By Torsten Lichtenau and Yukiko Tsukamoto
COMPANIES face geopolitical upheavals, supply chain disruption, inflation, and the threat of recession. Despite this perfect storm, their commitment to decarbonization hasn’t fundamentally wavered. The number of companies embracing science-based targets is continuing to grow at a rapid pace.
However, as they make pledges to reduce their carbon footprint, executives need to acknowledge the ways the environment for decarbonization and climate has quickly changed.
Setting ambitions has proven to be the easy part, but meeting those goals is difficult, with 33% of companies missing the absolute scope 1 and 2 targets that expired in 2021. Companies now find themselves needing to look beyond setting ambitions to tackling the real challenges of decarbonizing and finding ways to monetize it with customers.
Global policy has become more prominent and more complex. Some governments are acting more boldly to make the carbon transition a source of competitive advantage rather than risk losing the green business to another country. However, many governments also have had to make difficult near-term energy policy decisions, in some cases choosing between a looming climate disaster, keeping their people fed, and keeping energy costs from breaking the backs of the population.
As the effects of climate change quickly become more evident, so does the need to not only mitigate by reducing emissions, but also adapt by adjusting to a changing climate. Leading companies have stepped up their physical risks analytics and adapted their strategy, operations, and supply chain.
And as developing economies and underserved communities struggle with rising energy and food prices, companies face the reality that the carbon transition needs to be addressed in a way that is fair to all — a just transition. This means ensuring that energy is as low carbon and affordable as possible.
These changes come at a time when companies are devising and implementing downturn strategies and require difficult new choices. They need to address cost in an inflationary environment, reset supply chains for resilience, and scrutinize strategic investment in the face of uncertainty.
Each of these can be tackled with carbon and climate in mind. In cost reduction, for example, the best companies will deal with cost and carbon simultaneously to emerge from the downturn with a more competitive cost and carbon base. There can be an overlap between cutting cost and cutting carbon: less material, less energy, and less waste all equal less cost — and less carbon.
As companies reimagine their supply chains for greater resilience, winners will consider climate physical risks. And while some companies might view decarbonization efforts as discretionary budget items in a downturn, the best will maintain those investments, even optimizing them in the face of increased cost scrutiny.
It will take a combination of vision and pragmatism for companies to reach their decarbonization goals and create value in the process. Here are the five areas that companies must get right to succeed.
1.Strategic adaptation. Companies don’t need more climate scenarios but, rather, clarity on the relevant ones. Most important, they need to identify the signposts that will indicate what’s coming next. This is especially vital given the recently accelerated pace of policy changes and advances in technology. Historically, scenarios and signposts were focused on climate transition risks, such as changes in economics and market demand. Now, that is extending to climate physical scenarios — changes to weather patterns and business resilience. Especially in the current downturn, and with climate change intensifying, winners will adopt a living strategy, taking steps to deliver results today, such as improving energy efficiency and optimizing supply chains, while investing in next-generation solutions like hydrogen.
2.Investor and lender resonance. As companies face sharpened expectations on the part of shareholders and lenders, it will be critical for them to double down on proof points to clearly explain how a more profitable business in the medium-to-long term is also a more sustainable one. That means showing how they’ve started to reduce carbon in a cost-effective manner while also making the business resilient to transition and physical risks. They’ll also be required to show that they have the options to get to net zero and how they will be flexible based on evolving regulation and technology.
3.“Customer-back” decarbonization. Companies that are most successful in their climate transitions start decarbonization with the customer in mind and work backward across offerings, operations, and the supply chain. More than ever, it will be critical to clearly understand the sustainability priorities of customers who are navigating a downturn and are very focused on costs. Not all customers are moving at the same pace, so targeting the right ones based on their carbon ambition, progress, and internal carbon price used is the best way to achieve the right green premium.
4.Partnerships for results. Carbon transition is a problem far too big to be solved by any company on its own, and companies need to engage the wider ecosystem of customers, suppliers, and peers up and down the value chain. For example, when building the hydrogen economy, many players will need to come together, everyone from renewable energy generators to electrolyzers producers to offtakers. Policymakers should be part of these partnerships, as corporations can offer solutions that regulators may not have considered.
5.Empowered green organization from top to bottom. Top management may be fully convinced of the need for aggressive decarbonization, and new recruits often have chosen an employer based on its green credentials. Yet the task of delivering on decarbonization has solidly moved into middle management, and some companies underinvest in convincing and empowering middle management to get the job done. It’s now critical to integrate decarbonization delivery into a company’s current performance management system by aligning incentives to decarbonization, by putting a price on carbon in the decisions that matter — and by providing clarity and guidance to middle management on how to resolve trade-offs.
As CEOs plot their strategy across these five areas for navigating their carbon and energy transition in a downturn, it will be easy to get diverted by unrealistic future predictions or by the naive illusion that moving to a greener business is an easy task. Climate change becomes more evident. Geopolitical risks surface. Macroeconomic challenges emerge. But companies that take an approach of visionary pragmatism will be on solid footing to navigate the changes — and outpace their less-nimble and less-prepared competitors.
Torsten Lichtenau is a Bain & Company partner based in London and Yukiko Tsukamoto is a partner based in Manila.