Sustainable business leads to higher costs that can be passed to the consumers or assumed by the companies. Re-thinking some basic questions to reduce externalities is much better than finding someone to pay for them
Businesses are increasingly recognizing their responsibility to limit their impact on the environment and society at large. For many, it has become a priority to actively improve sustainability and reduce inequity.
Yet, while conscientious leaders may be committed to providing better and more equitable access to goods and services, they are also ultimately responsible for the financial viability of their organizations.
This can lead to a commercial conundrum. Sustainable business practices lead to higher costs, which can be passed on to consumers at a ‘green premium,’ but they may decide to choose cheaper alternatives or not to purchase at all. To avoid burdening customers, the cost can instead be absorbed by the company, but this will result in a hit on profits or serious sacrifices in terms of quality.
Esade’s Marco Bertini calls this dilemma a ‘taboo trade-off,’ as it offers no satisfactory solution for business leaders. However, he also believes that there is a way to mitigate—and perhaps even eliminate, in certain settings—green premiums. This happens when companies take a closer look at the pricing mechanism in a market and how it coordinates behaviors.
Writing in MIT Sloan Management Review, Bertini — an expert in monetisation and revenue growth — says smarter pricing is an efficient way to accelerate sustainability progress. The key is to involve all market actors to minimize externalities (and their associated costs) produced along the value chain of a product. This way, instead of adding up costs that will become a burden at the end of the process, we can tackle the problem beforehand.
Bertini’s strategy for rethinking price mechanisms, which has been developed in conjunction with John Pineda, Amadeus Petzke and Jean-Manuel Izaret from the global management firm Boston Consulting Group, sets out three questions for organizations to ask themselves when developing price strategies:
- What are customers paying for?
- Who is going to pay?
- When and how do we transact?
Rethinking the responses to these three critical questions, say Bertini and his co-authors, will help leaders to strike a better balance between sustainability and financial viability.
The pricing experts also offer six recommendations to guide leaders through the process of rethinking prices to find solutions that are profitable, scalable and attractive to consumers.
There are many pricing strategies already in place that veer from the traditional ‘make and sell’ model. Subscriptions and memberships, pay-as-you-go models, collaborative consumption, revenue-sharing agreements, and performance-based contracting have all become widely used and are familiar to many consumers.
But there are some companies and sectors pushing pricing boundaries further. They, and their customers, are already enjoying the benefits that come from seeking creative solutions to the ‘what’, ‘who’, ‘when and how’ questions posed by Bertini and his co-authors.
The cost of installing solar energy panels in individual households is prohibitive for many. And, after the initial investment, it can take several years before homeowners start to enjoy savings on their energy bills.
But when solar energy suppliers re-examined the three core questions, they identified new opportunities which have helped fuel exponential growth in the solar market.
What are customers paying for? Fundamentally, consumers want cleaner energy rather than the equipment (solar panels) necessary to produce it. Tesla Energy (operating under the former guises of Sunrun and SolarCity) offered customers a power purchase agreement (PPA) that installed panels on their roofs and then sold them the resulting energy output. The energy generated by the panels was reflected in a discount on utility rates, switching the focus from panel sales requiring a large upfront payment to simply the provision of clean energy.
Who is going to pay? The homeowner, with subsidies and tax credits provided by the US federal government. Leasing offered another alternative to homeowners, bringing down costs further.
When and how do we transact? Offering the PPA alongside the traditional funding model creates a dependable revenue stream for the supplier. This way consumers can enjoy instant access to clean energy from the first day at monthly payments below market rates, with no significant upfront cost.
The fashion industry is a major emitter of global greenhouse gases, with estimates attributing more energy consumption to the sector than aviation and shipping combined. The true cost of a pair of jeans retailing at €40, after taking into account the environmental cost, is closer to €73.
How do producers and retailers find ways to mitigate these costs and reduce the 12.8 million tons of waste created by the fashion industry every year in the US alone?
What are customers paying for? Fashion and their current ´look´. The ´make and sell´ model, which transfers ownership to the buyer at the point of sale, places the responsibility of disposal on the buyer. Introducing leasing and subscriptions allows people to enjoy fashion and the latest looks, while the retailer or producer retains responsibility for recycling or repurposing at the end of the leasing period.
Who is going to pay? The customer — but they buy access to the item, rather than the item itself. This has the added benefit of giving them access to high-end clothing they may not be able to purchase outright.
When and how do we transact? Several brands are already well underway in their development of transactions that promote sustainable fashion. Outdoor clothing company Patagonia offers customers store credit when they trade in old items; MUD Jeans leases jeans to customers for 12 months; Nuuly offers a clothing subscription that starts with six items for $88 per month.
The concept of leasing clothes rather than buying outright is rapidly gaining popularity, giving retailers more leeway in mitigating the true cost of clothing.
Six steps to smarter prices
Bertini and co-authors have developed six recommendations to help business leaders develop new solutions to the three fundamental pricing questions. Using this framework, they suggest, will help to strike a balance between sustainability goals and financial obligations.
- Make the ‘green premium’ transparent and actionable: providing clarity and visibility around the reasons for the higher costs of sustainable products allows people to make informed purchasing decisions.
- Focus on outcomes, not products: encourage a mind shift from ‘selling clothes’ to ‘clothing people’, or ‘selling cars’ to ‘providing mobility’.
- Align payments and benefits: upfront payments are often misaligned with the benefits achieved. Alternatives such as subscriptions, leasing or pay-as-you-go shift payments to coincide with benefits, while also making products and services more affordable.
- Serve populations, not segments: when a solution has broad applicability, focus on providing benefits for the entire population rather than delivering to individuals depending on their ability to pay.
- Activate the ecosystem: creative approaches to pricing often involve multiple partners, from financing structures to final delivery, that are outside the core remit of the producer.
- Create a shareholder tailwind: significant changes to price mechanisms require effective communication and engagement to illustrate and emphasize their long-term value creation.
This broader way of thinking on prices, say Bertini and his co-authors, may not be the ultimate answer to global challenges. But what it does offer is an alternative to the taboo trade-off between easing the burden of business on society and finding someone to foot the bill.
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