The Sustainability Imperative - Harvard Business Review

The Sustainability Imperative - Harvard Business Review: "The Sustainability Imperative"
by David A. Lubin and Daniel C. Esty

Most executives know that how they respond to the challenge of sustainability will profoundly affect the competitiveness—and perhaps even the survival—of their organizations. Yet most are flailing around, launching a hodgepodge of initiatives without any overarching vision or plan. That’s not because they don’t see sustainability as a strategic issue. Rather, it’s because they think they’re facing an unprecedented journey for which there is no road map.

But there is a road map. Our research into the forces that have shaped the competitive landscape in recent decades reveals that “business megatrends” have features and trajectories in common. Sustainability is an emerging megatrend, and thus its course is to some extent predictable. Understanding how firms won in prior megatrends can help executives craft the strategies and systems they’ll need to gain advantage in this one.

The concept of megatrends is not new, of course. Businessman and author John Naisbitt popularized the term in his 1982 best seller of the same name, referring to incipient societal and economic shifts such as globalization, the rise of the information society, and the move from hierarchical organizations to networks.

Our focus is on business megatrends, which force fundamental and persistent shifts in how companies compete. Such transformations arise from technological innovation or from new ways of doing business, and many factors can launch or magnify the process of change. Business megatrends may emerge from or be accelerated by financial crises, shifts in the social realities that define the marketplace, or the threat of conflict over resources. The geopolitics of the Cold War, for example, drove the innovations that launched both the space race and rapid developments in the field of microelectronics—ultimately unleashing the information technology megatrend. Electrification, the rise of mass production, and globalization were also megatrends, as was the quality movement of the 1970s and 1980s. The common thread among them is that they presented inescapable strategic imperatives for corporate leaders.

Why do we think sustainability qualifies as an emerging megatrend? Over the past 10 years, environmental issues have steadily encroached on businesses’ capacity to create value for customers, shareholders, and other stakeholders. Globalized workforces and supply chains have created environmental pressures and attendant business liabilities. The rise of new world powers, notably China and India, has intensified competition for natural resources (especially oil) and added a geopolitical dimension to sustainability. “Externalities” such as carbon dioxide emissions and water use are fast becoming material—meaning that investors consider them central to a firm’s performance and stakeholders expect companies to share information about them.

These forces are magnified by escalating public and governmental concern about climate change, industrial pollution, food safety, and natural resource depletion, among other issues. Consumers in many countries are seeking out sustainable products and services or leaning on companies to improve the sustainability of traditional ones. Governments are interceding with unprecedented levels of new regulation—from the recent SEC ruling that climate risk is material to investors to the EPA’s mandate that greenhouse gases be regulated as a pollutant.

Further fueling this megatrend, thousands of companies are placing strategic bets on innovation in energy efficiency, renewable power, resource productivity, and pollution control. (See the sidebar “Fueling the Megatrend.”) What this all adds up to is that managers can no longer afford to ignore sustainability as a central factor in their companies’ long-term competitiveness.

Fueling the Megatrend
Venture investing in clean tech reached a nearly $9 billion annual run rate in 2008 and shows signs of growing again after a slowdown in 2009. The flow of private-sector investment into the clean tech marketplace has been estimated at more than $200 billion a year—with fast growth not just in the United States and Europe but in China, India, and the developing world. And G20 governments have earmarked some $400 billion of their $2.6 trillion in stimulus funds for clean tech and sustainability programs.

Learning from the Past: Quality and IT

Megatrends require businesses to adapt and innovate or be swept aside. So what can businesses learn from previous megatrends? Consider the quality movement. The quality revolution was about innovation in the core set of tools and methods that companies used to manage much of what they do. Quality as a central element of strategy, rather than a tactical tool, smashed previous cost versus fitness-for-use barriers, which meant the table stakes were dramatically raised for all companies. The information technology revolution was about tangible technology breakthroughs that fundamentally altered business capabilities and redefined how companies do much of what they do. Digital technologies deeply penetrated corporations in the 1980s and 1990s, and the trend accelerated as IT made its way into the daily lives of workers and consumers with the advent of desktop computing and the internet.

In both the IT and quality business megatrends—as in others we’ve studied—the market leaders evolved through four principal stages of value creation: First, they focused on reducing cost, risks, and waste and delivering proof-of-value. Second, they redesigned selected products, processes, or business functions to optimize their performance—in essence, progressing from doing old things in new ways to doing new things in new ways. Third, they drove revenue growth by integrating innovative approaches into their core strategies. Fourth, they differentiated their value propositions through new business models that used these innovations to enhance corporate culture, brand leadership, and other intangibles to secure durable competitive advantage.

The quality story.
The economic downturn of the late 1970s, coupled with the 1979 oil shock, drove a dramatic shift in consumer preferences toward efficiency. Many industries were transformed, perhaps none more dramatically than the automotive sector. Of course, the seeds of change had been planted earlier. In the years after World War II, Japan had rebuilt its industrial infrastructure on a model of high-volume, low-cost factories that mass-produced goods of questionable durability and quality. “Made in Japan” was not considered a brand asset. By the mid 1970s, however, Japanese government and business leaders had seized upon the ideas of Edwards Deming and others who stressed quality as a core value. This incremental, process-oriented approach to systematic improvement fit well with Japanese executives’ views on how to drive change to compete effectively in the global market. Leading firms including Toyota and Honda embraced Total Quality Management (TQM) methods, fundamentally shifting their value propositions. Quality methods called into question the assumptions managers had relied on for decades, namely that high quality and affordability were mutually exclusive.

The focus on quality—initially adopted as a means of reducing defects—delivered a greater advantage to companies that took a holistic view and drove changes across their business operations. The famed Toyota Way applied quality methods to every stage of value creation from concept to customer—and ultimately to intangibles such as brand, reputation, and corporate culture. The reputational harm Toyota is experiencing thanks to the recent recalls underscores how important quality continues to be to the firm’s central value proposition. Toyota’s current troubles also highlight the need for firms to align core elements of strategy. In this case, the dissonance between its long-term quality strategy and a more recent topline growth strategy has seriously undermined Toyota’s model for value creation.

Rey Moore, the former chief quality officer at Motorola, describes a similar evolutionary process at the communications giant. Like most firms, Motorola first used quality methods to improve fault and error detection and thus reduce cost, waste, and risk. As those methods proved valuable, the company began to redesign manufacturing processes and product development functions to proactively reduce risks of product failures, functional inadequacies, and other inefficiencies rather than simply detect them. As quality’s potential business impact grew, Motorola developed Six Sigma methods and a standardized tool kit including items like Pareto charts and root-cause analysis models to take quality to scale. Eventually, quality became a defining attribute of Motorola’s brand and culture and a source of competitive advantage. The same story unfolded at firms in all industry sectors as leading companies rode the quality wave to enhanced growth and profitability—delivering a clear quality premium for their shareholders.

Capturing the Eco-Premium
http://hbr.org/2010/05/the-sustainability-imperative/sb2

The IT story.
When the recession of 1982 hit, pressure mounted at many companies to increase productivity, particularly by using emerging information technology innovations to drive cost savings. The early returns on these efforts were mixed. As with quality, skeptics described IT as a black hole into which firms poured money with little return. But some corporate leaders saw that the strategic application of IT could drive growth and provide decisive advantage. American Airlines, a classic example, captured more than 40% of all U.S. airline transactions thanks to its innovative Sabre reservations system.

A lesser known case is American Hospital Supply’s deployment of a revolutionary online purchasing system, which allowed hospitals to order medical supplies electronically, reducing costs, time, and errors for both the company and its customers. Over the next decade, the Analytic Systems Automatic Purchasing system—better known as ASAP—transformed how AHS delivered value to its customers.

Building on its success improving efficiency and reducing inventory risk, the firm developed service innovations that enabled it to deliver any product from any manufacturer at any time from any desktop computer to any hospital supply room. In the process, AHS amassed an extensive product and price database that gave AHS a clear advantage over less nimble competitors. Finally, AHS used IT to evolve its business model. The company, which had been a single-source materials provider to its hospital clients, began taking over their inventory management and procurement processes. This IT-driven innovation established the AHS brand as the leader in its business with a competitive edge based originally on price and later on service and helped the company grow earnings from $42 million in 1974 to $237 million in 1984.

The IT and quality megatrends show us that firms seeking to gain advantage in sustainability will have to solve two problems simultaneously: formulating a vision for value creation and executing on it. In other words, they must rethink what they do in order to capture this evolving source of value; and they must recast how they operate, expanding their capacity to execute with new management structures, methods, executive roles, and processes tailored to sustainability’s demands.