Managing Director & Senior Partner
Whatever the strength of the outcome of the climate change conference in Glasgow, the global business context just changed irrevocably, and for the betterment of the planet. And while the world’s commitments aren’t yet enough to limit warming to 1.5 C above pre-Industrial levels, the starting gun in a business innovation race has just been fired: a race where the finish line will likely eventually move from 2050 or so, to 2040. Most racers will need to get to half-way by 2030.
The winners in this climate innovation race will be those sustainability leaders whose business model innovation is the most durable to the environmental and societal challenges ahead, creating returns for shareholders and environmental and societal benefits for stakeholders. But what does this all really mean?
First the context. As the Treasurer noted in September, well before many countries realised, global investors had read the science and realised governments and civil society would have to act to limit warming and reduce emissions drastically. To win in this future world, investors needed their investment portfolios to do the same, driving up the cost of capital for ‘ESG laggards’, spurring change in companies they invested in. Customers and activists reinforced this.
The COP26 national emission reduction commitments now irrevocably reinforce this investment paradigm for investors, even if not for all governments yet: not just the ‘net zero by 2050’ headline, but the Paris objectives to keep cumulative emissions over the next thirty years below a certain level. The shorthand of what this requires is to halve emissions from 2005 levels by 2030, coincidentally what the Business Council of Australia says Australia can do.
Governments can make this transition easier and less costly than it otherwise would be, with globally consistent tools such as science-based measurement frameworks, ‘level-playing field’ regulation change for the new reality, markets that enable the rewarding of emissions reductions, and technology and structural adjustment funding. All these facilitate a smooth transition.
But to reduce emissions (and secure future investment at reasonable prices), all companies and organisations need to change their business models – some quite radically. The power generating and consuming ‘ecosystems’ of each country will need to change fundamentally to accommodate massive levels of renewable energy. We need to produce goods and services that delight customers, but ultimately without net emissions generated in production or subsequent use. And while all change is hard, some will be exceptionally hard, like producing zero-emission steel at scale, decarbonising the last 10% of electricity production, or replacing the world’s jet fuel with substitutes at 80% lower emissions per kilometre.
Necessity is, however, the mother of invention. The sustainability winners will fuse the traditional attributes of financially sustainable busines strategy with the emerging attributes of economically and socially sustainable practice. Both are needed. Some companies might already have the traditional advantages of a differentiated product, service or ecosystem that is hard to replicate, with scalable or network economics. But to win and become a sustainability leader in a world already assuming (as one example) disproportionate investment and customer preference goes to the leading emissions reducers in each sector, you also need to innovate to drive your ESG returns. Are you ahead of customers’ environmental and social expectations, and fulfilling the purpose you set yourselves? And do you create tangible environmental and social benefits for others, alongside required shareholder financial return?
We already know that sustainability leaders reap rewards other businesses do not. Aside from creating business advantage and value for shareholders, and environmental and societal surpluses for stakeholders, they typically enjoy 10% premiums paid for sustainable products and services. They are also more attractive employers, with about 40% of Millennials factoring sustainability into their job decisions. They often have lower operational costs, better access to finance, higher market valuations – the list goes on and on.
The climate innovation race may consist of many short sprints along the journey, in part because the ‘rules’ or investor and community expectations will change along the way, and in part because some things that will enable innovation haven’t been invented yet. And the sprints will ideally be reinforcing of both economics and value to the customer, as well as ESG returns. For example, industrial companies will also become energy traders, ensuring their energy needs can be varied to match the dynamic nature of the future grids, lowering their own costs and risks, but also enabling more stable electricity delivery for citizens.
Overall, the need to sustainably innovate business models presents huge opportunities for most businesses, with risks for those too slow to adapt, just as digital technology classically enabled the creation of the iPhone yet was missed by Kodak. The internal combustion engine will disappear – who or what will win the replacement race for each vehicle class?
It will be tempting to obsess over the detail being nutted out as COP26 progresses, both the surprise announcements and the inevitable disappointments over semantic wrangling. But for businesses, the strategic direction has been set already. What began in Paris is now cemented as the future paradigm against which large investors and many consumers will weigh their marginal decisions to invest or purchase. Delivering on COP26 will require sustainable business model innovation. Companies need to change irrespective of the semantics. Whether you wake up in the morning wanting to be the next iPhone, or merely to avoid being the next Kodak, you’d better start innovating.