Can We Afford Sustainable Business?

“How are we going to pay for this?”

In that question lies the conundrum faced by the growing ranks of corporate leaders who recognize that business must, at the very least, stop contributing to the most urgent problems facing humanity and ought to, at best, help solve them. In mission statements and strategic plans, many companies are making commitments to improving sustainability and reducing inequity — but when it comes to meeting those goals, they are tripped up by the financial implications.

In reality, we have no shortage of ideas on how to provide greater and more equitable access to goods and services, use them conscientiously and more effectively, and leave the least amount of waste behind. But we are frequently held back in implementing those ideas because of the presumption that any sustainability initiative invariably leads to higher costs, higher taxes, higher fiscal deficits, and, ultimately, higher prices. “How are we going to pay for this?” becomes a killer question seemingly designed to stifle progress.

Overlooked in the debate, however, is one factor that unnecessarily limits the scope that leaders in all spheres — whether business, politics, or nonprofit — need to implement solutions that can scale to meaningful impact.

That factor is the price mechanism. We contend that it’s possible to find creative solutions that rally all market actors around responsible behaviors that mitigate the negative externalities of commerce before businesses tally them up and price them in. In one sense, we argue that organizations act more as caretakers of markets than as simple producers, using the incentives and information embedded in the price mechanism to allocate the responsibility for broader and fairer access, for conscientious and effective consumption, and for handling waste more efficiently.

At the root of the problem is the premise that the only way companies can ease the burden of commerce on our society is to account for it properly and find someone to foot the bill. This premise corners businesses into what we call a taboo trade-off. A company can try to pass the incremental cost of environmentally or socially responsible practices onto customers, but they may not be willing or able to pay it and thus flee to cheaper competitors or leave the market entirely. Alternatively, the company can absorb this cost by sacrificing margin, cutting corners on quality, or making the supply chain “sweat” until the economics work out. In each case, the financial or reputational risk is such that the organization often sees “Do nothing” as the pragmatic solution. It dodges the trade-off instead of addressing it.

This conundrum is particularly frustrating for leaders who are committed to driving change. Emmanuel Faber led France’s Danone for over six years and was widely seen as a prominent advocate for a more responsible capitalism that serves not only shareholders but also the environment, employees, and suppliers.1 But in March 2021, Faber lost his job as chairman and CEO after activist shareholders voiced their displeasure with Danone’s financial performance, strategy, and governance.

The dismissal of someone like Faber reflects an undercurrent of skepticism that still simmers behind the scenes at purpose-oriented businesses. One CEO of a European multinational reportedly said that if he made his company’s environmental policy greener, “my profit margin would fall 3% per year, my stock price would fall 15%, and I would get fired.”2 Indeed, a recent study indicates that CEOs who enact greener or more sustainable policies are significantly more likely to get fired for poor performance than CEOs who do not.3

Capitalizing on Degrees of Freedom

The good news is that leaders have far more leeway with the price mechanism than they realize. This quickly becomes apparent when they stop thinking that “How are we going to pay for this?” is the only question and “Price in the externalities” is its only answer. In fact, every price decision builds on the answers to three basic questions:

• What are customers paying for?
• Who is going to pay?
• When and how do we transact?

Most businesses take these questions for granted and believe the answers to be moot and immutable. However, rejecting that assumption and thinking more expansively about what, who, when, and how can lead to innovative solutions.

Rethinking what customers pay for matters because it determines the extent to which organizations generate revenue by delivering outcomes that customers desire rather than providing them with inputs (products and services). The traditional “make and sell” approach can put a financial and physical strain on access, because it forces customers to find a solution and purchase it outright. This approach neither motivates customers to think responsibly about consumption nor guarantees that they will be satisfied with the purchase. Finally, “make and sell” transfers ownership — and therefore the burden of disposal — from suppliers to customers who may not have the drive or expertise to dispose of goods responsibly.

Today, a host of novel commercial arrangements — such as subscriptions and memberships, pay-as-you-go models, collaborative consumption, revenue-sharing agreements, and performance-based contracting — can address these challenges without transferring ownership. Each of these alternatives can ease the access problem inherent in traditional transactions, because companies earn their revenue only when they provide customers with direct, unencumbered access to their offerings. Similarly, pay-as-you-go and sharing approaches encourage sensible consumption because customers pay at each consumption episode, and performance-based contracts ensure that companies get paid only when they deliver value, not when they promise it.

As they consider who pays, business leaders need to question whether it makes sense for all customers to pay the same price, or even to pay at all. This may seem potentially unfair. But whenever universal access is the target in a sector, businesses should consider varying prices based on people’s ability or willingness to pay or, in the case of third-party payers, the value that an individual end user derives.

In certain situations, companies might think in terms of interconnected currencies such that customers might pay to satisfy their own basic needs in something other than money. One example is subsidizing the purchase of water filters in order to eliminate the need to boil water on wood fires to make it potable. The reduction in carbon emissions resulting from the decreased use of wood fires has a monetary value on the carbon market, and this can be used to fund the enterprise.4 The key here is to ensure that the behavior tied to the intermediate currency (such as fewer wood fires) aligns with the benefit pursued by the user (such as access to clean water). Otherwise, focusing on the former to generate revenue can distract from achieving the latter, which is in fact the primary goal.

Likewise, in some sectors, certain behaviors are clearly desirable from a social or environmental perspective, such as purchasing soon-to-expire food to avoid waste or participating in physical activity to improve one’s health. In those cases, businesses should consider varying prices not based on customers’ ability or willingness to pay, but based on their readiness to act responsibly.

Companies should likewise reconsider when and how to collect payment. They can turn to micropayments to allow more granular access. If reasonable, they can also defer payments to ease the financial burden on customers or, importantly, to better align the timing of costs and benefits. Finally, one can think creatively about payment as an opportunity to engage people. For example, to fight against low donation rates in 2014, the relief organization Misereor deployed interactive billboards that enabled bystanders to offer 2 euros by swiping their credit cards over the screen. True to its principle of “playful, not pitiful,” Misereor deployed technology such that the swipe activated an engaging interactive sequence depicting the credit card slicing a piece of bread to feed the hungry or freeing an imprisoned child.5

In the rest of this article, we show how a broader, more creative take on these three questions can alleviate the taboo trade-off and accelerate progress.

Scaling Solar Energy

The battle to mitigate the effects of climate change is widely seen as a race against time. This urgency was recognized by the 196 countries that signed on to the 2015 Paris Agreement, which committed to reaching zero carbon emissions by 2050.6 Conducting business as usual will doom those efforts.

Making progress against this ticking clock requires a multitude of solutions aimed at improving equitable access to renewable energy sources, combined with more conscientious consumption. The circumstances and challenges vary greatly from market to market, but one common denominator is that traditional views on the price mechanism create a taboo trade-off that hinders the adoption of cleaner solutions. How can the energy sector transition from a profitable carbon-based market to one that is equally profitable but greener?

One of the biggest obstacles inhibiting the adoption of solar energy among households is the upfront investment required to install solar panels. In developed countries, a residential installation can cost tens of thousands of dollars, even though the price per watt for photovoltaic (PV) panels dropped by almost 80% between 2010 and 2020. After making this investment, homeowners must wait many years to break even and start to enjoy the financial benefits that solar energy provides. The discrepancy between the timing of payments and onset of cost savings is so large that no reasonable price concession can bridge it satisfactorily.

However, opportunities emerged when the suppliers of solar energy solutions reexamined the three core questions.

• What are customers paying for? Simply put, households want to pay for cleaner energy rather than the inputs to access that energy. Recognizing this, pioneering companies Sunrun and SolarCity (now known as Tesla Energy) began offering customers a power purchase agreement (PPA). Instead of selling panels or establishing a fixed set of loan payments, they sold customers the energy output from the panels installed on their roofs, reflected as a discount to their utility rates. They also guaranteed the system output for 20 to 30 years. This change of focus, from panel sales to the provision of clean energy, enabled PV manufacturers to offer an alternative to the traditional approach predicated on a large upfront payment.
• Who is going to pay? Homeowners still pay for energy, but, to a large extent, the U.S. federal government has also paid large amounts of money for the installation of solar panels, through a mixture of subsidies and tax credits. Another alternative to outright purchase, leasing, lessens the need for these extensive government payments as a means to bring down the large upfront cost and create a purchase incentive. Ideally, this shift can take the government (and its taxpayers) out of the equation entirely and change the “who” to the homeowners themselves.
• When and how do we transact? Let’s assume that the upfront cost of a PV installation by Sunrun in the U.S. is $21,000, before tax benefits.7 The majority of homeowners are still opting to pay for or finance that expense and draw the “free” solar energy. But around 35% of homeowners now opt to enter into a PPA, which eliminates this upfront expense in exchange for a guaranteed energy supply from day one at monthly payments below prevailing market rates. This agreement creates a dependable revenue stream for the supplier and also offers consumers an appealing alternative to paying or financing a significant upfront cost.

Combined with the overall decline in PV prices, the introduction of PPAs alongside traditional leasing agreements helped fuel exponential growth in the solar market. Take California as an example. Installed capacity increased from 163 megawatts (MW) in 2010 to 1,950 MW in 2015. Leasing accounted for 63% of the installations in 2015, versus just 10% in 2010.8 For comparison, leasing historically accounts for around 30% of new car registrations in the U.S. each year.

It is interesting to note that the market for direct purchases grew impressively as well in the same period, from 147 MW to 720 MW. In other words, the lower prices for PV panels would have naturally driven growth.9 The lesson is that products can become even more accessible — and progress toward ambitious environmental, social, and governance goals can be achieved even faster — when companies are willing to reconsider preconceived notions about their prices.

The problem of energy access is universal. In sub-Saharan African countries, it can be prohibitively expensive to extend existing grids to serve remote populations. This includes 22 million displaced people in the region who lack access to electricity. Solar home kits have therefore become an attractive alternative, because they can help most families meet their basic power needs and avoid relying on diesel generators (or going without power). The upfront retail cost of a basic solar home kit is around $180, but that is a large expense for a family that might earn $1 to $2 per day.10 What has accelerated adoption of the kits is an approach similar to the one used by telcos: a deposit combined with a pay-as-you-go charge. Most people use their cellphones to make the micropayments directly. The overall benefits of the solar home kits are numerous, ranging from less pollution and greater safety to freeing up time for education or work. They also offer a more reliable source of energy, not only because of the abundant sunshine, but also because diesel fuel or other energy sources are subject to disruption.

Lifesaving Treatment for All

The hepatitis C virus (HCV) currently afflicts over 70 million people worldwide. It is a leading cause of cirrhosis and liver cancer; a Centers for Disease Control and Prevention study found that in 2013, it killed more people in the U.S. than the next 60 infectious diseases combined, including HIV and tuberculosis.11

What makes disease management challenging is the wide range of symptoms and the respective costs to treat them. It may cost only a few hundred dollars to treat patients with mild symptoms, whereas treatment costs can run as high as $300,000 for the roughly 10% of patients who require a liver transplant.

This reality presented Gilead Sciences, maker of breakthrough HCV therapy Sovaldi, with a significant taboo trade-off. By curing an otherwise chronic disease in just 12 weeks, Sovaldi literally provides a lifetime benefit to patients. But the industry’s standard pricing approach — which is to charge a price per treatment at the time of care — makes it prohibitively expensive to treat patients with mild symptoms. At a price tag well north of $50,000 for that 12-week course, Sovaldi makes economic sense only for that small minority of patients with severe complications.

A lower price point would broaden access and hasten the World Health Organization’s goal of reducing deaths due to HCV by 65% by 2030.12 But it would also make the cure far less profitable, creating a quandary for leaders in biopharma companies who have a mandate to recover substantial investments in R&D and yield returns to investors.

A novel approach to the price mechanism offered the health care ecosystem a way to resolve the taboo trade-off. Gilead worked with the state of Louisiana to rethink two of the fundamental questions outlined above:

• What are customers paying for? Instead of paying to treat only the most affected patients on the standard per-dose or per-therapy basis, health insurance payers could pay “per population cured.” This would allow for a spreading out of total benefits at the population level, regardless of the extent of any individual’s symptoms at the time of treatment.
• When and how do we transact? The payments are spread out over multiple years, rather than being due when treatment is administered, to better match the timing of the lifetime benefits to patients. This also benefits the Louisiana Medicaid system, which pays for fewer liver transplants and other expensive interventions. This approach allows funding to reach all patients where there is a clear clinical and economic rationale.

Spreading payments over time and benefits across the population yields better economics for all. This arrangement is aptly nicknamed the Netflix model, because it resembles a subscription to a streaming service. The buyer pays a fixed price for access to a catalog of content, rather than paying potentially much more for individual content streams a la carte. This model is similar to the concept of software vendors’ enterprise license agreements, under which an entire population of employees gains access to a software catalog. The supplier secures a constant revenue stream and serves many more users than it would on a case-by-case basis. The buyer secures value over time for the entire population in a way that allows everyone to benefit, regardless of their consumption level.

In 2019, Louisiana paid a subsidiary of Gilead a lump sum in exchange for as much of its HCV regimen as warranted to treat patients in its Medicaid program and correction facilities through 2024.13 The exact terms of the deal are not known, but the amount is estimated to be significantly less than the aggregate sum that would have been necessary to treat all HCV patients at the ongoing per-therapy price. If we assume roughly $35 million per year for the minimum 31,000 HCV patients mentioned in the news release, that amounts to about $1,130 per patient per year for population-level coverage, or approximately $5,600 per patient over the five years of the contract.14 Later in 2019, the state of Washington entered into a similar deal with the drugmaker AbbVie.15

There is some skepticism about the willingness of different players in the health care ecosystem to come to the table on this type of arrangement versus the more familiar pay-per-treatment one. But several new trends are helping all parties become accustomed to aligning prices with the timing of value delivery in a way that boosts efficiency. These trends include the increasing adoption of quality-adjusted life years as a generic measure of disease burden and a means to price treatments based on health outcomes, as evidenced by Roche’s recent efforts on personalized reimbursement models.16

Driving Efficiency in Education

The cost of higher education in the U.S. is increasingly untenable for both students whose financial futures are hostage to crippling levels of debt and to the federal government, which backs over 90% of the more than $1.7 trillion in outstanding student loans.17 At issue is how to prevent that pile of debt from rising further and, more broadly, how to ensure that spending on higher education actually leads to desired outcomes such as learning and employment.

One solution addresses the “who” and the “when and how” questions, and in some cases the “what” question as well. Known as an income-share agreement (ISA), the arrangement calls for the student to pay the educational institution only when they are earning an annual salary above a certain threshold. The payment is a percentage of their income until the tuition is paid in full. The difference between an ISA and a conventional loan is that there is no interest rate, nor are any payments required if the student remains unemployed or earns wages below the threshold. These programs may appeal to students in one- or two-year skill-certificate programs, but major universities such as Purdue have also launched ISA programs.18

The state of Tennessee has turned the principle of the ISA into a comprehensive program under the umbrella Drive to 55. The “55” refers to the target of having 55% of residents possess a college degree or technical certification by 2025. The program includes the Tennessee Promise, which offers scholarships for qualifying students to attend selected colleges or technical schools for free, and Tennessee Reconnect, which allows adults without a degree or certification to complete one at no out-of-pocket cost. The difference between the Tennessee programs and an ISA is that there is no repayment plan at all.

The program has worked for several years because it aligns the incentives for all parties. Students gain access to an education, while the state derives a return on its investment by creating taxpayers and also making the state more attractive to companies that need a large pool of workers with 21st-century skills. The state also gains because the Tennessee Promise program requires students to fulfill a community service commitment.

Closing the Loop in Fashion

If the fashion industry were a country, it would be the fourth-worst emitter of greenhouse gases in the world, trailing only China, the U.S., and India.19 One estimate shows that players in the sector consume more energy than aviation and shipping combined.20 At the same time, the dependence on cotton — and thus the corresponding dependence on irrigation and agrichemicals — has had considerable environmental impact: It can take as much as 2,700 liters of water to make one cotton T-shirt.21 Even then, each American on average throws away 80 pounds of textiles every year, which adds up to around 12.8 million tons of trash.22

Consider a pair of “fast fashion” jeans that retails for, say, 40 euros (roughly $50). The Impact Institute estimates the “true price” of these jeans, or the sticker price factoring in the cost to society and the environment of bringing the product to market, at 73 euros (around $90).23

The taboo trade-off here is clear. On the one hand, consumers are likely to balk at paying almost twice as much for something intended to last one or two seasons. On the other hand, most producers and retailers do not have nearly enough margin to absorb the spike in costs. Faced with this prospect, turning a blind eye to the environmental impact is almost understandable.

The challenge, then, is to look for ways to mitigate the negative externalities rather than pricing them in. To that end, companies are taking creative steps to reduce the waste inherent in the fashion pipeline. One of the most far-reaching steps is to promote reusing or recycling clothes instead of trashing them, as a means to close the loop. As Karl-Johan Persson, then-CEO of H&M, explained, “We have to change how fashion is made. We have to go from a linear model to a circular model, and we have to do it at scale.”24

This is exactly where rethinking the “what” question is critically important. The fashion industry’s traditional “make and sell” model, where the ownership of an item of clothing transfers from the retailer to the customer at the point of sale, puts the responsibility for closing the loop squarely on the shoulders of each individual. This is not efficient, given that people differ in their desire to do good and, even if sold on the idea of recycling, may not have the means or opportunity to do so.

One way to motivate people to be more responsible is to pay them for it. For example, as part of its Worn Wear program, popular outdoor clothing company Patagonia offers customers store credit when they trade in old items. However, the industry as a whole may not advance on circularity at the speed we need unless it embraces a means of generating revenue that is not predicated on the transfer of ownership — one that does not rely on individual customers to do the right thing.

For example, fashion labels should think seriously about introducing leasing and subscriptions, where customers buy access to apparel and accessories rather than the items themselves. This shift in the “what” does away with having to rely on the conscientiousness of individuals and puts reuse and recycling back on the shoulders of manufacturers, which presumably can handle this task more efficiently and at scale. Returning to the example of jeans, MUD Jeans from the Netherlands leases jeans to customers for 12 months, after which they can keep them or return them for recycling. Similarly, Rent the Runway lets people rent high-end clothes that would otherwise be prohibitively expensive to purchase, while Nuuly offers a clothing subscription that starts with six items for $88 per month.

As people grow more accustomed to renting clothes or subscribing to a wardrobe service, suppliers gain degrees of freedom to mitigate the taboo trade-off expressed in the true price of clothing.

Making Smarter Prices

Our own research and work with CEOs and other leaders have convinced us that organizations must rethink the three critical questions we have described if they want to strike a healthier balance between their sustainability goals and their more immediate obligations to customers, employees, and shareholders. The following recommendations — which run from the initial thought process through to implementation — should guide leaders to find creative new answers to the what, who, when, and how questions.

Make the “green premium” transparent and actionable. The root cause of the taboo trade-off is what Bill Gates dubbed the “green premium.” When an environmentally friendly product costs twice as much as the conventional “dirty” version, few customers or businesses are willing to foot the bill. But when managers have greater visibility into what is driving higher costs, they can make more informed decisions on where to direct their attention as they reconsider both how prices are set and the decisions in the supply chain that can reduce the footprint of business as usual.

Focus on outcomes, not products. This mind shift forces a broader scope that brings externalities into sharper focus. Some apparel companies, for example, are reorienting from “selling garments” to “clothing people” and are incorporating tailoring, repair, and recycling programs into their consumer engagement. Similarly, shifting from “selling cars” to “providing mobility” may reduce materials consumption and waste while providing vehicle makers and new competitors with new opportunities to meet customer needs. Offering true solutions to customer problems will remain aspirational as long as companies focus too much on the means rather than the end.

Align payments and benefits. For many solutions, the biggest hurdle is the clear misalignment between the timing of payments (usually upfront) and the onset of benefits (usually over time). For example, the sticker price on an electric vehicle such as the Chevrolet Bolt is about 40% higher than a comparable gas-fueled car, but the lifetime operating costs are significantly lower for the former, never mind the environmental benefit from lower emissions.25 Alternatives to paying upfront, such as subscriptions, leasing, pay-as-you-go models, and even performance-based agreements, shift the timing of payments to align better with the timing of benefits perceived by customers. They also make access to products affordable to more people by spreading expenses over time.

Serve populations, not segments. Population-based pricing agreements make sense when a solution has broad applicability, but individual customers’ willingness or ability to pay varies dramatically. In this case, the “what” shifts from a single dose or single product to coverage for an entire population. Optimal pricing based on target segments is exclusionary by definition, while population-based pricing aims to find a way to be inclusive. A salient example is the population-level agreements struck by Pfizer-BioNTech in the U.S. and Europe for its COVID-19 vaccine, which facilitated much lower price points than normal for such a breakthrough treatment.

Activate the ecosystem. Rethinking the company’s solution or time-shifting this year’s revenues into the future often creates opportunities that a single company cannot pursue on its own. Creative approaches to the price mechanism tend to involve multiple partners, such as financing partners for renewable energy and vehicles, and value-based health partners for migrating to health outcomes. Financing, support, and last-mile delivery are all common puzzle pieces in the ecosystem that require a company to look beyond its core business.

Create a shareholder tailwind. While tension may always exist between sustainability and profitability, more and more stakeholders are seeing the former as part of long-term value creation rather than a threat to it. Turning shareholder headwinds into tailwinds is an important factor. The leverage of powerful investors is now providing support for viable sustainability actions. For example, BlackRock has made a commitment to sustainable investing as a path to long-term value creation, and the California Public Employees’ Retirement System has recently pushed for more accountability on climate risk in oil and gas. In our experience, significant changes to the price mechanism requires dedicated communication and engagement with all stakeholders.

The way that most companies currently understand the price mechanism does not bode well for their ability to help address the world’s most pressing social and environmental challenges. The narrow focus on price points — what we can refer to simply as the “How much?” question — imposes constraints on an organization’s ability to achieve the scale that its sustainability solutions deserve.

Indeed, the now-popular notion of green premiums is, at its essence, a redefinition of that narrow “How much?” question. But business leaders need to stop thinking about pricing simply as a bar that they can prod up or down to get customers to buy less or more. Every pricing decision comprises additional, more strategic choices that can mitigate the negative externalities of commerce before companies price them in. 

The urgency to act is increasing. Businesses are facing growing pressure to translate commitments into action and impact, or they risk jeopardizing their relationships with their increasingly conscientious, dollar-voting customers and investors.

We obviously are not claiming that rethinking the price mechanism is the ultimate answer — but we are asserting that a more efficient price mechanism is among the necessary means to accelerate progress. Broader thinking on prices will help catalyze the search for innovative and enduring solutions that are profitable, scalable, and palatable to customers.