“Climate change is the biggest threat facing humanity!” “Solving climate change is profitable!” “It’s up to business to act!” Wait, what?
Scientists raised the alarm about climate change some 30 years ago. Today’s warnings of the risks of a much warmer “business as usual” future have become more strident. National and international leaders repeatedly have agreed on the need to avoid “dangerous” climate change, but they have not agreed on measures to do so.
It’s been almost 15 years since the World Economic Forum (WEF) characterized climate change as “the most pressing future issue facing the business community,” and climate risks have been at or near the top of the WEF’s annual Global Risk rankings ever since.
Anticipating near-term regulation, more than 20 years ago the U.S. electric sector led the business community in voluntary efforts to mitigate climate change. Today, the business community faces ever-growing pressure from the public, regulators, investors, and other stakeholders to do more, even to the extent of “solving the climate change problem if policy-makers won’t.”
Business decisions, however, depend on the answers to two critical questions: 1) is it worth it to me? and 2) can I do it? Notwithstanding countless reports, studies, and calls-to-action from environmental advocates, global consulting firms, and stakeholders suggesting either the presence of enormous risk or enormous opportunity, the reality today is that only a modest fraction of business decision-makers answer “yes” if asked whether climate change is a material enough business risk or opportunity to justify their substantial involvement, and an even smaller fraction has figured out a “can I do it” strategy with which they are comfortable.
“It’s up to us to solve this critical societal problem,” and “climate change is just one of many issues on my sustainability plate” are not compatible story lines, no matter how commonly held. Business decision-makers must choose between these contradictory but common assumptions. Decision-makers grappling with this topic should ensure that they effectively frame their risk and opportunity picture, adequately scoping and quantifying their climate change risks and opportunities. If deciding to pursue mitigation and adaptation strategies, they should ensure they have the best available information.
It should be no surprise that there is a gap between how society perceives the risks of climate change and how most business decision-makers view these risks. Business decision-making is usually conducted on a much shorter-term time frame than societal decision-making. Moreover, business decision-makers have a narrower view of their role in societal problem-solving than do policy-makers, and business decisions have to adapt to an existing business environment; policy-makers directly modify business environments through laws and regulations.
The net result is that business and policy makers have different perspectives on the “is it worth it?” and “can I do it?” questions underlying climate change decision-making. While some stakeholders may argue “it’s up to business to act!” to solve climate change, the business reality is that a company that chooses to play policy-maker and unilaterally internalize a high carbon price in the near term would likely be put at a competitive disadvantage. The responsible decision-makers would very possibly find themselves out of a job, while simultaneously failing to have any impact on climate change.
Private-sector actions cannot substitute for societal decision-making. But societal perceptions of climate risk are still relevant when it comes to business decision-making. Societal perceptions of climate risk will eventually translate into the business risk environment through policies and measures, brand-impacts, and structural changes to many markets.
The physical risks of climate change look very different through business and societal decision-making lenses. Most risk work by climate scientists and modelers, for example, is not easy to apply to the risk profile of an individual company. The Intergovernmental Panel on Climate Change has projected 10 to 32 inches of global sea level rise by 2100. But this estimate does not reflect the full probability distribution of potential outcomes, which extends to some 16 feet of sea level rise in the worst case.
This is critical information for business risk assessment, which is more about “what could happen with what consequences for me” than about what is most likely to happen at a global level. Factoring in the full probability distribution of potential climate change outcomes, and applying those outcomes to the geographic and other circumstances of an individual company’s operations and its supply chains, will often lead to radically different perceptions of climate risk (both higher and lower) than are being discussed at a national or global level. Robust business risk assessment has to dig deeper than the headlines.
Business risk is a function of the following formula:
Risk = Hazard x Consequence x Probability
When it comes to business climate risk assessments this formula is more complicated than it looks due to the multiple hazards in play, and the many potential combinations of consequences and probabilities. To better understand this business risk formula:
* Hazards are the underlying causes of potentially negative business outcomes. When it comes to climate change, there are a range of potential hazards that may or may not be relevant to a specific company:
- Physical hazards, e.g. the direct impacts of climate change on company operations, supply chains, and financial performance;
- Brand hazards, e.g. changes in consumer and investor perceptions and priorities;
- Policy hazards, e.g. laws, regulations, standards or other mandates;
- Structural hazards, e.g. changes in a company’s business environment due to the second-order effects of other hazards; and
- Liability hazards, e.g. potential legal responsibility for contributing to climate change, a potential business hazard being actively litigated today.
* Consequences encompass the potential manifestations of the various hazards at the company level, recognizing that each hazard is likely characterized by a distribution of potential consequences.
* Probability is the likelihood of a particular combination of hazard and consequence.
Risk gets complicated quickly as hazards and consequences interact. The likelihood of policy hazards, for example, almost certainly increases as physical hazards manifest themselves (hence Climate Action Tipping Points). Few business decision-makers have assessed their climate risks (or opportunities) in this way, often relying instead on pre-conceived notions of potential risk. Most common is the failure to pursue scenarios as part of the risk or opportunity assessment process.