Chapter 1 Introduction to Sustainability and Closed-Loop Supply Chains – Sustainable Operations and Closed Loop Supply Chains, Second Edition

CHAPTER 1

Introduction to Sustainability and Closed-Loop Supply Chains

1.1 Motivation and Trends

According to Esty and Winston,1 the top 10 environmental issues facing humanity include: climate change, energy, water, biodiversity and land use, chemicals toxins and heavy metals, air pollution, waste management, ozone layer depletion, sustainability of oceans and fisheries, and deforestation. A quick scan of the popular press reveals that the top two issues (climate change and energy) receive considerable attention, whereas landfill and depletion of natural resources only indirectly make Esty and Winston’s top 10 list, under “waste management.” Landfilling and depletion of natural resources, however, are critical to the sustainability of manufacturing firms. In a traditional supply chain, materials are extracted from the earth, processed, and used in the production of components. These components are assembled into a final product, which is distributed through different channels to reach consumers. After use, most of these products end up in a landfill. One person in the United States generates about 4.4 lbs of solid waste per day; 20 percent of that waste can be categorized as durable goods. Many materials in durable goods are non-renewable (such as zinc), even though recycling rates average 18 percent by weight for durable goods in the United States. At current rates of depletion, some predict that we may run out of zinc by 2037.2 Simply put, without a steady supply of raw materials, manufacturing is not sustainable.

Electronic products, in particular, illustrate the issues with the sustainability of current business practices. According to the EPA, the United States generated 3.14 million tons of electronic waste (e-waste) in 2013. About 40 percent of e-waste is recycled, with the remainder trashed in landfills or incinerators.3 Of the e-waste eventually recycled, some are shipped to developing countries for processing, although estimates vary between a mere 0.13 percent (International Trade Commission) and 10–40 percent (United Nations). This overseas shipment of e-waste is a gray legal area, as international treaties prohibit shipment of toxic waste across countries (and electronic waste is considered toxic, due to significant amounts of lead, mercury, cadmium, and other chemicals). Consumers typically replace their cell phones in the United States every two years (a standard contract with wireless carriers). In 2012, 140 million cell phones were thrown away, ending up in landfills in the United States, although there is a significant growth in the second-hand smartphone market.4 These statistics have not been ignored by policy makers, who have been and are devising take-back legislation for electronic waste (e-waste), which holds manufacturers responsible for collection and environmentally responsible recycling of electronic products post-consumer use; this is a topic of Chapter 2 in this book.

Global warming has prompted some countries to devise legislations targeted at reducing the level of greenhouse gas emissions. The European Union Emission Trading Scheme (EU ETS) was the first large greenhouse gas emissions trade scheme in the world, established in 2005, and it regulates more than 10,000 installations with a net heat excess of 20MW in the energy and some industrial sectors that are heavy emitters of CO2 (such as cement, steel, paper and pulp, aluminum, and chemicals) collectively responsible for close to 50 percent of the EU’s CO2 emissions. The government (each member state in the EU, such as Germany) issues each heavy emitter a number of emission allowances (allowing it to emit a certain amount of CO2 per year); these facilities can then buy and sell these allowances in a market place. This provides incentives for these facilities to reduce their CO2 emissions, due to its market-based economic value. The amount of allowances issued by the government determines the economic value of CO2, and consequently the resulting levels of CO2 actually emitted. As a historical note, this type of legislation, known as cap-and-trade, has also been implemented in the United States to decrease the amount of SO2 emissions, in order to mitigate the problem of acid rain. Thus, firms under direct regulation of CO2 in the EU must track their emissions. However, it is likely that cap-and-trade (or another type of legislation such as a carbon tax) will spread around the world, including in the United States. Many firms also view lower carbon emissions as a sign of higher efficiency in their processes, since energy consumption is directly correlated with carbon emissions. Efficiency means lower costs, and as a result, proactive firms take steps toward tracking and reducing their CO2 emissions. Carbon footprinting is addressed in Chapter 3.

Another trend in environmental sustainability concerns labels associated with green products or facilities. For example, Walmart’s concern for the sustainability of fisheries (and hence its future supply of fish) led it to target 100 percent of its farmed and wild seafood to be Marine Stewardship Council (MSC) certified; in 2017, this figure was in excess of 90 percent in the United States5 Green buildings provide savings in energy consumption (through smart appliances, use of natural light and smart lighting), and water consumption (through rainwater capture and water-efficient fixtures), although a significant portion of green building savings, which are used to justify such investments, come in the form of enhanced worker productivity.6 The Certification of green buildings via the Leadership in Energy and Environmental Design (LEED) rating system, promoted by the U.S. Green Building Council is being adopted rapidly: The number of LEED certified buildings grew from 11 in late 2000 to 1000 in late 2005 to 37,300 in 2017.7 As an example, the Empire State Building was retrofitted, reaching energy consumption savings of 38 percent, and awarded Gold LEED Certification in September of 2011. More details on LEED Certification are discussed in Chapter 4, and sourcing green products is addressed in Chapter 8.

1.2 What Is Sustainability?

In this book, we take an operations and business perspective on sustainability. A sustainable operation is one that can be carried on ad infinitum. As a result, a sustainable operation takes into account the 3Ps of sustainability when carrying out its decisions:

Profit. A sustainable operation has to be profitable. Businesses are not philanthropic institutions (although they can carry out philanthropic activities).

People. The operation has to be satisfactory to its stakeholders: shareholders (naturally), employees (since they carry out the operations), customers (as they drive revenues), governments, and communities where it operates (as this is the source of future and current customers and employees).

Planet. Material resources necessary to carry out operations can be sourced ad infinitum, and outputs of the operation preserve the resource base (i.e., no pollution).

Another way to put this is—a sustainable operation considers the triple bottom line when carrying out its decisions: economic (profit), social (people), and environmental (planet). When Walmart made its decision to source 100 percent of its wild seafood MSC certified, it considered the triple bottom line: economic (since fish caught in a sustainable manner guarantees Walmart’s future supply and consequently future revenues), social (since fish caught in a sustainable manner guarantees the livelihood of fish farmers for future years), and environmental (since fish caught in a sustainable manner avoids the depletion of fisheries). In this book, we will focus primarily on the economic and environmental aspects of sustainability, although Chapter 9 is dedicated exclusively to the social aspect of sustainability. There are several reasons for this focus:

There is significant science behind many of the concepts of environmental sustainability: lean and six-sigma (Chapter 3), life-cycle assessment (LCA), and carbon footprinting (Chapter 4), design for environment (covered in Chapter 5), remanufacturing (Chapter 7), and renewable energy (Chapter 10). Other topics in environmental sustainability include legal and financial issues (such as environmental legislation, Chapter 2, and leasing, Chapter 6), and strategic issues (environmental product differentiation, Chapter 8), which complement and support other disciplines in business education.

In contrast, the social aspect of sustainability is taught primarily through examples. Although the examples (some of which are covered in Chapter 9) are interesting, there is arguably “more meat,” from a teaching and learning in the classroom perspective, in the environmental rather than the social aspect of sustainability.

As we argue in Chapter 9, a profitable firm that is committed to environmental sustainability positively impacts communities, so the social aspect of sustainability is intertwined with the environmental and economic aspects of sustainability.

Closed-loop supply chains are a key aspect of environmental sustainability; we introduce this topic next.

1.3 What Is a Closed-Loop Supply Chain (CLSC)?

In a regular (forward) supply chain, the predominant flow of materials and products is “forward.” The supply chain for beer, for example, includes procurement of beer ingredients such as yeast, barley, hops, and water; beer preparation through mixing and fermentation of ingredients; bottling, which could be done in a separate facility; shipment to national beer distributors, then to regional distributors and finally to retail stores, where beer is sold. In reverse supply chains, the flows of products are in the opposite direction, from consumers to producers. As an example, the reverse supply chain for beer cans involves collection of used beer cans, consolidation in intermediate storage points, and shipment to aluminum producers and/or recyclers. The term closed-loop supply chain (CLSC) indicates a supply chain where there is a combination of forward and reverse flows, such that these two types of flows may impact each other, and may thus require some level of coordination.

As an example of CLSC, consider the supply chain for diesel engines and parts for Cummins (Figure 1.1). Figure 1.1 depicts representative flows in this supply chain; the flows are differentiated between forward and reverse flows. Forward flows consist of new parts and/or engines, and reverse flows consist of used parts and/or engines, and remanufactured parts or engines. Remanufacturing (or refurbishing) is the process of restoring a used product (i.e., post-consumer use) to a common operating and esthetic standard. For a diesel engine or module, remanufacturing consists of six different steps: (i) full disassembly, (ii) cleaning of each part (often through multiple sequential techniques), (iii) making a disposition decision for each part (keep for remanufacturing or dispose the part for materials recycling), (iv) remanufacturing (value-added work that restores functionality and appearance similar to a new part), (v) re-assembly, and (vi) testing.

New engines are produced and assembled from new parts, some of which originate from Cummins’ suppliers, who also supply the firm’s distribution center with spare parts. New engines are shipped to a main distribution center, from where they are then shipped to several regional distribution centers (not depicted in Figure 1.1), and from there to over 3,000 dealers in North America. Customers buy new (or remanufactured) diesel engines or engine modules. They receive a dollar credit from returning the old engine or module upon purchasing a new (or remanufactured) engine or module; the dollar credit can be as high as 30 percent of the purchase price. A remanufactured module or engine typically sells at a 35 percent discount relative to its corresponding new counterpart. Used modules or engines are shipped from dealers to one of several consolidation points in North America (not depicted in Figure 1.1), and from there to Cummins’ main used products depot. At the depot, customers are given the proper credit for returning the used module or engine; engines and modules are then shipped to one of two plants (or put into inventory for later shipment when needed): engine remanufacturing (plant A) or module remanufacturing (plant B). Remanufactured engines are shipped from plant A to the main distribution center, joining new engines or parts for distribution to dealers. Remanufactured modules are shipped from plant B to the distribution center or to remanufacturing plant A. Used parts that do not complete the remanufacturing process are sold to recyclers. Used products are typically referred to as returns or cores.

The supply chain in Figure 1.1 illustrates two major disposition decisions for cores: remanufacturing and recycling. In addition to landfilling—an option that is illegal for some products in some jurisdictions (e.g., electronic equipment cannot be landfilled in some U.S. states such as California, Maine, Massachusetts, and Minnesota)—disposition decisions for product returns include:

Figure 1.1 Closed-loop supply chain for Cummins (simplified).

Incineration. Incineration reduces the amount of solid waste going to landfills, and it may be an attractive option for products or materials where recycling is difficult or uneconomical. In addition, incineration is commonly used for energy recovery. For example, Denmark incinerates about 60 percent of its municipal solid waste toward energy recovery. On the other hand, incineration may increase the amount of toxic emissions such as mercury, and is therefore regulated.

Recycling. Recycling means material recovery, and it is an attractive option for products where returns have little economic value due to technological obsolescence (e.g., old computers), or are in poor quality condition (e.g., product returns heavily damaged during transportation). Recycling can be mandated by take-back legislation: in the Netherlands, 85 percent of the weight of each car at the end of its life needs to be recycled (as opposed to landfilled or incinerated); for electronic equipment, the current mandated recycling target is about 65 percent in the EU. We discuss take-back legislation in Chapter 2.

Parts Harvesting. Here, the firm recovers selected parts from a product return for use in warranty and service contracts. When the part is subject to wear and tear, as is common in mechanical components, this option is viable if the product has been lightly used such as consumer returns. Otherwise, for electronic components, this is a common disposition option.

Remanufacturing. this is a value-added operation as illustrated in the Cummins example, and it can be the most profitable disposition decision.

Resale (as-is). this can happen if a secondary market for the used product exists, such as is the case with used cars, and some standard IT equipment.

Figure 1.1 illustrates a CLSC where the main source of cores are end-of-use returns, where the product has undergone a full cycle of use with a customer, but the product still has significant value left for recovery. In addition to end-of-use returns, there are end-of-life returns, which are products that have reached the end of their useful life, mostly due to obsolescence, and whose main disposition decision is recycling; examples include very old computers, monitors, VCRs, and very old cars. Finally, there are consumer returns, which are products that have undergone little or no use by consumers—they are returned by consumers to retailers as a result of liberal returns policies by powerful retailers primarily in North America; most consumer returns are not defective. For example, about 80 percent of deskjet printers returned to retailers by consumers in the United States were not defective: reasons for return include remorse, and lack of product fit with consumer needs.

CLSCs will be discussed in more detail in chapters 57, since they constitute a critical characteristic of a truly sustainable operation, as we discuss next.

1.4 A Firm’s Journey Toward Sustainability

Suppose you are approached by a senior executive of a medium- to large-sized firm, with the following question: “We’ve heard much about sustainability, but I believe our company is not doing a whole lot in that space. What is the roadmap for us to become more sustainable?” This book aims to answer that question, providing a step-by-step path, with appropriate tools in each step of the path. The path is shown in Figure 1.2.

Figure 1.2 The path to a sustainable operation.

The first step toward sustainability is to reduce pollution and waste generated by the firm’s operations. Popular and widespread popular process improvement methodologies, such as lean and six-sigma, are appropriate tools here. Firms implementing lean have reported significant improvements in areas such as scrap and rework reduction (which clearly decreases energy and material consumption), and inventory reduction (which reduces energy consumption), in addition to common operating metrics such as cycle time. Six-sigma aims at reducing variability in processes, which also reduces scrap and rework, for example.

With lean and/or six-sigma fully implemented, the firm performs a LCA for each of its main products and processes. LCA is a methodology designed to assess the environmental impact (e.g., energy consumption) of a product or process, from raw material extraction to production (in its different stages), packaging, distribution, consumer use, and end-of-life/disposal. With a better understanding of the major impacts, the firm can then target actions designed to reduce the firm’s environmental impact (which in most cases also improves the economic bottom line), that is, the firm aims for eco-efficiency. Examples of tools here include 3R (reduce, reuse, recycle) initiatives, reducing the carbon footprint with clean and renewable energy sources, retrofitting/constructing green buildings (e.g., LEED-certified buildings), and implementing certain Design for the Environment (DfE) protocols, such as those aimed at designing products with low energy consumption, or reduced packaging.

The final step in the journey toward sustainability, which is the ultimate goal, is to close the loop. To close the loop, the firm starts by designing products for multiple life cycles (as in design for remanufacturing), or products designed according to the Cradle-to-Cradle® philosophy that ensures ease of disassembly and 100 percent recyclability (up-cycling as opposed to down-cycling), in addition to non-use of materials known to be toxic to humans or the environment. To close the loop, Cummins (Figure 1.1) designs engines that can be remanufactured (i.e., “sturdy” designs for multiple life cycles), has a reverse logistics network to handle used products (with collection of used engines at dealers for subsequent shipment to Cummins), has developed a remanufacturing process that guarantees that remanufactured engines operate “like new,” and has developed a remarketing strategy, through pricing and warranties, to ensure that customers buy remanufactured engines.

1.5 Organization of This Book and Target Audience

This book was written from the author’s experience in teaching a sustainable operations MBA elective in the Kelley School of Business at Indiana University since 2010. Although case studies are a useful tool in teaching, the author feels that a compact (but reasonably comprehensive) summary of the topics and issues of sustainability—from an operations standpoint—are just as useful, so that students get the “big picture.” For example, many faculty members have taught DfE through the Harvard case of Herman Miller.8 DfE, however, does not mean exclusively the cradle-to-cradle design protocol adopted by Herman Miller in the design of its Mirra chair, as detailed in that case. There is also design for remanufacturing, and there are other design protocols focused on eco-efficiency, and these concepts are explained in Chapter 5. Thus, the book’s main target audience is students in elective MBA or undergraduate courses in sustainability. Given its relatively short length, the book could also be used in executive education, particularly considering that the chapters are self-contained for the most part. It can be complemented by case studies, some of which are discussed throughout.

The chapters follow the sequence of the path in the framework presented in Figure 1.2, except for chapters 2, 9, and 10.

Chapter 2 provides an overview of take-back legislation. This topic was included in the book because many countries (such as those in the EU, China, Japan, and Korea), and several states in the United States have adopted take-back legislation, which assigns responsibility for environmentally friendly disposal (i.e., recycling) of used products, post-consumer use, to manufacturers. This type of legislation has a significant impact on the operations of impacted firms, particularly those that manufacture electronic products. Chapter 9 is dedicated to the social aspect of sustainability, including an analysis of the stakeholders impacted by the firm’s operations, as well as illustrating the concept of shared value creation.

Chapter 3 starts the path of Figure 1.2, and covers lean and six-sigma. The chapter starts by describing the seven forms of waste, and the overall philosophy of lean manufacturing. It then proceeds by providing a description of some tools in lean: pull processes, set-up time reduction, value stream mapping, 5S, and layout redesign. Then, the DMAIC process of six-sigma is presented, including the similarities and differences with respect to lean. Finally, the chapter concludes by providing the link between lean, six-sigma, and sustainability.

Chapter 4, the longest, is dedicated to eco-efficiency, the second step in the path of Figure 1.2. The first part of the chapter explains LCA in some detail, including several examples. The second part of Chapter 4 explains carbon footprinting, which is the process of measuring an organization’s emissions of greenhouse gases, and can be viewed as an application of LCA. This topic is covered in some detail because of the importance of global warming in shaping businesses’ strategies and the fact that many firms voluntarily disclose their carbon emissions. The third part of Chapter 4 focuses on environmental management systems and ISO 14001, a topic of importance given the increase in ISO 14001 adoption throughout the world, following a path similar to ISO 9000 in quality management systems. Finally, the last part of Chapter 4 discusses green building and LEED Certification. This was included given the exponential increase in LEED Certifications, as shown in Chapter 4. Chapter 10 provides some fundamental concepts in renewable energy and biofuels, which are key to reducing an organization’s carbon footprint.

Chapters 57 are focused on “closing the loop,” the final step in the path of Figure 1.2. Chapter 5 covers DfE. The chapter starts by presenting several general guidelines adopted in many DfE design protocols (such as materials selection, reduced energy consumption, etc.). Considering that packaging corresponds to 30 percent of the municipal solid waste in the United States, and it is a key component of product design, the second part of Chapter 5 presents the idea of packaging scorecard, including an example. The chapter then presents general guidelines for design for remanufacturing (such as the need for modularity, design for disassembly, etc.). Finally, the chapter concludes with an overview of an important design protocol, cradle-to-cradle, which presents some novel conceptual ideas.

Chapter 6 is about servicizing (i.e., the idea of selling services as opposed to products) and leasing, which are business models that facilitate recovery of a product post-consumer use, and can thus support a CLSC structure. The first part of Chapter 6 discusses the environmental benefits and drawbacks of servicizing and leasing. Then, accounting aspects of leasing are discussed, including the differences between operating and capital leases. Finally, the chapter concludes by providing an actual spreadsheet example, which illustrates the financial implications of a firm considering whether to buy or lease.

Chapter 7 presents an overview of remanufacturing, starting with an introduction about the scope of remanufacturing in the United States and abroad. The chapter then discusses product acquisition and remarketing—two key characteristics that differentiate remanufacturing from regular manufacturing, considering that the main input to remanufacturing operations is product returns, post-consumer use. The chapter then concludes with an overview of remanufacturing practice in four select industries: automotive engines, cartridges, cell phones, and Internet networking equipment; the industries were selected to illustrate the diversity of practices across industries, as well as challenges.

Considering that firms operate in supply chains, Chapter 8 describes the idea behind environmental product differentiation,9 which is a useful framework in understanding how triple bottom line firms select suppliers and source products. In particular, the chapter discusses different ecolabels, some of which establish credible information about the product’s green (or ethical) attributes to customers. In addition, many ecolabels have chain of custody requirements, which necessitate a rethinking of how firms design their supply chains in certain cases (e.g., food and wood products).

1.6 Web Resources

Because sustainability is an evolving and dynamic field, Web links are provided at the end of each chapter when appropriate, which provide more in-depth information about a particular topic. In general, several websites are specialized in collecting and disseminating news on sustainability. For some, the reader can subscribe to obtain a daily summary sent to his/her inbox. These include:

Environmental Leader: http://www.environmentalleader.com/

Sustainable Business: http://www.sustainablebusiness.com/

Ethical Corporation: http://www.ethicalcorp.com/