Operating Margin and Capital Expenditure
Hypothesis on Profit and Capital Through (i) the use of recognized standards and cleaner technologies in its own operations to use resources more sustainably, as well as advancing those through its supply chain, a business can (ii) improve its operational efficiency – its ability to turn inputs into productive outputs in a costeffective manner – as a result of which (iii) it will improve its net profit margin and optimize its capital expenditure.
The key role of resource efficiency in operations and its impact on earnings before interest and taxes (EBIT) is recognized today, especially in industries in highly competitive markets such as information and communications technology, car manufacturing and consumer goods. Traditional analysis on the business case has tended to start off by highlighting cost savings, in particular savings related to energy use. In as far as resources are wasted and polluting emissions not avoided, business earnings will additionally be taxed in more economies world-wide. An analysis of the carbon exposure of an emerging markets investment portfolio benchmarked against the S&P/IFCI LargeMidCap Index is illustrative. For 16 firms from emerging markets, analysis by Trucost (2010) has found that at US$108 per metric ton of carbon dioxide equivalent (CO2e) by 2030, carbon costs could equate to more than 100 % of their EBIT (Carbon Disclosure Project 2010).
The costs of penalties for inaction contrasts with the benefits of preventative action. 3M has been running its Pollution Prevention Pays (3P) program for 40 years by 2015. In 2013 it estimated that since its inception the program has served to avoid 1.9 million metric tons of pollutants (waste, air and water pollution) and saved the company nearly US$1.8 billion based on aggregated data from the first year of each 3P project (3M Sustainability Report 2014). LCM is applied to all its products. Furthermore, LCM evaluation as a required component of its New Product Introduction process. It is also building on its LCM experience to develop new sustainability solutions. Clearly this is no longer just about operational efficiency in the name of cost savings. More companies have also started to focus on increased revenues and competitive market position.
McKinsey (2011) has found that 70 % of productivity opportunities today have an internal rate of return (IRR) of more than 10 % at current prices. As a result, some argue that business finds itself in the era of the Resource Revolution (Heck and Rogers 2014). Alongside opportunities are growing risks related to resource use. The cost of raw material inputs is impacted by growing natural resource constraints, which puts at risk the profit margins and EBIT of a range of sectors. The past decade alone has reversed a 100-year decline in resource prices. Analysis of fast-moving consumer goods companies by WRI and ATKearney in the late 2000s considered the impact of commodity price rises (Callieri et al. 2008). They calculated an ecoflation scenario in which natural resource constraints cause a reduction of 13–31 % in EBIT by 2013, and 19–47 % by 2018 for companies that do not develop strategies to mitigate the risks posed by environmental pressures. Examining data from six firms with a global presence in producing food, beverages, personal care and household care items, they found that, on average, raw materials and packaging costs each equaled 15 % of revenues (Von Falkenstein et al. 2010).
What then is the connection between cleaner production standards, operational efficiency and capital expenditure? Improved efficiency in the use of resources will drive more optimal use of fixed assets (e.g., land, buildings, equipment, machinery, vehicles). A challenge for the LCM community is to define how life cycle management of fixed assets can bring efficiency improvements through the use of approaches such as remanufacturing. There also exists an LCM opportunity with respect to working capital, a financial value driver with respect to which limited research on the green business case exists. It is related to the use of product service systems (PSSs) in the form of leasing rather than buying equipment, which can bring significant savings alongside its environmental benefits. This includes efficiencies due to services provided at scale, onsite or offsite, by an external business partner (see Willard 2012). In how far is LCA able to capture such benefits with different system boundaries involved? If LCA and LCC can quantify the benefits of PSSs in physical and monetary terms, the findings will also be of special relevance to working capital expenditure. PSS-related efficiency improvements can serve as a driver for innovation in the way inventory and customer or supplier relations (receivables or payables) are managed.