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An inclusive, circular economy, Jevons paradox and a sustainable future

Circular economic practices not just clock up savings, they also bring revenue opportunities. Ultimately, CFOs will have to prepare the business case for balancing profit and the planet for the C-Suite.

July 29, 2020 / 11:14 AM IST

The turmoil released by the COVID-19 pandemic strongly reminds us that our “linear” take-make-dispose economic system, a predominant feature of global production and consumption since the industrial revolution, is not fit for purpose.

“Business as usual” has roiled societies and economic systems globally, painfully exposing the shaky building blocks of linear economies—its established firms and their supply chains, financial markets, and existing manufacturing and services industries. This model has crippled economic resilience, exacerbated social inequality, and depleted natural resources, hiding waste costs for future generations to address.

Enter the circular economy

The current crisis has made us all the more aware of the interdependencies binding our natural, social, and economic systems. It offers us a real chance to collectively re-imagine and redesign a post-pandemic recovery that is more resilient, and socially just and that prospers in harmony with nature.

A paradigm shift is needed toward more sustainable growth and consumption. The idea of the circular economy’s idea is described by ten Rs that are slowly gaining acceptance: refuse, reduce, reuse/resell, repair, refurbish, remanufacture, re-purpose, recycle, recover, and re-mine.

The concept focuses on environment-friendly production and consumption in terms of limited use of materials and resources, minimal emissions of hazardous elements into nature, and a highly efficient waste management system.

The circular economy stimulates the creation of circular supply chains that enable trading of products in closed loops or cycles. Governments, private firms and consumers have a moral imperative to act. Yet, policymakers and businesses in developing Asia have not fully appreciated its potential.

Raising consumers’ awareness is crucial. By making informed choices, consumers can support or hamper the successful transition to a circular economy. As centers of manufacturing connected to global production networks, many countries in the region are also global drivers of consumption, risking rising resource use, emissions, and environmental pollution due to the “butterfly” effect.

Key value-chain stakeholders need to understand how the benefits of the circular investment outweigh the financial costs and the costs of natural and social capital. It is the business opportunity that puts the circular economy on the radar of C-Suite executives.

Balancing profit and the planet

As green decision-making incorporates environmental, social, and governance factors into day-to-day operations, the transition to a circular economy will impact strategy, budgeting, reporting, and payroll.

CFOs will ultimately have to prepare the business case for balancing profit and the planet for the C-Suite. As presented by circular economy practices, the gains will come as cost savings and revenue opportunities.

All over the world, companies of all sizes are embracing the circular economy by incorporating social benefits and costs while calculating their profits and losses. In India, companies like Reliance, Tata, and the Mahindra group are already practicing circular techniques with great success.

Cost savings in a circular economy will come from:

- Reduced consumption. Businesses in a circular economy will need to reduce their dependence on the continued extraction of natural resources and their reliance on inputs made from new materials. This step will enable businesses to reduce costs due to an overall decrease in resource consumption and the use of reused, recycled, or remanufactured materials instead of newly extracted ones.

- Resource efficiency. Resource efficiency entails using fewer resources, such as materials, nutrients, energy, and water, to generate the same or higher value and avoid catastrophic environmental impacts. A best practice in sustainability-focused business is to put these cost savings aside to use for more capital-intensive technology upgrades and processes, like installing green energy infrastructure such as solar panels. This is crucial to reducing overall natural resource use.

- Waste reduction. The less a product has to be changed in reuse, refurbishment, and remanufacturing, the faster it returns to use, higher are the potential savings on the shares of material, labor, energy, and capital embedded in the products and redeployment of resources besides reduction in negative externalities like greenhouse gas emissions, and toxicity. Costs can also be brought down through a reduction in the amount of physical waste businesses produce. A vital principle of the circular economy is to “design out” waste. When a company produces less waste, it can achieve savings through lower disposal fees.

Circular economic practices also bring financial gain through revenue opportunities:

- Maximising the use of and revenue from underutilized assets through sharing platforms.

- Promoting a product-as-service model and other models in which the user pays a regular fee for being able to use the product reduces cash flows in the short-term. The company retains ownership of the product and makes revenue from providing services around it. The circular model requires a more cash flow based approach to finance rather than a plan based on collateral values. With cash-flows spread over time, the payback over a long period of investment reduces the bank's risk. Banks are able to create more healthy portfolios by directing more assets and capital to sustainable businesses and, in the process,  helping them contribute to low carbon operations. As a result, sustainability is now a business opportunity for the financial industry.

Combining bank loans with other forms of finance, like leasing, factoring & supply chain finance, and structured finance. Leasing provides off-balance finance primarily based on the collateral value of assets. By taking care of the outgoing payments from a large and creditworthy buyer to its suppliers, with the added possibility of advancing those payments based on the buyer's credit rating, it can offer a solution to the problem of balance sheet extension of circular business models.

- Extending the life of manufactured products, with additional and new revenue streams coming from repairing or remanufacturing products for end-users. Cash flow optimisation and value creation in second-hand markets can increase financeability. Designing for disassembly increases the residual value of products.

- Incentivising circular supply chains in which suppliers and purchasers continually cycle nutrients and materials through the supply chain. Supply chain finance unlocks trapped liquidity in the supply chain. Arranging pre-financing by selling uncertain future cash flows to a financial institution is likely to result in better cash flow management and lower working capital costs.

- Recovery and recycling, with revenue generated through selling by-products to other companies for reuse, recycling, or remanufacturing, in addition to waste reduction and cost savings.

Workplace culture and employee retention

While economic and environmental sustainability are critical aspects of any circular economy, one should not overlook the need for creating a workplace culture that values the circular economy and sustainability of human resources.

Employee retention is a critical challenge for small businesses. High employee turnover leads to higher costs over time, as turnover necessitates constant hiring and retraining. Businesses should focus on training and retaining employees to maximise value and increase local human knowledge and capacity around circular economy practices.

Among the critical factors for employee retention are the payment of fair wages, benefits such as healthcare, retirement plans, paid time off, and training and professional development opportunities.

Emerging markets have an edge

In the emerging market economies, many small and medium-sized enterprises and large informal sectors that form the backbone of economies already practice circular activities in some form or the other.

Regenerating local ecosystems and addressing the needs and aspirations of local stakeholders are vital to steering decisions towards a more circular model.

Embedding circular business principles in industrial growth and infrastructural development strategies can enable firms to engage in higher-value circular economy supply chains. And this can translate into new opportunities for accelerating growth, enhancing competitiveness, and mitigating risk without undermining sustainable development.

Unintended consequences

However, in the rush to realise the promise of a circular economy, businesses need to think through unintended consequences. Circularity can fundamentally change the employment landscape, similar to what disruption in technology has brought. Assessing the impact is a first step to addressing potential repercussions for those who lose from the transition.

Although zero waste and 100% circularity have become popular goals, achieving them can be quite resource-intensive and could sometimes lead to actions that compromise overall sustainability. Recycling will only be worthwhile from a resource perspective if the resources required for recovery and recycling are less than those needed for extraction and disposal.

Businesses should also be mindful of Jevons paradox: increasing efficiency does not necessarily lead to less consumption—it can lead to more.  While the consumer feels good about resource savings in one area contributing to the circular economy, it helps them to rationalize using more resources in another.

Way to go

Businesses should not wait for government directives to change. They need to lead on sustainability issues or risk a declining brand reputation and the accompanying loss of financial investment. By adopting circular principles, businesses can generate additional value from their materials and assets, create more efficient operating models, reduce operating costs, develop long-term service-based relationships with end consumers, grow employee loyalty, and create less waste in a world with finite resources.

A transition to the circular economy would be, for many, a departure from long-held norms. Getting there will be a slow process. They must implement circularity with deliberation and caution to optimize their impact and help society reap the benefits.

The author is a financial sector and regulatory expert with a multilateral bank. The views expressed are personal.

Arup Chatterjee
first published: Jul 28, 2020 11:18 am