When green regulation gets in the way of green innovation

Encouraging companies to implement more sustainable, greener practices through environmental regulation sounds like a good idea. But is it feasible for small businesses with limited money, people, and time?

New research by Esade professor Cristina Sancha and co-authors suggests that, at least for business-to-business (B2B) small and medium-sized enterprises (SMEs) in Chile, more stringent environmental regulation can sometimes make it harder to turn innovation into meaningful sustainability action.

It's not a question of whether environmental standards are necessary, but whether companies have the capacity to go beyond mere compliance and respond to them effectively. In a study of 140 Chilean B2B SMEs, the researchers found that while innovation and customer focus can facilitate the implementation of green business strategies, the pressure to conform to regulations can sometimes consume the very resources required to put those capabilities into practice.

Chile provides a highly relevant context. Recent regulatory reforms are addressing the time and complexity involved in obtaining permits. In 2025, the government introduced a new framework intended to reduce sectoral permitting times by 30% to 70%, while maintaining existing environmental and technical standards.

Two routes to becoming greener

The study aims to answer a simple question: what helps a small B2B company move from environmental intentions to actual green business strategies?

The researchers focus on two characteristics. Innovation orientation—which describes a company’s readiness to experiment with novel ideas and seek new methods to solve problems. They also assessed customer orientation—understanding the needs of business customers and leveraging that knowledge to guide decisions on products, services, and processes.

Each is important. The findings showed that innovation orientation and customer orientation both had similarly strong positive effects when it came to pushing green business strategy implementation. This, perhaps, could indicate good news for small businesses—they don’t necessarily have to choose between investing in innovation or responding to customer needs.

Customer pressure is especially important in B2B markets. Sustainability requirements often reach smaller suppliers after traveling down the supply chain from large corporate buyers. In the interviews conducted after the survey, one SME manager described how tenders in sectors such as transportation, mining, and banking could give suppliers more points for having sustainability certifications or certified green products.

Regulation can undermine innovation

The study's most unexpected finding concerns regulation.

The researchers expected that the more robust the environmental regulation, the more companies would innovate and create green business strategies. Instead, they found that regulatory stringency was restrictive. Despite having strong innovation orientations, SMEs were less able to translate that innovative capacity into green strategies when they operated under more stringent regulations.

The qualitative interviews help explain why. As the researchers report, one manager described the gap between regulatory ambition and practical reality: theoretically, the requirements may be worthwhile, but once implementation begins, the company may simply lack the means to make them work. Another manager said that the high costs and administrative burdens of compliance can stifle innovation, particularly in SMEs.

What this suggests is that regulation can compete directly with innovation when organizational resources are scarce. If money and management time are spent meeting immediate compliance requirements, they cannot simultaneously be invested in experimentation, product development, or new production processes.

Why regulation has this effect

So what is going on? Why can the regulation that is designed to encourage green strategies actually hinder progress towards sustainability? The researchers highlight three issues.

Firstly, compliance costs money. It can absorb financial and managerial resources that SMEs could otherwise devote to innovation. Secondly, when rules are unclear, uncertainty increases, making businesses cautious about investing in solutions when benefits are not immediately clear. Thirdly, inconsistent or technically weak enforcement can undermine confidence in making long-term investments.

Sancha and her peers argue that the problem isn’t simply regulatory stringency. It’s the mismatch between regulatory demands and the resources and realities of smaller businesses.

In the example of Chile, the OECD's 2025 Economic Survey of Chile identified regulatory and administrative burdens as relatively high, pointing to complex permitting processes, long durations, and multiple rounds of observations. The report showed that environmental impact assessments took 25 months on average.

Customers matter, but regulation affects that relationship too

Customer orientation, the desire to satisfy the customer, doesn’t provide an escape from this problem.

The study found that being customer oriented meant that businesses were more likely to pursue green business strategies. But the demands of a regulatory environment overrode the business’s relationship with the customer. The evidence suggests that this is because customer demands and regulatory requirements are not separate pressures for SMEs: they compete for the same limited resources.

A business may wish to provide a greener product to answer a demand from a major customer, but that business may face additional costs because the product must also satisfy complex regulatory requirements. As those costs increase, the company may have less capacity to respond to the customer's sustainability expectations.

For B2B SMEs, therefore, becoming greener involves navigating both market and institutional demands. Being innovative and listening to customers are valuable capabilities, but their effectiveness depends partly on the environment in which the company operates.

What should regulation look like?

The study leaves us pondering: how can regulation encourage the behavior it is intended to produce? The suggested answer isn’t to weaken regulation.

It’s a challenge that Chile is already attempting to address. Its new Law on Sectoral Authorizations, which entered into force in September 2025, allows permits to be processed in parallel and introduces a digital one-stop platform, with the stated aim of reducing waiting times without lowering environmental standards.

For policymakers, the message to take on board from this research is that environmental ambition and regulatory efficiency should not be treated as opposing goals. Clearer rules, more predictable enforcement and support that helps SMEs meet requirements could leave businesses with more capacity to experiment and develop genuinely sustainable solutions.

For managers, the significance of this research is practical: innovation and good customer relationships remain important sources of green business opportunities. But companies may need to carefully monitor the financial, managerial, and human resources devoted to innovation and be careful not to allow the efforts of compliance to absorb them entirely.

Finding a balance

The green transition requires ambitious environmental standards that businesses can realistically meet.

Large corporations can absorb the costs of compliance thanks to their substantial resources and dedicated teams. For an SME, it’s a different story; the same requirements can compete directly with the time and money needed to develop the next cleaner product or process.

The study highlights the greater challenge for policymakers: if SMEs are expected to innovate their way toward a greener economy, regulation must do more than demand change. It must leave them with enough capacity to make that change possible.