20 Apr 2011

HBS Faculty Comment on Environmental Issues


BOSTON—Earth Day focuses the world's attention on the both the dangers and opportunities facing the planet. But sustainability and the intersection between business and the environment are issues that need to be addressed all the time, as cities grow, resources diminish, and ecosystems are threatened by both nature and humankind. We asked a group of Harvard Business School faculty members to offer their views on the many facets of "going green."

Robert G. Eccles, Professor of Management Practice
Amy C. Edmondson, Novartis Professor of Leadership and Management

The world's cities are principal engines of economic growth and activity, with the largest 600 urban centers accounting for roughly 60% of global GDP. The creation of this economic and social value, however, involves the consumption of considerable natural resources. For example, cities today contain 50% of the globe's citizens (a number projected to grow to 70% – some 5.6 billion people – by 2050), but consume 60-80% of the world's annual energy usage. Vast amounts of natural resources are also used each year in building new cities and expanding existing ones through real estate development and construction.

The way cities are built and renovated and the way they operate is unsustainable from an environmental perspective. We need to build, improve, and manage cities in a smarter way. This calls for smarter design and construction, which requires new, more collaborative processes that enable different organizations – design, engineering, construction – to work together to create all aspects of the urban environment. Also necessary are new systems and processes for helping cities operate efficiently and effectively, including the use of new information and communication technologies already available but currently rarely used in this capacity. As always, more than half the challenge is creating and implementing the new management processes that make smart technologies work. In short, the so-called "soft stuff" presents challenges that will occupy management researchers and practitioners for decades to come.

Several recent innovations can help make cities in smarter ways, so that they are built more quickly, with less waste and overall impact on the environment during the construction process. Environmental performance will improve in part due to building better buildings. For individual building projects, owners, architects and contractors have been experimenting with integrated project delivery - a collaborative process that involves unprecedented teamwork and shared decision making throughout a design and building project. A number of companies are developing ecosystem-based business models.

A better building process, particularly for reducing waste, requires a modular approach to construction with extensive prefabrication. This also makes it possible to embed technology, such as sensors and actuators, into the very fabric of the building. But the greatest contribution of technology is through integrating hardware and software so that vast amounts of data can be captured and analyzed in order to improve the allocation and use of natural resources. Working with Microsoft and Cisco, Living PlanIT is doing this through its Urban Operating System™ — a unified, distributed, real-time control platform that converges cloud computing, deep sensing, simulation, analytics and application services with the fabric of buildings and infrastructure. The hope is that a smarter building process results in smarter buildings, and smarter buildings result in smarter cities. Many innovators today are working hard on the premise that smart cities will perform better environmentally, financially, and socially than has been the case in most of the world's cities to date. A pretty smart way, we'd say, of protecting our environment.

Benjamin G. Edelman, Assistant Professor of Business Administration

In most cities, the automobile is king of the commute, even though public transit often has lower direct dollar cost. The prevalence of private automobiles causes problems that go far beyond the combustion engine and its massive carbon footprint. In city centers, underground parking adds millions of dollars to building costs. In suburbs, surface parking demands large gaps between buildings, perpetuating urban sprawl and making walking infeasible. Meanwhile, road maintenance saps budgets at every level of government. Automobile owners face high costs, too, including insurance, maintenance, and fuel. And motoring imperils the lives of drivers and pedestrians alike. Had anyone suspected that parking lots and roads would consume up to 70% of urban land while causing more than 30,000 fatalities a year, cars would have been adopted much less enthusiastically.

It doesn't have to be this way. Imagine a system that preserves the best of the automobile – private on-demand service to many destinations, no delays for others to get on or off, and great flexibility for later expansion. Add the key advantages of public transit – a dedicated guideway without delays from other traffic, plus computer control so passengers can work or relax. There are also important environmental benefits – no local emissions, flexible power sources, and reduced energy consumption thanks to lightweight vehicles and automated guidance to prevent unnecessary starts and stops.

All this may sound like a pipe dream, but engineers and entrepreneurs envision personal rapid transit (PRT) systems that achieve these benefits. Such a system opened this week at Heathrow Airport's Terminal 5, taking passengers between the terminal and a parking lot two miles away. In addition, the city of Amritsar in India has contracted to install a system in its urban core, while Suncheon, Korea, will use similar technology to link parts of a park and wetland. Further studies abound.

In the long run, well-developed PRT could replace urban rail – making public transit faster, cheaper, more pleasant, and more flexible. In the short run, PRT will improve connections to public transit. A business park may be two miles from the nearest train station, but it is effectively adjacent to that station if PRT provides an on-demand, non-stop, four-minute connection from transit platform to building lobby. Early small projects invite decentralized innovation and private investment without far-reaching central planning. For example, a developer can install PRT to benefit its own property, thereby establishing initial PRT links without resorting to public funds.

Despite the high social and environmental costs of private automobiles, I don't fault those who rationally choose to commute by car. But if we can devise a better solution, savvy travelers will choose accordingly, and Planet Earth will be the beneficiary.

Rebecca M. Henderson, Senator John Heinz Professor of Environmental Management

Re–orienting current energy systems toward a far greater reliance on technologies with low or no carbon dioxide emissions is an immense challenge – one that will be hard to meet without significant innovation. To give us some sense of whether this can be done, and if so how, Duke Professor Richard Newell and I convened a group of scholars just over a year ago to discuss what we have learned about how best to accelerate innovation from industries like IT and pharmaceuticals – sectors in which the US leads the world and which saw enormous rates of technical progress over the last fifty years.

The results of our discussion will be published by the University of Chicago press on June 1 in an edited volume entitled Accelerating Innovation: Insights from Multiple Sectors. In detailed histories of agriculture, chemicals, semiconductors, computers, the internet and biopharmaceuticals we asked "what made the difference? Why did technical progress in this industry take off?" Comparing notes across sectors we identified two factors that were not a surprise to any of us – accelerating market demand and well managed federal support for fundamental research. But the third factor – the thing that appears to have made the difference in industry after industry – was indeed unexpected. Beyond supply and demand, the theme that emerges most clearly from our histories is the important role that public policy has played in fostering vigorous competition and "markets for technology" in each industry. Furthermore we noted the centrally important role that this competition played in accelerating innovation.

We know that small, entrepreneurial firms are the source of much of the innovation in the economy – but our work suggested that in many industries the emergence of those firms is greatly facilitated by the right kind of public policies: well designed intellectual property regimes; procurement policies that favor new firms; standards that allow competition by component rather than by system and – sometimes – antitrust enforcement that forces large, well–established firms to share the market.

I'm firmly convinced that private sector innovation could transform the energy sector. But this research leads me to believe that the right kind of regulatory framework and institutional policies are fundamental to making it possible.

Shon R. Hiatt, Assistant Professor of Business Administration

In the US, states and local governments are able to experiment with policies that can have positive impacts on innovation and entrepreneurship. After experimentation, policy makers are able to pick and choose among a variety of policies to implement those that work best. While some officials proactively search for superior policies and then make changes, in many cases laws remain the same, leading some localities to significantly underperform others.

Take geothermal power, for instance. New technologies often require the creation of legal definitions and categories in order to facilitate resource attainment, property rights, and transferability of ownership. When geothermal power was introduced in the 1960s, the technology was new, and states defined geothermal resources (the heat of the earth that is used to make electricity) in various ways. Some state legislators defined it as heat or mineral, others as water, and some as both or neither of the two. Little did policy makers know that these legal codifications would have tremendous impacts on the ability of entrepreneurs to obtain ownership rights to the geothermal resources and found new ventures.

Colorado, for example, has ambitious renewable portfolio standards and tax incentives for geothermal as well as the largest amount of economically extractable geothermal energy in the country. Yet largely because of its legal codification, it does not have an operational geothermal plant. Over the past 40 years, these simple technological definitions have become the greatest impediment for the sector's growth.

While regulatory experiments such as this can provide us with information on both successful and unsuccessful policies, a key issue facing the intersection of business and the environment is our motivation to recognize successful policies and then rally to adopt them quickly. In such a way, greater innovation and business development won't be far behind.

Rosabeth M. Kanter, Ernest L. Arbuckle Professor of Business Administration

Protecting the environment can be fun. It's also good business. Mother Nature – speaking through your friendly neighborhood banker – insists on it.

The fun part revolves around Earth Day festivals taking place around the world. But the biggest news isn't the millions of people partying in parks. It's the millions of dollars that banks are dedicating to solving environmental problems, joined by companies that see the gold in green (to paraphrase the title of Daniel Esty's book, Green to Gold), such as General Electric's push into wind and solar power. JPMorgan Chase, Citigroup, and Bank of America are among those adding environmental criteria to loan analyses. Venture capitalists like Kleiner Perkins see the future in green technology investments.

Environmentalists find the private sector increasingly receptive to their message (or pressure). Numerous companies know that reducing waste, recycling, and avoiding pollution makes economic sense. When Home Depot encouraged two of Chile's biggest loggers to stop buying land that is being deforested, the company pleased environmentally-conscious consumers today and ensured a wood supply tomorrow. WalMart's efforts to disclose the carbon footprints of all suppliers could have an even bigger impact, reaching as far as manufacturers in China.

Banks add special clout to the socio-environmental agenda. By offering or withholding capital, banks rival governments in their power to shape business behavior across various industries.

Cynics wondering if this is just window-dressing should consider the case of Santander Brazil, a top financial group that has profited by becoming an environmental conscience for its country. The group has influenced customers and suppliers to change their practices, whether by helping a fish harvesting operation in the coastal swamps minimize pollution or encouraging a motorcycle courier company to reduce emissions and accidents. Commercial customers can get financing to treat effluents, control atmospheric emissions, or make environmentally-oriented facility upgrades. Consumers can get loans to purchase solar-powered water heaters or convert cars from gasoline to natural gas.

Working with Friends of the Earth and Ethos Institute, Santander Brazil remedied its own environmental shortfalls, such as outdoor displays in environmental protection areas or using an illegal artesian pond to supply water to some of its offices. This is good business. Screening customers on their environmental behavior strengthens the loan portfolio. "A company that treats its employees well and maintains a healthy relationship with the environment has a higher probability of being economically sustainable," a Santander executive observed.

Can money be made while saving the earth? Can the private sector accomplish what politicians find difficult? Are financial incentives as powerful as regulations?

These questions remain. But for now, financiers and investors can join Kermit the Frog in having fun being green.

Joseph B. Lassiter, MBA Class of 1954 Professor of Management Practice

In 1993, Bill Murray starred in a movie called Groundhog Day, where he woke up each morning doomed to repeat the same mind-numbing day over and over and over again. Unfortunately, when it comes to oil, the American people and the politicians that represent them are trapped in a Ground Hog Day movie of their own making.

This year we will import over $350 billion of crude oil extracted from the soil of foreign powers, with prices set by an international cartel, the Organization of Petroleum Exporting Countries (OPEC). Arguably half of this money is nothing more than a ransom (a monopoly profit above competitive prices) that we have grown (disturbingly) accustomed to paying year after year. This ransom is $500 per year — year after year — for every American man, woman, and child. And we just keep paying it.

In an ideal world, the hidden costs of energy security and energy's environmental impacts (including local air pollution, globally threatening carbon dioxide emissions, remediation and catastrophes like the BP oil spill or the Fukushima nuclear power plant disaster) would be included directly in the prices of each of the various energy sources, not somehow shielded from the eyes of consumers. In a competitive world, private investment would flow to those alternative technologies that provided economically efficient and environmentally sound energy sources. But due to political legacies, these markets fail to function in nearly every energy sector today, and nowhere are the costs of these failures clearer than in the case of oil.

Lacking the domestic political consensus to have oil bear its true costs and the international political consensus to break the OPEC cartel, the US government and the American people must learn to accept the magnitude of this problem and its yearly drain on our economy. To break free, we must urgently fund (and properly regulate) alternatives that can secure our independence, going far beyond the $8 billion clean energy program proposed by the Obama Administration for 2011.

It is time to stop paying a $175 billion annual ransom to a cartel that robs us of the resources we need to have the environmentally sound and economically efficient alternatives that we value. It is time to repower our own independence. It doesn't have to be Groundhog Day for us.

John D. Macomber, Senior Lecturer of Business Administration

For me, two dominant global trends define the intersection of business and environment. First, rapid urbanization. The population of cities will increase by three billion people, more than doubling, in the next 30 years. These people are not all moving to New York and Shanghai; they will live in thousands of newly created cities. Second, resource productivity. There is already not enough energy, clean water, clean air, effective transportation, or space to put garbage. Rapid urbanization will only accentuate these shortages.

How should we address the problems in the confluence of these two trends? One approach is to expect governments to create more supply by building water plants, railroads, and power stations, among other things. But very few governments today have the financial means or the political capacity to do this on a huge scale.

A second approach is to expect governments to restrict demand via, say, a global carbon tax plus international restrictions on automobile miles-per-gallon. This is an equally worthy way of doing things, but it's not realistic to expect this course of action to coalesce on its own. Many of my colleagues in finance and engineering want to follow a third path — the pursuit of high-tech ways to increase supply — biomass, photovoltaics, carbon capture and sequestration, batteries, desalination, magnetic levitation (mag-lev) trains, and super sensors. All are examples of interesting technology that is challenging, investable, publishable, intellectual property protectable, and venture capital fundable. That said, they are also very expensive and hard to scale and worse, quite difficult to bring to the urban seven billion.

The fourth approach is the one we need to follow, and it's squarely in the domain of business and environment. The big, high leverage, scalable opportunity involves our extending resources, reducing demand, and making what we have go further. The best way to get more water and energy and clean air is to avoid wasting what we have. This is not high tech or pie in the sky; it's investment, negotiation, and allocation of costs and benefits. In short, it's business.

For financiers, entrepreneurial ventures, and Global 1000 product and service companies alike, this means organizations that are investing in and marketing resource productivity at scale — whether sharing assets or adding insulation. In the real estate and urban planning world, this means new cities with density, verticality, mass transit, and effective capture and re-use of water, heat, and energy. For cities, states, provinces, and nations, infrastructure that uses resources efficiently is also lower in cost and higher in attractiveness for citizens and business. Business and environment are more than intersecting vectors; they are fully aligned in concrete and steel and water in future cities and in businesses that stretch the resources we have. That's the future that I want to see before me.

Arthur I. Segel, Poorvu Family Professor of Management Practice

With a rising world population and a scarcity of resources, sustainable development is no longer a niche market; it's a necessity. The United States, in particular, lags behind much of the world in its efforts to incorporate sustainability on a large scale. Our challenge is to rethink the way we structure our communities. We live in a society that was built around the automobile, which has given us tremendous personal freedom, but at a tremendous cost. Greenfield developments have been built farther and farther from our core cities. America's answer to affordable housing historically has been the suburbs, away from employment centers because land is always cheaper on the fringe. This sprawl requires expensive infrastructure we cannot afford.

How will we tackle the large-scale changes necessary to reinvent our communities? Physical infrastructure needs a massive overhaul. We must give people the opportunity to be able to walk to stores or their workplaces again. We need to build new, safe models to protect our children, our elderly, and our scarce resources. Over the past few decades, we have raised our standard of living, but not necessarily the quality of our lives.

Real estate and the environment should not be thought of as incompatible interests. Scientists and philosophers have pointed to human beings' deep, historical connection with nature. When people are in a natural environment, they are healthier and happier and have a greater sense of well being. Why not incorporate more of this into our buildings? We can design green roofs. We can use storm water runoff for toilets and cooling systems. We can situate buildings to maximize natural light for interior spaces. We can use louvers, awnings, window systems and insulation to reduce heating and cooling costs. Buildings can incorporate biodegradable building materials. All supplies used by tenants and landlords alike can be required to be biodegradable. And we can create buildings with contours that complement the landscape. As Winston Churchill once said, "We shape our buildings, and our buildings shape us."

Robert G. Eccles, Professor of Management Practice
George Serafeim, Assistant Professor of Business Administration

Companies are caught in an economic dilemma when it comes to being responsible stewards of the environment. Society wants them to be efficient in their use of natural resources and to do as little damage as possible to the environment. Shareholders want them to provide a proper risk-adjusted return on capital while adhering to laws and regulations that concern a company's impact on the environment. But what if these laws and regulations are inadequate (e.g., no tax at present on carbon emissions)? The company then confronts the dilemma of taking actions that may lessen its environmental impact at the cost of reducing its return to shareholders, at least in the short term.

A combination of regulatory and market forces have recently increased the economic value of environmentalism. Expectations about raising the cost of environmentally irresponsible practices through taxes, along with increased awareness and pressure by customers, employees, and civil society, have made the case that better environmental performance can lead to better economic performance. One response on the part of corporations has been innovation in products and processes. However, this innovation has typically taken place in a predictable pattern. In nearly all cases, there is some "low hanging fruit" in areas such as greater energy efficiency (to reduce carbon emissions), recycling (to reduce waste), and better plumbing (to reduce water usage). Since these areas are largely about cost reductions, the economic case is easy to make. But the actual effort involved is often fairly small, and the company soon hits the point of diminishing returns. The good news is that even these small steps weren't being taken a few years ago, when general consciousness about the environment was lower than it is today. Bigger breakthroughs require bigger thinking, and we believe this is possible.

Two things must be done to spur innovation and realize the greatest benefits from it. The first is that companies must build more rigorous business models showing the relationship between financial and environmental performance (e.g., lower costs or higher revenues leading to better margins). They need to be more precise about how their efforts to improve environmental performance contribute to their financial performance and over what time period. Second, they need to communicate this externally in an integrated report, which shows the relationship between financial and environmental (as well as social and governance) performance. And when the company has decided that its environmental performance is more important in the short term to its financial performance, it should be explicit about this. True investors will appreciate this, since they know the result is a more sustainable strategy for the company over the long term.

In response to these issues, we have created a new elective course at HBS called "Creating and Communicating Value: Building Business Models." It will give students the opportunity to work with companies to build models showing the relationship between environmental, social, and governance issues and financial performance—the ingredients that form the foundation for integrated reporting.

About Harvard Business School

Founded in 1908 as part of Harvard University, Harvard Business School is located on a 40-acre campus in Boston. Its faculty of more than 250 offers full-time programs leading to the MBA and PhD degrees, as well as more than 175 Executive Education programs, and Harvard Business School Online, the School’s digital learning platform. For more than a century, faculty have drawn on their research, their experience in working with organizations worldwide, and their passion for teaching, to educate leaders who make a difference in the world. The School and its curriculum attract the boldest thinkers and the most collaborative learners who will go on to shape the practice of business and entrepreneurship around the globe.