communities’ disaster response systems and gave over 2,800 scholarships for higher education to needy students.
A large company like Walmart would have a greater reach in the extended value chain in a manner that smaller companies would not. Hence, a large company achieving even a moderate improvement can have a significant ripple effect on the supply chain.
Source: http://cdn.corporate.walmart.com/83/bf/f042060f46d-3b0e806289563c086/2016-grr-exectuive-summary.pdf
Market Structure and Firm Sustainability
A firm’s response to market and non-market pressures is mediated by the market structure it operates in. Thus, while a firm in a competitive market would be forced to match the moves of its competitors, just to stay in the reckoning, it has been shown that a monopolist may under produce quality of a product because of his or her focus on the marginal customer only. Most firms operate in an oligopolistic or monopolistic market where product differentiation is the key mechanism for them to make profits. Environmental and social attributes of a product or service can emerge as a key differentiator if the customer base is aware and has different willingness to pay for the product or service. Under these circumstances, it has been demonstrated that a set of firms are best off if they differentiate their product to the maximum. In other words, firms producing brown goods (that is, goods with very low environmental or social attributes) would always coexist with firms producing green goods, and the difference in sustainability attributes between the goods would be maximized for all firms to make profits. This could be of concern for society and provide a pointer for regulators, who would have to set the floor for environmental and social attributes to ensure that this tendency for differentiation does not result in a reduction of net economic benefits. The ability of customers to discern genuine sustainability measures from mere green-washing efforts can impact the extent of profits firm stand to make. Hence, encouraging disclosure of sustainability attributes and disseminating this information through measures such as transparent rating processes can lead to a race to the top for all firms within an oligopoly or monopolistically competitive market structure when there is a socially and environmentally aware customer base (Sarkar 2017).
The Emerging Role of Innovation in Sustainability Strategy
In the context of sustainability, a business firm’s strategic innovation has to result in the creation of something new that enhances the firm’s performance in social, environmental, and economic dimensions. While there can be a reduction in costs from becoming more resource- or energy-efficient, incorporating sustainability attributes into a product can result in additional revenues or in creating new or niche markets. As raising the bottom line or increasing the top line is the final objective of corporate innovation, the goals of achieving greater sustainability are aligned to the objective. There is debate regarding what constitutes an enhancement of performance. However, there is growing consensus that the innovation is not restricted to technology, but should also affect processes, operating procedures, business models, systems, and even thinking about the future (Szekely and Strebel 2012). Innovations for sustainability can be looked at in three distinct ways. They are incremental innovations, radical innovations, and systemic innovations that may be game changing.
Incremental innovation takes a particular view of a product or service where some new environmental social and economic issues are considered. Typically, such innovations tend to improve the eco-efficiency of the product or service. In most cases, such changes are add-on or end-of-pipe improvements in resource or energy use. Even when a new technology is used, it is often limited to a single factor of environmental performance such as CO2 emission or use of water. These innovations usually lead to a reduction in production costs.
Radical innovations in sustainability are a bit more complex as they try to address how dynamic systems interact. Hence, these innovations would involve the analysis of separate parts with multiple interdependent wholes, feedback mechanisms, and nonlinear change. A typical instance of radical innovation would be the transformation of supply chains to make them more sustainable. Such innovations would not only call for a change in the products and services, but also in processes and operations. The innovations also impact labor conditions, workers health, and gender equity. Further, they would entail addressing environmental issues like where the raw materials came from, the wastes produced in the manufacturing process, as well as end-of-life impact (See Box 8.3).
Box 8.3 How sustainability innovation works at Danone
A key trigger to innovating for sustainability is presenting employees with new problems to solve and forcing them to think in terms of bigger frameworks and unconventional ways. This empowers employees to act, often producing creative outcomes that increase the firm’s competitiveness. Danone, headquartered in Paris, one of the largest multinationals in the food sector, is a good example of a firm that practices this. According to the Danone leadership, no business plan is complete without a clear understanding of how it contributes to the world. Their CEO, Franck Ribaud’s famous words “we cannot grow in the desert” reflects this understanding. The company’s vision is to create economic value by creating social value. The sustainability strategy is loosely spelt out in terms of general guidelines and goals. However, each country’s business unit and their employees are empowered and encouraged to implement these ideas into specific actions.
One example is their notion of the environmental platform, social platform, and the economic platform. The environmental platform’s broad goal is to measure and monitor the carbon footprint of all its activities. The social platform focuses on the impact of all Danone activities on employees, as well as local communities where the people involved may have no direct connection with Danone. The economic platform goes beyond measuring tangible outcomes such as financial health or profitability into being concerned with intangible ones like reputation management. Danone had an internal reflection process around the question “What is the Danone we want for the next ten years.” This reflection resulted in a decision to identify four equally important focus areas for the organization, namely, innovation, people, nature, and Danone for All. This entailed shifts in the company’s central values, changes in its organizational structure, and encouraged internal debate from shared values to hiring practices, job descriptions, and employee objectives.
Danone, in involving its employees and tapping their innovative capabilities, floated a program called lab to land. The idea was to allow experimentation at a small scale and then facilitating the replication of successful projects at the country, regional, or global level. The scope of Danone’s innovation process has been broadened in recent years to nurture and help radical innovations where the company’s formal R&D unit has been allowed to engage with external parties through partnerships, joint ventures, and dialogs. It believes that technological innovation can come not only from the big companies that sell Danone machinery, but also from customers, people from the village, local suppliers, and so on.
Danone is an example of a company that, in determining its sustainability strategy and aligned innovative culture, has looked for other resources beyond its own. This includes collaborations with business partners and clients and public funding, thus making it part of a larger innovation ecosystem.
Finally, the game-changing (or systemic) innovations for a business firm relates to the transformation of relationships and interactions between the enterprises competing firms, customers’ behavior, and lifestyle, and even the very objective of doing business especially the long-term goals. One example of such an innovation in the 21st century would be the sharing–borrowing–loaning economy, which has been described as the advent of the age of access or collaborative consumption. This has obviously been facilitated by the rise of information and communication technologies. The trend of collaborative consumption has the potential to significantly disrupt and change consumer markets where the use of the product, rather than the product itself is more important.
As customer preferences change, favoring products and services that address and solve broader societal and environmental issues, competitive advantage can be gained from innovations arising from sustainability as an objective.
Going Beyond Stakeholder Expectations of Sustainability
The most important driver of corporate sustainability is the business firm itself—the people working for it and the nature of the leadership. The significance of corporate culture is that it is autonomous in nature (not driven by external pressures of stakeholders, competitors, and regulators) and has the capability of looking ahead of the curve. Leadership plays a crucial role in influencing the culture of an organization to weave in sustainability concepts in every thought and action the firm takes.
Given its knowledge about its operations and their impact, the firm is in a far better position to understand the sustainability implications of any of its initiatives (See Box 8.4). At the same time, it is also best placed to balance different stakeholder expectations, as well as influence and shape them. The impact of the firm on molding change in consumer behavior, so as to restructure the nature of demand itself would be much stronger than moral strictures made by special interest groups such as NGOs, governments, or religious organizations. Sustainability issues have taken the proportions of crises such as climate change or social unrest, and firms are better placed to manage this change in the business environment than to government whose expertise lies in administering and maintaining status quo. Enlightened leadership within a firm, which has a time horizon far beyond the here and now can, therefore, play a critical role in designing corporate strategies that are sustainable, not only for the firm, but have an impact on the industry, which, in turn, through its value chain linkages, would lead to a more sustainable outcome for society too.
Box 8.4 The sustainability balanced scorecard
Sustainability initiatives in a firm are often viewed as additional to and often in conflict with the other business decisions of the firm. Yet, there is a need to align and integrate sustainability objectives with the day-to-day business objectives of the firm. One way to address this is to align sustainability measures with corporate strategies through a sustainability balanced scorecard (BSC).
A BSC is a framework that adds strategic non-financial performance measures to traditional financial metrics to give managers and executives a more balanced view of organizational performance. It typically reflects four interrelated perspectives of the firm: financial concerns, customer-related concerns, internal business processes, and mechanisms of learning and growth. Metrics are identified for each, which translate into goals that employees at all levels of the organization have to meet.
In addition to the aforementioned, a sustainability BSC would incorporate metrics related to environmental and social issues under each of the four broad perspectives. As these now become explicit objectives against which employee performance is evaluated, sustainability concerns become an integral part of firm strategy. An example of how some social and environmental concerns can be reflected within a BSC is shown as follows.
Through this, companies can delineate the relationship between sustainability objectives and outcomes with corporate strategy and profitability. By integrating sustainability measures into business practices and by clearly linking an organization’s competitive strategy to its green outcomes, the BSC clarifies the relationship between sustainability outcomes and profitability or shareholder interests.
Figure from http://essay.utwente.nl/67287/1/boerrigter_BA_bms.pdf
We have discussed in the preceding two chapters how production and consumption can lead to market failures in the form of externalities. We have also discussed, briefly, how regulators and businesses grapple with the challenges of adverse negative externalities through the creation of pollution and wastes. Conventional economic wisdom creates solutions to the problems in terms of micro-firm or industry-based interventions. The macro or global impact of the problem is often not given due attention. Yet, arguably the biggest environmental challenge constraining the possibility of sustainable development is that of global warming and climate change. It has been referred to as the biggest market failure the world has ever seen (Stern 2006). The following chapter discusses the nature of the problem, the complexity of the challenge, and the difficulty of attaining a solution that has to be global in its impact.
1 Supply chain in a production process is the network of vendors and activities that link the main production activity by providing inputs at the right time, at the right price, and having the right quality.
2 Here, in the context of sustainable development, risk management means something more comprehensive than financial risk and its reduction. Risk could be many more sorts, many of them leading to large costs in the future, especially those that emerge out of environmental degradation.
3 Involving a very large number of contributors of money or other inputs into a project (paid or unpaid) usually mobilized through the Internet.