Circular Economy: The Path to Sustainable Profitability
By Dan Wellers and Christopher Koch
Though it doesn’t make any of the tourist guidebooks, one of the most famous places in Denmark is an unremarkable-looking industrial park in the small coastal city of Kalundborg.
An alternative to the traditional linear model of industrial production – take, make, use, and dispose – emerged here in 1972. An oil refinery began piping excess gas to a gypsum-board manufacturer nearby, creating a virtuous loop in which one company’s waste became another’s raw material input.
The motive behind the exchange was simple: profit. The oil refinery gained a new source of revenue, and the gypsum-board company saved money on buying gas. The side benefit that no gas was wasted was of little concern.
Almost five decades later, Kalundborg is famous as a highly effective example of a new economic model called the circular economy. To many environmentalists, governments, and business leaders, circular business models offer the best economic way forward in a world of increasing resource scarcity and mounting waste. Recycling is not an afterthought but an essential part of the business strategy.
Accenture estimates that organizations could create up to US$4.5 trillion in value by 2030 by adopting circular economy principles more widely.
The business-value argument – combined with a need to address climate change worsened by economic activities that waste too many resources – gets support from advances in technology and changing business models. Technologies like the Internet of Things (IoT), cloud computing, Big Data, blockchain, and analytics are enabling even far-flung companies to become more networked and interdependent – and at a lower cost – which will drive them toward a more circular philosophy. Business models like leasing and temporary rentals encourage conservation by enabling both enterprises and their customers to reuse assets, materials, products, and services.
Though no single company, not even in Kalundborg, has managed to adopt the circular model entirely and emit zero waste, the practices that point toward that goal are becoming more mainstream. They include designing products without waste and keeping materials viable as long as possible through reuse, repair, remanufacturing, and recycling. For example, consider Tale Me, a Belgian maternity wear and young children’s clothing company. Tale Me rents rather than sells its clothes, which delights mothers eager to return to their regular wardrobes as soon as possible and save money on outfits for their rapidly growing children. The company partners with a local factory that makes new clothes as needed and repairs or refurbishes the returned items.
Origins of the circular economy
Like all revolutions, the one that spawned the circular economy started small. Soon after that first exchange of materials between the Kalundborg companies in 1972, other companies in the industrial park noticed the gains their neighbors were making and devised their own exchanges. These efforts also serendipitously resulted in little or no waste. Now, 11 different companies in the area are saving almost $900 million a year while significantly reducing waste and emissions.
In other words, the companies in Kalundborg accidentally discovered that sustainability, specifically circularity, is one of the best paths to profitability. But their returns are a drop in the bank account compared to the potential gains to be had from incorporating circular resource usage methods into any company’s business model.
These practices are being adopted more widely due to an increasingly concentrated, urbanized population; global economic volatility; and clear consumer preferences for products, services, and brands that demonstrate a commitment to sustainability. For example, a 2019 Nielsen study of 21,000 U.S. households found that products that are environmentally friendly and use recycled packaging increase consumers’ willingness to pay more for them and that sales of natural shampoos gained market share.
Digital technologies are fast becoming another circularity driver. They relieve one of circularity’s main constraints: the need for companies to be physically near one another for circular exchanges to be profitable. The IoT and blockchain, for example, can be used as virtual intermediaries, compensating for physical distance and enabling companies located far from one another to go circular at scale. Big Data, analytics, and machine learning let companies create faster, more cost-efficient materials exchanges and allow for optimizing internal circular practices. Meanwhile, digital is the heart of the increasingly popular sharing economy, which drives circularity by keeping products in circulation longer.
Economic, social, and technological advances are making circularity more practical – and more profitable – without the kismet of Kalundborg.
How companies can join the circular economy
By starting with circularity in mind, companies can meet a rising customer demand while increasing profits.
The fatal flaw of the linear-production economy is that it ignores waste. Waste is an effect that corporations aren’t responsible for. Meanwhile, the appetite for government regulations designed to right the balance waxes and wanes with nations’ economic and political fortunes.
Now, however, creating profitable products with zero waste is increasingly possible by factoring circularity into product design, manufacturing, and logistics processes rather than treating waste as an afterthought.
Here are five key principles to consider when designing circularity into products and processes:
- Modularity: Modular components can be swapped out of a product when they wear out or become technologically obsolete instead of junking the entire item.
- Maintenance: When products are designed to be maintained, parts can be refurbished and reused rather than discarded.
- Disassembly: By designing products to be easily disassembled, companies can recover a higher percentage of the embedded materials for reuse or recycling.
- Regeneration: Products can be designed to use regenerative, easily accessible materials rather than scarce ones or those sourced from countries with high geopolitical risk. Meanwhile, the energy used to produce the products comes from renewable sources or is repurposed from other companies’ waste.
- Recovery: By designing product lines using as many similar and biodegradable materials as possible and by creating reverse logistics processes such as product trade-ins, companies can make it easier to recover the materials used in products so that they can be repaired, remanufactured, or recycled.
Sources: Ellen MacArthur Foundation and SAP research
Circular Economy 101
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Why the circular economy makes sense
Increasing resource scarcity and volatility are helping to persuade more companies to reap rewards from circularity. Skyrocketing demand for consumer goods has also turned finding and maintaining reliable sources for raw materials into an increasingly risky business.
Consider the raw materials used in electronic devices. Key ingredients come from destitute and politically unstable countries or countries that are controlled by powerful monopolies. In the Democratic Republic of Congo, conflict has raged over the ownership of cobalt mines. Meanwhile, China commands 85% of the global market for so-called rare-earth materials such as yttrium and lutetium, which are staples of most electronic devices, causing manufacturing costs to rise.
These conditions contributed to record price volatility for metals during the ’00s. With billions of new, middle-class consumers predicted to be added to the global economy by 2030, conservation, recovery, and reuse are the only logical – and profitable – responses to rising resource volatility.
But recycling alone won’t do the trick. Of the $16 worth of precious metals in a typical cellphone, only $3 worth is recovered using current recycling methods.
Even considering materials that are widely reused, such as plastics and paper, recycling is an inefficient means for reclaiming the mountains of waste generated by the linear system of production. Though they are the world’s champion recyclers, Germans nevertheless throw away more than 40% of their waste.
What does the circular economy look like?
There are many loops in the circular economy, but as the Ellen MacArthur Foundation shows, they all lead to the same destination: zero waste.
Furthermore, increasing urbanization is creating more concentrated markets, which will give the circular economy a boost. Today, 55% of the world’s population lives in urban centers. That proportion will rise to 60% by 2030, with one in three people living in cities with at least half a million residents, according to a United Nations report.
Urbanization drives companies to bring manufacturing closer to customers and employees. It also creates more opportunities to share resources and logistics, as two companies with operations in Costa Rica, construction materials giant CEMEX and food and beverage company FIFCO, have learned. CEMEX trucks that once drove empty now pick up goods at a FIFCO distribution center in a Pacific Coast area both companies serve. While the companies have invested in larger trucks and equipment to ensure the quality of both companies’ goods, the project has meant substantial savings on fuel and carbon emissions.
Designing for the circular economy
In the future, profitable and sustainable partnerships like the one between CEMEX and FIFCO will likely become easier as digital technologies such as blockchain, machine learning, robotics, and IoT become mainstream.
If blockchain’s energy consumption can be dramatically reduced, it could make sharing easier and less costly by replacing paper contracts with immutable, verifiable, cyber-based agreements. For example, an EU-funded startup called Circularise is developing an open-source blockchain platform that would enable companies in the plastics industry to identify recyclable materials and provide information on a product’s origin and environmental impact.
Instead of manually inspecting products to see if they contain, for instance, a battery or a circuit board, recyclers will use Circularise to sort the products automatically based on information provided by the manufacturers. This speeds up the sorting process while making the design specifications of the products invisible to everyone – even the recyclers.
Robotics, machine learning, and artificial intelligence (AI) also have big roles to play in making logistics more circular. Daisy, Apple’s second-generation disassembly robot, has the machine learning-imbued intelligence to rip apart and extract the usable materials from 15 different iPhone models at the rate of 200 per hour. In 2018, the robot helped Apple divert more than 48,000 metric tons of electronic waste as part of a recovery and reuse program targeting materials such as cobalt (used in batteries), aluminum (for computer enclosures), copper and gold (used in printed circuit boards), rare-earth elements like neodymium (used in magnets for audio), tungsten (used for device vibrations), stainless steel (phone and watch enclosures), and tin (used in logic boards).
When it pays to lease (and not own)
Business models can also make a difference in materials consumption. The trend toward consumers paying to use products rather than owning them outright is also spurring manufacturers to create circular business models. Rolls-Royce became a pioneer of the usage business model in 1962 when it began offering “power by the hour” on its expensive and complex jet engines.
Today, Rolls-Royce is using IoT sensors and artificial intelligence to monitor the condition of a new generation of engines and take aircrafts out of circulation before they fail. Meanwhile, its airline customers can use data to monitor and maximize their usage of their aircraft – where a fuel savings of just 1% per year can yield $250,000 per plane. Working together, Rolls-Royce and its airline customers can extend the useful lives of products and reduce downtime, repair, and replacement costs.
The usage model gives manufacturers the impetus to keep their products – which then become assets – viable as long as possible and to reduce end-of-life costs. They are beginning to incorporate principles of circularity into their product designs rather than trying to figure out ways to recycle products that were not created with that goal in mind. Products designed for recovery and reuse are less likely to fail prematurely or be discarded when they still have useful life left.
The concept of designing for longevity and reuse isn’t new. As France struggled to rebuild its economy after World War II, automaker Renault realized that it needed to keep the ownership costs of its vehicles as low as possible to build sales. In 1949, it began to refurbish parts in a plant outside Paris, giving customers an option to save when getting repairs.
The refurbished parts, which cost 30–50% less than new ones and have the same guarantee and quality control, were a hit. Over time, Renault expanded its output to include everything from water pumps to complete engines. Today, everything that comes into the factory goes out as a refurbished part or is melted down to reuse as raw material. In the process, the plant has reduced its energy and water use by 80% or more. The remanufacturing operation generates revenues of $270 million annually while continuing to build customer loyalty and increasing profits.
Renault’s success has driven the company to push its circular practices farther up the supply chain. It now designs its major vehicle components for easier disassembly to help reduce the cost of refurbishing parts.
Designing for disassembly isn’t easy, however. Even low-cost products have become complex, using many different materials and containing subassemblies (such as cellphone enclosures) that require multiple strong fasteners for longevity and maintenance.
Researchers have developed a few shortcuts, such as fasteners and sub-assemblies that come apart or pop out of shape when heated. But take up of these innovations has been limited because they cost extra when viewed from a linear-production perspective, where waste is not the manufacturers’ problem once the finished product leaves the plant.
Technology as a catalyst for the circular economy
That linear model is running out of steam, however. Opportunities to improve linear manufacturing methods exist, but “The gains are largely incremental and insufficient to generate real competitive advantage or differentiation,” according to the World Economic Forum.
Though circular business models are still in their infancy, they have already demonstrated tremendous potential for increasing efficiency and profitability while reducing the environmental costs to the planet. Digital technologies are helping to bring the circular economy tantalizingly close to the mainstream. And the opportunities for competitive differentiation abound.
Sensors streaming data about the condition, location, and availability of product components not only make pay-per-use business models profitable but also create the foundation for extending product life, maximizing usage, and reducing replacement costs, such as at Rolls-Royce. Big Data analytics and machine learning can enable the instant adjustments to shifts in demand and the smoothing of logistics needed for greater circularity, as they have for CEMEX and FIFCO and for Apple with its iPhone. Meanwhile, blockchain could someday automate and simplify the complex exchanges of value in circular systems, as Circularise promises to do.
These advances are creating the virtual bridges within and between companies that will make circular business models even more viable, effective, and profitable than their linear forbears. Circularity will help protect companies from the threat of greater resource volatility and the costs of disposing billions of tons of waste generated by the linear economy. Consumers have recognized this and are rewarding companies for doing purposely what those in Kalundborg did by accident: adopt circular, approaching-zero-waste practices that track to the bottom line.
In other words, the circular economy isn’t just – or even mainly – about saving the planet. It’s the best way forward as a business strategy.
From the SAP Insights editors – find more circular economy and sustainability examples in:
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