The limits of linear consumption
Recently, many companies have also begun to notice that this linear system increases their exposure to risks—most notably higher resource prices and supply disruptions. More and more businesses feel squeezed between rising and less predictable prices in resource markets on the one hand and high competition and stagnating demand for certain sectors on the other. The turn of the millennium marked the point when real prices of natural resources began to climb upwards, essentially erasing a century’s worth of real price declines [Figure 1].
Figure 1: Sharp price increases in commodities since 2000 have erased all the real price declines of the 20th century
McKinsey Commodity Price Index (1)
Index: 100 = years 1999–2001 (2)
1 Based on the arithmetic average of four commodity sub-indexes: food, non-food agricultural items, metals, and energy.
2 Data for 2013 are calculated based on the average of the first three months of 2013.
Source: Grilli and Yang; Pfaffenzeller; World Bank; International Monetary Fund; Organisation for Economic Cooperation and Development (OECD) statistics; Food and Agriculture Organization of the United Nations (FAO); UN Comtrade; McKinsey Global Institute analysis
At the same time, price volatility levels for metals, food and non-food agricultural output in the first decade of the 21st century were higher than in any single decade in the 20th century.2 If no action is taken, high prices and volatility will likely be here to stay if growth is robust, populations grow and urbanize, and resource extraction costs continue to rise. With three billion new middle-class consumers expected to enter the market by 2030, price signals may not be strong or extensive enough to turn the situation around fast enough to meet this growth requirement.
Other trends indicate that the power of the linear model is reaching its limits:
- In modern manufacturing processes, opportunities to increase efficiency still exist, but the gains are largely incremental and insufficient to generate real competitive advantage or differentiation.
- An unintended consequence of eco-efficiency has been accelerating energy use and resource depletion due to the rebound effect which has negative impacts when improvements to energy and resource efficiency drive increases in the real amounts of materials and energy used.3
- Agricultural productivity is growing more slowly than ever before, and soil fertility and even the nutritional value of foods are declining.
- The risk to supply security and safety associated with long, elaborately optimized global supply chains appears to be increasing.
- Many production sites with excessive requirements for virgin resources—water, land or atmosphere— are struggling to renew their licence to operate as they compete in sensitive local resource markets.
Against this backdrop, business leaders are in search of a ‘better hedge’ and many are moving towards an industrial model that decouples revenues from material input: the circular economy.4 Analysis of circular setups in manufacturing in Europe shows that the longer-term benefits would be highest in the materials-intensive automotive, machinery, and equipment industries.5 One of the early adopters of the circular economy in the automotive industry is the French car maker Renault.
Renault, has adopted circular principles across their business. The following examples illustrate the kind of operational changes they have made, and the economic benefits realised.
- Remanufacturing. Renault’s remanufacturing plant in Choisy-le-Roi near Paris, France, employing 325 people, reengineers different mechanical subassemblies, from water pumps to engines, to be sold at 50 to 70% of their original price, with a one-year warranty. The remanufacturing operation generates revenues of US$ 270 million annually. The company also redesigns components (such as gearboxes) to increase the reuse ratio and make sorting easier by standardizing components. While more labour is required for remanufacturing than making new parts, there is still a net profit because no capital expenses are required for machinery, and no cutting and machining of the products, resulting in no waste and a better materials yield. Renault has achieved reductions of 80% for energy, 88% for water and 77% for waste from remanufacturing rather than making new components.6
- Managing raw material streams. Renault is moving to maintain tighter control of their raw materials by developing ways to better retain the technical and economic value of materials all along the car’s life cycle.
- As well as actively managing a flow of quality materials dismantled from end-of-life vehicles and enhancing actual recycling processes, Renault also adjusts the design specifications of certain parts to allow closed-loop or ‘functional’ recycling. This makes it possible to turn end-of-life vehicles into high-grade materials appropriate for new cars and avoid downcycling.7
- Renault works with recyclers and waste management companies—including a steel recycler and Suez Environnement/Sita—to incorporate end-of-life expertise upfront into product design and provide access to a steady supply of components and materials.8
- Manufacturing service improvement. Across their supply chain, Renault has identified areas to work with suppliers to realise more circular benefits, which would be shared between Renault and their suppliers. For example, Renault has worked with their cutting fluid supplier to shift from a traditional purchase transaction to a service model. Previously, Renault bought the cutting fluids for their machining centres as a standing order from the manufacturer, but serviced the fluids in-house. The cutting oil had to be changed frequently due to impurity and incurred significant waste. Inspired by previous successes with circular principles, Renault asked the supplier to provide maintenance services for the cutting equipment, including fluids, supply and waste disposal. The manufacturer’s engineers went back to the lab, redesigned the fluid and usage process, and extended Renault’s usage period to a full year, yielding a total cost of ownership reduction of 20%. This saving also does not yet take into account the avoided cost for upgrading the waste water treatment plant given that the full fluid service leads to a reduction of 90% of the discharge volume of the plant for this particular function. The supplier was able to turn a commodity product into a differentiated solution to capture the first-mover advantage and lock in a service contract with Renault.9
- Access-over-ownership business model. Renault became the first car maker to lease batteries for electric cars to help retain the residual value of electric vehicles (to encourage higher consumption) and make batteries fully traceable, ensuring a high collection rate for closed-loop reengineering or recycling.
In the words of Philippe Klein, Renault’s Executive Vice President, Product Planning, Programs & Light Commercial Vehicle Division:
“The circular economy now impacts our business in a positive way. The peaks in raw material costs, similar to those experienced in 2004 (when steel price rose 40% in one year) have had a serious impact on production costs. It is extremely difficult to price this volatility, as it does not represent an immediate functionality for the customer. Therefore, closed- loop recycling is an important lever of risk management for the company. Another example is re-manufacturing of parts: the profitability of Choisy le Roi is far higher than the average profitability of Renault’s industrial sites. If you look at Choisy as an individual business unit, the business model is already very profitable.”10