Managing Director & Senior Partner
Fresh water is the basis of life on our planet, a basic human right, a critical factor in the health of our global environment, and a vital part of the operations of businesses in a wide range of industries. But this resource is fragile and prone to crises. According to the United Nations, 4 billion people—more than half the world’s total population—suffer from water scarcity every year. The diversity of freshwater species has declined more than 80% since 1970. And in 2018, businesses worldwide reported $38.5 billion in financial losses related to water scarcity or pollution.
In short, the situation is dire—and it will only get worse as global warming changes hydrological patterns around the world. Although greenhouse gas emissions and water issues are related global problems, they require very different solutions. Our climate is a globally intertwined system, and slowing down climate change demands global actions. Every independent action we take contributes to the overall effort to reduce greenhouse gas emissions.
Water crises are different, in three critical ways. First, water crises are largely local. No matter how large or small, every water crisis affects people and businesses within clear boundaries. But both the effects and the root causes can extend beyond those boundaries; too much rain in one location may result in drought in another, for example.
Second, water crises are dynamic. Whereas greenhouse gases, once released, can remain in the atmosphere for several generations, the availability and quality of water can change from day to day. The supply of water shifts both seasonally and over the long term as a result of climate change. Demand also changes month by month and is increasing in response to global megatrends such as the growing middle classes. Aging water infrastructure, too, affects our ability to dynamically balance supply and demand.
Finally, fresh water is a shared resource, and it suffers heavily from the tragedy of the commons. Always relatively cheap, and sometimes free for industrial applications, water may be abused by individual users acting in their own self-interest, contrary to the common good of all stakeholders.
Consequently, the effort to mitigate the effects of any particular water crisis needs to be largely local, and carefully coordinated among many different stakeholders; otherwise, even the best intentions may well counteract each other. Indeed, many such efforts have long been thwarted by basic disagreements about both the causes and the consequences of specific local water crises and by the lack of a systematic approach to understanding them.
As a first step toward such an approach, we propose the BCG Water Risk Matrix, a framework for clarifying and understanding the challenges underlying water crises, as well as their impacts. We believe the matrix can help guide stakeholders toward workable solutions, enabling policymakers, environmentalists, and business leaders to cut through the complexity inherent in every water crisis and consistently assess the risks, prioritize the mitigation efforts, and make investment decisions related to the use of water.
Every water crisis has a multitude of underlying causes. Algae blooms may be caused by a combination of warming temperatures and excess nitrogen runoff from farmers’ fields, chemical pollution by careless industrial practices and lower water levels, flooding by changing precipitation patterns and the disappearance of natural water-absorbing wetlands. It is the complex, interrelated nature of the root causes that makes it so difficult to develop a consistent approach to assessing the risks involved in any particular crisis. To clarify the risks, we first sort the root causes into two kinds of challenges.
We then divide the impacts of water crises into three categories, depending on the role water plays and the stakeholders affected.
On one level, the relationship between the challenges and the impacts is straightforward: every quantity- or quality-driven challenge impacts to some extent the roles of water and the stakeholders involved. But every local water crisis is different. Assessing the risks and putting together a successful mitigation plan depends on a full understanding of the local factors that determine which impact category is most affected and which challenges must be prioritized to address the most pressing impact.
The goal of the Water Risk Matrix is to help further that understanding by clarifying the nature and likelihood of each of the three types of impacts in the event of a water crisis. This, in turn, should help stakeholders find the right path to action.
Exhibit 1 shows how this works in an example of risk analysis for the Rhine River in Germany. Critical to the nation’s transport infrastructure, the Rhine is a major source of economic risk if logistics are impeded by excessively low water levels.
This is exactly what happened in the summer and fall of 2018. Following a prolonged drought throughout Europe, water in the Rhine River fell to its lowest levels ever recorded, bringing shipping to a standstill for weeks. Major global enterprises with operations in the Rhine’s water basin were forced to slow production, or even halt it entirely, as they ran out of crucial inputs. And fuel prices in southern Germany spiked to a level more than 8% higher than prices in the north. Businesses that understood the risks inherent in their reliance on the Rhine for transport would have been able to develop contingency plans for their logistics needs.
Exhibit 2 illustrates how the matrix method can be put into practice for several major water basins around the world. Each location’s matrix assesses the level of risk associated with each impact, giving stakeholders a way to assess the relative impact of any local water crisis. This, in turn, enables them to better direct their decision making and the initiatives needed to mitigate the risks.
The two water-related challenges of quantity and quality can stem from a variety of causes that are often interrelated.
The key to alleviating, and possibly reversing, the effects of this vicious cycle lies in understanding who is impacted and how they are affected.
The impacts of any given water crisis in any particular location are the result of the various challenges and their relative weights. The impacts fall into three categories—environmental, social, and economic—according to the role water plays and the stakeholders involved.
Environmental Impacts. Freshwater systems are the basis of our planet’s climate, and significant changes in the quantity or quality of fresh water bring adverse effects to the body of water itself and to surrounding wetlands, forests, and oceans—indeed, to entire regions.
One key metric for ecological impact is the loss of biodiversity in local ecosystems. The vicious cycle of quality and quantity has already had severe effects on global biodiversity. As noted earlier, the number of animal and plant species living in and around fresh water has declined dramatically, and will continue to do so. Shrinking biodiversity creates another negative feedback loop, reducing the resilience and the self-cleaning and self-recovery ability of bodies of water. Failing freshwater ecosystems are no longer able to provide vital services such as natural waste treatment, flood and drought prevention, and microclimate control.
Everyone in the world is a potential stakeholder when water crises affect local environments. But it has largely been nongovernmental organizations that push society and governments to understand the critical relationship between water and local ecosystems and to initiate action to alleviate the impacts.
Social Impacts. The United Nations has codified the right to clean water and sanitation as the sixth of its Sustainable Development Goals (SDGs), which states, “By 2030, achieve universal and equitable access to safe and affordable drinking water for all [and] access to adequate and equitable sanitation.”
Clean drinking water alone is of course not enough to provide people with healthy, productive lives. Lack of fresh water for agricultural production can mean famine for millions. That, in turn, can lead to political unrest. The Nile, for example, is the primary source of drinking and irrigation water and a source of energy for many of the ten nations along its course. As a consequence, the Ethiopia-led Grand Ethiopian Renaissance Dam project sparked conflict among these ten nations, ultimately requiring the US to step in and mediate in response to a call for help.
It is in the interests of governments, NGOs, and citizens alike to pursue the water and sanitation goals codified in the sixth SDG. In order to ensure a peaceful, prosperous population, governments must devise policy- and regulation-driven schemes to minimize the causes of water-driven crises, and they must commit to enforcing them. NGOs must continue to advocate for sustainable environmental goals, including the responsible use of water. And people must come together in efforts to demand these key human rights.
Economic Impacts. Water is critical to the operation of just about every kind of business—as a direct input and commodity for industries such as food and beverages, agriculture, and mining, and as a means of transport for maintaining reliable worldwide supply chains. In textiles, for example, a single T-shirt can require 2,700 liters of water, much of it used to grow the cotton the shirt is made of.
Unsurprisingly, the threat of water crises has been among the top risks reported by the World Economic Forum in each of the past five years. It currently stands as the fourth greatest risk, after weapons of mass destruction, extreme weather events, and failure to mitigate climate change. Tools such as the Water Risk Matrix can help companies assess water-related business risk—to better understand the extent to which companies are already affected by water-related issues and to plan their operational and investment strategies. (See “Assessing the Business Risk of Water Crises.”)
According to the CDP, which provides information to investors on the transparency with which individual corporations report their environmental risks, the impact of water crises on companies—not just scarcity but also flooding and general water stress—is severe. In 2018 alone, companies reported water-related losses of $38.5 billion. Just 6% of those losses were attributable to reputational risk; the rest came from operational risks (such as higher operating costs, reduced or disrupted production capacity, impact on company assets, and constraints on growth) and from fines, penalties, and increased compliance cost. Yet despite the risks and the very real impacts, water is often extremely inexpensive, sometimes even free of charge for industrial use, which often leads to a lack of attention from businesses.
The Water Risk Matrix provides a critical first step in a consistent assessment of water-related business risks. These risks can then be further categorized according to type (physical, regulatory, or reputational) and point of impact (supply chain, operations, or product use). The frequencies with which companies cite these risks, and their impacts, vary considerably; companies report far fewer impacts on supply chains and product use than on their operations. (See the exhibit “In the View of Companies, Physical and Regulatory Risks Far Outweigh Reputational Risk.”) This perception likely stems from a lack of understanding and analysis of the more indirect impacts of water stress on their businesses.
That situation is beginning to change. Far-sighted companies are starting to take the indirect risks into account in their decision making. An assessment of the impact of water shortages on its customers in highly water-stressed markets, for example, led one leading consumer goods manufacturer to develop water-saving personal hygiene and laundry products.
Assessing the total degree of water-related risk companies might face in a specific location depends on the location and the type and extent of the operations there.
The exhibit “Total Water-Related Business Risk Depends on Basin-Related and Operational Risks and the Size of a Company’s Operation” examines how a hypothetical business should assess the risks in relation to four water basins. Consider India’s Ganges River basin, for example. The basin-related risk there is high, driven by the river’s extreme contamination—already identified in the Water Risk Matrix—and by the river’s cultural importance and the uncertainty of local regulatory frameworks.
If the hypothetical business were a beverage producer, for example, the operational risk, too, is high, because the company’s activities are heavily reliant on clean water. This analysis would be instrumental in helping the company decide whether to expand its operations in the basin (or whether to keep them there) and identify which aspects of the water risk warrant further analysis and mitigation.
In contrast, the same hypothetical company operating in the Rhine River basin faces considerably less business risk, primarily because the basin-related risk is much lower. Extreme drought and low water levels remain rare occurrences in this location.
The benefits from taking these risks into account, and sustainably managing them once they are understood, can be great. BCG analysis shows a correlation between strong water management practices and higher EBITDA margins; in the consumer packaged goods sector, for example, companies with strong practices posted EBITDA margins that averaged 3.1 percentage points higher than those of their less sustainability-minded peers.
This makes it incumbent on stakeholders, including both businesses and governments, to work toward the conditions needed for the responsible use of water. Businesses need to incorporate water sustainability in their daily decision making, but they require steady working conditions and a clear regulatory framework that enables them to plan long-term investments and business development while fulfilling societal demands and retaining their “license to operate.” It is the responsibility of governments to provide such a framework.
Understanding the challenges, impacts, and risks of any local water crisis is only half the battle. Equipped with this knowledge, stakeholders must then coordinate efforts to cut through the complexity and diversity of the root causes and symptoms that make a water crisis so different from the CO2 debate. This, we believe, is the only way to reduce pollution and waste, increase resilience to a location’s specific impacts, and secure sustainable water sources for everyone affected.
The 2019 Water Summit, hosted by World Wide Fund for Nature, BCG, Reuters, Ceres, and the Frankfurt Stock Exchange, brought together leaders and officials from industry, banking, NGOs, and governments in hopes of cutting through the complexity of water-related issues and arriving at a consensus as to the actions required. The conclusions reached at the summit fall into four areas.
Water Reporting Standards. As noted earlier, sustainability can provide a very real financial boost. And investors are increasingly making companies’ sustainability and societal impact a part of their decision making. But given inconsistent standards and a lack of comparability among approaches, this remains a problematic task.
Several organizations are working toward creating internationally accepted reporting standards for water- and sustainability-related risks. Such standards will be critical in the effort to integrate water and sustainability into the day-to-day decision-making processes of businesses and other stakeholders. So far, however, the business community has not taken a role in defining standards; mostly, it merely reacts to the efforts of groups like the CDP (formerly the Carbon Disclosure Project). By taking a leadership role, businesses would have a unique opportunity to shape an internationally recognized sustainability reporting standard, which would likely have an impact similar to that of the International Financial Reporting Standards, which are agreed to by most counties.
The Value of Water. For the most part, the price of the water used by businesses reflects neither its value to the business nor the impact of its use on the environment and supplies of drinking water. Put bluntly, water is far too inexpensive to encourage many businesses to use it responsibly. In fact, businesses committed to the sustainable use of water note that the low cost of water makes it difficult to encourage their supply chain partners to change their water usage practices.
Making sure the entire business supply chain has a stake in any sustainability plan requires a better understanding of the true value of both fresh water and wastewater and an appropriate adjustment to prices. At the same time, it is important to strike the right balance between a properly valued price to businesses and a fair and affordable price to the public.
The Role of Government. The task of valuing water properly should fall to government policymakers and regulators, who must develop strong water governance frameworks in combination with stakeholder partnerships. Their first task will be to make available the data needed to understand watershed-wide quantity and quality challenges. This, in turn, will enable them to devise smart water regulations that are appropriate for the local challenges they face.
Rigorous regulations should cover both the supply of water and the demand for it and be designed to protect water resources and allow fewer exceptions. Governments should create water budgets for businesses, farms, and even personal use, considering the amount of sustainably available fresh water and wastewater, to ensure that water is fairly distributed and used at a regenerative rate. Finally, regulators should promote the development and use of low-water technologies and penalize waste, in much the same way that many governments promote the development and efficient use of renewable energy technologies.
Closing the Funding Gap. Carrying out the UN’s sixth sustainable development goal—ensuring the availability and sustainable management of water and sanitation for all by 2030—will require an amount of funding that far exceeds the current level of investment in sustainable water. Globally, we are currently investing about $330 billion in water-related projects such as water supply systems and wastewater treatment facilities, but the OECD estimates that the global funding needed to reach the UN’s goal is about $1 trillion annually for the next ten years. The question is how to fill the gap of close to $700 billion annually.
Unfortunately, the private stakeholders that may be willing to make the investments often lack the knowledge to do so effectively. The only way to generate the necessary resources is through public-private partnerships that can put together “bankable” projects through a variety of blended financing structures. (See “Liquid Assets.”) This will require investors to work more cooperatively than they typically like to do. Public entities and NGOs must also be willing to contribute their subject matter expertise to the effort to create bankable projects.
Fixing water issues requires significant investments, whether in water pipes, wastewater treatment, or better systems such as smart irrigation and smart industrial processes that reduce water demand or improve its quality. Given the sheer size of the investment required—about $1 trillion annually, according to the OECD—governments are in no position to plug the gap on their own. And many such projects, particularly those in emerging markets, struggle to generate adequate rates of return for private investors, putting their “bankability” in question.
To overcome this challenge, development financial institutions (DFIs), commercial banks, and other financial institutions are exploring blended finance opportunities. These deals can take different forms. Typically, DFIs and governments aim to enhance the bankability of projects by providing a financial cushion (in the form of concessional finance at below-market rates). By funding the early-stage development of a project (and taking on the risk that it fails) and accepting the initial tranche of project losses or providing financing guarantees to potential investors, they can attract private capital to participate in deals.
When structured properly, these deals can be a win for all concerned, multiplying the impact of DFIs, improving the risk-return profile of commercial banks’ investments, and enhancing the well-being and resilience of water users.
Everyone—environmentalists, governments, businesses, and the public—has a stake in ensuring the availability of clean fresh water. It is critical that all stakeholders understand the challenges of quantity and quality inherent in any body of water and the potential environmental, social, and economic impacts that attend crises in any basin or watershed. This understanding—the goal of the Water Risk Matrix—will allow stakeholders to assess the risks and to address them as they determine the proper environmental and social policies and business investment strategies.
Any effort to mitigate the risks and the impacts of water crises will require clear standards for reporting water-related risks, a proper determination of the value of water, resolute action on the part of governments to regulate water use, and the financing needed to ensure enough water for everyone. All stakeholders must be willing to collaborate and compromise to achieve the goal. Clean fresh water is in everyone’s interest.