The perfect company has long been thought to be structured around externalizing cost and avoiding risk. The modern limited liability company—modeled on Queen Elizabeth I of England’s sovereign guarantee to the British East India Company—was designed to invite investment by limiting the cost of failure and spreading risk across an entire society. But, perfection starts to look very different in a resource-efficient climate-smart economy, where a leading commercial and societal value is ecological noninterference.
Externalities are costs or benefits that are not counted as part of a given transaction, business sector, or field of inquiry. They are external to the relationships in question, because effects fall on others.
- There are negative externalities, like air pollution, which is not factored into routine business costs, and not paid for up-front by investors, but which imposes a heavy burden on people external to the transactions that generated it, and on the wider society.
- There are positive externalities as well, such as the surge in incomes that occurs over decades as the result of investment in education.
- The accumulation of too many negative externalities leads to market failure.
The Dust Bowl of the 1930s is a chastening example of market failure.
- A combination of financial sector struggles, low wages, unemployment, and consequently low consumer market prices, drove production increases that pushed commodities prices lower, making it nearly impossible for many farmers to reliably earn a living.
- As small farmers produced more to earn more, prices continued to fall, and arable land was degraded.
- Loss of topsoil meant dustier conditions, which meant the high-speed winds that prevail at the center of the North American continent had an easier time removing huge volumes of dry dirt, further depleting the production capacity of farmland.
- Millions of people were devastated by the largest-scale environmental disaster in US history.
The Dust Bowl was a pure and defined case of market failure. It was caused by human behavior, reacting to badly structured market incentives, which degraded human actors’ ability to respond ably to degradations in the natural environment.
With the global dominance of hydrocarbon combustion to produce energy, we have now put so many heat-trapping molecules into the atmosphere that the planet is warming (both atmosphere and ocean) at speeds too fast for natural systems to adapt to. Pooling investment risk across all of society and the planet’s life support systems simply doesn’t make mathematical sense when there are cleaner, cheaper ways to get energy that don’t generate negative externalities on such a scale.
Whole industries are about to face a shocking challenge: the demand that they transition with unprecedented speed from a model of maximum externalization of cost and risk to a model of maximum direct user benefit with minimal external interference. The externalization-as-finance strategy is no longer a sign of investment optimization, which means finance for such strategies will start to dry up.
The perfect company would be immune to these structural market shifts.
About a year ago, an executive at a leading company that depends on externalization of cost through carbon emissions made the following observation:
A company that doesn’t need to externalize emissions costs, or water resource management costs, or land use costs or infrastructure costs—in other words: a company that can carry all of its own costs—would be “the perfect company”.
It was a lightbulb moment, as investors, competitors, and policy-makers began to think about the power of that insight and the implications for how optimal investment strategies would be designed in the future.
Throughout the entire period of human industrialization, we have been operating on the assumption that big resource-intensive businesses should not have to manage or account for all of their costs. The assumption has been that letting the wider society, including human health and natural systems, absorb some of the cost and harm would be more efficient for everyone. Pool the risk, but don’t track or disclose it.
This standard has led to bubble economies, where inflated value pushes the limits of mathematical sustainability, until the bubble bursts and market failure imposes a correction. The don’t ask, don’t tell standard for externalizing industrial cost and harm has, in short, guaranteed we will be saddled with imperfect companies whose business models are a threat to their own future viability, and to the future viability of many other things we cherish.
The perfect business model may be always just out of reach, but the company that refuses to depend on negative externalities is becoming a core demand of the market. These critical steps will put you ahead of the curve:
- Assess all operational costs and wider business model impacts;
- Reduce dependency on subsidies and structural incentives to zero;
- Plan to carry even external costs while comfortably generating returns;
- Provide customers with reliable innovation and ongoing user empowerment.
The faster an enterprise learns how to cover even historically externalized costs, account for those inefficiencies and budget for profits that include that accounting, the faster it will be on the path to a vibrant future in the resource-efficient economy of this century.
[ The Note for July 2017 ]