Business and environmental drivers of return on natural resources
Article based on research by Tobias Hahn & Frank Figge
More than two decades after the concept of sustainable development was first adopted in the field of management scholarship, there is a growing consensus that firms depend on natural resources and well-functioning ecosystems to generate long-term profits.
Yet despite the magnitude of sustainability-related challenges, few studies address the question of how well firms perform in terms of their usage of natural resources. New research from Esade’s Tobias Hahn and co-author Frank Figge addresses this gap: they explain how business and environment-related firm activities influence the use of natural resources.
Financial performance versus environmental performance
Until now, much of the existing research on the relationship between firms and the natural environment focused on explaining and enhancing financial performance rather than environmental performance. As natural resources are increasingly depleted, private firms are called to strategically manage their use of natural resources. However, few studies examined the use of natural resources at firm level.
In ‘Business and environment-related drivers of firms' return on natural resources’, published in Long Range Planning, Hahn and Figge focus on explaining environmental performance. They explain firms’ return on natural resources, i.e., how much profit a firm creates per unit of natural resources it uses. Using a conceptual model, they identify four comparative advantages in four distinct configurations to explain above-market levels of return on natural resources.
The four comparative advantages are:
- Profitability advantage: How much more profit per economic capital used does the firm achieve?
- Sales advantage: How much more profit per sales does the firm achieve?
- Green utilisation advantage: How much more sales per natural resource use does the firm achieve?
- Green technology advantage: How much more capital per natural resources use does the firm invest?
The model shows how unique combinations of these four advantages result in four configurations that drive firms’ return on natural resources: business-driven, capital-driven, volume-driven, and environment-driven. The authors apply their model to assess the carbon performance in the car manufacturing sector worldwide.
- In the business-driven configuration firms achieve above-market levels of return on natural resources through outstanding financial performance in terms of high sales margin and return on capital. This configuration is solely based on strong business advantages. For instance, Hyundai’s carbon performance 2011-2014 was marked by a business-driven configuration.
- By contrast, with the environment-driven configuration, firms drive their return on natural resources by excelling with regard to the productive utilisation of natural resources and through investing in green technology. As an example, Renault’s carbon performance in 2016 was based on an environment-driven configuration.
- In the capital-driven configuration, superior levels of return on natural resources stem from high levels of return on capital and strong investments in green technology. Volkswagen’s carbon performance in 2012 was characterised by a capital-driven configuration.
- The volume-driven configuration achieves superior levels of return on natural resources by combining a high sales margin with a productive utilisation of natural resources. Suzuki’s carbon performance 2011-2013 was based on a volume-driven configuration.
All four configurations represent distinct possibilities for firms to outperform their peers with regard to return on natural resources.
Using this model, the authors illustrate that superior environmental performance does not depend on a single factor. Rather, it results from the interdependence and interplay of different business-related and environment-related factors. At the same time, it highlights the different specific combinations that can be conducive to above-average levels of return on natural resources.
Natural resources
Superior environmental performance cannot be achieved through arbitrary combinations of these measures. Different business-related and environmental drivers of return on natural resources are linked, which allows identification of suitable and unsuitable combinations and their comparative advantages. Using these combinations, firms can improve their return on natural resources.
In contrast to the common assumption of business-case thinking, an above-average return on economic capital and an above-average return on natural resources will not always be compatible. In two out of four of the configurations identified by Hahn and Figge, an above-average level of return on natural resources does not go along with an above-average level of return on economic capital.
Firms that are more financially successful will find it easier to also achieve a higher return on natural resources
While there can be a positive link between business-related comparative advantages and the return on natural resources, financial success is not a sufficient – or even necessary – condition for achieving above-average levels of environmental performance.
Firms that are more financially successful will find it easier to also achieve a higher return on natural resources. A firm that has neither a green utilisation advantage nor a green technology advantage must rely on strong business-related comparative advantages and a strong competitive position as a differentiator.
By contrast, the environment-driven configuration shows that similar levels of return on natural resources can be reached by firms that underperform the market on the financial side as long as they have strong green technology and green utilisation advantages.
Beyond the business case perspective
By clarifying the relationship and role of financial success and environment-related comparative advantages, the Hahn and Figge model contributes to the development and operationalisation of the emerging research stream on a natural resource dependence theory.
Their research abandons the narrow focus on financial performance and shows how firms' use of natural resources and environmental performance depend on different environment and business advantages. By placing the return on natural resources central to the analysis, they offer a conceptual foundation as well as managerial guidance for a better understanding and management of firms' dependencies and scarcities regarding natural resources.
This reasoning contrasts with the conventional line of thought of the dominant business case perspective on the natural environment where financial performance and business-related comparative advantages are emphasised over environmental performance. The authors offer an alternative argument for the relevance of market-oriented capabilities and financial performance that is based on environmental, rather than financial, performance. Strong environment-related comparative advantages may be futile when the corresponding business-related comparative advantages are lacking, and vice versa.
Practical implications
The four basic configurations represent a starting point for different improvement paths for firms. A firm with a low sales margin and low return on economic capital, but environment-related comparative advantages with regard to green utilisation and green technology, may be more likely to increase its return on natural resources by developing its business-related comparative advantages.
The research results have important managerial implications. The analysis reveals that similar levels of above-average return on natural resources can stem from different combinations of business-related and environment-related comparative advantages. Most importantly for the choice of a pertinent strategy mix, the model reveals which business-related and environment-related comparative advantages are compatible with increasing the return on natural resources.
These insights help managers to identify their strengths and weaknesses with regard to environmental performance and to focus on relevant areas when developing pertinent responses to improve their use of scarce natural resources.
Full reference of the study: Figge, F. & Hahn, T. (2020). Business- and environment-related drivers of firms’ return on natural resources: a configurational approach. Long Range Planning, published online ahead of print. doi: 10.1016/j.lrp.2020.102066