MGMT 235 Sustainability

Management and Governance

8. Sustainability markets
and strategy

Ted Tschang
Recap

• Measures
• What are their purposes (for whom’s use and how)
• Indicators – institutions
• LCA – uses, challenges in use
• In this lecture, measures can be incorporated into
strategic decision-making
Outline

• What is strategy (recap)

• Benefits of engaging in a sustainability strategy
• 5 environmental approaches (“strategies”)
• Details on product differentiation, risks
Recall: Selected benefits of sustainability strategies
(goals if they create strategic advantage)

• 1. Creation of markets for environmentally differentiated

products
• 2. Eco-efficiency (cost-efficiency with sustainability, e.g.
pollution prevention via toxics reduction)
• 3. Creating competitive advantages that is further
leveraged (e.g. having a capability to do …)
• 4. Reputational advantage (by engaging in …)
• 5. Key stakeholders engaged (collaborating with
stakeholders or satisfying their needs)
•  all covered by Reinhardt next (#4 is related to risks)
• (Except #3 which is seen in traditional strategy courses)
• Notes that sustainability decisions are for the long run
Integration of environment into business thinking (based
Reinhardt’s 1999 HBR, Bringing the environment down to earth –a different reading
from the reading list’s, which is Reinhardt 1998 *)

• Reinhardt proposes 5 approaches to integrate environment

into business strategic thinking
• 1. Differentiate products, charge higher prices
• Note: this is the topic of our reading: Reinhardt (1998)
‘Environmental Product Differentiation’
• 2. Manage competition (working with partners)
• 3. Simultaneous cost efficiencies with protecting environment
• 4. Manage risks to reduce legal etc. costs
• 5. Systemic changes to redefine markets
• Note:
• we focus on #1, 4 today. #3 was in natural capitalism, #2 is
company is guided by stakeholders
• To a degree, may also apply to social attributes
Bringing the environment down to earth
(Reinhardt 1998)
• Note: Reinhardt provides an early conception of how to
integrate sustainability (specifically, the environment)
with core strategy concepts
• Represents conventional business economics thinking on
the firm (i.e., thinking in terms of a profit maximization
model), but which is still current thinking
• In the terms of the “’sustainable finance’ models
(lesson 7),
• Perspective is like Sust. Fin. level 1.0 (where F >> S and E),
or between 1.0 and 2.0 (I = F+S+E), but not yet at 2.0
• Also considered a compliance or beyond compliance (e.g.
involves pollution prevention, product stewardship *)
Reinhardt’s 5 Strategies – relates to
other bodies of business knowledge
• Relates to other functional areas of business – e.g. to
sustainability markets
• concept of ‘environmental product differentiation’
connects markets to strategy
• May involve practices on technology or practice level -
- e.g. industrial ecosystems (biomimicry), eco-efficiency
(“win win” practices)
• Strategies may involve new business models (as part
of implementation of the strategy)
• As differentiated products need to be sold differently
• e.g. turning product into service models (e.g. in natural
capitalism)
Strategy #1. Environmental Product
Differentiation (see Reinhardt 1998 California Mgmt.
Review for full explanation)

• Provides a simple framework for thinking about what

criteria firms should consider make in order to make a
decision on an environmentally friendly product (EFP).
• Whether an EFP
• Creates environmental benefits (over environmental costs)
• But that potentially raises business costs
• And enables the business to capture market share (i.e.,
consumers are willing to pay) with any price premium (or
firm has to be at least as well off as before)
• Note
• Strategy is most clearly rooted in business economics,
consistent with profit-maximizing or –seeking theories
Strategy #1. Three conditions for
environmental product differentiation
• (1) The business must find, or create, a willingness
among customers to pay for environmental quality
• (2) The business must establish credible information
about the environmental attributes of its products
• (3) Its innovation must be defensible against imitation
by competitors.

• If any of the 3 break down, product differentiation may

not work

• (Slides based on Reinhardt 1998)

Strategy #1. Three conditions for
environmental product differentiation
(1) The business must find, or create, a willingness
among customers to pay for environmental quality
• WTP measures (by survey) the “value” to the public of
an environmental amenity, or a “quality” (i.e., feature)
of a product
• Condition is directly related to economics - as part of
internalizing externality, need consumers to pay for it.

• Cases
• Successful … Patagonia because …
• Failure … Starkist because …
Strategy #1. Three conditions for
environmental product differentiation
• (2) The business must establish credible information
about the environmental attributes of its products
• Condition is related to imperfect (market) information
from economics (as part of internalizing externality)
• In economics, markets often assumed to have perfect
information, but we know that real world markets do not
• Consumers need to know what environmental attributes
they are paying for, and why
• How do we make information credible?
• Cases
• Successful …Patagonia because …
• Failure … Monsanto because …
Strategy #1. Three conditions for
environmental product differentiation
• (3) Its innovation must be defensible against imitation
by competitors.
• Condition is related to Porter’s 5 forces (barriers to entry).

• What are some barriers to entry?

Cases
• Successful … Ciba inputs – because …
• Failure … “Dolphin safe” – because …
Strategy #2. Managing the competition
- by working with “partners”
• Industry associations, cooperation with government etc.
• Reputational effect can involve eco-labels and certification (or
joining associations can resemble the effects of such labels), but
associations also share best practices, coordinate actions etc.
• e.g. Responsible Care - Industry association of leading
chemical firms that formed in 1988 to circumvent impending
government regulation
• Ejects members for noncompliance
• Abide by 6 management codes on pollution prevention, process
safety, emergency response (i.e., practices for sustainability)
• Reduced toxic releases by more than other industries (by 50%
between ‘88 and ‘94)
• As a result: Firms improved their competitive position
… #2 Industry association (as ‘stakeholder’) –
firms’ motivated by reputational effects
• Awareness at the industry level combined with some
entrepreneurship created new institutions
• E.g. industry associations like chemical industry’s CERES
which became today’s Responsible Care
• Advocating better practices
• This occurred in the post-regulatory, pollution prevention
“era” (1990s on), and continued on into the sustainability
era
• Problem: inequitable outcomes in small vs. large firms
• Larger firms saw in it their own interest to join these, as it
creates a reputational effect differentiating them from
smaller competitors (who could not join due to their small
scale making it harder to abide by the practices)
#3. Saving costs with environmental protection

• About: Reconciling shareholder value with

environmental management
• E.g. cutting both business (input) costs and cleanup costs
by reducing harmful or polluting inputs, outputs or
wastes
• Related to eco-efficiency *
• E.g.s
• hotel chains’ reduction of shampoo volumes, sheet
washing etc.
• Xerox’s 1990 environmental leadership program:
• waste reduction, product takeback, design for environment
… #3. Saving costs with environmental
protection
• #3 also captures the earlier practice of pollution prevention
• Many low hanging fruits (easy to perform and achieve practices)
were already discovered by the chemical and other industries (see
previous slide on ‘Responsible Care’).
• After low hanging fruit is achieved, innovations are still possible but
may be harder to achieve (e.g. reengineering of business processes
to cut back on waste/become more efficient).
• Also relates to eco-efficiency (concept from natural capitalism)
• Some eco-efficient or environmentally-friendly practices
reduced costs but needed the cooperation of consumers
• E.g. hotels’ adoption of practices to sacrifice a little cleanliness (e.g.
not washing the sheets everyday) required guests’ cooperation, but
essentially also gave them “choice” since guests could choose to
have the sheets washed.
#4. Integrating risk management

• About ensuring that environmental risks are also costed in

terms of effects on the company (positive and negative)
• E.g. the BP oil drilling disasters (see earlier class)
• risks to operations came from not operating with full risk
coverage, sacrificing safety to cost reducing behavior

• Question is: How should environmental risks be treated?

• Often treated by firms as safety risk, not as financial risk (first
is operational, second is strategic in nature).
• A few cases do show that risks can be translated into social
and even financial returns: that the provision of environmental
goods… can cost effectively reduce long-term business risk
… #4 - Integrating risk management
• Reinhardt points out that environmental risk is hard to
measure, but needs to be combined into an overall risk
management strategy
• Reinhardt was not clear here on how to measure environmental
risks, but his was an early viewpoint before practices on the
management of sustainability risks matured.
• Risks can concretely be assessed as potential for negative
impacts of a firm’s actions on for e.g.:
• Firm’s bottom line (costs), e.g. legal costs, liabilities
• Firm’s reputation (future profits when customers lose trust)
• Firm’s stakeholders (e.g. loss of jobs)
• Firm’s culture, e.g. morale (loss of motivation to workforce), e.g.
Google may have suffered problems after firing its top AI ethics
researchers for speaking out about problems with AI.
#4. Integrating risk management

• There are different conceptions of risk

• Probability theory used in Finance – options theory and
portfolio theory is simplest use
• Scientific risk assessment
• Business use involves version of scientific risk applied to firm
• Next slides expand on Reinhardt’s point to include
discussion by Bekefi and Epstein (which some of the
following slides is drawn from)
• How do we recognize and capture risks
• Easier when risks are known, what if unknown, or low
probability? Harder to prepare for?
• Or, should better operating firms should reduce room for
accidents
…#4. Integrating risk management: (Bekefi
and Epstein, 2006 *)

• Societal perceptions of the connections between a

company and particular social and political risks can
cause enormous costs to companies, regardless of the
company’s direct involvement in the issue.
• Whether society is reacting to a real or perceived risk, it
may take action, including consumer boycotts, leading
to loss of sales or increased regulation
• that negatively affect a company, whether by (a)
increasing its costs, or (b) prejudicing its achievement of
business objectives or its ability to carry out its strategies.
• Thus, managing these types of risks is critical, whether
they are real or perceived.
…#4. Integrating risk management: (Bekefi
and Epstein)

• In 2006, a McKinsey survey found

• Only 3% of the 4,238 executives who responded to a poll
reported that their companies were doing a good job of
anticipating risk.
• 46% of respondents said they have “substantial room for
improvement.”
• Qualitative approaches (to risk assessment)…
• since the mid-1970s, when multinational firms, particularly
in the extractives and banking industries, built in-house
teams employing political scientists and former CIA and U.S.
State Department personnel. These teams looked at risk
assessment qualitatively, producing detailed local briefings
that outlined challenges in various locations.
…#4. Integrating risk management: (Bekefi
and Epstein)

• From the qualitative model emerged efforts to quantify

political risk, to make it more relevant to corporate
management.
• Including:
• Scorecards
• Statistical analysis
• Scenario-based methods (Next slides)
• Adjusted discount rate and cost of capital *
• … this method is difficult to implement.
…#4. Integrating risk management: (Bekefi
and Epstein)

• Scenario-based methods - If quantified, can calculate as:

• Exposure = (event) x (hypothetical likelihood) x (hypothetical
consequence)
• Note: Similar to scientific risk assessment:
• Risk = Likelihood x severity of impact [calc as impact to individual x total
population]
• (Risk) mapping (through scenarios) as currently practiced (*) does not
provide a link to the financial statement, or to the ROI calculation that
is critical for comparisons between possible project options.
• This causes risk to be devalued in financial decisions.
• With some modification, including assignment of monetary values to
the hypothetical consequences, … such a risk map could correlate to
financial data and be integrated into ROI...
• Authors appear to propose a combination of specific risk assessments and
translation into financial (monetary) impact
…#4. Integrating risk management: (Bekefi
and Epstein)

• There are numerous types of “accountability” (liabilities etc.)

affecting companies operating in other countries, For e.g.
• Affected by (local national) regulations and fines
• Local government corruption
• Legal liabilities, e.g., lawsuits
• Accusation of profiteering from natural resources, despoiling the
environment
• Unsafe or unethical labor conditions, e.g. conflict diamonds
• Involvement in conflicts causing local inequity, etc.
• Cost of disruptions and closure
• Consumer boycotts *
• Damage to reputation *
• Lost of access to financial capital *
* typically considered in sustainability by frameworks and firms
Summary

• 5 environmental strategies (variant of F >> E+S model)

• Discussion on environmentally differentiated products,
sustainability markets
• Discussion on risks
• Discussion of Shipbreakers – does LCA, risk assessment
and CBA still play a role