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?
Business and the Environment

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&D
 Revenue enhancement via market research and
new offerings
 Cost containment via lifecycle analysis and
supply chain management
Business and the Environment

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.
Business and the Environment

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).
Business and the Environment


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.
Business and the Environment
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.

Business and the Environment

Drivers: Consumers
Willingness to pay of some market segments
 Changes in taste.
 High incomes.
 High education levels
 This is a fundamental challenge—market
differentiation—market segmentation,
determining willingness to pay, barriers to entry.

Business and the Environment
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.

Business and the Environment

Drivers: Competitors
Lose 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.

Business and the Environment

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?

Business and the Environment
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.

Business and the Environment


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.
Examples

Chemical Manufacturers Association—
Responsible Care.
Business and the Environment

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.

Business and the Environment

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.
Business and the Environment
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.

Business and the Environment
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.

Business and the Environment

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

Business and the Environment
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.

Business and the Environment

Drivers: NGOs
Can 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.

Business and the Environment

Alliances with NGOs
Corporate sponsorship
 Firm contributes to the environmental group
financially or in kind through becoming
involved in specific environmental causes or
fund raising
 NGO provides product endorsement
 Task force to develop economically feasible
solutions for the greening of business practices

Business and the Environment




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
Business and the Environment

Firm perspective
Access to complementary assets
 Credibility
 Additional communication channels
 Scientific knowledge


NGO perspective

Direct impact on firm’s behavior, potential ripple
effect within industry
Business and the Environment

Firm perspective
Negative backlash if the project fails
 Confidentiality issues
 How to retain the Intellectual property rights?


NGO perspective
Open to criticism that is becomes and ally of
industry (“sleeping with the enemy”)
 Open to criticism that it looses neutrality

Business and the Environment
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 objectives
 Maintain an arm’s length relationship: formal
contract

Business and the Environment

Other drivers
Employees—motivation and company
culture.
 Press and other media—mold demand.
 Religious—mold taste regarding the
environment.

Business and the Environment

Academy—research on impact. Information.
Global warming concerns, water, waste, energy
 Ozone 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.

Business and the Environment

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?

Business and the Environment
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.

Business and the Environment

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.

Business and the Environment

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 products
 Trade. Globalization.
 In such markets firms may be reluctant to adopt
environmental products or processes. Why?

Business and the Environment

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?

Business and the Environment

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?

Business and the Environment

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?

Business and the Environment

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.

Business and the Environment

We have covered:
Drivers of environmental action by firm
managers.
 Market structure impact.
