Gaining competitive advantage through environmental investments - includes related articles on environmental costs and pulp and paper competition

Business Horizons, July-August, 1995 by Benjamin C. Bonifant, Matthew B. Arnold, Frederick J. Long

In the late 1980s, environmental concerns became more urgent in almost every country in the world. In 1992 these concerns culminated in an "Earth Summit," which drew more world leaders than any other such meeting in history. As the arcane language and visionary goals of national and international agenda-setting are translated into regulation, the ensuing wave of environmental legislation is being felt by manufacturers.

Many view the growing environmental demands with concern, fearing highly restrictive and costly new rules. However, a more optimistic view is also emerging that sees opportunity in environmental requirements. As the environment looms larger in production costs, innovative companies are cutting their expenses through more efficient methods of compliance. They can capture markets with products that help customers meet their own compliance requirements.

This notion that superior environmental performance can enhance business performance does not yet hold universal consensus, but it is becoming much more prevalent within industry. The basis for such guarded optimism lies in two factors. First, many environmental standards today afford companies substantial flexibility in determining how to meet requirements. Numerous observers have suggested that greater market incentives and flexibility in the design and implementation of regulation would achieve environmental goals at the least possible cost. Although they have occurred at a glacial pace, the effects of long efforts by economists and business leaders to relax the rigidity of regulations are finally becoming evident.

Second, and perhaps more important, new regulations are focusing heavily on substances with essential functions in production, creating opportunities for manufacturers to reduce materials use and for suppliers to develop effective substitutes. In a recent study of industries affected by regulations (conducted under the guidance and within the conceptual framework of Professor Michael E. Porter of the Harvard Business School, with support from the U.S. Environmental Protection Agency), we found that this previously unrecognized factor may be the most important reason environmental concerns are becoming a more important characteristic of competition.

The major environmental regulations of the last 20 years in the United States have focused primarily on high-volume byproducts of manufacturing, such as sulfur and nitrogen in fossil fuel combustion, or organic matter in waste water from wood pulping. These regulations attempted to control the release of substances ancillary to the main event--the generation of heat for electricity, or pulp for paper-making. Today's regulations, in contrast, are more often aimed at eliminating the releases of compounds, which are used in and then discarded from production processes. Regulation of these types of materials is inherently flexible because opportunities exist to eliminate the substance from production by adopting alternative raw materials or processes to achieve the same outcome. Such flexibility is not inherent in regulations focused on byproducts. Together, these factors are leading to greater variability in investment within industries, as well as greater advantages to firms that develop innovative and effective solutions to new requirements. Michael E. Porter and Claas van der Linde (1995) discuss the conclusion that innovation in response to environmental pressure can lead to competitiveness.

Figure 1 maps out some recent environmental initiative factors that have led to the flexibility allowing some firms to gain advantage over others. The remainder of this article discusses how this flexibility has led to profit opportunities for suppliers and reduced compliance costs for regulated manufacturers. Our conclusion is that creative approaches to environmental regulation are only partially responsible for the environmental issues in many firms' planning. Competition among alternative raw materials and processes has emerged even under traditional methods of regulation as the regulatory targets have switched to materials used in manufacturing and away from those generated as byproducts.

THE TRADITIONAL APPROACH: RIGID ENVIRONMENTAL REGULATION

Most environmental regulations in the United States are developed with technology-based standards. Levels of emissions are determined for existing methods of control, and all manufacturers are then required to implement operations similar to those used by the best-performing facilities.

Of course, many environmental regulations lead to new costs for manufacturers. Innovative firms search for new means of production that will lower releases and new means of control that will reduce the costs of dealing with the releases that remain. However, using a technology approach severely limits innovation by the regulated industry and, critically, the suppliers of equipment and materials to that industry. The following four factors explain why a technology-based system implemented using a permit and compliance approach often leads to low levels of innovation by industry.