I asked the question: “Who will pay these higher costs?”
The consensus reaction from my environmentally-concerned LinkedIn friends was: “We all should.” I agree. We all share the responsibility to address the climate challenge.
But now let’s imagine the following scenario.
You are the CEO of XYZ Automaker. You’ve recently pledged to become net-zero by 2050 and get halfway there by 2030. You’ve been encouraged to make this commitment by your employees, some important shareholders, environmentalists, and family members. XYZ’s marketing team advises that this move will please sustainability-minded customers too. You like the idea of XYZ being viewed as a leader in this important area.
Now it’s time to get to work. You’ve got an ambitious EV strategy underway and you’ve already taken the easy and low-cost steps to decarbonize. Now you ask your team to identify what’s next.
- The Procurement Department reports on the zero-carbon steel alternative, as well as the 30–60% higher price tag.
- The Operations Team presents some options on how to source more clean energy, but it too requires premium pricing.
- Your Sustainability Crew summarizes options for purchasing carbon removal credits, which XYZ will need, since you can’t lower emissions substantially overnight. Another hefty expense.
- And so on.
“Wait a minute,” you say to your team, “I was told this would be ‘win-win.’ If we can’t pass all of these additional costs on to customers — and I don’t see how we can while remaining competitive — profit margins will be hurt badly.”
“Maybe we can jam our steel suppliers a bit and get them to share the extra cost of low-carbon steel,” one team member suggests.
“Pressure tactics won’t work with purchases of carbon credits,” says your CFO.
“I wonder whether this will satisfy our ESG-minded shareholders?” asks your Head of Investor Relations.
You agree. “Right. Will those investors pay a higher multiple for our stock when we do what they say they want? Because if they don’t, and if our profitability goes down with these new costs, our stock price is headed down too.”
Your Chief of Staff suggests you discuss all of these challenges at your upcoming Board meeting. You remember that your own performance evaluation is based on Return on Equity targets that have been out of reach recently, even before these new costs.
The meeting adjourns, everybody leaves, you’re alone in your office and think, “It’s tough to be a CEO.”
It is lonely at the top. But this type of scenario — where the theoretical commitment to ESG conflicts with the harsh reality of the costs — plays out for everyone involved.
- The institutional investor leading a big ESG equity fund who has warned that they may dump the stock of non-compliant companies . . . and is now asked to remain a supportive shareholder in the face of lower profit margins.
- The environmental consumer who is mindful of her carbon footprint and votes for representatives with strong climate policies . . . and then faces a much higher price tag when they need a new XYZ car.
- The employee at XYZ who asked about ESG in his job interview and continued to push the company to take the net-zero pledge . . . and now learns that bonuses will be lower this year due to reduced company profitability.
Getting back to our XYZ CEO, a philosophical view about what society should or shouldn’t do doesn’t really help. Without a real plan to manage or pass on most of these new costs, he is likely to back away from decisive and difficult action now. The company may stick with the bold announcement about 2050 — after all, it’s a long way off. They might also talk in broad ways about how XYZ will decarbonize over time. But will there really be meaningful progress in the near term?
An urgent issue to solve then is identifying how to pay for the likely costs of decarbonization.
Can’t we turn to the government?
Of course better public policy would address much of this problem. Everybody — i.e., taxpayers — would bear the costs.
For example, a high and rising price on carbon would do so much good. Carbon polluters would pay dearly for fossil fuel use. Clean energy would be more cost competitive. Increased demand across the board for lower-carbon alternatives would reduce costs and increase incentives for new technologies and innovations.
Alas, such policy seems highly unlikely in the near term. There is no evidence of majority political support in any of the big emitter countries for a carbon tax.
I think we should keep trying to price carbon. But in the meantime, we can and should lobby for other policies (see below) that will encourage decarbonization.
So what should net zero-pledging CEOs do in the meantime?
The initial moves are fairly straightforward, not very difficult, and broadly well-understood.
- Conduct an audit of your emissions; figure out how ambitious you are about reducing them, and declare your goals.
- Join a net-zero coalition like the Science Based Target initiative.
- Get started.
But it’s how you plan for what’s next — when you’ve picked the low-hanging fruit and need to start spending big money to decarbonize — that will really matter.
- Identify the range and cost of the next identifiable near-term emission reductions opportunities and carbon removal options.
- Determine how much you can afford to spend.
If you’re a very profitable and not-carbon intensive company like Microsoft, then you can probably afford to just get going.
But if you’re in a commodity business with lower margins — and especially if they are cyclical — you likely won’t always be able to afford much additional expense.
I suggest that you lock in your commitment by creating a formula that spells out how much and under what conditions you would spend money on decarbonization. For example:
When operating margins are x% or higher, we will spend y% of operating profits on carbon reduction.
Of course, the specifics would vary for every company, and it is a decision that needs to be made carefully. Such transparency would be a big step forward.
- Get very explicit about how you are going to reduce emissions. Help people understand the constraints that you are under, as well as the efforts you are making.
Be upfront that the most appealing options are those that are the lowest cost. If high-quality carbon removal is lower cost than your next incremental decarbonization move, you will likely choose the former over the latter. Such discussion will likely stimulate some new decarbonization and carbon removal ideas.
- Turn to your suppliers who have made net-zero commitments and ask if they can help you address this specific problem and in exchange you will share the credit.
- Look to your customers who are reducing their own carbon footprint — especially other corporations with net-zero commitments — and explain why you need to raise prices, how much of the cost burden you are taking on yourselves, and how you hope you can count on their support.
- Reach out to institutional investors, especially the ESG ones, and ask for advice. Ask them, as shareholders, how far they are telling you to go, given your cost projections. What else do they recommend?
- Finally, most importantly, lobby the government. Let them know if they want you to decarbonize, you need help. Outline specific requests. For example, they could mandate that utilities sell you more clean energy. They could provide tax incentives. They could support research and development in this field. And of course, they could put a price on carbon. Then your net-zero strategy initiative will suddenly be much less disadvantaged.
Please don’t get me wrong. I am all for voluntary net-zero climate commitments by corporations. They are hugely positive. But we can’t rely on voluntary good intentions alone. Here’s a chance for CEOs to distinguish themselves as a straight-shooting, serious decarbonizers. In a world of grand announcements that sometimes lack credibility or are too back-end dated, CEOs can be the leaders who elevate the discussion and make it completely reality-based.
Go get ‘em.