Responding to the environmental challenge

Responding to the environmental challenge – Business and the Environment

Pieter Winsemius

In April 1990, Sony President Akio Morita boldly spoke of the environmental challenge as one of “the central issues of the 21st century.” In a McKinsey survey of more than 400 senior executives of major companies worldwide that was conducted one year later (1991), only seven disagreed with him. When Jack Welch, CEO of General Electric, asserted that “only a total commitment of everyone in the company can provide the level of responsibility that will be acceptable to government, employees and customers,” more than 80 percent of his peers concurred.

Senior managers expect environmental expenditures to increase from the current average of 2.4 percent of sales to 4.3 percent by the year 2000. Because public awareness and sensitivity are growing rapidly, the environment ranks first on the political priority list in many industrialized countries. Value changes among people, both young and old, have added to an increasing unwillingness to accept mishaps. Names such as Seveso, Bhopal, Basel, Valdez, Minimata, and Love Canal still send shivers through various company headquarters.

Business leader recognize that increased societal awareness of environmental problem is exerting pressure on all sectors of industry from four directions (see Figure 1). With some notable exceptions (the energy industry and Japan), a majority of all respondents to the McKinsey survey feel that government regulation aimed at reducing environment related targets by 50 percent, for product and/or process standards that are critical to their industries, is likely by the year 2000. Most executives also agree that consumers will be increasingly critical of a company’s behavior vis-a-vis the environment, and that a negative environmental record represents a definite handicap in attracting and retaining top talent. Finally, environmental legislation that differs among countries has become a decisive factor in plant location and thus can put specific competitors in a favorable position.

Faced with such increasing pressures, many companies have takne positive initiatives. However, new thinking is still needed for society to develop solutions that simultaneously satisfy three criteria: effectiveness (contributing to improving the environment); efficiency (improving the environment at the minimum cost); and equity (showing fairness in the burden sharing among players). To achieve these three criteria, the divisions that currently separate the players in the environmental policy-making arena must be bridged.

This article will first examine the inadequacy of current approaches in meeting these challenges. It will then outline some frameworks for understanding how and why companies and governments have responded so far that can provide some pointers for future developments. Finally, we will look at some success stories and the barriers companies must overcome in responding to the environmental challenge.

CURRENT APPROAHCES ARE INADEQUATE

The state of the environment worldwide is deteriorating. A new generation of environmental issues has surfaced with characteristics more threatening than any faced before. The traditionally local pollution problems of water (“burning” rivers in heavily industrialized cities) and air (smog) have become regional (acid rain) or global (ozone depletion and global warming). Seas, no longer just rivers and lakes, are now subject to eutrophication due to the excessive spread of fertilizers. Single-substance/ single-media issues (such as mercury in water) have been succeeded by multi-substance/multi-media issues (such as the acidification of the air, the soil, the waters, and even our buildings due to an excess of [SO.sub.2], [NO.sub.x] and ammonia), frequently involving a complex string of more than 10 chemical reactions. Most important, some of the “new wave” of environmental issues might cause wide-spread, irreversible damage. Thus, Laurens-Jan Brinkhorst, Director General of Environment & Nuclear Safety of the European Communities, stated that “we are the first generation that can destroy its very existence.”

Faced with this responsibility, we must recognize that current approaches are inadequate for battling pollution. No government policy, whether based on regulation or economic instruments, can cover the exact situations of all companies that have to change their behavior to the benefit of the environment. Regulation tends to be rigid and inflexible, and the essential international harmonization is often sadly lacking. Most important, however, government policy is generally formulated in reaction to a problem and therefore is, per definition, late. Thus, official policies simply cannot be expected to pass the 3E-test of effectiveness, efficiency, and equity.

As critical regulations are tightened, this test will become all the more relevant. Almost half of the respondents in the McKinsey survey feel that achieving 50 percent tighter standards by the year 2000 is a realistic goal for their companies, but many are wary of the impact (in terms of efficiency and equity) of the necessary actions. Specifically,] many executives have expressed serious concerns about their ability to pass on the associated cost increases to the market (see Figure 2).

Despite recognizing the environmental challenge and the urgency of additional measures, firms must be expected to increase resistance. So the question for the players in the policy-making arena is how to shape environmental policies so that they–better than before–can pass the test of being effective, efficient, and equitable.

LESSONS FROM THE POLICY LIFE CYCLE

Environmental issues vary widely in their scope, sources, effects, risks, and social and economic consequences. A specific solution must therefore usually be found for each issue. However, most issues pass through a policy life cycle (PLC) consisting of four distinct phases (see Figure 3). The characteristics of each phase are determined by the political “weight” attached to a specific issue at a given moment in time.

Phse 1: Recognition. The first signals that a problem might exist typically come from researchers or environmentalists. In the beginning, opinions usually differ greatly as to the nature and extent of the problem, as well as it causes and effects. Because factual knowledge is incomplete, a key factor for success is the management of uncertainty. The demand for a suitable policy comes when the government authorities responsible reach the conclusion that the problem must be solved, often as the result of a major incident.

Phase 2: Policy Formulation. Political discussion about the most appropriate measures and the correct distribution of costs is often fierce during this phase. As a result, press coverage is intensive. Faced with increasing external pressures, the key to success is often crisis management. Policymakers therefore emphasize effectiveness rather than efficiency: find a solution that works, whatever the costs, and push it through the legislature.

Phase 3: Implementation. Actual policy implementation is often costly and has a major impact on such target groups as industry, power generation, transportation, agriculture, or private households. However, once a solution has been determined, political and societal attention tends to wane. Further, as focus shifts toward operational management, more emphasis is placed on enforcing and particularly on streamlining regulations and procedures (reregulation) for efficiency. In turn, this often involves decentralizing responsibilities to lower levels of government (states, municipalities).

Phase 4: Control. The final phase of the PLC begins when the initially targeted improvement in environmental quality has been realized and the problem reduced to politically and technically acceptable proportions. Policy-makers must now ensure that the problem remains under control. As the policy is internalized throughout society, regulations can often be simplified and sometimes even abolished (deregulation). Ongoing vigilance, however, remains necessary.

Two aspects of interpreting the PLC are critical for developing policies that can pass the 3E-test. First, countries tend to be “out of synch.” Industrialized countries may already be in Phase 4 or Phase 3 (see Figure 4) for issues, whereas developing countries are in Phase 2 or even Phase 1. To a lesser degree, this also holds true even among the most advanced countries, where the position of a specific issue in the life cycle is primarily determined by the political urgency felt–often the result of a near mishap. Thus, air pollution controls are furthest advanced in Japan, whereas the United States and the Netherlands lead in soil clean-up programs, and Scandinavia and Germany are on the front lines of the battle against acidification. Given their very different priorities, national governments often find it extremely difficult to reach agreement on international action.

Second, the characteristics of each phase differ; therefore, the key factors for success for all players, including industry, will change when passing from one phase to the next. In a Darwinian “struggle for survival,” each player has developed the skills and the culture needed to deal with the most immediate tasks. For most companies these are Phase 3 activities. Indeed, throughout all industries and geographic regions, a majority of respondents in the McKinsey survey provides evidence of a highly operational environmental focus. They consider compliance with regulations and prevention of incidents as their top two environmental concerns. Enhancing corporate image, integrating the environment into company strategy, and realizing new environment-related market opportunities occupy much lower positions on the corporate agenda (see Figure 5).

Government policymakers, on the other hand, “specialize” in Phase 2 activities. Their culture reflects this focus. Government and business speak very different languages and have difficulties communicating. As an illustration, respondents to the McKinsey survey find government policy inconsistent, lobbies ineffective, and communication with the public insufficient. The culture gap between the other major players in the policy-making arena–the environmental scientists focused on Phase 1 and the environmental organizations with their skills at accelerating the transition from Phase 1 to the PLC peak–is even more marked.

Each of these parties, with its own objectives and area of expertise, plays a key role in formulating and implementing environmental policies. However, government invariably knows too little about business, and is almost always late with a reaction. Environmental organizations know too little about both business and government; environmental scientists tend to be too distanced from the public. Finally, business and most of its trade associations know too little about government and–surprisingly–about the environmental attitudes of the public. The moral is clear: If these policies are to be effective, efficient, and equitable, they must be based on a bridging of interests and cultures among all players.

SOLUTION IN THE MAKING

Will it be possible to build bridges between traditional adversaries? The PLC illustrates how individual policies are developed to address individual issues. Over a period of two decades, much experience has been accumulated, and despite frequent disappointments major progress has been made in the abilities of government and industry to respond to environmental issues with mucy greater sophistication and at a considerably higher level of aspiration. Even in the most advanced countries and in the most responsive companies, many answers still have to be found.

However, the contours of long-term development can be discerned in the more or less parallel four-step development of government policy-making and corporate response formulation, from ad hoc, through technocratic, to top-management-driven, and ultimately to vision-driven policy.

Government Policy-Making

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Experiences of more advanced countries in Western Europe and North America show that it is generally possible to distinguish four development stages in environmental policy (Figure 6):

1. Reactive policy. During the first phase of environmental policy-making, the official response to external challenges is characterized by an ad hoc handling of urgent tasks. Reacting to the most imminent needs and crises and dealing with highly skeptical counterparts in other government departments and in industry, the policy-making departments lack appropriate resources, experience, organization, and credibility. A major share of resources is spent on developing tools (such as regulations), networks, and infrastructure. The planning horizon of policymakers in general is less than one year; their objectives can best be characterized as “survival.”

2. Sectoral policy. The transition to the second stage of environmental policy-making is made when the basis is sufficiently sound for a target setting per environmental sector (air, water, noise, soil). Work programs focus on near-term regulations, implementation, and enforcement objectives. From an overall perspective, the main objective is internal integration–aligning all government units with a direct environmental responsibility at a national, regional, or local level. Although the sectoral plans often provide a medium-term perspective, for practical purposes the planning horizon generally is one year. In the more advanced countries, the transition from Stage 1 to Stage 2 was made in the early 1980s, often at the time when the Environment Department received full cabinet status.

3. Topical policy. Based on the improved organization and cohesion of environmental units, the policy-making focus now changes to external integration–integrating environmental objectives into the strategy of other government departments (industry, energy, transportation, agriculture), each with its own sector-specific goals. This requires “translating” these goals into terms that are workable in these departments and the relevant target groups within industry. Plans typically have a horizon of three to five years and specify overall reduction targets to be realized during that time.

This transition to integrative planning is all the more necessary since sectoral policies frequently prove inadequate in dealing with the increasingly complex environmental issues of advanced economies, requiring an overarching perspective involving more than one sector. Governmental organizations are therefore refocused around central policy themes such as acidification, eutrophication, or global warming. Representatives of different sectoral units work together on a program or project basis to develop practical solutions, often in direct interaction with representatives from other departments and relevant target groups.

4. Comprehensive policy. The contours of the fourth stage of policy-making can be seen in the most environmentally advanced countries. The co-responsibility of third parties, especially the target groups, is needed to develop effective, efficient, and equitable solutions for environmental issues. Joint objectives are set based on a situation analysis of the state of the environment, and the time paths to realize these objectives recognize the specific situation of each of the target groups and its realistic wishes and needs. Moreover, in assessing the options for actions, the strengths and weaknesses of the government organization are taken into account. The resulting action plans thus tend to be more realistic than in the earlier stages. Although the planning horizon is much longer, about ten years, comprehensive policy-making recognizes the unpredictability of major parts of the environmental agenda and allows for a dynamic adaptation as new evidence or political priorities develop.

Corporate Response

The changing response patterns among leading-edge companies and industry sectors are manifest in “the way we do business around here”–in the integration of business functions, in the cooperation among people and organizations, and in the generation of new ideas and concepts. In each of the four phases of the changing response patterns the requirements for success will differ (see Figure 7).

1. Reactive response. The onset of government policy-making is generally met with a defensive approach. Companies, and especially their sector organizations, dig in their heels and feel that any new claims are greatly exaggerated. Led by larger, internationally oriented corporations, they tend to adopt a posture of loyal citizens: “We will do what is legally required, but we don’t like it.” Assigning responsibility to staff specialists, usually as an extension to the existing health & safety departments, they implement the prescribed end-of-pipe solutions consisting of add-on features to the existing facilities while trying to minimize their response and the costs thereof.

2. Receptive response. Gaining experience and becoming more comfortable with the new responsibilities, companies shift to an attitude of “Okay, if we have to do it, let’s be smart about it.” Line management is now made responsible–within the boundaries of the current business–for developing solutions that meet the criteria set by the government in the most efficient manner. Most solutions still involve optimizing the existing production configurations, although they will often include some process redesign.

3. Constructive response. A few companies have begun to look beyond the boundaries of their current businesses to find more fundamental answers to the environmental questions. In more advanced countries, stimulated by government intervention, industries have developed so-called “cradle-to-grave” approaches whereby they accept responsibility for their products even after they have been sold. As a result, the traditional industry delivery chain in, for instance, the packaging or automotive industries is changing rapidly. Companies are also starting new cooperations with suppliers, customers, and especially competitors to facilitate joint objectives, such as waste collection and recycling, “green” product labeling, or contractual agreements (“covenants”) with governments that establish new environmental objectives. Moreover, existing approaches can often no longer meet much tighter targets, necessitating industrial players to strive for technological or organizational quantum leaps.

4. Proactive response. Very few companies have reached this phase yet. Still, the contours of the response pattern can be sketched by looking at the policy development in leading countries and at the role specific companies play. Increasingly, companies will internalize the environmental challenge as an element of quality management. To meet the challenge and at the same time focus on the needs of their customers, they will optimize their own functioning and especially their value proposition (products plus services at a given cost). Companies and industry sectors will pool their resources with those of governments, scientific institutions, and often environmental organizations to find solutions to the increasingly complex environmental issues that can pass the 3E-test.

The challenge of bridging interests and cultures among players of great diversity is considerable. Leaders in government and business, as well as in environmental organizations and scientific institutions, must generate a vision that can serve as a reference for all workers in their organizations. Within industry, this vision must inspire the full internalization of the environmental challenge throughout a company. Top management must take the lead in defining far-reaching but understandable goals–like Du Pont’s and Asea Brown Boveri’s “zero emissions”–that stretch the organization to look beyond the horizon of today’s concerns. However, building on the experience of the first three stages, this long-term vision must also drive the medium-term strategy that in turn can be built on in practical short-term action plans.

MAKING IT HAPPEN

Against the background of the evolutionary patterns of government policy-making and corporate response outlined above, companies must decide on an appropriate environmental strategy. In doing so they must take into account not only their traditional business objectives, but also the environmental pressures in the countries and industries where they are most active. As these pressures differ, no generally applicable recipe for action can be provided. Reflecting the insights of top management, companies should chart their individual paths in the environmental arena, for the costs are too great to rely any longer on reaction.

In this section we will use the development patterns sketched above to briefly touch upon the current situation with regard to policy-making and corporate response in the industrialized world. The lessons from the PLC can then be applied to develop a first view of the implications of environmental strategy choices.

Current Situation

With mounting pressure from an increasingly concerned population, the developments in environmental policy of industrialized countries have been accelerating over the last few years. In Europe, for instance, countries such as Germany, Switzerland, and the Netherlands are rapidly moving into the third stage of topical policy-making, and even experimenting with comprehensive planning. Others, such as the United Kingdom, France, Belgium, and Italy, follow close behind in the sectoral policy stage, with most Southern European nations still making the transition from Stage 1 to Stage 2. Only the Central and Eastern European countries, struggling with the disheartening environmental inheritance from the past decades, are still forced to adopt ad hoc reactive policies.

Importantly, in spite of state-of-the-art approaches to pollution prevention and tough regulatory measures such as the new Clean Air Act, a recent study by Environmental Resources Limited (1990) concludes that “a coordinated approach is still unlikely in the U.S. where departments develop independent plans and there is little scope for integrated planning. Environmental agencies are very dispersed, divided by media as well as between federal, state and local agencies.”

On the corporate level, the lead is shared by an increasing number of entreprenuerial organizations with strong environmental leadership and, importantly, some major representatives of Fortune 500 companies. Among the latter companies, the most constructive responses (Stage 3) can be found consistently in multinational companies in highly competitive industries that are close to the consumer and headquartered in cutting-edge regions. Even in the more advanced nations, a much more reactive, or at best receptive, response can still be found in a majority of small and medium-sized companies and in industry sectors that are characterized by a high degree of oligopoly or a tradition of government involvement. It would appear that a “protection” from public scrutiny results in less attention to environmental concerns.

Requirements for Change

In the long run, business–across all industries and all nations–must expect a development toward a constructive and eventually a proactive response pattern. However, few companies can permit themselves the luxury of omitting competitive considerations in strategic decision making. Thus, given the increasing relevance of environmental considerations in virtually all industries, each individual management team is well advised to decide on an appropriate environmental strategy for its company. Some may elect to become an industry leader, whereas others can choose to become a follower or even–a high-risk course–a relative laggard. If the choice results in a constructive or proactive positioning, the consequences are significant.

For example, companies must develop internal and external antennae that scan the environmental horizon for emerging issues, allowing them to make a first assessment of the potential impact of such issues on the competitive arena. Just over a quarter of the respondents in the McKinsey survey indicated their company has instituted an advisory board or group of external environmental experts. This obviously does not suffice if management is to bridge the gaps between it and the environmental scientists and activists and make constructive use of the knowledge and insights these parties have acquired in “surviving” in the recognition and formulation phases of the PLC.

More difficult still, the environmental thinking of corporate strategists and decision makers must be turned from Phase 3 (implementation) to Phase 2 (formulation) of the PLC. If companies, in a constructive or proactive mode, want to stimulate solutions that can pass the 3E-test, they must become deserving partners in the environmental policy formulation process. The key to earning such a set at the policy-making tables is a better understanding of and greater respect for government policymakers and their objectives. More than before, business will have to integrate environmental considerations into strategies and their subsequent operational implementation.

Above all, however, top management must overcome the skepticism among its own middle management. Top-level executives recognize the relevance of the environmental challenge but at the same time express serious concerns about their company’s ability to pass on the associated cost increases to the market. A number of subsequent, targeted questionnaire surveys through the ranks of major multinational companies–from chief executive to shift managers on the shop floor–indicated that these concerns are even more pronounced at lower echelons of the firm. Expectations of regulation tightening are shared, the realism of such targets for theirown company is recognized, but business unit managers in particular exhibit skepticism about recovering environmental costs in the market (see Figure 8). As long as middle managers, with their pivotal position in implementing changes throughout a company, perceive “environment” as a threat to their own functioning, it is unlikely that the top-down vision of senior management can be realized in practice.

Signals of Change

With such barriers to overcome, is it realistic to expect large-scale changes to happen? We should not underestimate our own abilities to respond to challenges and change our collective attitudes and behavior. Industry has assimilated massive changes before, be they society induced, such as industrial democratization in the 1970s, or technology driven, such as IT-based production and logistics in the 1980s. Each time the response pattern was analogous to that described before: ad hoc reactive; technocratic receptive; top-management-led constructive; and vision-driven pro-active. Each time the winners were those companies that turned a perceived threat into an opportunity, such as people empowerment or time-based management.

The signals of change are encouraging. An overwhelming majority of our survey respondents now subscribe to 3M’s Pollution Prevention Pays philosophy. Similar programs can now be found in many large corporations: WRAP (Waste Reduction Always Pays) at Dow Chemical; Chevron’s SMART (Save Money And Reduce Toxins). Other companies, such as Shell, are integrating environment into their corporate strategy and scanning the horizon for business opportunities that will provide them with a new source of competitive advantage. At the Second World Industry Conference on Environmental Management (WICEM II) held in April 1991 in Rotterdam, a large number of companies signed the Business Charter for a Sustainable Development proposed by the International Chamber of Commerce. Leading chemical companies urge their peers to join the Responsible Care Program.

Even more important, new policy approaches have increasingly distinctive Stage 3 (constructive response) characteristics. The Clean Air Act in the United States is heavily based on economic instruments, such as the bubble concept, that emphasize market-driven, intra-industry responses.

In September 1990 Bill Reilly, administrator of the EPA, invited industry to join a voluntary emission reducation program concerning 17 chemicals; the response has been encouraging. Recent German policy builds on a cradle-to-grave responsibility of all suppliers of packaging materials, ranging from producers to supermarket outlets. European automobile manufacturers are joining hands with recyclers in redesigning their products for collection and regeneration of waste. The Dutch chemical industry signed a covenant with the government to reduce its energy consumption by 20 percent in a 10-year period.

Even farther reaching, with shades of a Stage 4 proactive response, energy utilities in the Netherlands and California have developed voluntary action plans to reduce the energy consumption of their customers. The list of constructive and proactive responses in the more advanced countries is expanding exponentially.

Clearly, corporations and governments worldwide have a long way to go. The 1990s will be a decade of experimentation, developing new answers, and building the credibility and trust that provide the essential foundation for Stage 3 and 4 responses. Undoubtedly, frequent setbacks will occur when individual parties retreat to traditional adversarial roles or initiatives fail. Still, a large majority of the survey respondents agreed with Tom Stephens, CEO of Manville Corporations, who in the early 1980s learned a painful lesson from major asbestos incidents: “To minimize the chance of future tragedies, we should pursue a partnership of government, industry and academia.” This is even more so if such solutions are to pass the 3E-test.

Awareness of the environmental challenge has greatly increased. With its rapidly changing values, society will hold business responsible for its impact on the environment. Business will answer new questions and accept new challenges. Industry sectors will rethink the entire concept of their industrial process to adapt profitably to an increasingly environment-conscious world. Companies will recognize the need to assume responsibility for their products even after they have left the plant. Even now, few senior executivves disagree (see Figure 9). The environmental challenge thus is ultimately translated into a challenge of making it happen.

References

Environmental Resources Limited, “Comparison of Environmental Policy Planning in Industrial Countries in the Context of the National Environmental Policy Plan,” Study for the Dutch Ministry of Housing, Physical Planning and the Environment, 1990.

McKinsey & Company, “The Corporate Response to the Environmental Challenge” (Amsterdam, 1991).

Pieter Winsemius is a director of McKinsey & Company in Amsterdam.

Ulrich Guntram is a principal of McKinsey & Company in Stuttgart.

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