Green to Gold

How Smart Companies Use Environmental Strategy to Innovate, Create Value, and Build Competitive Advantage
By Daniel C. Esty Andrew S. Winston

Yale University Press

Copyright © 2006 Daniel C. Esty and Andrew S. Winston
All right reserved.

ISBN: 978-0-300-11997-8


Chapter One

Eco-Advantage

Washington, D.C.: General Electric CEO Jeff Immelt announces a new initiative, "ecomagination," committing the mega-manufacturer to double its investment in environmental products-everything from energy-saving lightbulbs to industrial-sized water purification systems and more efficient jet engines. Backed by a multi-million-dollar ad campaign, Immelt positions GE as the cure for many of the world's environmental ills.

Bentonville, Arkansas: In a speech to shareholders, Wal-Mart CEO Lee Scott lays out his definition of "Twenty First Century Leadership." At the core of his new manifesto are commitments to improve the company's environmental per- formance. Wal-Mart will cut energy use by 30 percent, aim to use 100 percent renewable energy (from sources like wind farms and solar panels), and double the fuel efficiency of its massive shipping fleet. In total, the company will invest $500 million annually in these energy programs. Moreover, in a move with potentially seismic ripples, Wal-Mart will "ask" suppliers to create more environmentally friendly products: some of the fish Wal-Mart sells will have to come from sustainable fisheries, and the clothing suppliers will use materials like organic cotton. "We believe that these initiatives will make us a more competitive and innovative company," Scott emphasizes.

By either market cap or sales, GE and Wal-Mart are two of the biggest companies in human history. Neither company springs readily to mind when you say the word "green." But these are not isolated stories. Companies as diverse as Goldman Sachs and Tiffany have also announced environmental initiatives. As the Washington Post observed, GE's move was "the most dramatic example yet of a green revolution that is quietly transforming global business."

What's going on? Why are the world's biggest, toughest, most profit-seeking companies talking about the environment now? Simply put, because they have to. The forces coming to bear on companies are real and growing. Almost without exception, industry groups are facing an unavoidable new array of environmentally driven issues. Like any revolution, this new "Green Wave" presents an unprecedented challenge to business as usual.

NEW PRESSURES

Behind the Green Wave lie two interlocking sources of pressure. First, the limits of the natural world could constrain business operations, realign markets, and perhaps even threaten the planet's well-being. Second, companies face a growing spectrum of stakeholders who are concerned about the environment.

Global warming, water scarcity, extinction of species (or loss of "biodiversity"), growing signs of toxic chemicals in humans and animals-these issues and many others increasingly affect how companies and society function. Those who best meet and find solutions to these challenges will lead the competitive pack.

The science, we stress, is not black and white on all these issues. Some problems, like ozone layer depletion or water shortages, are fairly straightforward. The trends are plainly visible. On other issues-climate change most notably-uncertainties persist, but the evidence is clear enough and the scientific consensus strong enough to warrant action.

A broad-based set of players now insists on attention to these issues. Government, the traditional superpower of influence on corporate behavior, has not gone away. Far from it. Regulators worldwide no longer turn a blind eye to pollution. Citizens simply won't allow it. Across all societies, we see serious efforts to control emissions and make polluters pay for the harm they cause.

Other actors, however, now play prominent environmental roles on the business stage. NGOs, customers, and employees increasingly ask pointed questions and call for action on a spectrum of issues. To give just one example, HP says that in 2004, $6 billion of new business depended in part on answers to customer questions about the company's environmental and social performance-up 660 percent from 2002. These demands reshape markets, create new business risks, and generate opportunities for those prepared to respond.

The breaking news is the arrival of a new set of stakeholders on the environmental scene, including banks and insurance companies. When the financial services industry-which focuses like a laser on return on investment-starts worrying about the environment, you know something big is happening. Wall Street stalwart Goldman Sachs announced that it would "promote activities that protect forests and guard against climate change." The company said it would "encourage" its clients to act greener and pledged $1 billion for investment in alternative energy, having already bought a company that builds wind farms. Even for Goldman, a billion dollars is not a token gesture. JPMorgan, Citigroup, and other big names have made similar commitments-and they have signed on to the "Equator Principles," which require environmental assessments of major loans.

For a painful example of how this one-two punch of natural forces and new stakeholders can slam a company, just ask Coca-Cola's two most recent ex-CEOs, Doug Ivestor and Doug Daft. Within the past five years alone, the world's largest soft-drink manufacturer faced angry protests in India over its water consumption, came under pressure to stop using refrigerants that hurt the ozone layer, and withdrew its flagship bottled water Dasani from the British market after the supposedly purified drink failed European Union quality tests. Today, the company has a vice president dedicated to water and environment issues, Jeff Seabright, and a new CEO, Neville Isdell, who works closely with the company's Environmental Advisory Board, on which one of us (Dan) serves.

THE BUSINESS CASE FOR ENVIRONMENTAL THINKING

We see three basic reasons for adding the environmental lens to core strategy: the potential for upside benefits, the management of downside risks, and a values-based concern for environmental stewardship.

The Upside Benefits

Nobody, not even market-savvy Toyota, could have predicted the success of its hybrid gas-electric Prius. Given the poor track record of electric vehicles, this leap of faith was anything but a clear path to profit. Yet Toyota executives saw potential value down the road, and they could not have been more correct. After a decade-long research push, the Prius was named Motor Trend's Car of the Year in 2004, by which time customers were waiting six months to get their hybrid cars. While Detroit was nearing bankruptcy, laying off tens of thousands of workers, and offering "employee discounts" to everybody, Toyota was raising prices, expanding production, collecting record profits of $11.8 billion in 2006, and closing in on the title of world's largest automaker.

Toyota's green focus is no accident. In the early 1990s, when Toyota wanted to design the 21st-century car, it made the environment a major theme, ahead of all the selling points that automakers traditionally used: size, speed, performance, or even ability to attract beautiful girls or hunky guys. Smart move.

Similarly, BP has rebranded itself as an energy company, preparing to move "beyond petroleum" and investing in renewable energy. These companies have figured out that it's better to remake your marketplace and eat your own lunch before someone else does.

Our research suggests that companies using the environmental lens are generally more innovative and entrepreneurial than their competitors. They see emerging issues ahead of the pack. They are better prepared to handle the unpredictable forces that buffet markets. And they are better at finding new opportunities to help customers lower their costs and environmental burden. By remaking their products and services to respond to customer needs, they drive revenue growth and increase customer loyalty.

The "gold" that smart companies mine from being green includes higher revenues, lower operational costs, and even lower lending rates from banks that see reduced risk in companies with carefully constructed environmental management systems. They also reap soft benefits, from a more innovative culture to enhanced "intangible" value, credibility, and brand trust.

Scholars and pundits have noted that businesses now face a world where traditional elements of competitive advantage, such as access to cheaper raw materials and lower cost of capital, have been commoditized and whittled away. On this altered playing field, going green offers a vital new path to innovation and to creating enduring value and competitive advantage. Nike executive Phil Berry puts it simply: "We have two maxims. Number 1: It is our nature to innovate. Number 2: Do the right thing. But everything we do around sustainability is really about number one-it's about innovation."

The Downside Risks

Inside oil giant Shell, executives use the acronym TINA-There Is No Alternative-to explain why they do some things. To them, thinking about how climate change affects their business or caring how stakeholders feel about the company is no longer optional. It's just a fact of life. Even through well-publicized problems with local communities and governments in places like Nigeria, Shell has continued to hone its stakeholder relations skills. The company spends millions of dollars working with the people living around key oil and gas projects such as the massive Athabasca Oil Sands in British Columbia, Canada.

As head of Shell's famed scenarios group, Albert Bressand helped the executive team think about what could hurt the company in the long term. As he told us, "We are a prisoner of the market.... there are people who can remove our license to operate."

The idea behind license to operate is simple: society at large allows companies to exist and gives them a certain leeway. If your company oversteps the bounds, societal reactions can be harsh and, in severe cases, destroy the company. Former partners of Arthur Andersen learned that lesson at great cost when the accounting giant vanished in the wake of the Enron scandal. Or remember the case of chemical industry leader Union Carbide? After the company's 1984 disaster in Bhopal, India, which killed over 3,000 people, Union Carbide's future fell apart until finally it was swallowed by Dow.

More pointedly, society's expectations about company behavior are changing. A company that abuses the local environment can find it impossible to get permits to expand operations. Regulators, politicians, and local communities raise fewer barriers for good neighbors.

Heavy industries are especially aware of this social license issue, but others feel the heat as well. After years of unfettered expansion, Wal-Mart has come under fire from protestors who contend that the company's stores increase sprawl, destroy wetlands, and threaten water supplies. In some communities, regulators have joined the chorus and begun to impinge on the retail giant's expansion plans. In internal meetings, Lee Scott told Wal-Mart executives that their sustainability efforts would help protect the company's "license to grow."

Environmental challenges can seem like a series of small holes in a water main, slowly draining value from the enterprise. Or they can appear suddenly as major cracks in a dam and threaten the entire business. Maybe the problem is unexpected costs for pollution control or a cleanup for which nobody budgeted. Maybe it's a very public disaster like the Exxon Valdez. Sometimes, too, the downside of mismanaging these issues can get very personal. Executives who preside over the mishandling of toxic waste, for example, can face jail time.

Efforts to cut waste and reduce resource use, often called "eco-efficiency," can save money that drops almost immediately to the bottom line. Redesign a process to use less energy, and you'll lower your exposure to volatile oil and gas prices. Redesign your product so it doesn't have toxic substances and you'll cut regulatory burdens-and perhaps avoid a value-destroying incident down the road. These efforts lower business risk while protecting the gold-reliable cash flows, brand value, and customer loyalty, for example-that companies have painstakingly collected over time.

The Right Thing to Do

Repeatedly during our research we asked executives why their companies launched environmental initiatives, some of which cost significant money up front and had uncertain paybacks. More often than you might imagine-and far more often than we first expected-they said that it was the right thing to do.

Is the case for thinking and acting environmentally based on values? Not primarily. At least that's not what we heard from the executives we interviewed. For most of them, the moral argument was not a separate imperative. It was deeply intertwined with business needs. Building a company with recognized values has become a point of competitive advantage, whether you have 2 employees or 200,000. Doing the right thing attracts the best people, enhances brand value, and builds trust with customers and other stakeholders. In fact, it's hard to conceive of a business asset more central to long-term success than trust among stakeholders-or one that is more easily lost. As investing legend Warren Buffett once said, "It takes twenty years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently."

Even those who agree with Nobel Prize-winning economist Milton Friedman that the main "social responsibility of business is to increase its profits" can't ignore the growing ranks who believe that companies have an obligation to do more. The logic of corporate environmental stewardship need not stem from a personal belief that caring for the natural world is the right thing to do. If critical stakeholders believe the environment matters, then it's the right thing to do for your business.

MAGNIFYING FORCES

The Green Wave, with its threats and opportunities, rises within a business landscape already in the throes of radical change. Companies face a number of mega-trends that interact with the effects of the Green Wave, accelerating change and magnifying its impact and scope.

Globalization and Localization

As author Thomas Friedman describes it, outsourcing is just the tip of the iceberg. The "flattening" of the global markets for goods and services will disrupt nearly all industries. The continued rise of both China and India seems likely to have a profound effect on businesses across the world, especially in North America and Europe.

Economic integration and trade liberalization intensify competition. Globalization creates opportunities for many, but fundamentally rewards scale. Size, however, creates suspicion of excess power. Large enterprises come under extra scrutiny for their business practices, including environmental impacts.

Simultaneously, the world is fragmenting, with niche markets demanding tailored products and services. For example, in many of its restaurants in India, McDonald's serves curry, not its brand-defining hamburgers. Operating in ways that respond to localized needs and preferences is becoming essential. The scale of environmental issues, ranging from entirely local to inescapably global, only adds to the complexity of this already daunting management challenge.

Insecurity

The security tensions that have swept through the United States and much of the rest of the world in the wake of 9/11 are changing public attitudes and the political landscape. Beyond fears of terrorism, there's a growing public distress over reliance on oil from the Middle East. Increasingly, people express a willingness to pay a premium for fuel supplies closer to home, including alternative energy sources such as wind or solar power. Thus, the energy future looks very different from the past, with profound environmental consequences.

(Continues...)



Excerpted from Green to Goldby Daniel C. Esty Andrew S. Winston Copyright © 2006 by Daniel C. Esty and Andrew S. Winston. Excerpted by permission.
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