Circular economy – forging institutions: On how circular business model innovation shapes the circular economy while instigating the new rules of the game

This dissertation is embedded in one of the major themes of our time: a needed shift to an economy that is sustainable in the long run and functions within our planetary boundaries (Brundtland, 1987; IPCC, 2014, 2021). We are not making sufficient progress in becoming climate neutral (IPCC, 2021). Our current economic rationale seems incapable of unifying economic and environmental activities in a meaningful way. The transition to a circular economy (CE) is proposed as an important part of the solution to this paradox. A circular economy is restorative by intention and design (EMF, 2011) and has rapidly become a leading sustainability paradigm (Geissdoerfer et al., 2017). In a circular economy, businesses are the key actors. Businesses that create circular business models (CBMs) in circular business model innovation (CBMI) processes create a value proposition and design business processes based on circular economy principles (Linder & Williander, 2017; Lüdeke‐Freund et al., 2019). However, implementing CE principles in new CBMs has proven challenging (Bocken, 2020; Vermunt et al., 2019).

Businesses that attempt to implement CBMs often encounter a misfit between certain key characteristics of CBMs and the institutional setting that is based on a linear economy rationale. Seen through the lens of institutional analysis, a multidisciplinary framework focussing on how the “rules of the game” of socioeconomic systems are defined (North, 1990; Ostrom, 1995; Williamson, 2000), we have seen that the current institutional setting reinforces the current economic rationale (i.e., take, make, use, waste) (Fischer & Pascucci, 2017). It favours incumbent linear logics and business models, while hampering future circular ones. This dissertation considers the dynamic of institutions in the circular economy transition and revolves around the following overall research question: To what extent do circular business models fit within the current institutional setting and how does circular business model innovation forge new institutions to drive the circular economy transition? The answer to this research question is formulated based on four chapters that each answer a specific sub question.

Chapter two provides insight in circular economy taking shape in new organisational forms of inter-firm collaborations and how this stimulates the emergence of new institutions that enhance sustainability. The chapter proposes an institutional perspective into the circular economy transition that is currently is lacking yet can improve our understanding of the complexity of moving towards a circular economy when constrained by an institutional system that is aligned with the status quo of a linear economy. The formulated research question of this chapter is how requirements for transitioning to CE create new organizational forms in inter-firm collaborations, and ultimately how they stimulate the emergence of new institutions. Two transition pathways are distinguished. The first pathway is called the ‘status quo’ (SQ) pathway and is characterised by engaging in circular activities such as optimising up-cycling technologies and infrastructure that further build on existing current linear institutional system.

The second pathway is the ‘Product-as-a-Service (PaaS) pathway and is characterised by a more fundamental shift of business activities from selling products towards providing services. CBMs following the SQ pathway are more likely to fit within the current institutional setting whereas CBMs following the PaaS pathway encounter a higher number of challenges that are specifically related to contracting, financial mechanisms and chain coordination.

Chapter three elaborates on the role of contracts for circular economy, and more specifically on the relation between contract design and CBMI for creating Product Service System (PSS[1]) models and revolves around the question ‘how contractual mechanisms can enable innovation processes in the design of a PSS model between service providers and clients in relation to servitisation, longevity and modularity’.

The definition of the scope of circular services seems to be pivotal for defining a contract template aimed at servitisation. Exactly specifying the services provided under the contractual agreement embody the servitisation element of the PSS value proposition. Deciding on the tenure of the contract impacts managing and extending the lifespan and delaying the obsolescence of products, hence provides incentives for longevity. An adjustment of the tenure has been needed to optimize the product lifespan in multiple use cycles, thus aligning economic and technical product lifespan, adapting termination to new optimal lifespan predictions, balancing technical performance and sustainability performance, and finally avoiding linear depreciation of products (assets) over time. Defining risks and securities between the service provider and users creates clarity for contract parties on rights and responsibilities in using and managing the devices – that are used for providing the services – on a modular level, - i.e. modularity. Managing products at a modular level enables a more detailed system in which the lifespan of independent modules allows product life extension, since only the weakest link (i.e. a broken modules) needs to be replaced and not the product itself.

This chapter stresses contractual dimensions being explicitly related to the process of configuration of a PSS model architecture. Agreements on ownership, usage right, risk allocation and managing circular value propositions are key in PSS contracts, albeit tensions surface between ownership and contractual aspects when attempting to manage circular business practices. Moreover, conditions of uncertainty are related to new technological, organizational and contractual practices in the innovation process, as well as to the higher (institutional) level of the fit between the CBM in the broader transition from a linear status quo towards a new unknown state (i.e. a circular economy). Finally it finds evidence for the increased importance of relationships – and relational contracting – in case of PSS models.

Chapter four concerns finance and accounting concepts that pose opportunities and challenges for the circular economy transition. The chapter aims to bring relevant finance and accounting issues into circular economy and sustainability scholarship and revolves around the question ‘how we can understand the differences in accounting and financial valuation between linear and circular business cases and how we can create a level playing field to assess all companies by standards aligned with the goals of a sustainable circular economy’. An analysis of three cases shows the main finance and accounting hurdles to the circular economy transition and provides directions for overcoming current barriers to unlock finance and accounting as levers for the circular economy transition.

Specific hurdles concern the relative newness CBMs to accountants and financiers. CBMs aim to generate value over a longer time horizon and often involves increased control of- and responsibility for products and materials. This can impact financial ratios to be outside the ‘commonly accepted brackets’ and to be perceived as more risky than linear BMs. Moreover, valuation of products and materials is currently not assuming ongoing cycling as proposed in CBMs. Instead, current tax measures incentivise the rapidly depreciation of products. In the circular economy transition we suggest rethinking depreciation schemes and propose to ‘appreciate’ the value of (residual and harvested) products and materials that can be used in ongoing cycles. For the institutional field of accounting, this could mean recalibrating core concepts such as depreciation and value.

Moreover, the chapter urges taking a closer look at the risks of linear BMs, and the risks of not transitioning to a circular economy. In the long run, circular economy helps to mitigate risks associated with the scarcity of materials and climate change (Durán-Romero et al., 2020), that will pose an increasing threat to the continuity of businesses. CBMs are currently new and unknown but can become risk mitigants in a system that is characterized by resource scarcity and other limiting environmental conditions. Finally, risks incurred by continuing linear business should be considered. Such a shift would level the playing field by moving from neglecting circular companies (by not valuing positive impact) and rewarding linear companies (by subsidizing) and/ or not punishing them for polluting towards a levelled field where all companies adhere to a new ruleset that does rewards positive- and punishes negative impact.

Chapter five considers the process of institutional field formation of the circular economy. This chapter zooms out from specific institutions as presented in chapter three (legal and contracting institutions) and chapter four (frameworks and rules regulating finance- and accounting) to analyse the occurrence of circular institutions and answers the question how we can understand the role of institutional intermediaries in the emergence of circular economy as an institutional field. In the void of general regulatory frameworks, organizations participating in projects aiming at implementing CE principles in CBMs identify, define and shape enabling institutions, forming ‘islands of rules.’ The chapter presented two findings that can help us better understand the institutional field formation process in CE.

The chapter shows how circular value proposition elements and regulatory principles can be ostensibly at odds with one another but are reconciled with the purpose of enabling CBMs. Different interpretations of circular elements (think about different potential starting points for the circular value proposition, e.g. starting new materials to build a circular product or from harvesting existing products) and different understandings due to professional backgrounds (e.g. business developer versus lawyer or accountant) have to be made explicit before they can be aligned. Making these ambiguities in interpretations and terminology explicit plays an important role in aligning and defining the building blocks of CBMs. Vice versa this enables relating these building blocks of CBMs to institutional formation processes. Moreover, institutional intermediaries function as translators and brokers between circular businesses on the one hand and regulators and regulatory frameworks on the other hand in creating a field where CBM activities are possible, which can be seen as a contribution to the formation of a regulatory landscape for CE.

Being able to understand the relation between business models and CBMI on the one hand and this necessary systemic shift and institutional dynamics on the other hand was an important driver for this dissertation. If the aim is to change the system, then scholars and practitioners must also engage in changing the ‘rules of the game.’ Looking at economic activities and specifically CBMI from this perspective was not done before, therefore we proposed an institutional analysis lens towards the role of CBMI in the circular transition.

Albeit the field of institutional analysis is scattered we defined institutions as ‘the rules of the game’ as defined by the socioeconomic system (North, 1990; Ostrom, 1995; Williamson, 2000). Institutions are seen as humanly devised constraints that shape interactions (North, 1990) and are key to structure incentives in human exchange (Coase, 1988; Williamson, 2000). In this literature institutions are mainly seen as constraints. The first part of the research question relates to this perspective, asking to what extent circular business models fit within the current institutional setting. The answer – in brief – is that the current institutional setting is indeed constraining CBMI. More specifically CBMs that are more radical – i.e. PaaS models and models than increase chain collaboration and interdependencies – encounter more difficulties than CBMs that are less radical.

Besides looking at institutions as constraints, they can also be very effective in providing a clear framework and boundaries that we all adhere to. Strong institutions provide clarity and safety and lower transaction costs in economic exchanges. The second part of the research question therefore looks at how new rules, that are created in CBMI processes, can become institutionalised. A clear trajectory can be observed. CBMs start with self-enforcing constraints that are embedded in the value proposition. These constraints are formulated in legal contracts between supply chain partners and clients. With the increase of CBMs and contractual agreements, the institutional setting – characterised by e.g. policies and law – will change as well. This is the process of forging institutions for the circular economy.

 

 

 

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