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Strategy tools and the Kyoto protocol's flexible development mechanisms.

INTRODUCTION

In the years since the 1997 Kyoto Protocol was ratified, expressions of corporate environmental and social responsibility continue to be a mandate in terms of a firm's strategic planning (Carroll, 1979; Hart, 1995; Hosmer, 1994). As a result, firms are faced with the problem of how to integrate environmental responsibility into their business activities while maintaining strategic focus. It may be argued that environmental pressures have forced firms to adopt strategic intents, visions, or missions which incorporate mitigation of the environmental and social impact of their activities. The challenge to a firm is to design its activities to support this environmental focus while maintaining a good fit with a firm's basic strategic intent, core competencies, and generic strategic position in the market in order to create and maintain competitive advantage.

The three flexible development mechanisms outlined in the Kyoto protocol provide a potential avenue for firms' strategic response to pressures, both social and regulatory, to express a commitment to reduce the environmental impact of a firm's continuing activities, to enter into new markets, and to develop new products. While there is ample evidence of the profitability of CSR activities, such as philanthropy to the firm (Russo & Fouts, 1997), empirical evidence on the characteristics of strategic intent statements, vision/mission statements, and generic market strategies that best fit with each of the three mechanisms outlined within the protocol is sparse. The effect of a firm's level of international diversification on climate change strategy has also been identified as lacking (Pinske, 2004). This research gap intensifies in importance as society's awareness of climate change and related policy increases, the processes associated with implementation of climate change strategy streamline, and the mechanisms outlined in the Kyoto protocol become a realistic, perhaps cost-effective option for firms to express their environmental and social responsibilities.

The purpose of this research is to examine how the time-tested tools of strategic planning may be used in the decision processes of whether a flexible development mechanism is an appropriate avenue for a firm to pursue in response to climate change pressures from the external business environment. It is worth reviewing in the background section the mechanics of the three flexible development mechanisms and to illustrate how a firm is able to participate in one of the United Nations' (UN) climate regime programs as part of a larger strategic plan. The background and literature review sections describe the use of strategic intent, core competencies (through balanced scorecard), and generic competitive strategies in the decision to pursue a project type outlined in the Kyoto protocol in propositional form. Finally, the firm's level of internationalization is explored as a moderating factor in the propositions presented. A summary, discussion, and implications for further research conclude.

BACKGROUND

At the 1992 United Nations Conference on Environment and Development (UNCED) meeting in Rio de Janeiro (the Earth Summit), the United Nations Framework Convention on Climate Change (UNFCCC) was accepted as the global, market-based roadmap to combat climate change. It is left to speculation whether in the current regulation-friendly atmosphere this type of free-market based mechanism would be as readily accepted in favor of strict carbon emission quotas.

The agreement outlined the UN's collective commitment to reducing greenhouse gas (GHG) emissions, mainly carbon dioxide, in an effort to stop or slow global warming. In keeping with the UN's overarching mission to promote growth in developing countries (DCs), the framework went one step further to define a scheme where the world's developed nations may take advantage of the lower cost of pollution abatement by using emission reduction activity credits generated in the DCs to meet climate regulations at home. The framework initially provided limited guidance to the implementation and development mechanisms to carry out this grand vision (Torman & Carzola, 1998), though over ten years later the rules governing options such as the clean development mechanism (CDM) seem to be moving toward solid foundation (UNFCC, 2008).

As of October 2008, most of the developed and developing nations (over 180 countries) have ratified and put into force the legally binding reductions agreed to at the subsequent UN Conference of Party (COP) meetings; however, the United States, the world's leader in carbon dioxide emissions at the time, signed the protocol but did not ratify it (United Nations, 2008). The United States' main argument for holding back is the exclusion of developing countries like China, currently the world's largest polluter (United Nations, 2009), to the list (Annex 1) of those countries agreeing to mandatory reductions ("Anger at US climate retreat," 2008). The protocol uses 1990 emissions levels as a benchmark and outlines target GHG emission reductions in those terms. For example, Canada agreed to reduce emissions to 6% less than those of 1990 for the first enforcement period of 1998-2012 ("Canada-Kyoto Timeline," 2007). In effect, this means that developed (or economies in transition) Annex 1 countries agreed to reduce GHG emissions while many manufacturing-intense developing countries have no such commitment, at least for the first commitment period of 2008-2012.

The 1997 Kyoto conference presented these three market-based options to mitigate global GHG emissions: clean development mechanism projects between a developing and a developed country, joint implementation projects between two developed countries, or outright purchase of tradable emissions credits registered with the UN's credit registry or purchased on one of the regional trading schemes. At the core of these options, the right to pollute was deemed transferable and thus has become tradable. All three are based on the creation of Carbon Emission Reduction (CER) credits as the tradable asset or currency. The UN and other regulatory institutions have made a market for the CER currency by creating scarcity--in this case, restrictions on global availability on the right to pollute for developed countries. A CDM project is one in which a developed (Annex 1) country invests in a developing country in the form of projects aimed at reducing emissions, increasing efficiency, or creating offset allowances by sequestering carbon, reforesting, or preserving forest lands (aforestation) (3). These types of projects have positive spillovers for the host country, both economically and in the form of technology transfer (Schneider, Holzer, & Hoffman, 2008). A joint implementation (JI) project is similar in nature but occurs between two or more firms of developed Annex 1 countries. Finally, the protocol allows for the establishment of carbon trading markets where CERs can be sold at a profit or bought and used to comply with a firm's home country emissions limits.

The three flexible development mechanisms are available to firms that wish to comply with their home country's national emissions regulations without internalizing the reductions. Of course, the mechanisms' basic premise rests with the marginal cost of reducing (abating) emissions externally or the cost of purchasing CERs (emissions credits) being lower than the cost of reducing emissions within the firm (internalization) (Wara, 2006). This is the "low-hanging fruit" idea, where firms can invest in abatement where the costs are lowest. These mechanisms pay homage to the roots of the basic theory of the firm, where the decision to produce internally or to obtain the resource externally rests with the relative efficiency of the market (Coase, 1937). The mechanisms are a market-based attempt to push clean development projects (in the face of regulatory pressures) to areas where it is most cost-efficient: developed--to developing; developed--to--developed; or to simply purchase the right to pollute.

There is currently no central, globally organized carbon trading market in which a developing country's firm might sell its CERs; however, the firm may agree to directly sell the credits or sell on one of several national markets in Europe (the UK and EU Emissions Trading schemes), the US (Chicago Climate Exchange, the Regional Greenhouse Gas Initiative), and the Asia-Pacific Region (the Australia Climate Exchange) (Kaya, 2008). The United States is currently evaluating the cost and macroeconomic effects of creating a national carbon credit exchange as the US continues its objection to the preferential treatment of the developing nations in the protocol ("Anger at US climate retreat," 2008). The current "cap and trade" discussion in the United States Congress is an attempt to regulate and formalize the same type of market-based mechanisms already adopted by the Kyoto signatories, the US as the lone world power holdout.

Illustrative Example

As an illustrative example, in 2006, the Canadian mining and energy firm Sherritt was approved for a CDM project to convert a gas-powered electricity generation plant in Cuba from a less efficient initial open-cycle setup to a more efficient combined-cycle configuration (UNFCC, 2006). Sherritt had been involved initially in a joint venture with a Cuban firm to construct the first phase. The new conversion project was projected to cost about $67,000 USD and was designed to generate 16674 CERs based on the reduction in GHG emitted from the reconfigured plant. Since Cuba is not an Annex 1 country, the CERs would be allocated to the Canadian firm. The firm may use its share of the CERs to comply with the Canadian government's environmental agency's regulations or sell the credits either privately or on one of the carbon exchanges. However, there is some evidence that these markets do not work efficiently. Wara (2006) asserts that the price paid on the EU Emissions trading Scheme is sometimes 10 to 100 times more than the cost of the reductions. The lengthy and complicated application and acceptance process also produces transaction costs in terms of assistance and administration averaging 20.5% of total project costs for energy efficiency projects and 14.4% for renewable energy projects for the period 1993-1998, though the trend is one of improvement over time (Michaelowa & Jotzo, 2005). Not surprisingly, project participants criticize the process as slow and lacking transparency, and they warn of the threat to the very existence of the mechanisms (Kuvolesi, 2007). Regardless, the CDM program is growing very rapidly from 64 projects pipelined in 2005 to 2,647 projects estimated for 2007 (Schneider et al., 2008). In addition to the intended cost-effectiveness incentive (see Wara, 2006), firms may be motivated to take on a project to publicly display their commitment to the environment or enter new markets (Lile, Powell, & Toman, 1998).

The decisions facing the firm under both regulatory and market pressures in this scenario are whether to attempt further (and perhaps more costly) reductions in their Canadian operations, to pursue a JI which, again, would arguably have a higher marginal cost of abatement, pursue a CDM with a presumably lower marginal cost of abatement, or to simply buy emissions credits on one of the markets in order to comply with its home country's emission regulatory agency guidelines, which, according to Kyoto, are about 6% less than Canada's 1990 levels ("Anger at US climate retreat," 2008).

In the parlance of the strategy process, the firm is responding to pressures from a sixth (4) force added to Porter's five forces model (Porter, 1979), complementary products/the government/ the public after analyzing the external environment. In essence, the decision to pursue CDM, JI, or to buy credits is the basic "make or buy" decision and is an examination of internal strengths and weaknesses. Specifically, three main components are appropriate areas for analysis. First, is pursuing the CDM or JI project in line with strategic intent and the firm's mission/vision? Second, are the core competencies in place to be able to maneuver in the often cumbersome process? Finally, under which generic corporate strategy configurations do the two basic types of greenhouse gas reduction projects (energy efficiency and renewable energy) make sense? As a final area of inquiry, how does the firm's level of internationalization affect these relationships?

LITERATURE REVIEW

Studies on corporate response to climate change issues and the associated regulatory pressures have generally taken three forms: identification of emergent strategic positions and responses to environmental pressure (Hart, 1995; Kaya, 2008; Kolk & David, 2001; Kolk & Pinske, 2004; Rugman & Verbeke, 2000), studies of transaction costs and markets (Michaelowa & Jotzo, 2005; Stavins, 1995; Wara, 2006), and case studies of early projects (Kuvolesi, 2007; Lile et al., 1998). The existing literature base is relatively new for the flexible development mechanisms, but the strategy literature base is much more developed and has produced several landmark pieces which provide practitioners a foundation for vetting operational decisions. These two research streams can be integrated to outline a testable theoretical framework for CDM/JI/CER purchase decisions.

Strategic Intent

Hamel and Prahalad (1989) added their contribution to the strategy literature base through articulating the success of firms which clearly state an overarching, far-reaching goal. Firms which clearly and publically articulate this goal move ahead to establish commanding global positions, for example, Honda's push to be a "second Ford" and automotive pioneer (Hamel & Prahalad, 1989). The three flexible development mechanisms are still institutionally immature ("Green quadrant: CDM project developers," 2008) with a declining but substantial amount of waste in the current system (Kuvolesi, 2007; Wara, 2006). Therefore, companies engaged in the strategic planning process which are examining flexible mechanisms as a strategy option may likely have a higher tolerance for risk and may very well be extending their reach in order to pursue an audacious goal. This goal may often be expressed formally through company mission and vision statements. In the human resource management field, research into the effect of formal versus informal ethical socialization of employees found that formal socialization is more effective in institutionalizing ethics (Mujtaba & Sims, 2006). Companies undertaking this inefficient and potentially risky route would likely require employees highly committed to the clean development goals in order to more effectively tackle the bureaucratic difficulties present in the current system. Since formally stating ethical intent has been shown to be more productive in generating organizational ethics, taking this link a step further lays the groundwork for the following proposition:

P1: Firms which clearly state strategic intent to better the environment in their mission or vision statements will be more likely to pursue both CDM and JI projects (versus emissions trading).

Core Competencies

Core competencies of the firm are organizational skill sets which directly support the strategic intent (Prahalad & Hamel, 1990). The authors fit this idea with strategic intent and posit that firms should first identify and articulate a grand vision and then continue to develop capabilities to operationalize that intent. In the context of the flexible mechanisms, both the CDM and JI options require extensive managerial know-how. A project must be identified, several layers of project design documentation must be prepared, and follow-through in terms of reporting and evaluation are required (Kuvolesi, 2007). This process is not simple; for example, firms must document that the project does indeed provide "additional" reductions compared to business as usual, must measure emissions and establish baselines, must describe the measurement techniques, and comply with host country regulations. For these reasons, firms pursuing CDM or JI would likely require core competencies in managing complex processes, as well as competency in navigating the complex administrative requirements with the UN.

Kaplan and Norton (1996) add to the strategy literature by providing a management tool, the Balanced Scorecard, which integrates quantitative feedback as well as a commitment to and measurement of non-financial measures. The development and use of the scorecard itself may be a reflection of the firm's ability to measure, document, and manage processes - the same organizational know-how likely to lend itself to successful implementation of a CDM or JI. Kaya's 2008 study of 92 Turkish companies from 15 sectors examined the effect of size, private versus public ownership, sector, and multinationality on firm climate change responses. Kaya (2008) found that size, sector, and multinationality were positively related to firms' level of response to climate change (p.73). It may be argued that, in general, larger firms have the resources to devote to better develop management tools (like the Balanced Scorecard, TQM programs, or ISO certifications) and that this relationship may explain the size effect found in Kaplan's study. Further, Pinske (2007) notes in her most recent study that firms that plan to participate in emissions trading and offset projects have already invested in the needed process improvements. For these reasons, the following propositions regarding core competencies, CDM, and JI are supported by existing research:

P2: Firms which have developed core competencies through process-based tools such as Balanced Scorecard, ISO certification, or TQM will be more likely to pursue a CDM or JI project (versus emissions trading).

Generic Competitive Strategy

Porter's generic strategies categorize corporate strategy in terms of whether the market is targeted or broad and whether the firm aims to maximize profits by charging a premium for a unique value proposition or to lead the market with low cost. These strategies have largely stood the test of time and most successful strategies can be categorized using this framework (Campbell-Hunt, 2000).

CDM or JI projects can take the form of energy efficiency projects as in the example of the Cuban electricity generation plant project described earlier, or they may be investments in renewable energy projects, such as solar street lighting or building wind-powered electrical generation plants. It follows that certain strategy positions lend themselves to the pursuit of one or the other of the two types of projects available from the flexible development mechanisms. The cost-leadership strategy, an internally focused, cost-controlling strategy may likely be the generic strategy best suited to successful energy-efficiency project implementation due to the firm's organizational competence with similar programs efficiency projects such as ISO 14000 implementation. Ironically, the reverse may actually be more likely. The transaction costs associated with innovative, renewable energy projects have historically been lower than those of energy efficiency projects as shown in Table 1. This leaves a gap in the theoretical base to support a cost-leadership firm's decision to pursue a cost/energy-efficiency project (which would likely be more in line with the cost-leadership firm's core competencies).

This potential mismatch is counterintuitive. As traditionally performed, strategy planning would dictate that firms with core competence in efficiency/cost cutting would match project type to align with the firm's generic strategy (perhaps the notion that innovation is not "who we are"). The main type of generic strategy a firm has adopted is thus predicted to influence project choice in the following manner:

P3a: Firms which have taken a cost-leadership market position are more likely to pursue energy-efficiency CDM or JI projects than renewable energy projects. P3b: Firms which have taken a differentiation strategy are more likely to pursue renewable energy CDM or JI projects than efficiency projects.

International Diversification

Pinkse (2004) notes that one area of climate change strategy response that has not been developed is the "effect of the degree of internationalization of the firm" (p.5). In the related CSR literature, the number of countries in which a firm operates has been shown to positively affect the intensity of corporate CSR, as well as positively affect the multinationals' tendency to behave badly in terms of CSR (Strike, Gao, & Bansal, 2006). The international nature of the CDM/JI program may affect the expected relationships put forth previously. For example, Pinske (2007) argues that multinationals have the know-how to deal with foreign companies and institutions and that this may better position them to benefit from the flexible development mechanisms. Interacting with developing nations may involve operating in the face of corruption, political risk, and settlement risk. Therefore, firms with global experience may arguably be better suited to deal with the UN multicultural nature and pursue projects more vigorously, thus strengthening all relationships proposed in the previous propositions.

P4: The degree of internationalization of the firm moderates the relationships between constructs in the CDM decision framework.

Existing strategy literature can be integrated into firm's decision-making and strategic planning activities. Figure 1 is a diagram representing the use of four established tools, Porter's "Six" Forces model, Hamel and Prahalad's Strategic Intent, Hamel and Prahalad's insight regarding Core Competency of the firm, Kaplan and Norton's Balanced Scorecard, and Porter's Generic Competitive Strategies.

Many of the tools of strategic planning have limitations of use and are only useful at specific points of the strategy generation process or for certain levels of an organization. For example, Porter's Six Forces model may only be used for external analyses; Strategic Intent, Core Competencies, and Porter's Generic strategy positions may be problematic for high-level planning in multi-business enterprises. Kaplan and Norton's Balanced Scorecard is limited by its requirement that quantifiable data must be used. Figure 1 summarizes the decision framework which may be useful to practitioners. Figure 2 presents the theoretical framework presented in the development of the four major propositions.

Planning in multi-business enterprises. Kaplan and Norton's Balanced Scorecard is limited by its requirement that quantifiable data must be used. Figure 1 summarizes the decision framework which may be useful to practitioners. Figure 2 presents the theoretical framework presented in the development of the four major propositions.

SUMMARY

Market-based mechanisms for curbing greenhouse gas emissions are the currently accepted method in the international community to combat climate change. The basic premise of these market mechanisms is the creation of scarcity and the transferability of the right to pollute in the form of tradable Certified Emissions Reductions (CERs) credits. CERs are generated through projects which reduce emissions either between developed and developing nations (the Clean Development Mechanism) or between firms in two developed countries (Joint Implementation). These credits can then be presented to a firm's home country regulatory body to comply with environmental protection standards or sold on one of approximately ten regional exchanges. Firms which find the cost of internalizing reductions projects greater than the cost of purchasing credits have the option to buy credits on the open market in order to comply with home country environmental regulations.

The adoption of the Kyoto protocol has placed both social and regulatory pressures on multinational firms to create and support strategic intents which support environmental concerns. The existing language and tools of the strategic planning discipline may be integrated into the decision framework for analyzing CDM, JI, or emissions trading decisions (Figure 1). Existing research on firm responses to climate change pressures can then be developed into a testable model of the relationships between the tools discussed and their CDM/JI outcome (Figure 2). It is proposed that the CDM/JI option (versus buying credits) is better suited to firms with audacious and clearly articulated strategic environmental intents, better suited to firms which have developed core, process-based competencies as demonstrated by the adoption of the Balanced Scorecard, ISO certification, or TQM programs, and lastly that these relationships are strengthened in the presence of high levels of internationalization.

DISCUSSION AND AREAS FOR FURTHER RESEARCH

This examination is largely practitioner-oriented in that several usable tools of strategy were integrated into the CDM decision framework. The strategy positions examined are also fairly simplistic in that a majority of firms adopt strategic positions that integrate several different typologies. It is unlikely that firms adopt a pure cost-leadership strategy, for example. While this is useful, more theoretically based perspectives were necessarily omitted.

Most notably, the CDM decision process can be thought of as an activity to manage relationships with stakeholders. Stakeholder theory is a particularly useful lens to examine climate response as the theory recognizes that firms must manage relationships with various groups simultaneously (Freeman & McVea, 2001). In the interest of simplicity, this important perspective was not explored here.

The second area for further research is the integration of so-called 'strategic' CSR activity. Bhattacharyya (2008) notes this line of strategic CSR examination includes Burke and Logsdon's 1996 framework which deems CSR activities strategic if they are central to the firm's mission and vision, specifically benefit the firm rather than add to the collective good, are proactive, voluntary, and visible. As a CDM project may be viewed as a CSR subset, these tools may provide yet another lens to examine the CDM decision. At present, however, the visibility of CDM projects is fairly low. This may also be a function of the concentration of CDM projects in industrial sectors like mining (Kaya, 2008) which tend not to advertise. Many companies (for example, Sherritt Corporation which was used as an illustrative example) may not prominently communicate their CDM commitments as part of a larger strategic CSR thrust. The lack of transparency of the UN and the relative obscurity of the CDM may render this framework premature, but this may change quickly as end consumers begin to question the entire network of activities in the supply chain of their consumer goods ("Fair trade," 2008).

Finally, despite the fact that CDM and other development projects commonly take the form of utility projects or other industrial sector activity, consumer interest in climate change mitigation efforts is increasing. For example, the Bonneville Environmental Foundation, a non-for-profit organization, sells carbon offset credits to individual consumers who wish to express their support of environmental efforts without the pain of greening their households. The site offers an emission calculator for the individual's daily activities and shows the dollar amount of offsets to purchase in order to mitigate the individual's carbon footprint ("BEF carbon offsets," 2008). Proceeds go to green development projects. The consumer-driven aspect of global carbon mitigation efforts will likely continue to grow in tandem with the growth of the flexible development mechanisms and is an area largely unexplored.

REFERENCES

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(3) Although not examined here, CDM projects may also be designed as unilateral, where the developing country handles the entire process by itself and then may sell the resulting CERs.

(4) The six force is generally not credited to a single source (i.e. Rugman & Verbeke, 2000).

Patricia Nicelli is an instructor & chair for the Information and technology department at Jamestown Business College. She developed curriculum and assessment tools, served on the Academic Council, and provides support to students and colleagues. She still continues to research in the areas of Marketing and International Business.

Ramdas Chandra is an Associate Professor of International Business at the H. Wayne Huizenga School of Business and Entrepreneurship. He received his Ph.D. in International Business and Marketing from the Stern School of Business at New York University

Table 1.

Swedish Activities for Joint Implementation
as a Percent of Total Costs

          Transaction costs as a
          percentage of total
          costs, by start year

Start     Energy        Renewable
year      Efficiency    Energy

1993      ----          18.3%
1994      16.8%         12.9%
1995      28.8%         14.7%
1996      20.1%         14.3%
1997      20.0%         12.3%
1998      12.7%         14.0%
Average   20.5%         14.4%

Source: Michaelowa & Jotzo, 2005
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Author:Nicelli, Patricia; Chandra, Ramdas
Publication:Advances in Competitiveness Research
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Date:Jan 1, 2013
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