As São Paulo, Brazil, suffers from the worst drought in its history, multinational pulp company Fibria, which is headquartered in the city, is one of many that has felt the pinch. At times, water has been shut off to 40% of the city and even now, after the rainy season, only 6-13% of the city’s reservoir’s capacity has been filled. In response, the company is working to reduce the amount of water it uses for forest irrigation.
This isn’t the first time that Fibria has had to adapt to a shifting environment. Over the last several years, the rising scarcity of several essential resources – including water, fertilizer, labor and land – has pushed the company to reconsider its business model. It has diversified into renewable energy, biofuel production and sustainable real estate development. Fibria’s goal is to make these portfolio additions 20% of total free cash flow by 2025, making the company less pulp-dependent and giving it alternative options for future business growth in light of looming sustainability challenges.
It’s not hard to see why Fibria is adapting to sustainability challenges. Its business model, like those of many of the world’s largest companies, was forged at a time when climate change, urbanization, resource scarcity and rapid population growth weren’t mainstream concerns. As a result, companies were able to prioritize the financial bottom line above all else. Today, however, these external conditions have made it difficult for many companies to maintain the status quo.
Making urban life sustainable
According to Model Behavior II: Strategies to Rewire Business, a report recently released by SustainAbility, increased urbanization is a major trend driving sustainability. Today, half of the world’s population lives in urban areas; by 2050, that figure is expected to increase to 66%. As 2.5 billion more people move into cities, they’re likely to strain food security, infrastructure, waste management services and transportation networks. Their arrival will necessitate new housing with limited environmental impacts, shared living circumstances, and the ability to quickly and safely construct housing for growing populations.
Businesses are beginning to respond to these requirements. For example, the Broad Group, a Chinese construction company, is updating its business model in response to challenges associated with Asia’s swift urbanization through green building. The company has been decreasing its environmental impact by developing 90% pre-fabricated, quick-stacking modules that it can use to build safe, energy-efficient multi-story buildings. The buildings can filter 99% of particulate matter (PM2.5), an air pollutant, and are made to withstand a 9-magnitude earthquake.
The impact of accelerating urbanization will extend far beyond the boundaries of cities. As rural workers, lured by the promise of better opportunities, move to cities, their migration will affect companies that are dependent upon smallholder agriculture. These companies – including Nestle, Syngenta, Mars Inc and Mondelez International – have been forced to grapple with workforce instability, which could easily lead to supply instability. Not surprisingly, a growing number of companies are adopting an inclusive sourcing or sales model, in which multinationals invest in smallholder farmers to ensure supply or a steady customer base.
The costs and opportunities of climate change
The SustainAbility report also identifies climate change as a major trend that is affecting all aspects of corporate value chains, from sourcing to production, distribution and sales. Some industries, the report argues, will feel these strains earlier, creating a ripple effect to others. Corporate insurance premiums, for example, are likely to increase (or disappear all together) to match growing threats from more frequent catastrophic natural disasters, such as the March cyclone that devastated Vanuatu, and sea level rise, currently threating many Small Island Developing States (SIDS) such as Kiribati and the Maldives.
According to the Ceres Insurer Risk Report, global average annual weather-related losses increased more than tenfold in the last several decades – from $10bn per year in the period 1974-1983 to $131bn in 2004-2013 – while the proportion of those damages that are insured is steadily declining.
Companies are not the only ones witnessing and responding to these shifts. A cadre of institutional investors is calling for a transition to a more long term lens. For example, in April 2015, Larry Fink, the CEO of BlackRock, the world’s largest asset manager, wrote a letter to S&P CEOs asking them to stop focusing on short term results “at the expense of long term value”. Even traditional hedge fund managers such as Paul Tudor Jones have expressed skepticism with the role of capital and capitalism in solving social inequalities and begun to look at how to address solutions through a lens of just capital.
Other actors have also called for a transition to a longer term outlook. The B20, the business forum that advises G20 governments, released a report last year that highlighted the importance of policymakers when it comes to tackling the structural gap in infrastructure investment. The report explicitly cited the need to refocus investment horizons in favor of longer term returns.
Some large institutional investors have also moved toward longer term thinking. Calpers, for example, the California retirement fund for public employees, in March changed its investment policies to reflect sustainability in decision making. At the same time, some foundations and major universities, such as Stanford and Georgetown University, have divested from companies with poor environmental performance.
Evolving market conditions are, increasingly, rewarding companies that act quickly to adapt their outlook beyond the next quarter. For example, when Novelis, the largest producer of rolled aluminum, faced financial instability after insufficient hedging against volatile prime aluminum prices, the company turned this constraint into an opportunity. Now Novelis is in a unique position. From 2011 to 2014, it used 33%-46% scrap aluminum; in the next decade, it’s on track to use 80% scrap – the largest percentage of recycled aluminum content in the industry.
As external conditions make it difficult for large companies to generate the same level of profit over the long term, business model innovation for sustainability will become increasingly essential. Business leaders who respond to and harness these external forces to drive innovation will have a distinct advantage in the future.