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Why understanding climate change is key to long term profitability

All companies will need to develop their sustainability strategy to survive and prosper, says Mike Rosenberg, associate professor of strategic management, IESE Business School.

Today it is more important than ever for business to take the lead on climate change, as well as air and water pollution, which are much critical for many people.

The starting point for a discussion about the role of business is to understand that sustainability can not only be profitable but there are also deeper strategic reasons which are driving many companies to do much more than required by the law or operational concerns.

In the first place the connection between sustainability and cost reduction is well established.

Increased energy and water efficiency as well as producing less waste saves money and thus increases profits. The only issue is that sometimes it is necessary to make additional investments in order to achieve lower, and more stable, operational costs but this is a financial, rather than an operational question.

In terms of climate change, Christiana Figueres the person who brokered the Paris Agreement in 2015 believes that the move to a low carbon economy is the biggest business opportunity of all time and will generate 65 million new jobs.

The key point she makes is that the issue is not if the world would change its energy mix but when. If the world does implement the Paris agreement and take the voluntary targets it is based on even further, then the transition will happen over the next 10-20 years.

If not, then humanity will find itself forced to take the path in any case as climate change becomes much more severe and we find ourselves forced to make the change. In all cases, de-carbonization will have an enormous impact on specific industries and jobs.

Some companies, such as the manufacturers of wind generators, solar panels, electric vehicles, etc. will clearly benefit from this transition and the faster and deeper it goes, the better for them.

On the opposite side are businesses which a stand to lose big if and when the transition occurs due to regulation. Coal mining and processing come to mind as the biggest losers followed closely by the oil companies. In my view the right strategy for companies in this category over the long term is diversification into other cleaner forms of energy or completely new businesses. Unfortunately many have decided that the best plan is help elect politicians who will push us to the second of Ms. Figueres’ scenarios.

Somewhere in the middle of these two extremes lie most companies.

Some like the large manufacturers of energy equipment and even the car companies are essentially hedging their bets. GE for Example, purchased Alstom gaining market share in China and technology in hydropower and even some more advanced technologies such as concentrated solar power generation. GE, of course, also makes thermoelectric plants which are powered by coal, oil and gas.

The power generation sector is also paying attention and those that have a significant presence in gas and nuclear stand to gain, at least in the medium term, as these technologies offer the fastest way to cut carbon emissions in most countries.

Another large group of companies are not as exposed to environmental issues directly but may be affected by concerns such as the opinions of their consumers, employees, shareholders or even the larger idea of civil society.

I call this idea “Environmental Sensibility” and it has to do with the degree to which a specific company is exposed to the issue from any direction including, but not milted to regulation.

Some groups of employees, for example, are demanding that the companies they work for are positive corporate citizens.

This is the main reason I believe that Google, Facebook, and other such firms are striving to build hyper efficient data centres and offset any remaining carbon in their system. Costs and efficiency are also important to them but without attracting the most talented young men and women, they will not keep pace with their competition.

An interest in appealing to consumers might also drive increased activity by some companies. While most studies appear to indicate that only some people will pay more money for products and services they feel are more sustainable, there is evidence that the overall environmental reputation of a brand does enter into purchase decisions if everything else is equal.

An example of this is Coca Cola which claims that it has made its worldwide operations neutral in 2016 in terms of utilising fresh water and made a similar commitment to eliminate waste by 2030.

There are also studies that indicate that firms with a stronger environmental reputation have a higher stock market evaluation over time than firms which do not and may even be able to secure lower cost long term financing.

This might be the main motivation that has led Walmart to undertake what it calls Project Gigaton. The idea is to work with its suppliers to reduce emissions in its global value chain by one billion metric tons – a gigaton – by 2030. Essentially every major supplier to Wall-Mart needs to figure out what it can contribute to this goal.

Differing opinions

I also find there are different attitudes amongst business leaders on this topic. There are certainly some business leaders such as Yvon Chouinard, the founder of outdoor clothing firm Patagonia, or the late Ray Anderson from Interface who have a deep commitment to the natural environment and have committed their companies, their money and their lives to the issue.

There are, of course others who would agree with the US president that the whole thing is a Chinese hoax despite the science and public opinion. An interesting question that I ask my MBA students is if it really matters what the CEO’s motivations are?

The thing is that regardless of politics and conviction, there are strategic reasons for paying attention to the issue of environmental sustainability even if the only reason is to hedge against some catastrophe that might occur due to an industrial accident or sabotage.

For me the only question is whether to follow the relevant regulations or to go “beyond compliance” to use Harvard’s Forest Reinhardt’s phrase.

Putting these two ideas together, I see six basic strategies that most, if not all firms are following. I call the first strategy “break the law” and do not recommend or condone it. VW followed such a path in its diesel engines in the US and has paid heavily for it. Companies can end up breaking the law even if Sr. Management does not mean to do so. If people feel they are under too much pressure or results, they might feel they need to go over the line in order to achieve those goals.

If, however, a firm’s environmental sensibility is low, then perhaps it should just obey the law. I call this strategy “take the low road” and do not see anything wrong with it. I recommend this approach only when neither a company’s shareholders, employees, consumers or the regulators are particularly concerned with what the firm is doing.

Another approach might be to recognise that the issue may not be important today but may become more important tomorrow. I call this strategy “Wait and See” but what it does require is to at least understand the issues that a firm may face in the future and perhaps keep track of what consumers or employees think about these topics.

Other firms have, for a number of reasons – including straightforward cost reduction, decided to take steps which improve their environmental profile and may choose to talk about it publicly. Some, such as Unilever, have made their approach an integral aspect of their communications strategy. I call this approach “show and tell” and differentiate it from greenwashing which is when the communications efforts exceed the real work behind the scenes.

The challenge in “show and tell” is to be sure that all the different activities of the company, perhaps all over the world, really live up to the rhetoric from the communications people. This can be a challenging effort and environmental interests groups will call out any large company that does not do so.

I also see two reasons to go much further than the current state of legislation and pressure from consumers, employees or civil society. One reason is due the conviction of the CEO or major shareholders. I call “pay for principal” and the key issues are s to be clear about the additional costs of such an approach and to have full transparency with minority shareholders. Tesla comes to mind.

The other I refer to as “think ahead” and is the approach I recommend when the CEO and the Board have the belief that the issues connected with environmental sustainability will become more important in the future and it makes more financial sense to begin the transition right away.

In summary, it is my personal conviction that the issue of climate change and environmental sustainability is real and here to stay.  All companies will need to develop their sustainability strategy if they have not already done so.

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