With so much recent focus on geopolitical uncertainties, it’s easy to overlook one of the most important factors compressing operating margins—the rising cost of emissions as new regulations come into force. In the face of these changes, companies are making major investments, sourcing low-carbon materials, redesigning components and products, and even building entirely new value chains by recycling products at the end of their life.
In this episode of McKinsey Talks Operations, host Christian Johnson is joined by Matthias Ballweg, CEO and cofounder of Circular Republic, and by two McKinsey experts, Anna-Christina Fredershausen, an associate partner in McKinsey’s Frankfurt office, and Johan Bengtsson, a partner in the Stockholm office.
The following conversation has been edited for length and clarity.
Christian Johnson: So, let’s dive right in. Anna-Christina, could you please explain why decarbonization is relevant now, even or perhaps especially in times of geopolitical tensions?
Anna-Christina Fredershausen: Sure. If we look at it from a European angle, [Italian economist] Mario Draghi, for example, has announced decarbonization as one of the three core pillars to ensure Europe’s competitiveness. At the same time, in some industries where Europe is leading, for example, in cleantech, we see increasing competition from outside of Europe. So, it’s important to stay ahead here.
Matthias Ballweg: Maybe I can add to that. This is a hot topic right now because the issue of resilience is increasingly important. We realize that Europe, as a continent, is almost 100 percent dependent on imports when it comes to energy, at least all kinds of fossil energy. But there’s also materials, which are the source of more than 50 percent of all emissions. And it’s much harder to decarbonize materials than it is for classic energy in most sectors. So it’s a challenge to build the capabilities quickly.
The good news is that more ideas and plans are coming into play about how to realize this mission through the business case. For example, every 1.4 years we have a value chain crisis or some disruption of the value chain. A ship stuck in the Suez channel, for instance, or some might remember the crowd of ships in Shanghai harbour during COVID. All of this causes major disruptions, and these disruptions are costly. Cargo helicopters need to fly in to keep the production of European automotive going, and obviously, that comes with costs. This is now more viable and quantified by companies. Because of that, we’re beginning to see business cases with a payback of one to two years, with measures that pay into decarbonization and dematerialization.
Christian Johnson: Thank you, Matthias. And Anna-Christina, you talk about carbon as a fully integrated topic in the European Union’s overall position as well as its companies’ cost basis. Why is that?
Anna-Christina Fredershausen: Amid all the other topics that are ongoing and top of mind, I think decarbonization is still something that you need to look at as an integrated business case. Given that, with all the upcoming regulations, you cannot ignore it. There are forthcoming costs for the majority of companies operating in Europe. The way to think about it is on the one hand to mitigate cost, and on the other to see the potential upside and investigate whether there are business opportunities from that. And how to leverage certain topics such as circularity, for example, to make the most of a positive, viable business opportunity.
Christian Johnson: Thank you for bringing us up to speed on that, Anna-Christina. This sounds challenging and maybe even scary to some companies, but it can also be turned into a real opportunity. Johan, can you tell us more about that?
Johan Bengtsson: Sure. I think you can look at this from a couple of different angles as a company. If you look at the landscape of opportunity and the levers that you can pull to decarbonize, many of those are what we would call “in the money,” essentially lowering cost and carbon at the same time. So, it’s a true win–win. Some are probably more cost-neutral, and there are some that need significant investments. With that understanding, you can really start acting on the low-hanging fruit or the in-the-money type of levers now to gain real momentum on both improving your EBITDA as a company and on making step changes on the decarbonization journey.
And then, of course, if you look at it more through the lens of an offensive play a little bit, as Anna-Christina was saying earlier, there are signs in several industries of potential green premia, where you can essentially charge more, build brand position, and strengthen your brand overall. Acting on this now brings an advantage ahead of all the upcoming regulations that will come into play more and more, so that you have a stronger position vis-à-vis your competitors and peers.
Christian Johnson: That sounds like a great opportunity. But I guess it begs the question of how to set yourself up for success on this journey. Johan, I know you’ve worked extensively in this space for many years, helping numerous clients across industries. Could you share some of the insights you’ve garnered along the way? Is there a secret recipe, a secret sauce for success here?
Johan Bengtsson: What has excited me over the past years when working in this area is the excitement that it builds among employees working on something that is truly meaningful for the broader world and environment, but at the same time improves the position of the company, its results, and its financials. The recipe is quite simple. In the end, it’s about integrating the work around decarbonization and carbon into the daily business. So that means first understanding where the emissions come from and the drivers of that. If you want to understand and address your cost levels, you need to understand the drivers of cost in the same way that you need to understand where the carbon comes from.
By having that transparency, you can ask, “What are the different actions I can take to change here? What are the different materials I can source? How can I design my products in a different way using more circular material?” Then it’s about execution, which may involve working on or redesigning your supply chain, working closely with your suppliers, and working with your engineers on the implementation and redesign of your products. So, it’s a bit like a three-step model that follows the logic of how we traditionally would have worked with cost, but you’re adding a lens and bringing that into the overall business. You almost triangulate the different trade-offs of what to do, where, and when.
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Christian Johnson: Thank you, Johan. Zooming out now, I was hoping you could also tell us more about how this fits into an overall transformation and what sorts of changes companies must undergo to succeed with all of this. So, Anna-Christina, since you kicked us off with the Draghi report, which connects decarbonization to a broader European transformation in a similar way, maybe you could elaborate on this topic a bit for us.
Anna-Christina Fredershausen: If we think about what companies can do now to operationalize this more overarching topic of decarbonization that Draghi put as one of the core three pillars, I think it’s really about integrating it fully into the business and into, for example, an end-to-end cost-out program.
Companies could think about decarbonization in ways that are in the money. For example, sourcing or design-to-value levers where you add a carbon cost to the cost plans. Adding the carbon lens with a financial perspective helps you work to reduce costs and carbon at once. If you create your baseline of emissions and then look at what can be done to reduce emissions overall, you can prioritize the levers that are in the money, where you save cost and carbon at the same time.
Of course, that needs quite a granular, bottom-up plan, which means looking in detail across your different products and material groups you’re sourcing, for example. Then, you can make an informed decision about each material and each product, because they will differ depending on the overall composition.
Christian Johnson: Matthias, what would you add here?
Matthias Ballweg: I agree with Anna-Christina, but I want to add a point around talent. If you ask yourself, who would you put on that project to do all that design-to-cost, the granular plan that reduces cost and emissions, and run that program, who is the person to put there? Also, from a young talent point of view, which project would you ask to be put on to forge a good career in your company? Is it the next cost-cutting program? Is it reconfiguring sales, or is it that dual-mission carbon accounting project? This is also a mindset question, and it depends on how these issues sit with the board. If you want to make sure that this is successful, you need to ensure it’s attractive. You want people within the company to feel that running such a program successfully might make them a board member one day.
Knowing how to combine cost cutting and carbon reduction, knowing how to reconfigure value chains, talking to the right suppliers to work with less virgin material and get the benefits out of it, building the value chains accordingly—that’s quite a lot to learn. Or it’s something that you can be good at or not so good at. It’s critical that, as a company, you invest in the talents that drive this and signal that there is a career to be made in running dual-mission projects.
Christian Johnson: That’s great. Johan, moving on, once companies have set their baseline and integrated decarbonization into their transformation strategy, what are the critical steps they need to follow to move from transparency into action?
Johan Bengtsson: It’s an excellent question. I think it’s very much about understanding the potential actions you can take. What different levers can you pull, and what implications do those actions have on the overall business case? Which of those costs money? Which of those are in the money? Which have implications on performance or the product? Which of those affect customer value in any other way? It’s also about setting a granular plan on what to do when and setting the implementation strategy around this, meaning how do I go to the suppliers and when? How do I work with internal stakeholders to potentially change requirements during the redesign of the products? Typically, we talk about this as a couple of different steps where you first essentially set the value, meaning you size the potential impact and all the different implications of the actions, then you create the action plan of what to order and when and how to do it. It’s then essentially about action, really driving toward implementation.
I think Matthias made an excellent point earlier about talent, insights, understanding, and experience in this. How do you build that? Because while all of these things have similarities to how we work with cost or other types of performance efforts in companies historically, they also come with a new set of information and a new set of steps or points that you need to either discuss with your suppliers or internal stakeholders, or most likely both. It’s super important to get traction on this over time.
Christian Johnson: Thanks, Johan. So it’s about finding the value, making a plan, and then acting on it to implement that strategy. Anna-Christina, you’ve been working with various clients on this. There must be a mindset shift happening as the industry decarbonizes, right? How have you seen companies responding to this new reality?
Anna-Christina Fredershausen: A few years ago, a lot of companies set out ambitious decarbonization targets. And there is the Science Based Targets Initiative. In short, SBTi involves using a uniform language, a nomenclature, to define targets and ensure that everybody speaks about the same level of emissions when they set targets and that they are aligned with the goals of the Paris Agreement. Looking at those so-called SBTi targets, we can see that while they have been quite ambitious in the past, some companies are now postponing them or reducing them. I think what we can also see is that, at the same time, they are really looking at decarbonization measures that are more in the money and that help them to, on the one hand, mitigate costs that are upcoming due to regulation, but on the other hand also use the opportunity to make a business out of it.
Both Matthias and Johan made the great point that you need an integrated group working on this topic. It cannot be a separate group that works on decarbonization while everyone else works on the regular business. What you can see now is a mindset shift that’s being integrated into the overall business. If we take procurement as one function, you can see that although carbon might not have been one of the decision factors for traditional supplier selection a few years back, carbon is now commonly part of the selection process. It’s one of the factors that suppliers are being asked for.
Christian Johnson: Matthias, can you share any real-life examples that you have seen in your work?
Matthias Ballweg: Absolutely. Just adding to your point, Anna-Christina: Choosing this path is not only some sustainability mindset, but it’s also more and more about upcoming regulations. If I work with suppliers that have value chains on fossil-based energy, for example, there is a much higher likelihood that they’ll become more expensive. They’ll be unable to deliver, they’ll be taxed at a higher rate, and so on.
You asked me for an example, Christian. We at Circular Republic are working on circular-economy projects, with the material side of things more than with the energy side of things. If you look at the materials, which are Scope 3 for many companies, there are lots of cases where people realize they can change something by working on the material footprint, which involves directly reducing Scope 3 emissions.
For example, Lorenz is a company from Germany that makes water meters—brass poles with electronics inside that are in the bottom cellar of every house. They measure how much volume, how many gallons or cubic meters of water, are flowing into the dwelling. The company began struggling because the cost of brass kept increasing, which is an absolute cost challenge. To decrease brass costs, they considered the lever of recycled material.
When you look at it, recycled material to begin with is even more expensive. It takes quite some effort to ensure quality and so on. But if you start the journey and go a little bit further, you discover measures to mitigate that. They discovered new talents and capabilities. They took it seriously. It was a CEO topic again. They started calling all the major plumbers, asking them to deliver the material, finding mechanisms to understand how this could be done in the context of quality, because at first, quality was low.
Once they allowed the plumbers to send everything back, even the non-Lorenz components, they started receiving all the materials they needed. They started building the grading capabilities. If something came back, there were mechanisms to decide whether that item went into the shredder to get some goods recycled content from it, or whether it could even be reused.
They started putting that thinking into product design as well. Now they’re 15 years in the game with that strategy. And it has only been a few years, by the way, since they called it a decarbonization or circular-economy strategy. Before that, it was about securing the business.
So, in summary, what Lorenz did was decrease its material footprint and emission footprint. The most interesting thing is that the profits went up by a factor of eight because, obviously, they had less cost. Revenue also increased because they became well known for their approach and their ability to deliver even higher quality. I think Lorenz is a good example of the dual mission.
Christian Johnson: It’s great to have an example of something we all have in our homes as well. And Matthias, we’ve all seen examples where things might be made smaller, the materials might be made a bit thinner. So now, how valuable are those kinds of examples in this pursuit of the dual mission of cost and carbon reductions?
Matthias Ballweg: Ideally, these incremental examples are not the prime examples. It is good if companies make something a little bit thinner. And by doing so, this accounts for slightly lower emissions. But the real art is to rethink your value chain in a way that, by doing more business, you also pursue your mission. If you make something just a little bit thinner and you double your business, you’ll still have almost double the mission, just not double the emissions.
Lorenz really started reconfiguring its value chain, and now it uses a meter-as-a-service business model. With every additional meter they bring out, they reduce the materials’ overall use because people are not buying a meter. Lorenz is basically renting out meters now. I think it’s important to bring forward examples to raise ambition and make sure that people can be ambitious and inspired about these dual missions. Ideally, you’re looking at those whose mission has extended into their business model.
Christian Johnson: I love that thought about raising ambition and not just making incremental improvements. So, thank you. Johan, is there anything that you would add there? I’ve heard you talk previously about changes to the points in the value chain at which you’re assessing cost and carbon reduction. Is there anything that you would add here about the opportunities?
Johan Bengtsson: What we have seen with many clients across industries is that there are so many exciting examples of actions that have proven true to the dual mission—cases ranging from pretty bold changes of materials or specification or requirements, even companies changing material and making that visible to the customer, and capitalizing on that in the marketing and brand building. But there are also examples where you can go into your value chain and find better options from a carbon emissions perspective, and still cheaper, or at the same cost alternatives that make a significant difference on the end footprint of a specific product, yet it doesn’t change the product itself. This could be achieved by perhaps moving to a supplier with access to a different type of energy.
Christian Johnson: So Anna-Christina, can you say just a little bit more about what the dual mission could be? What’s the real potential here?
Anna-Christina Fredershausen: There are a few examples that we could name. On the commercial side, you’re negotiating with the current suppliers as well as potential new suppliers to make sure that you get, for example, carbon-reduced material. On the other hand, it’s about thinking about the product from a holistic perspective and thinking about design shifts and features optimization. That means asking, can we alter the product in a way that is beneficial to the customers by reducing carbon at the same time?
Another angle I’d like to add is about recycling and circularity, where you can think about designing the product in a way that is recyclable and, at the same time, think about how to increase the share of your recycled material. And a final point about energy efficiency: Businesses can ask themselves if they can change their manufacturing process, or if they can use a different supplier with a more efficient process, or use a different energy source—whichever is more sustainable.
Christian Johnson: Thank you so much, Matthias, Anna-Christina, and Johan, for sharing your insights. It’s clear that the journey to net zero is going to be a full, enterprise-wide task that requires close collaboration across functions and a significant shift in mindset.
That wraps up today’s episode of McKinsey Talks Operations. We hope you found it informative and actionable. Remember, the path to decarbonization is complex, but with the right strategies and mindset, it’s achievable. Thank you for listening.
