Chapter 3: Micro-level analysis – inside the firm

Contents

  • Scopes
    • Mars confectionary
    • motivation to engage with scopes framework
  • SWOT in 50 seconds
  • Indicative solutions to questions concluding the chapter

Grant Reid, CEO Mars Confectionary, on supply chains and scope 3 emissions: “few consumers probably realise the incredible journey that goes into bringing Royal Canin to their dog’s food bowl, M&Ms to their corner store, veterinary services to thousands of our clinics or Ben’s Original to their dinner table. Because to truly deliver net zero, we must eliminate or offset GHG emissions across the entire breadth of our value chain – from the farms that provide our ingredients all the way to the end use of our product with consumers.” (Guardian, 5 October 20221). Reid says that he cannot stress the importance for firms like his own to cover the emissions from the whole of, what he calls the value chain (a variation on the theme of supply chain with the difference that each stakeholder in a value chain adds some value to the product; for example coffee roasters adding value to coffee beans). Indeed 75 per cent of Mars’ carbon footprint is associated with agriculture (cocoa to meat for pets). At the time of his article, Mars had cut all emissions – scopes 1, 2 and 3 by 7.3 per cent (since 2015). Here are some initiatives:

  • ensuring deforestation is eliminated from the value chain
  • embedding climate action at the heart of business operations
  • linking climate/GHG targets to executive remuneration
  • requiring suppliers to set their own GHG emission reduction targets

At the same time, Barry Parkin, Chief Sustainability and Procurement Officer at Mars was doing interviews with business journalists. The sound recording below is his interview with Dominic O’Connell on the BBC’s Today Programme on 6 October 2021. He highlights the need to simplify supply chains, have robust governance and the complete sanction of senior management. Note also that it is a process rather than a single act. The company’s target is 2050 and they are working back from that. Whether that is the right way to do it is a question worthy of discussion. Whilst Mars may be ahead of its competitors and suppliers, 2050 seems a little too far into the future on current knowledge.

Motivation for firms to engage with scopes framework

A common question – particularly from SMEs – is, why should we invest in systems that count carbon? This is just a cost with no bottom-line benefits.

The drivers of scopes compliance (see chapter 1 in book and companion website) are captured in the following graphic:

This graphic summarises the case for investment in a report from 2021 by McKinsey, On target: How to succeed with carbon-reduction initiatives. The market represents customers who are increasingly demanding evidence of carbon reduction programmes. Every customer will need to account for their own carbon emissions – scope 3 (emissions from the supply chain) – will need to be accounted for. Firms that cannot provide these data may be “delisted” from any preferred supplier list.

Transition risks are viewed by the World Economic Forum as: “…a classic example of a risk-risk trade off, where the measures introduced to mitigate one risk become the source of additional risks. In the case of decarbonization, these secondary risks are small compared to the huge benefits of mitigating climate change.” In other words, being proactive is better than reacting to external forces driving the transition agenda. The WEF reports on an academic study of experts that highlighted eight key transition risk categories: economic, financial, societal, environmental, technological, energy-related, geopolitical and corporate. They produced a policy brief.

Investor disclosure – investors are increasingly adopting capital allocation strategies that take account of ESG – Environmental, Social and Governance – measures.

Government and regulators – slowly, but progressively, governments are imposing on firms requirements to report emissions. Moreover, firms and public-sector bodies increasingly need to account for their carbon emissions and offset them (find ways of neutralising their carbon emissions by investing in programmes such as reforestation, developing world technology transfer and carbon capture and storage, CCS). These can be seen as costs that can be mitigated by investment in carbon reduction within the business or corporate entity.

Some sectors are performing better than others. The extractive industries – coal, oil, mining – in combination with agriculture, hospitality, aviation and cement are lagging behind industries such as power generation, apparel and retail. The reasons for this are numerous; however, the lag industries have no short-term means of carbon reduction. For example, the aviation industry does not anticipate low-carbon aeroplanes to be available before 2035, and even then, only short-range planes.

Business strategy

From a business strategy perspective, sustainability is achieved by: mitigation, adaptation and business model innovation:

Mitigation is discussed in chapter 1 of the text and is seen by Klein et al. (2005) as referring “to all human activities to reduce or stabilize greenhouse gas (GHG) emissions to prevent (further) climate change” (p. 580). For firms this includes investment in carbon neutral sources of energy, removing emissions from a firm’s own activities (operations, distribution, etc.).

For Klein et al. (2005):“[A]daptation in the context of climate change refers to any adjustment that takes place in natural or human systems in response to actual or expected impacts of climate change, aimed at moderating harm or exploiting beneficial opportunities” (p. 580). In the text, the example of the rail industry is used. Higher average temperatures put stress on assets such as track and rolling stock. The industry will adapt by changes to the tolerances of the materials used to make the assets.

Circularity, or butterfly economy, translates into a shift in a business model whereby firms take responsibility for not only the whole lifecycle of a product, but also to ensure zero or limited waste. It requires products to be manufactured to be recycled, re-used, repurposed or disposed of safely. The interface between these provides a sustainable (long-lived and environmental) strategy.

Sustainability and competitive advantage

Whilst carbon budgeting can be seen as a cost, it can provide competitive advantage for firms leading in carbon accounting, adaptation and circularity postioning.

Auditing remains in its infancy. There are a number of methodologies available to implement the scopes framework. Large consultancy firms offer services, as do specialists such as the Carbon Trust. Whilst scopes 1 and 2 are relatively simple to identify and account for, scope 3 is far more complex as it is necessary to account for all carbon generated throughout the supply chain, including shipping. This can lead to some double counting. But the Greenhouse gas protocol provides guidance on how to initiate the process.

Some firms signal compliance and leadership by achieving global recognition. B-Corps (benefit corporations) are a growing family of firms that have achieved a determined ESG reporting and systems. Likewise, the ISO 14000 family of environmental management standards provide globally-recognized accreditation.

Whilst circularity is the ideal, sustainability is a journey rather than an end in itself. Hence, firms with existing products and services may look towards circularity. New firms, however, should look to embed circularity in the business model from the outset.

The intersection of these three provides the potential for competitive advantage.

Supply chain stress

In a climate scenario, supply chains generate a number of issues and challenges. First, where they are extended – global – the carbon emissions are exported (I do not take responsibility for the embedded carbon in my mobile phone, for example). Second, there are other ESG issues (relating to the UN Sustainable Development Goals) that are outsourced. Third, shipping/global logistics are carbon intensive. Fourth, they are subject to stress in unstable global environments.

On this latter point, the climate emergency has been declared because of severe weather events, flooding, drought, heat, etc. These impact hugely on the efficient management of extended supply chains. In recent times, we have seen supply chains disrupted by Covid-19 – a global pandemic. Many firms did not have contingencies in place to deal with these disruptions. Moreover, increasingly, “hollowed out” governments/states have been reducing their inventories of emergency resources such as PPE on the assumption that procurement is always possible. This assumption was reliant on the continuation of supply chains; but even where they functioned, the manufacturing capacity was insufficient to meet a truly global demand for safety equipment, tests, etc.

Another unanticipated shock to supply chains in recent months has been the re-emergence of war in Europe which has disrupted energy supplies to many countries including Germany, Poland and Bulgaria (the latter two had gas supplies suspended by Russia over a payment dispute – in which currency to pay for gas – Euros or Roubles).

Using the Venn diagram approach once more, the interface of these three factors is supply-chain disruption and stress. They add costs because of the need for contingency. Not surprisingly, the response to energy supplies has been to invest hastily in renewables and achieve state or regional self-sufficiency (in the case of the EU). This fits the climate emergency agenda, too, as it inherently decarbonizes.

The question then is to what extent should firms look to shorten their supply chains? This is a question for all businesses. Motivations for outsourcing production has primarily been cost; but if delivery is no longer secure then costs become difficult to anticipate and control. Firms are bringing back operations to home or trading territories. In some cases, outsourcing IT service providers such as Tata and Infosys are opening subsidiaries in trading areas satisfying a dual need of security and some degree of domestic employment. Cost is becoming less of a determinant of operations.

For some sectors, however, costs are very sensitive and domestic production remains infeasible. The apparel industry is a case in point, and particularly where so-called “fast fashion” is involved. Companies like H&M and Inditex used to lead in this field, but newcomers such as Shein and Boohoo have slashed design-production-delivery times. The concept of “ultra-fast-fashion” has now entered the lexicon. To do so, however, by definition, ensures that planetary boundaries are breached (t-shirts for under €5 cannot reflect the full-costs of production). Moreover, the business model promotes disposability and consumptive culture. These clothes are sometimes to be worn once only. In the new era, consumers are advised to buy only three new items of clothing in any year!

Other sectors suffer from a concentration of supply; for example, micro-chips. Micro-chips are ubiquitous largely due to the cost efficiencies associated with high-volume specialized manufacture. Over time, the forces of globalization have resulted in a so-called comparative advantage for a few manufacturers in a few countries (for example, Taiwan Semiconductor Manufacturing Company). It takes about 4 months to turn silicon wafers into usable chips, so disruption to demand caused by the pandemic led to reduced capacity that could not be reversed quickly when demand picked up sooner than analysts had anticipated. The industry itself has many stakeholders – the machine tools are equally specialized and do not sit in warehouses waiting for buyers. Building new factories, equally, takes time and does not relieve short-term demand challenges. Chips are increasingly strategic commodities – hence states/governments have started to act to secure supply of this vital commodity in the face of external threats and the normal business cycle (of which the chip business cycle is notoriously cyclical and liable to disruption.

Supply chain relationships

Security of supply is often determined by the types of relationships between stakeholders. These are discussed at length in Chapter 12 of the text. However, a distinction can be made between transactional- and non-transactional relationships in the supply chain. Globalization has arguably led to increasing transactional relationships based on cost and price. Many consumers are used to purely transactional relationships – order a product and receive it on the basis of a fixed price and specified delivery time. Non-transactional relationships have a transactional element, but the relationships between customer and supplier are mediated by some degree of trust, itself a product of long-term partnership, authenticity (see chapter 12 of text), appreciation of cultural difference and norms, shared intellectual property and/or strategic partnership, perspective and purpose.

Sustainable business models

Meeting the challenges of climate change, the sustainable development goals and other external shocks to the business of business arguably requires some innovation in, and reconfiguration of, business models. For Tunn, et al (2019), there are three components of a (sustainability-focused) business model each with their own factors:

  • value proposition (what value is provided and to whom?)
    • product service
    • customer segments and relationships
    • value for customer, society and (natural) environment
  • value creation and delivery (how is value provided?)
    • activities
    • resources
    • distribution channels
    • partners and suppliers
    • technology and product features
  • value capture (how does the company make money and capture other forms of value?)
    • cost structure and revenue streams
    • value capture for the environment and society
    • growth strategy ethos

What is observable from this categorization is the merging of traditional business model measures and environmental and social factors. On the one side, we have argued that sustainability/zero-carbon potentially bestows short- to medium-term competitive advantage. critical here is a question of value capture and ways in which other forms of value can be captured and leveraged. For example, carbon negative firms (i.e. those that generate carbon credits, for example, by generating a surplus of renewable electricity), can trade their surpluses. Moreover, those firms with a knowledge of carbon accounting and systems can leverage such a capability as strategic (valuable, rare, inimitable, organizationally supported).

In the new era of ESG accounting, the natural environment has intrinsic value both to the firm and the customer. There is room here for firms to demonstrate a social return on investment (Chapter 10 of text). Essentially, calculating in addition to the value of an investment in terms of financial return for the firm, but also the additional value apportioned to society more widely. For example, the building of a new stretch of railway can facilitate otherwise immobile people to seek and get work through which they enhance their wellbeing (and that of their families), have a reduced call on health services, etc. These have monetary value that firms can demonstrate in reporting their performance.

This feeds into the growth strategy ethos – what is growth for? Who benefits? How can – and should – the benefits be shared? The challenge is to revise growth indicators to reflect a social and environmental value.

Old and new

Assuming that business is at a point where some radical thinking is in order to address the climate crisis, what is old and what is new in terms of thinking. The table below offers some thoughts:

The purpose of the firm is discussed at length in the text (chapter 12). The problem with purpose as a concept is that often firms capture purpose in a mission statement but not in their articles of association. There are some discussions about the legality of not profit-maximising, again covered in the text, but we can illustrate with the example of Google. The founders’ mission (stated purpose) of the company was “to organize the world’s information and make it universally accessible and useful.” This is a good purpose providing the information that is organized is accessible and democratic. However, the purpose of Google/Alphabet, legally, is to leverage that information for profit. It becomes a private rather than public good. Caution is needed, therefore, in translating mission statements and legal purpose. Many of the ideas in the text are drawn from the British Academy project, The Future of the Corporation. The project is well worth engaging with, as are Colin Mayer’s books, in particular, Prosperity.

Business models need to be adapted. The table below offer four challenges: extraction, energy, waste and product:

This section has focused on opportunities for firms that may be reluctant to invest in carbon reduction and sustainability more generally. It suggests that sustainability is a source of competitive advantage, but some of the benefits may need to be deferred; at the very least, managers need to think carefully about the firm’s role in the future – on a planet that is warmer and one for which resources are scarcer and probably more expensive and regulated.

One simple rule for using SWOT in the age of climate change (in 50 seconds)

Indicative solutions to questions concluding the chapter