Published July 13, 2016
The concept of circular economy is a grand, sweeping vision, which we hope will lead to better business models and environmental outcomes. Following promising reports by the Ellen MacArthur Foundation (EMF) and the adoption of an EU Action Plan for the Circular Economy, the topic has moved front and center of the sustainability dialogue.
While it’s encouraging that public and private-sector leaders are awake to the importance of reducing waste generated by linear business models, we need to carefully evaluate the way forward for circular economy practices, especially in the context of regulatory mandates.
The economic figures in support of circular economy are quite appealing, but they’re mainly based on macro-level principles and extrapolations of rather simple assumptions. They overlook micro-level research from the last two decades in Industrial Ecology and Operations Management. This work reveals a number of challenges and offers careful perspectives necessary to achieving the potential of circular economy models.
Big transformations like the ones advocated by the circular economy are set in complex, dynamic systems where unexpected, non-linear knock-on effects can spoil the dinner. Stated differently, we should be careful about simple, linear arguments regarding the circular economy. As they say, the devil is in the details. We see some devilish details in four particular obstacles to the circular economy.
1. Customers Demand Freedom of Choice
Prioritizing product reuse through closed-loop leasing models is a central tenant of circular economy. A washing machine is an example (cited by the EMF) of a product that could be leased numerous times over a 20 year lifespan to reduce environmental impact, increase profits and still provide cost savings and other benefits to customers.
But do customers want to lease a machine that is 5, 10 or 15 years old? Are marginal cost savings enough to sway deeply ingrained customer preferences for new products? If not, are regulations a palatable solution? Or does that bring to mind how many Eastern European citizens during the Cold War had no option but to drive the same model vehicles indefinitely?
Whether allowed or controlled, freedom of choice is a powerful force that must be reckoned, and changing consumer behavior is a tall order.
2. Technology Wants to Bound Forward
One of the reasons customers desire new products is that they incorporate improved technologies and designs. Even if a product, such as a washing machine, is designed to be updated with new sensors and software in the foreseeable future, major technological advances are rarely foreseeable. (How about washing machines that don’t need water or soap?)
We can’t ignore or control the technological clock speed that makes older products less attractive—nor should we. Locking in product lifecycles would restrict the introduction of substantially improved, disruptive technologies and decrease the competitive market forces that drive their development.
Quite a few products we use now may be replaced by distinctly different solutions long before their specially designed, extended-life versions are meant to be recycled. (Will smart phones or tablets still be necessary five years from now?)
3. Market Conditions Are Complicated
Even if customers wanted to keep the same products and technologies in circulation, it often doesn’t work from the manufacturer’s perspective. If you look closely at these business models, three things become apparent.
First, we need to understand whether and when closed-loop recycling (as promoted by circular economy advocates) is the best solution. For instance, why would an original equipment manufacturer (OEM) recycle only its own products (closed loop) in instances where there are valuable economies of scale and clear advantages of open loop? Research shows the utility of materials can be preserved through open-loop recycling or by ensuring materials are used and reused through more advanced networks or industrial symbiosis.
Second, we need to fully understand the reverse logistics required to successfully operationalize circular economy models. When customers acquire products, forward logistics can be organized to benefit from scale economies. But taking products back from consumers is a particularly sticky and cost-prohibitive problem. The lack of economies of scale in first-reverse-mile logistics can drive costs through the roof in many developed countries and cities.
Third, leasing can be a challenging business model to implement, and there’s no guarantee it will be more profitable for manufacturers than selling. Service guarantees, while reasonable for a durable washing machine, could increase the leasing fees of less durable goods to the extent that many customers would prefer to buy a product instead. The switch to leasing could also change the financial structure for manufacturers that would no longer be able to cash in revenues immediately. Also, OEMs are unlikely to have maintenance networks in every region where they sell. Outsourcing the management of leasing agreements means third parties could be more likely to benefit than manufacturers, if leasing became the norm.
4. Environmental Benefits Are Uncertain
Finally, even if we find the means to overcome the three obstacles mentioned above, are we sure circular economy models will have less environmental impact? Couldn’t increased back-and-forth logistics cancel out greenhouse gas emission gains from producing fewer new products? Or, could it be possible leasing will cause companies to prematurely retire functioning products in order to keep from cannibalizing demand for new products, as research published in 2012 suggests?
We wholeheartedly support the concept of circular economy. But we also believe it needs a solid foundation for success. This requires advance critical thinking on how to operationalize and implement the concept on the ground. That is, OEMs would be well advised to complete serious business model analyses and carefully calculate who will bear the costs and who will reap the benefits. Similarly, it’s our hope that lobbyists and lawmakers will engage with the scientific research already underway on these topics in established fields to better understand the obstacles and find solutions that ensure the success of this appealing concept.
Vishal Agrawal is Assistant Professor of Operations and Information Management at the Georgetown University McDonough School of Business.
Atalay Atasu is Associate Professor of Operations Management at the Scheller College of Business at the Georgia Institute of Technology. He also is a senior editor of the sustainable operations and industry studies and public policy departments for Production and Operations Management.
Luk Van Wassenhove is Professor of Technology and Operations Management and The Henry Ford Chaired Professor of Manufacturing at INSEAD.