Global business is trending toward a low-carbon, sustainable economy. But adapting quickly to the decarbonized world can feel daunting, especially for small to medium-sized enterprises (SMEs). The cost of decarbonization may seem prohibitive, and the return too far afield. However, many of the costs associated with decarbonizing a business can be offset by the positive economic benefits of energy savings, improved brand reputation, and investor and regulatory compliance that come with risk mitigation.
This blog will help you understand why SMEs should care about decarbonization, the benefits—and difficulties—of decarbonizing, and how you can estimate your return on investment (ROI).
Why should small- to medium-sized enterprises decarbonize?
Global efforts to combat climate change have seen nations come. The Paris Accord stands out, wherein 196 countries committed to limit global warming to well below 2°C, aiming for 1.5°C above pre-industrial levels. In tandem, the G20, which consists of the world’s largest economies, has taken significant strides to promote sustainable development, emphasizing the critical need for decarbonization to ensure economic and environmental stability. These initiatives, along with numerous climate disclosure regulations, represent a unified front to transition the world toward a more sustainable future.
While it may feel like large enterprises are poised to take the brunt of climate regulation, combined, SMEs make up the majority of business-related greenhouse gas emissions. In the EU alone, SMEs make up 63.3% of enterprise emissions, which means reducing their emissions is a crucial part of mitigating climate change.
But decarbonizing is also good business. SMEs can take advantage of economic benefits and tax incentives like the Inflation Reduction Act (IRA), stand out with their supply chain partners, save big through operational efficiencies, and much more.
What are the economic benefits of decarbonization for SMEs?
Value creation in decarbonization falls into three main buckets: market advantages, energy efficiencies, and regulation/risk mitigation. Understanding these economic benefits will help determine the time and resources required to start and evolve your company’s decarbonization and net-zero approach.
The EPA says, “Energy efficiency is the fastest, least expensive, and largest single solution for simultaneously saving energy and money.” Changing behavior, switching to more energy-efficient products, and adopting clean energies are some of decarbonization’s quickest and most tangible economic benefits.
Engaging with employees to change behavior can lower energy use and requires little to no investment, so it is usually the best place to start. Using low-cost, energy-efficient products like LED bulbs, which can save between $10-20 per year and produce less than half of the emissions of the next most sustainable bulb. Across a building with hundreds of light fixtures, these savings and emissions reductions can quickly add up. Improving building insulation and upgrading HVAC and other equipment can also generate emissions reductions and economic benefits. For example, it took less than eight years to pay back the investments in upgrading the insulation in an existing office building.
Companies can also switch to renewables by investing in installing solar and batteries in their offices and factories. The payback period for solar installation can vary wildly depending on geography and other factors, but, on average, it is 9.89 years. After that, energy bills would go straight to the company’s bottom line for the duration of the solar panel’s lifespan (around 25 years), and with renewable incentives from government tax breaks, the ROI could increase further.
In the case of the U.S., the Inflation Reduction Act gives small businesses a tax credit that covers 30% of the cost of switching over to low-cost solar power, a tax credit of up to $5 per square foot to support energy efficiency improvements, and tax credits covering 30% of purchase costs for clean commercial vehicles.
As climate policies advance globally, they’ll affect SMEs on a much broader level. This could happen directly through policies like the EU’s Corporate Sustainability Reporting Directive (CSRD), where SMEs (any company with over 250 employees) will be required to provide detailed climate information. Alternatively, it could be indirectly, as larger companies may ask for emissions data and information to meet their own compliance requirements. In either case, SMEs will need to comply with climate policies. In the case of the UK’s climate disclosure regulation, which affects medium-sized companies with more than 500 employees, non-compliance could bring fines between £2,500- £50,000.
Companies that are proactive in their decarbonization strategy will appeal to enterprise buyers and investors with ambitious supply chain decarbonization goals. For example, Microsoft recently announced it would require customers to report emissions as part of its supplier code of conduct.
Related reading: The impact of Amazon’s supply chain sustainability push
While putting a dollar amount on a damaged reputation from regulatory non-compliance is difficult, some statistics show that a damaged reputation can be substantially more harmful than fines. A GrantThorton study found that while fines, on average, equated to 0.045% of a company’s market cap, the average value of reputational losses came in at a much higher 5.49% of the market cap.
Market advantages have a slightly more intangible economic benefit of decarbonization that’s harder to place an accurate dollar amount on. Still, they should factor in when evaluating the overall impact and value of decarbonization for your business.
Consumer trends favor low-carbon sustainable products. A recent study showed that products that consider environmental or social factors perform 8% better than products without. Another revealed that most consumers are willing to pay a premium for sustainable products.
Although there are clear economic benefits of decarbonization for small to medium-sized companies, the benefits can vary greatly based on several factors such as the size of the company, its energy consumption patterns, dependence on fossil fuels, location, and others.
What factors affect the ROI of decarbonization for companies?
Multiple factors determine how cost-effective decarbonization can be for SMEs and their potential return on investment. Consider these factors before building decarbonization strategies.
- Initial investment: Investments in energy-efficient equipment, renewable energy systems, or process upgrades may require significant capital expenditure. The higher the initial investment, the longer it may take to achieve a positive ROI. But also factor in things like sustainable tax incentives in the Inflation Reduction Act.
- Type of company: Depending on your company’s sector, the cost of decarbonization may be far higher than others. For carbon-intensive industries like oil and gas, the path to a positive ROI for their decarbonization investments may be long and winding. For SMEs in the services or retail sector, decarbonization could reduce energy costs or increase market advantages for a positive ROI.
- Company size: The amount of revenue and employees correlates with the energy and resources a company consumes, directly impacting the potential savings from decarbonization efforts. Size also affects the reporting disclosures that could impact your company.
- Company jurisdiction: The price of energy and energy volatility, government financial incentives, grants, or tax credits all affect the cost of decarbonization (and cost reductions).
It’s important to conduct a comprehensive assessment that considers these factors, including the cost and potential savings of different decarbonization options, to accurately determine the ROI of decarbonization.
SMEs with successful decarbonization ROI
Many companies have had a positive return on investment in their decarbonization efforts. Whether through investing in energy efficiencies, improved brand reputation, or government subsidies, the cost of decarbonization has been repaid many times over. The three case studies below offer real-life examples of decarbonization efforts that have resulted in favorable ROI.
Strauss Family Creamery: In 2004, the farm, which makes organic milk products, invested $300,000 in a methane digester. The methane digester converts the waste from the farm’s 300 cows into electricity. That electrification strategy fulfills 90% of the farm’s energy needs, paying for itself in under five years. It also powers the creamery’s electric vehicle fleet, saving them $10,000 annually.
Guayaki: Guayaki is an organic, mission-driven drinks company where sustainability and decarbonization are central to their market-driven regeneration approach. The more sales they make, the more forest regeneration and carbon sequestration they do. This brand image and reputation as a restorative company have helped it become profitable through its ability to resonate with environmentally-minded consumers.
Bright Power: Bright Power is a small energy and water management services provider. It believes that the energy investment tax credits, home owner-managed energy savings rebates, and other subsidies and credits from the Inflation Reduction Act will allow it to bring on substantially more customers and grow its business.
How to measure the ROI of decarbonization
Despite the different factors that affect a company’s cost of decarbonization and ROI, there are six key steps to take to estimate the cost of decarbonization and how long it would take for measures to pay for themselves.
- Measure emissions: Performing an initial and ongoing carbon audit to measure emissions across operations, products, facilities, and suppliers will help companies understand where their emissions concentrate. This will inform the building of strategies for each subsequent step and determine the effectiveness of each decarbonization method.
- Identify decarbonization measures: Once you have identified emissions hotspots, you can explore decarbonization measures that could be effective in building a strategic implementation hierarchy. This could include energy-efficient technology, starting with low-hanging fruit, like cheap LED light bulbs, renewable energy installations or purchases, a retrofit of existing equipment, engaging with employees for changes in behavior, working with suppliers, or other initiatives to reduce carbon emissions.
- Assess initial investment costs: Determine the upfront costs associated with each decarbonization measure. This includes equipment or technology purchase costs, installation expenses, and professional fees. Research if there are any tax credits or subsidies in your jurisdiction and obtain quotes from suppliers or contractors to estimate accurate initial investment costs.
- Calculate ongoing savings and potential new business: Estimate the anticipated energy and operational savings resulting from the decarbonization measures. Consider factors such as reduced energy consumption, lower utility bills, operational efficiencies, and potential cost savings associated with complying with regulations. You can also attempt to factor in optimization measures and any new business or customers the company may bring in due to offering low-carbon products or services.
- Determine the payback period: Calculate the payback period for each decarbonization measure. The payback period represents the time required for the cumulative savings to equal or exceed the initial investment cost. Divide the initial investment cost by the estimated annual savings to determine how long it will take to recoup the investment.
- Evaluate ROI: Once you have the payback period, assess the ROI of each decarbonization measure. ROI is calculated by subtracting the initial investment cost from the cumulative savings over a specified period and dividing it by the initial investment cost. Multiply the result by 100 to express it as a percentage. Compare the ROI of different measures to make more informed decisions on future decarbonization investments.
The return on investment of decarbonization depends on various factors. However, if SMEs better understand their sectors, jurisdiction, and options for decarbonization, they can build an effective decarbonization strategy, reducing climate risks and improving their bottom line.
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