Environmental management is rife with unreconciled extremes. On one side is a rousing rallying-cry that is almost entirely irrelevant to everyday business concerns; on the other, a reactive compliance devoid of vision or synthesis of any kind. In many companies, both sides are present simultaneously: vision is unhitched from practical decision making, and decision making is uninformed by any unifying vision. As a result, despite the massive amounts of management attention they receive, environmental issues are still misunderstood and mismanaged.

Current wisdom about the environment can be characterized as a set of beliefs with which most managers would probably agree:

• Environmental costs have rocketed, but the worst is almost over.
• Costs are uncontrollable and nondiscretionary.
• Regulations fall uniformly on all competitors in an industry.
• Just do the right thing, and the rest will follow.

These beliefs reflect a generation of hard-earned experience. They seem to be founded in reality and to work reasonably well in preventing costly disasters. They provide practical guidance in making difficult decisions. They give management a vision that has proved helpful in leading companies forward and guiding the public relations efforts that play such an integral role in dealing with environmental issues.

Yet these beliefs are really dangerous myths responsible for many companies’ poor management of the environment. By acting on these myths, executives miss the opportunity to understand how environmental problems are related to other key business issues. By believing that they have no discretion, they lose what freedom they actually possess. By assuming that regulation affects all businesses equally, they fail to see how they might achieve a competitive edge through better environmental management.

Myth: Environmental costs have rocketed, but the worst is almost over

Reality: Costs will continue to rise

For managers to believe that environmental spending will soon be on the decline is only natural. Even at the most savvy companies, it is common to see graphs of projected costs that look like a camel’s hump, rising steeply, peaking, and then falling off just as sharply (Exhibit 1). This is especially true given the anti-environment sentiments in the US Congress today. (Ironically, many of the legislative reforms suggested by congressional Republicans will cause total costs for business to rise, not fall.) Yet given current regulation, law, and public feeling, the odds of environmental costs declining any time soon in most industries are virtually nil.

It is important to understand why specious forecasts persist, and how they can destroy value. The facts are these. In recent years, US spending on environmental protection has risen from about 0.9 percent of GDP in 1972 to about 2.5 percent today. Over a shorter period, environmental spending by companies in environmentally-sensitive industries has grown at double-digit rates: Monsanto’s overall environmental costs rose by 13 percent between 1988 and 1992, and Texaco’s environmental capital expenditures increased by 20 percent between 1990 and 1993.

Environmental spending is rising in relation to other costs, too. In oil and gas companies, it grew more rapidly than any other category of expenditure between 1987 and 1990. The Chemical Manufacturers Association (CMA) reported forecasts that about one-sixth of future plant and equipment spending in the industry will be devoted to environmental protection, more than the sums spent on producing new products (almost 15 percent) and on efficiency improvements (about 14 percent).

Easy problems have mostly been fixed—the remaining obstinate challenges are becoming increasingly expensive to resolve

The marginal costs of pollution abatement are also rising. Easy problems have mostly been fixed, and the remaining obstinate challenges are becoming increasingly expensive to resolve. Dioxin in water, for example, is now regulated in parts per quadrillion, requiring ever more sophisticated and costly measurement and control.

Given this background, why does the notion of an imminent decline in costs prevail in boardrooms across America? The main reason is that capital budgeting processes are often inept at capturing environmental costs. Corporations tend to have short planning horizons of only three to five years, while many environmental issues have long lead times. And the precise impact of these issues on cost is frequently shrouded in uncertainty. Since managers like to be sure of their facts before they submit capital requests, these unknown quantities never find their way into budgets, hence the chronic underestimates.

Moreover, most companies have difficulty capturing the full range of issues facing them, especially those affecting them indirectly via suppliers or customers. This problem is most acute for companies with multiple businesses and markets. An oil refiner, for instance, needs to understand not only the environmental issues facing its own businesses, but also those confronting its suppliers and customers. If one of them has a pressing problem, it will be a problem for the company too.

Another difficulty lies in understanding the full extent of environmental spending. Actual environmental budget items are only the tip of the iceberg, at about 0.25 percent of company revenues. Expanding the definition of environmental expenditure to include indirect and distributed costs and items, such as plant personnel and waste disposal, might push its share up to between 0.5 and 2 percent of revenues. A broader definition that includes capital expenditures, regulatory interpretation, communication, and support will take the environment up to a significant 3 to 10 percent of revenues. Casting the net even more widely to include strategic matters like pricing and competitive impact, emerging issues, business configuration, and customer needs will probably push the figure beyond 10 percent. Cases exist where it exceeds 20 percent.

The problems born of inaccurate forecasts are legion. A good forecast buys a company time and gives it flexibility—two valuable assets, especially in a complicated area like the environment. Conversely, by the time a company realizes that its capital forecasts are grossly underestimated, it is often too late. Room for maneuver is limited, costs increase, and management is forced into a purely reactive mode.

Underestimating capital needs also makes implementing an environmental program far more difficult. Business decisions are best made when there is time to generate and select from a series of options, not when budget shortfalls create emergencies. Not only do poor budgets put strategies at risk, they also jeopardize other important capital projects as unplanned but unavoidable costs gradually emerge.

Myth: Costs are uncontrollable and non-discretionary

Reality: There is much more control and discretion than there seems

No one in an environmentally sensitive business is stuck in a compliance-only situation

Like the one before, this myth takes the pressure off environmental managers. If you have no discretion, why bother spending time on anything but complying with regulation? This is a victim mentality. In reality, no one in an environmentally sensitive business is stuck in a compliance-only situation.

This myth is dangerous for many reasons. Deciding what constitutes compliance is a difficult task. Regulation is open to numerous interpretations, and even then compliance is seldom straightforward. Technicians charged with implementing a compliance strategy often over-engineer products and processes to ensure there can be no liability. Their zero-risk approach is probably not what the executives who planned the strategy had in mind, especially if they were aware of the benefits of less engineered solutions.

Many corporations have environmental policies that are more stringent than prevailing legal requirements. International Paper plans to go elementally chlorine-free by the end of 1996. Without being prompted by regulation, Dow Chemical stopped deep-well injection of hazardous waste in the early 1980s. DuPont continues to inject into underground wells, but has committed to phasing the practice out by 2000. Arco produced lead-free gasoline before any legal mandate existed, pushing the market toward lead-free more quickly than any regulation could have done.

One pulp and paper company recently conducted a major review of its capital expenditure program. It did so without taking into account likely environmental events such as changes in customer preferences concerning the use of chlorine and recycled material. It also failed to consider the possibility of changes in water regulation. Given the large and lumpy investments that such companies are forced to make, this one will almost certainly face major equipment retrofits.

Though managers tend to assume that environmental costs are nondiscretionary, significant flexibility may in fact exist

Though managers tend to assume that environmental costs are nondiscretionary, significant flexibility may in fact exist. The first question is whether to respond to environmental pressure at all. If regulation is involved, there is clearly no choice. Should customers or suppliers be the source of pressure, however, a company may have a range of options, from doing nothing at one extreme to satisfying demands completely at the other. Stakeholder expectations, competitive pressures, and ability to shape the outcome are all factors in deciding whether to respond.

When to respond is also an issue. Opportunities may exist to mitigate the pressure or cost of a response through judicious timing; for instance, predicting when regulation will arrive and understanding how competitors will respond. Managers should ask whether there is any advantage in being the first mover and perhaps shaping regulation or consumer needs, or whether it is better to lag the industry.

The US electric utilities discovered the importance of timing in fashioning a response to regulation. When the 1990 Clean Air Act Amendments were first promulgated, most coal-fired utilities claimed they would be forced to install scrubbers to meet acid rain regulations. But they later discovered that switching to low-sulfur coal was much more cost-effective. By the time compliance was mandated, only 16 percent of phase 1 plants intended to install scrubbers while 55 percent planned to switch to low-sulfur coal.

Environmental problems normally have a number of possible technical solutions, and exploring even the most unlikely may yield valuable insights. A company in a process industry seeking to reduce workers’ exposure to a particular substance might try to shape regulation by advocating its position with regulators and safety associations. Alternatively, it might adjust its production process by, say, increasing external venting, installing hoods, rotating workers to reduce individual exposure, or providing protective clothing. Or it might change the product to eliminate harmful releases, working with customers to develop a substitute. An even more radical solution would be to rebalance capacity, manufacturing the problem product at newer plants with better exposure control.

What at first seems a straightforward issue actually has many possibilities. In practice, the solution adopted by the company combined several options, rather than being the single "silver bullet" response that might have been expected.

In addition to employing discretion, it is important for managers to pull together all the issues faced by their business: cumulatively, they may point to a different decision than would be reached by examining each one in isolation. Watching a business die from a thousand cuts is painful when it could have been put to rest much earlier to preserve as much value as possible.

Envisaging where an issue could end up can help managers avoid incremental thinking. They might consider, for example, how a particular production process would differ if a solvent that is currently under regulatory control were to be banned outright. Incremental moves may be justified, but taking small steps should be a conscious decision, not something that happens by default. The alternative—taking one giant step—should be compared for cost and effectiveness with the cumulative impact of a series of more modest actions.

One interesting consideration is when to take advantage of the "free ride" benefit in an industry, and when to blaze trails alone. This decision is complicated by a tendency to overestimate the value of the free ride. The CMA, which includes most large chemical companies, often acts as advocate on behalf of its members. Some of them, believing that what is good for them is good for the industry, have led aggressive campaigns on issues that are crucial to them, but only peripheral to others. The use of trade associations to serve self-interest relies on the widespread acceptance of the next myth.

Myth: Regulations fall uniformly on all competitors in an industry

Reality: Regulations fall unevenly, disadvantaging some and benefiting others

Environmental managers who believe this myth deny themselves the opportunity to improve their competitive position. It is wrong on several counts. Even within well-defined domestic industries, direct compliance costs do not fall evenly on competing facilities. For one commodity chemical, estimated five-year environmental cost projections per ton of capacity for three separate US facilities vary by as much as 200 to 300 percent (see Exhibit 2).

In a cost-curve business with depreciated facilities, tight marginal pricing, and significant overcapacity, competitor A is clearly advantaged, com-petitor C may no longer have a sustainable position, and competitor B faces tough strategic choices. It can try to pass incremental costs on to customers, risking losing market share if A and C do not follow, or it can signal that it is willing to pick up the costs and hold prices, hoping that C will exit and allow it to recoup its near-term losses once industry capacity has rationalized.

There are many reasons why the distribution of environmental costs is uneven:

Location. While in theory all regulations are equal, in practice some local regulators are more equal than others. A plant situated near a number of larger "bad actors" will figure less strongly on the local regulator’s radar screen than a freestanding competitor located in a wetlands area in another state. Less attention means lower costs.

Size. While large facilities can spread compliance costs such as waste treatment across a larger revenue base, a smaller plant may fall outside some provisions such as permit or reporting requirements by virtue of its size.

Technology. Different historical investments in control technologies such as waste-water treatment mean there will be varying incremental cost implications when the next wave of regulation hits. Closed production processes that solved early air emission problems might, for example, increase the burden of complying with worker exposure limits in the future.

Age. Older production technologies almost always create more waste, which may fall under previously unforeseen regulation. High SO2 and NOx outputs from older industrial coal-fired boilers, for example, may be outlawed under future clean air provisions.

Dramatic differences in environmental cost are common, but the ability to recognize and exploit them is rare

Dramatic differences in environmental cost are common, but the ability to recognize and exploit them is rare—a shame, since this is not high science. Most of the information needed to identify opportunities is readily available through public sources, and capturing them is a matter of traditional fact-based competitive analysis.

Suppose a product line is based on a highly volatile raw material. Transportation and logistics costs associated with the material are rising with increasing safety regulation. Worse, there is a risk that a major incident like a tanker explosion could trigger a total transport ban. This would have a substantial differential impact on competitors in the industry.

Non-integrated producers would be forced to stop using the material or exit the market. Not so for integrated producers manufacturing the material on site; not needing transportation, they would suffer no extra cost or risk. Instead, they would gain an instant advantage over their less flexible competitors.

The story is similar in methanol derivatives. With more states mandating reformulated gasoline based on methanol to comply with clean air rules, a rapid increase in methanol consumption is expected, leading to tighter supply and sharp price increases over the next two to three years. While all producers using methanol derivatives will be hit by this upstream environmental pressure, those that are integrated or have more secure sourcing arrangements will be better able to weather the storm before new production capacity comes on line. Companies that failed to identify this problem and build appropriate contingencies into their business plans will be in trouble.

As in any competitive analysis, environmental managers should look beyond conventional boundaries for threats to their position. A narrow and static definition of an industry that ignores cross-border competition and substitute products is a liability. Even where environmental costs land evenly within a clearly defined domestic market, to assume they can be passed on to customers is naive in a world with substitute products and international competition. Downstream customers, themselves wrestling with environmental impacts on costs and availability, are becoming increasingly willing to consider alternative suppliers and materials.

Offshore producers of price-sensitive commodity products have traditionally avoided markets where their transportation costs made them uncompetitive. Today, however, with environmental costs for domestic producers rocketing, they have new incentives to enter some markets. At one US-based chemical manufacturer, environmental costs ran at more than 6 percent of sales and were growing at a double-digit rate. Assuming that these costs could be passed on indefinitely and neglecting the impact of non-traditional competitors would be suicidal.

The hidden unevenness of environmental cost distribution can create opportunities for those that recognize and act on it

The hidden unevenness of environmental cost distribution can create opportunities for those that recognize and act on it. They can win advantage by using traditional weapons—like sourcing strategy, plant location, and pricing—that have nothing to do with the environment. As always, driving a cost-disadvantaged competitor out of a market creates value for those that remain.

Consider two dominant producers competing to supply a raw material to consumer goods companies. Both use the same production process. This generates large amounts of a mildly toxic solvent regulated both by the Environmental Protection Agency as an air reportable, and by the Occupational Safety and Health Administration in relation to worker exposure. Producer A has traditionally vented much of its waste into the air, positioning it well on worker exposure, while producer B has invested in closed production, reducing atmospheric releases but increasing worker exposure inside the plant.

Recognizing that regulation is likely to demand a reduction of 30 to 70 percent in worker exposure levels, producer A launched a successful campaign with EPA regulators to relax air reporting requirements, increasing its freedom to meet more stringent worker exposure standards through its traditional, relatively low-cost venting method. Blind to its own interest, producer B threw itself behind the campaign, even though a successful outcome would create more advantage for its competitor and still leave it open to millions of dollars of investment to comply with the new worker exposure regulations.

Clearly producer B would use its advocacy resources to better effect by addressing worker exposure regulators directly, so why did it adopt this seemingly irrational and value-destroying approach? Quite simply, the information it needed to make a sound decision—advocacy strategy, technical knowledge, and competitive assessment—was not integrated at business manager level, and could not be acted upon to make the value-maximizing choice.

Another case illustrates the positive side of this story. Company X competes with three or four other manufacturers in supplying a plastics material to auto parts makers. The material releases a toxic substance during customer extrusion processes. An anticipated compulsory reduction of 30 to 60 percent in worker exposure levels would compel many customers to invest in tighter controls or switch to substitutes.

Analysis has shown that company X’s product releases less of the toxic substance than competitive products do (thanks, incidentally, to underlying physical properties rather than conscious "environmental design"), making it more attractive to customers. Only when two key pieces of information—the environmental department’s knowledge of the regulatory trend and product performance data from the technical staff—were integrated at business unit level was the marketing department able to recognize and capture this accidental but valuable advantage.

Myth: Just do the right thing

Reality: What is right depends on the situation

The time when environmental strategy meant fending off regulation for as long as possible and then doing the bare minimum to comply is long gone. The pendulum has swung to the opposite extreme, with many prominent executives espousing an equally simplistic notion. "Just do the right thing," they say, "and all the rest will follow." Translated into top-down company-wide initiatives supported by green incentives, this strategy will, they believe, help their company get ahead and improve the environment.

Most large companies face hundreds if not thousands of environmental issues

The problem with "doing the right thing," however, is that it gives no real guidance to executives trying to make the complicated, subtle tradeoffs that environmental management involves. Most large companies face hundreds if not thousands of environmental issues; taking action on just one of them is likely to be expensive, since environmental expenditure is typically measured in millions of dollars. Even with investments that have a positive payback, pursuing several targets simultaneously can quickly exhaust capital reserves and divert resources from other essential activities.

With the advent of the 1990 Clean Air Act Amendments, oil companies had to think about investing in standalone or refinery-based oxygenate units to comply with 1992 requirements, as well as planning how to meet standards coming into effect in 1995. At the same time, they had to invest in satisfying 1995 reformulated gasoline requirements, which involve changes in refinery operations. In 1993, Chevron put two of its refineries up for sale, explaining that adapting them to comply with regulation would cost $275 million. The company estimated its environmental compliance bill for the next five years at approaching $2 billion.

Even in an ideal world where all green opportunities would be economically attractive, no company could do everything

Even in an ideal world where all green opportunities would be economically attractive, no company could do everything. And what do people mean by the "right thing," anyway? That which science dictates? What regulators want? What environmentalists value? What the public desire? What consumers would like? These are often poles apart, leading down completely different paths.

Another complication of striving to do the right thing is figuring out how far to go. One plastics company wanted to do something about emissions of a solvent suspected of being carcinogenic, though it was operating well within regulatory guidelines. It found it could carry on using the solvent but reduce worker exposure for between $1 and $3 million; move to an alternative solvent with its own problems for $7 to $10 million; or adopt a solvent-free technology for $30 to $50 million. It was not easy to see which was the "right thing" with the highest payback—environmentally or otherwise.

And when should you act? Timing is critical. Being the first out of the blocks with a new process, product, or technology may confer an advantage in the form of favorable customer perception or the chance to shape regulation. But being first can also be expensive, with competitors quickly following you along the learning curve. Moreover, governments are not always kind to companies that move early on issues. It may make sense to be opportunistic, leapfrogging a competitor just after—rather than before—it makes a major capital commitment.

Though "just do the right thing" might seem to set a clear path for managers to follow, the opposite is true. It actually sends a mixed message, leaving them unsure whether they should be maximizing long-term returns or serving some other purpose. While social concern might be noble, markets have little tolerance for actions that fail to lead to bottom-line results. This approach can make operating managers tune out and become skeptical of environmental opportunities.

Moreover, such strategies may not be sustainable over time. Many companies that launched ambitious emission reduction initiatives around 1990 have scaled them back dramatically on cost grounds, and some have even revised their environmental mission statements to focus only on compliance.

Finally, a vision confined to doing the right thing ignores crucial differences between businesses. Being out front is not always the best course of action. What is best will depend on the source and intensity of environmental pressure, the severity of the problem, the nature of the solution, the pace of technology, and the business’s competitive position.

Rather than pursue a universal but unimplementable green strategy, a company should base its approach—as it does in other aspects of its operations—on the conditions facing each of its businesses. It will clearly need to make commitments to other stakeholders, and want to adopt some high-profile issues of its own, but it must ensure that its senior managers have the tools and incentives to develop the right differentiated strategies.

Managers have no choice but to embrace these new realities of environmental management. The bad news is that environmental costs will continue to rise for the foreseeable future. The good news is that these costs do not hit all competitors equally. Some businesses will actually have their competitive position improved by environmental regulation. While these opportunities are not immediately obvious, they can be systematically ferreted out by placing environmental spending and issues in their fullest business context. In doing so, managers will see that they actually have far more discretion, flexibility, and opportunity than they think in meeting their environmental burden. They will, however, have to accept the hard truth that this burden will only increase in the years to come.