Business and the Environment2

Business and the Environment2

http://online.wsj.com/article/SB122304950601802565.html Carbon footprint

Lecture 2: Drivers of manager decision making within firms—stake holders, market structure/conditions. Understand the pressures and conditions that affect

managerial decisions regarding environmental efforts. Firm objective to maximize profits: Problem areas

that affect firm behavior and responses to the environment.

Two key problems:

Business and the Environment

Agency problems. Deviation of management from share owner interests. Social Responsibility of business debate.

Problem of uninternalized benefits and costs in profit maximization.

The source of the environmental and natural resource problem.

We will return to this issue in more depth because it is central to the environmental problem.

How to link environmental action to firm profitability?


Other factors affecting firm managers as they consider environmental issues. Internal decision making

Trade offs on products within profit constraints.Trade offs on short/long term, R&DRevenue enhancement via market research and

new offeringsCost containment via lifecycle analysis and

supply chain management


Drivers of environmental positions. Hoffman slide (Hoffman, 2000, p. 17). Regulatory

Tax Regulation Market instruments Uncertainty Efforts to mold policy and gain a strategic advantage We will return to this issue with regard to GHG regulation

and other environmental policies.


Drivers: Financial resource—investors, insurance companies, banks

Risk to insurance companies for liability for environmental damages. Strict liability; negligence rules. Depends on how the law is structured.

Nuisance actions.—defend the right to use one’s property free from disturbances or influence from activities created by others (externalities).


Negligence actions.—defend against injury due to loss of due care. Standards? Was due care applied? Changes in polluttee behavior. Precaution.

Strict liability—Polluter pays. Liable for damages to third parties, even if they could not be avoided with due care. Used when there is a likelihood of great harm. Incentive effects. Polluters consider costs. May over compensate. Pollutees do not consider costs.


Risk to investors if unready for policy or policy is harmful.

Risk to investors. Due diligence for environmental damages that could place the loan at risk.

Environmental performance proxies for overall performance.

TXU case.


Drivers: ConsumersWillingness to pay of some market segmentsChanges in taste.High incomes.High education levelsThis is a fundamental challenge—market

differentiation—market segmentation, determining willingness to pay, barriers to entry.


Which consumer groups will be concerned about environmental quality?—Segment markets by gender, age, education, ethnicity, location, income, urban/rural, north/south, political affiliation

Core competencies of a firm—how to match with environmental differentiation?

Will return to this issue.Major strategy issue for firms.


Drivers: CompetitorsLose competitive position vis a vis competitors

who more rapidly and credibly respond to market demand for environmental action.

Alternatively gain competitive advantage vis a vis competitors who do not meet new demands. First mover.

Toyota-General Motors example.


Drivers: Trade Associations and other forms of collective action.

Use norms, rules for members to follow.Group certification. Reputation. Industry wide.

Larger firms are most active-why?


May preempt government regulation. Might be preferable to industry—more industry

specific, more flexible, more focused, less uncertain, less risk, more discretion.

May be less regulation than society desires, but if lower cost and more effective may be superior to government regulation.

Customers might benefit if more flexible and lower cost.


Can force higher costs on competitors—usually incumbents gain advantages over smaller new entrants. There are differences in compliance costs. Upfront, fixed costs that can be spread across larger output in larger firms.

ExamplesChemical Manufacturers Association—

Responsible Care.


Motivation—Crises. Bhopal, Love Canal, PCBs in the Hudson

River. A series of federal actions—1976 Toxic

Substance Control Act and Resource Conservation and Recovery Act. Empowered EPA to regulate. 1980 Superfund Law with joint and several liability for industrial wastes. Ex post liability for entire cleanup costs.

Industry fears more.


1984 RC launched. Largest firms. Provided motivation for public good provision without

government regulation. Focus on management practices not numerical targets

(why?). Action plans to implement management codes—

emergency response, pollution prevention, safety, health, product stewardship, distribution.

http://www.americanchemistry.com/s_responsiblecare/doc.asp?CID=1298&DID=5086

Various studies of its effectiveness.


Other examples: Forest Stewardship Council (FSC) founded by environmental groups and Sustainable Forestry Initiative (SFI), founded by industry groups.

SFI 1994 by American Forest and Paper Assn. Largest companies advocates. Some small. Crises—concerns about land management

practices.


Collective action to set up principles and action plans. Some defection among smaller firms over costs.

Less world wide coverage. Differences in land management and forestry practices around the world. Harder to have uniform regulations.

Issues of how strict are the rules and coverage.


Drivers: Suppliers Risk of lost business when suppliers are linked

to one or two producers.Alternatively, supply chain management—firm

seeks to avoid problems with suppliers in supply chain. Damage product or service reputation in the market. Firms can require that their suppliers adhere to certain environmental standards


Risk in this, with competition if it raises cost, so that firms in perfectly competitive markets may not be responsive.

Green supply chain—works if there are cost advantages. Firm can appropriate some of the social benefits. Implies that the firm is in an oligopoly or less competitive industry.


Drivers: NGOsCan be influential interest groups—both as a

market segment and as a political force. Hoffman, 2000, p. 107, 108.Source of legal challenges. Uncertainty. Time

costs.Cooperate. Place on Board of Directors, etc.Cooperate in design of policy. Environmental

Defense.


Alliances with NGOsCorporate sponsorship

Firm contributes to the environmental group financially or in kind through becoming involved in specific environmental causes or fund raising

NGO provides product endorsementTask force to develop economically feasible

solutions for the greening of business practices


Perceived crisis and shortcomings of adversarial approaches to problem solving

Lawsuits might take years and results in greater costs

Problems that are so complex that they require multiple actors to solve them, disagreement over solution,

Environmental groups may have expertise and public support but lack power of implementing solution


Firm perspectiveAccess to complementary assetsCredibilityAdditional communication channelsScientific knowledge

NGO perspectiveDirect impact on firm’s behavior, potential ripple

effect within industry


Firm perspectiveNegative backlash if the project failsConfidentiality issuesHow to retain the Intellectual property rights?

NGO perspectiveOpen to criticism that is becomes and ally of

industry (“sleeping with the enemy”)Open to criticism that it looses neutrality


Ability of the parties to provide complementary assets.

Keep alliance based on subjects that are far from firm’s IP (packaging for McDonald’s)

Clear definition of objectivesMaintain an arm’s length relationship: formal

contract


Other driversEmployees—motivation and company

culture.Press and other media—mold demand.Religious—mold taste regarding the

environment.


Academy—research on impact. Information. Global warming concerns, water, waste, energyOzone layer. Mario J. Molina & F. Sherwood

Rowland, Stratospheric Sink for Chlorofluoromethanes: Chlorine Atomic Catalyzed Destruction of Ozone, 249 Nature 810, 810 (1974). Helped to galvanize firm support for regulation and Montreal Protocol.


Firms face market pressures as they consider responding to environmental problems. Overall market considerations. Market slide

Demand issues.Price elasticity of demand. Want it to be less than one.Which markets will satisfy this condition?


Market segments have different willingness to pay—taste and income.

Price discrimination (where different prices are charged to different consumer groups) depends upon competitive conditions.

We will examine these in more detail as part of market structure.


Supply issues.Cost of responding. Innovation options. Input costs and past contracts may limit options.Government policies—subsidies, tax, regulation.Productivity, cost and firm size. Returns to scale,

constant cost, increasing cost. Small firms may have fewer options? Or be more flexible.


Market structure as it affects firm response.Competitive—

many firms, many very close substitutes, ease of entry, consumer power, high price elasticity, pressure on price and cost.

Commodities—computer hardware, ag productsTrade. Globalization. In such markets firms may be reluctant to adopt

environmental products or processes. Why?


Monopolistic competition. Many firms, somewhat differentiated products. Ease of entry.More market segmentation possible. Mass retail.Specialized retail, niche markets. Possibly limited individual firm response to

environmental pressures. Why?


Oligopoly. Few firms. Differentiated products. Lower price elasticity of demand. More power over price and output. Price

discrimination possible. Market segmentation.Firms may be more responsive to environmental

demands. Why?


Monopoly. One firm. Differentiated products. Price discrimination. Low price elasticity of demand. Market segmentation.Firm may or may not be responsive to

environmental demands. Why?


Measures of market structure.Concentration. Herfindahl index—sum of the

squared market shares, HHI = 0 to 10,000 (more concentrated). Affects competitive environment.

More differentiated, generally competitive markets are more likely to have firms that are responsive to environmental concerns.

Heterogeneity. Non price competition. Differentiation.


We have covered:Drivers of environmental action by firm

managers.Market structure impact.

Documents

Business and the Environment2