THE NEW ECO-CAPITALISM

When Being Green Puts You in the Black

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By Daniel C. Esty
Sunday, March 4, 2007

Are America's capitalist titans really going green?

This week's announcement that two of the country's largest private equity firms, Kohlberg Kravis Roberts and Texas Pacific Group, will purchase the Dallas-based utility TXU made headlines, and not just because the $45 billion deal represents the largest private equity transaction in history. The even bigger news was the environmental dimension of the takeover proposal. It calls for scaling back construction of new coal-fired power plants, ramping up commitments to wind and solar power, supporting mandatory controls on greenhouse gas emissions and promoting energy efficiency.

One can overdo the hyperbole here, of course. Henry Kravis -- allegedly the model for the 1980s bestseller "Barbarians at the Gate" -- isn't just a Green Knight riding into the Lone Star State to save it from a polluted future. He's a smart businessman who wants to make money. And that is just the point.

This deal shows that we are in the midst of a revolution. Environmental progress no longer depends on hundreds of bureaucrats at the Environmental Protection Agency mandating what piece of pollution-control equipment will be on each smokestack. Government must continue to set standards. But the burden of innovation and technology development will shift to the private sector.

Moving from "command and control" regulations to a market approach to environmental protection means that there will be real costs for pollution -- including a price to be paid for greenhouse-gas emissions -- for every business. But these costs sharpen the economic incentives for pollution control research and development, and create big opportunities for companies that come up with solutions for society's environmental problems.

At the recent World Economic Forum in Davos, Switzerland, CEOs fell over one another stepping up to the issue of climate change. Companies large and small are redoubling their environmental efforts in the face of Wal-Mart's demands that its suppliers reduce waste and improve energy efficiency. Billions of dollars of venture capital are flowing into alternative energy and pollution control technology. Leading companies -- call them "WaveRiders" -- have begun to fold environmental thinking into their corporate strategies.

They recognize that we face a carbon-constrained future. While the Bush administration remains opposed to the emissions limits of the Kyoto Protocol, the European Union has imposed greenhouse-gas-reduction obligations on its industries and set up a carbon market to facilitate cost-effective implementation of these requirements. Dozens of American states have likewise taken action in response to the threat of climate change. In fact, five Western states, following the lead of California Gov. Arnold Schwarzenegger, announced plans last week to set up their own system for trading carbon emissions. And more than 400 U.S. mayors have committed their cities to emissions-reduction targets.

The next U.S. president is almost certain to bring the nation back into climate-change negotiations and commit to a "beyond Kyoto" set of greenhouse gas reductions.

With the prospect that carbon emissions will soon bear a price -- and perhaps an escalating one -- the decision by the new owners of TXU to steer away from a focus on carbon-intensive coal-based power makes good business sense. In fact, leading-edge companies nationwide are factoring in carbon charges and thus higher prices for burning fossil fuels into their business planning models. This new approach has several important implications. By making companies pay for every increment of pollution, society puts an economic premium on vigorous environmental effort, and forces executives to make pollution control and management of natural resources a core part of their strategy.

Companies that fail to grasp this point put themselves at competitive risk. Ford Motor Co. teeters on the edge of bankruptcy because it did not spot the public's emerging desire for more fuel-efficient and less-polluting vehicles. At the same time, Toyota reported record profits last year because it put these issues at the center of its design strategy, which includes hybrid engines, "lightweighting" of its vehicles through the use of carbon fiber and other advanced materials, and "smart systems" that use computer power to improve efficiency and performance.

The environmental imperative on business arises not just from tighter regulation, but also from the reality of higher energy costs, shortages of natural resources and pressure from environmentally oriented stakeholders, such as those who shaped the TXU deal. With energy costs rising, an expanded focus on conservation and efficiency will pay off in many areas. From high-efficiency LED lighting to smart appliances and green buildings, opportunities to link information-age technology to environmental challenges abound.

A growing number of companies are finding their business plans pinched by limits imposed by nature. For example, Coca-Cola's ability to sell soft drinks depends on access to water, something that cannot be taken for granted in markets such as India. Today, many companies are operating in communities that care deeply about the environment. And employees increasingly want to work for companies that have good environmental records in line with their values. Top corporate leaders recognize that environmental issues represent more than a set of regulations to follow or costs to bear. There are enormous profit opportunities for companies that respond to climate change, water shortages, air pollution and other problems. Jeffrey Immelt, chairman and chief executive of General Electric Co., for example, is selling off his plastics business to focus on high-growth, high-margin environmental goods and services, such as more efficient jet engines, wind power, solar energy and water purification.

This new approach to environmental progress has several important implications. By making companies pay for every increment of pollution, society puts a premium on vigorous environmental effort and forces executives to make pollution control and natural resource management a core part of their strategy. So KKR and TPG have most certainly have not gone soft. The masters of the universe have not given in to greenmail in a fit of political correctness. To the contrary, they are super-sophisticated business people who have learned that success in the marketplace now depends on getting corporate environmental strategy right.

daniel.esty@yale.edu

Daniel C. Esty is the Hillhouse Professor at Yale University and the co-author, with Andrew Winston, of "Green to Gold: How Smart Companies Use Environmental Strategy to Innovate, Create Value, and Build Competitive Advantage" (Yale University Press).


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