Hernan Saenz, Bain & Company | A Glance into the Future of the Planet, the Power of Circular Transformation and the Role Private Equity Can Play
2:30 "Remanufacturing" and forces applying pressure to traditional operations
5:21 What is the circular economy?
13:13 The current policies set up by the government related to the circular economy
16:03 Barriers to a circular economy
25:21 How can tech be leveraged to support the circular economy?
27:13 Measuring progress toward circularity
29:25 The role of private equity in promoting circularity
30:28 Incorporating circular principles into investment strategies
33:01 Investment opportunities and most promising sectors
35:46 Challenges a PE firm might face when investing in a circular economy
37:13 How can firms work with portcos to improve sustainability?
39:39 How PE can collaborate with governments and other stakeholders to promote the circular economy
Welcome to the Karma School of Business Podcast. In this episode, we have a special host, BluWave's very own, our managing director and head of client coverage, Rena Frackt. Rena has a very insightful conversation with Hernan Saenz, Bain & Company's Global Head of Performance Improvement. Rena and Hernan discuss growing global resource depletion, the circular economy, impacts on business, and private Equity's role. This episode is brought to you today by BluWave. I'm Sean Mooney, BluWave's founder and CEO. BluWave is the go-to expert of those with expertise. BluWave connects proactive business builders, including more than 500 of the world's leading private equity firms, to the very best service providers for their critical and variable on-point and on-time business needs.
So, today on the Karma School of Business, we have Hernan Saenz, who's a dear friend of mine, but also the Global Head of Performance Improvement Practice at Bain & Company, as well as an advisor to the World Economic Forum platform for shaping the future of advanced manufacturing and value chains, and faculty member at Cornell. Hernan, I am so thrilled to have you, it's my debut podcast, and there's no one else I'd want to share the screen and mic with.
It's an honor and a privilege.
Thank you again. Before we go into all things sustainability and circularity, I would love for you to give us a quick background of who you are, even outside of the world of Bain & Company, who you are, what makes you tick, and all that good stuff.
Excellent. Well, you know I am a dad, a husband. I love spending time with family. I'm a Latino, so that means very extended family. I love events and sports, so if I am not working, you will find me participating in something with music, performing arts, sports, culture, et cetera. So that's a little bit about me.
Fair enough. And I get the extended family piece, coming from a big Jewish family, so got you on that. So you're here today to talk to us about what may have been a buzzword that is probably shifting into more of a reality. Growing up, we heard a lot of reduce, reuse, recycle, and now in the business world, we'll hear remanufacture. What's that all about and how did that become something that you've become interested in?
Oh, absolutely. Well, look, let's start with what's happening in the world of operations. Where have we been? We have been in a place where we have a very long, very global, very brittle, very opaque supply chains, and they are optimized around one and one variable only, lowest unit cost. But there's a number of forces that are applying pressure on that type of design. One of those forces is geopolitics. We came from a world where you could assume that any particular input could go anywhere in the world, it might be turned into something that got manufactured, and that output could go anywhere in the world.
That's no longer true. There are not only tariffs, but there are trade barriers of other types. We are now in a post-globalized world and in that post-globalized world, there's a lot of questions about where to actually put your manufacturing, where to shore, if you will. But that's just one of the forces, there's other forces. There are natural forces, the pandemic was another force, so we're seeing supply and demand shocks. Think of those that come from climatic events, those that come from labor force challenges, from a boat being stuck in some canal. So our supply chains have become incredibly brittle and they are breaking, and that's a massive problem. We did not build any flex into our supply chains in the past.
The third thing is it was perfectly fine to have a supply chain that was both brown and opaque, you didn't have to know where it came from and you did not care about what externality it might have created. None of those things are going to work in the future. The world is trying to build right-shored, more flexible, more transparent, green supply chains that still have to make money. And so there's a massive issue out there, why is circularity coming to the top of the list? Because it is an enabler to many of these things. It is an enabler to much more sustainable supply chains, it is an enabler to growth and improved economics, it is an enabler to resilience. And in that way, it's coming out as the great enabler of the future supply chains of the world.
So correct me if I'm wrong, we're in a traditional linear economy, that's correct, and so with this transition into a circular transformation, why is it so important and also what is it for those that are may not be familiar with the term?
Yes, yes. Well, what's the linear economy? It's what we've all seen in the past. We extract a virgin resource, we may collect cotton from a field, we convert it into a product, the cotton turns into a t-shirt or a pair of jeans, we use the product, and then we dispose of it, and the next time we're going to make something, we go back to the field and extract from it. Now, as our global population has grown, the size of our planet has not, and so we are consuming more, producing more, with a relatively fixed earth. Just to give you a sense, we're extracting right now over 100 billion tons of materials per year, that number has quadrupled since the day I was born 50 years ago.
And today, if you looked at the biological capacity of the earth, what the land can give us, what the oceans can give us, what the lakes can give us, we are basically consuming about 1.75 earths every year, so our demand... By July 28th, we're done, the earth has given us what it can give us for the year. The problem is we start depleting the earth's supply for future years, because we end up overfishing and then we don't have fish anymore, or we end up killing, creating dark spots in our lakes, in our rivers, in our oceans. By the way, that date, July 28th, has moved up two months in just 20 years. Now think of a circular world.
In a circular world, you're trying to not use a virgin resource, you're trying to use a resource you already extracted and put it back into the economy, so that alone starts solving a lot of the problems of sustainability, but extracting resource requires energy and converting also requires energy. If you use circular principles, you can actually reduce greenhouse emissions by about 40%. It's amazing, so what circularity can do is actually fundamentally change the equation of the sustainability side. But by the way, does it also solve resilience? Of course, imagine being able... All of those things that are in short supply, they cannot go to the waste pile, they have to come back, so it helps with that. And as we'll talk, I'm sure, it can lead to dramatically improve the economics. Circular models have created remarkable growth and remarkable profitability.
So really, what you're saying is that we're turning our world into a pressure cooker at the rate that we're moving?
We are. I can imagine the biological capacity of the earth is somewhat fixed. Despite all of the advances in technology, our material productivity has not improved over 50 years, so we're consuming than we can and reducing that supply curve in the future.
Sure. And it sounds like it's conceptually simple, but it's not. So it's a huge endeavor and I don't think it's just you can't act alone, it's all or nothing, so everyone has to be bought in
Absolutely. Absolutely. Well, and let's start, look, is circularity new? No, no. Papers about the circular economy, cradle-to-grave, or moving to cradle-to-cradle, they came out in the early 2000s, we're 20 years into this. The question is what happened? Why have we been talking about circularity for 20 years, but not achieved circularity at scale? I would say that there's probably three things. The first one is that we focused circularity on sustainability, so we wanted to do it because it was sustainably good. Well, a model focused only on sustainability and not focused on economics is not going to scale in a market economy. Yes, we need to focus on the sustainable implications of circularity, but also the economic ones. Once we make sustainable circular models that are also economical, it will scale, that's point number one.
Point number two, as you said, is that we equated circularity with recycling. We said, "Let's be circular, that means recycling." So I'm not an engineer, but I think I understand this well, you have an optimized system and you change one variable in that system, I'm no longer going to use virgin resource, I'm now going to use recycled resource. What happened when you change one variable of an optimized system? You suboptimize it. Is any business going to rationally scale a suboptimal system? No. So we can't just play with recycling, in order to create models that work, we have to change all of the other variables. You said one of them, remanufacture, but there's plenty more, can you refurbish, can you repair, can you reuse? And so if you can change all of the variables, then you can create a system that is optimized at a different level, not for a line, but for a circle.
And the third thing, as you said, is companies did it alone, I am going to turn the world into a circular world through my own value chain. Well, it takes a village, in fact, I would argue it takes multiple villages, because the whole value chain needs to become circular. So you have to work with your suppliers and their suppliers, probably with your competitors in a pre-competitive space, and with your customers and consumers so that the whole value chain can become circular. And by the way, you often have to work with adjacent value chains, because your outputs might be useful to somebody else's inputs, not necessarily to you as inputs, and so we need to build ecosystems.
And I imagine it's also very important to be able to track everything, so if you look at it from the corporate point of view, they would have to track supply chain and trace where everything's coming from and where it's going for multiple reasons, and again, that's a huge infrastructure change.
It is, absolutely. Again, we have lived in very opaque supply chains. There is a reasonable visibility of your suppliers, but only 14% visibility of your suppliers' suppliers and very little visibility downstream. As I like to say, you can't bend the line into a circle if you can't see the line, and so traceability is a big, going to be a big part of the solution.
Yeah, absolutely. So are there current incentives or policies set up by the government? What's their role right now?
Yes. I think governments are catching on and... Well, let's recognize governments move at different speeds, so as you would expect, the Europeans are leading in this. But Europe has what what's called the Circular Economy Action Plan, which has about 35 actions that basically are directed to using less across a lifecycle of products, including textiles, electronics, packaging, construction, et cetera. They require reusability, recyclability, et cetera. There's also in Europe, what's called EPR, Extended Producer Responsibility, and basically, this is an approach or a law that basically says producers have financial and or physical responsibility for the treatment of their post-use products. All of this is happening in Europe and so very soon, there's going to be incentives and also punishments for not having circular value chains.
Now, in the US, it's not necessarily far behind. The National Recycling Strategy is aiming to increase recycling to 50% by 2030, that's actually a massive increase. 12 states have introduced or implemented EPR legislation, 25 states now have electronics recycling laws. What's really amazing is China is also not far behind. Remember, material productivity has not really increased in the world. China is basically saying by 2025, that's two years from now, they want a 20% increase in material and resource productivity. They are hoping to reduce energy consumption by about 14%, water consumption by about 16%, this is in the context of a growing economy. They are planning to phase out single-use plastics, they want recycling of electronic waste at 50% by 2025. So let's be clear, if you think that a linear model is going to be profitable and winning in 10 years, I don't think the answer is yes. Now, can they make money today? Absolutely, because we haven't had the full transition.
Sure. So, it sounds like everyone's on board, but I would imagine that you see flags of these are challenges in implementation, these are the barriers we're facing, what are some of those?
Well, let me start with one barrier is the government alone can't do it, you also need the market to do it, so where is the market at? First of all, do consumers care? The short answer is they do. If you ask the average consumer, and I know that the average consumer doesn't exist, but if you ask the average consumer what they care about, they care about climate change, plastic waste, water pollution, water shortages, waste of food, deforestation, and waste of water. All of the ones I just mentioned are related to circularity, they care, and by the way, they say they're going to act on the basis of those things that they care about. 71% would say that they want to buy sustainable products, 75% are willing to pay a premium for the sustainable or circular product, 80% of them are willing to recommend using NPS-type metrics, sustainable products once they used them, et cetera, et cetera, et cetera.
The market appears to be there. Now, we all know there's something called the say-do gap. I say that I care, I say that I'm going to behave in a certain way, but my wallet operates in a different way. And so there are two forces here. One force is the experience curve. These circular models are not far down on the experience curve versus linear models, so you have to go down quickly to have the curves cross, so the market will start picking up more once it becomes not only the sustainable solution, but also the economic solution. And the other curve you want to care about is the S-curve, the penetration curve. Certain segments will move faster, in fact, they're willing to pay more, and certain segments will move once it is the economic.
Now, what's happening is we probably haven't gone down the experience curve, so part of it is we don't have as much product or price in the market, but we have other problems, like these products are not easy to find relative to the other products, and by the way, you don't trust them. Imagine the number of green certifications out there has obviously led to greenwashing concerns, and that includes the circular economy. So, one barrier is that the governments and the market need to operate together and the governments are acting and the market wants to act, but we now need companies to get into the mix, go down those experience curves, segment the market correctly, so that you get into the S-curve movement relatively quickly.
But you asked me a question which is like, "Look, what's hard?" And let me give you the four things that I think are hard. One of them is companies are not organized to move from a linear to a circular world, because companies are still vertically organized, they are functional in nature, they are siloed, and they have functional excellence. Nothing wrong with that in a stable environment, but we're not in a stable environment, and to move from a linear to a circular supply chain is a cross-functional horizontal problem. You have to change your strategy, your go-to-market, how you segment and talk to customers, you have to change the supply chain, you have to change the IT, so A, companies are not organized for this. By the way, we saw that they were not organized for this type of transformation 10 years ago, when we were trying to implement digital and it was very hard.
The second problem is traceability, we don't have the data, we don't have the technology, and therefore we don't have the visibility. Again, in order to bend a line into a circle, you have to see the line, and today that line is connected through a chain that does not have the right data connectivity in it, it does not have the right enabling technology, it does not have the right visibility. The third problem is that this, as we were discussing, this is an ecosystem problem and ecosystems don't exist. We are all scared of working with our competitors and getting in trouble with the law, and so there's no muscle to work with competitors in a pre-competitive space. We all work with our suppliers, but we don't work with our suppliers' suppliers, and we certainly don't ask our customers what are they going to do with our product? That ecosystem is not built.
And the last one is there are parts of this market that simply don't exist, recovery services. This is all going to create massive economic growth, but some stuff's not getting recovered. There's some circular markets that actually don't exist, and so that becomes really important. So, those to me are the big barriers.
So who's doing this well right now? What are some successful examples?
Well, that's the good news, successful examples do exist. And even better new, you can categorize them in many ways, but I like to categorize them in two ways, one of them is incumbents versus insurgents. So, can big companies change their linear models to circular models? Yes. And also, can entrepreneurs come into the market and fundamentally change a market that has been linear to one that is circular? Yes. So, examples of incumbents, Schneider Electric and its process drives, its ecodrives in France, they have the ability to collect it from the customer, triage it into a refurbish, remanufacture, recycle, or resell environment, and basically, you have essentially a circular model for their process drives. Similar with Phillips and their professional medical equipment, relatively large modular pieces, similar to Schneider Electric. Mahindra & Mahindra, one of the big automotive companies in India, 70% of the waste generated in the end of life of every one of their vehicles is now either reused and recycled. So, these are big companies with fully circular models, or-
That's an incredible number, 70%.
Yes, exactly right, that is an incredible number. And there's also insurgents. I'll give you a sense, and I apologize for the names, but these are the actual names, BlaBlaCar. BlaBlaCar is a carpooling platform in France. The French are no longer buying as many cars because they carpool through this platform to get to Paris or to the city they work in, so we are now not producing as many cars for them. By the way, we're utilizing massively underutilized capacity, because cars get used less than 2% of the time. They have a nasty, nasty, nasty carbon footprint, making them is really expensive for the environment, and we don't use them, and so this solves it.
TheRealReal, one of the many platforms that sells luxury goods and apparel in secondary markets, is doing incredibly well. Ralph Lauren now has the capacity to authenticate many of its best garments, allowing them to participate and partner in secondary markets. And one more insurgent in Europe called Back Market, they refurbish and resell electronics. By the way, they're traded and their value is probably higher than most of the electronic retailers in Europe these days. So, look, these models exist.
I've got a drawer at home with about 10 phones that I, back in the day, didn't really know what to do with them, but now with advancements, you can send them off and hope that they come back in another life as a phone.
Exactly right. In fact, they can be refurbished, resold, and that will require one less phone being made in the world.
Exactly. So, let's talk technology and innovation. Can tech be leveraged to support the circular economy and what are some emerging trends in the space?
Yes. In fact, technology is a massive part of the answer. In fact, we could do an entire discussion on this, so I will just focus on one or two. But we talked about the fact that a single company or a single value chain cannot pull this off, that it's going to take a village, it's actually going to take multiple villages. It's really a value chain, and even better, a collection of adjacent value chains, but they need to be connected. They need to be connected, the data has to be connected, the data has to be visible.
So, to me, one of the big, big, big applications that we need is digital traceability. Digital traceability is the ability to see something from the inputs coming in to the transportation of the inputs, to the conversion process, to the transportation, into the distribution centers, eventually to the end user, and by the way, in its post-use life. I believe that blockchains are going to be the answer here, because they're a very good platform to store and share the data both securely and privately, but allowing you to do everything. To me, digital traceability is one of the big enablers of circularity.
Yeah, I agree, we could probably spend a good hour on that topic, for sure, and that's interesting that you say blockchain. But we have limited time, so maybe we'll have to do an episode two and get into that.
So, how can we measure and track progress towards a circular transformation and what indicators should be used to assess success?
That's a great question, Rena. It's an incredibly insightful question. I think one of the mistakes we made 20 years ago is we wanted to measure circularity. Circularity is an enabler, it's not a goal, and measuring circularity takes us away from the outcomes we're looking for. What's the end goal? Economic growth, profitability, resilience, less virgin material extraction, less greenhouse emissions, gas emissions, so I think we should be measuring those as they are enabled by circularity.
The other thing is there's an economist in Japan, Yoichi Kaya, who developed what he calls the Kaya identity equation. He developed it as a way to think about how do we get carbon solved, but I think there's a general form of his equation that basically decomposes circularity into three things, are we using virgin versus recycled inputs, how much input do we need for the output, and can the output provide a service for more people or for longer? That's, I think, how we should measure it. We should measure, as inputs, what percentage are we using raw, virgin, material productivity, can we improve it, can we use less input to produce the output, and the last thing is can we get that output through sharing economy, through refurbishing, remanufacturing, reuse, to last a lot longer and serve a lot more people? And so I like using the Kai identity as the best measure.
Great. So, as you know, BluWave's primary client base is private equity firms and many of our listeners come from that world, so I'd like to spend a little bit of time there. Starting off, what is the role of private equity in promoting the circular economy and why is it important?
Oh, I think private equity could be the great accelerator to circularity. Think about it, there's lots of businesses out there today that are linear and in the right markets, in the right sectors, they are much, much more valuable if you make them circular. They will literally trade at a different multiple, that may be hard to do in a public market and a lot easier to do in a private market. There are also small businesses that are ready to literally change the dynamics of an industry and they're ready to disrupt and they need to be scaled professionally, and that has been one of the things that the private equity has done well. So, I think both in incumbent businesses and insurgent businesses, private equity is the right vehicle, not only from the for funding source, but bringing some of the know-how.
And how would you advise a private equity firm in incorporating some of the circular principles into their investment strategies?
Well, to me, just like carbon footprints was a new and complimentary lens to the ways that private equity used to look at assets, I think circularity is yet again a new and complimentary lens, and the question is, can I create value through the application of circular tools or circular models? And it could be what I'm going to call an engine one, which is I'm going to change the value chain to be more circular and make it more valuable, or can I build an engine two, a new business, related business, that creates growth because of a circular vector? Private equity funds are well-known for their intellectual rigor, and so to me, again, the two tools that I would be using are experience curves, when does the circular solution cross over to become as good or even better than a linear solution? You can do that in a subsidized environment with governments or in a non-subsidized environment. And then what do we think the penetration or S-curve is going to be, and in particular, how do we segment the market to accelerate moving through that S-curve as quickly as possible?
And so, actually, again, because of the sophistication and rigor of private equity funds, you can use these tools relatively quickly to identify how to scale these assets. By the way, can these assets be turned from being valued at a certain multiple to a different multiple, because in addition to being economically good, they are sustainable. This will be at the intersection of the particular legislation, what incentives are out there, what specific laws will make it very difficult to be linear, as well as the market, are there segments that are large enough that are willing to shift-share or pay a premium here? Where are we seeing the most activity?
So, what are the investment opportunities for a private equity firm in the circular economy and what sectors are most promising?
Consumer tech hardware, for sure. As you mentioned earlier in our conversation, phones and computers, there is a so much of that that is not being recycled, refurbished, remanufactured. And by the way, they have some very important materials that are no longer in plentiful supply. Large technology devices for business, particularly those that can be modularized. We talked about process drives, we talked about health tech, absolutely have the potential to be part of the circular economy. A lot of machinery has the ability to be refurbished, upgraded, et cetera, reused in different contexts. Automotive, as we were discussing, we're seeing not only Mahindra & Mahindra, but a number of players. By the way, it's not just changing the supply chain, it might be moving to a sharing economy, so you might not sell trucks, but you might sell access to trucks, so it's basically anything as a service. Obviously, in CPG and plastics, if there is any way to find solutions to some of the plastics and packaging problems we have today, because you can expect that there will be regulation associated with both microplastics, as well as single-use plastics.
I believe the construction and the built environment will also have significant amount of circularity. Electric batteries, this is big. In fact, one of the large automotive manufacturers in Japan is probably not going to sell its electric vehicles, it's probably going to lease them, but maintain ownership of them. Why? Because they want the electric battery back. That tells you a lot. And then I think later in life, not yet, but apparel. We cannot continue to buy the number of goods we buy and dispose of them in a waste spot. So, actually, I think there's going to be more, rather than less, opportunity, because I just gave you a lot of sectors, and these are sectors covered by regulation, by incentives, and where we have seen consumers and customers tell us that they care.
But I would have to imagine there's also going to be challenges for private equity firms when investing in a circular economy?
Yes, absolutely. I told you, we know the tools, the experience curve, the S-curve, but how far, how fast are we going to move down the experience curves? We don't know. We also don't know the extent or the longevity of regulation. So, maybe it's economic because we have a subsidy from the government to do something, but what if that subsidy actually disappears or comes down? We also have a say-do gap. Private equity funds can talk to consumers and they'll say, "Yeah, yeah, of course, I will buy this product and I'll pay a premium." Well, how do you close that say-do gap? But I think the biggest challenge for private equity is this may take longer. If you are into relatively short holding periods, this may not work out, so you have to hold the asset a little bit longer to actually get some of the stars that I was just talking about to align. The other one is if you're buying global businesses, all of this will not move in synchronicity, and so it's going to be easier to do it with businesses that are covered by similar regulations, similar dynamics.
So, right now, you have the ear of hundreds of private equity firms via this podcast. How can the firms work with their portfolio companies to implement circular economy practices and improve sustainability?
Very good question, multiple vectors. First of all, you own a number of businesses, and so question number one, if your customer or consumer would shift-share or pay more for circular, can you turn your value chain into something more circular? Is there potential to share, reuse, repair, refurbish, remanufacture, recycle? Second, can I build a new economic model, anything as a service, and actually monetize in a different way? Third, can I enter what I'm going to call adjacent moves? For example, can I create a circular marketplace? Can I create recovery services? Can I create enabling services? And against all those moves, look at do I get growth? Do I get profitability? Do I improve resilience? Do I improve the carbon footprint? Do I improve virgin material utilization? And by the way, that actually have an impact on my multiple.
And based on that analysis, you're not going to do all the circular things, but then I would prioritize based on what I'm going to call the economic potential of the move and the likelihood of success, which I do believe is going to include regulation. The last thing you need to have if you're a private equity fund is you need to have a scaling plan. Because I also believe that circularity is like digital is a place where pilot purgatory can always happen. And so you can't just pilot things. Do you have the op model, the ecosystem, the data tech infrastructure, the use cases to actually scale?
Yeah. And we see that a lot. We get a lot of requests here for advisory services because I think people are really starting to realize that they need specialists on staff and just guidance instead of just putting their finger in the air and hoping that they're making the right decisions. So we're coming up on time, but we have one very important question left for you. How can private equity firms collaborate with governments, NGOs, and other stakeholders to promote the circular economy?
I think that there are three. I think first and foremost, building a design and innovation capability that you can bring to all your portfolio companies will make the experience curve of a private equity fund faster and steeper, or the road faster and the curve's steeper, and so I think one of the things is learning how to innovate in order to design into circular models. Number two, private equity funds can, much more easily than any given company, bring coalitions together, connect the value chains, create ecosystems. In fact, you can own companies in the same value chain or adjacent value chains to actually create circular models that create value across all of your companies or all of those that are related into those value chains. And the last thing is governments want to implement circularity, they don't know how to implement circularity. And so, private equity funds that have very well-developed ideas can go to the governments and say, "Look, this is the type of legislation, these are the types of incentives that, for this particular industry, can help us all move into a circular world."
I think that's so important, it's the how. You're right, I think everybody wants to, even from the consumer's point of view, we all want to do better, it's how can we do better and be consistent with it? Hernan, this is such an important topic and I'm so glad that I had the chance to dive deeper into it with you. I am so thrilled that you were able to join me today and I just can't thank you enough.
It is, again, always nice to be with you and an honor and a privilege, so thank you for having me.
Of course, my pleasure.
Special thanks to Hernan for joining Rena. That's all we have for today. For more information, go to BluWave.net/podcast. That's B-L-U-W-A-V-E.net. Please continue to look for us anywhere you find your favorite podcast, including Apple, Google, and Spotify. We truly appreciate your support. If you like what you hear, please subscribe, review, and share. In the meantime, let us know if there's anything we can do to support your success. Onward.
BluWave Founder & CEO Sean Mooney hosts the Private Equity Karma School of Business Podcast. BluWave is the business builders’ network for private equity grade due diligence and value creation needs.
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Select and hire a PE-grade resource that fits your needs