Climate change and sustainability regulation: how industrial companies can successfully plan today

To a large extent, the sustainable transformation of the economy is also shaped by legal framework conditions. For many companies, it feels like regulatory requirements are constantly changing and new ones are being added. Long-term and reliable planning therefore seems to be difficult. In this post, we provide an overview of what companies should pay attention to now – also to benefit from many entrepreneurial opportunities created through regulation.

Growing legal requirements – how should we plan?

Recently, one of our customers whispered in conversation: “Strategically, we are flying blind here! With constantly changing regulations in terms of sustainability, how are we supposed to make sensible investment decisions into our machinery? Do I know if my today’s assessment will still be valid in three or five years? But we invest for at least ten years!” Similar statements can be heard in the corridors of many companies. Positively speaking, many industrial companies perceive regulation in terms of environment and sustainability as very dynamic. Existing legal frameworks are being amended, new ones are being added. For example, around 10 new regulations in the field of environment and energy came into force in Germany at the beginning of the year 2022. In addition, laws and regulations are created at different levels (EU, national state, region, local authorities), sometimes with different regional impact. In this light it is often criticized that reliable framework conditions, enabling long-term planning for companies, are more and more at risk.

Target horizon is clear and will remain stable for decades to come

This perspective is understandable, but it does not quite get to the heart of the matter. Regulatory requirements are actually not as unreliable in terms of predictability as they seem in the first place. Looking at the “why” of regulation instead of the “how”, one cannot dismiss consistency and predictability out of hand, even for the coming decades. At the latest since the adoption of the Paris Agreement in December 2015 and the coming into force of the 17 Sustainable Development Goals of the United Nations (SDGs) in January 2016, long-term goals of sustainable regulation have been clear – and these are also broadly supported by the global economy. In recent years, objectives have become even more concrete, at least in Europe. So it is clear: a transformation of the industry towards a climate-neutral economy is being desired. This goes hand in hand with restructuring energy supply, transforming mobility and logistics systems and, in some cases, with changes in production processes and value chains. This transformation shall be conducted in such a way that the European economy remains competitive and ideally even gains in attractiveness, e.g. through technological leadership in particularly important areas such as energy (keyword hydrogen) and mobility. At the same time, industry branches should not be overburdened on the transformation pathways. Industrial sectors and regions that are deprived of the basis of their business models or the current local economy by the transformation (e.g. coal industry) shall be enabled to participate in the economy of the future.

Certainly, the link between these long-term goals and the “how” – i.e. specific regulatory measures – is sometimes controversial and part of a social discourse. Companies can assume that this will remain the case, at least as far as very specific measures are concerned, because interests and framework conditions are constantly changing. Therefore, it is very likely that there will be short-term changes when it comes to specific measures. So what does this mean for companies for today’s planning and decision-making?

The focus points for regulation are defined

One opportunity for orientation provides the “what” of regulation, i.e. the object of regulation, the intermediate level between objectives and concrete measures, so to speak. And here the legislators, together with industry associations, are quite unanimous. The “European Green Deal” provides the framework and it includes approaches for regulation in the coming years and possibly decades. The most important regulatory objects include:

– The pricing of CO₂ and other greenhouse gases, e.g. by introducing a trading system for emission allowances.

– Create incentive systems for climate neutrality. This includes, for example funding for greenhouse accounting and development transformation concepts.

– Reform of the reporting system for companies, in particular by expanding sustainability reporting requirements or the introduction of a supply chain act.

– Incentives for circular economy approaches to increase resource efficiency and to avoid waste, as described for example in the EU Circular Economy Action Plan

– Transparency and standardisation of sustainability performance and corresponding incentives for investors and procurement managers (especially in the public sector) for sustainable investment and procurement. This is anchored in the so-called EU taxonomy.

– Promoting innovation, e.g. through the Innovation Fund set up by the EU.

Planning with scenarios and transparency in the supply chain as success factors

These regulatory fields and the long-term goals behind the legislation can now be used by companies as a planning horizon. In contrast to classic planning and decision-making, where specific regulatory requirements are evaluated and accordingly priced-in, it is now necessary to think in scenarios. This is particularly relevant for long-term planning, such as investment projects, product design or further development of the business model. Risks of different scenarios are evaluated and considered in the decision-making process. In order to carry out the best possible risk assessments, companies can use additional methods, such as the use of internal CO₂ prices or analyses of material flows and data in the value chain, even beyond own company boundaries. At the same time, this approach also creates transparency that enables companies to discover and leverage potential that goes beyond meeting regulatory requirements.

By the way: Transparency in the value chain as described above will be a crucial point for almost all industrial companies. It is not only a prerequisite for good planning, but also for the implementation of future strategies and for leveraging innovation potential. For most industries, it is assumed that new cooperation and joint action in the value chains are necessary in order to be successful in the long term and also to meet the goals of the sustainable transformation. This sometimes requires changes in thinking and also in the processes of companies. As a side effect, however, companies also have increased opportunities to participate in innovation, to access new technologies, to diversify risks and to implement digitization. The latter, in turn, is regarded as a driver of sustainable development.

Specific approach depends on industry and context

What does this mean in concrete terms for individual companies? To illustrate, here are a few short examples of different industries:

When developing products, mechanical engineering companies should consider parameters such as the energy efficiency of their products or the material used in the production process when using the systems. Both regulation and customer requirements call for more efficient or partly also replacement solutions. The customer, who, for example, uses the machines to produce fabrics from plastic materials, wants or has to move to bio-based raw materials in the future. This may require new technologies for machine builders. At the same time, innovation potential can arise, as the machine manufacturer can offer new value-adding services with increased knowledge of the customer’s value chain.

Business models of the energy-intensive industry usually depend on energy efficiency of the production processes and procurement prices for energy. In long-term planning, scenarios about the development of energy prices, including regulated CO₂ prices, are therefore relevant, combined with considerations about security of supply and access to more efficient technologies in the production process. Scenario-based planning also allows the development of options for hedging risks within the value chain.

Manufacturers of Fast Moving Consumer Goods (FMCG) will have to create transparency on a wide range of sustainability criteria (environmental impacts, social and ethical factors) in a comparatively short period. In addition to regulatory requirements, e.g. coming from the Supply Chain Act, trade industry also uses corresponding purchasing criteria. Long-term planning should therefore consider scenarios along the entire value chain based on a well-founded database. In return, companies also benefit from accelerated realization of efficiency potentials and marketing opportunities for particularly sustainably produced goods.

Anticipatory planning enables agile action

To sum up: dealing with sustainability regulation requires companies to change perspective – away from a purely reactive and compliance-oriented approach and towards an anticipatory and reflective view. Of course, compliance management and the implementation of specific requirements will remain a requirement that all companies must master. However, it is no longer sufficient for long-term success because it is very likely that otherwise it will be difficult to follow future dynamics and to participate in the developments. The danger of being left behind as a single company would be quite real. However, an anticipatory approach, in which different scenarios are taken into account, also enables further opportunities: In addition to a more robust planning process, agile structures often emerge that enable better organizational learning and thus better adaptability to changing conditions. Thus, companies not only create a basis with good planning, but also develop the respective competences for implementation in regulatory environment that is volatile – at least as far as the “how” is concerned.

Are you already using scenario techniques to anticipate future sustainability regulation in strategy and production processes? We are curious about your examples! Please do not hesitate to contact us if you would like to find out how your company can already anchor the necessary competencies today required for dynamic planning alongside sustainability regulation.

Image source: istockphoto.com/NicoElNino