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    Sustainability

    Leading decarbonization: business has a crucial role to play in tackling climate change 

    by Knut Haanaes Published 31 May 2023 in Sustainability • 8 min read

    Companies must step up action to cut emissions if a climate catastrophe is to be averted, and progress will accelerate as they realize that significant business advantages can be gained from decarbonization strategies, says Knut Haanaes. 

     Business has a vital part to play in efforts to decarbonize our economies, limit global warming to 1.5°C above pre-industrial levels, and avoid the most catastrophic consequences of climate change. This is partly because business is responsible for 70% of greenhouse gas emissions, so it will be impossible to hit net-zero targets if businesses do not decarbonize. But it is also because the private sector is particularly well equipped to make a major contribution – when there is a clear need for action, business can move fast, scale solutions, and drive innovation. 

    There has been a huge increase in understanding of the role business has to play in recent years, partly because of the UN Sustainable Development Goals and the 2015 Paris Agreement, and regulatory change means that action on decarbonization is no longer voluntary but now mandatory for many businesses. 

    From 2024, the European Union’s Corporate Sustainability Reporting Directive will require large European companies and non-European firms with significant operations in the EU to set out a net-zero transition plan. Meanwhile, in the US, the Securities and Exchange Commission has proposed regulation that will require public companies to disclose greenhouse gas emissions from their value chains.  

    At the same time, investors and other stakeholders are pressing businesses to tackle a whole range of environmental, social, and governance (ESG) issues, and climate action is often at the forefront of their demands. 

    This has led to a push for businesses to improve their reporting of climate-related financial information. The Task Force on Climate-related Financial Disclosures (TCFD) was set up in 2017 to develop recommendations on the information that companies should disclose to help investors and lenders assess risks related to climate change, and the proportion of companies disclosing TCFD-aligned information has increased steadily since then.  

    Meanwhile, more and more companies are announcing decarbonization targets. Almost 10,000 companies have committed to reach net zero by 2050 as part of the United Nation’s Race to Zero campaign, and 40% of Fortune 500 companies have set net-zero targets, although not all of these include Scope 3 emissions – those that do not come from companies’ own operations but from their larger value chains. Meanwhile in Europe, at least 13,000 large and medium-sized companies have disclosed their climate footprints as part of their sustainability transition plans. 

    A race against time 

    There is still a gap between ambitions and actions, and we face a race against time – the climate is not going to wait for us. But there are some early reasons to be optimistic.  

    Companies have accelerated their efforts significantly in the past five years and the pace of the energy transition will almost certainly gather further pace in the five years ahead, not least because the scale of the crisis is becoming increasingly evident. We have somewhere around two million startups that are looking for climate-related solutions.  

    But decarbonization will be a long process, and businesses have to take it one step at a time, using a sort of “stairway to heaven” approach. 

    The starting point is building awareness and understanding. This is about playing not to lose – minimizing transition and reputational risks and ensuring compliance with regulation. 

    The second stage is when companies move into building a business case for action, exploring what is financially interesting, what can they scale up, and what works for them in terms of costs and revenue. This is when climate action becomes part of the business model. 

    The final step is when decarbonization becomes part of the strategy of the business and delivers a competitive advantage. At this point it is about playing to win. 

    There are a number of trailblazers who have reached this third stage. Finnish company Neste switched from being a traditional oil refining business to become the world’s largest producer of renewable diesel from organic waste. Maersk is leading the way in efforts to decarbonize the shipping industry. And steelmaker ArcelorMittal has set ambitious emissions reduction targets with the aim of driving progress on decarbonization across the steel industry. 

    From 2024, the European Union's Corporate Sustainability Reporting Directive will require large European companies and non-European firms with significant operations in the EU to set out a net-zero transition plan.
    “Another challenge is the need to overcome resistance from those who think that companies should focus on maximizing profits rather than issues like climate change.”

    Clearly there are sectoral differences. There has been rapid progress by wind and solar power and electric vehicles, while construction and heavy industry have much further to go. The shift in the car sector towards electric vehicles, particularly in Europe, has been massive in only a short space of time, and provides an example to other sectors of what can be achieved. 

    Action will trickle down to SMEs 

    Large organizations are best placed to lead the way because of the resources at their disposal, but there is likely to be a trickledown effect as small and medium-sized enterprises copy the practices of their larger peers. 

    Action by many SMEs will be driven through the supply chain. While many of the upcoming regulations technically only apply to large companies, these firms will require data from their value chain firms to comply with the new rules, and SMEs will have to provide this information if they want to continue supplying bigger companies.  

    This is perhaps the biggest challenge of all, because the bulk of a company’s greenhouse gas emissions are Scope 3. Many large companies will only be able to reach net zero if their supply chains and distribution networks decarbonize too, and this will be the hard for their SME suppliers. 

    Reluctance to move first 

    Another barrier to action is a reluctance to move first because of the uncertainty of going it alone when you have nobody to learn from. So, while big companies in most industries have been ready to take decisive action and to move relatively early, they have often been wary about moving first. 

    Uneven regulation on how companies pay for the societal impact of carbon emissions is also a concern for businesses. Carbon taxes are generally imposed where goods are produced, and wide variations in these taxes have led some companies to play the system and relocate production facilities away from places like Europe to countries in Asia and the Middle East where they pay a much lower price for such “externalities”. 

    The EU is hoping to address this problem through its Carbon Border Adjustment Mechanism (CBAM) regime, which will introduce a carbon tax on goods entering the EU from 2024. By ensuring that a fair price is paid for the carbon emissions generated in the production of certain goods imported into the EU, the regime is intended to encourage cleaner industrial production in non-EU countries and support the decarbonization of EU industry.  

    Overcoming backlashes 

    Another challenge is the need to overcome resistance from those who think that companies should focus on maximizing profits rather than issues like climate change. 

    Such backlashes can come from investors – as seen when fund manager Terry Smith criticized Unilever for putting purpose before profit, blaming the consumer goods group for the underperformance of his Fundsmith Equity Fund – or from politicians, as seen with the anti-ESG movement in some US Republican states. 

    Collaboration is also important because it can remove the risks associated with going it alone, as well as giving businesses a role in shaping the agenda and defining competitive standards.

    Businesses themselves may also start to have doubts as they come to terms with the scale, speed, and complexity of the task of decarbonization. Rolls-Royce CEO Warren East last year described the friction caused by reporting on emissions as “a pain” and said he regretted signing up to the UN Race to Zero pledge because of the burden of bureaucracy involved, although the company remains committed to its net-zero targets. 

    Progress by businesses will therefore never be a one-way street. However, the key to overcoming all these challenges is a realization that significant opportunities and advantages can be gained from decarbonization. 

    By moving relatively early and innovating in a way that makes sense from a customer perspective, some companies are gaining a real edge and building advantages such as access to new clients and higher prices, and their example will embolden other businesses to follow suit. Concrete evidence of these advantages is provided by a recent McKinsey study showing that companies that do best on tackling ESG issues achieve shareholder returns 2.4 percentage points higher than the worst performers. 

    Collaboration reduces risks 

    Collaboration is also important because it can remove the risks associated with going it alone, as well as giving businesses a role in shaping the agenda and defining competitive standards. There are already numerous industry initiatives in this area – we have identified 150 business ESG alliances, and 75 of these are climate action partnerships. 

    Collaboration between business schools can help too. Businesses are hampered by huge capability gaps as they try to play their part in tackling climate change. It is partly the job of business schools to help them remedy this problem, and the eight institutions that came together to form the Business Schools for Climate Leadership (BS4CL) alliance in 2021 are therefore collaborating on research on best practices to support the business community’s response to climate change. 

    Business Schools for Climate Leadership (The University of Cambridge Judge Business School, HEC Paris, IE Business School, IESE Business School, IMD, INSEAD, London Business School, and Saïd Business School at the University of Oxford) are holding a conference for researchers, alumni, and invited guests at IESE Business School in Barcelona on 1-2 June 2023. Leading decarbonization is the overall theme.  

    Authors

    Knut Haanaes

    Knut Haanaes

    Lundin Chair Professor of Sustainability at IMD

    Knut Haanaes is a former Dean of the Global Leadership Institute at the World Economic Forum. He was previously a Senior Partner at the Boston Consulting Group and founded their first sustainability practice. At IMD he teaches in many of the key programs, including the MBA, and is Co-Director of the Leading Sustainable Business Transformation program (LSBT) and the Driving Sustainability from the Boardroom (DSB) program. His research interests are related to strategy, digital transformation, and sustainability.

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