We are fortunate that, for the good of the planet, consumers and regulators have environmental concerns much more ‘front of mind’ than ever before. From carbon emissions to resource depletion to the junk that floats in our seas, we all have a far greater awareness of the need to be much more careful about how we use and dispose of all the things we buy.
Manufacturers and other players in the distribution chain have, for the most part, not been slow to recognise that they have legal and moral responsibilities to society. The smarter ones have seen a business opportunity as well.
The culmination of this is the development of the concept of the circular economy. Recycling – disposing of something that we’re done with in a way that it can somehow be at least partly reused – lies at the heart of the genesis of the move away from the buy-use-scrap linear economy. The modern phrase for this is ‘urban mining’: instead of sourcing raw materials from a mine and making new components and products, the products themselves are ‘mined’.
In Figure 1, this schematic of the circular economy, the first circle means that people try to use the product for as long as possible. In the second circle, components are reused in similar products. In the third circle, all the raw material inside a product is recycled as source material.
But the circular economy concept is developing further, becoming more structured and sophisticated in its approach. In its wake are coming new ideas about product ownership and use, new business models – and new financial models to support circular supply chains.
Collaboration is the keystone in these emerging paradigms. We are going to see new forms of collaboration between partners up and down the physical, financial and information supply chains, upstream and down.
There are three things that need to be borne in mind as we rethink supply chains in a circular world.
1. Changing ownership
One thing that seems certain to change is the concept that ownership of a product is a prerequisite to using it. In the traditional model, you buy something, you use it. We’ve seen a leasing-type model for products such as photocopiers for many years – albeit driven more by economics than by environmental concerns.
We are now seeing an evolution of this concept with products such as cars, where it’s becoming increasingly common to pay a car pool organisation to use a vehicle for as little as an hour. It’s a concept that’s related to, but really quite far removed from, the laborious process of hiring a car for a week from an airport kiosk.
Instead of ownership, we should increasingly be thinking of ‘products as a service’. Legal ownership might remain with the manufacturer, a finance company or an organisation that buys a pool of assets and makes them available on a short-term basis to end-users.
Now imagine that this idea is taken forward – not just with a car, but with its various components. In an electric vehicle, for example, the batteries are a significant part of the cost but they also present unique environmental challenges. The electronics have a very different product life from the aluminium chassis and shell.
Who, then, is best placed to own these various components – and thereby to retain control of how they are disposed of? And what are the implications for how manufacture, distribution, sale, use and disposal are financed?
2. Changing cash flows
If in a circular economy the end-user is less and less likely to be the end-buyer or ultimate owner, then the cash flow models will be vastly different. In traditional supply chains, products pass from one party to the owner through a succession of purchases. In a circular economy, the flow of cash is more likely to resemble that of a lease or rental contract.
At the same time, however, business models for repair and maintenance and traditional insurance risks will have to change: no longer will a user of a product – a washing machine, for example – pay a lump sum to buy it and then take on responsibility for its upkeep and insurance. Rather, they will expect the product provider to ensure that the consumer is never left without the ability to wash their clothes. Whether that means the product provider services, repairs or replaces the product will be of little concern to the consumer. In this new world, therefore, more parties and more collaboration will be the order of the day in order to ensure that consumers get the use of a product that they expect.
3. Residual value becomes more important
Sellers have no interest in the residual value of a product that is no longer theirs. Neither, for the most part, do traditional consumers, who most commonly buy something and then keep it until it’s either of no further use or superseded by something newer and shinier.
That’s changing. The separation of ownership and use – and the disaggregation of the ownership models for components of complicated products such as electric vehicles – means that players in the supply chain have a greater vested interest in residual values than they have had previously.
Now, instead of looking at a car as just a car – a thing that gets people from A to B – you can also look at the car as a set of components that can be reused by taking the car apart and reselling the components. More than that, it is a set of raw materials that can be reused for other products. The car becomes a repository of raw materials.
In fact, in the circular economy it makes economic sense to be more finely attuned to residual values – whether the value of a product as a whole, the value of particular types of components that can be reused or the value of raw materials that can be refabricated into something else. For example, In a disaggregated world, the optimum time for the actual owner of the batteries in an electric car to replace them may be quite some time before the batteries – or the car – have expired.
Figure 2 below is a schematic to show the interplay between the market value of a product as a product, as a collection of components and as a repository of raw materials. It shows how, for example, there comes a point where a product has more value as a portfolio of components than as a product that consumers are willing to use. Ultimately, a product’s value as a pile of raw materials provides a floor to the market value of a product that would otherwise have no value, because it is no longer usable. There will come a time, for instance, when today’s smartphones will be unwanted by any consumers, who will view them as outdated. But they will still have value because of the raw materials such as gold that sit inside them.
Samsung recently announced environmentally-conscious plans to deal with the 4 million Note 7 smartphones it had to recall because of safety concerns relating to overheating batteries. It said that some phones would be supplied with fresh batteries and sold as “refurbished or rental phones”. Other phones would be stripped of any reusable components while others would have raw materials such as metals extracted by specialist recycling companies.
Collaboration – the way ahead
In order to know how assets and their economically and environmentally valuable components are flowing through the economy, the concept of ‘track and trace’ will develop beyond logistics into the new structures of the circular economy. One important issue will be the ability to have verifiable data about products, components and raw materials. Something akin to a blockchain model – which is specifically designed to ensure that data is trusted – may well emerge to ensure that such critical components and raw materials do not fall out of the circular economy by getting lost or disposed of improperly.
A manufacturer of something may not necessarily be the best party to disassemble it and reuse the components. In order to make sure a washing machine comes back in four years and recoup all the material, a manufacturer may have to enter into a collaboration with a third party service provider. Some form of sharing of the economic benefit that comes from this new process will have to be agreed.
All of these changes will clearly require supply chain finance models to support this. Finance can be an important enabler for a circular economy. More and more, financial structures will depend on the actual asset itself and the supply chain structure around it rather than an being tied to individual entities.
Supply chain finance is already good at doing exactly that, by financing a flow of goods in a collaborative way rather than providing loan finance to single entity. Banks and other financial institutions will have to better understand these new circular economy supply chain structures and the underlying assets much more if they are to provide the right financing structures.
I go so far as to say that supply chain finance is an extremely important pillar – maybe even the foundation – for making the circular economy possible. That’s why we need collaborative financing models that support these new supply chains to make the circular economy happen.