The challenges of business adapting to change and its implications on sustainable transitions

In this article we look at the specific challenges companies face in this context. Ultimately, succeeding in achieving such a transition from a business point of view is in most cases nothing else but a profound change process. A good example for this is a study that the Swiss Federal Office for the Environment conducted in 2017 on the sustainability of the portfolios of Swiss pension funds. It has been found that the investments would lead to a warming of up to six degree Celsius. Hence there is substantial need for change in how the businesses operate that were part of the portfolios covered in this study. The remaining article is structured as follows. Firstly, reasons for the difficulties of mastering change are discussed. Secondly, options to facilitate change are presented. The last section concludes with specific key takeaways and measures that might help achieve the desired change. 

Reasons for the difficulties of mastering change

If we think about a change scenario as is represented by the example of the necessary decarbonisation of Swiss pension funds, we might think of a system innovation scenario characterised by radical innovation. In order to pursue radical innovation, a company needs to generate new knowledge by building up new capabilities. By doing so, it ensures competitiveness in the long run and avoids obsolescence. This is in contrast to incremental innovation. Incremental innovation is characterised by leveraging existing knowledge and capabilities in order to increase efficiency, thereby securing market share. Put differently, incremental innovation may be viewed as exploitation mode whereas radical innovation may be viewed as exploration mode.

Now, we will look at specific challenges regarding change on three distinct dimensions. 

Organisational. Exploitation mode is characterised by consistency, stability and control since existing knowledge is applied. Exploration mode, on the other hand, is characterised by the need for experimentation, flexibility and risk taking. If these two modes are applied simultaneously within a company, this may lead to internal tensions while increasing complexity and coordination efforts. As a result, company performance will be lower than it would be if only exploitation mode had been applied. 

Business model innovation. Apart from organisational aspects, exploration also often requires business model innovation. In the most extreme case, this means tearing down what made a company successful in the first place. Considering that there will be a transition period where profits will be lower, since it takes time until the new business model matches the scale of the old one, adds to the complexity of business model innovation. Viewed in the light of the prevailing shareholder value maximisation paradigm, this may lead to a potentially significant decrease thereof temporarily. Instead of investing in initiatives that contribute to successful business model innovation, a company might as well use these funds for optimizing efficiency of existing operations or paying out higher dividends to shareholders. Hence there is a conflict of interests represented by one approach that is rather long-term and risk-seeking, while the other one is rather short-term and risk-avoiding. 

Regulatory. Finally, in terms of sustainable transitions, another factor needs to be considered. Whereas normal innovation generally occurs in the form of market pull stemming from new consumer demands or technology push from the supply side, sustainable innovations also require regulatory push. As long as it is still profitable to engage in business that is contradictory to climate change mitigation measures, it is difficult to achieve significant diffusion of sustainable innovations in the market. 

Pathways to pursuing change successfully

Organisational. It has been stated in the previous section that pursuing both exploitation and exploration at the same time may lead to tensions within a company. Because of this, it intuitively makes sense to decouple the two modes from one another. Apart from the option to generate new knowledge and capabilities in-house, it is possible to acquire these via strategic alliances or acquisitions. In any case, it is recommended for each mode – exploitation or exploration – to determine how it should be pursued. For example, if exploration should be achieved via setting up an internal business unit that is shielded off from general company processes, or, via strategic alliances. This ensures that activities to pursue the respective modes are streamlined within each option (in-house, strategic alliances, acquisitions). 

Business model innovation. Since profits are often considerably lower from a new business model than from a previous one at the beginning, many managers are reluctant to shift. They do not want to be the ones responsible for lowering shareholder value. Moreover, it often takes experimentation to find a new business model, which also results in increased costs. Considering this, it would make sense to incorporate aspects such as the findings of the Swiss Federal Office for the Environment regarding Swiss pension funds into the investment decision making process. If such long-term factors were priced-in, the need to pursue initiatives that may be contradictory to the present model would become more apparent. This would also highlight the costs of not doing so, meaning in the worst case risking the long-term survival of a company. 

Regulatory. This side is very straight-forward. One just imagines a scenario – to take the previous example – where Swiss pension funds are obliged to hold a portfolio reflecting companies contributing to limiting global warming to one point five degrees Celsius. This is a very extreme example, but it shows the magnitude of change that would occur simply by who would receive investment going forward. Hence policy makers can, next to facilitating an environment nurturing innovation, also enforce radical innovation – system change – by introducing policy measures that leave no room but to change. 

Conclusion

Concluding, two main takeaways can be drawn. Firstly, it is important that initiatives serving exploration – radical innovation – should be executed in a space shielded off from business-as-usual practices. This is to reduce the threat of lowering performance by applying conflicting working principles in the same space. Moreover, it should give companies the time to experiment and thinking of the future while using the traditional business to fund these activities. Secondly, as would be expected, the regulatory side plays a highly important role in what areas innovation occurs. This is particularly true when discussing sustainable transition pathways. Nevertheless, more regulation and free markets have always been controversial topics. The final question that remains is if free markets without additional regulation are capable of, for example, reducing the carbon footprint of Swiss pension funds by threefold – from a six degree to a two-degree Celsius warming scenario.