Get it while it's hot: Why McKinsey calls adaption a ''buy'', and how to sell it to the CFO

Transcript:

SAIF: If the world wants to adapt, the world would need to spend $1.2 trillion annually by 2050. Three-quarters of that is just to protect against heat and drought. Just think about that. $1.2 trillion a year, three-quarters of that is heat and drought. Welcome to another episode of the State of Sustainability. I'm your host Saif Hameed. In this episode, we speak with Mala Krishnan, partner at the McKenzie Global Institute. Mala is one of the foremost thought leaders on the topic of climate risk. I've worked with Mala before and I know her to be exceptionally deep and thorough with her analysis and also an incredible communicator of what can often be pretty daunting insights. Mala has a report out several weeks ago on the topic of adaptation and resilience. I encourage you all to read it. We'll put the link in the show notes and we wanted to dive in deep with her in this conversation. Before we get started, I have really appreciated hearing from many of you directly over LinkedIn after the last episode. In case you want to meet me in person, we're hosting two live events in Amsterdam and Chicago over the next several weeks. If you want to join us, please drop me an email at saif@Altruistiq.com and I'll link you up to our events team. Hey Mala, welcome to the show. So glad to have you here.

MALA: So lovely to be here with you, Saif. Looking forward to this conversation.

SAIF: Likewise. Likewise, Mala. So I'm excited to catch up with you in general. I'm really excited to dive into this topic as well. We're going to have a link to the report that you published on adaptation in the show notes. But I just wanted to get our listeners started by reading out some of the highlights from the at-a-glance section, and then there's a bunch of bits that I'd love to dive into right off the bat if that's okay, Mala.

MALA: That's great. You made my job easy for me by reading this out. It's great. [laughter]

SAIF: If I kind of look at the highlights — the highlights that I took away from the report and the stuff that's there up front — climate change is not new. Societies have adapted to climate change for millennia. The world in fact spends quite a lot already on adaptation and mitigation, so $190 billion annually go to defending against extreme weather, and we can dive into where that goes exactly. The bill is going to get bigger, and so as the climate warms, exposure to heat and drought will increase the most, and we'll talk a little bit about what that means as well. At two degrees of warming, even current protection levels — if we maintain them — will cost about 2.5 times today's spending. I think we can dive also into just developed versus developing countries and low, middle, and high income, which I thought was really nicely called out in the report. And then I really liked how your final point was framed, which is adaptation is a good buy — it makes sense, the return is there — but it's not a given that anyone is going to take it or spend the money that it takes. Have I synthesized that appropriately, Mala?

MALA: You absolutely have. Maybe two things I'd say. The first is you said climate change is not new, and I think the starting point was actually just that societies having adapted to their climate is not new. Not necessarily climate change, but human beings have lived in cold climates, in warm climates, in wet climates, in dry climates for millennia and have found ways to live and organize their lives around that. That was more the first point. And then I would love to pick up on the last point because to me that is just such a profound conundrum behind the adaptation question. It is both simultaneously a good buy — it makes what economists might call societal sense — but we're not spending the amount that we could be spending today. And the question is, will we make the most of this good buy going forward?

SAIF: For sure. And I think it's also interesting just to call out that both of us, I believe, are individuals who've sort of made the journey from locations that are going to be heavily impacted by the stuff that we're talking about — over in South Asia — towards the west and the global north, where we're much more insulated against the impact. And I know that it is true for me, and I think it's true for you as well, that that just makes this much more personal as a topic to think about and talk about.

MALA: Absolutely. You know, over the years, having gone back to India — which is where I grew up, and now I live in the United States — but going back to India, you start to experience ever warmer weather. And that is of course exacerbated not just by the fact of the climate changing, it's exacerbated by the fact that we've built in ways that are raising risk in already exposed areas, and we've built in places that haven't necessarily kept adaptation and resilience in mind. So it's all those things that are coming together in how the world experiences this today.

SAIF: It's kind of funny, right, that we sort of assume the world is going to stay exactly the same for decades to come. It's almost like we're planning a massive capex project in how we do our infrastructure and how we do our planning around our cities. But we could go along this segue for a while. I want to get into the meat of it. And so I guess the first thing that really struck me as I was reading through the report, Mala, is that you take for granted that 2° is the baseline expectation. And I think that that's true. I actually think you could make a case for saying that 2.5°, 3°, maybe even 3.5° in some situations is possible or probable. But for many of our listeners who are still working on sustainability targets linked to 1.5 degrees, or still have 1.5 degrees in their head, it may seem like we've sort of ceded the floor or given way on that point. How did you and the team behind the report square that thinking and decide not to actually anchor on 1.5?

MALA: Yeah, it's such a good question and it actually is a great segue to the comment you made earlier. So as we did the research, we didn't want to make any predictions actually about how much the world is expected to warm, and in fact we think that's a bad way to approach planning. So instead our philosophy was much more to ask the question: what is the world expected to do on the current trajectory of emissions? We looked at about 25 or so scenarios — everything from McKenzie's own scenarios to scenarios from the IPCC, scenarios from organizations like the IEA — to say across these scenarios, what does the current emissions trajectory suggest in terms of warming? And what we found was actually astounding: how close they all cluster. Across these scenarios, they all say that the world is expected to warm by about 1.5°C relative to pre-industrial levels by about 2030. And this is not a single year of 1.5°C of warming — it's multi-decadal periods of 1.5°C of warming — and get to 2°C by 2050. So if we take that as the expectation on our current path out to 2050 — not out to 2100, out to 2050 — and then you ask yourself questions around adaptation. If you think about many adaptation measures, they have two features. One is that many adaptation measures have long lifetimes. So that means things that we're putting in place today will be around 20 years from now, 30 years from now, maybe even 40 or 50 years from now. And they also come with long lead times, which means that if we're planning for something that we want to have in place by 2030 or 2040, we need to start planning for many of those things today. Even in the Netherlands, which by all accounts is a country that has adapted very well, we found evidence that some large projects to do with flood protection, for example, took as much as 10 years to implement. And so just from a prudency standpoint, if we're starting to think about adaptation, we need to not just live in this static world, but anticipate the future — both because of the lead time as well as the lifetime of measures. And in doing that planning, thinking about the current trajectory of emissions and the expectations on the current trajectory of emissions is just the prudent thing to do when you're asking yourself questions about adaptation. So that was really the philosophy behind the 1.5°C and 2°C. And in some sense, it means that what the world needs to do is walk and chew gum, right? We need to both think about how to decarbonize and prevent those higher warming levels, but not simultaneously forgo planning for those higher warming levels when we're doing large capex buildouts, for example, today. That's just not good risk management.

SAIF: Yeah. No, I agree. And we're going to get deeper into initiatives, but one thing that just came to mind as you were speaking, Mala, is flooding is a very real, very now impact — a very current impact for many countries. And I remember I was working on a massive flood relief effort in Pakistan in 2010 when I was working for the government, and there were about 20 million displaced people. At the time it was considered the biggest natural disaster in the region for maybe a hundred years, and it was complete and total annihilation — just everything: villages destroyed, families losing their livestock and their livelihoods. And it dominated everything that my government did for about 5 to 8 months. And then we moved on, right? And we had all this reconstruction effort. I remember like three model village projects, and then there was something else the year after, and then floods hit again 3 years later or two years later. It was the same story. Why do you think we keep getting it wrong — despite the fact that, and the interesting thing in Pakistan is I'm talking about the same government, the same politicians, basically seeing this story at least three times — the same individuals. And I suspect this is the same in many flood-hit countries as well. It's a fairly predictable disaster in some ways. You can predict that it's going to happen over the next several years. Why do you think we don't make the investments that we need to make when it's so real — it's not abstract?

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MALA: Yeah, absolutely. So first, just to your point about we already experience many of these events today — in our research we looked at four different categories of climate hazards. We looked at heat in various forms: heat waves, heat stress, which is longer month-long chronic conditions of high heat and humidity. Different forms of flooding: rain-driven flooding, which is the example that you described for Pakistan, but also coastal flooding and river-related flooding. Wildfire and drought. Already today, what we find if you look across those four categories of hazards is that 40% of the earth's land mass is exposed to those hazards today — meaning people living in 40% of the earth have some likelihood of experiencing these events today. That by the way translates to 4 billion people around the world that are exposed to some form of these events. The number of people that we estimate have really robust protections of that 4 billion is only about a billion. Which means that 3 billion people around the world — of course the vast majority of them in low and middle income places — have much more limited forms of protection. They're probably doing something to protect themselves, but it's not really robust protections that we see in other parts of the world. So that's already the baseline today. And then you marry that with the point that you made earlier, which is that adaptation is a good buy. What we find with our work is that for every dollar that you invest in an adaptation measure already today, on average that leads to $3 of benefits in terms of avoided damages — avoided economic disruption, avoided loss of productivity, avoided asset damages, and so on and so forth. And so this is, to me, the heart of the question, right? It's such a profound conundrum to say this is a good buy, large parts of the world experience this today, and unlike mitigation, by the way, we have proven measures — we're not innovating on substantially new technologies — and yet we aren't spending enough. We try to unpack this a bit in the work, and we don't have the full answer to this, but there are very clear signals of the sorts of things that are happening. One reason it's not happening is certainly a capacity-to-pay question. The fact that you see much larger resiliency gaps and protection gaps in lower income parts of the world — of the 3 billion people that I described that have limited protection today, about 77% of them live in lower income parts of the world. So clearly there is a capacity-to-spend question, and it's a capacity-to-spend question in a world where the people making these investments are also dealing with competing spending priorities. If I'm a national government, I'm debating with a fixed pool of money: am I spending on adaptation, or am I spending on healthcare, or am I spending on education? I think that's one dynamic that is clearly at play. The other is what you alluded to with the flood example — where the nature of adaptation benefits are often invisible, and they manifest only if and when the event occurs. No one gets paid for a disaster that didn't happen, basically.

SAIF: Exactly. Right.

MALA: And there's some really interesting academic literature that has tracked how much — exactly to your Pakistan example — how much spending rises post an event. And you see this repeatedly. I mean, the Los Angeles wildfires is another example of this, where post an event suddenly you see an increase in spending. But then how sticky that is — it's just not something that is sticky over time. So I think there's something really about the nature of these benefits feeling invisible, and only becoming top of mind if and when — especially if you're talking about acute events that don't occur every year — that is very much an if-and-when question. And so I think this comes back to: how do you raise risk awareness? How do you better demonstrate the return on the investment? How do you really make the case for these? And for me at least, the somewhat good news of all of this is that as events become more intense and more frequent, as we start to also see an intensification of more chronic events, at least that invisible will start to become more visible.

SAIF: Very true. And I guess I kind of want to start talking a little bit about corporations. If I stick with some of the flooding examples — if I look at, let's say, the irrigation systems in many of the countries that are most impacted, and I think of Pakistan or India — a lot of the irrigation system has its roots in colonial setups that were done to really boost grain production capacity for instance. So we're sort of talking about adaptation measures and resilience measures that actually are there for a corporate purpose — really for production, for supply chain, for value. And given that the sheer number of people that you're mentioning is so big, there must be a massive impact on corporations as well. I know that the quantification that you've done is sort of global and macro, but this must also materialize in corporate cost of goods, or distribution costs. How did you and the team think about that? And obviously McKenzie has a massive body of corporate and client work, and I'm sure you must be having conversations with corporate clients around the impact of this sort of analysis. Could you share a little bit around that with us?

MALA: Yeah, absolutely. It's a very interesting phenomenon that we observe when it comes to companies. At some level what I'm describing is anecdotal and pattern recognition based on the companies that I've spoken to, but it also is backed up a bit by some surveys we've done with companies. What we find — and the picture is much more complex to understand — so let me unpack it a little bit. On the one hand, when you're a large Fortune 500 company — and I'll come to non-Fortune 500 companies in a moment — when we look at large Fortune 500 companies and their direct operations, their facilities, their physical assets, their worker protocols for things like heat, we actually find that large Fortune 500 companies with their direct operations are generally quite resilient. Now this is not because they're thinking about climate change, but it's because they've designed or put in place protocols with very high risk thresholds. If I am a Fortune 500 company that is operating a large piece of physical infrastructure, I'm not designing it for a 1-in-100-year event, I'm designing it for a 1-in-10,000-year event. And now, even if climate change means that that 1-in-100-year event intensifies, the 1-in-10,000 tolerance is already well protecting. But the gaps that we find with companies in the Fortune 500 bucket — one sort of gap is that they're focused very much on their direct operations. They may not call it adaptation; it's just standard design standards or business continuity planning — just baseline resilience. But in their indirect arenas — their supply chains, their distribution channels, their customers, things that they don't necessarily have a direct remit over — that's where we often find there are large resiliency gaps. That's one sort of challenge we see for Fortune 500 companies. The other challenge is that as the climate changes, more and more places will start to see events that they didn't encounter at really substantial scale in the past. Heat is the classic example of this. If you look at parts of Europe, historically Europe has not experienced extremely hot days for multiple days at a time with anything approaching regularity. But as the climate warms, large swaths of Europe will start to experience locally intense heatwave events. Maybe for you and me coming from South Asia they may not seem that hot, but for local infrastructure, local assets, local buildings, local workers, they will be incredibly hot periods that happen with greater regularity. And so I think the other gap that we observe for Fortune 500 companies is that to the extent that they will start to experience events they have historically not experienced, that's not something that's necessarily on their radar. And I think heat is the primary example of that.

SAIF: Did you look at — my favorite example of an unexpected event was a plague of locusts on my farm, caused by changing weather patterns, and the locust migratory pattern sort of shifted, which was unexpected.

MALA: Oh my god, this sounds very biblical, Saif. [laughter]

SAIF: I know. I know. But my question was actually going to be: to what extent, when we talk about this sort of unexpected new challenge as a result of these extreme temperatures, to what extent did you look at things like agricultural disruption — not just because of the heat changing the yield, but also just the ability of farmers to go out into the fields? Because you talked about the temperatures that we might have grown up with. Where I'm from — Lahore in Pakistan — if you go south to the tomato belt, you're going to be seeing temperatures touching 51°C, 52°C. I think you're probably going to get that in Spain as well, which is a very similar agroclimatic zone. So this is going to — at certain times, probably actually what used to be the peak yield time — I've looked a lot at tomatoes and I know the peak yield time is just before it gets blazingly hot. So actually there's going to be massive disruption I would expect in yield outcomes, partly because the plant can't tolerate the temperature, but also partly because it's just too hot for someone to go out into the field and pick something. To what extent did you guys think about this sort of impact on agricultural production?

MALA: Yeah, such a good question. So when we did our research, we looked at a variety of climate hazards as I described, and some of the ones that are especially relevant for agriculture — we looked at heat stress, which we define as chronic conditions. So they occur every year — chronic periods of extremely high heat, and in some cases high heat and high humidity, which is even worse for human physiology. We set quite a high bar. We looked at places that experience with regularity a month or more of such conditions. And so what we found with that was that of course some parts of the world already experience conditions like that today. But two things happen as the earth warms between today's climate to say a 2°C world. The first is that the geographic spread of places that experience heat stress events of that kind grows. The second is that when such events occur, they happen with greater intensity. So today for example, on average, the places that experience heat stress events of that magnitude experience it for 10 weeks or 12 weeks in a year. Going forward, that number would be more like 16 weeks or 18 weeks in a year, and the average temperatures also increase.

SAIF: More days and hotter days.

MALA: Exactly. More places, more days, and hotter. And if you think about how that affects people — one way it affects people is of course you and me sitting in our homes doing office work inside a building, or people living in their homes. And that's actually one of the reasons that as we did our research and looked at adaptation costs, what we found is that by 2°C, if the world wants to adapt at the standard we put in place for adaptation in the developed world today — we don't always implement it in the developed world, but we apply it — the world would need to spend $1.2 trillion annually by 2050. About three-quarters of that is just to protect against heat and drought.

SAIF: Right. Just think about that. $1.2 trillion a year, and three-quarters of that —

MALA: Mostly on air conditioning and irrigation. Air conditioning and irrigation. So going back to the workers point — the air conditioning is something that you can imagine for workers in a home, for people working inside a building, for people living in their homes, of course. And there are all sorts of questions about whether air conditioning is the most effective cooling solution, also because of the emissions footprint. And I think if anyone wants to innovate for adaptation, innovating on cooling solutions is the thing to do. But then there's a profound question of what happens to workers that are working outdoors — both workers in urban settings, like construction workers, but also agricultural workers. And that's a much harder thing to think about an adaptation response to. Effectively, what do you do? You create temporary cooling shelters so a worker can go take a break in the middle of the day — which can work in urban settings, but is much harder in rural settings. You provide personal cooling equipment, whether that's little fans that people are now starting to attach to their bodies, or providing regular water breaks, things of that kind. But beyond that, the only thing you can do is to start to shift working hours. And so we are seeing some places start to experiment with that — whether that's large cities that are shifting construction timings to the nighttime or early morning, some of that happening in agriculture as well. So on the one hand the good news is we have many of these measures that we can put in place, but at the same time many of them come with quite profound shifts in how we run our lives today, and we need to start thinking and planning around that.

SAIF: I mean, Mala, already if I kind of synthesize a bit of what you're saying, I find several areas where corporations — and I think mostly about consumer businesses and food and beverage companies — there are already several things that I think about. One is of course what is the impact on the supply chain in a world where you just can't have picking season in the same way, at the same time, at the same yield and productivity — let alone the changes on the actual produce from a yield perspective. I think there's a whole logistics impact that we haven't really touched on. When we talk about cooling and keeping stuff at temperature, I think about the need for transporting things — whether it's agricultural material, or ice creams and soft drinks and medication and pharmaceuticals — under cooled conditions. I think about just having consumers who can go out to a store and buy something because it's not blisteringly hot for them to make that trip. And it occurs to me that sustainability professionals in these corporations have a role to play in helping their company navigate this disruption. It seems to me like there's a need for data and analysis that can pinpoint where these opportunities and risks might be, and also a need for a communication toolkit to be able to position this to the CFO, the CPO, the CMO — whatever C-suite — and say, look, here are things that have a reasonable probability of happening, a certainty of happening over a period of time, and a reasonable probability of happening in any given year. How would you make those sorts of arguments given that we're mostly talking about risk, which is always difficult to position? How would you frame this to a senior executive?

MALA: And maybe one thing before I get to that — between your two points, the data and the communication, I think there is an intelligence step as well. So much of what we're describing is such a profound shift to the current way of working and being and doing that it does require understanding all the different channels of impact that a particular organization might experience, both directly and indirectly. As I described earlier, often times the data will help you understand the direct, but you have to think to ask the question around the indirect. There is that step of: how do you actually use the data in an effective way to really ask questions not just of first-order impacts, but all the things that you might not see in your supply chain or your distribution channel? In terms of making the case, there are two sorts of things that we're seeing organizations that are really starting to think about this systematically — and as you said, often times it is companies linked with agriculture, food and beverage, consumer, logistics, heavy assets, because these are the things that immediately get affected. Two sorts of things that I think they're doing well. The first is framing these issues really understanding the business impacts as you think about framing the ROI case. An example might be for a company that has a heavy asset base: thinking about what is the likelihood of a flood event occurring, what is the physical damage that would occur if that flood event were to take place, what does that translate to in terms of dollars, and then how does that compare with the resiliency investment? For a company that is in the food and beverage space: what is the likelihood of a supply chain disruption event? And then what are the whole sets of measures you can take to manage that? That's everything from diversifying your footprint, to raising stockpiles and inventories in some places, to making your facilities more resilient. Really understanding the business impact — whether that's business economic disruption, loss of stockpile, asset damage, worker productivity loss — and then framing the ROI and business case associated with that. What's the investment you need to adapt, and then what's the benefit you get in terms of avoided damages? By the way, there are also other kinds of benefits you get. For an irrigation system, for example, not only does it protect you if a drought occurs, but it can also boost yields. So in some cases there can be other knock-on benefits as well. That's one sort of thing we're seeing them do well. The other sort of thing that I think is really important as one approaches this is to approach it with some pragmatism and sense of prioritization. One of the organizations that we've been speaking with that has done a lot in this space — they had exposure to climate in many many different ways across a large footprint through many different channels of impact: through their supply chain, their asset exposure, their worker exposure. And they recognized they couldn't do everything at once.

SAIF: And so there was a very systematic process that they went through to say, okay, here are the 20 things that we could do to adapt to all of these different forms of impacts. How do we effectively prioritize? How do we effectively think about what we do this year versus next year versus the year after? And then how do we fold this into standard business processes such that this is not a retroactive thing — but wherever we're making forward-looking investments, building new facilities or working with a new supplier, how do we already embed this upfront into these processes so that it's something that's organic and natural, and not a band-aid you have to put on later? And so I think there's also the question of what channels can you think about for this to become practical and pragmatic so that it actually gets done.

MALA: Exactly.

SAIF: Mala, I want to go deeper into that and I realize the time has sort of flown by. So this is my last question — I kind of want to ask a question and then give a couple of examples to frame what I mean. Do you think that corporations — the ones that emerge as winners out of this, the ones that capture the opportunity of the moment — do you see them taking on a more expansive role than a traditional corporate role? You mentioned, for example, investing in canal systems, investing in irrigation to secure their supply chain. This is a more expansive role than they might otherwise take. Two examples that I quite like — one from when I was growing up and one more recent. Both are Nestlé actually, and I think it makes sense that it would be Nestlé because they're big enough to kind of have to own this responsibility. The one from when I was growing up is that in Pakistan a lot of the milk went to waste, and so when Nestlé entered the market they basically had chillers installed all across the ecosystem — dairy farmers with one animal or two animals could then use those chillers. It gave Nestlé an amazing network to acquire milk, but it also reduced spoilage that would have otherwise happened because of the heat. More recently, I noticed Nestlé has a massive insurance program for coffee in Indonesia as well, which they launched a few years ago. And I think that's a really nice way of mitigating some of the effects that will happen — building resiliency amongst coffee farmers. Do you think that there's going to be more of this sort of thing? Do you think corporations — the winners — are going to really emerge and take on a bolder mandate in some of the communities where they operate, or do you think that's wishful thinking?

MALA: It's a great question. In reality it's going to lie somewhere in between the two. I do feel like for a lot of companies, a couple of things are true. One is that wherever there's a clear business case — and in your examples it was an immediate return, but there was also this knock-on return in some sense, of establishing a presence and establishing relationships with local communities. So I do think for companies that are especially operating in regions where the capacity for individuals to pay for adaptation, or the capacity for local government to pay for adaptation measures, doesn't exist — I do expect that companies are going to take on more of this. But it is going to be in a way that is not just purely Altruistiq [laughter]. There has to be ultimately an economic return for a company to take on an investment. But I do think we're going to see more examples of that, where it is linked to value creation for their business in some way. And it may in fact be linked even to a license to operate in some jurisdictions. I will also say that the other thing I expect to see companies do more of — in this kind of first-mover sense that you're alluding to — is that companies are also starting to recognize that this is not just about them managing their own risks and capturing upside by implementing adaptation measures themselves. But for some companies at least, they can play a role in actually providing the products and services that support the resilience needs of others. If I am a water management company, suddenly for me it's a strategic imperative to start thinking about broader flood protectio n measures. We're starting to see more and more investors think about what is the value creation thesis oriented around adaptation and resilience. We're starting to see more banks think about what is the adaptation finance opportunity. And I think that's all a good thing, because effectively what it will mean is that it will drive more innovation in this space, help build more efficient and effective technologies, and help reduce costs — which we certainly need, for things like cooling for example, for that to really be deployed at scale in parts of the world that need it. And so that's the other angle we're starting to see companies take on: what is their role in the provision of products and services to support adaptation.

SAIF: So exciting. Mala, I know that you have dived into this set of topics multiple times, and so I'm looking forward to hearing more from you and seeing how this plays out — and also regrouping maybe in a year or two and seeing if we've catalyzed some change across these conversations.

MALA: Thank you so much, Saif. This was just an absolute pleasure. Thank you.

SAIF: Thanks for listening to this edition of the State of Sustainability podcast. If you liked the episode, hit follow so you don't miss the next one. We'll be back with you in a couple of weeks. And once again, if you're interested in meeting me in person in Amsterdam or Chicago, drop me a note at saif@Altruistiq.com.

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