As countries continue to consume more resources than they replace, is moving to a circular economy the answer? Some companies are already shifting into service provision so they can control sustainability, rather than selling products that end up in landfill. Silvia Pavoni looks at the business argument.
While business leaders are busy attempting to control running costs and hit targets, there is one global budget that is running out of control but has largely been overlooked. Since the 1970s, the world has been in ecological deficit.
In the decades since, the consumption of natural resources has been spiralling upwards to the point that, in 2018, the world’s economic systems took out of the earth in one year what it needs 1.7 years to regenerate, according to estimates by think tank Global Footprint Network, using data from the UN and other sources. By August 2018, the world had burned through the raw materials ‘budget’ for the entire year.
With the increasing pace of consumption, the problem of waste management has also mounted. For example, the value of waste from the North American healthcare market alone is equal to the entire gross domestic product of the Netherlands, according to technology and healthcare group Royal Philips. Waste management is problematic, with much waste being sold to countries, particularly in Asia, that do not always have reliable disposal standards and increasingly do not want it.
The current situation is fast becoming unsustainable, from either an environmental or an economic point of view. Commodities can still be sourced at times of scarcity, but the sharp increases in price that accompany such situations mean that they become economically unviable for companies.
Supply, demand and geopolitics
Geopolitical considerations make matters worse, even with materials that are relatively abundant. Take, for example, rare-earth elements that are used in X-ray machines, computer hard drives or aircraft engines. These are predominantly extracted in China, which also produces most of the 27 raw materials identified by the EU as critical because of their supply shortage risk and the higher impact they have on the economy compared with other materials. Clearly, ongoing trade tensions between the US and China could well have a serious effect on global supply chains.
However, because in the majority of countries, the ratio of recycling input barely moves above zero, new products necessitate further extraction of fresh resources. Yet the risks of reliance on finite or unreliable sources are being overlooked by the financial industry. “Only a handful in the finance sector have paid enough attention, because you just take access to resources for granted,” says Shiva Dustdar, head of innovation, finance advisory division, at the European Investment Bank (EIB). “The assumption is that there is always a price for everything and that in a global trade system you will get access somehow.”
The world has become accustomed to a model that extracts natural resources to make short-lived products that, once obsolete, are dumped – most often taking still usable components with them into landfill. It is a linear economic model that does not prescribe reincarnation.
One solution to this problem could be a so-called circular model, where the life of products is extended thanks to improved design or repair and where, as much as possible, inputs come from recycled materials, not new resources. Innovations in technology, as well as disincentives (such as taxes) to dispose of products in landfill (thus causing pollution), are nudging companies in this direction.
Some major companies are convinced that this is where their future lies, and have already taken action (often under the guidance of the Ellen MacArthur Foundation think tank, set up by a former record-breaking sailor). These include Royal Philips, Danone and Intesa Sanpaolo, among others. Meanwhile, start-up entrepreneurs are lending their ingenuity to the cause, with ideas ranging from technologically enhanced materials that are easier to recycle to new renewable energy sources.
Google, for one, has committed to eliminate completely its data centres waste that goes to landfill, which stood at 9% in 2017, according to Kate Brandt, sustainability officer at the Silicon Valley tech giant. Fashion group H&M is working with Sweden’s Re:newcell and UK start-up Worn Again to employ technology to recycle cotton, viscose and polyester into new clothing, according to environmental sustainability manager Cecilia Brännsten. Andamong others the EIB has financed a project to produce aviation-grade titanium alloy from scrap collected from airplane manufacturers by Eramet.
A complex business
Intuitively, recycling is increasingly being seen as just common sense (only a few decades ago, it was common even for consumers in industrialised countries to attempt repairs before buying new replacements). Advancements in materials are making the process easier for complex products as well. But the solutions of the circular economy are not immediate and the shift towards it remains marginal. To work, the model is reliant upon co-operation within sectors and supply chains, and across countries. There is also a reliance upon the backing of deep-pocketed investors who recognise the risks of the linear system and can spot new opportunities.
Andrew Morlet, chief executive of the Ellen MacArthur Foundation, says not only are circular business models feasible but the switch would lead to palpable gains. He says research by the foundation estimates that keeping materials in flow, rather than discarding them, would unleash a potential $600bn into the European durable goods sector alone. Other studies have this figure at $4500bn, he adds.
“It is not just about reducing the harm of the linear economy. The circular economy is saying: ‘How do we look at this in terms of value creation opportunities in a different way, that has environmental, social and other benefits?’,” says Mr Morlet.
But to reach those benefits, there are a few hurdles to get over. These have to do with economic incentives, technical difficulties and the uncertainty of potential new markets and business models.
Even early and vocal proponents of the model recognise its challenges. “The circular economy is technically difficult,” says Fabrice Barthélemy, acting CEO of Tarkett Group. Tarkett, a flooring company based in France, has 34 industrial sites across the world where two-thirds of materials comes from sources either considered abundant or recycled (such as fibre recycled from fishnets). It is preparing for a future in which the company will be able to reuse flooring a decade after installation, and believes this will be the norm for the sector in 15 years. To achieve this, research and preparation needs to go into materials so that end products can be easily disassembled, refurbished and reused.
So far, half of Tarkett’s production is ready for this process. Mr Barthélemy says an environmental approach to business is key to attract and retain employees (who now specifically ask about it). But he admits that Tarkett has “the advantage that our products are not made of 1000 different components of 1000 different materials. It is much easier to recycle flooring than it is to recycle a car.”
The need for systemic change
This problem is true of smaller items as well, as lighting company Signify (formerly known as Philips Lighting) acknowledges. Currently, the cheapest way to manufacture luminaires is to seal together all the movable components in a way that “is exactly the opposite of the circular economy because you cannot repair [a product], upgrade it, recycle it, you can’t get the [individual] materials back; you cannot do anything with it [after its use],” says Anton Brummelhuis, senior director of sustainability at Signify.
However, assembling lights in a modular fashion costs more – by about 10% according to some estimates. So buyers will need to be convinced that this is an up-front price worth paying. Furthermore, one-off efforts by individual companies have achieved little in terms of easing the pressure on natural resources: rather, whole sectors need to be moving in the same direction.
“To transition to a circular economy is a systemic change,” says Mr Brummelhuis. “If you only change a few elements it will not benefit the whole transition. You have to design a product in a certain way, you have to adapt your business model, you have to organise logistics, and you have to collaborate with the right parties to make it happen.”
Signify has begun to move towards a model that sells light systems as a service, rather than a product. In this way the company retains ownership of equipment and enters into an agreement to ensure buildings are lit. In 2015, it signed up Amsterdam Schiphol Airport and designed lighting fixtures that are 75% longer lasting than conventional ones, according to the company. Fixture components can be individually replaced, reducing maintenance costs and avoiding the need to replace whole fixtures while waste and recycling costs are, in theory, also reduced, as is the volume of raw material consumption. Retaining ownership of products inevitably incentivises the application of technology to make those products as durable as possible (such as long-life light bulbs).
Long live the equipment
On the other side of the argument, purchasers who outsource an element of their business inevitably run risks, which may raise concerns, particularly in sensitive sectors such as healthcare. Royal Philips also intends to move towards providing healthcare equipment as a service rather than a product. This will entail tracking machines throughout their lives, repairing but also replacing them with newer versions for clients that need cutting-edge technologies (such as academic hospitals), and repurposing older ones for clients with more routine needs.
The company will recycle components where possible and dispose of waste in an environmentally friendly way. It considers the switch to this model as a way to prolong equipments’ lives and enables clients to pay just for using, rather than owning, equipment. Many components have a longer lifespan than the product they make up; for example, Royal Philips already recovers between 50% and 70% of returned X-ray tube parts. It has also begun to design products in a more modular way so repair is easier.
Of Royal Philips' total revenues, 11% came from circular activities, where products and materials are meant to keep in flow for longer, in 2018 and 2017, and there is commitment to reach 15% by 2020. In addition, revenues from activities that meet broader green standards were 60% of the total in 2017 and are set to grow by 10 percentage points in 2020. The company also publishes an environmental profit and loss account.
A world view
Many consider Royal Philips to be ahead of the curve when it comes to circular economies, and the company is listed as an industry leader in the Dow Jones Sustainability Index. Chief executive Frans van Houten has received a World Economic Forum award for being a pioneer among multinationals; he also helped create Pace, a platform to accelerate the circular economy, which he co-chairs. Mr van Houten says circularity fits with the group’s long-standing commitment to society at large: “It’s in the Dutch code of business that you need to take a multi-stakeholder approach; and for us it’s not just customers, employees, shareholders, it’s also the world that we live in and therefore the resources that we use.”
But he adds: “Unless you embed it in your business model, it will never scale up; it will remain as a series of experiments or hobbies. You need to bring it into every business and product lines, in your normal operations, so it becomes part of the culture of 75,000 employees that all start pulling on the same side of the rope rather than [leaving it to the] corporate social responsibility department, where you have 20 people doing something about it.”
Scale is crucial as changing cost structures raise doubts over the profitability of circular models. Can circular be profitable?
“The parameters to make money will need to change,” says Signify’s Mr Brummelhuis.
As things stands, the cost of recycling is an issue. For a group such as Tarkett, it is typically twice what the company pays to send products to landfill, depending on local tax regulation. This is usually higher in northern European countries, where the recycling culture is more established, and generally lower in the US. “I strongly advocate making incineration or use of landfill more expensive. It’s only in this way that we will be able to recycle greater amounts of products,” says Mr Barthélemy.
Furthermore, there is the cost of making products more environmentally friendly. Tarkett, for example, decided to exclude phthalate chemicals from its production six years ago, following a European ban on their use in food packaging as it believed the regulation would eventually cross into other sectors. But this came at a cost. “New products complying with our circular regime are slightly more expensive and often, in half of the cases, customers are willing to pay for the additional cost – but we’re willing to do our part as well,” says Mr Barthélemy.
Circular argument
It might take some time for lenders and investors to get used to the circular rationale as well. Only a handful have began to look at it in a more structured way. ABN Amro, ING and Rabobank have created circular economy guidelines that they hope others will use and which define terminology and the role that finance can play in supporting a transition towards the circular economy. This is particularly important for the shift to a service model.
Joost van Dun, circular economy lead at ING’s sustainable finance division, says it is important for banks to realise what the shift from ownership to excess to assets would entail. “In the old days, with linear models we used to finance assets. In the circular economy, we are financing services. The underlying contract between user and provider is becoming more important than the actual assets,” he says.
The EIB’s Ms Dustdar is looking further into the future. “This is where a lot of the headaches come. When banks give out mortgages, for example, they have a collateral: the building,” she says. But in the future, in a circular model, the building may be the object of a contract closer to a leasing than a sale, where there would presumably be no recourse on the assets. “This has huge complications, but I’m confident that we [in finance] can find a way. Right now, it is a matter for banks to become aware, look at their current portfolios and realise where their linear risks are hidden,” says Ms Dustdar.
Outside support
As always, support from multilateral organisations that are more inclined to take risks with the ultimate aim of crowding in private sector capital helps. Philippe Le Houérou, chief executive of the International Finance Corporation (IFC), the private sector arm of the World Bank, notes a growing numbers of initiatives that are circular in nature, such as new recycling facilities. In 2018, for example, the IFC approved an investment in a 13.2-megawatt waste-to-energy plant in Colombo, Sri Lanka, that will take in about 500 tonnes per day of municipal solid waste, which now goes entirely to a dump. It will also generate electricity from the waste at an estimated 80 gigawatts per year.
“In some ways, lower income countries are more circular than their industrialised counterparts – much economic activity revolves around sorting and reusing waste,” says Mr Le Houérou. “However, these countries face huge gaps that make it difficult to use hi-tech solutions.” Facilitating the development and application of those solutions is crucial, as is the support of start-ups that contribute to the new, closed-loop economic model. Sitra, the Finnish Innovation Fund, has a portfolio of 20 companies with circular projects while in the UK private equity specialist Circularity Capital has invested in Winnow, a company that works with big hotel chains to avoid food waste, and Grover, which lends electronic consumer goods from Apple watches to digital cameras. As these investments generate returns, they become a safer place for heavy-hitting funds.
“If you’re a sovereign wealth fund or a big pension fund, you may be extremely interested but would want to have a bit more ammunition to go [into circular economy businesses] than just trust [in the model] and a gut feeling,” says Robert Metzke, board member of Circularity Capital, and chief of staff for innovation and strategy and global head of sustainability at Royal Philips. “Something such as Circularity Capital can help to prove that these investments [work].”
Supporters of the circular economy believe it is the only option for the future. Natural resources are running out so it is also a sensible business decision. But not everyone perceives the risk as urgent. What is still needed is a widespread explanation of how moving to a circular economy could reduce many of the world’s sustainability issues – and just how untenable the decision would be to continue with a linear model.
