Trapped in the linear lock-in
- Aligned incentives occur when individual or short-term choices result in optimal solutions for the system or in the long term. Changes nearly always need to happen at a systems-wide level along the entire supply loop or product usage cycle to establish circular setups. When these cycles are fragmented among many players externally along the globally dispersed value chain and internally among the departments in charge of providing services and product delivery to customers, misaligned incentives often result in the inability to create, capture and redistribute value.
- Customers and users often only evaluate the transactional costs at the point of sale (i.e. the price of the purchase), even if the net present value of upgrading to a more expensive but longer-lasting product at lower usage costs would be more economical. Giving such users additional incentives to adopt alternative models (such as trials, or adjusted fee models) can tip the scales in favour of the product with the better total cost of ownership.
- Within companies, establishing more circular business models still depends on navigating incentive misalignments, which often stem from conflicts of interest and engrained habits. Frequent internal issues include fear of cannibalization, or the higher capital and cash required to change a product design and move from a sales-based to a usage-based model without transfer of ownership. The need to create an integrated reverse supply chain is also an issue (including incentives for users to return products to the company), and companies worry about simplifying designs and limiting product variants to achieve scale. One of the biggest concerns for Ricoh’s management before launching GreenLine was the potential cannibalization of new products. The GreenLine team put together a control plan in addition to the business case to carefully monitor the sales development of new and GreenLine products to ensure optimal coverage of the different customer segments.95 Simplifying materials variants (even when complexity is mostly driven by legacy systems) is challenging as it usually involves major changes to processes, and sometimes regulatory approval or consumer acceptance.96
- Along supply chains, it is hard to share the benefits. How can a manufacturer divide out the gains from an optimized design or reduced number of materials at the start of the chain, if these are changes that ultimately increase the end-of-use value of the finished product? Consider returnable bottles. Store owners generally opt for less materials-productive one-way systems to maximize floor space capacity, which promises higher sales from a wider product range. The beer industry has experienced a noticeable drop in the share of returnable bottles systems in Europe, from about half of the bottle use in 2007 to a third in 2012 in some markets. In mature markets, this decline is expected to continue and to reduce the bottle system’s gross margin significantly, unless some proactive steps are taken. SABMiller believes that while the closed loop bottling system is under pressure, strategic shifts could see returnable bottle thrive in a future circular economy.97 Misaligned incentives across the value chain are the key driver of the decline. Both external and internal factors contribute, including store keepers’ inclination to free up more sales space for linear-based business opportunities, assumed consumer needs (the perception that one-way bottles convey a more premium image), and marketing’s preference for one-way bottles to differentiate products.
- Across geographies and political borders, a strong case can often be made for investing in regional remanufacturing capabilities that enable job creation and re-industrialization in local communities. However, this would also often lead to lower economic output in the exporting countries that engage in primary manufacturing. At the macro level, the circular economy setup therefore needs to balance the benefits for different geographies. The number of new units shipped from manufacturing countries will decrease as more remanufacturing takes place in Europe and North America. To offset this, companies can agree that the remanufacturers will send recycled components and raw materials to the manufacturers (taking advantage of the low return shipping costs [Figure 16]). This loop creates materials cost savings for the manufacturers. In addition, closing local loops in manufacturing countries such as China and Brazil would generate the economic arbitrage opportunities outlined in the previous section, because these economies have grown into such strong consuming economies.
- Markets of scale are at the heart of the current inbound production process for products and services, and the continuous reconfiguration of their sophisticated, efficient and responsive multi-tier supplier networks. These markets create value because they are transparent and able to provide robust streams of materials, components and products reliably and respond quickly to fluctuations in demand. However, such ‘industrial-scale’ markets do not yet exist for many materials suitable for reverse cycles, making it hard or impossible for companies to secure quality-controlled and reliable secondary materials and components to complement or replace primary stock.
- Reverse cycle infrastructure and logistics capabilities are essential to close the geographic imbalance between points of (re-)manufacturing and usage. The setup needs to ensure that costs do not eliminate the positive arbitrage opportunities embedded in the difference between recovered and virgin materials, components and products. In the linear take-make-dispose economy, last-mile transport to landfills and incinerators is historically often local, with little or no ability to sort and handle different types of materials carefully enough to maintain quality and purity at scale. Only a few integrated industrial players such as Veolia and Waste Management have emerged so far with the geographic reach and capabilities to improve reverse cycle flows across multiple product or materials classes.
- Enablers are needed in many areas to pave the way for new circular business models. Boundary conditions are one such example (e.g. regulation), or funding and sufficient transparency on opportunities. Many companies have adopted access-over-ownership business models to appeal to the new consumer mindset and profit from using idle capacity in the economy. Among the best known are Airbnb, Lyft, Zipcar, Renault’s Twizzy battery rental scheme, and Philips’ Pay Per Lux business model. However, current support services and regulations often lag behind. Pioneers of circular business models have faced difficulties in raising sufficient funds as a result, or sometimes run into problems with local authorities. Desso has found it difficult to convince financial institutions to finance their carpet leasing model, as carpet tiles are generally considered to belong to the building materials segment. This has low residual value after five, seven or ten years of use, and does not take into account the materials value after end-of-use.98
The list of leakages and barriers to accelerating the scale-up of the circular economy is long, and some will be tough to resolve. But none are insurmountable, and solutions seem to lie this side of the technology frontier. Aspects of geographic dispersion, materials complexity/proliferation and systems lock-in have all been dealt with successfully, at least in part. International standards for materials have been defined and adopted. Systems transition to supply/delivery and reverse logistics aligned to the principles of the circular economy can commence once the hinge points have been identified and acted upon. The next chapter describes which hinge points would benefit from a concerted effort—across companies, along the supply chain and across geographies.