Circular Economy: How SMEs can participate

This article first appeared in Enterprise, The Edge Malaysia Weekly, on January 13, 2020 - January 19, 2020.
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Circular economy business models involve rather simple concepts. For instance, consider your waste as a resource that can be turned into raw material. Design your products so it can be reused, repaired or remanufactured. And do not let your waste go to the landfill.

But how can businesses change their models from a linear (cradle to grave) to a circular one (cradle to cradle)? This can be especially challenging for small and medium enterprises (SMEs), which have limited resources and only form one part of the supply chain.

Phang Oy Cheng, director of governance and sustainability at KPMG Management & Risk Consulting Sdn Bhd, has been working with the EU to help SMEs in that region do exactly that.

While they found that the circular economy has created opportunities for new types of businesses along the value chain, there are new risks as well.

One risk is in terms of financing. A popular business model in the circular economy is product as a service, where a company earns revenue by renting out its assets. This way, its resources are shared among many, thus eliminating idle and duplicated resources. Customers pay for a service instead of a product.

“Most of the risks involve the need for increased capital through pre-financed grants. We also need to recognise there will be a change in cash flow because we are moving from a collateral business to a service business,” said Phang at the International Conference and Exhibition on Waste Management in Shah Alam, Selangor, last September.

The cash flow for these companies may be spread out over a longer period of time because their customers do not buy a product. Instead, they pay whenever they use the service. Banks may find this risky and hesitate to offer these companies a loan.

“With the pay-per-use model, your products are not a collateral but a service. It takes the valuation of collateral out of the balance sheet. So, it is a paradigm shift,” said Phang.

As a result, different types of capital or loans have to be considered by SMEs that want to go into the circular economy.

On the legal side, companies will have to consider the different definitions of waste by the government, particularly with regards to hazardous waste. This may affect whether the company is able to send its waste to another facility to be transformed into another product.

 

Circular economy framework

This is where a regulatory framework on the circular economy is important, Phang suggests, which could help SMEs that want to seek financing and overhaul their linear business models. “The companies that are most advanced [in adopting circular economy] are in the EU because the region has a Circular Economy Action Plan. It has been working on extending the lifecycle of products since the early 1990s,” she tells Enterprise.

“We have an opportunity to leapfrog now because of the technological advances in recycling and reusing. But until we sit down with multiple agencies and say these are the things we need to do, it will be difficult for us to progress.”

The EU released its Circular Economy Action Plan in 2015, outlining programmes and goals covering the whole cycle, from production and consumption to waste management and the market for secondary raw materials.

Nonetheless, European SMEs still face challenges in adopting the circular economy model. “The challenges have been in helping these companies understand what a resource is and what it is not, as well as how they can structure their risks so they are able to manage them. We also have to help them understand the new business concepts,” says Phang.

The EU has a supportive ecosystem for the companies to transform. The European Commission hired KPMG in the Netherlands in 2018 to help SMEs achieve these goals. Industry associations are also playing an active role to provide resources and information to its members.

Having the right ecosystem is crucial. Otherwise, SMEs may have to source from suppliers abroad to create products that can be taken apart or reused, for instance, which incurs higher costs. That is currently the main drawback in Malaysia, Phang observes.

“It is very good that we have a strategic roadmap on plastic waste. But that is just one aspect. The way our laws treat waste is still mired in the past. Although it was refreshed 10 years ago, it still looks at waste in categories. That is why we have such a proliferation of waste-to-energy or biomass-to-energy projects. It is just talking about one aspect of waste instead of looking at waste in its entirety,” she says.

The EU’s Circular Economy Action Plan covers plans for plastic, waste management, innovation and investments, among other things.

On another note, can Malaysian SMEs adopt circular economy principles, given how Industry 4.0 (which is fully supported by the government) is still progressing slowly?

“The drivers need to be there. If you look at why SMEs are not responding to IR 4.0, a lot of companies say they do not know about it. When I was dealing with the green technology fund, a lot of SMEs did not know about this incentive. [This happens] if you do not offer a structured process for SMEs to engage,” says Phang.

Other deterrents include onerous paperwork when applying for grants or complying with regulations.

 

Can OEMs adopt these models?

Some SMEs in Malaysia are original equipment manufacturers (OEMs), which produce goods and equipment sold by another company. OEMs may find it more difficult to change their business models as their costs and actions are constrained by their customers.

For example, their customers may not want to change the design of the product or raw materials to make these reusable. This could change in the future as multinational corporations (MNCs) focus more on sustainability, says Phang.

“The best example is IKEA. It launched a circular economy programme stating that it will take back every product it sells to refurbish, repurpose and resell. It started to work with OEMs and asked them to think about reusing and reducing,” she adds.

The automotive industry has achieved this by launching cars that can be recycled at the end of their lifetime. “That involves every part of the supply chain. A few European and Japanese companies are doing this,” says Phang.

This could be a business opportunity for OEMs that are able to meet the standards of these MNCs. But the period for return on investment may be longer than usual and SMEs may not find it an attractive proposition right now. Many customers also prefer to pay less for a product, Phang observes.

Regardless, there is a business case for SMEs to adopt circular economy models now, she says. That is because resource scarcity risks such as water stress, climate change impacts — including sudden weather changes or flash floods — and fluctuating costs of raw materials are becoming material risks for companies.

It can also lower the cost for companies in the long run. “We pay when we buy waste as a raw material, when we process it and when we throw it away. We pay for waste three times. So, why would you throw it away? Wouldn’t it make more sense to see what waste can be reduced to lower your operating and raw material costs?” says Phang.

Many investors are also paying attention to companies’ adherence environmental, social and governance principles. “Traditionally, companies are used to managing financial risks such as profits and losses, structures and systems. But they do not think about non-financial risks. What kind of social and environmental risks do you face? Every firm has to maintain its social licence to operate,” she says.