Leveraging Resources, or Future Planning for Future Rewards

by | Jan 10, 2011

A number of items passing across my computer screen (or my ears from the radio) have prompted an additional posting on “leveraging” following our last blog on leveraging manufacturing.

These are, in no particular order, the continuing development of the Chinese high speed rail network (as reported on NPR recently), recent emails among a few “green friends” on the need for, and feasibility of, inclusion of influences other than economic terms in net present value (NPV) calculations, and a discussion I had recently with some design folks at a meeting on how a major company can include green manufacturing “awareness” in its products and get some recognition of this from the consumer.

These sound unrelated – but, I will now try to string them together. And apologies in advance if this sounds like rambling to you.

Let me start with the NPV discussion. This came up due to an article in a trade press basically stating that, since “green technologies” really only have positive net present value due to subsidies they cannot really drive economic recovery or create “high value jobs.” This was presented as part of a discussion as to why we will be better off without cap and trade.

So, first, what is NPV? Referring to our old friend, Wikipedia, net present value is “simply the present value of future cash flows minus the purchase price.” It is a means to take expected future cash flows from an investment, usually a series of expected cash inputs over time, and convert them to an equivalent sum (present value, PV, or present worth, PW) based on an assumed interest rate or growth rate over the time of the future flows. Sort of, if you had this amount today (present value), and invested it over the same time period, it is the accumulation of value you’d realize over the amount started with.

If the NPV is greater than zero, the investment will yield positive results and may be worth the risk of investing. As Wikipedia says, “NPV is an indicator of how much value an investment or project adds to the firm.” The assumption is, then, that if the NPV is zero, or less, the investment is not worth it.

So, now we throw in environmental considerations, or carbon footprint, or some other metric of impact or consumption, These are hard to monetize so the impact of these potential “rewards” cannot be easily determined. So, some say, we should not consider them in our calculations of investment and only go with those costs that can be solidly determined.

So, since we cannot estimate the “value” of reducing the carbon footprint of our process, or product, we cannot really determine whether the NPV of any investment which has the effect of reducing the carbon footprint is worth it. And, this brings cap and trade into the cross hairs. Cap and trade is a market-based approach that uses economic incentives to drive pollution reduction by steadily reducing the allowable amount of pollution that can be emitted. The idea is that if you are successful in reducing pollution below your allowable level, you can “sell” your excess allowance to someone else who has not yet been able to reduce their pollution.

And this is, to some, an artificial subsidy to some technologies that reduce pollution that cannot be justified by a reasonable economic analysis, like NPV.

The challenge is, can you include environmental metrics into NPV?

This was originally brought to my attention by Ralph Resnick of NCDMM in a note to a few of us asking whether or not we could include sustainability metrics in NPV. One response from John Sutherland, a professor at Purdue University and a leader in green manufacturing, referred to a great article in Forbes from June 2009 on “Calculating the true cost of carbon” by David Serchuck. This article offers a balanced and rational (to me!) explanation of carbon cost evaluation and the value of carbon taxes in an economy to drive CO2 reduction and technology. And the article puts an average price of $20 per ton of carbon dioxide.

The real question is – how do you value risk? And, then, how do you figure this in your NPV calculation?

Most folks I talk with, over a wide range of companies, see the potential risks associated with driving full speed off the “business as usual cliff” as real. Recall our recent discussions about water, rare earth metals, etc. This is all part of the equation. What is it worth to you to be able to reduce your carbon footprint and is the investment needed to do this worth it?

One common proxy for carbon is electricity (or rather one common proxy for electricity is carbon!). You can calculate the cost of electricity. You can determine the impact of your use based on where you are and the mix of fuels used by your local utility. So, we can use that for NPV.

You can estimate the impact of regulation on the cost of your product if we expect some areas of the world (and California) to start to track the carbon footprint of your product and, maybe (probably) tax you for excessive carbon use. This already occurs in France when you buy a car that has a gCO2 equivalent/kilometer traveled value less than a prescribed level. So, I can use that in my NPV for transportation.

There are probably more. We’ll work on it.

NPV is a way to estimate the impact of future benefits in today’s terms. Or, put another way, the degree to which an improvement today leverages benefits in the future.

So, what about the Chinese trains? The  NPR program talked about a new high speed train that cut the travel time from Shanghai to Wuhan to just 4 hours. It used to take 10 hours.  Wuhan is a rural area with lower costs of operation (by 50%) than in Shanghai nearer to the coast. Companies are moving there now (and these are international companies) due to the supply of labor, lower costs of operation (like living expenses for employees and, yes, local incentives) but accessibility due to the train. And they mentioned the investment in high speed train networks in China which will create a high speed rail network with more kilometers of track than the systems of the rest of the world combined.

And in the U.S., some recently elected governors are refusing to accept Federal stimulus funding to build high speed high speed rail networks in their states.

In another email exchange on some common research collaboration on energy efficiency and resource effectiveness we had a go around on the meaning of terms. John Sutherland made a simple definition that is worth sharing: In lay language, efficiency is “doing things right,” and effectiveness is “doing the right things.”

That’s a great way of looking at investments that can be leveraged in the future for big returns – like high speed rail, for example – with big returns on impact/unit of distance traveled.

Finally, conversations with “design folks.”

One of the discussions was on the motivation that companies (and societies) have for “doing the right thing” even if it is not possible to fully compute the benefits today. Sounds like the NPV discussion!

I was chatting with a particularly clever designer and we came up with a neat “app” for your smart phone or pad computer – “text messages from the future.” Meaning, some algorithm for sending you, extemporaneously, a hypothetical text message from some friend (or relative) far in the future commenting on their life experience, or job or some other topic – just like you get text messages from folks today.

We thought of one – “Hi great-great-grandpa, wish you had cut down on your CO2 emissions 50 years ago; bought a new respirator today and my sister just moved to a great ocean front place in Savannah.” LOL (not).

What do you think are likely text messages from the future?

We’ll get back to more on green technology next time. And, let me know if you have ideas about calculating the leverage effect of your green technology wedges.

David Dornfeld is the Will C. Hall Family Chair in Engineering in Mechanical Engineering at University of California Berkeley. He leads the Laboratory for Manufacturing and Sustainability (LMAS), and he writes the Green Manufacturing blog.

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