Collaborative Internal Carbon Pricing with customers and suppliers

It is a downside of the close association that Internal Carbon Pricing (ICP) has with External Carbon Pricing (in the form of taxes and levies particularly) that ICP is often first experimented with as a punitive measure. Indeed, when ICP is used in a tax-based system, it typically is punitive. Departments or geographies within the organisation are charged with a tax or levy based on their carbon emissions, and that money is moved into a central fund.

In some organisations, a punitive and competitive approach can work with the existing culture. However, in many other organisations, the culture does not suit this approach. The understanding of culture and the nature of relationships is particularly important when we start to implement ICP at the borders of the organisation, i.e. where we start to interact with customers and suppliers.

Strictly speaking, once you start levying a tax on a customer or supplier, it is no longer an Internal Carbon Price. But that distinction aside, there are other reasons why we might want to rethink the model we use with these external relationships.

In the last decade, Supplier Engagement has sprung up as a key term in sustainability. And for good reason. The success of many sustainability and carbon initiatives have been based on how they encourage good actions to filter down through the value chain and through the economic food chain through influence, reputation, and a bit of friendly customer pressure. Take the setting of Science Based Targets (SBTs), or the need to report to TCFD standards (Taskforce on Climate-Related Financial Disclosures) these actions are typically picked up (by choice or by legislative design) by bigger players, finance providers, global brands, etc. who then encourage their value chain to follow suit.

It is a model that works. As a mid-tier supplier, if your biggest customers have all set SBTs and are asking you for details on the emissions of your products, you take note, and start taking action.

With ICP we can take the approach to charge our suppliers a tax based on how far they fall short of supporting our own carbon targets. Or we can charge our customers a tax if they pick products that have higher embodied emissions. But that doesn't always fit with the dynamics of the relationships built throughout the value chain.

Another approach is to use ICP informatively (as a shadow price) to support and enhance relationships. Collaborative ICP you might call it. Take an example of a producer of packaging, who is asked by their customer to make a product for a new line. They can make something based on the typical requirements of balancing quality with cost minimisation (let's call it option A), or they can suggest (B) using alternative materials that are greener, don't compromise quality, but are more costly. Presenting this option alone back to the customer is difficult, the customer has asked for A and while you are saying "yes we can do that" you are also presenting B with an extra cost for a potentially undefined benefit, most sales teams would be sceptical about this approach. So, you must define the benefit of what you are offering. Being able to define the CO2e saving of changing from A to B is a great start. But given that you as a supplier also know the cost for this change, you can also provide the customer with the implicit price:

This information can be compared to your own decarbonisation initiatives, your customer can also use this metric to compare with other ways that they are also trying to meet their decarbonisation targets. You have supported your customer in meeting their targets (which helps you), you have given them additional value and the benefit of your industry knowledge, strengthened the relationship, and provided them with information in a way that helps them make the right decision for them.

The above is a customer-based example, but collaborative ICP can also be used with suppliers. As an organisation we may understand how we need to decrease the carbon impact of a particular product or service we are contracting for, let's assume a construction project. If we understand the typical cost to decarbonise construction (perhaps based on some broad assumptions on material substitution and efficiency measures) then we can calculate an implicit price for decarbonisation of construction projects. As the customer, we may have to be prepared to bear much of that cost ourselves, but we can use the implicit price in contracting to set the boundaries of allowable cost ranges to provide the carbon savings we want. The use of competition in this instance is based on beating the implicit price and incentivise suppliers to find the lowest cost way of reducing carbon impact. In this situation we have incentivised the suppliers to use their expert knowledge to bring innovation to the project, we have acknowledged the additional costs for doing that, but set clear boundaries on those costs.

These are just illustrations of what is possible, and ultimately there are so many possible designs of ICP. In the end, it is just the use of a metric to convert a carbon impact into a cost. How you use that metric is up to you. But it is my strong advice to not lose sight of what you already know about the decisions and the relationships that you are applying it to and think about the dynamics and culture before deciding punitive is best.