Chapter 8 Sustainability in the Supply Chain – Sustainable Operations and Closed Loop Supply Chains, Second Edition

CHAPTER 8

Sustainability in the Supply Chain

8.1 Selling Green Products: Environmental Product Differentiation

Environmental product differentiation refers to the idea of designing and marketing products that provide a lower environmental impact than competing products of similar functionality. Designing and manufacturing “green” products typically (but not always) increase a firm’s production costs, as discussed in Chapter 5; for example, the firm needs to use higher quality materials that can be upcycled at the end of a product’s use with consumers. As a result, for a green product to be economically sustainable to the firm marketing it, it needs to:

1. Increase the firm’s market share by attracting new customers who find the “green” attribute appealing, and/or

2. Command a price premium

Thus, the firm needs to differentiate the “green” product along environmental lines. Following established principles of strategic management, Forest Reinhardt suggests three requirements for a successful environmental product differentiation strategy, and they are outlined in Table 8.1.1 Although the requirements in Table 8.1 were originally developed considering environmental product differentiation, they are equally valid for the purposes of differentiating a product along socially responsible, or ethical lines (i.e., the other “P” of sustainability—people). Understanding these principles is important not only for firms attempting to design and market green (or ethical) products, but also for firms who buy green (or ethical) products from suppliers (such as is the case with Walmart or other retailers). We therefore comment on these requirements in detail now.

Table 8.1 Requirements for successful environmental (or ethical) product differentiation2

Number

Requirement

1

Create or find a willingness to pay (WTP) among customers for environmental (or ethical) quality

2

Establish credible information about the product’s green (or ethical) attributes

3

The “green” (or ethical) innovation must be defensible against imitation by competitors.

8.2 Requirement 1: Create or Find a Willingness to Pay (WTP) Among Customers for Environmental (or Ethical) Quality

Industrial Markets

In industrial markets, a firm can increase the customer’s WTP for its green product under two scenarios:

Reduction in total cost of ownership for the product. Industrial buyers are sophisticated, and therefore consider the total cost of ownership, throughout the product’s life cycle, when making a purchasing decision. As discussed in Chapter 6, Interface is a manufacturer of modular carpet tiles, which can be replaced selectively (e.g., a customer may replace tiles in high traffic areas more frequently). Interface has also developed a proprietary recycling technology—ReEntry 2.0—allowing carpet materials (nylon facing, and PVC backing) to be upcycled. Interface is a firm that promotes its environmentally friendly practices in carpet design, manufacturing, and end-of-life, and it can thus increase a customer’s WTP for its modular, greener carpet, if the design actually reduces the total cost of ownership for the customer. This can be accomplished through an operating leasing program, where Interface owns the carpet, and recovers the carpet at the end of the leasing period. The recovered carpet is valuable to Interface as a source of raw materials (considering its recycling program), and if there are additional tax benefits (such as those discussed in Chapter 6, related to depreciation tax savings), then Interface can reduce the leasing payments, and make it more attractive to the customer.

Reduction in regulatory compliance risks: If there is the risk of future environmental regulation related to a dimension impacted by the green product, the green product has the potential to reduce future compliance costs. For example, the European Union (EU) has set a target of 20 percent for the proportion of electricity derived from renewable sources (such as wind, solar, hydroelectric, and geothermal) for each of the member states by 2020. This high-level requirement (at the country level) may trickle down to firms, if a country in the EU passes legislation regulating electricity consumption at the customer level. Thus, a large retailer may find it attractive to install solar panels at its stores (with a high initial investment cost) rather than purchasing electricity from regular sources, in order to reduce potential future compliance costs.

Consumer Markets

Firms may find consumer segments that are willing to pay a premium for the green attributes of the product:

Selling to “altruistic” consumers. These would be consumers who are willing to pay a higher price for a product because this is the “right thing to do.” Examples include consumers of Fairtrade products, as documented in the case about Nestlé’s introduction of Fairtrade coffee in the instant coffee segment in the UK.3 Fairtrade is a certification provided by the Fairtrade Labelling Organization and its affiliates that ensures that certified products have their agricultural raw materials—coffee beans in this case—comply with certain standards, for example, farmers are paid minimum prices (i.e., they are not paid according to prevailing commodity market prices, which fluctuate according to supply and demand), and/or certain ethical conditions are met. Nestlé’s marketing department had documented three segments of consumers with respect to the “ethical product” category: “Global Watchdogs,” “Conscientious Consumers,” and “Do What I cans.” Consumers in the first two segments were targets for the introduction of an instant coffee that was Fairtrade certified, despite its price premium.

Green (or ethical) product provides a “health” appeal. This is evidenced by the growth of organic food sales: organic food and beverage sales in the United States have grown from $1 billion in 1990 to $47 billion in 2016, with a growth rate of 8.8 percent from 2015 to 2016.4 As another example, Walmart’s consumers—who are likely to be more price sensitive—are apparently willing to pay a premium for clothes made with organic cotton (due to the overall feel and quality of the product, in addition to its health appeal), considering that some of these products sell at a premium.

Products make a statement to friends and acquaintances. Products that are highly visible when being consumed may provide some consumers with the recognition they want for being “cool.” For example, the Toyota Prius had a distinct design, which made it easily recognized. This feature is appealing to some consumers who want to advertise to others (friends and/acquaintances) that they are concerned about the environment, considering the vehicle’s advertised green qualities. (This is in direct contrast with, e.g., the Toyota Camry hybrid, which looked just like the regular gas-only Camry).

8.3 Establish Credible Information about the Product’s Green (or Ethical) Attributes

This is more easily accomplished through government, or third-party certification (of the product’s green and/or ethical attributes) that is credible. Self-Certification initiatives are problematic because customers do not have a mechanism to directly assess the firm’s environmental friendliness claims. In addition, some firms may advertise a product’s environmental qualities for a single stage of its life cycle, such as during consumer use. As we have been stressing in this book, a product’s environmental impact must be assessed using such tools as Life-cycle Assessment (LCA), where a product’s environmental impact is measured and added across all stages of the product’s life cycle: raw material extraction, transportation, manufacturing, packaging, distribution, use by consumers, and end of life. For example, many hybrid and electric car manufacturers stress in their marketing initiatives that those products are more environmentally friendly than vehicles with regular internal combustion engines. That is certainly true if one considers energy consumption (and consequently global warming potential) during the product’s use by consumers. Hybrid and electric cars, however, by design contain a significant amount of batteries, and the environmental impact of those batteries—either at the end of their life (i.e., recycling potential)—or regarding materials choice (toxicity, depletion levels, etc.) must be assessed, among other dimensions, for a complete picture.

Products can be certified through government-sponsored labels, or third-party certifications. We discuss some examples of each type now.

Government-Sponsored Labels

There are several examples of government-sponsored labels:

Energy Star

This is a symbol backed by the U.S. Environmental Protection Agency (EPA) that can be displayed on energy-efficient products (and buildings). The EPA has some guiding principles when awarding a product the right to display the symbol.5

The product category must contribute significant energy savings: larger appliances (such as refrigerators, dishwashers, water coolers, and washers), building products (such as insulation, roofing, windows, and doors), heating and cooling, lighting and fans, and water heaters.

Products must deliver similar performance to comparable products, in addition to being more energy-efficient.

Customers should be able to recover their initial investment—if the Energy Star certified product costs more initially than a comparable non-Energy Star product—through lower utility bills, in a reasonable period of time.

Product energy consumption and performance can be measured and verified with testing.

Products must display the Energy Star label visibly to consumers, to differentiate from other products.

SmartWay

SmartWay is a collaboration between the U.S. EPA and the freight transportation industry, targeted at improving fuel efficiency in that industry. The SmartWay program has three components6:

SmartWay Transport Partnership. Here carriers, logistics companies, freight shippers, multimodal carriers, and rail carriers agree to calculate and track their fuel consumption and carbon footprint annually. In exchange, EPA ranks and publicizes each firm’s performance in the SmartWay Partner list. Best performers have the right to exhibit the SmartWay partner logo.

SmartWay Brand. This program develops test protocols, and verifies performance of vehicles, and other technologies with the potential to reduce greenhouse gases from freight transport. Example of technologies tested and certified here include idle reduction technologies (such as electrified parking spaces, auxiliary power units, thermal storage system, among others), aerodynamic technologies (such as trailer gap reducers, trailer side skirts, and trailer boat tails, among others), low-rolling resistance tires, and verified retrofit technologies (such as diesel oxidation catalysts, and diesel particulate filters). Best performers can display the SmartWay brand, helping to accelerate availability, adoption, and market penetration of fuel saving technologies.

SmartWay Global Collaboration. This program provides guidance and resources for other countries that want to implement programs similar to SmartWay. It also works with organizations to harmonize sustainability accounting methods in the freight sector.

USDA Organic

The United States Department of Agriculture (USDA) National Organic Program provides standards and regulations that certify organic products sold by a firm, wild crop harvesting, or handling operation. Broadly speaking, organic operations should be able to demonstrate that they are “protecting natural resources, conserving biodiversity, and using only approved substances.”7 There are accredited certifying agents in many states in the United States, as well as more than 20 countries on all five continents. A brief summary of the requirements for USDA organic labeling is provided in the USDA website, and reproduced below8:

Organic crops. The USDA organic seal verifies that irradiation, sewage sludge, synthetic fertilizers, prohibited pesticides, and genetically modified organisms were not used.

Organic livestock. The USDA organic seal verifies that producers meet animal health and welfare standards, did not use antibiotics or growth hormones, used 100 percent organic feed, and provided animals with access to the outdoors.

Organic multi-ingredient food. The USDA organic seal verifies that the product has 95 percent or more certified organic content. If the label claims that it was made with specified organic ingredients, you can be sure that those specific ingredients are certified organic.

RoHS (Restriction on the Use of Certain Hazardous substances)

This is actually a directive (regulation) introduced by the European Union (EU) in 2003, and in effect since 2006; it became law in all EU member states. The directive restricts the use of six substances—lead (Pb), mercury (Hg), cadmium (Cd), hexavalent chromium (Cr6+), polybrominated biphenyls (PBB), and polybrominated diphenyl ether (PDBE)—in electric and electronic products, as defined by the WEEE directive (see Chapter 2). PBB and PDBE are flame retardants used in several plastics. The maximum concentration allowed for these substances is 0.1 percent (except for Cd, whose maximum allowed concentration is 0.01 percent) by weight of homogeneous material (i.e., any substance in the product that can be separated mechanically). Products must exhibit the RoHS label. Even though RoHS is law in Europe, some retailers in the United States (such as Walmart) adopted a policy of buying only RoHS-compliant electronic products such as TVs, computers, audio products, and phones.9

Dolphin Safe Tuna

The U.S. Department of Commerce sponsors a label that certifies that tuna caught in the eastern tropical Pacific Ocean—where tuna and dolphins are closely associated—preserves and protects dolphin stocks. The certification is accomplished through systematic audits, as well as through spot checks. There are, however, other dolphin safe labels provided by third-party agencies, such as the Earth Island Institute. According to the Earth Island Institute, over 95 percent of the world’s tuna canners are dolphin safe.10 Thus, this particular certification is not really a differentiator in the market place, but rather a requirement.

Third-party Certifications

There are numerous third-party certifications for a product’s green attributes. We provide some well recognized examples below, but of course, this list is far from exhaustive.

Marine Stewardship Council (MSC)

MSC is a non-governmental organization (NGO) that sets standards for sustainable fishing, which was established by Unilever and the World Wildlife Fund (WWF). Due to overfishing, a study in the journal Science pointed out that all species of wild seafood are severely depleted and predicted a collapse of worldwide fisheries by 2048.11 There is thus an increased interest in and attention on sustainable fishing practices. As of May of 2017, there were 286 certified fisheries in the MSC program, all over the world. To be certified, a fishery must comply with the MSC environmental standard for sustainable fishing. In a nutshell, the MSC environmental standard for sustainable fishing is built on three principles12:

Principle 1. Sustainable fish stocks: The fishing activity must be at a level that is sustainable for the fish population. Any certified fishery must operate so that fishing can continue indefinitely and is not overexploiting the resources.

Principle 2. Minimizing environmental impact: Fishing operations should be managed to maintain the structure, productivity, function, and diversity of the ecosystem on which the fishery depends.

Principle 3. Effective management: The fishery must meet all local, national, and international laws and must have a management system in place to respond to changing circumstances and maintain sustainability.

The principles above are supported by detailed criteria, available at the MSC website.13 Once a fishery has been certified, all companies in the supply chain—from boat, to the restaurant or retailer that wants to sell MSC certified seafood—must have the MSC Chain of Custody Certification, and apply the corresponding ecolabel. To obtain the MSC Chain of Custody Certification14:

The MSC Chain of Custody Standard is a traceability and segregation standard that is applicable to the full supply chain from a certified fishery or farm to final sale. Each company in the supply chain handling or selling an MSC certified product must have a valid MSC Chain of Custody certificate. This assures consumers and seafood-buyers that MSC labeled seafood comes from a certified sustainable fishery.

As a component of its sustainability strategy, Walmart has committed to purchasing 100 percent of its wild seafood from MSC certified suppliers, and the company is close to achieving that goal in the United States, at 90 percent. Because of decreasing output in world fisheries as discussed before, a key benefit to Walmart of obtaining MSC-certified seafood is continuity of supply, considering the firm’s large purchasing volumes worldwide.

Forest Stewardship Council (FSC)

FSC is an NGO that was established in 1993 in response to concerns over deforestation globally. Similar to MSC, FSC provides three types of certification: Forest Management, Chain of Custody, and FSC Controlled Wood. Forest Management Certification must meet specific requirements that are derived from 10 basic principles, which can be summarized as follows15:

Legality Verification—follow all applicable laws

Demonstrated long-term land tenure and use rights

Respect rights of workers, indigenous peoples

Equitable use and sharing of benefits

Reduction of environmental impact of logging activities

Identification and appropriate management of areas that need special protection (e.g., cultural or sacred sites, habitat of endangered animals or plants).

The Chain of Custody Certification ensures that forest products can be traced back to the producer, and is targeted at firms that manufacture, process, or trade in forest products (such as timber). The FSC Controlled Wood Certification allows manufacturers to mix FSC-certified wood with non-certified wood, and then apply a MIX FSC label. The non-certified wood, however, must comply with the FSC Controlled Wood standards, which specify that the following five origins must be avoided16:

1. Illegally harvested wood

2. Wood harvested in violation of traditional and civil rights

3. Wood harvested in forests in which high conservation values (areas particularly worth of protection) are threatened through management activities

4. Wood harvested from conversion of natural forests

5. Wood harvested from areas where genetically modified trees are planted

FSC sets the standards, but the Certification itself is performed by independent Certification bodies. FSC is well recognized. For example, a building can obtain one point (MR Credit: Building Product Disclosure and Optimization—Sourcing of Raw Materials) toward LEED Certification (see Chapter 4), if it uses a minimum of 25 percent (based on cost) of FSC-certified products for wood building components, such as structural framing, flooring, doors, and finishes. There are, however, other competing ecolabels for wood such as the Sustainable Forestry Initiative, and the Rainforest Alliance.

Fairtrade

As discussed earlier in this chapter, Fairtrade is a Certification provided by the Fairtrade Labelling Organization and its affiliates that ensures that certified products have their agricultural raw materials (e.g., coffee beans, cotton, fruit, bananas, rice, tea, fresh fruit, among others) comply with certain standards. For example, producers (farmers) must be paid minimum prices (instead of fluctuating commodity market prices), and/or certain ethical conditions must be met. In addition, producers must be paid an additional sum—the Fairtrade Premium—to invest in their communities.17

LEED (Leadership in Energy and Environmental Design)

LEED is a rating system for buildings created by the U.S. Green Building Council (USGBC), and it was discussed previously in Chapter 4. Although a building is not a consumer or industrial product, a firm may use its achievements in LEED certified buildings (say, its headquarters, factories, or warehouses) to boost its green image among consumers.

Cradle-to-Cradle

This is a Certification provided by McDonough Braungart Design Chemistry (MBDC) for products designed according to cradle-to-cradle principles. These principles were discussed in detail in Chapter 5, and can be summarized as follows: (i) product components must be homogeneous in terms of materials (i.e., made of either biological materials, which can be composted, such as wood and cotton; or technical materials, which can be upcycled, such as aluminum and some plastics), (ii) all materials in the product must satisfy non-toxicity requirements, and (iii) the product must have a minimum material reutilization score, which is derived from the percentage of recycled materials, as well as the percentage of recyclable materials. Products certified at the silver, gold, and platinum levels should meet additional criteria, in terms of renewable energy use, water stewardship, and social responsibility. As discussed before, the set of criteria for certification are quite stringent, and to date relatively few complex products have been cradle-to-cradle certified.

The list above is just a sample of well-known green labels; a list that grows quickly every year. But the key point is that a firm can establish credible information about its product’s green attributes by pursuing a credible third-party (government or not) certification, and reputable ecolabels provide just that. Self-reported, difficult to validate and verify claims of greenness can easily backfire, and firms should understand the perils of greenwashing.

8.4 Requirement 3: Barriers to Imitation

For successful differentiation along environmental lines, the product’s environmental attributes must be difficult to imitate. Examples of barriers to imitation include:

Patent protection. If processes or technologies can be patented, they provide a natural barrier to imitation. Examples here abound, as firms usually pursue patent protection for technologies developed in-house.

Unpatentable but proprietary capabilities. Some capabilities are not really patentable, but they may nonetheless be difficult to replicate. For example, Benziger is a California winery known for its biodynamic vineyards, which are self-regulating systems that go beyond organic agriculture. Biodynamic vineyards function according to closed natural cycles. For example, water used in wine production is completely purified through a natural system of ponds and living organisms. As another example, the vineyard has a patch of plants that attracts “good bugs,” which then prey on the “bad bugs,” eliminating the need for pesticides. Weeds are controlled via a flock of sheep. The integrated set of such biodynamic agricultural practices is a capability that is difficult to replicate, at least in the short term.

First mover advantage. First movers (i.e., early adopters of green technologies) enjoy the reputation effects of being first, as well as being further down the learning curve. As an example Sanofi Genzyme’s headquarters (Sanofi Genzyme is the specialty care global business unit of Sanofi, specializing in therapies for rare diseases, multiple sclerosis, oncology, and immunology) was the largest corporate office building to earn the Platinum LEED Certification, and one of only 13 buildings ever to receive this rating, at the time of the Certification in 2005. Many auto executives attribute Toyota’s reputation as a green auto manufacturer to Toyota Prius, which was the first successful hybrid vehicle.

An integrated approach to environmental issues. Some firms have developed a green reputation over time, a result of years of programs and practices designed to minimize their environmental impact. Examples here include Patagonia in apparel, Steelcase and Herman Miller in office furniture, and Interface in carpeting. Reputation is difficult to imitate.

The three principles of environmental product differentiation detailed above provide some guidance to firms seeking to establish their green credentials, both in terms of their own products and services, and from their supply chains. In fact, some ecolabels (such as FSC, MSC, and Fairtrade) have chain of custody requirements as detailed above, which calls for an integrated supply chain approach. This is not surprising because firms are linked by complex, global supply chains, and sustainability actions by one firm in the chain have a direct impact on other firms in that chain.

8.5 Web Resources

The following websites provide more in-depth information about the requirements for earning some of the green labels discussed in this chapter:

U.S. EPA Energy Star: http://www.energystar.gov/

U.S. EPA Smartway: http://www.epa.gov/smartway

USDA organic: http://www.ams.usda.gov, Natural Organic Program

MSC Certification: http://www.msc.org/

FSC Certification: http://www.fsc.org/

Fairtrade Certification: http://www.fairtrade.net/

Cradle-to-Cradle design Certification: http://www.mbdc.com/