green and competitive: ending the...

Green and Competitive:Ending the Stalemate

by Michael E. Porter and Claas van der Linde

Reprint 95507

Harvard Business Review

This static view of environmental regulation, inwhich everything except regulation is held con-stant, is incorrect. If technology, products, pro-cesses, and customer needs were all fixed, the con-clusion that regulation must raise costs would beinevitable. But companies operate in the real worldof dynamic competition, not in the static world ofmuch economic theory. They are constantly find-ing innovative solutions to pressures of all sorts –from competitors, customers, and regulators.

Properly designed environmental standards cantrigger innovations that lower the total cost of a product or improve its value. Such innovationsallow companies to use a range of inputs more pro-ductively – from raw materials to energy to labor –thus offsetting the costs of improving environmen-tal impact and ending the stalemate. Ultimately,this enhanced resource productivity makes compa-nies more competitive, not less.

Consider how the Dutch flower industry has re-sponded to its environmental problems. Intense

Copyright © 1995 by the President and Fellows of Harvard College. All rights reserved. FIGURES BY DAVID HORII

Michael E. Porter is the C. Roland Christensen Professorof Business Administration at the Harvard BusinessSchool in Boston, Massachusetts. Claas van der Linde ison the faculty of the International Management Re-search Institute of St. Gallen University in St. Gallen,Switzerland.

An underlying logic links the environment, resource productivity, innovation, and competitiveness.

by Michael E. Porter and Claas van der Linde

The need for regulation toprotect the environment getswidespread but grudging ac-ceptance: widespread becauseeveryone wants a livable planet, grudging becauseof the lingering belief that environmental regula-tions erode competitiveness. The prevailing view isthat there is an inherent and fixed trade-off: ecologyversus the economy. On one side of the trade-off arethe social benefits that arise from strict environ-mental standards. On the other are industry’s pri-vate costs for prevention and cleanup – costs thatlead to higher prices and reduced competitiveness.With the argument framed this way, progress on en-vironmental quality has become a kind of arm-wrestling match. One side pushes for tougher stan-dards; the other tries to roll them back. The balanceof power shifts one way or the other depending onthe prevailing political winds.

Green and Competitive:

DRAWINGS BY DAVID CROLAND 121

The authors are grateful to Benjamin C. Bonifant, Daniel C. Esty, Donald B. Marron, Jan Rivkin, Nicolaj Siggelkow, and R. David Simpson for their extremely helpful comments; to theManagement Institute for Environment and Business for jointresearch; and to Reed Hundt for ongoing discussions that havegreatly benefited the thinking behind this article.

cultivation of flowers in small areas was contami-nating the soil and groundwater with pesticides,herbicides, and fertilizers. Facing increasinglystrict regulation on the release of chemicals, the

Dutch understood that the only effective way to ad-dress the problem would be to develop a closed-loopsystem. In advanced Dutch greenhouses, flowersnow grow in water and rock wool, not in soil. Thislowers the risk of infestation, reducing the need forfertilizers and pesticides, which are delivered inwater that circulates and is reused.

The tightly monitored closed-loop system alsoreduces variation in growing conditions, thus im-proving product quality. Handling costs have gonedown because the flowers are cultivated on special-ly designed platforms. In addressing the environ-mental problem, then, the Dutch have innovated inways that have raised the productivity with whichthey use many of the resources involved in growingflowers. The net result is not only dramaticallylower environmental impact but also lower costs,

better product quality, and enhanced global com-petitiveness. (See the insert “Innovating to BeCompetitive: The Dutch Flower Industry.”)

This example illustrates why the debate aboutthe relationship between competitiveness and the envi-ronment has been framed in-correctly. Policy makers, busi-

ness leaders, and environmentalists have focusedon the static cost impacts of environmental regula-tion and have ignored the more important offset-ting productivity benefits from innovation. As a result, they have acted too often in ways that un-necessarily drive up costs and slow down progresson environmental issues. This static mind-set hasthus created a self-fulfilling prophecy leading to ev-er more costly environmental regulation. Regula-tors tend to set regulations in ways that deter inno-vation. Companies, in turn, oppose and delayregulations instead of innovating to address them.

Ending the Stalemate

The whole process has spawned an industry of liti-gators and consultants that drains resources awayfrom real solutions.

Pollution = InefficiencyAre cases like the Dutch flower industry the ex-

ception rather than the rule? Is it naïve to expectthat reducing pollution will often enhance compet-itiveness? We think not, and the reason is that pol-lution often is a form of economic waste. Whenscrap, harmful substances, or energy forms are dis-charged into the environment as pollution, it is asign that resources have been usedincompletely, inefficiently, or inef-fectively. Moreover, companies thenhave to perform additional activitiesthat add cost but create no value forcustomers: for example, handling,storage, and disposal of discharges.

The concept of resource productiv-ity opens up a new way of looking atboth the full systems costs and the value associatedwith any product. Resource inefficiencies are mostobvious within a company in the form of incom-plete material utilization and poor process controls,which result in unnecessary waste, defects, andstored materials. But there also are many other hid-den costs buried in the life cycle of the product.Packaging discarded by distributors or customers,for example, wastes resources and adds costs. Cus-tomers bear additional costs when they use prod-ucts that pollute or waste energy. Resources are lostwhen products that contain usable materials arediscarded and when customers pay – directly or in-directly–for product disposal.

Environmental improvement efforts have tradi-tionally overlooked these systems costs. Instead,they have focused on pollution control through better identification, processing, and disposal of

discharges or waste – costly approaches. In recentyears, more advanced companies and regulatorshave embraced the concept of pollution prevention,sometimes called source reduction, which usessuch methods as material substitution and closed-loop processes to limit pollution before it occurs.

But, although pollution prevention is an impor-tant step in the right direction, ultimately compa-nies must learn to frame environmental improve-ment in terms of resource productivity.1 Todaymanagers and regulators focus on the actual costs ofeliminating or treating pollution. They must shifttheir attention to include the opportunity costs ofpollution – wasted resources, wasted effort, and di-minished product value to the customer. At the level of resource productivity, environmental im-provement and competitiveness come together.

This new view of pollution as resource inefficien-cy evokes the quality revolution of the 1980s and

its most powerful lessons. Today we have littletrouble grasping the idea that innovation can im-prove quality while actually lowering cost. But asrecently as 15 years ago, managers believed therewas a fixed trade-off. Improving quality was expen-sive because it could be achieved only through in-spection and rework of the “inevitable” defectsthat came off the line. What lay behind the old viewwas the assumption that both product design andproduction processes were fixed. As managers haverethought the quality issue, however, they haveabandoned that old mind-set. Viewing defects as asign of inefficient product and process design – notas an inevitable by-product of manufacturing – wasa breakthrough. Companies now strive to buildquality into the entire process. The new mind-setunleashed the power of innovation to relax or elim-inate what companies had previously accepted as

fixed trade-offs.Like defects, pollution often re-

veals flaws in the product design orproduction process. Efforts to elimi-nate pollution can therefore followthe same basic principles widelyused in quality programs: Use inputsmore efficiently, eliminate the needfor hazardous, hard-to-handle mate-

rials, and eliminate unneeded activities. In a recentstudy of major process changes at ten manufactur-ers of printed circuit boards, for example, pollution-control personnel initiated 13 of 33 major changes.Of the 13 changes, 12 resulted in cost reduction, 8in quality improvements, and 5 in extension of pro-

RESOURCE PRODUCTIVITY

122 HARVARD BUSINESS REVIEW September-October 1995

Pollution’s hidden costs – wastedresources and effort – are buriedthroughout a product’s life cycle.

The shift from pollution controlto prevention is a good first step,

but companies must go further.

HARVARD BUSINESS REVIEW September-October 1995 123

Environmental Regulation Has Competitive Implications

Sources: Benjamin C. Bonifant, Ian Ratcliffe, and Claas van der Linde.

Sector/Industry Environmental Issues Innovative Solutions Innovation Offsets

Lower operating costs though greater use of by-product energy sources25% initial price premium for chlorine-free paper

Printing inks

Pulp and paper Dioxin released bybleaching with chlorine

Improved cooking and washing processesElimination of chlorine by using oxygen, ozone, or peroxide for bleachingClosed-loop processes (still problematic)

Paint and coatings Volatile organic compounds (VOCs) in solvents

New paint formulations (low-solvent-content paints, water-borne paints)Improved application techniquesPowder or radiation-cured coatings

Price premium for solvent-free paintsImproved coatings quality in some segmentsWorker safety benefitsHigher coatings-transfer efficiencyReduced coating costs through materials savings

Electronicsmanufacturing

Volatile organic compounds (VOCs) in cleaning agents

Semiaqueous, terpene-based cleaning agentsClosed-loop systemsNo-clean soldering where possible

Increase in cleaning quality and thus in product quality30% to 80% reduction in cleaning costs, often for one-year payback periodsElimination of anunnecessary production step

Refrigerators Chlorofluorocarbons (CFCs) used as refrigerantsEnergy usageDisposal

Alternative refrigerants (propane-isobutane mix)Thicker insulationBetter gasketsImproved compressors

10% better energy efficiency at same cost5% to 10% initial price premium for “green” refrigerator

Dry cell batteries Cadmium, mercury, lead, nickel, cobalt, lithium, and zinc releases in landfills or to the air (after incineration)

Rechargeable batteries of nickel-hydride (for some applications)Rechargeable lithium batteries (now being developed)

Nearly twice as efficient at same costHigher energy efficiencyExpected to be price competitive in the near future

VOCs in petroleum inks Water-based inks and soy inks

Higher efficiency, brighter colors, and better printability (depending on application)


Innovation-Friendly Regulation

Regulation, properly conceived, need not drive upcosts. The following principles of regulatory designwill promote innovation, resource productivity, andcompetitiveness:

Focus on outcomes, not technologies. Past regula-tions have often prescribed particular remediationtechnologies, such as catalysts or scrubbers for air pol-lution. The phrases “best available technology” (BAT)and “best available control technology” (BACT) aredeeply rooted in U.S. practice and imply that one tech-nology is best, discouraging innovation.

Enact strict rather than lax regulation. Companiescan handle lax regulation incrementally, often withend-of-pipe or secondary treatment solutions. Regula-tion, therefore, needs to be stringent enough to pro-mote real innovation.

Regulate as close to the end user as practical, whileencouraging upstream solutions. This will normallyallow more flexibility for innovation in the end prod-uct and in all the production and distribution stages.Avoiding pollution entirely or, second best, mitigatingit early in the value chain is almost always less costlythan late-stage remediation or cleanup.

Employ phase-in periods. Ample but well-definedphase-in periods tied to industry-capital-investmentcycles will allow companies to develop innovative re-source-saving technologies rather than force them toimplement expensive solutions hastily, merely patch-ing over problems. California imposed such shortcompliance deadlines on its wood-furniture industrythat many manufacturers chose to leave the staterather than add costly control equipment.

Use market incentives. Market incentives such aspollution charges and deposit-refund schemes draw at-tention to resource inefficiencies. In addition, tradablepermits provide continuing incentives for innovationand encourage creative use of technologies that exceedcurrent standards.

Harmonize or converge regulations in associatedfields. Liability exposure in the United States leadscompanies to stick to safe, BAT approaches, and incon-sistent regulation on alternative technologies detersbeneficial innovation. For example, one way to elimi-nate refrigerator cooling agents suspected of damagingthe ozone layer involves replacing them with smallamounts of propane and butane. But narrowly con-ceived safety regulations covering these gases seem tohave impeded development of the new technology inthe United States, while several leading Europeancompanies are already marketing the new products.

Develop regulations in sync with other countries orslightly ahead of them. It is important to minimize

possible competitive disadvantages relative to foreigncompanies that are not yet subject to the same stan-dard. Developing regulations slightly ahead of othercountries will also maximize export potential in thepollution-control sector by raising incentives for inno-vation. When standards in the United States lead worlddevelopments, domestic companies get opportunitiesfor valuable early-mover advantages. However, if stan-dards are too far ahead or too different in characterfrom those that are likely to apply to foreign competi-tors, industry may innovate in the wrong directions.

Make the regulatory process more stable and pre-dictable. The regulatory process is as important as thestandards. If standards and phase-in periods are set andaccepted early enough and if regulators commit tokeeping standards in place for, say, five years, industrycan lock in and tackle root-cause solutions instead ofhedging against the next twist or turn in governmentphilosophy.

Require industry participation in setting standardsfrom the beginning. U.S. regulation differs sharplyfrom European in its adversarial approach. Industryshould help in designing phase-in periods, the contentof regulations, and the most effective regulatory process. A predetermined set of information requestsand interactions with industry representatives shouldbe a mandatory part of the regulatory process. Both in-dustry and regulators must work toward a climate oftrust because industry needs to provide genuinely use-ful information and regulators need to take industryinput seriously.

Develop strong technical capabilities among regu-lators. Regulators must understand an industry’s eco-nomics and what drives its competitiveness. Betterinformation exchange will help avoid costly gaming inwhich ill-informed companies use an array of lawyersand consultants to try to stall the poorly designed reg-ulations of ill-informed regulators.

Minimize the time and resources consumed in theregulatory process itself. Time delays in granting per-mits are usually costly for companies. Self-regulationwith periodic inspections would be more efficientthan requiring formal approvals. Potential and actuallitigation creates uncertainty and consumes re-sources. Mandatory arbitration procedures or rigidarbitration steps before litigation would lower costsand encourage innovation.

For an extended discussion of the ways in which environ-mental regulation should change, see Michael E. Porter andClaas van der Linde, “Toward a New Conception of the Environment-Competitiveness Relationship,” Journal ofEconomic Perspectives 9, no. 4 (fall 1995).

duction capabilities.2 It is not surprising that totalquality management (TQM) has become a source ofideas for pollution reduction that can create offset-ting benefits. The Dow Chemical Company, for ex-ample, explicitly identified the link between qual-ity improvement and environmental performanceby using statistical-process control to reduce thevariance in processes and to lower waste.

Innovation and Resource ProductivityTo explore the central role of innovation and the

connection between environmental improvementand resource productivity, we have been collaborat-ing since 1991 with the Management Institute forEnvironment and Business (MEB) on a series of in-ternational case studies of industries and sectorssignificantly affected by environmental regulation:pulp and paper, paint and coatings, electronicsmanufacturing, refrigerators, dry cell batteries, andprinting inks. (See the table “Environmental Regu-lation Has Competitive Implications.”) The dataclearly show that the costs of ad-dressing environmental regulationscan be minimized, if not eliminated,through innovation that deliversother competitive benefits. We firstobserved the phenomenon in thecourse of our research for a study ofnational competitiveness, The Com-petitive Advantage of Nations (TheFree Press, 1990).

Consider the chemical sector,where many believe that the ecology-economytrade-off is particularly steep. A study of activitiesto prevent waste generation at 29 chemical plantsfound innovation offsets that enhanced resourceproductivity. Of 181 of these waste prevention ac-tivities, only one resulted in a net cost increase. Ofthe 70 activities with documented changes in prod-uct yield, 68 reported increases; the average for 20initiatives documented with specific data was 7%.These innovation offsets were achieved with sur-prisingly low investments and very short paybacktimes. One-quarter of the 48 initiatives with de-tailed capital cost information required no capitalinvestment at all; of the 38 initiatives with data onthe payback period, nearly two-thirds recoupedtheir initial investments in six months or less. Theannual savings per dollar spent on source reductionaveraged $3.49 for the 27 activities for which thisinformation could be calculated. The study alsofound that the two main motivating factors forsource reduction activities were waste disposalcosts and environmental regulation.

Innovation in response to environmental regula-tion can fall into two broad categories. The first isnew technologies and approaches that minimizethe cost of dealing with pollution once it occurs.The key to these approaches often lies in taking theresources embodied in the pollution and convert-ing them into something of value. Companies get smarter about how to process toxic materialsand emissions into usable forms, recycle scrap, andimprove secondary treatment. For example, at aRhône-Poulenc plant in Chalampe, France, nylonby-products known as diacids used to be incinerat-ed. Rhône-Poulenc invested 76 million francs andinstalled new equipment to recover and sell thesediacids as additives for dyes and tanning and as co-agulation agents. The new recovery process hasgenerated annual revenues of about 20.1 millionfrancs. New de-inking technologies developed byMassachusetts-based Thermo Electron Corpora-tion, among others, are allowing more extensiveuse of recycled paper. Molten Metal Technology ofWaltham, Massachusetts, has developed a cost-sav-

ing catalytic extraction method to process manytypes of hazardous waste.

The second and far more interesting and impor-tant type of innovation addresses the root causes ofpollution by improving resource productivity in thefirst place. Innovation offsets can take many forms,including more efficient utilization of particular in-puts, better product yields, and better products.(See the insert “Environmental Improvement CanBenefit Resource Productivity .”) Consider the fol-lowing examples.

Resource productivity improves when less costlymaterials are substituted or when existing ones arebetter utilized. Dow Chemical’s California com-plex scrubs hydrochloric gas with caustic to pro-duce a wide range of chemicals. The company usedto store the wastewater in evaporation ponds. Reg-ulation called for Dow to close the evaporationponds by 1988. In 1987, under pressure to complywith the new law, the company redesigned its pro-duction process. It reduced the use of caustic soda,decreasing caustic waste by 6,000 tons per year and



Innovating to meet regulationscan bring offsets: using inputs

better, creating better products,or improving product yields.

hydrochloric acid waste by 80 tons per year. Dowalso found that it could capture a portion of thewaste stream for reuse as a raw material in otherparts of the plant. Although it cost only $250,000 toimplement, the process gave Dow an annual sav-ings of $2.4 million.3

3M also improved resource productivity. Forcedto comply with new regulations to reduce solventemissions by 90%, 3M found a way to avoid the useof solvents altogether by coating products withsafer, water-based solutions. The company gainedan early-mover advantage in product developmentover competitors, many of whom switched signifi-cantly later. The company also shortened its timeto market because its water-based product did nothave to go through the approval process for solvent-based coatings.4

3M found that innovations can improve processconsistency, reduce downtime, and lower costssubstantially. The company used to produce adhe-sives in batches that were then transferred to stor-age tanks. One bad batch could spoil the entire contents of a tank. Lost product, downtime, and expensive hazardous-waste disposal were the re-

sult. 3M developed a new technique to run rapidquality tests on new batches. It reduced hazardouswastes by 110 tons per year at almost no cost, yield-ing an annual savings of more than $200,000.5

Many chemical-production processes require aninitial start-up period after production interrup-tions in order to stabilize output and bring it withinspecifications. During that time, only scrap mate-rial is produced. When regulations raised the cost ofwaste disposal, Du Pont was motivated to installhigher-quality monitoring equipment, which inturn reduced production interruptions and the as-sociated production start-ups. Du Pont lowered notonly its waste generation but also cut the amountof time it wasn’t producing anything.6

Process changes to reduce emissions and use re-sources more productively often result in higheryields. As a result of new environmental standards,Ciba-Geigy Corporation reexamined the waste-water streams at its dye plant in Tom’s River, NewJersey. Engineers made two changes to the produc-tion process. First, they replaced sludge-creatingiron with a less harmful chemical conversionagent. Second, they eliminated the release of a po-tentially toxic product into the wastewater stream.They not only reduced pollution but also increasedprocess yields by 40%, realizing an annual cost sav-ings of $740,000. Although that part of the plantwas ultimately closed, the example illustrates therole of regulatory pressure in process innovation.

Process innovations to comply with environ-mental regulation can even improve product con-sistency and quality. In 1990, the Montreal Proto-col and the U.S. Clean Air Act required electronicscompanies to eliminate ozone-depleting chloroflu-orocarbons (CFCs). Many companies used them ascleaning agents to remove residues that occur inthe manufacture of printed circuit boards. Scien-tists at Raytheon confronted the regulatory chal-lenge. Initially, they thought that complete elimina-tion of CFCs would be impossible. After research,however, they found an alternate cleaning agentthat could be reused in a closed-loop system. Thenew method improved average product quality –which the old CFC-based cleaning agent had occa-sionally compromised – while also lowering oper-ating costs. Responding to the same regulation,other researchers identified applications that didnot require any cleaning at all and developed so-called no-clean soldering technologies, which low-ered operating costs without compromising quality.Without environmental regulation, that innovationwould not have happened.

Innovations to address environmental regula-tions can also lower product costs and boost re-



Environmental Improvement CanBenefit Resource Productivity

Process BenefitsM materials savings resulting from more complete processing, substitution, reuse, or recycling of production inputsM increases in process yieldsM less downtime through more careful monitoring and maintenanceM better utilization of by-productsM conversion of waste into valuable formsM lower energy consumption during the production processM reduced material storage and handling costsM savings from safer workplace conditionsM elimination or reduction of the cost of activities involved in discharges or waste handling, transportation, and disposalM improvements in the product as a by-product of process changes (such as better process control)

Product BenefitsM higher quality, more consistent productsM lower product costs (for instance, from material substitution)M lower packaging costsM more efficient resource use by productsM safer productsM lower net costs of product disposal to customersM higher product resale and scrap value

source productivity by reducing unnecessary pack-aging or simplifying designs. A 1991 law in Japanset standards to make products easier to recycle.Hitachi, along with other Japanese appliance pro-ducers, responded by redesigning products to re-duce disassembly time. In the process, it cut backthe number of parts in a washing machine by 16%and the number of parts in a vacuum cleaner by30%. Fewer components made the products easiernot only to disassemble but also to assemble in thefirst place. Regulation that requires such recyclableproducts can lower the user’s disposal costs andlead to designs that allow a company to recovervaluable materials more easily. Either the customeror the manufacturer who takes back used productsreaps greater value.

Although such product innovations have beenprompted by regulators instead of by customers,world demand is putting a higher value on resource-efficient products. Many companies are using inno-vations to command price premiums for “green”products and to open up new market segments. Be-cause Germany adopted recycling standards earlierthan most other countries, German companieshave first-mover advantages in developing lesspackaging-intensive products, which are both lowerin cost and sought after in the marketplace. In theUnited States, Cummins Engine Company’s devel-opment of low-emissions diesel engines for suchapplications as trucks and buses – innovation thatU.S. environmental regulations spurred – is allow-

ing it to gain position in international marketswhere similar needs are growing.

These examples and many others like them donot prove that companies always can innovate to reduce environmental impact at low cost. How-ever, they show that there are considerable oppor-tunities to reduce pollution through innovationsthat redesign products, processes, and methods ofoperation. Such examples are common in spite ofcompanies’ resistance to environmental regulationand in spite of regulatory standards that often arehostile to innovative, resource-productive solu-tions. The fact that such examples are common car-

ries an important message: Today a new frame ofreference for thinking about environmental im-provement is urgently needed.

Do We Really Need Regulation?If innovation in response to environmental regu-

lation can be profitable – if a company can actuallyoffset the cost of compliance through improving re-source productivity–why is regulation necessary atall? If such opportunities exist, wouldn’t compa-nies pursue them naturally and wouldn’t regulationbe unnecessary? That is like saying there will rarelybe ten-dollar bills to be found on the ground be-cause someone already will have picked them up.

Certainly, some companies do pursue such inno-vations without, or in advance of, regulation. InGermany and Scandinavia, where both companiesand consumers are very attuned to environmentalconcerns, innovation is not uncommon. As compa-nies and their customers adopt the resource produc-tivity mind-set and as knowledge about innovativetechnologies grows, there may well be less need forregulation over time in the United States.

But the belief that companies will pick up onprofitable opportunities without a regulatory pushmakes a false assumption about competitive real-ity–namely, that all profitable opportunities for in-novation have already been discovered, that allmanagers have perfect information about them,and that organizational incentives are aligned with

innovating. In fact, in the real world,managers often have highly incom-plete information and limited timeand attention. Barriers to change arenumerous. The Environmental Pro-tection Agency’s Green Lights pro-gram, which works with companiesto promote energy-saving lighting,shows that many ten-dollar bills arestill waiting to be picked up. In oneaudit, nearly 80% of the projects of-

fered paybacks within two years or less, and yet thecompanies considering them had not taken action.7

Only after companies joined the program and bene-fited from the EPA’s information and cajoling weresuch highly profitable projects implemented.

We are now in a transitional phase of industrialhistory in which companies are still inexperiencedin handling environmental issues creatively. Cus-tomers, too, are unaware that resource inefficiencymeans that they must pay for the cost of pollution.For example, they tend to see discarded packagingas free because there is no separate charge for it andno current lower-cost alternative. Because there is


Our research on competitivenesshighlights the role that outsidepressure plays in motivatingcompanies to innovate.

no direct way to recapture the value of the wastedresources that customers already have paid for, theyimagine that discarding used products carries nocost penalty for them.

Regulation, although a different type than is cur-rently practiced, is needed for six major reasons:M To create pressure that motivates companies toinnovate. Our broader research on competitivenesshighlights the important role of outside pressure inovercoming organizational inertia and fosteringcreative thinking. M To improve environmental quality in cases inwhich innovation and the resulting improvementsin resource productivity do not completely offsetthe cost of compliance; or in which it takes time forlearning effects to reduce the overall cost of innova-tive solutions. M To alert and educate companies about likely re-source inefficiencies and potential areas for techno-logical improvement (although government cannotknow better than companies how to address them).M To raise the likelihood that product innovationsand process innovations in general will be environ-mentally friendly.M To create demand for environmental improve-ment until companies and customers are able to

perceive and measure the resource inefficiencies ofpollution better. M To level the playing field during the transition pe-riod to innovation-based environmental solutions,ensuring that one company cannot gain position byavoiding environmental investments. Regulationprovides a buffer for innovative companies untilnew technologies are proven and the effects oflearning can reduce technological costs.

Those who believe that market forces alone willspur innovation may argue that total quality man-agement programs were initiated without regula-tory intervention. However, TQM came to the Unit-ed States and Europe through a different kind ofpressure. Decades earlier, TQM had been widelydiffused in Japan – the result of a whole host of gov-ernment efforts to make product quality a nationalgoal, including the creation of the Deming Prize.

Only after Japanese companies had devastatedthem in the marketplace did Americans and Euro-peans embrace TQM.

The Cost of the Static Mind-SetRegulators and companies should focus, then, on

relaxing the trade-off between environmental pro-tection and competitiveness by encouraging inno-vation and resource productivity. Yet the currentadversarial climate drives up the costs of meetingenvironmental standards and circumscribes the in-novation benefits, making the trade-off far steeperthan it needs to be.

To begin with, the power struggle involved in set-ting and enforcing environmental regulations con-sumes enormous amounts of resources. A 1992study by the Rand Institute for Civil Justice, for ex-ample, found that 88% of the money that insurerspaid out between 1986 and 1989 on Superfundclaims went to pay for legal and administrativecosts, whereas only 12% was used for actual sitecleanups.8 The Superfund law may well be the mostinefficient environmental law in the United States,but it is not the only cause of inefficiency. We be-lieve that a substantial fraction of environmental

spending as well as of the revenues ofenvironmental products and servicescompanies relates to the regulatorystruggle itself and not to improvingthe environment.

One problem with the adversarialprocess is that it locks companies in-to static thinking and systematicallypushes industry estimates of thecosts of regulation upward. A classicexample occurred during the debate

in the United States on the 1970 Clean Air Act. LeeIacocca, then executive vice president of the FordMotor Company, predicted that compliance withthe new regulations would require huge price in-creases for automobiles, force U.S. production to a halt by 1975, and severely damage the U.S. econ-omy. The 1970 Clean Air Act was subsequently en-acted, and Iacocca’s dire predictions turned out tobe wrong. Similar stories are common.

Static thinking causes companies to fight envi-ronmental standards that actually could enhancetheir competitiveness. Most distillers of coal tar inthe United States, for example, opposed 1991 regu-lations requiring substantial reductions in benzeneemissions. At the time, the only solution was tocover the tar storage tanks with costly gas blankets.But the regulation spurred Aristech Chemical Cor-poration of Pittsburgh, Pennsylvania, to develop a



Businesses spend too many oftheir environmental dollars onfighting regulation and notenough on finding real solutions.

way to remove benzene from tar in the first process-ing step, thereby eliminating the need for gas blan-kets. Instead of suffering a cost increase, Aristechsaved itself $3.3 million.

Moreover, company mind-sets make the costs ofaddressing environmental regulations appear high-er than they actually are. Many companies do notaccount for a learning curve, although the actualcosts of compliance are likely to decline over time.A recent study in the pulp-and-paper sector, for ex-ample, found the actual costs of compliance to be$4 to $5.50 per ton,whereas original industry esti-mates had been as high as $16.40.9 Similarly, thecost of compliance with a 1990 regulation control-ling sulfur dioxide emissions is today only abouthalf of what analysts initially pre-dicted, and it is heading lower. Witha focus on innovation and resourceproductivity, today’s compliancecosts represent an upper limit.

There is legitimate controversyover the benefits to society of specif-ic environmental standards. Measur-ing the health and safety effects ofcleaner air, for example, is the subject of ongoingscientific debate. Some believe that the risks of pol-lution have been overstated. But whatever the levelof social benefits proves to be, the private costs tocompanies are still far higher than necessary.

Good Regulation Versus BadIn addition to being high-cost, the current system

of environmental regulation in the United Statesoften deters innovative solutions or renders themimpossible. The problem with regulation is not itsstrictness. It is the way in which standards are writ-ten and the sheer inefficiency with which regula-tions are administered. Strict standards can andshould promote resource productivity. The UnitedStates’ regulatory process has squandered thispotential, however, by concentrating on cleanupinstead of prevention, mandating specific technolo-gies, setting compliance deadlines that are unreal-istically short, and subjecting companies to unnec-essarily high levels of uncertainty.

The current system discourages risk taking andexperimentation. Liability exposure and the govern-ment’s inflexibility in enforcement, among otherthings, contribute to the problem. For example, acompany that innovates and achieves 95% of targetemissions reduction while also registering substan-tial offsetting cost reductions is still 5% out ofcompliance and subject to liability. On the otherhand, regulators would reward it for adopting safe

but expensive secondary treatment. (See the insert“Innovation-Friendly Regulation.”)

Just as bad regulation can damage competitive-ness, good regulation can enhance it. Consider thedifferences between the U.S. pulp-and-paper sectorand the Scandinavian. Strict early U.S. regulationsin the 1970s were imposed without adequate phase-in periods, forcing companies to adopt best avail-able technologies quickly. At that time, the re-quirements invariably meant installing proven butcostly end-of-pipe treatment systems. In Scandi-navia, on the other hand, regulation permittedmore flexible approaches, enabling companies tofocus on the production process itself, not just onsecondary treatment of wastes. Scandinavian com-

panies developed innovative pulping and bleachingtechnologies that not only met emission require-ments but also lowered operating costs. Eventhough the United States was the first to regulate,U.S. companies were unable to realize any first-mover advantages because U.S. regulations ignoreda critical principle of good environmental regula-tion: Create maximum opportunity for innovationby letting industries discover how to solve theirown problems.

Unfortunately for the U.S. pulp-and-paper indus-try, a second principle of good regulation was alsoignored: Foster continuous improvement; do notlock in on a particular technology or the status quo.The Swedish regulatory agency took a more effec-tive approach. Whereas the United States mandatedstrict emissions goals and established very tightcompliance deadlines, Sweden started out withlooser standards but clearly communicated thattougher ones would follow. The results were pre-dictable. U.S. companies installed secondary treat-ment systems and stopped there. Swedish produc-ers, anticipating stricter standards, continuallyincorporated innovative environmental technolo-gies into their normal cycles of capacity replace-ment and innovation.

The innovation-friendly approach produced theresidual effect of raising the competitiveness of thelocal equipment industry. Spurred by Scandinaviandemand for sophisticated process improvements,local pulp-and-paper-equipment suppliers, such as


Bad regulation is damaging tocompetitiveness, but the right

kind of regulation can enhance it.

Sunds Defibrator and Kamyr, ultimately made ma-jor international gains in selling innovative pulpingand bleaching equipment.

Eventually, the Scandinavian pulp-and-paper in-dustry was able to reap innovationoffsets that went beyond those di-rectly stemming from regulatorypressures. By the early 1990s, pro-ducers realized that growing publicawareness of the environmentalproblems associated with pulp-milleffluents was creating a niche mar-ket. For a time, Scandinavian compa-nies with totally chlorine-free paperwere able to command significantprice premiums and serve a rapidly growing marketsegment of environmentally informed customers.

Implications for Companies Certainly, misguided regulatory approaches have

imposed a heavy burden on companies. But man-agers who have responded by digging in their heelsto oppose all regulation have been shortsighted aswell. It is no secret that Japanese and German auto-mobile makers developed lighter and more fuel-efficient cars in response to new fuel consumptionstandards, while the less competitive U.S. car in-

dustry fought such standards and hoped they wouldgo away. The U.S. car industry eventually realizedthat it would face extinction if it did not learn tocompete through innovation. But clinging to the

static mind-set too long cost billions of dollars andmany thousands of jobs.

To avoid making the same mistakes, managersmust start to recognize environmental improve-ment as an economic and competitive opportunity,not as an annoying cost or an inevitable threat. In-stead of clinging to a perspective focused on regula-tory compliance, companies need to ask questionssuch as What are we wasting? and How could weenhance customer value? The early movers – thecompanies that can see the opportunity first andembrace innovation-based solutions–will reap ma-jor competitive benefits, just as the German and


Innovating to Be Competitive: The Dutch Flower Industry

The Dutch flower industry is responsible for about65% of world exports of cut flowers – an astonishingfigure given that the most important production in-puts in the flower business would seem to be land andclimate. Anyone who has been to the Netherlandsknows its disadvantages on both counts. The Dutchhave to reclaim land from the sea, and the weather isnotoriously problematic.

How can the Dutch be the world’s leaders in theflower business when they lack comparative advan-tage in the traditional sense? The answer, among otherreasons, is that they have innovated at every step inthe value chain, creating technology and highly spe-

cialized inputs that enhance resource productivity andoffset the country’s natural disadvantages.

In selling and distribution, for example, the Nether-lands has five auction houses custom designed for theflower business. Carts of flowers are automaticallytowed on computer-guided paths into the auctionroom. The buying process occurs in a few seconds.Buyers sit in an amphitheater, and the price on theauction clock moves down until the first buyer signalselectronically. That buyer’s code is attached to thecart, which is routed to the company’s shipping andhandling area. Within a few minutes, the flowers areon a truck to regional markets or in a specialized, pre-

German and Japanese carmakers captured early-mover

advantages, but U.S. car makerschose to fight regulations.

Japanese car makers did. (See the insert “The NewEnvironmentalists.”)

At this stage, for most companies, environmentalissues are still the province of outsiders and special-ists. That is not surprising. Any new managementissue tends to go through a predictable life cycle.When it first arises, companies hire outside expertsto help them navigate. When practice becomesmore developed, internal specialists take over. Onlyafter a field becomes mature do companies inte-grate it into the ongoing role of line management.

Many companies have delegated the analysis of environmental problems and the development ofsolutions to outside lawyers and environmental

consultants. Such experts in the adversarial regula-tory process, who are not deeply familiar with thecompany’s overall technology and operations, in-evitably focus on compliance rather than innova-tion. They invariably favor end-of-pipe solutions.

Many consultants, in fact, are associated withvendors who sell such technologies. Some compa-nies are in the second phase, in which environmen-tal issues are assigned to internal specialists. Butthese specialists – for example, legal, governmen-tal-affairs, or environmental departments–lack fullprofit responsibility and are separate from the lineorganization. Again, the result is almost alwaysnarrow, incremental solutions.

If the sorts of process and product redesigns need-ed for true innovation are even to be considered,much less implemented, environmental strategiesmust become an issue for general management. En-vironmental impact must be embedded in the over-

all process of improving productivityand competitiveness. The resource-productivity model, rather than thepollution-control model, must gov-ern decision making.

How can managers acceleratetheir companies’ progress toward amore competitive environmental ap-proach? First, they can measure their

direct and indirect environmental impacts. One ofthe major reasons that companies are not very inno-vative about environmental problems is ignorance.A large producer of organic chemicals, for example,hired a consultant to explore waste reduction op-



cooled container on their way to nearby Schiphol air-port. Good airports and highway systems may be plen-tiful elsewhere, too. But the Netherlands’ innovative,specialized infrastructure is a competitive advantage.It leads to very high productivity. It is so successfulthat growers from other countries actually fly flowersthere to be processed, sold, and reexported.

Paradoxically, having a shortage of general-purposeor more basic inputs can sometimes be turned into anadvantage. If land were readily available and the cli-mate more favorable, the Dutch would have competedthe same way other countries did. Instead they wereforced to innovate, developing a high-tech system of

year-round greenhouse cultivation. The Dutch con-tinually improve the unique, specialized technologythat creates high resource productivity and underpinstheir competitiveness.

In contrast, an abundance of labor and natural re-sources or a lack of environmental pressure may lead a country’s companies to spend the national resourcesunproductively. Competing based on cheap inputs,which could be used with less productivity, was suffi-cient in a more insular, less global economy. Today,when emerging nations with even cheaper labor andraw materials are part of the global economy, the oldstrategy is unsustainable.

Companies that adopt theresource-productivity frameworkwill reap the greatest benefits.

portunities in its 40 waste streams. A careful audituncovered 497 different waste streams–the compa-ny had been wrong by a factor of more than ten.10

Our research indicates that the act of measurementalone leads to enormous opportunities to improveproductivity.

Companies that adopt the resource-productivityframework and go beyond currently regulated areaswill reap the greatest benefits. Companies shouldinventory all unused, emitted, or discarded re-sources or packaging. Within the company, somepoorly utilized resources will be held within plants,some discharged, and some put in dumpsters. Indi-rect resource inefficiencies will occur at the level ofsuppliers, channels, and customers. At the cus-tomer level, resource inefficiencies show up in theuse of the product, in discarded packaging, and inresources left in the used-up product.

Second, managers can learn to recognize the op-portunity cost of underutilized resources. Fewcompanies have analyzed the truecost of toxicity, waste, and what theydiscard, much less the second-orderimpacts that waste and dischargeshave on other activities. Fewer stilllook beyond the out-of-pocket costsof dealing with pollution to the op-portunity cost of the resources theywaste or the productivity they forgo.There are scarcely any companies that think aboutcustomer value and the opportunity cost of wastedresources at the customer level.

Many companies do not even track environ-mental spending carefully, and conventional ac-counting systems are ill equipped to measure

underutilized resources. Companies evaluate envi-ronmental projects as discrete, stand-alone invest-ments. Straightforward waste- or discharge-reduc-tion investments are screened using high hurdlerates that presume the investments are risky– leav-ing ten-dollar bills on the ground. Better informa-tion and evaluation methods will help managers reduce environmental impact while improving re-source productivity.

Third, companies should create a bias in favor ofinnovation-based, productivity-enhancing solu-tions. They should trace their own and their cus-tomers’ discharges, scrap, emissions, and disposalactivities back into company activities to gain in-sight about beneficial product design, packaging,raw material, or process changes. We have beenstruck by the power of certain systems solutions:Groups of activities may be reconfigured, or substi-tutions in inputs or packaging may enhance utiliza-tion and potential for recovery. Approaches that fo-

cus on treatment of discrete discharges should besent back to the organization for rethinking.

Current reward systems are as anti-innovation asregulatory policies. At the plant level, companiesreward output but ignore environmental costs andwasted resources. The punishment for an innova-



The New Environmentalists

Environmentalists can foster innovation and re-source productivity by speaking out for the right kindof regulatory standards and by educating the public todemand innovative environmental solutions. TheGerman section of Greenpeace, for example, noted in1992 that a mixture of propane and butane was saferfor cooling refrigerators than the then-prevalent cool-ing agents – hydrofluorocarbons or hydrochlorofluoro-carbons–that were proposed as replacements for chlo-rofluorocarbons. Greenpeace for the first time in itshistory began endorsing a commercial product. It ac-tually ran an advertising campaign for a refrigeratordesigned by Foron, a small refrigerator maker on theverge of bankruptcy. The action was greatly leveraged

by extensive media coverage and has been a major rea-son behind the ensuing demand for Foron-builtpropane-butane refrigerators and the switch that theestablished refrigerator producers in Germany latermade to the same technology.

Environmental organizations can support industryby becoming sources of information about best prac-tices that may not be well known outside of a few pio-neering companies. When it realized that Germanmagazine publishers and readers alike were unawareof the much improved quality of chlorine-free paper,Greenpeace Germany issued a magazine printed onchlorine-free paper. It closely resembled the leadingGerman political weekly, Der Spiegel, and it encour-

Resisting innovation will lead to loss of competitiveness in

today’s global economy.

tive, economically efficient solution that falls shortof expectations is often far greater than the rewardfor a costly but “successful” one.

Finally, companies must become more proactivein defining new types of relationships with bothregulators and environmentalists. Businesses needa new mind-set. How can companies argue shrillythat regulations harm competitiveness and thenexpect regulators and environmentalists to be flexi-ble and trusting as those same companies requesttime to pursue innovative solutions?

The World Economy in Transition It is time for the reality of modern competi-

tion to inform our thinking about the relation-ship between competitiveness and the environment.Traditionally, nations were competitive if theircompanies had access to the lowest cost inputs –capital, labor, energy, and raw materials. In indus-tries relying on natural resources, for example, thecompetitive companies and countries were thosewith abundant local supplies. Because technologychanged slowly, a comparative advantage in inputswas enough for success.

Today globalization is making the notion of com-parative advantage obsolete. Companies can sourcelow-cost inputs anywhere, and new, rapidly emerg-ing technologies can offset disadvantages in thecost of inputs. Facing high labor costs at home, forexample, a company can automate away the needfor unskilled labor. Facing a shortage of a raw mate-rial, a company can find an alternative raw materialor create a synthetic one. To overcome high spacecosts, Japanese companies pioneered just-in-time

production and avoided storing inventory on thefactory floor.

It is no longer enough simply to have resources.Using resources productively is what makes forcompetitiveness today. Companies can improve re-source productivity by producing existing productsmore efficiently or by making products that aremore valuable to customers – products customersare willing to pay more for. Increasingly, the na-tions and companies that are most competitive arenot those with access to the lowest-cost inputs butthose that employ the most advanced technologyand methods in using their inputs. Because tech-nology is constantly changing, the new paradigm ofglobal competitiveness requires the ability to inno-vate rapidly.

This new paradigm has profound implications forthe debate about environmental policy–about howto approach it, how to regulate, and how strict regu-lation should be. The new paradigm has broughtenvironmental improvement and competitivenesstogether. It is important to use resources pro-ductively, whether those resources are natural and physical or human and capital. Environmentalprogress demands that companies innovate to raiseresource productivity – and that is precisely whatthe new challenges of global competition demand.Resisting innovation that reduces pollution, as theU.S. car industry did in the 1970s, will lead not onlyto environmental damage but also to the loss ofcompetitiveness in the global economy. Develop-ing countries that stick with resource-wastingmethods and forgo environmental standards be-cause they are “too expensive” will remain uncom-petitive, relegating themselves to poverty.


aged readers to demand that publishers switch to chlo-rine-free paper. Shortly after, Der Spiegel and severalother large magazines did indeed switch. Other envi-ronmental organizations could shift some resourcesaway from litigation to focus instead on funding anddisseminating research on innovations that addressenvironmental problems.

Among U.S. environmental groups, the Environ-mental Defense Fund (EDF) has been an innovator inits willingness to promote market-based regulatorysystems and to work directly with industry. It sup-ported the sulfur-dioxide trading system that allowscompanies either to reduce their own emissions or tobuy emissions allowances from companies that have

managed to exceed their reduction quotas at lowercost. The EDF-McDonald’s Waste Reduction TaskForce, formed in 1990, led to a substantial redesign of McDonald’s packaging, including the elimination ofthe polystyrene-foam clamshell. EDF is now workingwith General Motors on plans to remove heavily pol-luting cars from the road and with Johnson & Johnson,McDonald’s, NationsBank, The Prudential InsuranceCompany of America, Time Warner, and Duke Uni-versity to promote the use of recycled paper.

Source: Benjamin C. Bonifant and Ian Ratcliffe, “Competitive Impli-cations of Environmental Regulation in the Pulp and Paper Industry,”working paper, Management Institute for Environment and Business,Washington, D.C., 1994.

How an industry responds to environmentalproblems may, in fact, be a leading indicator of itsoverall competitiveness. Environmental regulationdoes not lead inevitably to innovation and competi-tiveness or to higher productivity for all companies.Only those companies that innovate successfullywill win. A truly competitive industry is more like-ly to take up a new standard as a challenge and re-spond to it with innovation. An uncompetitive in-dustry, on the other hand, may not be orientedtoward innovation and thus may be tempted tofight all regulation.

It is not at all surprising that the debate pittingthe environment against competitiveness has de-

veloped as it has. Indeed, economically destructivestruggles over redistribution are the norm in manyareas of public policy. But now is the time for a par-adigm shift to carry us forward into the next centu-ry. International competition has changed dramati-cally over the last few decades. Senior managerswho grew up at a time when environmental regu-lation was synonymous with litigation will see increasing evidence that environmental improve-ment is good business. Successful environmental-ists, regulatory agencies, and companies will rejectold trade-offs and build on the underlying economiclogic that links the environment, resource produc-tivity, innovation, and competitiveness.



1. One of the pioneering efforts to see environmental improvement thisway is Joel Makower’s The E-Factor: The Bottom-Line Approach to Envi-ronmentally Responsible Business (New York: Times Books, 1993).

2. Andrew King, “Improved Manufacturing Resulting from Learning fromWaste: Causes, Importance, and Enabling Conditions,” working paper,Stern School of Business, New York University, New York, 1994.

3. Mark H. Dorfman, Warren R. Muir, and Catherine G. Miller, Environ-mental Dividends: Cutting More Chemical Wastes (New York: IN-FORM, 1992).

4. Don L. Boroughs and Betsy Carpenter, “Helping the Planet and the Econ-omy,” U.S. News and World Report 110, no. 11, March 25, 1991, p. 46.

5. John H. Sheridan, “Attacking Wastes and Saving Money...Some of theTime,” Industry Week, February 17, 1992, p. 43.

6. Gerald Parkinson, “Reducing Wastes Can Be Cost-Effective,” Chemi-cal Engineering 97, no. 7, July 1990, p. 30.

7. Stephen J. DeCanio, “Why Do Profitable Energy-Saving Projects Lan-guish?” working paper, Second International Research Conference of theGreening of Industry Network, Cambridge, Massachusetts, 1993.

8. Jan Paul Acton and Lloyd S. Dixon, “Superfund and Transaction Costs:The Experiences of Insurers and Very Large Industrial Firms,” working pa-per, Rand Institute for Civil Justice, Santa Monica, California, 1992.

9. Norman Bonson, Neil McCubbin, and John B. Sprague, “Kraft Mill Ef-fluents in Ontario,” report prepared for the Technical Advisory Commit-tee, Pulp and Paper Sector of MISA, Ontario Ministry of the Environment,Toronto, March 29, 1988, p. 166.

10. Parkinson, p. 30.

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