Why It Pays to Become a Rule Maker

For two decades, business leaders have argued that corporations could promote sustainability effectively by pursuing win-win profit opportunities. But during that time, the health of the natural environment has worsened. In response, top managers in some leading companies have been pioneering a different approach to sustainability, one that radically alters businesses’ traditional economic role. It treats businesses as not simply players in a competition structured by governmental and societal rules; instead, they are rule makers.

DuPont’s response to warnings that chlorofluorocarbons (CFCs) caused major damage to the ozone layer that shields the planet from harmful UV rays provides an early example of this approach. Given that DuPont was the leading producer of these chemicals, DuPont managers were understandably concerned about how regulation would impact their own business and that of their customers. Yet once evidence emerged that CFCs were creating a hole in the world’s ozone layer, DuPont got behind a worldwide phaseout of these products and helped shape new regulations.

Why would a company support regulation that would ban its own products? To be sure, ethics and responsibility played a role, but so did a desire to influence the regulatory process. After initially opposing the ban, DuPont executives realized that limits on the supply of CFCs would cause prices to rise, motivate consumers to move to better alternatives and raise DuPont’s profits. “This is an industry where you make money at the beginning and the end of a life cycle,” explained Michael Parr, North American advocacy manager for DuPont’s chemicals and fluoroproducts business. By engaging with government on the structure of the phaseout, DuPont helped bring an end to one profitable product life cycle and spawn another.

Twenty years later, DuPont is playing a familiar role — this time backing the phaseout of hydrofluorocarbons (HFCs), which are coolants used in air conditioners and refrigerators. The company’s scientists developed HFCs to replace the hydrochlorofluorocarbons (HCFCs) that, in turn, replaced CFCs back in the 1990s. Although HFCs helped stabilize the ozone layer, researchers have found that they have high global warming potential that contributes to climate change. Yet as the world’s burgeoning middle class buys more air conditioners and refrigerators, the emissions of HFCs are likely to multiply. In response to this new threat, DuPont is again supporting new rules to limit its own products — in this case, HFCs. The company’s support has influenced the thinking of executives at other companies and encouraged international action. In September 2013, the United States and China agreed to work together for a worldwide phaseout of HFCs.

For managers, DuPont’s story shows that engaging in the rule-making process can help ensure that effective regulations allow a company to increase returns from internal capabilities (such as the ability to develop new products) while addressing a public good such as reducing greenhouse gas emissions. “There is an expression in Washington,” noted DuPont’s Parr, “that it is better to be at the table than on the menu.”

Forming Self-Regulatory Institutions

Advancing new regulations isn’t always feasible. An alternative approach is to get industry players to adopt standards that substitute for missing government regulation. Such an approach is most achievable when companies share common interests. Resort hotel operators, for example, are eager to work together to maintain local amenities and keep the overall appearance of the destination locale they are part of attractive. Similarly, companies within an industry can join together to maintain the industry’s reputation. One need only consider the Fukushima nuclear accident in Japan in 2011 to appreciate how the events at one company’s plant can send shock waves through an entire industry. To avoid the “tragedy of the commons” involving the depletion of shared resources, banding together to regulate collective behavior can be smart business.

Consider, for example, the Equator Principles, which were formed by major financial institutions in June 2003. The Equator Principles require participants to conduct detailed social and environmental impact assessments of large projects and to refuse to lend money or provide financial support if standards are not met. It might seem strange that banks would be willing to handcuff themselves in this way, but a closer inspection of the underlying structure of project finance shows that such rules are in the collective interest of banks.

Since project financing is essential for expensive, large-scale ventures (such as pipelines, infrastructure and mines), banks must join together to provide the necessary financial resources. Typically, one bank originates the loan and does the due diligence, and other banks join in. These “syndicate” banks must trust that the project sponsors have done their homework and know the potential sources of project risk; as a result, the syndicate banks benefit from shared standards such as the Equator Principles.

The banking industry is not alone in following this approach. After the nuclear accident at Three Mile Island in the United States in 1979, nuclear power operators banded together to raise safety standards. Likewise, the chemical industry created a well-known code of conduct, Responsible Care, to prevent accidents. For managers, the lesson of the Equator Principles and other examples where companies have banded together is that a careful rule-making strategy can reduce incentive alignment problems and make everyone better off.

Rewriting Supply-Chain Rules

Sometimes, companies need to address sustainability problems that affect the whole supply chain, not just a single industry. In many cases, a product’s sustainability attributes are difficult for consumers to discern. Standing at a fish counter, for example, what is the average customer to think? Some of the fish is apt to come from well-managed fisheries, some from overfished ones and some from aquaculture farms. But how do you know which is which? A study by the nonprofit Oceana found that more than 40% of the U.S. restaurants and grocery stores tested in the study sold mislabeled fish.

To differentiate sustainable products and help consumers make better purchasing decisions at the fish counter, the consumer goods company Unilever teamed up with the World Wildlife Fund (WWF) to create the Marine Stewardship Council (MSC), a nonprofit that promotes sustainable fishing practices. The MSC certifies fish wholesalers, processors and distributors, thereby giving consumers confidence in the quality of the fish they are buying.

Although Unilever’s decision to support the MSC may seem charitable, it has a business rationale as well. As “one of the world’s biggest buyers of fish,” management explained in a corporate report, “our fish business relies on access to reliable supplies into the future.” In addition to securing supply, the MSC system allows Unilever to insure the quality of the fish it buys. Certification helps fishermen who operate sustainably by increasing demand for their product, and it reduces demand for fish from stocks that are endangered. Unilever’s involvement in the MSC shows how an effective strategy for rule making can encourage more efficient use of resources throughout a supply chain.

Influencing Customer Behavior

New strategies for rule making are continuing to evolve. One opportunity involves influencing the behavior of customers. Indeed, many companies have come to realize that the way customers use products can be a big factor in the size and shape of their products’ environmental footprints. Procter & Gamble Co., for example, found that the biggest environmental impact of its hair care products isn’t from production, distribution or disposal but the energy and water customers expend in long, hot showers. The same goes for electric utilities, whose residential customers are often lax about taking simple energy-saving steps.

What can companies do to motivate customers to take action? Marketers have long used people’s desire to do as well as their neighbors to sell products. Now some companies are using behavioral science to prod customers to become more sustainable. Although we get to see some of the products our neighbors own (for example, cars parked in driveways), seeing how much they recycle or how effectively they conserve energy has been less visible. To nudge customers to become less wasteful, Opower, an information services company based in Arlington, Virginia, works with electric utilities to develop products and services for communicating with customers in ways that lead to reduced energy consumption. Together with Opower, utilities have redesigned billing statements to highlight information about how customers are performing relative to their neighbors, as well as steps they can take to do even better. The results have been impressive: Each electrical bill including Opower’s comparative information causes customers to cut their electricity consumption by 2% to 3%. Opower managers are working on other applications that use peer-group information to change individual behavior.

In many situations, the free market doesn’t lead to the best outcomes; a better approach is for market participants to develop new rules.

Recasting Industry Norms

For managers looking to recast the norms of their industry around sustainability, there are several ways forward. First, managers may need to prepare their colleagues for a shift in how they view regulation. Simple simulations can be helpful. For example, a well-known simulation game called “Fishbanks,” originally developed by Dennis Meadows, then a professor of systems management at the University of New Hampshire, asks participants to make decisions affecting fishing stocks and demonstrates how the absence of rules can lead to inefficiency. (John Sterman, director of MIT’s System Dynamics Group, and I later adapted this game for Internet use, and it can be found online.) Simulations can show that in many situations, the free market doesn’t lead to the best outcomes; a better approach is for market participants to develop new rules.

Second, managers need to develop heuristics for when particular rule-making strategies make sense. There are several useful tests, including:

• Are some companies able to impose costs on society as a whole?
• Do shared or common resources (as in project finance) allow companies to shirk responsibility or free ride on others?
• Does missing information about a product’s or service’s attributes make it difficult for consumers to assess quality?
• Are some parts of the value chain using resources in-efficiently?

If the answer to any of the questions is “yes,” more efficient rules may be beneficial to both individual companies and society as a whole.

Third, managers need to identify potential allies and collaborators in rule making. Although some stakeholders have been fearful that corporations could use rule making as a way to dominate an industry, a few stakeholders have come to realize that the right collaboration may let them occupy an important seat at the table. By teaming up with Unilever, for example, the WWF helped to establish the credibility and independence of the Marine Stewardship Council. Other NGOs are doing likewise. The Nature Conservancy works with forest product companies to develop and certify better practices, and the National Wildlife Federation is helping to set up new standards for the beef industry.

Corporations must be prepared to be transparent about their actions. Corporate involvement in rule setting is not without risks, and public monitoring is needed to prevent malfeasance. Despite the inherent danger, many interest groups now look to leading corporations as allies in rule making. Enlightened managers have access to enormous resources and a strong incentive to act.