Q2 2018

Circular Economy: Reshaping the Industrial Ecosystem

Circular Economy: Reshaping the Industrial Ecosystem

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.

More than four 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.

The circular economy is sustainability taken to its ultimate goal: zero waste. In the circular economy, waste is neither expected nor accepted. It’s a failure. 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 from adopting circular economy principles more widely (see “Circularity Principles”).

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.

The Profit Motive

Like all revolutions, the one that spawned the circular economy started small.

Soon after that first exchange of materials between companies in 1972, other companies in the Kalundborg industrial park noticed the gains their neighbors were making, and they devised their own exchanges. These efforts also serendipitously resulted in little or no waste. More than 40 years later, 13 different companies in the area are saving almost $100 million a year while reducing waste and emissions significantly.

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. Nielsen’s most recent Global Corporate Sustainability Report found that brands associated with sustainability grew 3% more in one recent year than the rest of the field.

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 Internet of Things (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 ever-more 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.

Circularity Principles

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 corporations aren’t responsible for. Meanwhile, the appetite for government regulations designed to right the balance wax and wane 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: Circle Economy and PGGM, Ellen MacArthur Foundation, and SAP research

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Why Circularity 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, a civil war is raging over the ownership of cobalt mines. Meanwhile, China commands 97% of the 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—greater than that of any decade of the 20th century, according to a report by the McKinsey Global Institute. McKinsey’s math also shows that with 3 billion new middle-class consumers expected 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 world-champion recyclers, Austria and Germany nevertheless throw away nearly 40% of their waste, according to the environmental advocacy organization Planet Aid.

What Does the Circular Economy Look Like?

There are many loops in the circular economy, but they all lead to the same destination: zero waste.

Notes:

1. Hunting and fishing
2. Can take both post-harvest and post-consumer waste as an input

Source: Ellen MacArthur Foundation

Furthermore, increasing urbanization is creating more concentrated markets, which will give the circular economy a boost. Today, 54% of the world’s population lives in urban centers. That proportion will rise to 66%, or roughly 2.5 billion additional urban dwellers, by 2030, according to a report by the United Nations.

Urbanization drives companies to bring manufacturing closer to customers and employees. It also creates more opportunities to share resources and logistics. These opportunities have become so irresistible in some places that even direct competitors are teaming up to share. In Belgium, for example, Nestlé and PepsiCo have combined their truck fleets and routes to deliver fresh, chilled products to food stores.

The collaboration addressed the problems of partially filled trucks and overlapping retail deliveries: imagine one full truck, rather than two that are half full, delivering to a single store. By not wasting space, the partnership cut transportation costs by 44% and reduced carbon emissions by 55%, according to the World Economic Forum (WEF), thanks in part to analytics and tracking technologies such as GPS that optimize the routes. To avoid spilling trade secrets or tempting antitrust regulators, a third party handles the logistics to maintain privacy between the two logistics streams.

Designing for Circularity

In the future, profitable and sustainable partnerships like the one between Nestlé and PepsiCo will likely become easier as digital technologies such as blockchain, machine learning, robotics, and the IoT become mainstream.

Blockchain 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 to give logistics providers (in this case, recycling companies) the information they need to more efficiently and effectively separate materials for reuse when a product reaches the end of its life without revealing the details to competitors.

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. That 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 also have big roles to play in making logistics more circular. Liam, Apple’s disassembly robot, has the machine learning–imbued intelligence and powerful physique—29 arms—to rip apart and extract the usable materials from an iPhone in 11 seconds. Thus far, Apple has recovered 61 million pounds of reusable material, including 2,204 pounds of gold valued at $40 million.

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, IoT sensors enable Rolls-Royce to monitor the condition of a new generation of engines and take the aircraft out of circulation before they fail. Meanwhile, its airline customers can use IoT 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 subassemblies 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.

No More Running Room

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 WEF.

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 Nestlé and PepsiCo in Belgium 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 to protect companies from the threat of greater resource volatility and the costs of disposing of 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. D!

Read the Executive Brief:
Virtuous Circles: The Circular Economy Gets Rolling.


About the Authors

Christopher Koch

Christopher Koch is the Editorial Director of the SAP Center for Business Insight. He is an experienced publishing professional, researcher, editor, and writer in business, technology, and B2B marketing.

Dan Wellers

Dan Wellers is the Global Lead of Digital Futures at SAP.