Sustainable development: can functional economy fit square pegs in round holes?

Photo Yoann Sidoli / Ph. D. candidate in sociology, SENSE laboratory of Orange Labs / University of Nice Sophia Antipolis / May 28th, 2013

Economists, as well as companies, increasingly care about the ecologic crisis. Various approaches are emerging that all strive to reduce the environmental impacts of the production and consumption of manufactured goods. Among them, functional economy triggers three dramatic mutations, regarding value estimation, ownership and the relation to time. The company’s business strategy is no longer focused on selling a greater number of products, but on aggregating a greater number of users. In a conventional economic model, the company can increase its profits by reducing the life cycle of products; whereas in a functionality approach, the provider must maximize the number of uses of its offer by designing sustainable products.

The development of green technologies is the ultimate solution that has been proposed to mitigate the energy footprint of industrial societies. However, it does not address all environmental issues. The design and development of these technologies require the extraction of natural resources and imply expensive processes and devices. In addition, they often overlook the rebound effect resulting from the interaction between these technologies and social practices: once equipped with energy-efficient technologies that reduce the burden on their budget, consumers have a strong tendency to overuse them, as has been observed for low-energy bulbs. At the end of the day, green techs only deal with the energy sources deployed in a particular socio-economic system, whereas sustainable development calls for a drastic reworking of the same system.

Other approaches seek to integrate economic, social and environmental issues. For instance, circular economy – sometimes referred to as “cradle to cradle” – seeks to limit the flow of energy and raw materials, by aiming at a closed loop model: the producer reintroduces end-of-life products into the production loop. What was once considered as waste can then be transformed into a usable component and the producer can consider a revaluation of his assets (renovation, reuse, recycling, etc.), while drastically reducing the environmental impacts of his production.

Another approach, collaborative economy – or economy of sharing – promotes a distributed, peer-to-peer, economic vision. The consumer becomes part of the production process by allowing third parties to use his property: the owner of a car leases it to drivers without a vehicle (e.g. CityZenCar), a private individual rents his unoccupied guest room to tourists (e.g. Airbnb). This pooling of goods dramatically increases their use. Indeed, this sharing system provides a limited number of goods to a large number of individuals, without having to limit their needs. The access to goods increases, without necessarily boosting contaminating activities, as illustrated by the example of car sharing.

In a similar perspective, functional economy belongs to powerful trend of servitization of products. It is based on providing an access to the functionality of goods rather than their property rights. In this configuration, consumers don’t, for example, buy a vehicle but request a service that provides them with mobility; a professional business no longer needs to invest in a photocopier, but contracts a printing solution (for instance, Xerox). Functional economy intends to support sustainable development without adding an additional burden on the shoulders of economic growth. Beyond the disappearance of use on sale, this particularly ambitious approach cannot be understood without contemplating the three mutations it triggers: value estimation, ownership and the relation to time, all of these crucial features are reconsidered in the light of functional economy.

Decoupling economic growth from the flows of raw materials

In response to increasing scarcity of raw materials and processing problems of industrial waste, functional economy intends to reduce the overproduction of manufactured goods. Unlike the traditional market approach, value no longer results from the intrinsic value of a product, but from the commercialization of its uses. Products can be considered as a medium of value. Goods should therefore be used to their full capacity and also be sustainable, to allow the service provider to maximize profits.

The automotive market is a shining example: consumers do not buy a vehicle but seek a provider who delivers a mobility service that is billed on a per-use basis i.e. the number of kilometers traveled. In a conventional market, it is in the manufacturer’s interest that clients frequently renew their vehicle(s); whereas in the logic of functional economy, for a car sharing service such as Autolib’, the service provider must lengthen the life cycle of its vehicles to maximize the number of kilometers and ensure business profitability. In the case of Autolib’, this idea is embodied by the extended life of the LMP (Lithium Metal Polymer) batteries that equip the Bluecar fleet – approximately 200,000 kilometers according to the service provider.

autolib
An Autolib station in Paris

The company’s business strategy is no longer focused on selling a greater number of products, but on aggregating a greater number of users. In a conventional economic model, the company increases its profits by reducing the life cycle of products; whereas in a functionality approach, the provider must maximize the number of uses of its offer by designing sustainable products. Functional economy is therefore the exact opposite of the so-called planned obsolescence that contributes to the accumulation of waste electrical and electronic equipment (WEEE) and the emission of greenhouse gas (GHG).

The durability of goods can also be extended beyond the product life-cycle: in the case of standardized goods, parts or components can be restored by replacing faulty pieces. What was considered as waste can be transformed into a usable component, provided that the goods are designed from the outset as entirely modular and upgradable. Under these conditions, the company can reassess its goods, measuring and developing their capacity for renovation, reuse, recycling, etc. Extending their circulation time will allow a better return on investment and therefore greater profitability, while drastically reducing the environmental impacts of production.

As such, the print service of the manufacturer Xerox achieved a record 92% rate of recycling and reuse of waste equipment. Xerox was an early mover and since 1999, they have saved approximately $200 million by adopting this method.

Fuji-Xerox-Closed-Loop-System
Fuji Xerox Closed Loop System

Functional economy is related to the so-called “circular economy”, since the reinstatement of end-of-life products in the production loop resembles to a closed circuit production model. To do this, producers must remain the owners of the goods they offer.

Property rights not to be transfered

In addition to the extension of product life cycle, the non-transfer of property rights ensures the maximization of the income of the service provider, while allowing a better management of the whole life-cycle costs of products. Indeed, in a model of mass production, the cost of using the product, such as energy, or expenses related to maintenance and servicing, are charged to the consumer. Meanwhile, the cost for destroying obsolete or defective products and those related to waste treatment are not borne by the producer either.

The manufacturer thus generates negative externalities, such as economic and environmental costs, that are imposed to third parties. In a functional economy, rather than seeking a posteriori to transfer these external costs to the company (for example, through taxation), the provider remains the owner of the product. As such, he is responsible for all the economic and environmental impacts that will occur during the product’s life cycle.

Service providers include the product’s long-term costs, including operating, maintenance, servicing and destruction. This is a crucial incentive to reduce energy consumption, from the product design to its reintroduction into the market. This unexpected approach, from the point of view of the service provider, is only possible if the company is able to compensate the operating costs of its products and bring its business model into a virtuous cycle.

This compensation happens when the service provider considers its products as assets, and takes interest in ensuring regular maintenance to support the investment, that will in turn capture value. The very fact of being the owner of the product until the end of its life cycle allows the provider to reintroduce part of the capital in the production loop, and thus renew the offer at a lower cost.

As such, the technology developed by Michelin, as well as the specialized maintenance staff they provide, allows them to extend the life of the tires they designed for trucking companies: new tires, regrooved tires, retreaded tires and eventually, tires regrooved for a second time.

This model seems very attractive for providers but one crucial issue remains: how to ensure a satisfactory quality of service for consumers?

Long term contracts

Since the consumer doesn’t purchase a property right, but a limited right of use over a period of time, the contract with the provider ensures the consumer with an access to a service with a predefined level of quality. In a traditional sales model of property, the vendor will commit to medium-term or very short-term contracts; whereas in functional economy, the vendor accepts the terms of a contract with medium to long-term results and secures the needs of customers. Here again, a balance must be found for the sake of the provider: the contract must specify the conditions for a normal use within the rental period of the product and mitigate the risks of deterioration.

Non-possession may indeed free clients from their responsabilities and undermine the efforts of service providers to extend the life of their products. The case of Velib’ is a good illustration: from 2007 – the year the service was launched – to 2009, 16000 bicycles have been damaged and 8000 more have been stolen. This represents an overall cost of 8.5 million euros. Consumers should gradually change their habits enherited from the from the throw-away society era. This change of behavior could be supported by public authorities. Thus, an awareness campaign was organized by Paris local authorities, which helped reduce vandalism on Velib’ by 46% between 2009 and 2012.

Another strong edge of functional economy is that the initial investment is borne by service provider, not the customer. As shown by a survey on carsharing led in 2013 by the research unit 6-t (in partnership with France Autopartage and with the support of ADEME), an increasing number of private owners have accepted this new paradigm: through the membership of carsharing services, the number of households that don’t own cars increases by 40%. The providers can thus circumvent resistance to prices for those of their products that require heavy investment. Through their business to business activities, Xerox and Michelin were able and open their business strategies to a rental and service-based logic in order to expand their markets, despite the price of their products. The longer the term of the contract, the more the provider will be sure to get a reasonable return on investment; and the more sustainable the investment, the more profitable will the business model get.

For consumers, the benefits of this type of contract do not only depend on a satisfactory and consistent level of service, but also on the definition of a customized offer. Indeed, unlike models where the competitive advantage is translated into the pricing policy, functional economy introduces a customization strategy that takes into account the needs of customers in order to provide them with a level of stable performance.

The offered solution, which includes the access to products and services, is co-designed through a dialogue between a customer’s request and the expertise of a service provider. This process greatly limits the existence of oversized offers, for which the number of unnecessary options often justifies prohibitively expensive sale prices. This is often the case with software suites that offer features that will be used by a minority of users only.

Ruptures and reconciliations

The implementation of a functional economy model requires disruptions, not only with the usual representation of the value chain – which affects most departments (production, marketing, human resources, management, management control, etc.) – but also with the non-transfer of property rights, an innovation that could unsettle more than one consumer. On the one hand, the renunciation to property is hampered by the ostentatious and emotional values conferred by the possession of goods. How are we to express our social status without resorting to the external signs of wealth and success provided by objects? On the other hand, the transition from a mass consumption regime – at its peak with the practice of planned obsolescence – to a system of consumption linked to product durability, is a drastic change and will certainly require a period of adaptation.

The logic of use involves designing solutions that integrate products and services. It therefore requires to redefine the core businesses of the companies specialized in the production and sale of goods. The issue is then to understand the strategies to manage change and get people to work on the basis of this new business policy.

Ultimately, functional economy contributes to sustainable development far beyond reducing energy impacts and obsolescence: the service-based logic can lead to the creation of local jobs that are non-relocatable, by developing maintenance activities, training, personal services, etc. This dynamic will most certainly be backed by local authorities, always ready to bring their help to the sustainable economic growth of their area.

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