Sustainability Management and

Governance

6. Sustainability of Business:
Introduction

Ted Tschang
Recap last class

• Climate impacts
• Climate mitigation solutions
• Economic mechanisms
Outline

• What causes firms to become sustainable

• Sustainable finance frameworks
• Modifications to account for “non-market” strategies (i.e.
not pricing related)
• Natural Capitalism concept
• Circular economy concept
Introduction to sustainability of firms

• Economics teaches us that firms have to have

externalities internalized in prices, or they “won’t” act
• Yet, this depends a lot on the government correcting
for market imperfections
• Regulation
• Or waiting for technological change (could be better or
worse, usually worse)

• However, firms take on sustainability projects and

move away from being unsustainable on their own
• How do they get away from free rider effects?
Recall: sustainability problems have complexity
characteristics, challenging policy
• …the need…to address problems that are far more
complex, multi-media, and are of large geographic,
sometimes global, extent.
• Policy in this era deals with complexity by
• Applying systems thinking to capture the situation
• Engineer thinking – design thinking for efficiencies and other
practical uses
• Design thinking for social welfare and economics etc
• Being multi-disciplinary in assessment, highly integrated
solutions that include input from many disciplines and
stakeholders **
•  Some of the same has to be incorporated into firms,
especially systems thinking and stakeholder involvement
Recall: sustainability problems have complex
characteristics: challenges policy and industry
• According to previous material:
• Firms engaged in pollution prevention projects in order to
avoid costly regulations (also yielding cost savings)

• But, what happens in the sustainability era?

• Complex effects of individual firms acting due to variety of
other stakeholders applying pressure
• Some issues become existential*: leaders act on their own
What motivates firms to become
sustainable? give e.g.s of following
• Internal
• Leadership, leading to firms that are “born
sustainable” (visionary leader, e.g. Patagonia’s)
• Innovation *
• Changes in business environment
• Regulations (previous class)
• Market (later class) – strategy pov, looking at
marketing efforts for environmental products
• Other stakeholders (which ones and why?): does
“reporting” play a role? (later class) – there is no one
theory that guide these stakeholders behaviours
What causes firms to become
sustainable?
• Note: I refer to sustainable in the social, environmental
sense (being financially sustainable is a given, but not
“the goal”)

• Other questions
• Are sustainable firms “born” sustainable ?
• Do they have the “luck” of leaders?
• Can underperforming firms “become” sustainable (and,
slowly or fast)?
Sustainable finance framework (Schoenmaker and
Schramade)
How to characterize sustainable firms

• As balancing multiple objectives (dimensions)

(economic, social, environment)
• Dimensions sometimes act as constraints and sometimes
work together (e.g. when innovation occurs)
Types of sustainable firms: a financial
sustainability perspective
• Finance (as a field) has a theory to characterize “how
sustainable firms are”
• Implications for strategy, to understand what firms can
do and choose to do (within constraints)

• Notes
• not yet related to risks
• Can connect with other theories and concepts
• (The sustainable finance framework is also relatable to
costs, benefits and risks but doesn’t show how to do it)
A ‘sustainable finance’ framework
(relating financial to other sustainability objectives)

• Assumes it is a zero sum game between balancing financial returns and socio-ecological gains
• Assumes stakeholders or executives have a sustainability mindset or end goal
Sustainable finance framework (Schoenmaker and
Schramade)

• Authors claim:
• The majority of firms are at… [SF] 1.0 level, putting
financial value first.
• About 30 to 40 per cent of financial institutions and 20 to
30 per cent of corporates adopt sustainable principles in
their investment and business practices
• ... But these firms are only partly…maximising integrated
value… (they are) between Sustainable Finance 1.0 and
2.0.
Sustainable finance framework (Schoenmaker and
Schramade)

• SF 1.0 level ”model” - Refined shareholder value

• Max F subject to S+E (S+E act as constraints, set at some level)
• Investors optimise the financial value 𝐹𝑉 of their portfolio by
increasing profits and decreasing their risk (i.e. the variability of
profits), while avoiding excessive negative social and
environmental impact by setting a minimum level 𝑆𝐸𝑉min.
• What does “subject to” mean
• Who defines the constraint?
• SF 2.0 level - Stakeholder value (or a “triple bottom line”)
• Optimize I (an integrated value) = I = F + S + E (‘+’ means ‘and’)
• If any S+E “subtract” from F, firm in effect gives up some profit
Sustainable finance framework (Schoenmaker and
Schramade)

• SF level 3.0 - Common good value

• ‘S and E’ > F
• Optimise S and E subject to F
• where F is non-zero (my view)
• S&S assert that < 1 percent are of this type
• Some economists would say that such firms do not exist
• In fact, authors do not provide convincing real world examples,
citing industrial associations/forums such as WBCSD (World Bus.
Council on Sust. Dev.) and the World Economic Forum (Davos)
• Some debate whether these are just “feel good” organizations, e.g.
high emissions and great expense to fly in people, just to talk
• Possibly, B corporations (or extreme ones), for-profit social
enterprises (i.e. ones run for profit but at a minimal (i.e. low)
profit)
Recall: view of sustainability –s relationships
between the 3 pillars *
Fig 1 – more consistent with more Fig 2 – consistent with environmentalist
thoughtful businesses’, economic views including ones trying to reform
views business (e.g. ‘Natural Capitalism’)
Sustainability challenges and needs

• In surveys, despite markets becoming sustainable, and US

firms expressing interest in sustainability initiatives,
• Few initially took it up, due to “significant barriers”:
• A “lack of understanding of what sustainability is”
• Uncertainty of what’s involved and how it (becoming
sustainable) affects firms (in terms of their performance)
• Uncertainty of what to do, and how seeking to become
sustainable affects firms’ risks and profits  business case
• Challenges in making the “business case for sustainability”
(lack of knowledge on how to justify it)
• Failure to execute plans properly, including difficulty in
changing mindset across the entire corporation (many firms
possess “inertia” or unwillingness to change) *
Consulting
view
Note:
• Various firms
and thinkers
adopt a
variant of
this (PwC
may not have
5th stage)
• Is this about
leadership or
markets or
trends in
external
forces?
Another managerial framework
(consulting-type) view (Hart)
• Relates some of previous stages to 2x2 that embeds traditional
strategy dimensions of time, internal vs. external view of the firm
Role of business case, business model

• Much written on strategy but I prefer BMs

• BM as a ‘configuration of a firm and its resources that
helps it create, deliver and capture value, and achieve
its objectives’
• BM also provides some details over a strategy’s
• (though similar)
• To justify strategies, firms need ‘business case’ involving
• trends
• cost-benefit analysis, risk analysis  qualitative
• existence of business model (validates case)
• BM helps validate a strategy *
 Relating business models to strategy *

How to do
Who (with) (not detailed) What (not
-not detailed detailed)

How
(resources)

Why “Opportunity” vs. competition

The business environment: Observations on
sustainable finance framework
• Max F subject to S+E (1.0)
• (vs 2.0) Max I = F+S+E – how big is I?
• (vs 3.0) Max S+E > F – where F is possibly small
• (feasibility of) each depends on
• 1. What creates a ”social value” to S+E, captures cost of
achieving S+E
• Relates to nature of markets (and who shapes markets) and
expectations of society (may take form of “stakeholders”)
• 2. Can this S+E be related to F
• jointly maximized, or some F exists to support high S+E value,
or co-attaining high S+E
• Relates to firm’s production function (see circular economy
firm e.g.s)
‘Sustainable finance’ framework (Schoenmaker
and Schramade) for grading firms’ sustainability

• Firms’ level of sustainability are based on how their

objectives incorporate sustainability with financial
considerations.
• The models/levels are arbitrary. *
• Derived from economics paradigm - the asserted models
help to make sense of (classify) firms’ sustainability
• Baseline hypothesis (SF 1.0) is that firm is an economic “profit
maximizing” entity with some minimal level of sustainability
• Some models seen elsewhere: Reinhardt’s ‘environmentally
differentiated product’ (later class) is also based on profit-
maximizing (economics), so resembles SF 1.0 (bit like SF 2.0)
• Is SF 3.0 unrealistic or achievable in a capitalistic society,
and is SF 2.0 the most that we can expect?
Sustainability strategies: benefits

• Selected benefits of engaging in sustainability

• 1. Market advantage (environmentally differentiated
products)
• Market leadership (changing product lines), opportunity-seeking
• 2. Eco-efficiency (cost-efficiency to the firm is achieved
together with improved environmental sustainability)
• 3. Creating and a competitive advantages that is further
leveraged (e.g. capability to do X)
• 4. Reputational advantage (by engaging in X)
• 5. Key stakeholders engaged (mutual gains)
• Note
• These can be used to justify or motivate a firm’s engagement
in sustainability practices
Market/business environment: market trends

This is actual sales (HBR, others note that rosy market

sentiment surveys do not get reflected in purchases)
Natural Capitalism

• Look at some well-known (in past) higher level

frameworks
• Many concepts still in use today in other frameworks,
forms
• Means of analyzing for cases of “firms combining F with
S+E” in their production functions
Natural Capitalism: The argument

• Natural capitalism was an earlier, innovative concept

for how to reconceptualize and reorganize firms
• Doesn’t reflect reality of “how firms compete” (profit-
max), essentially saying, “there’s another way”
• We look at natural capitalism as an early template for
“how to be sustainable”, as many of the concepts the
authors proposed are still in use today in other
frameworks and practices
• In particular, a current framework - the circular economy -
uses similar concepts to motivate recycling in natural ways
Means of implementing natural capitalism
(high level practices)
Authors suggest that to implement natural capitalism:
• (1) Dramatically increase the productivity of natural resources
by
• (2) Redesign production according to biological models
• Incur a lot of changes, goes against traditional beliefs and BMs
• (3) Change the business model
• To a solutions-based e.g. grab versus private own cars: grab drivers contribute
to more wastage  depends on nature of business and service
• (4) Reinvest in natural capital

• Note (can be related to what NC as a framework contains)

• For me, many frameworks will embed some combination of practices good for firms
and good for the environment
• Some embed measures (indicators)
• All embed values of some sort, and maybe conceptual material
Notes (from natural capitalism article)

• Main argument: Companies waste resources because

they
• Do not employ the correct accounting procedures to cost
their impacts…
• Do not view things in terms of efficiency
• Do not view firms as existing within the natural
environment (concept of ‘natural capital’, much in same
way as ecosystems services)
Natural Capitalism

• Frameworks have different assumptions of the firm’s

production function and how it relates to the
environment
• Sustainable finance framework appears to suggest a zero-
sum game, or leaves open the relationship
• NC seems to suggest that firms can gain financial
benefits from pursuing sustainability
Natural Capitalism advocates: (1) increasing the
“productivity of natural resources”
• Dramatically increase “productivity of natural
resources” by reducing the wasteful and destructive
flow of resources from depletion to pollution”
• Such companies will “stretch” the use of resources.
•  this is a business opportunity.

• Notes
• The authors earlier describe the simultaneous cost
reductions from improved productivity of natural
resources as “eco-efficiency”.
• (The pollution prevention era also involves this logic *)
Natural Capitalism advocates: (1) increasing the
“productivity of natural resources”
• Through “fundamental changes in both production design
and technology” such as by
• “Whole-System Design” (design to take into account waste,
including less-considered ones) (systems thinking below)
• Seen in innovative technology designs, e.g. Lovin’s Hypercar
**
• Note: this type of design is a kind of systems thinking
• We used systems thinking earlier to characterize natural
systems, and evaluate or assess human impacts on them
• In the case of design, systems thinking is used within the
design process to account for the wider impacts of the design
• This is later described as lifecycle thinking (next lesson)
• https://knowledge.autodesk.com/search-result/caas/simplecon
Natural Capitalism advocates (2) shift to
biologically-inspired production models
• involves seeking “not merely to reduce waste but to eliminate
the very concept of waste”.
• Via “closed-loop production systems” which imitate nature in the
way they do not discard waste, rather that “every output either is
returned harmlessly…(to the ecosystem as a nutrient, like compost)
or becomes an input for manufacturing another product”
• Ultimately, what makes a novel industrial system successful is
complicated. Two critical assumptions and conditions are:
• That while companies are “profit maximizing”, they will find it just
as valuable to recycle as it is to “dispose waste”
• To shift to this, could still involve societal intervention, e.g. by
governments changing the “value” of “waste”, such as by increasing
the cost of disposal, or by consumers’ having a “willingness to pay”
(e.g. for recycled content).
… biologically-inspired production models
(product level)
• The discussion of biologically-inspired models that
inspire “closing the loop” solutions is similar to the
current-day concept of a circular economy
• In other writings, this is referred to this as “industrial
symbiosis”, “biomimicry”, and in localized areas:
industrial ecosystems or eco-industrial parks.
… Biomimicry e.g.s

• Premise:
• nature is more efficient (in use, in recycling, etc.)
• The discipline of biomimicry takes nature’s best ideas as a
mentor and then imitates these designs and processes to
solve human problems.
• Biomimicry can occur at different scales (product level
to a city- region level to a regional/national/cross-
national level)
• 1. product level: natural forms
• Kingfisher-shaped Shinkansen
• Also: trucks *
…Biomimicry at product levels:
note the classroom carpet
• 2. Firm level
• …carpet company Interface, tells the story of the creation of his product
Entropy.
• David Oakey, the head product designer of Interface, sent his design team
into the forest with the instruction to find out how nature would design floor
covering. “And don’t come back,” he instructed, “with leaf designs—that’s
not what I mean. Come back with nature’s design principles”
• Product level: Biomimicry is designed into products based on
inspirations from natural forms e.g. of Interface carpets - partial
replacements of tiles made possible by the patterns
Biomimicry at regional/industrial
system levels (industrial ecosystems)
• 3. Industrial ecosystems (or an industrial symbiosis *)
• Industrial ecosystems are means to organize co-located
firms so that one firm’s waste become another’s inputs
• most famed e.g. is in Kalundborg, Denmark
• Firms from different industrial sectors recycle each others’
waste and byproducts (e.g. energy, chemicals, materials
use), which reduces overall waste, thus resembling a
natural ecosystem.

Kalundborg video:
https://www.youtube.com
/watch?v=1yCYGOxnpSY
Kalundborg, DK
http://www.symbiosis.dk
Issues with biomimicry (regional levels
– can also question product models)
• Region level: despite the effectiveness of the Kalundborg
project, not many eco-industrial parks (EIPs) have been
created. This raises the question:
• How did Kalundborg come about?
• Kalundborg may have arisen due to the costs of waste
industrial disposal in Denmark (and the location being
remote), suggesting that there were “forces” that
encouraged firms to cooperate *
• Note
• A different industrial ecosystem that was “designed” over a
wider area is the agricultural produce-based industrial
symbiosis in Iskenderun Bay, Turkey
• https://www.youtube.com/watch?v=t9-6cDPwvcA
(Natural Capitalism advocates move to a
(3) solutions-based business model
• The idea (really a hypothesis) is that services would be less
resource-intensive than products
• The business model of traditional manufacturing rests on the sale of
goods. In the new model, value is instead delivered as a flow of services
–providing illumination, for example, rather than selling lightbulbs.
• This raises the question of: Whether this is true (that services are
more sustainable).
• It may only be true under specific conditions and assumptions.
• For e.g., whether business model exists to capture revenue exists
and is desired by customers
• Under its Evergreen Lease, Interface no longer sells carpets but rather
leases a floor-covering service for a monthly fee, … Since at most 20%
of an area typically shows at least 80% of the wear, replacing only the
worn parts reduces the consumption of carpeting material by about
80%.
Aside: biologically-inspired production models
relate to circular economy, practices
• biologically-inspired models ~ “closing the loop” ~ circular
economy
• The circular economy refers to how waste within the economy
is continually recycled (and reused, reduced) within the
economy’s production systems
• All used to be parked under ‘reduce, reuse, recycle’ (a hierarchy
of “good practices”) - but that thinking was in terms of single firm
or consumers
• The circular economy notion supposedly helps firms invent
practices that transcend (go beyond) single firm solutions.
• Some of this thinking already preexisted - in the natural
capitalism and other frameworks - but also for single firms, no
good working business models existed then, and really, needed
transformation of the business environment to happen first.
Biological vs. Material
Circular economy embeds what we
traditionally view as good practices
Natural Capitalism advocates (4) Reinvest in
natural capital
• The idea is that firms should replenish natural capital stocks.
• Ultimately, business must restore, sustain, and expand the planet’s
ecosystems so that they can produce their vital services and biological
resources even more abundantly.
• Pressures to do so are mounting as human needs expand, the costs
engendered by deteriorating ecosystems rise, and the environmental
awareness of consumers increases.
• This view is consistent with the ‘ecosystem services’ (valuation) approach
• The following claim is also subject to scrutiny:
• “Fortunately, these pressures all create business value.”
• The authors later claim that adopting such techniques will change public
perception – i.e. affects firms’ reputation (which then helps account for
the practices financially). It could also reduce a firm’s risk (of disasters or
poor publicity from their actions), but under certain conditions, such as
the practices being safer.
Note: Need to consider economics, financial
value vs. other (social, environmental) value
• Natural capitalism falls outside of the economics
paradigm. It prescribes high level practices out of an
“environmental need”.
• From an economics perspective, to do adopt any of
these 4 practices would require the firm to also be
accountable to market pressure or regulatory
authorities.
Comparing natural capitalism to the
‘sustainable finance’ models discussed earlier
Another explanation:
• Authors assume firms adopt new principles that value
environment over financial value
• Similar to expectation that consumers recycle – needs
different valuation of “sustainable practices”
• I = F+S+E condition shows its possible under certain
situations
• Authors are trying to move firms away from FS level 1
• By the F,S,E logic, we need to look for situations where
engaging in the practices make both business (economic)
and environmental (or social) sense
• What are some situations?
Relating natural capitalism to circular economy
(firms): watch and discuss
• What is circular thinking
• https://youtu.be/6g0AYbEoOGk?t=370
• to 14 mins.
• Does it represent natural capitalism? In what way?
• Why is the firm’s business model financially viable?
• What information are we missing?
Summary

• Different views of the sustainability of firms

• Financial (economics-based) theory of different models
sustainability
• Natural capitalism – model based on presumed
effectiveness of high level practices
• Ultimately, how does market capture value the firm is
creating (or can firm shape the market)?
• What’s the strategy?
• Does business model exist?
Extra slides