FORUM Industrial Ecology and Competitiveness

Strategic Implications for the Firm

Daniel C. Esty Yak Law School Yak School of Forestry and Enuironmental Studies New Haven, CT, USA Michael E. Porter Haruard Business School Boston, MA, USA

- I Keywords Summary closed loop competitiveness In the emerging field of industrial ecology one of the un- corporate environmental settled questions is the degree to which design for the en- management vironment, closing energy and materials loops, and other eco-efficiency externalities industrial ecology concepts apply at the firm level. In this remurce productivity article we examine this issue with a particular focus on whether industrial ecology can guide company strategy and efforts to enhance competitiveness. We conclude that industrial ecology thinking will often be useful for firms seeking to improve their resource pro- ductivity and thus their competitiveness.The systems per- spective that industrial ecology promotes can help companies find ways to add value or reduce costs both within their own production processes and up and down the supply chain. But industrial ecology cannot always be

Address correspondence to: counted upon to yield competitive advantage at the firm Daniel Esty level. In some cases, the cost of closing loops will exceed Yale School of Forestry and the benefits. In other cases, regulatory requirements do Environmental Studies 205 Prospect St. not fully internalize environmental costs, and thus polluting New Haven CT,065 1 1, USA firms may gain temporary or permanent cost advantages email: daniel.esty8yale.edu relative to companies that attempt to eliminate all emis- sions. Finally, because industrial ecology focuses attention on materials and energy flows, it may not optimize other variables that contribute to competitiveness within the 8 Copyright 1998 by the Massachusetts Institute of Technology and Yale UniverJity Corporate Setting.

Volume 2. Number 1 I

Journal of Industrial Ecology 35 1 FORUM

Introduction many respects, a fundamental alignment between good environmental performance and recent in- Industrial ecology offers an analytic tool that novation-driven views of what produces com- can be applied in various ways and at various pe titive advantage. levels of economic aggregation.’ Because the field is still emerging, considerable debate exists over industrial ecology’s use and value in differ- Industrial Ecology as a Guide ent contexts. In this article, we explore one di- to Resource Productivity mension of industrial ecology: its potential In some respects, recent work in industrial application as a tool for shaping firm strategy ecology-with its emphasis on how effectively and competitiveness. We examine, in particular, various critical resources are employed in a pro- the connections between industrial ecology and duction process-is building on thinking that current work in the fields of competitive strategy emerged in the late 1980s and early 1990s on “en- and international competitiveness. We observe vironment and competitiveness” (Porter 1990; that industrial ecology can spur a certain type of Porter 1991; Esty 1994).While traditional eco- corporate thinking that, when screened through nomic thinking argues that competitive positions the lens of resource productivity, may lead to in- are built on low-cost inputs, recent work on cor- novations that improve efficiency, lower costs, porate competitiveness focuses on the dynamic and raise the value created by a production pro- nature of business and the importance of innova- cess. Industrial ecology can thus serve as a tool tion (Porter 1990). Today’s competitive advan- for sharpening firm competitiveness. We note, tage often derives from finding unexpected ways however, that although industrial ecology has to lower the cost of producing goods or identify- potential in the realm of competitive strategy as ing ways to increase a product’s value-either di- a “discovery”tool, it has limitations as a broader rectly or indirectly. Enhanced resource productivity firm-level guide for strategy generally. is thus what makes companies truly competitive Design for the environment (ME), materials (Porter and van der Linde 1995a, 106). cycling, and an emphasis on closed-loop produc- Resource productivity can be defined as: tion processes will yield competitive advantages in some circumstances. But in other cases, these resource productivity of input x = approaches will not enhance a firm’s competi- f (value added by x - the direct costs of x - tive position. Notably, closing some loops may the indirect costs of x + the indirect add costs that exceed the benefits to be ob- opportunities for value added from x). tained, especially if the regulatory system within In this equation, the direct value added and which a company operates does not fully inter- costs are the parts of the production process to nalize the costs of air or water pollution or waste which firms currently pay attention. The value disposal. In addition, attention to energy and added by a resource to the final product of the materials flows can distract from the optimiza- firm is obviously central to its productivity. As a tion of other scarce resources such as the ana- product becomes more useful and thus worth lytic attention of managers. more to customers, its value increases. Hence companies recognize the importance of trying to find ways to improve the quality, features, or Firm-Level Industrial Ecology functionality of their products. Direct costs-la- Managing at the firm level through an indus- bor and material inputs-are also traditional trial ecology lens offers both opportunities to ad- parts of most companies’ accounting calculus. vance competitiveness and potential risks. In the Companies understand that to the extent they sections that follow, we identify and analyze the can produce their products with fewer or potential benefits and then review the limits of cheaper inputs, they will improve resource pro- industrial ecology as a corporate strategy tool. In ductivity, lower costs, and increase profits. doing so, we find, in many circumstances and in Some aspects of industrial ecology address

36 journal of Industrial Ecology FORUM 1 opportunities to improve environmental perfor- Within the Firm mance and simultaneously to increase the value Many ways are available to improve resource of a product or to lower direct costs2 For ex- productivity by identifying and eliminating waste ample, producers, made more attentive by indus- and thereby lowering the costs of production. trial ecology thinking and life-cycle analysis to Even before the advent of industrial ecology, waste disposal problems their customers face companies were pursuing these opportunities un- from the products they have sold, may make der the rubric of “pollutionprevention’’ (Dorfman changes in a product’s design to facilitate recy- et al. 1992). By fostering a fusion of thinking from cling or reuse. Such ME strategies can lower the the physical sciences about the conservation of customers’ costs and therefore enhance the mass and energy with the teachings of economics product’s value. Likewise, a manufacturer who about efficiency, industrial ecology can go even adopts a waste minimization strategy may find further in helping firms obtain maximum returns he can recapture and reuse raw materials and from a given set of inputs-that is, to optimize re- thus purchase fewer inputs, thereby cutting his source productivity. Moreover, by encouraging direct costs of production. systems thinking-including attention to a In addition, many indirect or hidden opportuni- company’s materials balance, the possibility of ties exist to lower costs or to improve the value of closed-looped systems, and design for the envi- a product. In general, these opportunities arise be- ronment opportunities-an industrial ecology yond the scope of a firm’s traditional product defi- perspective can encourage companies to focus on nition, management vision, and accounting the multiple dimensions of resource productivity procedures. Below, we separate out three critical that must be considered to optimize competitive- places to look for hidden resource productivity ness. Attention to a company’s materials balance, gains: (1) within the firm; (2) within the chain of the possibility of closed-looped systems, and DfE production (involving suppliers or customers);and opportunities can add to the value of a product or (3) beyond the chain of production. In each area reduce the cost of production. of opportunity, industrial ecology may be helpful as Dow Chemical, for example, redesigned its a discovery tool, broadening the perspective of cor- process for scrubbing the hydrochloric acid used porate decision makers, encouraging innovation, to make chlorinated organic compounds. The and facilitating the reconfiguration of product refined procedures allowed Dow to eliminate the definition, design, production, delivery, and dis- need for certain wastewater evaporation ponds, posal in ways that can be both profitable and envi- to recapture part of the former waste stream for ronmentally beneficial. reuse as inputs in other production processes, to No doubt skeptics will ask why, if these op- reduce its caustic waste by 6,000 tons per year, portunities for improved competitiveness are so and to cut its acid waste by 80 tons per year. readily available, companies have not already With an investment of $250,000 to implement moved to take advantage of them. There are the new process, Dow obtained $2.4 million in several answers. First, some companies are find- annual savings on inputs and lower waste dis- ing these resource-saving opportunities inside posal costs-cutting both direct and indirect and outside their firms that are bringing down production expenses (Dorfman et al. 1992,150). costs and improving efficiency. Second, corpo- Similarly, companies that have attended to rate managers have limited time and capacity to their energy flows-for example, by redesigning focus, and many are just now beginning to ap- their office and factory lighting as part of the preciate the depth of the opportunities pre- U.S. Environmental Protection Agency’s sented by paying attention to resource flows. (USEPA) Green Lights program-have Finally, to obtain resource productivity gains achieved significant reductions in their electric managers must comprehensively reexamine bills and thus their production costs (Porter and their operations and think about their firms’ ac- van der Linde 1995a,99). Although such operat- tivities in new ways, and not everyone has the ing expenditures as lighting are allocated as a ability to make the requisite shift in thinking. cost in production, they are often not considered

€sty and Porter, Industrial Ecology and Competitiveness 37 1 FORUM to be within the management domain of those Dutch flower producers, under pressure to re- responsible for a particular production process. duce the use of fertilizers and pesticides that pol- Indeed, the key to the success of the USEPA lute groundwater, achieved similar unanticipated Green Lights program was its emphasis on aggre- benefits from a commitment to rethinking their gating lightbulb changes and getting companies production process from a DfE perspective. They to shift responsibility for managing this “re- developed a closed-loop system for growing flow- source” from janitors with little incentive to ers in water and rock wool that offers significant make cost-savings investments in new lightbulb enhancements in resource productivity (Porter optimization strategies to senior managers who and van der Linde 1995b, 130). The growers do have such incentives. found that the closed-loop growing method low- Industrial ecology thinking promises broadly ered the risk of disease, reduced the need for pes- to spur attention to opportunities for cost savings ticides and fertilizers (which could be that would otherwise go unnoticed. Many com- recirculated in the water), and narrowed the panies have undertaken pollution prevention variations in’ growing conditions which im- programs with similar cost reduction goals in proved product consistency and quality. Because mind. 3M attributes more than $700 million in the flowers in the closed-loop system are culti- cost savings to its Pollution Prevention Pays pro- vated on specially designed platforms that make gram (Kelly 1994). A number of other compa- cutting and shipping easier, handling costs also nies have reported similar results (Miller 1996; dropped. From a resource productivity perspec- Hart and Ahuja 1996, Regan 1993). A some- tive, the Dutch flower growers increased the what broader industrial ecology focus might well value of their product, lowered the cost of inputs, yield even larger resource efficiency gains. and lowered the indirect costs of production by In other cases, the industrial ecology analytic reducing waste and disposal expenses, thus dra- framework has sparked creativity and innova- matically improving their competitiveness. tion that has led to unanticipated benefits that Although the central focus of industrial ecol- go beyond waste minimization. Hitachi, for in- ogy and competitive strategy should be on reduc- stance, adopted a DfE strategy in its washing ing real or “intrinsic” economic costs, in many machine division to facilitate recycling of old cases, attention to resource productivity will also washing machines. In redesigning its product to highlight opportunities to lower regulatory com- make disassembly easier, the company developed pliance burdens or other “induced” costs. DE a process by which its washing machines could strategies that encourage, for example, reduced be made with just six screws. Not only did this reliance on toxic chemicals may yield such ben- new design facilitate disassembly and waste dis- efits. A smaller inventory of hazardous materials posal at the end of the washing machine’s life, translates into a less onerous set of waste-track- but the six-screw structure cut manufacturing ing procedures, fewer toxic release inventory time by 33% and significantly reduced the num- forms to file, and lower regulatory costs. In many ber of parts that needed to be kept in inventory, companies, however, the opportunities to cut tracked, and acquired. Hitachi also discovered compliance expenses are not readily apparent to that the six-screw washer required less service, managers, because the regulatory burden is not so that the customer got higher reliability and allocated directly to particular product lines but lower repair bills. Hitachi’s efforts resulted not rather buried in a general overhead cost category only in an environmentally preferable washing over which line managers have little control and machine but a higher-value product with im- thus limited incentives to reduce. proved customer satisfaction, lower production Thinking in industrial ecology terms may also costs, and reduced indirect costs of disposal help improve resource productivity by enabling a (JACO 1996). In this case, the Hitachi commit- company to redefine a product and thereby in- ment to thinking in industrial ecology terms crease its value to customers. For example, while produced a multidimensional increase in re- trying to reduce its use of chlorine bleach, source productivity that made the company’s Melita, a coffee filter manufacturer, found that product much more competitive. some of its customers, fearing a dose of chlorine

38 lourno1 of Industrial Ecology FORUM 1 residue with their coffee, preferred unbleached attention to the interdependence of the various filters (Thomas 1994). The “brown” filters repre- parties in the production and distribution pro- sent added value in this segment of the market. cess and the potential for synergies among these Some of the strategic benefits that a company companies (and also, as we discuss in the next might achieve from viewing their activities section, with those beyond the production pro- through the lens of industrial ecology are even cess but in physical proximity), industrial ecol- more subtle. Producers of computer printer toner ogy can help overcome a variety of obstacles to cartridges have recently begun to take back more efficient resource use. In particular, the sys- empty cartridges on terms that make it very easy tems thinking that is induced can help to address for the customer (Business Wire 1997). This re- imperfect information, organizational inertia, duces the customer’s waste disposal cost. It also agency and control problems, and difficulties in allows the company to recapture the cartridge aligning incentives in ways that optimize the and to reuse it. More important, it ensures that value extracted from resources (Porter and van “after market” toner cartridge producers, who der Linde 1995a, 99). By cutting costs or gener- might otherwise get their hands on the product ating value for suppliers or customers, companies and refill it and sell it, do not have ready access to are often able to improve their competitive posi- a supply of cartridges. Many producers of dispos- tion. A food wholesaler that agrees to take back able cameras seem to have missed this lesson. and reuse packing materials, such as pallets, pro- Rather than taking back the used camera shells duces an external benefit: lower waste disposal from film developers, a number of major producers costs for its customer. These lower costs may of disposable cameras have allowed a thriving af- yield more loyal customers. Of course, the ter-market to emerge in which entrepreneurial wholesaler may also be able to capture some of companies acquire the discarded camera bodies the value in the less wasteful packing process by and reload them (Sanders 1996). Thus the original charging for the take-back service (Twede 1995). disposable camera producers face competition from Careful analysis of environmental costs borne a new set of “used” disposable camera makers. upstream and downstream by suppliers and cus- Some companies have found that by paying tomers offers real opportunities for improved attention to their waste and materials flows, competitiveness. Absent a concerted analytic they have been able to uncover opportunities effort to think through material and waste flows not only to reduce the cost within their existing that go beyond the firms’ boundaries, many production processes or to increase the value of kinds of pollution costs-and potential resource their output, but also to create new products or productivity gains-will remain invisible to a services that add value beyond the process under company. In particular, if it is not the producer scrutiny. DuPont, for example, has begun to that currently pays for resource misuse or ineffi- manufacture pen and pencil sets out of Corian ciency but rather the suppliers, customers, dis- countertop scrap (Tebo 1997). This reduced the tributors, or other actors in the flow from the waste disposal costs from its countertop produc- extraction of raw materials to the disposal of the tion operations and created a new product and final product at the end of its life, there is little source of revenue for DuPont. Similarly, Rhone- incentive to address the problem. Poulenc found a market for the diacids that are But even if a company can-legally-“exter- a by-product of its nylon production (Porter and nalize” some part of its environmental burdens, van der Linde 1995b, 125). Instead of incinerat- it may not want to do so. Specifically, if a com- ing these chemicals as waste, the company now pany can reduce the cost that its customer must has customers that purchase the diacids for use bear, it may be able to charge more for its prod- as coagulants in dyeing and tanning processes. uct, capturing the benefit of downstream waste reduction. If customers must pay for the disposal Within the Value System of packaging wastes, it may well be in a Even more deeply hidden sources of opportu- producer’s interest to reduce the volume and nity can be discovered by looking to reduce costs weight of packing materials. The strength of in- up or down the chain of production. By forcing centives for upstream and downstream innova-

Esty and Porter, Industrial Ecology and Competitiveness 39 1 FORUM tion to improve resource productivity depends (1982) make clear-and everyone who makes a on the degree of vertical integration among the living as a management consultant knows- various links in the chain of production, which many opportunities to increase value and reduce in turn determines the transaction costs of coop- costs remain undetected in the real world. eration. In a tightly integrated supply chain, the producer is very likely to be responsive to dis- Beyond the Chain of Production posal costs faced by the end user. Under these The opportunities to close loops in conjunc- circumstances, the price signals related to waste tion with other industrial facilities in close disposal down the line are transmitted relatively physical proximity but outside of one’s own pro- efficiently up the chain of production, thereby duction chain represent another dimension of spurring efforts to refine production processes. industrial ecology that offers the promise of rais- Where the end user is a different company ing resource productivity. “District heating,” from the producer but a relatively close rela- where one company’s waste steam is diverted as tionship exists between supplier and customer, a source of heat to nearby businesses or resi- price signals may travel reasonably efficiently. dences, offers a well-known example of the sort Thus a supermarket that regularly buys products of symbiosis that is possible. More dramatic ex- from a wholesaler may be able to induce the amples can also be found such as “eco-industrial supplier to reduce packaging waste as part of parks” where synergistic companies share inputs, their ongoing relationship, even if most of the outputs, and by-products, thereby reducing benefits accrue to the store and not the distribu- waste and cutting costs. The best-documented tor. Industrial ecology may help companies to partnership of this kind is the cooperation of focus on the needs of their upstream and down- Asnaes Power Company, a Novo Nordisk phar- stream partners to generate gains for their com- maceutical plant, a Gyproc wallboard factory, mon enterprise, viewed as a whole. Where, and a Statoil refinery in Kalundbourg, Denmark however, the relationship between customer (Ehrenfeld and Gertler 1997). and supplier is loose, such as in spot market sales, the producer has little incentive to attend The Limits of Industrial Ecology to the needs of the end user or vice versa. In this case, the price signals do not travel very Although industrial ecology can help im- smoothly up and down the supply chain, and prove resource productivity, its stand-alone value thus the opportunities to reduce waste, close as a guide to company strategy and competitive- loops, and cut costs will likely not be maxi- ness is limited. In particular, paying attention to mized-even if readily available ways to im- energy and materials flows and closing loops prove resource productivity exist. within the production process will, in some cir- By forcing attention to the interdependence cumstances, detract from rather than improve a of various parties in the production process and company’s competitive position. Three such situ- identifying the potential for synergies among ations come immediately into mind. these companies, industrial ecology can help overcome a variety of obstacles to more efficient Costs Exceed Benefits resource use. In particular, it may promote orga- The belief in the perfection of the circle can- nizational learning (Argyris and Schon 1974) or not be taken too far. Even when company gains collaboration with customers and even coopera- and social benefits are summed, the costs of clos- tion with competitors (Brandenburger and ing some loops may exceed the benefits. The re- Nalebuff 1996). Of course, if markets operated capture of water vapor, for example, may well flawlessly and the economists’ assumption of create large private costs for any company that “perfect information” were always true, compa- undertakes to do so, and is unlikely to produce nies would have already optimized their search benefits to society (or the company) that justify processes for finding these synergies. But as Por- the investment. In this case, it makes sense not ter and van der Linde (199%) and earlier March to close the loopboth from a company point of and Simon (1958) and Nelson and Winter view and from a broader societal perspective.

40 Journal of Industrial Ecology FORUM 1

The tendency of some industrial ecology ad- environmental outcomes regardless of the im- vocates to overstate their case and insist on the perfections in the regulatory system. Thus the superiority of entirely closed-loop systems is self- gap between social costs and private costs may defeating. There are many places where a DfE not be as large as some observers tend to suggest. approach will generate value. Conceding that, in some realms, closing loops will not generate Policy Fragmentation value strengthens the case for industrial ecology Although the goal of industrial ecology is to as a corporate strategy tool. Moreover, a more stimulate systems thinking across the various in- nuanced theory of industrial ecology, which ac- puts to a production process, in some circum- knowledges its limitations and concentrates on stances, the focus on materials and energy flows the substantial zone of overlap with competitive can cause a company to take its eye off the com- strategy thinking, will be far more persuasive to petitiveness ball. In particular, if attention to the business community. closing these particular loops is undertaken at the expense of other scarce resources, it may re- Imperfect Regulation sult in strategic disadvantage to the company. Because our current environmental regula- An everyday example illustrates the risk. tory system does not capture all of the harms that Using two-sided copying to produce a docu- emerge from particular production and distribu- ment will reduce paper flow. But if the document tion processes, firms that seek to close loops and must be edited, and editorial productivity drops to recycle wastes that they (and their competi- as a result of having to flip the two-sided copies tors) can currently legally emit-and thus exter- back and forth (as the authors of this piece as- nalize-will often find their competitive sert), then the emphasis on reducing materials position diminished, not enhanced.’ The larger flows, in this case paper, will come at the expense the gap between the private costs faced by firms of a much more scarce and valuable resource: and the social costs of their activities, the less analytic time. By reducing editorial efficiency, useful industrial ecology will be as a guide to firm the industrial ecology thinking that focused at- strategy. In particular, under an imperfect regula- tention on the flow of paper-a relatively less tory system, where environmental externalities scarce resource-has detracted from, not added are not fully internalized, companies that invest to, the productivity of the system in question. in emissions controls or other loop-closing strat- In the corporate context, attention to rela- egies may find themselves facing pollution costs tively unimportant resource flows can distract at- that their competitors do not bear. In this cir- tention from more important contributors to cumstance, closing a loop may produce social productivity and competitiveness. The prospect benefits that exceed the social costs, but the pri- of squandering scarce managerial time represents vate costs of recapturing the waste will exceed an obvious risk. A company might, for example, the private benefits at the company level. become so attentive to closing the loops in its But of course, as discussed above, what is per- materials and energy flows that its management ceived as “waste” (and pushed out a smokestack will lose focus on developing new products, refin- or effluent pipe) may in fact have some value. In ing production processes, or uncovering innova- other cases, environmental burdens that firms tions that might contribute dramatically to the externalize do not become social costs borne by corporation’s ultimate value. all, but rather private costs to some other party-as argued earlier in our discussion of re- Conclusion ducing environmental impacts across the chain of production. Systems thinking, in the form of At the firm level, industrial ecology offers a resource productivity analysis or industrial ecol- promising discovery tool for enhancing resource ogy, may therefore highlight this fact. It may also productivity and ensuring that companies oper- lead to interfirm cooperation, so long as the ate with optimal efficiency and profitability. In- costs of coordination (i.e., transaction costs) are dustrial ecology can promote innovation and not too high, that improves both economic and help managers find opportunities, both inside

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