Climate Change Is Transforming the Economy. How Will Your Company Adapt?

So: Are businesses prepared? From the perspective of a casual observer, they may appear to be. After all, they’ve been addressing the problem of climate change for years—through a series of pledges, initiatives, consortia, partnerships, and commitments to report sustainability numbers.

Yet, according to Klaus Weber, a professor of management and organizations at the Kellogg School, this standard response—designed as it is to placate investors, consumers, and regulators rather than take a hard look at business models and strategy—might not be enough to ensure long-term survival.

“Companies have to move beyond seeing climate change as an external relations issue—addressed through CSR initiatives and transparency—and instead begin viewing it as part of the business environment, as inevitable as changing consumer demographics or technological change,” Weber says. “Everyone will have to adjust. The question is whether they innovate at the core of their business or limit themselves to quick fixes and actions at the margins.”

In other words, it’s one thing to set emissions targets or promise to work with green suppliers; it’s another thing to integrate the reality of climate change into business processes and decisions, from product development to hiring to strategy.

“Until organizations learn to internalize the threat,” Weber says, “they’re in danger of falling behind.”

Just Scratching the Surface

For the most part, companies have dealt with climate change in an ad hoc, piecemeal fashion, with an emphasis on reputation management rather than innovation.

Take the coffee and chocolate industries, where “sustainability” often involves a set of standards or certifications meant as a way to build consumer trust, not a challenge to rethink products or design new processes in light of a changing planet. To be sure, it is important to invest in local communities where the coffee beans or palm oil are sourced and to promote sustainable forestry—as many companies now do—but what is ultimately being sustained is an old business model of extracting finite raw materials, the production of which will be affected by climate change.

“Most of these moves are designed to appease activists and NGOs, which is different from asking more fundamental questions,” Weber says. “If you use palm oil for making chocolate, for example, one question might be: ‘How do we deal with the public concern that we’re the cause of deforestation?’ Another, much more basic question is: ‘Is using palm oil a long-term solution with the reality of climate change?’ Reputational management is a band-aid that can buy you time to deal with the long-term issues on your own terms, without getting pushed around. But it’s not the solution to the problem.”

Many times, companies have found it easier to impose high standards on others (as Walmart did by demanding its suppliers use less packaging) than to directly address their own impact on energy consumption or waste production, for example, through distribution requirements and marketing decisions.

“It’s effectively asking that a third party bear the burden of adaptation,” Weber says.

Here’s another example: most companies today focus on sharing data on carbon emissions, water use, recyclability, and other measures with investors. After all, because investors care about profitability, they increasingly want to know how companies plan to deal with the risks related to climate change.

But while a comprehensive sustainability report might attract interest and increase short-term access to capital, “it doesn’t automatically help a company understand the challenges that are most material to its business and how to address them,” Weber says. This is especially true if the report fails to focus on data on the areas of greatest environmental impact, and if the reported numbers aren’t integrated into internal decisions. A company that relies on mega-farms or uses vast amounts of water isn’t doing much by reporting a drop in kilowatt usage at its corporate headquarters.

Finally, when it comes to dealing with regulation, companies have tended to be more defensive than proactive, in part because of political uncertainty and the fact that regulations vary significantly from country to country (and even state to state). This is slowly changing.

“It’s complicated,” Weber says, “but there’s no reason why companies can’t promote regulation, rather than simply waiting to see what happens. If you accept that change is inevitable, it’s in your interest to engage with policymakers and be a part of shaping the new industry landscape.”

After all, he continues, if you fail to engage, there is a risk that you will be forced to make changes you are unprepared for, or that your competitors will be the ones to shape regulations without you.

A New Business as Usual

So what does internal change in response to a warming climate look like?

For Weber, it’s about rethinking the business model itself—the difference between, say, buying renewable energy credits in order to continue business as usual and developing a competitive strategy around a changing energy landscape.

Of course, no company can transform its business model overnight. But there are steps businesses can take to prepare themselves.

For example, many will have to figure out how to make climate change part of their product development process. Some companies are already doing this. For instance, AB InBev recently created new barley varieties that can use up to 40 percent less water. Unilever is working on ways to replace petrochemicals with natural, biodegradable ingredients. Danone, the owners of Evian, are trying to develop a bottle made entirely of plant-based plastic. (Packaging represents 51 percent of Evian’s overall carbon footprint.)

“These are substantial efforts because they’re central to the business,” Weber says. “It’s where they can have the biggest impact.”

Another step would be to integrate climate-related information in management accounting standards. At Microsoft, for example, business units pay an internal tax based on their energy usage—a system known as “carbon pricing,” since every kilowatt-hour used and gallon of fuel burned gets converted into metric tons of carbon and accounted for. (The money earned from the tax goes into a common fund that invests in environmental sustainability projects.) This carbon fee gives business units an incentive to reduce consumption and has pushed Microsoft as a whole to use more renewable sources of power.

Other companies, like European supermarkets Carrefour and Sainsbury’s, use “shadow carbon pricing.” Anticipating stricter government regulation of greenhouse gas emissions in the years to come, they preempt the shift by assigning a hypothetical or “shadow” price for carbon for the sake of planning long-term investments.

What’s key about these efforts, says Weber, is that they are about internalizing the issue of climate change by making it part of “regular” financial indicators. “The point is to make it part of your routine decision-making systems—to make it more integral to how you do business on a daily basis.”

For many companies, this also means incorporating climate change into their training and hiring decisions—and shifting the responsibility for climate-change responses away from specialist sustainability groups.

Take marketing, for example. In addition to consumer analytics and branding, marketers might need to involve themselves in the product development and sourcing process. This may require new teams dedicated to researching, for example, consumer behavior around packaging and disposal—and thus hiring marketing professionals who have an understanding of a product’s cradle-to-grave environmental impact.

The Auto Industry as a Cautionary Tale

Weber thinks companies can draw valuable lessons from the experience of the auto industry, which never fully internalized the reality of climate change as imminent and has failed to innovate decisively enough.

The relevance of climate change for the transportation industry has been known for decades. But for a long time, the industry saw climate change as a regulatory problem they could manage externally. So they viewed regulations like fuel-efficiency standards as an imposition to be bargained over, and new technologies such as electrification and integrated-mobility solutions as distant futures left to a few designers who developed concept studies. This came at the neglect of thinking through the business risks and opportunities in a thorough way, and at the neglect of integrating new types of expertise in their engineering and business development groups.

A shift in consumer behavior and investor bets on new technologies pushed companies towards a new standard much faster than they anticipated: cars with electric sensors and computer systems governing core functions like braking and air-conditioning. As a result, they were forced to change much about how their products were developed, and reconsider their long-term business models. And they had to hire a new kind of employee—software experts.

Now the industry is scrambling to prepare for an even larger shift to a world of electric, and possibly autonomous, transportation and fewer car owners. “Arguably, they waited too long to make these internal changes, which is why their business models are experiencing so much disruption,” Weber says.

And in some ways part of the industry is still clinging to quick fixes—most notably by encouraging the Trump administration to relax fuel-economy standards. The dilemma for some carmakers is clear: they know the world is moving away from internal combustion engines, but their SUVs and crossover models—the least fuel efficient—remain their best-selling cars.

“The easy way out is to say, ‘We want to sell cars now, so we need regulation that best matches our current product portfolio. Then we can figure out how to solve the long-term problem later.’ But when you do that, you reduce the pressure to innovate, which is crucial. Yes, a quick fix keeps you financially viable, but if you stop there, it prevents you from going in the direction you know you need to go.”