Capital goods: Transforming a key driver of the global economy

Capital goods manufacture uses 6 billion tonnes of raw materials every year. How can it become more circular?

Capital goods are not something that most people think about – indeed, many probably don’t even know what they are. Yet these goods, which include physical hardware products as diverse as servers, medical scanners, and ships, are a key driver of the global economy. Capital goods enable us to meet a wide range of societal needs while also expanding critical services such as connectivity, healthcare and logistics.

“Capital goods have similar characteristics in the sense that they are all made for producing goods [or services], have long lifespans (and are therefore more focused on technical specifics rather than trends), are high value and complex,” says ING economist Gerben Hieminga.

These attributes make capital goods ideal for circular models and their scale means circularity could make a real difference to how the global economy functions.

PACE, the Platform for Accelerating the Circular Economy, is a public-private collaboration launched by the World Economic Forum, World Resources Institute, Philips, Ellen MacArthur Foundation, UN Environment Programme, and over 40 other partners, including ING. A recent PACE report says that capital goods manufacture uses 6 billion tonnes of raw materials globally ever year: “It is therefore essential to optimise stocks of capital goods and their use through circular strategies”.

Joost van Dun, circular economy lead at ING, says that the capital goods sector’s switch to circularity has the potential to become a virtuous circle. “The refurbishment or remanufacturing of capital goods leads to an extended lifetime and offering products-as-a-service (PAAS) results in the development of more durable products,” he notes. “In addition, with PAAS the manufacturer is responsible throughout the product lifecycle, including remanufacturing or responsible dismantling.” As Accenture notes, PAAS – where consumers or companies don’t own a product but instead just lease it or pay for the benefits they gain from it – shifts companies’ focus from volume to performance.

As the mention of PAAS suggests however, circularity requires some major changes at capital goods firms. Developing a valid business case for circular propositions or getting the right mindset in their organisation to drive circularity among the relevant departments are significant challenges, according to van Dun.

One step at a time

For smaller capital goods companies or start-ups, it is possible to jump straight into a circular model as they are not encumbered with legacy technologies or existing sales-driven models. For existing companies – especially the kind of massive companies that tend to dominate capital goods sectors – that’s not an option given the time and investment required to develop appropriate technology and the need to retrain the sales force.

Instead, firms are most likely to evolve towards a circular model in a series of stages, according to Hieminga. Initially, they might move from product sales to a maintenance-driven model that enables them to build closer client relationships. This can then evolve to a service model that utilises performance-based contracts – whether for a photo copier or a CT scan – where the manufacturer takes care of reverse logistics, not just to improve circularity but to assist its clients. “The final destination is circularity, where capital goods are designed to retain their value and for ease of re-use and recycling,” he says.

An ING report on this phased route to circularity, From assets to access, notes that the transition is already underway. Increasingly, the technology industry earns its money through provision of services. “Whereas 20 years ago almost two-thirds of (earned) income came from production activities, that figure has fallen to around 56%,” it notes. The driver for this change is not necessarily sustainability, says Hieminga. Instead, product complexity often means that “clients want manufacturers to assume a larger role during the product’s life to enable them to focus on their core activities.”

A collaborative approach

One of the greatest challenges associated with capital goods companies’ migration to a circular model is the need to bring scores of other companies along for the ride – the transition from linear to circular only works if the rest of the value chain switches too.

“Creating circular supply chains is challenging for manufacturers,” confirms Hieminga. “For example, while the supply chain for electric vehicles is shorter than for internal combustion engine vehicles it still involves dozens of suppliers. Moreover, while a supplier of batteries might be circular, others – of electronics, for example – may not. The key to circularity is for the main manufacturer to design the car from scratch in a circular way, embrace a more collaborative approach to design with suppliers, and provide incentives to suppliers to adopt circularity.”

Frans van Houten, CEO of healthcare and lighting firm Philips, which has made significant advances in entrenching regenerative circular-economy practices throughout its business, agrees. The most important thing is to involve suppliers in rethinking products “so that it becomes co-creative and so that we can learn to design our value chains better,” he says. “Our mind-set needs to be 15 years out – not just ‘now’ – and it requires us to think in an end-to-end way, involving our suppliers and sales force.”

To help accelerate supply chain change, ING took the lead in setting up the Circular Supply Chain Accelerator (CiSCA) to help companies build a business case for circular supply chains. In addition, ING has developed circular financing principles as a framework to assess the circularity of borrowers’ business models and enable banks to lend. “If borrowers can demonstrate circularity and the benefits of their approach compared to a traditional model, they would be allowed to issue circular bonds or access circular loans,” explains Hieminga. “The pricing of such bonds or loans could be dependent on circular performance during the product’s lifetime.”

Accelerating development

The scale of the transformation required to move to circularity not only requires stronger partnerships in the capital goods supply chain but also greater sharing of knowledge – even among competitors. The Capital Equipment Coalition is a group of nine forward-thinking businesses that have committed to applying circular economy principles to preserve and recover value across the lifecycles of their products. Since the group’s formation in January 2018, its members have shared information and discussed how to implement circular economy projects.

This collaboration bodes well for the future, says van Dun. “It’s good to see that the partners of the Capital Equipment Coalition have joined forces to share their ideas and best practices to accelerate the development of circular capital equipment!”

Among these bright ideas are a recognition that business cases may not meet traditional rules for financial investment. Instead, scenario modelling – that incorporates drivers such as access to new markets, future-proofing the business, and triggering innovation capacity – can be used to demonstrate value. Another insight is that facts and figures are not enough to drive change. The PACE report, which draws lessons from the Capital Equipment Coalition, says it is essential to develop a compelling narrative “to help employees understand the bigger picture and how it connects to their business”.

What is not required, according to Hieminga, is compulsion. “The imposition of regulations or obligations on industry to become circular is not a good idea,” he says. “However, it would be valuable if government could track materials use – as they do with renewable energy today – and set targets. This would result in the creation of mechanisms, such as subsidies or incentives for circularity, that companies could respond to.” Van Houten at Philips would also like governments to lead by example and set procurement policies that stipulate set proportions of products manufactured according to circular-economy principles.

Building a circular economy for the capital goods sector will continue to be a struggle for the foreseeable future. As Hieminga concedes, resource scarcity – usually seen as a primary driver for circular models – is not an urgent issue in the capital goods market. “Nevertheless, circularity still makes sense as there is an increasing consumer and company preference for sustainable production, which carries a green premium,” he adds.

Ultimately, it may be the business opportunities presented by circularity and the benefits for customers that spur its uptake by capital goods firms. Philips now has LED streetlight installations in Singapore and Buenos Aires where it sells light as a service. “We install the equipment, maintain it, and make sure that it runs for a very long time,” explains van Houten. With energy savings of up to 70% compared to traditional streetlights, LED streetlights can effectively pay for themselves. “LEDs have five times the lifetime of normal lights, which in turn means much lower maintenance and operating costs for us.” In other words, lower costs for the customer, a profitable business for companies and a better future for the planet.