Five years ago, during the celebrations of Earth Day 1990, I found myself repeatedly asking a simple question. Could companies gain competitive advantage from becoming environmental leaders?
There was much noise and celebration surrounding corporations’ contributions to the environment. Lots of talk about pollution prevention, and the million dollar savings that 3M had generated from its total quality environmental programs. More intriguing, to my mind, were some of the companies which had begun to mount more proactive, innovative initiatives. Wellman, for example, had linked up with Pepsi and Coke bottlers to produce recycled PET plastic, while Shaman Pharmaceuticals was researching potential new drugs by learning from traditional indigenous healers.
Was the marketplace rewarding companies that had begun to mount more proactive environmental initiatives? If so, we might be able to more deeply harness the power of the marketplace to serve and support sustainability.
So began five years of research and consulting designed to explore this question. In every industry I have investigated to date, I have found at least one company successfully "leading the change" toward more sustainable practices to produce significant competitive advantage. These companies have excelled beyond regulatory compliance, beyond the cost-saving achievements of pollution prevention, to entirely redesign their products and services to be more sustainable. Some have even changed their industries’ rules of the game, forcing their competitors to adopt similarly sustainable practices.
These proactive companies were more successful because they were willing to respond early to signals that the market was restructuring in response to environmental challenges and were prepared to partner with, rather than oppose, environmental stakeholders to co-create solutions to tackle these issues. Having now researched dozens of industries and interviewed as many companies to understand why such leadership has been rewarded competitively, the following picture has emerged.
Market Restructuring: A Gateway to Sustainability
What all of these leading companies recognized is that environmental forces were beginning to restructure their marketplaces. These environmental forces were causing whole product markets to go into serious decline, while creating others to grow dramatically in their place. For example, as lead was phased out of gasoline, sales of tetraethyl lead declined to virtually zero by the early 1990s. By contrast, sales of MTBE, a safer anti-knock replacement, were rising dramatically. Sales of HCFCs had similarly expanded to replace CFCs until they too declined in the face of further environmental opposition.
Across a broad array of markets downstream of the chemicals industry- including pulp and paper, detergents, solvents, and gasoline- the same trend could be seen. Chemicals like chlorine or phosphates that were causing major environmental problems in downstream markets were suffering serious decline. By contrast, chemicals that were helping to solve those same problems were enjoying exceptionally rapid growth.
Similarly, in the oil industry, companies like Chevron were mounting serious efforts to improve their environmental and social performance to gain a share of the lucrative oil exploration market by becoming the operator-of-choice in environmentally sensitive regions. Meanwhile, downstream, oil was losing its share of the energy market to natural gas, which has much lower emissions of SOx, NOx and C02 per unit of energy.
These examples suggested that environmental concerns were beginning to seriously restructure entire marketplaces, up and down the value chain. Environmental challenges were becoming more than regulatory issues for business. They were beginning to create profoundly market-based challenges and opportunities.
A Simple Choice
I would argue that this market restructuring poses a rather stark choice to companies. They can choose to deny this reality and continue with business as usual, rather than innovating to create more sustainable products and services. In this case, their businesses will continue to cause environmental problems, fueling the market restructuring and ultimately creating a downward competitive spiral for the company.
By contrast, a company can decide to learn from other stakeholders – such as environmental groups, regulators, the media and so forth – in order to create more sustainable products for its core businesses. This decision further fuels the market restructuring, but this time to the company’s advantage. The creation of these "green" products in turn helps to accelerate the pace of the environmental market restructuring, creating new competitive rules of the game from which these leading companies are uniquely well positioned to benefit.
The Laggards’ View
However, most companies do not recognize the potential of this environmental market restructuring. When we surveyed the US chemicals industry, we found that managers saw only 9 percent of their environmental challenges arising in downstream markets which were restructuring and creating major declines and growth in their product sales. Similarly, less than 8 percent of environmental challenges were seen to be arising in upstream markets – where companies like Chevron were seeking to gain market share by becoming the environmental operator of choice.
Although most companies’ policies (63 percent) focus on compliance concerns, by contrast, their executives felt that 25 percent of future opportunities lay in new business lines that environmental issues were creating in downstream markets. A sea-change was in the air, which some companies had begun to sense and capitalize upon.
The Leaders’ View
Leading companies have dearly gained competitive advantage by recognizing and responding to this environmental market restructuring. Spanning over a dozen industries, these companies have gained market share, increased profit margins, or entirely changed the competitive rules of the game to create incremental value for themselves – and for the environment – as a result of their response to these environmental forces.
Take Henkel, for example, one of Europe’s largest chemicals and detergents companies. In the late 1970s, Henkel began to notice the concerns rising in West Germany surrounding the potential impact of phosphates in detergents on rivers and streams. At the time, Henkel manufactured 50 percent of the country’s phosphates and sold 49 percent of its phosphate-based detergents.
Instead of attempting to downplay the problem, Henkel decided to invest considerable R&D monies into finding a substitute for phosphates. The company’s success led to the surprising and courageous decision to cannibalize both of its phosphates businesses – up- and down-stream – and replace them with new products based upon their newly patented substitute, zeolite.
Henkel was the first consumer products company to introduce phosphate-free detergents in Europe, entirely replacing all their old product lines. As a result, the company increased its market share from 16 percent to 23 percent for its top brand in Germany, and strengthened its foothold in the French market, gaining a 6 percent share for its new phosphate-free brand. At the same time, Henkel, in conjunction with joint venture partner Degussa, built a 70 percent market share of the European zeolite production capacity, while its former phosphate production competitors were suffering major overcapacity and hemorrhaging losses.
Gasoline, Plastics, and Pharmaceuticals
Similarly hopeful examples can be found in industries as improbable as oil and gas. When Arco first noticed the likely shift towards lead-free gasoline, it moved early into MTBE, ending up with the largest worldwide share of this expanding market. More surprisingly still, Arco led its industry again with a decision, in August 1991, to replace all of its leaded gasoline sales in California with a new reformulated product, EC1. EC1 is a specially designed substitute formulated to run on pre-1975 cars, which accounted for only 15 percent of gasoline sales but 30 percent of the California auto pollution problem. Arco’s market share rose dramatically from under 17 percent to over 25 percent in just nine months.
Leaders can even be found in industries as notorious as plastics. Wellman, for example, sustained a 40 percent growth rate and 21 percent return on equity over a period of six years when, almost a decade ahead of other plastics companies, it took on the challenge of creating the market for the recycled plastic, PET. Wellman teamed up with a set of non-traditional allies, including Coke and Pepsi bottlers who were recovering their used PET bottles from the bottle-bill states. This leadership helped PET become one of the most heavily recycled plastics – which in turn enabled PET to gain market share over rival resins, enhancing Wellman’s sales still further.
As competitors began to invade Wellman’s niche, it expanded its recycled product range downstream into the fibers business, helping to catalyze yet another high-value recycled materials market by selling these Coke and Pepsi bottles to Patagonia to manufacture a new line of "recycled" fleecy outdoor clothing.
Other companies have begun to change the rules of the game in their industries. Shaman was formed five years ago to develop pharmaceutical drugs by learning from traditional indigenous healers which plants they use to treat various diseases. When these plants are tested for effectiveness in treating those diseases, half the plants test positive – a hit rate over 50 times that of most drug companies.
Two Shaman drugs, now in phase II testing, may complete their FDA trials within 7-8 years of their initial plant screening, compared to an average of 10-12 years for conventional drug companies. Since the FDA grants patent protection – and thus exclusive "monopoly" profits – to drug companies for up to 17 years after initial screening, this could provide Shaman with up to 4 years’ additional protected revenues and profits.
Shaman plans to share the profits from these potentially billion-dollar drugs with the indigenous communities from whom it first learned of such possibilities – offering an alternative revenue source to oil and timber extraction for these vulnerable peoples.
Outstanding leadership can even be found in products as humble as baking soda. It was members of two Canadian environmental groups who first knocked on Bryan Thomlison’s door at Arm & Hammer, the baking soda company, to ask why the company was not educating consumers about baking soda’s use as an alternative, non-toxic cleaner. Thirty- six months later, baking soda sales had risen 30 percent – in an industry in which sales had been stagnant for decades.
Thomlison began to deepen his relationships with other environmental stakeholders – environmental groups, educators, the media, regulators, and beyond. Further innovations followed. One of the founders of Earth Day USA asked if baking soda had ever been used to dean printed circuit boards, where traditional solvent cleaners were creating major CFC and VOC problems Thomlison put them in touch with the head of Research and Development. Two weeks later a prototype product was developed, which now forms the basis for a full line of patented industrial cleaners.
Arm & Hammer probably works more closely with environmental stakeholders than any other US company. Recently, we measured how much incremental value this stakeholder approach has created for the company, evalu
ating its contribution to new product development, revenues, and profit margins. While 15 percent of company revenues are derived from the "green" market, the company’s stakeholder approach alone contributes an entirely incremental 5 percent of revenues. These incremental sales are created by the additional "green" consumers that this uniquely powerful stakeholder approach attracts. Furthermore, Arm and Hammer has found that its stakeholder strategy is twice as cost effective as traditional marketing approaches, generating $10 for every $1 invested, compared to $4 for the company’s traditional marketing approach – yet another source of competitive advantage.
Why Were These Leaders Successful?
What do leading companies do right?
- Successful companies learn how to predict and lead their markets as they restructure towards more sustainable products and services. Like Henkel with the specter of phosphates looming or Wellman operating in the increasingly controversial plastics industry, these leaders recognize that environmental concerns can and will reshape their markets in profound ways.
- Successful companies collaborate with environmental stakeholders to envision new solutions to environmental problems Then they embed these solutions into their core businesses, fuelling the restructuring of the market in ways which powerfully benefit their bottom line.
- Successful companies make a clear up-front commitment to become a part of the solution. This commitment enables them to build the trust required to foster strong learning and innovation across stakeholder boundaries.
- Successful companies explicitly invest in long- term, learning-oriented relationships with stakeholders to co-create these growing businesses. They do not seek to persuade or negotiate with stakeholders to defend poor business practices – a fundamentally different process.
Companies have not traditionally recognized the value of including environmentalists and indigenous people along with customers, suppliers and investors in their core business decisions. However, creating learning-oriented relationships with stakeholders can help a corporation answer questions central to its future, including questions about market restructuring and potentially profitable solutions to environmental challenges. Such learning can help a corporation build competitively powerful and sustainable businesses.
The Bottom line
Overall, the answer to the question, "Can it be profitable to conduct business in sustainable ways?" is certainly "Yes." Companies have gained competitive advantage by leveraging the environmental forces that are already reshaping and restructuring their marketplaces to create profitable business solutions to environmental challenges. This success often depends upon the quality of learning and innovation that these companies build into their relationships with environmental stakeholders. As a result of these companies’ leadership, whole markets have continued to restructure towards more sustainable solutions.
By contrast, companies can choose to deny these new realities – and fail to introduce sustainable innovations. However, their businesses will continue to cause the environmental problems that fueled the market restructuring and ultimately create a downward, uncompetitive spiral. A profound lack of sustainability is certainly the hallmark of companies whose industries now face "dinosaur extinction" status. Decommissioning costs for the nuclear industry, for example, and even Superfund clean-up costs for chemicals, place the long-term viability of both these industries in doubt unless ways can be found to pass the bill on to taxpayers.
The new paradigm may not, in fact, leave companies with much of a choice at all over the longer term. Interestingly, between 1979 and 1989, 47 percent of the "Fortune 500" organizations dropped off the "top 500" list there because they were not adaptive enough. As one commentator concluded: "In the next decade, change or die." As the magnitude of the environmental challenges we face increases, sustainability will also increase in its effectiveness as a competitive strategy. Businesses may therefore find themselves saying over the next few decades: "Sustain or die."
Sue Hall founded Strategic Environmental Associates in 1992 to assist companies and other stakeholders in creating business-based solutions to environmental problems. She is currently also Executive Director of the Institute for Sustainable Technology (IST). The research in this article was done while a research fellow at Harvard Business School in 1991. You can reach Sue at IST, 4 Chenowith Road, Underwood WA 98651.