Companies Discover the Costs and Benefits of Being Environmentally CleanPublished: January 14, 2005 in Knowledge@Wharton
Businesses ignore the environment at their peril. If they spew air and water pollution, they could find themselves the target of protests, lawsuits and unflattering media coverage. Even so, scholars still wrestle with such fundamental questions as how best to encourage companies not to pollute and why some firms flaunt their adherence to environmental norms, while others continue to flout the law.
A practitioner and a professor who participated in the United Nations Global Compact Academic Conference titled, "Bridging the Gap: Sustainable Environment," which was held recently at Wharton, have come to different conclusions on these questions. Jim Hagan, vice president of corporate environment health and safety at GlaxoSmithKline, says his company, one of the world's leading drug makers, was motivated by a combination of pragmatism and pride. Glaxo concluded that pollution imposed costs, both in dollars and in harm to its reputation. But it also wanted to be seen as a responsible steward in the communities where it operates.
Michael Lenox, a management professor at Duke University, analyzes the situation differently. He and two colleagues studied why companies seek out certification for their environmental management systems from the International Organization of Standardization, a private-sector body. They concluded that firms do it not to appease environmentalists or win kudos in the press but to send a signal to potential customers. These firms want their customers to know that they're safe partners. "Think of Ford wanting to have its suppliers certified to manage some of the liabilities that it might face from the suppliers' activities," Lenox explains.
Hagan began his career at GlaxoSmithKline about two decades ago. At the time, few of the company's top managers believed that the company was polluting. "Put yourself in their minds," he says. "We make little pills, and our facilities are generally very clean, pristine even. When I met with one of our vice presidents, he said, 'Jim you're a nice guy, but why did we hire you? What environmental problems do we have?'"
As the U.S. government began to monitor toxic emissions more assiduously, Glaxo's managers soon learned that they did pollute. "Remember the movie Erin Brockovich? We had fact patterns that were similar to what Pacific Gas & Electric faced in California, where Erin Brockovich took place," Hagan recalls. "In one situation, a site manager in California created a [wastewater] lagoon, and that lagoon leaked and went right through to drinking water of the surrounding community."
Unlike PG&E, Glaxo didn't try to stymie its opponents in court. It settled its lawsuits and set about cleaning up its polluted sites. "We spent well over $250 million remediating those sites," Hagan notes. "The lesson we learned was that the environment matters and not just because it was ethical. It had a real impact on the bottom line."
Glaxo's executives also learned that a poor environmental record could impose harder to quantify costs. Some site managers, who were accustomed to being seen as community leaders, found themselves being vilified in the press. "These were people you'd go to if you wanted to create a Little League," Hagan says. "All of the sudden, they were tarred in the op-ed pages. After that, they were very keen to have me work with them."
In the end, these experiences motivated Glaxo to do more than simply clean up its messes. It decided to try to slash its amount of waste and announced that it would halve it within five years. "We spent millions. And in five years, we were able to reduce emissions by more than 99%. Over the long term, that really helped the bottom line. We made our drugs in a more cost-effective way, and we didn't have the same problems and costs of dealing with regulatory agencies."
Those successes have made the company more aware of its environmental impact and have motivated it to try to protect its reputation as an environmental leader. That has meant trying to anticipate problems, rather than merely responding to them. These days, for example, a team of scientists assesses the "total lifecycle impact" of each drug that GlaxoSmithKline produces, Hagan says. They measure everything from waste produced during manufacturing to the amount of residual chemicals that patients who take the drugs excrete. "Our biggest impact is probably from our patients getting in their cars and driving to the pharmacy," Hagan quips. Jokes aside, GlaxoSmithKline is seeking ways to reduce this sort of pollution, too. Like its patients, its sales people drive millions of miles a year as they visit doctors' offices. The company has begun to ponder whether it can sell drugs and communicate with physicians in more efficient ways, Hagan says.
Given the effort that GlaxoSmithKline expends on environmental management, it would seem to be an ideal candidate to have its environmental systems certified by the International Organization of Standardization. After all, certification would give it bragging rights. But Lenox and his co-investigators - Andrew King at Dartmouth College and Ann Terlaak at the University of Wisconsin at Madison - have found the opposite. It's not clean companies that seek certification, but rather dirty ones, that is, those producing more toxic emissions.
To understand why, it is important to understand the certification process. It requires that companies have environmental management systems (EMS). It doesn't mandate that they reach particular performance goals such as, say, cutting their emissions by 20%. That structure - approval for systems, not performance - raises the question of what certification really proves: Does it point to top performers or merely companies that are trying to do better? "There's always been a belief that it represents the good guys out there, that it's a signal that a firm is a superior performer," Lenox notes.
The U.S. Environmental Protection Agency has pondered whether certified firms should be given fast-track consideration for emissions permits. Based on the research by Lenox and his co-authors, they shouldn't. After all, the scholars find that these firms pollute more than noncertified firms do. "It's kind of a shocking finding," Lenox admits. "How do we make sense of it? My co-author likes to use the analogy of a 1980 Buick vs. a 2002 BMW. If you have the Buick, you most likely have a maintenance plan in place, and it therefore performs better than it otherwise would. But it'll never perform like a 2002 BMW. I think that older facilities are finding that they need environmental management systems to get their hands around their emissions, whereas newer, cleaner facilities don't need to go that route."
The three scholars further find that instituting an environmental management system leads to performance improvements but that seeking certification of that system doesn't yield any additional improvements. If the best performers aren't seeking certification, companies must be doing it for reasons other than demonstrating their environmental prowess, Lenox argues. Similarly, if they were interested only in improving their performance, they could put systems in place without seeking certification.
So why do companies ask to be certified? Lenox believes it's a way of saying to their customers, "We may be polluting, but we're trying to do better and care about our performance." If this is true, firms that are, for example, located at a distance from their suppliers and customers should be more likely to seek certification. A firm next door to its customers could just invite them inside to examine its operations. But one that's far away would have to find other means of signaling its soundness - like certification. And this is exactly what Lenox and his co-authors discovered - firms that are farther from their customers are more likely to get certified.
The same holds for firms that are tightly integrated with their suppliers. Take, for example, a company that supplies parts to a big automaker. The supplier functions almost as a division of the car company and, because of their closeness, the market no longer disciplines their relationship; it's too costly and time consuming for the carmaker to constantly shop for new suppliers. Both parties are aware of this imbalance, so the supplier might seek certification to show that it's still striving to operate efficiently.
Lenox calls such situations "information asymmetries." Where two parties to a transaction have unequal information about each other, they suffer from an asymmetry. The classic example of this predicament is the sale of a used car. Assuming the seller is the original owner, he knows everything about the car's history, while the buyer has only what he can glean from inspecting the car.