MBAs and Climate Change

Why MBAs Should Care About Climate Change

by Professor Anant Sundaram

(Originally published as two blog posts prior to COP15 in December 2009.)

An Externality

Few issues will loom larger in the next few decades than climate change. Science says that greenhouse gases (GHGs) – of which carbon dioxide CO2 is the biggest one – linger in the atmosphere for decades, and that higher GHG concentrations will lead to significant surface warming. The consequence is potentially grave and irreversible impacts on a wide range of earth systems. Much of this impact is the result of human-caused GHG emissions, primarily from the burning of fossil fuels, land use (in particular, mining and deforestation), and agriculture (especially, rice farming and meat production).

This imposes an externality: i.e., our private actions that produce GHG emissions impose a potentially serious cost on the rest of society. This cost will be felt in two ways. One, from preempting or mitigating the likely impacts of climate change, and two, where mitigation is too expensive or not feasible, from adapting to its consequences.

At some point, society will then ask emitters to internalize the cost of their actions, by putting a price on GHG emissions, either via a carbon tax or a system of cap-and-trade. Colloquially, people refer to this as a ‘price on carbon.’ Thus, it is quite likely that, in the next few decades, economic growth will unfold in a world with a price on carbon.

Because carbon is omnipresent in our energy chain, and energy is embedded in every economic transaction, the implications are enormous.

What is the Business Link?

Unlike other major global issues – such as, say, hunger or global poverty – climate change is one where businesses have the most significant cause-and-effect relationship. Companies are the largest emitters, and in the final analysis, they will be the ones to commit resources and develop technologies to solve the problem.

As a result, there is a potentially sizeable ‘climate economy’ emerging in two key areas: energy efficiency from existing (fossil fuel-based) operations, and new sources of non-fossil fuel based energy. The challenges and opportunities for businesses from the ‘climate economy’ are vast. Large amounts of wealth will be created (or preserved) by companies that get in front of this issue. Equally, large amounts wealth may be lost (or not captured) by those that fall behind.

Consider this. Just the companies in the S&P500 emit between 3 and 4 billion metric tons of GHGs annually. If the costs associated with this are required to be internalized, the impact will be significant. Using a market price of $20/ton of CO2 as a benchmark, companies would be collectively required to sign a check for $60 billion to $80 billion annually. The present value of this liability could be as high as one-tenth of the market capitalization of all the companies in the S&P500 stocks today.

To preempt such a cost, we will likely see major investments in technologies for emissions abatement and increased carbon productivity – e.g., in areas such as energy efficiency, low-carbon and non-fossil fuel-based energy (renewable sources such as solar and wind, and nuclear), carbon capture and storage, geoengineering, and agriculture, land use, and forestry. Such investments could run into many trillions of dollars across the globe.

Similarly, the market for emissions allowances could become sizable – conservative forecasts put it at a $1 to $2 trillion market within the decade.

The Emerging Climate Economy

It is quite apparent now that the careers of MBAs graduating today will unfold in a world in which there is a carbon price.

What will that mean? I think that it will be a game-changer in the same way that the internet or the economic ascendance of the BRICs was. Just as we take for granted a ‘digital economy’ or an ‘emerging economy’ today, we will soon be talking about the ‘climate economy.’ Much of what we do in this arena is going to be correlated with innovations to create greater efficiencies, to eliminate waste, and to find new sources of clean energy in managing a company’s value chain, and consequently, the larger economy.

Forward-thinking companies are taking climate change concerns head-on. Many are committing serious amounts of management talent, resources, and capital to address climate change. Over two-thirds of the S&P500 now measure their carbon footprints using globally accepted reporting guidelines and protocols. (The most widely accepted protocols split emissions into three categories – Scope 1, Scope 2, and Scope 3 – which, essentially, lie along a continuum of direct emissions from operations to those that are indirect, e.g., from the life-cycle use of their products). Many companies have initiatives in place to manage this footprint, via investments in energy efficiency, renewable energy, and incentive-based, time-bound abatement goals.

Consider a few examples. Scotch-tape maker 3M, across its global operations, has reduced its carbon footprint by 69% between 2002 and 2008. Apple measures and reports the life-cycle carbon footprint for each one of its products. This analysis was central to the company’s innovations on product and process design, e.g., their decisions to shift to ‘unibody’ aluminum Macbook Pro laptops.

UPS tracks and incentivizes employees on the basis of the metrics such as ‘GHG emissions per 1000 Kg. of packages delivered.’ Staples today has become one of the largest (non-utility) producers of solar energy in the US, with solar panels on the roofs of most of their retail and warehousing outlets. Walmart has instituted aggressive carbon targets for its suppliers worldwide, where they have been put on notice that those suppliers achieving those targets get to the front of the line in doing business with the retailing behemoth. PepsiAmericas has become one of the biggest investors in highly energy-efficient, low carbon-footprint, ‘Platinum LEED-certified’ buildings.

The list of such forward-thinking companies runs into the hundreds, today.

New Career Opportunities

Two-fifths of the S&P500 companies today have an e-level officer, with titles such as a ‘Chief Sustainability Officer’ or ‘VP: Sustainability & Environment’ to manage climate change concerns. A study by the Carbon Disclosure Project – the world’s biggest repository of data on companies’ carbon footprint – reports that one-fifth of the S&P500 companies now link employee incentives and goals related to climate change.

Many firms in finance, consulting, private equity and venture capital are positioning themselves for the emergence of the climate economy. Every major bank or asset management firm in the US and the EU now has climate initiatives, often in partnership with NGOs. Firms such as HSBC and Deutsche Bank are leaders. New financial products will be created or equity research will develop around the carbon footprint of portfolios, or around the market for GHG emissions allowances, pioneered by the likes of Goldman Sachs. We will see the growth and development of new financial instruments such as climate derivatives and ‘catastrophe’ bonds.

Advice on coping with climate change (as well as energy efficiency and renewable energy) is emerging as a vital area of practice for consulting firms. Leading firms such as McKinsey & Co. and PriceWaterhouseCoopers come to mind. There are now a half-dozen climate change-related scorecards and rankings produced by major media outlets and NGOs to which companies are having to pay attention (including one that I developed for CFO magazine, called the ‘Fossil Fuel Beta,’ or FFß). Investments in renewable energy (‘clean-tech’ and ‘green tech’) have already become significant in private equity and venture capital, led by companies such as Hudson Clean Energy Partners and Khosla Ventures.

A Hard-Nosed View on Link to Business Value

MBAs graduating today should ask – even better, be prepared to offer views on – a few simple questions related to their future employer (and the industry to which their employer belongs): Should the CEO, CFO, and members of the Board of the company care about climate change? If so, why? How? What they can learn from others that are getting in front of the issue?

My view – perhaps a controversial one for those who look at this solely through the lens of ‘corporate social responsibility’ – is that it is crucial to be hard-nosed on whether and how something, indeed anything, ‘matters’. In a world of competing priorities and limited resources, an issue will get the attention of CEO only if we can articulate that it has a meaningful impact on the value of the business (or at the very least, its continued viability).

Value, in turn, is a function of just two things: cash flows and cost of capital. Our actions increase value only when they increase cash flows or decrease cost of capital. In turn, ‘cash flow’ comes from revenues, costs, and investment spending. ‘Cost of capital’ is determined by the risk of our actions or, equally, inaction.

Thus, when we attempt to link climate change-related initiatives to value creation, we should be attempting to make a connection to specific financial metrics – i.e., we should be seeking to anchor our initiatives on answers to the following questions:

  • What is the impact, if any, of the initiative in increasing revenue?
  • What is the impact, if any, of the initiative on decreasing costs?
  • What is the impact, if any, of the initiative on the investment spending practices and processes that the company uses to achieve its future growth – e.g., capital budgeting practices, new product introduction or new market entry, product and process innovation, M&A, supply chain configuration?
  • What is the impact, if any, of the initiative in reducing the risks of future cash flows, i.e., on our cost of capital?
  • Finally, even if we are measuring and managing all these links well, how do we communicate it to key corporate constituencies so as to ensure buy-in and ongoing support?

These are the specific questions that today’s MBAs will need to be thinking about, and getting front of, in relation to whether and how climate change will affect their careers.

I believe passionately that those that do not inform themselves to answer such questions run the risk of falling behind in the emerging climate economy.


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