How innovative companies can gain vital support in the drive to net zero
If climate change is among the greatest challenges currently facing humanity, we all have a responsibility to think hard about how to overcome it.
Governments might make the headlines with the targets they set at major conferences but – as in so many things – it will be the private sector that delivers.
The process begins by looking at the data, and what they show is illuminating. In a report by Boston Consulting for the World Economic Forum almost two years ago, it was found that more than 50 per cent of all global emissions come from the supply chains in only eight business sectors. These are:
- Food
- Construction
- Fashion
- Fast-moving consumer goods
- Electronics
- Automotive
- Professional services
- Freight
It went on to explain that only a handful of companies at the top of that chain are indirectly responsible for these emissions. Now, it is unlikely that the bosses of many major corporations are reading this. (Although if you are a subscriber
to Business Time In Essex, hi Jeff!) But it makes practical business sense for those supply-
chain businesses in our region who serve large companies to help their climate agenda succeed just as much as their commercial objectives.
If 50 per cent of all global emissions come from the supply chains in those eight sectors, then small- and medium-sized enterprises (SMEs) serving multinationals can make a big difference to the trajectory of global emissions. The reason for this is that now, all over the corporate world, sustainability is under scrutiny through the Environmental, Social and Governance (ESG) lens.
Listed companies are subject to an increasing focus among investment funds, indices and regulators around their climate impacts. Many are placed under the obligation to deliver specific ESG reports, setting out their sustainability credentials. The momentum is growing and the markets’ verdicts on companies’ performance in this area will impact their share prices.
Collective
It is unlikely, though, that supply-chain SMEs are subject to instruction from their large-company clients to clean up their carbon act. As the Boston Consulting report states: “Decarbonising supply chains is hard. Even leading companies struggle to get the data they need and to set clear targets and standards to which their suppliers must adhere. Engaging an often-fragmented supplier landscape is challenging – especially when emissions
are ‘buried’ deep in the supply chain, or when addressing them might require collective action at the industry level”
But even if they are unaware of it, the emissions of supply-chain SMEs are increasingly considered an integral part of their large-company clients’ carbon footprints. This is under the Greenhouse Gas (GHG) Protocol. This calculates companies’ direct emissions from fuel combustion in plant and equipment and company-owned vehicles as “Scope 1”.
The indirect emissions are “Scope 2” and consist of purchased electricity for those companies’ own use. The “Scope 3” upstream emissions are those from things like staff business travel, from waste disposal, from produced in the production of purchased materials or from contractor-owned vehicles. That is to say: what the supply chain contributes to a company’s production processes. Then there are “Scope 3” downstream emissions, which come from transporting products and what is generated in their end use and their disposal.
Incentive
This “whole-life-carbon” accounting is the purest form of calculating emissions and is driving large-cap companies’ efforts to decarbonise their operations. As ESG reporting gathers pace, their market capitalisation will soon be impacted by their extended carbon footprint from Scope 3 emissions. With this in mind, it becomes plain there is a major incentive for SMEs to gain an edge over peer-group companies by competing not only on price and service but also on their sustainability performance.
And given what is at stake for them, many major corporations are transforming their operations as a result. In a recent tweet as part of its announcement of its transition from a linear to a circular economic model, the Renault Group hinted that there is a large gap that can be closed by enterprising companies in the automotive sector.
This has knock-on impacts for supply-chain SMEs. If, for instance, your firm were the manufacturer of parts to car companies, your own supply chain might well have been impacted by the war in Ukraine, by difficulties with sea, river and rail freight during the summer heatwave or by the increased costs of energy. This might have put the company under financial strain. But these issues also present opportunities for nimble executives.
By developing methods for production lines to reuse and recycle materials from end-of-life cars, an SME can start to cut its reliance on gummed-up supply chains and on new materials and inputs altogether. Indeed, the impending shift to electric vehicles might in time threaten that same parts-manufacturer’s entire business model. After all, there is no carburettor in a Tesla.
But electric cars do have other needs. The cobalt, manganese, nickel, aluminium and lithium that go into batteries are hard to come by, needing to be mined in far-off countries run by often-questionable regimes. But by pivoting elements of the company’s production line towards the recycling of mobile phones, laptops and tablets – thus acquiring these key metals from sources closer to home – the SME can pivot to a more sustainable future, both environmentally and commercially.
Diversify
These opportunities are not by any means the sole preserve of car-parts manufacturers. As business processes evolve in this new era of low-waste processes, of clean energy and battery power, of robotics, of the internet of things and of quantum computing, a process of creative destruction is under way. The opportunities for supply-chain companies to diversify will grow even as the threats to their existing business models intensify. But the pursuit of diversification might be a worry to some. As an economic downturn bites, investing in sustainability measures might
not seem like a priority. And it may look like a prohibitively expensive undertaking even if you decide to take the plunge. But the evidence points to a different conclusion.
Boston Consulting’s Net-Zero report explains:
“Net-zero supply chains would hardly increase end-consumer costs. Around 40 per cent of all emissions in these supply chains could be abated with readily available and affordable levers
(less than €10 [$9.87, £8.61] per tonne of CO¬2 equivalent), such as circularity, efficiency and renewable power – with only marginal impact on product costs. Even with zero supply-chain emissions, end-consumer costs would go up 1-4 per cent at the most in the medium term.”
This equates to a route to net zero for an activity making up half of all global carbon emissions, delivered at a fraction of the rates at which standard inflation is currently running. That calculus sounds like a goal worth striving for among UK-based SMEs. Particularly if it means winning more business for them from major multinational clients.
Indeed, in this current inflationary environment, the opportunity to pass on costs to end-use customers discreetly through price rises or
“shrinkflation” is increased. With less price sensitivity, it follows that SME businesses who can deliver direct benefits to sustainability-focused multinationals by achieving decarbonisation for their supply chains will be the ones who win out.
Opportunity
The snag is that, as Boston Consulting pointed out, completely decarbonising operations for supply-chain companies is hard. Achieving full net zero will undoubtedly require a good deal of intellectual input. But where there is a difficult task requiring new ways of thinking – in other words, research and development (R&D) – there is also an opportunity for external support.
At the heart of UK industrial policy is the government’s £15 billion-a-year investment in the HMRC R&D Tax Credits Scheme. Under the Scheme, UK-based limited companies can apply for tax relief to support their innovation in new products and processes. This can be achieved in one of two ways.
The first is under the SME scheme. This provides tax relief of up to 33 per cent on a company’s
R&D expenditure. It means successful claimant companies can recover up to 33p in every pound spent on qualifying R&D, in terms of the time spent and the materials used in its delivery.
Even the costs of water and energy such as fuel and power directly used in the R&D activity are claimable, which is a relief in more ways than one in the current financial climate. The relief is even available to companies who are loss making. Substantial cash credits can be paid to them for qualifying R&D – and often within weeks of the submission of the initial claim.
However, if an SME obtains a subsidy for its R&D activity – from either a large company contracting them to carry out the work, or perhaps through grant funding from a charity – then it will be unable to claim for that portion of the costs through the SME scheme. Instead, it must
make a claim under the so-called Research and Development Expenditure Credit (RDEC) Scheme. Available reliefs under this scheme are less generous and amount to up to 13% of the overall R&D expenditure, although any expense incurred over and above the subsidy can also be claimed for under the SME scheme.
Expertise
f it sounds complicated, that is because it can be. Companies can deliver their own claims according to the records they have produced of their R&D activity. But it tends to take up valuable management time. They can also engage their accountants to carry out the work in calculating the claim.
But many generalist accountants themselves consider it preferable to contract out their claims under the scheme to reputable, specialist R&D tax agents whose expertise specifically lies in the area. This is usually the route to minimising the burden on management while maximising the chances of success of the claims made under the HMRC R&D Tax Credits Scheme.
Most often it is best to engage with a reputable R&D specialist even before the outset of the
R&D project or projects. That way the best record of the activity being undertaken can be provided to HMRC to support the claim. Because, worthy though the endeavour undoubtedly is, if decarbonising supply-chain operations is hard, then doing so while running your own tax-credit claim in the background can be doubly so.
Still, if by successfully doing so you can reduce your corporation-tax burden too, the case for hitting the road in the drive to net zero seems unquestionable.