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Global Sustainability and the Creative Destruction of Industries STUART L. HART Associate Professor of Management Director, Sustainable Enterprise Initiative Kenan-Flagler Business School University of North Carolina—Chapel Hill CB #3490, McColl Building Chapel Hill, NC 27599-3490 Phone: 919-962-4509 Fax: 919-962-4266 E-Mail: email@example.com MARK B. MILSTEIN Doctoral Candidate Kenan-Flagler Business School University of North Carolina—Chapel Hill CB #3490, McColl Building Chapel Hill, NC 27599-3490 Phone: 919-962-9687 Fax: 919-962-4266 E-Mail: firstname.lastname@example.org Not for citation or distribution without the permission of the author Accepted for publication in Sloan Management Review July 1999 More than fifty years ago, economist Joseph Alios Schumpeter described the dynamic pattern where innovative upstarts unseat established firms through a process he described as “creative destruction.”1 While most twentieth century economists have focused upon competition under conditions of static equilibrium, Schumpeter was original in his insistence that disequilibrium was the driving force of capitalism. Entrepreneurs creating new processes, products, and markets tend to be the key actors in this process, not the managers charged with administering existing businesses. Since Schumpeter’s time, the theme of creative destruction has received growing attention in the literature.2 There is now little doubt that the economy is driven by firms that are able to capitalize on the “new combinations” so eloquently described by Schumpeter: Coal Age technologies gave way to Oil Age technologies which are now giving way to Information Age technologies. With each wave of change, the technological and economic infrastructure of society experiences dramatic transformation, with new institutions, enterprises, and geographic patterns of development created in the process. During periods of dramatic change, most incumbent firms are not successful in building the capabilities needed to secure a position in the new competitive landscape. There is no shortage of notable examples: manufacturers of horse carriages, sailing ships, vacuum tubes, steam locomotives, and propeller engines were all displaced by new combinations of social and technical systems that came from outside of the existing industries. 1The importance of entrepreneurs to creative destruction was first discussed in J. Schumpeter, The Theory of Economic Development, Cambridge, MA: Harvard University Press, 1934. The thesis was later extended to include consideration of how large corporations might participate in this process in J. Schumpeter, Capitalism, Socialism and Democracy, New York: Harper Torchbooks, 1942. 2 There is an extensive literature on this topic, including: A. Cooper and D. Schendel, “Strategic responses to technological threats,” Business Horizons, February 1976, pp. 61-69; W. Abernathy and J. Utterback, “Patterns of innovation in technology,” Technology Review, 1978, vol 80: pp. 40-47; S. Winter, “Schumpeterian competition in alternative technological regimes,” Journal of Economic Behavior and Organization, 1984, vol 5, pp. 287-320; W. Abernathy and K. Clark, “Innovation: Mapping the winds of creative destruction,” Research Policy, 1985, vol 14, pp. 3-22; M. Tushman and P. Anderson, “Technological discontinuities and organizational environments,” Administrative Science Quarterly, 1986, vol 31, pp. 439-465; R. Foster, Innovation: the Attacker’s Advantage, New York, NY: Summit Books, 1986; R. Henderson and K. Clark, “Architectural innovation: The reconfiguration of existing product technologies and the failure of established firms,” Administrative Science Quarterly, 1990, vol 35, pp. 9-30; and most recently, A. Cooper and C. Smith, “How established firms respond to threatening technologies,” Academy of Management Executive, 1992, vol 6, pp. 55-70;. C. Christensen and J. Bower, “Customer power, strategic investment, and the failure of leading firms,” Strategic Management Journal, 1996, vol 17, pp. 197-218; and M. Tripsas, “Unraveling the process of creative destruction: Complementary assets and incumbent survival in the typesetter industry,” Strategic Management Journal, 1997, vol 18, 119-142. 2 Not surprisingly, the notion of creative destruction makes many managers uncomfortable—and it should. Time and again, incumbent firms have either discounted the significance of an emergent technology or have reacted to changes by becoming more committed to existing products and markets. Incumbent firms that survive episodes of creative destruction do so because they display a higher degree of foresight than their peers—they invest and partner to acquire new competencies, and they experiment in new, untested markets. They are not held hostage by their current technology or market position. Foresight is the key to survival. Managers able to perceive trends and “weak signals” where others see only noise or chaos are able to capitalize on the changing nature of the market to reposition their firms before new entrants have an opportunity to become a serious threat. Nowhere is it written that foresight is the sole domain of the entrepreneur or start-up company. Armed with the proper tools and frame of mind, managers of incumbent firms can possess as much foresight as the CEO of the hottest new IPO. Foresight, however, requires the manager to strip away many assumptions so that the world can be viewed through a new set of lenses. In this article, we argue that the emerging challenge of global sustainability is a catalyst for a new round of creative destruction which offers unprecedented opportunities to managers with the foresight to capitalize on it. Today’s existing corporations can develop the foresight and agility to seize the opportunity for sustainable development, but to do so they must look beyond continuous, incremental improvements. We propose a framework for helping managers to see the business world through a different set of lenses, so that sustainability-driven opportunities can become more apparent. Finally, we suggest the need for a series of new metrics that can help managers evaluate their organizations’ current performance and realize new, sustainability-driven business opportunities. Continuous Improvement versus Creative Destruction 3 Episodes of creative destruction are driven by waves of scientific and technological discovery or major periods of socioeconomic change. Today, we are in the early stages of such a revolution—the transformation toward sustainable development—that has been largely ignored, overlooked, or contested by firms. Most of today’s large corporations developed in an era of abundant raw materials, cheap energy and limitless sinks for waste disposal. Over the past few decades, however, it has become increasingly clear that many of the technologies developed during this period contribute to the destruction of the very ecological systems on which the economy depends: The specters of toxic contamination, depleted forests and fisheries, eroded soils, loss of biodiversity, global climate change, burgeoning population growth, and a widening gap between rich and poor are explicit signals that managers must rethink the social and environmental impact of their technologies, products, and processes. Scenarios abound suggesting that in the absence of dramatic change, we are destined to devolve into a world of environmental degradation, social upheaval, and mass migration on an unimaginable scale.3 Greening = Continuous Improvement While commendable and important, most efforts to date in “greening” and “environmental management” serve only to improve incrementally the performance of existing products and processes (Figure 1). Sector-based collaboration in pollution prevention and product stewardship is used to solidify the competitive positions of incumbents by rewriting the rules of the game in their favor. In this sense, collaboration among competitors is serving to perpetuate the current industry structure. As a result, “greening” fosters continuous improvement rather than reinvention or fundamental innovation.4 In the long run, however, the dynamics of creative destruction will work against firms that rely only on incremental improvements and fail to change the fundamental manner in which products, processes, and services are provided. 3 See: J. Coates, J. Mahaffie, and A. Hines, 2025, Greensboro, NC: Oakhill Press, 1997, and A. Hammond, Which World? Scenarios for the 21st Century, Washington D.C.: Island Press, 1998. 4 See, for example, S. Hart and G. Ahuha, “Does it pay to be green?” Business Strategy and the Environment, 1996, 5, pp. 30-37. 4 --------------------------------------------------- Insert Figure 1 About Here --------------------------------------------------- An example of such incremental improvement is the Chemical Manufacturers Association’s (CMA) Responsible Care Program, which helped rescue the industry from near oblivion, but has not led to revolutionary practices by its members. Following the Bhopal disaster in 1984 (in which 3,000 residents of Bhopal, India died as a result of a toxic chemical explosion at a Union Carbide plant), leading chemical companies (e.g. Dow, DuPont, Monsanto) pressed for self-regulation in the face of public hostility and calls for stricter regulatory measures that threatened the continued survival of the industry. This culminated, in 1988, in the adoption by the CMA of Responsible Care—a statement of environmental principles and codes of management practices, that included provisions for pollution prevention, product stewardship, and community involvement. To give the program teeth, the principles and codes were made obligatory for CMA member companies, which comprised 90% of the chemical capacity in the US; non- compliance was grounds for expulsion from CMA. Since 1988, Responsible Care has transformed the chemical industry’s environmental behavior and helped to change the public perception of the industry from one of shameless polluter to more responsible actor. While successful in reestablishing the legitimacy of an industry under tremendous public pressure, Responsible Care has failed to address the fundamental underlying problems associated with the chemical industry—many of its products and processes are highly toxic, resource intensive, and continue to place enormous pressures on air and water resources. As an industry-level collaborative process, the Responsible Care Program has fostered incremental improvement by forcing laggard chemical firms to mimic the leaders in terms of environmental management. This has left the leading firms such as Dow and DuPont in a stronger competitive position by helping to shore up 5 support for their right to operate, but, ironically, reduced the likelihood of fundamental innovation by chemical industry incumbents.5 Global Sustainability = Creative Destruction If we reflect on the commonly held definition that sustainable development is the ability of the current generation to meet its needs without compromising the ability of future generations to meet theirs, it is not difficult to see how most existing products and processes fail to meet this criterion.6 A growing body of data suggests that today’s extractive and material-intensive industries (e.g. mining, energy, chemicals, forest products, agriculture, and transportation, to name but a few) are not environmentally sustainable as currently conceived.7 As an illustration, if the entire world were as materially intensive as North America, it would take three Planet Earths to support the material requirements of the present world population, let alone future generations.8 The challenge of global sustainability should thus be viewed as a major discontinuity with the power to radically transform the structure of many of today’s industries.9 This challenge presents an opportunity over the next decade for visionary companies to drive the redefinition and redesign of their industries toward sustainability.10 Material- and energy-intensive industries will find global sustainability to be a competency destroying challenge which calls for radical repositioning and new 5 For more detail on the competitive dynamics of the Responsible Care Program, see A. King, and M. Lenox, “The benefits of membership: Performance implications of the responsible care program,” Academy of Management Best Paper Proceedings, 1998, San Diego, CA. 6 For an elaboration on this definition, see: World Commission on Environment and Development, Our Common Future, New York: Oxford University Press, 1987. 7 See, for example, W. Van Dieren, Taking Nature into Account, New York: Springer-Verlag, 1995; T. Graedel and B. Allenby, Industrial Ecology, Englewood Cliffs, NJ: Prentice Hall, 1995; G. Keoleian et al., Industrial Ecology of the Automobile, Warrendale, PA: Society of Automotive Engineers, 1997; E. von Weizsacker, A. Lovins, and H. Lovins, Factor Four, London: Earthscan, 1997; and G. Daily, Nature’s Services: Societal Dependence on Natural Ecosystems, Washington, D.C.: Island Press, 1997. 8 See M. Wackernagel and W. Rees, Our Ecological Footprint, Philadelphia, PA: New Society Publishers, 1996, for extensive data on the “ecological footprints” associated with human activity. In the U.S., for example, it currently takes 12.2 acres to supply the average person’s basic needs; in the Netherlands, 8 acres; in India, 1 acre. The footprint analysis makes it clear that dramatic reductions in footprint will be necessary to support future generations of a growing population. 9 See: P. Hawken, The Ecology of Commerce, New York: HarperBusiness, 1993, and S. Hart, “Beyond greening: Strategies for a sustainable world.” Harvard Business Review, January-February 1997, pp. 66-76. 10 For a complementary argument, see C. Fussler, Driving Eco-Innovation, London: Pitman Publishing, 1996. 6 competency development. Information- and service-intensive industries will find global sustainability to be a competency enhancing challenge which offers significant potential for substitution and leapfrogging. Overall, innovators and entrepreneurs will view sustainable development as one of the biggest business opportunities in the history of commerce.11 Even in the chemical industry, where the Responsible Care program has emphasized incremental improvement, the early stages of creative destruction can already be discerned. A handful of chemical companies have begun to reposition themselves in fundamental ways. Leading players such as Monsanto and DuPont are questioning whether the industry can remain committed to the use of petroleum feedstocks and toxic materials (unsustainable). They are betting that higher performance can be realized by shifting to biologically-derived, more benign materials (potentially sustainable). In fact, over the past decade, demergers, spin-offs, acquisitions, and significant new technology developments have structurally transformed the chemical industry (Figure 2). DuPont recently divested Conoco to focus on products with higher service and information content. Monsanto, Hoechst, and Rhone-Poulenc have spun off their chemical businesses to focus on life sciences, food, pharmaceuticals, and biotechnology. ICI, Sandoz, and Ciba-Geigy have refocused on chemicals, by spinning off their life sciences and biotechnology investments (witness the creation of Zeneca and Novartis). Dow and DuPont are ramping up significant investments in biotechnology. Still other firms, such as Novo Nordisk, the fast-growing Danish pharmaceutical and biotechnology company, and Empresas La Modernal, an emerging Latin American life sciences powerhouse, are exploring “green chemistry,” and finding biological substitutes for synthetic chemicals. Led by Monsanto’s transformation to life sciences, several companies are pursuing sustainable development strategies related to agriculture. Dow has initiated development of “green” pesticides using “tracer” technology—fermentation-based substitutes for existing chlorinated chemical pesticides. DuPont’s Agricultural Products Business has committed to developing less toxic, low use-rate agricultural chemicals in 11 Where incumbents do not drive the process of creative destruction, it is inevitable that entrepreneurs and 7 their program “A Growing Partnership with Nature” where biological products become substitutes for current material- and toxic-intensive crop protection chemicals. --------------------------------------------------- Insert Figure 2 About Here --------------------------------------------------- A similar portrait could be painted for virtually every energy- and material- intensive industry from oil to automobiles. In ways that are not yet completely clear, the challenge of global sustainability has begun to drive the process of creative destruction. Yet, many managers resist or discount sustainable development as a business driver, arguing that its ill-defined and contestable nature renders any action premature. History teaches us, however, that once clarity is achieved and standards are set, winners and losers have already been defined. Strategy is about taking action under conditions of uncertainty or even ambiguity. During periods of creative destruction, hesitancy equals death. Foresight is therefore needed to help managers remove blinders and begin to see opportunity where they now see only chaos or rhetoric. In the next section, we describe a new conceptual lens managers can use for framing and identifying the business opportunities being driven by the transformation to global sustainability. A New Conceptual Lens Managers, particularly those in large, transnational corporations, have become too accustomed to viewing the global market as a single entity. Attention has been focused almost exclusively on markets that have achieved a certain measure of affluence. Business opportunities are evaluated by the degree to which they offer sales potential consistent with the global market standard, which facilitates selling products and services worldwide with minimal changes. Markets are of value only to the extent that consumers have purchasing power comparable to that found in the United States, Western Europe, or new entrants will. 8 Japan. Capturing the opportunities of sustainability-driven creative destruction, however, will require that managers radically expand their notion of the global market. The truth is that within any country or region, even the United States, there exist three types of markets or economies—one developed, one emerging, and one trying to survive.12 To better understand sustainability-driven creative destruction, managers must begin to evaluate business opportunities through all three of these lenses. First, there is the developed, consumer economy where nearly 1 billion customers around the world have the purchasing power to afford most anything they might desire. In the consumer economy, the infrastructure exists to enable the rapid manufacturing and distribution of products and services, and consumption occurs at very high levels. Second, there is the emerging economy (roughly 2 billion strong) where basic needs of consumers are met and some minimal purchasing power has been obtained. There is little extravagance in the emerging economy, but there is no desperation. Rapid industrialization and urban migration is increasing the demand for additional products and services for this large and rapidly growing market. Finally, there is the survival economy, which comprises roughly half of humanity (3 billion). Members of the survival economy are largely rural and poor with basic needs that remain mostly unnoticed and unmet. There is no infrastructure to allow those needs to be addressed, and few companies have dared to invest in what they perceive at best as a risky and long-term proposition.13 Such distinctions are important because each of these economies requires different strategies to achieve sustainable development. To compete sustainably in the consumer economy, managers must focus on reducing the life cycle (cradle to grave) impacts of products through technological innovation. That is, managers should seek to reduce the “footprint”(see footnote 7) of their firms’ activities by reinventing their products and processes. To meet the long term needs of the emerging economy, managers must engage in commercial activities that help to avoid the collision between rapidly growing demand 12For an in-depth discussion of consumer, emerging, and survival economies, see S. Hart, 1997, op.cit. 13For details on income levels and numbers of people associated with each of these three economies, see: World Bank, World Development Report: Knowledge for Development, New York: Oxford University Press, 1999. 9 for products on the one hand, and the physical basis for supply or waste disposal on the other. That is, managers must help their organizations leapfrog outdated practices and technologies relied on in yesterday’s consumer economy. Finally, to realize the opportunity in the survival economy, managers must recognize and exploit the inherent opportunity presented by a massive group of potential consumers whose basic needs remain unfulfilled. Each of these three strategies is discussed in more detail below. The Consumer Economy: Reducing the Corporate Footprint Approximately 80 metric tons of materials are used to produce, distribute, operate, and dispose of the products and services consumed by each American every year.14 The typical American consumes 17 times more than his or her Mexican counterpart and hundreds of times more than the average Ethiopian.15 Western Europeans, Japanese, and other highly affluent consumers around the world are not quite as material intensive, but are not far behind. By any measure, the 1 billion participants of the consumer economy leave a very large footprint compared to their counterparts in the emerging or survival economies. Individuals in the consumer economy leave large footprints because so many of the resource- and energy-intensive industries serving their needs—chemicals, automobiles, oil, and mining, to name a few—leave very large corporate footprints. Usually, the full life cycle costs of these industries are not captured in market prices— substantial impacts are externalized onto society at large. Footprints can be reduced by driving the material content out of products in favor of service, information, and functionality. And where waste is generated, it must serve as input for some other value- added process. Product systems with large footprints are usually based upon mature technologies. As technologies mature they reach a point where even large additional investments in technical development yield only small gains in performance. The combination of large footprint and technological maturity creates openings for creative destruction. It is at this point that innovations begin to appear as entrepreneurs with radically new technologies 14 See A. Hammond, op cit. 10 work to generate significant performance gains with comparatively modest investments. Mature technology causes the gap between price and life cycle cost to widen and grow, resulting in both technological and environmental forces that drive creative destruction. To identify sustainability-driven opportunities for the consumer economy, managers must address questions like the following: How large is the gap between price and full life-cycle costs? Are most of our technological advances incremental in nature? Where can we drive material content out of our products? How can our service content be dramatically increased? Where can our waste become inputs to other processes? Consider the automobile industry. The skyrocketing costs of technology and product development in the industry are indicative of mature technology reaching its limits. Customers continue to press the industry for performance improvements and new features, but the gasoline powered internal combustion engine and metal working technologies that underpin the industry are inherently inefficient.16 As currently conceived, the automobile creates extraordinary life-cycle costs in the form of junkyards, smog, and greenhouse gas emissions that worsen with each passing year. The industry is ripe for creative destruction via technologies that radically improve efficiency, reduce automotive material content, and eliminate tailpipe emissions. Like sharks circling their hapless target, designers of fuel cells, ultralight bodies, and radical new drivetrains are poised to revolutionize all aspects of the automobile, from the manufacturing process to aftermarket services and disposal. In the carpeting industry, Collins & Aikman Floorcoverings is driving a creative destruction process through a push to shrink its corporate footprint. The company has developed a patented technology to produce new carpet from old on a closed-loop basis. The process involves extruding and calendering reclaimed carpet tile to produce new 15See M. Wackernagel and W. Rees, op cit. 16See, P. Hawken, op cit. for a discussion of inefficiencies in conventional automotive technology: only about 1% of energy used is transferred to forward motion. 11 PVC-based backing for its ER3 floor coverings. ER3 modular carpet tile has now become the company’s standard product—virgin tile will no longer be produced— eliminating the need for virgin, petroleum-based feedstocks. In 1998, over eight million pounds of material was diverted from the landfill and recovered. This figure is expected to double in 1999. Given that raw material constitutes nearly 40% of the typical carpet- maker’s cost structure, it should come as no surprise that Collins & Aikman is roughly twice as profitable as its closest competitor. The company is using some of these profits to invest in “next generation” floorcoverings that will eliminate the use of PVC as a material and facilitate more sustainable building designs and flooring systems. In the chemical industry, DuPont has embarked upon a corporate quest to dramatically shrink the company’s footprint. New CEO Chad Holliday is seeking to transform the corporation from a large-volume producer of chemicals and materials to a high value-added producer of information products and services. As Holliday recently put it: “The objective for our industry ought to be sustainable growth. In the next century, we are going to have to find ways to create value while decreasing our environmental footprint.”17 To help fuel the creative destruction process, Vice President Paul Tebo has created an analytical tool which allows the company to compare each of its businesses in terms of their footprint. By comparing the total pounds of materials consumed per annum with shareholder value-added (SVA) per pound, the analysis has highlighted three distinct groups of businesses (Figure 3). --------------------------------------------------- Insert Figure 3 About Here ---------------------------------------------------- Businesses with small footprints and high SVA per pound are “differentiated” businesses that include photopolymers and electronic materials, low use-rate agricultural chemicals, agricultural biotechnology, Lycra, Tyvec, Corian, and auto finishes. Businesses with medium footprints and medium SVA per pound are “foundation” 17 Remarks by Chad Holliday at the Chemical Industry Conference, Washington, D.C., November 9, 1998. 12 enterprises that include some of the company’s largest and best established such as Nylon, PET, and polyethelene (PE). Finally, businesses with large footprints and low SVA per pound such as the petroleum subsidiary Conoco represent the least company’s least desired enterprises. The high earnings, cash flow and intellectual content (R&D/capital) of the differentiated businesses are seen as the models for the future. Foundation businesses represent opportunities for improvement and repositioning. On the other hand, large footprint-low knowledge intensity enterprises are divested to fuel future growth in the differentiated businesses. Over the next several years, company efforts will be directed at identifying and launching entirely new business platforms in the upper left portion of the graph. Through its internally-initiated process of creative destruction, DuPont is systematically shrinking the corporate footprint by driving material content out of their products in favor or service and information content. Service companies can also play an important role in shrinking corporate footprints. In the telecommunications industry, for example, some companies are beginning to explore ways to make a number of existing, resource-intensive products obsolete. Companies such as Hewlett-Packard and Lucent Technologies are attempting to substitute information for energy and material use. The high life-cycle costs associated with such industries as oil, automobiles, and airlines create opportunities for substitute products and services with substantially smaller footprints. These companies view e- mail, telecommuting, teleconferencing, and internet transactions as ways to dramatically reduce overall levels of material and energy consumption. The Emerging Economy: Avoiding the Collision Course Today, less than one-third of the world’s population lives in urban areas. Over the next few decades, this figure is expected to swell to well over two-thirds. In China alone, nearly 300 million people are expected to migrate to cities over the next twenty years (a number greater than the current population of all of North America).18 Rapid urbanization and industrialization together with increased demand for products and 18 See A. Hammond, op cit. 13 services are placing intense pressure on ecological and social systems. Technologies that fueled the development of the consumer economy in the past will not be adequate for meeting those future demands without exceeding nature’s capacity for replenishment. Avoiding the collision course between rapidly growing demand and a stable or diminishing stock of material supply and waste sinks will be the biggest challenge facing emerging economies. To identify sustainability-driven opportunities, managers must ask themselves questions such as the following: Is it environmentally feasible to double or triple the size of our industry? What factors prevent our industry from such growth? Can we meet growing consumer needs without depleting the natural systems upon which we depend? Can we use emerging economies to incubate “leapfrog” technologies? How can we meet growing needs without exacerbating urban problems? The past several decades have witnessed an unprecedented boom in emerging economies around the world: Nearly two billion people have joined the ranks of this economy over the past twenty years alone. The recent financial crises in Asia and Latin America, however, highlight the fact that past growth has been premised upon the unsustainable exploitation of natural and human resources. In many emerging economies, development has resulted in pollution on a previously unimagined scale— dead rivers, mountains of garbage, noxious air, and cesspools of toxic waste. From China to Thailand to Mexico, the problem has moved beyond that of eyesore to one that seriously jeopardizes public health and prospects for future development. Nevertheless, in the emerging economy the demand for an increasing range of products and services will continue to rise. In meeting these growing demands, however, firms have tended to replicate the same strategies, products, and processes that were successful in the consumer economy. Given the scale and speed of development in the emerging economy, however, a repeat performance of the consumer economy is almost certain to lead to environmental meltdown. Sustainable development of the emerging 14 economy will depend upon the ability of firms to meet rapidly growing demands without repeating the wasteful, outdated practices of the consumer economy. Because of the high rate of manufacturing growth in the emerging economy, the capital stock in manufacturing is being replaced at a very rapid rate. In Asia, for example, this translates into a doubling of the equipment stock of manufacturing plants every six years.19 Thus, there exists a significant opportunity for firms that are able to leapfrog to clean (closed- loop, zero discharge) manufacturing technologies in emerging economies. Technological leapfrogging will be essential if economic development is to continue at the rates required to keep so many people out of poverty. The sustainability challenge in the emerging economy is particularly acute for industries that depend on renewable resources. For example, the global forest products industry must meet worldwide demand that is forecasted to grow at 1-2% per year for the next several decades, even as the overall global supply of available timber declines.20 Continued commercial extinction of native forests, lack of reforestation, conversion of forest lands for agriculture and industry, and tightening regulations are combining to dampen wood supplies for the foreseeable future. The global industry, built primarily upon the rapid harvesting of standing native forests, must find an alternative approach to supplying the world’s needs. Recognizing this collision course, several companies have begun to rethink their strategies for “sustainable forestry.” A few, such as Weyerhaeuser, have embarked on intensive agroforestry to ensure increased fiber supplies while minimizing impacts on additional lands. Their high yield model provides higher returns while simultaneously minimizing and containing environmental impacts by producing high-quality wood and fiber on fewer, continuously regenerated acres. Concentrating production on a smaller number of intensively managed acres is entirely consistent with the preservation of the remaining native and frontier forests of the world. Similarly, the agriculture industry is being challenged to supply the world’s burgeoning population at the same time that water resources become more scarce, many croplands become less arable, climate changes, and crops become more homogenized and 19 US-Asia Environmental Partnership, Report of the Independent Technical Review Panel, Washington, D.C., 1995. 20 Food and Agriculture Organization, Forest Products Forecasts to 2010, Rome, Italy, 1995. 15 susceptible to mass failures. Growing populations and increasing affluence are driving demand upwards at a rate that far exceeds the productivity improvements occurring on croplands around the world. Global water consumption has doubled over the past fifty years, and is expected to double again within another twenty, with two-fifths of the world’s population already suffering from serious water deficits. Meanwhile, sources of freshwater are not increasing. With the lion’s share of water being used in agriculture, the industry is beginning to feel pressure for revolutionary changes. Lack of water could curtail food production at precisely the time that world population soars from 6 billion toward 8-10 billion. At the same time, cropland is lost each year to urban encroachment and industrial development forcing more marginal lands into production. Furthermore, desertification and changing global climate patterns place additional pressure on the productive capacity of existing agricultural lands.21 The existing model of commercial agriculture that is heavily dependent on the intensive use of water, chemical pesticides, and fertilizers is experiencing diminishing returns. A growing number of agricultural companies view this “collision course” as a business opportunity. Monsanto, for example, has focused its strategy on reinventing the world’s agricultural system through the use of biotechnology to design crops which are resistant to pests, require less water and fertilizer, and are more nutritious.22 Service companies can also realize opportunities in the emerging economy. Some telecommunications companies have recognized the benefit of leapfrogging prohibitively expensive terrestrial systems (land lines). Through satellite and radio systems, they are reaching previously unserved rural areas with telecommunications comparable to those found in urban areas. Such wireless systems erase differences among regions and nations in access to information, allowing for smaller scale economic development that reduces pressures for urbanization. Teledesic, a $9 billion venture, is working to install such a system by forging a global partnership of service providers, manufacturers, governments, and international agencies. Their “global internet” aims to bring high bandwidth service to the most remote locations through the deployment of a global network of 840 low 21A. Hammond, op cit. 22See J. Magretta, “Growth through global sustainability,” Harvard Business Review, January-February 1997, pp. 79-88. 16 earth-orbit satellites (LEOs). Transmission times comparable to those for fiber optic connections will make the network well-suited to time-sensitive, high-data rate applications as refined as teleconferencing, medical imaging, and interactive multimedia. Additionally, the company’s network will not be vulnerable to natural disasters, allowing it to serve as a vital lifeline for emergency communications. The Survival Economy: Meeting Unmet Needs Unlike either the consumer or emerging economies, the survival economy is dominated by poverty and desperation. It is most often found around the world in rural villages, urban slums, and shanty towns. The sheer size of this economy is staggering: it is composed of nearly 3 billion people—over half of humanity—who are subsistence- oriented and tend to meet their basic needs directly from nature. Demographers generally agree that as the world’s population doubles over the next 40 years, the bulk of that growth will occur in the survival economy.23 Because vibrant rural communities stem the pressures for mass migration, and accompanying social, political, and environmental breakdown, stabilization of the survival economy is both a key to sustainable development and an unprecedented business opportunity for firms visionary enough to understand it. These opportunities exist to the extent that companies can focus on developing technologies, products, and services geared specifically to the unmet basic needs of the survival economy. To do that, managers must overcome two long held assumptions. First, they must understand that significant profits can be realized by meeting the needs of the poor and disenfranchised. This is in conflict with conventional wisdom that holds the poor do not make good customers given their lack of money and education. Second, managers must understand that meeting those needs requires the application of state-of- the-art technology in fundamentally new ways. Simply transplanting business models from the consumer or even the emerging economy will not work. Identification of sustainability-driven opportunities can begin by asking such questions as: 23 See S. Hart, op cit, for more discussion of the survival economy in relation to global sustainability. 17 Can our products and services meet the basic needs of the poor? How can we apply state-of-the-art technology to meet the most basic of human needs? Are there market “vacuums” that firms have overlooked? Are we blinded by our current business model? How do we build a customer base that can grow in sophistication over time? Companies recognizing the business opportunities of the survival economy have done so by clearly understanding and catering to the needs of poor customers. Consider the clothing and apparel industry. Companies like Levis or Lee depend on wealthy consumers who can buy their denim products in large retail stores near urban areas. However, in India, Arvind Mills has created an entirely new value-delivery system for blue jeans.24 As the world’s fifth largest denim manufacturer, Arvind found Indian domestic denim sales limited because a $20-40 pair of jeans is neither affordable to the masses nor widely available, since the existing distribution system reaches only a few rural towns and villages. In direct response to this problem, Arvind introduced “Ruf and Tuf” jeans—a ready-to-make kit of jeans components (denim, zipper, rivets, patch) priced at about $6. It was distributed through a network of 4,000 tailors, many in small rural towns and villages, whose self-interest motivated them to market the kits extensively. Ruf and Tuf jeans are now the largest selling jeans in India, by far, easily surpassing Levi’s and other brand names from the U.S. and Europe. Business models from the consumer economy blind firms to opportunities that exist in the survival economy. Companies that look at poorer areas as dumping grounds for wastes or outdated, dirty technologies and manufacturing facilities miss identifying market “vacuums” with minimal competition. In the energy industry, for example, solar power remains uncompetitive in the consumer economy, but is a particularly attractive business opportunity in the survival economy, where centralized, grid-based systems of electrical generation are prohibitively expensive. With nearly half of humanity lacking 24M. Baghai, S. Coley, D. White, C. Conn and R. McLean, “Staircases to growth,” McKinsey Quarterly, 1996, 4: pp. 39-61. 18 access to electric power, the opportunities for distributed, modularly deployed solar and renewable energy have never looked more promising. Indeed, transmission lines cost between $20,000 and $40,000 per mile to install. This makes alternative sources, such as small-scale wind, photovoltaic, and hydro generators attractive for rural areas, bypassing existing grids altogether. As a consequence, British Petroleum, Shell, and Amoco-Enron have all initiated significant investments in solar and renewable energy. Firms that succeed in the survival economy do so because their managers recognize the benefits of developing markets and building future customer bases. The Korean chaebol Daewoo, stands as an example of a conglomerate that has decided to focus its strategic attention where its rivals aren’t—the survival economy. Realizing the limits of competing head-on with American, Japanese, and European firms in overcrowded, technology-intensive markets of the consumer economy, Daewoo is relocating much of its industrial base to remote areas of the world such as Burma, Iran, Uzbekistan, Russia, China, Vietnam, Brazil, and Tatarstan where it can make long-term investments in economic infrastructure. Daewoo enters poor regions as a long-term “development partner” that offers skills in infrastructure planning, environmental management, and manufacturing. When hard currency is scarce, the company accepts barter. Uzbekistan, for example, is paying for their half of a joint venture factory with cotton, which Daewoo’s trading arm sells on the world market. By using first mover advantage to build relationships, Daewoo is enacting a long-range strategy of growing by catering to the world’s poorest regions. Establishing a foothold in the survival economy allows a firm to meet basic needs in the short run and grow as those needs mature over time. Twenty years ago, a college professor in Bangladesh, Mohammed Yunas, was becoming increasingly disenchanted with the state of the country. Surrounding his campus were growing numbers of people living in abject poverty. Determined to do something that would improve their situation, Yunas began by asking several of the locals what it would take to fundamentally change their lives for the better. He was astonished to find out that in virtually every case, people knew exactly what they needed (e.g. money to buy a cow, or supplies for home-based production of products) and that the costs involved were minimal. He compiled a list of 19 48 people with needs that totaled only $75. Yunas loaned them the money out of his own pocket, never expecting to see it again. Much to his surprise, within a three month period, each of the 48 people had paid him back, with interest. He expanded his lending effort by guaranteeing loans made to the poor by a local bank whose managers did not believe that the poorest of the poor were credit worthy. After expanding this operation to several other villages Yunas decided to create his own bank that focused on micro-credit to the region’s poorest. Today, the Grameen Bank provides micro credit to more than 3 million customers in over 35,000 thousand villages in Bangladesh. In 1996, the bank lent over $1 billion in Bangladesh with the average loan size being $15. Even more impressively, Grameen has achieved a 99% repayment rate, higher than virtually all banks in the United States. Most people receiving micro credit in rural Bangladesh were hampered by an inefficient transportation system and lack of access to information, making further efforts at self-improvement difficult. Yunas then realized that the Bank’s efforts could be greatly enhanced through telecommunications. He started a new subsidiary, Grameen Phone, with the vision of supplying wireless phone service to every village in Bangladesh. Global telecom companies saw no potential in Bangladesh, because poor people could not afford cellular phones, yet Yunas created a new business model by selling phones to local entrepreneurs on credit, who then “sold” phone service to the residents in each village. Grameen Phone has grown rapidly and been profitable from its inception because cellular phone calls proved much more economical for residents than traveling for several days on mules and buses to acquire some desired information. As telecommunications needs have grown more sophisticated, Yunas has now turned his attention to extending services that include computer and internet connections to rural villages. The internet allows for the delivery of related services including telebanking, telemedicine, and teleeducation. To build the necessary infrastructure, it has become evident that villages need a source of “premium” power to run the more advanced systems. Spearheading this development, Yunas has created Grameen Energy, a subsidiary seeking to partner with producers of decentralized photovoltaic, wind, and fuel cell based electrical generating systems. This, in turn, has opened up significant 20 business opportunities for alternative energy suppliers and, through volume purchase, has brought costs down substantially. Yunas’s businesses have materially improved the way people live in rural Bangladesh. As basic needs are met at the village level, pressure for migration to overcrowded urban areas is reduced. Furthermore, citizens able to meet basic needs no longer need to cut forests for cooking fuel, pollute and drink contaminated water, or avoid expensive health care, thus strengthening their social and environmental systems. As villages prosper, a growing economic base has jump-started entrepreneurship, employment has increased, and the overall standard of living has improved. Firms like Grameen Bank and Daewoo grow and prosper in tandem with these changes. A New Set of Metrics Recognizing global sustainability as a catalyst of creative destruction and frame for new business development may prove crucial to corporate survival in the 21st century. Awareness and foresight are important first steps toward strategic change, but a new set of metrics is also necessary to focus managerial attention and track progress toward sustainability. Without a clear understanding of how sustainability-driven creative destruction can improve the economic payoff for the firm, it is unlikely that senior managers will commit resources to such strategies. In this last section, we offer some ideas for sustainability metrics tied to the three economies discussed above, and suggest how these new metrics relate to key business and financial payoffs that are important to the firm (Figure 4). --------------------------------------------------- Insert Figure 4 About Here --------------------------------------------------- Consumer Economy. The key sustainability challenge in the consumer economy is to reduce the corporate footprint, or the impact business has on the natural environment throughout its life cycle. To identify opportunities for material content reductions not 21 currently obvious to the firm, key metrics should capture and track the material- and energy-intensiveness of the company’s products and processes—not just those emissions required by regulations. Tracking pounds of materials used (and the proportion of that which is toxic in nature), along with levels of greenhouse gas emissions, provides a quick and inexpensive way to benchmark the firm’s footprint. For some companies, it will be desirable to gain a more detailed measure of the footprint. This necessitates measuring “life cycle” impacts.25 The first step is to track the amount of raw materials that are extracted from the earth to make a firm’s products or services. Next, the manufacturing and distribution processes should be scrutinized for additional materials use and waste generation. Finally, the firm should track the amount of waste and pollution produced as its products are consumed and later disposed. Such analyses will highlight opportunities for changes that can lead to the reduction, reuse, or replacement of toxic materials and high impact activities. A full understanding of all upstream and downstream impacts can spur a dramatic rethinking of product design and concept. Firms should also track public perceptions regarding their products and services. The goal should not be to broadly confirm the perception that the firm already holds of itself. Instead, effort should be made to tap into the different views that exist at multiple levels and include local communities immediately surrounding company facilities, as well as regional, national, and international public opinion. There should be an attempt to understand whether social values are shifting, and if so, in which direction. Tapping into broad stakeholder attitudes and values, evaluated together with the measures above for materials use, can help managers think about how their current offerings meet or fall short of expectations. Through dematerialization, cost reduction, product portfolio changes, and improved corporate reputation, strategies to reduce the corporate footprint should help the firm achieve higher levels of earnings growth and improve it’s shareholder value-added. As noted earlier, such metrics have enabled firms like DuPont to reevaluate 25 Traditionally, life-cycle analyses have been regarded as extremely complex and time-consuming procedures that produce results of questionable utility. More recently, however, organizations such as Battelle, Eco-Balance, Franklin Research, and Carnegie-Mellon’s Green Design Initiative have developed simplified life cycle tools that produce more usable results. 22 their business portfolio and move toward creative destruction of their industry though the systematic shrinking of the corporate footprint. Emerging Economy. The key sustainability challenge in the emerging economy relates to avoiding the collision of meeting rising demand for products and services without overburdening natural and social systems with outdated technology. In regions of rapid industrialization, dramatic reductions in emission levels is a critical metric. Additionally, strategies must lead to corporate activities that conserve water, land and renewable resources. Tracking the rates of natural resource use and replenishment stemming from company initiatives is important for revealing opportunities for sustainability-driven technological innovations. Metrics that capture the degree to which brownfield sites are developed over greenfield sites or the degree to which a firm’s products and services encourage urban development versus creeping sprawl can also help direct attention to sustainable business strategies. Given the rapid rate of urban migration associated with emerging economies, it is also crucial to track the rate of job creation and economic development associated with corporate investments. Measuring the percent of corporate assets invested in the emerging economy provides a useful proxy for commitment to this aim. The creation of urban jobs is particularly important so that corporate activities do not contribute further to urban sprawl. As the demand for a growing range of products and services increases, the emerging economy holds tremendous potential for growth in the coming years as compared to the relatively saturated markets of the consumer economy. As such, business opportunities stemming from the emerging economy represent potential growth engines for the firm. Over the medium term, tapping into these opportunities should lead to increases in sales growth and increased value for a company’s stock. Survival Economy. The key sustainability challenge in the survival economy is meeting the unmet basic needs of the poor so that they develop a solid economic foundation and increase their quality of life. Few managers seriously consider those who are not being served by their company’s current product or service portfolio. Here, we do not mean those consumers who decide to purchase a competitor’s product. Rather, firms should take time to understand the particular needs of those not actively engaged in the 23 market economy. These economic voids and vacuums offer small-scale commercial opportunities that might grow to become tomorrow’s core businesses. Establishing and growing the sales presence in the survival economy relative to the consumer or emerging economies is an important measure of progress toward that goal. The survival economy lens should help extend the breadth of a firm’s service and product offerings into the world’s down markets. Strategies that build the social infrastructure of potential markets through education, training, and increased worker wages are also important. Products and services that can be applied on a small-scale will enhance local community development and alleviate pressures for urbanization as compared to large scale, centralized projects that degrade rural communities and encourage urban migration. The survival economy represents tomorrow’s business opportunities. Creating a strong position that taps into this vast, emergent market will help position a company for meeting the future needs and demands for the bulk of humanity. Over the long term, investment in the survival economy should improve the firm’s price-earnings ratio and share of new wealth creation. 24 Conclusion Schumpeter was skeptical of the ability and motivation of large, incumbent corporations to drive the process of creative destruction, but he did not dismiss it completely. He felt that large investments in an installed asset base and misaligned managerial incentives would conspire to reduce incumbents’ motivation to make their own established positions obsolete. Yet, he also recognized that, paradoxically, large corporations possess financial, technical, and organizational resources that can not be matched by small, entrepreneurial new entrants. By seizing the opportunities inherent in sustainable development, existing corporations can drive the creation of new competitive landscapes. To capture sustainability-driven opportunities, however, corporations must fundamentally rethink their prevailing views about strategy, technology, and markets. This starts with an understanding that there are multiple levels to what is currently regarded as a single global economy. Focused attention at the three levels—consumer, emerging, and survival economies—will enable managers to see business opportunities where now they see none. Each level offers short, medium, and long-term payoffs arising from innovations that simultaneously reinvent the firm around sustainable development while fundamentally changing current industry structure. A new set of metrics focused on global sustainability will help managers direct attention and take the first steps toward identifying the opportunities that will lead to those innovations. The importance of taking that first step cannot be overemphasized. Firms that hesitate and waver over global sustainability trends will become future cases for business historians as new entrants systematically unseat them. Companies whose managers treat sustainable development as a source of new opportunity will drive the creative destruction process and build the foundation for their firms to compete in the 21st century. 25
"Sustainability and the Creative Destruction"