Circular business models:An opportunity to generate new value, recover value and mitigate risk associated with pressure on raw material availability and price volatility

Abstract

The demand for resources has shown a sharp increase over the last decade. As resources become scarcer due to limitations of their physical supply resource prices rise and have become more volatile. Adding to this volatility are increasing tensions in the geopolitical-economic context stemming from the increasing resource scarcity. For LED lamps, the product analyzed in this thesis, it was found that more than half of the materials used in the production of LED lamps have shown an annual resource price increase exceeding 10% and an annual price volatility above 36% between 2007 and 2012. The increasing difficulty of companies to secure resources at a reasonable price threatens the continuity of production, their potential to grow, and because of the geopolitical implication also their competitive advantage. As an alternative to the current resource intensive production system where the influence over resources is lost, in this thesis we explore the introduction of circular business models as a strategy to reduce overall resource demand by closing the resource loops throughout the production cycle. Such business models have the potential to reduce the dependency to purchase resources from the market thereby potentially mitigating the risks associated with volatile and generally rising resource prices. In a case study circular business models were applied to the production of lamps. In particular focusing on different end-of-life scenarios to recover value throughout the production cycle. Currently a transition in the lighting industry is materializing from one dominated by incandescent lamps and CFLs to a market that will be dominated by LED lamps. Therefore demand for specific resources for the production of LED lamps are required while at the same time valuable resources used in CFLs are being disposed. This gives an opportunity to re-use components from CFL lamps for the production of LED lamps. Our findings suggest that the value recovered through component harvesting is four times higher than material recycling because the production costs embodied in the product - for energy and labor input costs – can be recovered. Sensitivity analysis showed that key determinants in the end-of-life scenario were the labor wages and resource prices: higher resource costs have a positive effect on all three scenarios and higher wages have a negative effect on the component harvesting scenario. The profitability of circular business models focusing on end-of-life strategies depend on many uncertain variables such as resource price developments, product demand, and technological development. To analyze and monetize the effects associated with these uncertainties the real option valuation method was applied which is better equipped to incorporate uncertainty and determine the profitability of circular business model than traditional investment decisions metrics such as the net present valuation (NPV) method. Results suggest that the NPV can significantly underestimate the value of circular business models; for example, the profitability for the recycling scenario was underestimated by a factor five using the NPV method. Furthermore, the risk premium was calculated as a means to quantify the implicit costs for companies associated with the vulnerability stemming from increasing and volatile resource prices. The risk premium corresponds to the value by which circular end-of-life strategies mitigate the potential impact of rising and volatile resource prices. The avoided risk premium increases the margin of recycling, component harvesting, and component & recycling by respectively 24%, 18% and 30%. Outcomes suggest that applying circular business models in the form of smarter end-of-life scenarios for the production and refurbishment of lamps may recover value over the production lifecycle. When this is combined with higher shares of products and resources that are maintained within a manufacturer’s production cycle it may increase operational stability by mitigating effects related to raw material scarcity and price volatility.