These interventions will drive value in a Net Zero economy

Regarding the advice BRPs provide clients, they are always trying to think like a chess player and plan four or five moves ahead. In this game, you have to think bigger than your next move.

Much literature has been written about South Africa’s current economic growth challenges, which are being hamstrung by an underperforming power utility. While it seems like these challenges are never-ending, this too shall pass.

Once the Energy Crisis has been resolved, South Africa will need to accelerate its Net Zero commitments. Where is the value creation sweet spot in a Net Zero economy? How will this impact value creation, productivity and financial distress? If BRPs approach this from a business turnaround point of view, specific interventions can be made to ensure a smooth transition.

Push ahead on value creation with vision and ambition

The McKinsey article points out that the volatile economic environment in many regions makes it even more important for companies to orient their sustainability agendas around value creation in nascent or fast-growing markets. The advantage of being an early mover in these new markets is that companies can solidify pole position for offering low-carbon goods and build out production capacity before latecomers enter the market. However, being early to segments with growth potential often requires vision and ambition.

Consider a tier-one automotive supplier that set out to be a first-choice supplier for leading automotive OEMs looking to decarbonize. The supplier needed to offer a set of zero-carbon products at a competitive cost to do so. Executing this agenda has required the company to build leading capabilities in tracking and verifying the carbon content of the materials and components it procures, finding new suppliers, and utilizing carbon as a new element in product design. By investing in these areas, the company now has industry-leading capabilities in enabling Scope 3 emissions reductions. (Scope 3 emissions are indirect emissions that arise across a company’s value chain.)

Integrate cost and carbon reductions

The McKinsey research shows that the companies that fared well coming out of the 2007–08 financial crisis systematically invested in improving the cost competitiveness of their core offerings. In many cases, that means driving down the cost of goods sold (COGS). To date, lowering COGS has often been considered at odds with reducing a product’s carbon footprint. However, through our work with leading companies across sectors, we are now seeing that a trade-off between cost and carbon reductions is often not required.

Companies in chemicals, pulp and paper, oil and gas, metals, and other process industries are going after the dual benefit of cost and carbon reductions by improving energy efficiency and process yields, as well as by shifting to lower-carbon raw materials and feedstocks where possible. Manufacturing companies are addressing the same challenge by making changes in design, material specifications, and supply chain choices. Energy efficiency and yield improvements are not new strategies, but with higher energy prices, the value of investing in these areas has increased. In addition, sophisticated analytics tools have unlocked even more potential for dual savings.

The article points out that, in one example, a leading paper and packaging player set out to reduce energy costs and direct emissions at its largest mill. The company deployed engineering solutions such as heat integration and steam optimization to reduce energy consumption, as well as advanced analytics to track it. The paper player found an opportunity to reduce its energy costs by 10% to 16% and reduce direct emissions by 12%. With many industrial players still facing relatively high energy prices, such energy efficiency opportunities are abundant. In Europe, for example, we estimate that energy-intense industries could create anywhere from €3 billion to €12 billion in value by deploying energy efficiency measures such as advanced analytics. In a different case, a speciality chemicals player is looking to combine cost and carbon reductions in a systematic and highly aspirational sustainable raw-material program. The company has identified a pathway to reduce more than half of its emissions by 2050 while reducing up to hundreds of millions in costs annually.

Such approaches can come with added benefits down the line. Companies that build carbon reduction competencies across the organization or lock up the scarce supply of low-carbon raw materials and components can gain a longer-term edge in the marketplace.

Create customer partnerships to be an early winner in the market

The article points out that, in the current economic cycle, companies in competitive markets may feel a slowdown in their order books and tougher competition for deals. In turn, sales organizations work harder to fill the order pipelines, and pricing decisions become difficult.

Meanwhile, for companies that have unique, zero-carbon product offerings, there are opportunities to gain market share. One way to do this is by signing up partners through offtake agreements—that is, agreements for customers to purchase all or a substantial part of the output. Offtake agreements can help solidify an early and disproportionate share of demand in more nascent markets, and the income can be invested into scaling further capacity. In some cases, partnerships can also help companies earn a price premium. Such steps may require some market shaping to maximize impact.

The article adds that calls for offtake commitments are often made at the very top through CEO-to-CEO dialogue. Offtake agreements can also be a strategic advantage for the customer, as the customer can lock in a supply of early-to-market goods and services ahead of the competition. Once partnerships with off-takers are born, partners can build business ecosystems for the value chain that will allow the category to grow (bringing together raw-material suppliers, technology partners, or regulators, for example). Players who create top-level relationships with their potential customer and partner base ahead of others could have a head start on capturing value from their green offerings.

Companies that produce sustainable goods can also earn green price premiums through product differentiation. What we have learned recently is that green premiums can vary based on a product’s carbon credentials—that is, a zero-carbon offering may earn a higher premium than a lower-carbon one. We have seen this play out in metals: lower-carbon aluminium has been on the market for some time, but the price delta compared with traditional aluminium has been negligible. On the other hand, zero-carbon or green steel has earned a clear price premium compared with any other type of steel.

Update the portfolio to secure profitable growth

Companies that are generating profits with legacy, higher-emissions businesses could face a conundrum: Should they hold on to the legacy business to help finance greener investments or pull out of the legacy business proactively?

The McKinsey analysis shows that companies that came out the strongest from the 2007–08 financial crisis were the ones that divested early and then acquired businesses ahead of others. With this in mind, our perspective is that now is the time for companies to take stock of their portfolios with a focus on the long-term outlook of each business. If there is an opportunity to improve the overall growth of the portfolio by rotating out some businesses that are facing diminishing returns due to their carbon emissions, and adding businesses that are propelled by sustainability tailwinds, there may be no reason to hold back.

For instance, over the past two decades, NextEra Energy moved out of its thermal-generation portfolio and became a leader in renewable power (in 2020, the company closed its last coal plant in Florida). NextEra is also investing in clean fuels, hydrogen, and battery storage—forms of on-demand, dispatchable generation that can support wind and solar power, which are non-dispatchable. NextEra’s subsidiary, Florida Power & Light, plans to convert all of its remaining 16 gigawatts of thermal generation to clean fuels or hydrogen generation while driving value to investors and leading the industry in returns and market cap.

The article adds that the potential value of gearing portfolios toward low-carbon businesses can also be seen at the sector level. A McKinsey review of chemicals companies, for example, revealed that green leaders—companies with both greener product portfolios and exposure to end markets associated with sustainability, including electric vehicles and energy storage—see two to three times higher total shareholder returns compared with laggards.

Additionally, in light of higher interest rates, capital cost is becoming an increasingly important factor. For example, research by the University of Oxford suggests that low-carbon electric utilities in Europe have a lower cost of capital than peers with higher-emission portfolios. As the net-zero transition continues, executives can look for opportunities in industries where capital costs are evolving.

Build and scale new green businesses

The McKinsey research suggests that companies that built new businesses in the last economic downturn outperformed peers by 10% during the crisis and 30% through the cycle. These companies took out their magnifying glasses, identified pockets of growth, and positioned themselves to take advantage. They anticipated market needs and allocated money to accelerate innovation.

It should not come as a surprise that the net-zero transition is creating several pockets of growth. The growing demand for low-emission products, in part propelled by corporate emission reduction commitments, is creating opportunities for commercial scaling of a wide range of climate technologies and related services. This demand is further supported by major regulatory initiatives. For example, last year’s Inflation Reduction Act in the United States allocated about $370 billion for climate and energy spending. Multiple policy packages under the umbrella of the European Green Deal, including the recent Green Deal Industrial Plan, promise to further accelerate the region’s shift toward a net-zero economy by facilitating faster access to funding. Similar to previous regulatory programs—such as early offshore wind auctions in the United Kingdom, the German feed-in tariff scheme for renewables, and California’s Low Carbon Fuel Standard—these policy packages are setting the stage for companies looking to scale a wide range of zero-carbon technologies and processes, as well as drive down costs.

The article adds that while the climate technology space has largely been known for its start-ups, such as Northvolt, we are already seeing encouraging examples of incumbents tapping into green business building. A German multibillion-dollar revenue technology group has announced that by 2030, new climate technology areas such as hydrogen electrolysers will account for 70% of its business. In Asia, an Indonesian mining company is planning to cut income from coal by 50% while investing hundreds of millions in renewable energy and build an electric-vehicle ecosystem in the country.

In taking on green business building, incumbents are still challenged by start-ups with a DNA of innovation and ambition. To scale at the pace that’s often required to reach competitive cost levels, incumbents will likely need to push themselves beyond their comfort zone.11 When getting started, companies should avoid fragmentation of efforts and investments and resist the tendency to maximize cost synergies between the core and growth businesses. For some, a way to steer clear of these pitfalls has been to bring in external investors to the growth ventures. This type of setup provides a scaling experience that many incumbents lack and forces governance that’s arm’s length from the core business.

Execute at digital speed to create competitive distance

The article points out the advantages of being first or early to market with low-carbon offerings. Companies that execute quickly and effectively can capture the largest green premiums, bring costs down faster to earn higher margins and reap the capital expenditure benefits from getting projects done faster.

Executing at high speeds is often more familiar to digital players. Commercializing green technologies typically requires significant investments in physical assets, which isn’t required for software development or digital engineering. Still, green business builders can learn lessons from successful digital scale-ups.

Executing the actions laid out in this article at digital speed takes both the right mindset and the right capabilities. Companies can consider a few approaches:

• Reducing costs and carbon at speed first requires an honest analysis of the trajectory of current emission reduction activities compared with the trajectory required to meet customer demands or net-zero commitments. Companies can then move with urgency to collaborate with suppliers and partners that can help the company meet both their cost and carbon reduction goals;
• Being fast in forging partnerships to gain market share is, first and foremost, about being in the right executive-level discussions with potential partners in the early stages of business building. The early dialogues provide an opportunity to shape the value proposition before all parameters on the product side have been locked in;
• The speed of portfolio rotation is contingent on the availability of buyers and sellers and converging views on valuations. That said, players with a well-anchored portfolio strategy and serial M&A capabilities are likely to find it easier to execute at pace. For them, the decision-making related to each deal can focus on the specifics of the transaction at hand rather than a comprehensive debate on whether it is beneficial to exit or enter a certain business or what the true market potential of that business is; and
• Companies that have built and scaled green businesses successfully—and quickly—tend to take a series of key actions. They lead with game-changing ambition, sign up captive demand before scaling, and often build capacity with parallel scaling. For digital start-ups, the funding dynamics often force leaders to challenge conventional wisdom about how quickly an investment project can be planned, engineered, and executed or how quickly a new concept can be turned into a product available for customers. Whether start-ups or incumbents, green business builders could start with such a mentality.

A reset is needed

The past few years have highlighted that corporate leadership needs to undergo a significant reset regarding the mindset that develops the strategy that runs businesses in the current corporate environment.

Moving towards Net Zero will require another reset in thinking as a more collaborative environment will drive value creation. The communication value chain needs to include creditors, employees and clients. While companies have paid significant attention to this in the past, we may be moving towards an environment where companies are not only creating an environment that enhances the customer journey but an inclusive environment where the KPIs of creditors need to carry equal weight.