Clearing the Air: How Companies Operate in a Climate-conscious EraPublished: June 11, 2008 in Knowledge@Wharton
Where to locate a new headquarters, how to close a supply-chain loop, how to anticipate customer demands: These are all decisions that companies must wrestle with as they respond to increasing concerns about global warming. According to Timothy Juliani, a senior fellow at the Arlington, Va.-based Pew Center on Global Climate Change, global warming "involves everything. It's a function of how we live our lives, the way we use energy, how we manufacture and transport goods. In that sense, humanity has never faced something quite so systemic."
With so many moving parts, how do companies gather intelligence and know what steps to take in a new climate-conscious era? Should they prioritize upgrading their corporate headquarters to environmentally friendly standards, or rush a new product to market that appeals to green consumers? Wharton faculty and other experts note that companies have to rely on a combination of internal and external resources, often feeling their way forward, as they try not only to manage the risks of climate change, but also to gain a competitive edge.
For major companies based in the United States and beyond, responding to climate change is no longer optional, says Paul Kleindorfer, an emeritus professor of operations and information management at Wharton. "Increasingly, shareholders and non-governmental organizations are operating in a very strong, vocal fashion to insist that companies at least understand their environmental impact." And with all the three presidential candidates endorsing so-called "cap-and-trade" legislation, which aims to provide economic incentives to reduce carbon emissions, climate-related regulation is a "certainty," adds Eric Orts, director of Wharton's Initiative for Global Environmental Leadership.
According to a 2007 report from Manhattan-based investment bank Lehman Brothers, companies must consider not only their regulatory exposure, but also their vulnerability to the physical effects of global warming, competition from other businesses, and reputational exposure, including the risk of being targeted for a lawsuit. "The firms that will prosper in a climate-changed world will tend to be those that are early to recognize its importance and its inexorability, foresee at least some of the implications for their industry, and take appropriate steps well in advance," says the report, "The Business of Climate Change," authored by Lehman Brothers' senior economic policy advisor, John Llewellyn.
With some of these risks in mind, many companies are now engaged in "scenario planning," or trying to assess not only the uncertainties around how and when planetary warming will begin to have a physical impact, but also how the public may react to such climate-related events, says Kleindorfer.
"Imagine the consequences of a major piece of Antarctica breaking off and moving into the South Atlantic, or another season of Category 4 or 5 storms. The contagion effect of an alarmed public could drive legislation with very strong impacts on company operations, particularly for those with environmental exposure," notes Kleindorfer, who currently a research professor at INSEAD in France. "Businesses must put in place systems that will steer their companies, with some degree of grace, through these events, should they ever materialize."
While some in the wider public may debate whether global warming is man-made or not, Orts says decision makers in most companies have moved beyond questioning the science underpinning the assumptions of climate change. "As some companies put it to me, whatever the science, there is a political reality of climate-change regulation in the near future."
Confronting piecemeal environmental regulation around the country has also pushed businesses to lobby for a coherent national policy, he adds. "Legislation is inevitable, and they want to make it as rational as possible. Some see a strategic opportunity in getting out ahead of the regulation curve" by taking voluntary measures.
But which voluntary measures to take? While dream technologies can be imagined -- a car that runs on trash, or hyper-efficient solar panels -- companies must decide what can be actually achieved, says Michael Tomczyk, director of Wharton's Mack Center for Technological Innovation. "The U.S. has more coal than the Middle East has oil, but coal-fired utilities produce 40% of the carbon emissions in the U.S. The ideal technological solution might be to provide 'clean coal,' but is clean coal a myth or an achievable objective?"
Such uncertainties, however, can also open new opportunities, says Tomczyk. "Innovators love daunting challenges. Right now, researchers in companies, utilities and universities are seeking innovations that will reduce emissions from coal-fired plants, sequester carbon dioxide and provide more efficient solar cells."
Companies may find themselves out in front, pioneering green strategies whose value propositions have not yet been tested, adds Tomczyk, "but there are early indications that companies that are taking the risks are, in fact, reducing their carbon footprint and achieving quantifiable results."
To better navigate these complex scenarios, companies are turning not only to one another but also to expert non-governmental agencies, such as the Pew Center on Global Climate Change. Forty-two companies now belong to the center's invitation-only Business Environmental Leadership Council, which requires that all member companies set specific targets for reducing carbon emissions and publicly endorse the call for mandatory legislation to reduce greenhouse gas emissions.
'We Don't Need 100% Agreement'
Chicago-based Exelon, a member of the Pew Center council and a sponsor of Wharton's environmental leadership initiative, reports it is on track to meet its own goal of reducing greenhouse gas emissions by 8% by the end of this year.
According to Helen Howes, vice-president of corporate environment, health & safety for Exelon, the company is using a number of strategies to reach that goal, including shutting down inefficient plants, improving energy efficiency in administration buildings and vehicles, implementing a limited carbon sequestration program, and working with its utility subsidiaries to reduce one insulating gas in particular. Explains Howes: "We wanted to set voluntary targets to earn the right to be at the public policy table to help frame federal legislation."
In making decisions about lobbying and company practices, she says, Exelon seeks information and advice from "credible voices," such as the United Nations-sponsored Intergovernmental Panel on Climate Change, which is considered the leading voice of scientists on the issue, and non-governmental organizations like the Pew Center. In addition to building up expertise on the issue within the company, Exelon sometimes relies on outside consultants. "We also listen to employees who are concerned and want us to be as aggressive as possible on the issue, and we listen to the communities where we operate," she says. "We hear from multiple voices, and we don't always need 100% agreement to take action."
For Memphis, Tenn.-based International Paper, another sponsor of the Wharton environmental leadership initiative, experimentation and learning are part of a strategy for facing the complex risks of climate change, according to David Struhs, vice president of environmental affairs. "The approach we've taken is to get as many different kinds of experience in as many different parts of the world as we can, whether that involves environmental reporting or new product development or emissions trading. We want to have a rich set of experiences, knowing that some will pay off and some won't but that we're better off for being on the leading edge so that when things get more certain in the future, we're not trying it for the first time. We've stuck our toe in the water."
In 2003, for example, International Paper's sustainability report followed guidelines set by the Global Reporting Initiative, an Amsterdam-based non-profit that seeks to standardize and deepen sustainability reporting. "We did it to prove to ourselves that we could," says Struhs. "It seemed like a very comprehensive emerging standard for transparency in reporting, and we said, 'Let's go for it; let's learn from that experience.' We probably won't do it again, not because it was a bad experience, but because we felt we learned the lessons, and there's no magic in [the process]. We can still meet the overarching objectives of transparency and timeliness. That's what matters."
The GRI, says Struhs, included questions that were "not relevant" to the paper industry, such as questions about child labor in the developing world and health policy. "We watch what others are doing, and we benchmark [ourselves] against other companies, but in the end, we make our judgment about what we're comfortable reporting."
Struhs says International Paper tries to optimize two separate but overlapping objectives: lowering energy costs and lowering greenhouse emissions. According to Kleindorfer, making supply chains more efficient often brings those two objectives together. Mattel, the El Segundo, Calif.-based toy manufacturer, recently restructured its logistics to not only save money but also to cut down on carbon emissions. "Turns out the two are related," he says. Similarly, Wal-Mart, under pressure in the U.S. to make its operations more sustainable, started cutting down on packaging on children's toys in 2006, resulting in a savings of $2.4 million a year -- and a savings of more than 1,000 barrels of oil, according to the company's own assessment.
Large companies like Wal-Mart, says Kleindorfer, are in a position to act alone. "They don't have to wait around to get an industry group together. They can tell people in their supply chain: 'Get religion.' I think these companies feel responsible [about climate change] and they also see the long-term, almost fatal consequences of not being prepared."
One of the most uncertain aspects of climate change is how it will manifest itself in the coming decades. Coastal flooding, violent storms and an increase in tropical diseases are just some of the scenarios predicted. Each industry, even each company, will be impacted in different ways, according to an April 2008 report from the Pew Center, "Adapting to Climate Change: A Business Approach." The construction industry, for example, may have to cope with more days when conditions are too hot, or too wet, for workers to be on site.
"Not every company is going to need to act right now, but it's probably worth it for every company to see what the risks are and keep tracking them," says Juliani. For some companies, assessing a future with a warmer climate might affect decisions like where to locate a new headquarters, says Wharton's Orts. "You might think twice about relocating to Miami if you want to be there for 100 years."
One sector that is -- or should be -- particularly attuned to the long-term risks of climate change is the insurance industry, says Howard Kunreuther, co-director of Wharton's Risk Management and Decision Processes Center. According to a March 2008 report Kunreuther co-authored, insurance providers find themselves in a "new era of catastrophe." While the role of climate change is "not clear" in recent extreme weather events like Hurricane Katrina, "there is a growing concern that global warming might lead to the occurrence of much more intense hurricanes hitting the coast over a shorter period of time," write the authors in the report, titled, "Managing Large-Scale Risks in a New Era of Catastrophe." What is certain, the report states, is that "property values at risk in hazard-prone areas in the U.S. have drastically increased in recent years."
Just as proposals for a cap-and-trade system or a "carbon tax" put a price on carbon emissions, so Kunreuther argues that developing insurable assets in risky areas needs its own price tag. "If you have insurance premiums that reflect risks, they can play an important role in signaling hazards" and discouraging development in hazard-prone locations, he says.
The "Managing Large-Scale Risks" report calls on public funding, rather than discounted insurance premiums, to deal with the equity and affordability issues that would result from increased insurance premiums in risky areas.
Climate change, says Kunreuther, parallels the risks of smoking. "If you continue to smoke, you have a larger risk, and if we continue to operate the way we operate now, we're likely to have higher sea levels. The lesson is to bypass myopia and short-term thinking by offering people rewards and benefits now so they will take action today."