In a circular economy, products and materials flow in loops, maximising asset utilisation and minimising waste by design. It avoids the economic losses along the value chain and negative externalities inherent to the traditional linear model of production and consumption. The Ellen MacArthur Foundation, SUN and McKinsey have identified that by adopting circular economy principles, Europe can create a net economic benefit in 2030 of €1.8trn compared to today, double that offered by the current linear development path2. The circular economy can simultaneously create opportunities for growth and jobs, stimulate industrial renewal and innovation, and reduce environmental pressures.
For companies to capitalise on this opportunity, business models as well as collaboration across the supply chain need to be reconsidered. The following two examples of circular economy business models being used on the ground are illustrative. One hundred La Place restaurants in the Netherlands provide 2.5t a week of waste coffee grounds to GRO-Holland, a company that uses them as a growth substrate for oyster mushrooms. The mushrooms are then sold back to the same restaurants to be used as ingredients. The supply chain is therefore made symbiotic or ‘circular’ by turning one player’s by-products into feedstock for the other.
As an example of pay-per-use, in addition to selling lightbulbs, Philips now also signs contracts to provide light, by the lux. The company keeps ownership of the lighting system, taking care of maintenance and remanufacture during the contract. Such a model can be both more profitable than traditional products sales for the manufacturer and cheaper for the user. It also promotes increased customer interactions – and potentially loyalty.
How do these business models affect companies’ (and customers’) working capital and financing needs? In the symbiotic ‘circular supply chain’ model there is a potential reduction in non-payment risk. Players become both buyers and suppliers and so possess a more equal balance of economic power, likely formalised by contracts that incentivise the continuation rather than termination of the relationship. Can such a risk reduction be measured and priced? Could cash handling costs be reduced, and more liquidity unlocked, by using closer bonds in the supply chain to net off more transactions and to extend supply chain finance to earlier in the purchase process?
The pay-per-use model increases working capital requirements by extending the time, potentially by years, before which production costs are recovered. It increases credit risk towards customers, but reduces risk from volatile raw materials prices by extending the useful life of the asset. Can assets on the now-extended balance sheet be valued by component rather than by product to allow depreciation to depend on each’s remanufacturing cycle? Can a leasing model share between the user, producer and financier the higher underlying value created by reduced future production costs?
These questions are part of a fundamental re-think of how companies create value and the potentially profound impact on their cash flow and financing: what is at stake is a transformation of the core business strategy, not a mere CSR plug-in.
Finance in a circular economy is a young field. More such innovative financial thinking is needed. How do treasury professionals see the potential for cash and risk management in their own institutions changing to take account of circular economy business models? What are the more radical ideas for new instruments to enable these models? The answers will help shape the financial landscape of the future.