Abstract
The property and construction industry's lack of progress towards sustainability is sometimes blamed on corporate short-sightedness and short-term profit-seeking. What is unfortunately not often taken into account is what constitutes an appropriate business model. The industry faces a paradox: long-term sustainability of this sector requires major changes to current practices, but in order to finance the necessary investment to change, short-term profits are required. Inherent structural characteristics of the industry inhibit this desired transformation, especially as industry structures currently do not reward those responsible for a building's added-value or performance. A business model is needed which genuinely relates price and earnings to the actual performance delivered to the customer and society. This dilemma is considered from the points of view of businesses and individual professionals. Research into sustainability of buildings should be underpinned by innovation in business models that: (1) provide business incentives for long-term service levels and performance of actual facilities; (2) enable and empower professionals within the businesses to act according to long-term goals; and (3) provide sufficient short-term returns for financing the two other objectives.
Le manque de progrès des secteurs de l'immobilier et du bâtiment dans le sens de la durabilité est parfois imputé au manque de vision et à la recherche du profit à court terme des entreprises. Ce qui constitue un modèle d'entreprise adapté est ce dont il n'est malheureusement pas souvent tenu compte. Cette industrie est confrontée à un paradoxe : la durabilité à long terme de ce secteur exige d'importants changements dans les pratiques actuelles, mais, pour pouvoir financer les investissements nécessaires pour opérer cette évolution, des bénéfices à court terme sont nécessaires. Les caractéristiques structurelles inhérentes à ce secteur entravent cette transformation souhaitée, en particulier dans la mesure où les structures du secteur ne récompensent pas actuellement les personnes responsables de la valeur ajoutée ou de la performance d'un bâtiment. Il y a nécessité d'un modèle d'entreprise qui établisse vraiment le lien entre prix et profits et la performance réelle fournie au client et à la société. Ce dilemme est envisagé du point de vue des entreprises et des professionnels individuels. Les recherches menées sur la durabilité des bâtiments devraient être sous-tendues par de l'innovation dans des modèles d'entreprise qui : (1) fournissent des incitations commerciales ciblant les niveaux de service à long terme et la performance des installations réelles; (2) donnent la possibilité et les moyens aux professionnels au sein des entreprises d'agir en fonction des objectifs à long terme; et (3) assurent suffisamment de rendement à court terme pour financer les deux autres objectifs.
Mots clés: culture d'entreprise, modèles d'entreprise, industrie du bâtiment, bâtiment basé sur la performance, professionnalisme, chaîne logistique, bâtiment durable, valeur
Introduction
SustainabilityFootnote1 of individual buildings and the built environment is ultimately about balancing between two aspects: the utility and service provided to building users; and the long-term environmental, economic and societal performance of the built environment. Both aspects must be satisfied in order for a building or a community to qualify as sustainable: an insufficient service level leads to redundancy (and eventual demolition or unnecessary upgrades and facelifts) in the short-term, whereas compromises in building performance lead to loss of both attractiveness and business performance of the properties in the medium- to long-term.
Traditional speculative property and construction business culture with its inherent emphasis on short-term financial performance tends to neglect both aspects. Considerations of service level to users are often marginalized only to covering superficial characteristics (finishing materials, visible design aspects, etc.), and long-term performance even more often has to succumb to cost savings for short-term yield.Footnote2 Individual professionals might sometimes – or even often – advocate service and performance improvements, but their opinion is overshadowed by the prevailing business culture.
The property and construction sector's lack of progress towards sustainability has been blamed on its corporate short-sightedness and short-term profit-seeking. What is unfortunately not often taken into account in is that fact that short-term business performance and profits are a prerequisite for investing in improvements in future performance. Hence, the industry is facing a paradox: long-term sustainability of the property and construction industry requires a major change to current practices, but in order to finance the necessary investment to change, short-term profits are required.
Financial sustainability as a prerequisite for change
The financial performance of property and construction companies is also a fundamentally sustainability issue. A (somewhat clumsy) parallel can be drawn from the Eurozone crisis. At the core of the financial crisis in Europe lies an inherent long-term mismatch between government spending and income, leading to serious levels of public debt in comparison with the overall economic activity. Similarly, sustainable investment into a better built environment in the future can only be based on profitability. Investments that do not provide sufficient yield in an acceptable timeframe for the investor are not viable. And the capital to reinvest in sustainable developments must be generated through profits made in current business.
Both scientific research results and anecdotal business evidence exist to make sufficiently and convincingly the business case for sustainable buildings and built environments.Footnote3 The investment performance of sustainable buildings has been shown to be better in the long- and medium-terms than standard practice buildings due to lower risk levels, lower operating and maintenance costs, less vulnerability and exposure to variations in energy and other utility prices, better service levels and productivity of end users, attractiveness because of corporate image, etc. Hence, the relatively low share of genuinely sustainable investment is not due to lack of an investment rationale or financial performance. The challenges reside mostly in the inherent structural characteristics of the property industry which inhibit transformation towards sustainable practices and hinder individual professionals from fully contributing to this process.
A vast majority of sustainable construction research efforts have focused on developing products, technologies and systems, and on improving design strategies, design tools and processes. However, a large omission is industry structure transformation and business model innovation.Footnote4 It is these industry structures that both research and practical efforts should focus on in order to pave a way for a sustainable construction sector.
Key challenges
Fragmented construction value chain
Sustainable construction should deliver environmental, societal and economic performance, and value (in terms of quality) to the end user and to society. Performance and value can only be delivered if these objectives are shared through the value chain, i.e. if common objectives, targets and requirements are passed on undisrupted between subsequent players in the value chain.
In real life even simple construction projects comprise tens, if not even hundreds, of individual suppliers, subcontractors, designers, supervisors, etc. The value network created by these players includes a vast amount of interfaces where performance requirements are defined, and goods or services delivered against specified requirements. Each value chain interface constitutes a possible disruption in performance delivery. In many cases actual performance requirements are not even defined, and therefore no compliance occurs.
Simplification of construction value chains is a fundamental prerequisite of delivering performance and sustainability. Value chain simplification implies a smaller number of players in the value chain, and consequently a broader performance responsibility and accountability assumed by each of the value chain players.
On the other hand, from a perspective of commercial enterprise, assuming broader performance responsibility implies a higher risk level and longer and more complex liabilities, especially if targeted outcomes are difficult to measure explicitly. This in turn requires a mindset change by the whole industry and its customers: in order for a business to be sustainable, higher risk must go hand in hand with higher reward. This means a higher price for broader performance responsibility. In an industry that has grown accustomed to being compensated on a cost-plus basis, pricing services based on performance and value, and being prepared to pay for performance instead of cost, are a huge cultural change.
Rewarding mechanisms and incentives
Bonus schemes, performance incentives and other individual rewarding mechanisms are standard practices in many lines of business. A well-functioning incentive scheme is usually based on measuring and evaluating the value that an individual or an organizational entity creates for the business and its stakeholders. However, when the price of a company's service or product is defined on a cost-plus basis, the value that an individual or a unit creates is defined in terms of cost savings rather than value added.
Rewards based on cost-saving targets incentivize minimizing upfront cost in all levels of the construction value chain, regardless of the negative impacts this has on building performance. This has implications on the level of both individual professionalism and business models and the earnings ‘logic’ of enterprises. When the whole construction value chain from end customer to raw material producer is rewarded based on minimized cost, performance targets are largely omitted – or at least no incentive is provided for reaching or exceeding specified performance levels.
Performance-based business models
Private finance initiative (PFI) and public–private partnership (PPP) models are among the only examples of business models that at least in principle aim at providing compensation for provided value. In principle, both are based on the customer defining the service and performance targets, and providers competing with concepts fulfilling the specified targets at the lowest life cycle cost for the customer. Conceptually this is a gigantic leap forward in construction business model thinking.
Unfortunately experience suggests that many PFI/PPP projects do not result in a significant sustainability performance improvement. Often this has been due to sufficiently rigorous performance targets not having been introduced as part of the PPI provision for fear of unaffordability. Another reason seems to be that in many cases PFI and PPP models are applied as an alternative financing mechanism rather than as a way of procuring improved performance. In other words, these business models are in practice not applied to their full potential in terms of sustainability. More disciplined and knowledgeable application of PFI and PPP by customers, and perhaps also more development and tooling of these business models, is required in order to realize their full potential.
A better example of new business models may be energy performance contracting (EPC) which has the potential of successfully delivering performance improvements. In an EPC project a service provider analyses the target building, defines a set of investments and other measures, implements these, and is rewarded through sharing the energy cost reduction resulting from the implemented measures, within the context of explicitly defined and rigorous comfort performance criteria, and supported by rigorous commissioning and post-occupancy evaluation methods for ensuring that the targeted performance level is actually reached.
Large numbers of energy service companies (ESCOs) have been established over the last decade in both Europe and North America, and they are successfully applying the EPC business model. This has happened both through the start-up of small enterprises basing their whole business concept on performance contracting, and through large established corporations expanding their service portfolio from traditional offerings towards performance-based services.
Experiences – both positive and negative – from EPC should more actively be analysed and broader performance-based business models developed to tackle the full sustainability agenda beyond energy performance only.
Professionalism in the construction industry
How should professionalism in the property and construction industry be defined? What characterizes an individual with a high degree of professionalism?
It would be tempting and simple to define professionalism through objectively assessable levels of specific skills and competencies. A number of professional institutions worldwide define appropriate skills and competence levels, and in some cases are also developing and promoting professional codes of conduct defining how professionals should utilize their acquired skills for the benefit of the community.
However, from the point of view of promoting and ensuring sustainability of the built environment in the long-term, individual professionalism is a much more fundamental question of combining skills and competencies with a particular attitude, mindset and approach to exercising one's profession. In this context, professionalism could be defined as a work ethic aiming at promoting and ensuring decisions and outcomes which balance both the short-term benefit of the company and its direct stakeholders, the value expectations of end customers, and the long-term broader good of the society. In other words, sustainable professionalism means consistency and integrity in applying one's skills and competencies for the benefit of the community.
Unfortunately, in the current state of affairs this indeed is a matter of individual ethics, and progress is understandably constrained to a certain extent by the need for securing individual short-term economic survival. Only few inbuilt mechanisms exist in the industry for promoting, rewarding or incentivizing this type of individual behaviour. These include the requirements in certain types of professional service contracts regarding the professional's duty to utilize his/her skills for the full benefit of the client, and the emerging professional codes of conduct mentioned above. On the other hand, examples unfortunately exist where this type of professional integrity is either implicitly hindered by not being included in contractual service-level definitions, or even explicitly penalized as counterproductive to the short-term profit targets of a business – or just brushed aside as a disruption to business as usual.
How should the construction business be structured and the earnings logics redefined in order to value individual professionalism? It is unreasonable to assume that change can occur through a changed mindset at the individual level – even if this is also an important prerequisite for sustainability. It also requires a business infrastructure and culture (both within the industry and among the industry's various customer and stakeholder groups) which not only allows, but also actively puts a monetary value on performance.
Fortunately, some change is occurring due to the younger generation. Some professionals are not accepting to work for companies whose business model, value drivers and overall business objectives do not coincide with the individual's value system. Valuing individual professionalism will be a prerequisite for the industry being able to attract and retain talent in future.
Business model transformation
The business model defines the architecture, principles, logic and capabilities that an enterprise applies for creating, delivering and capturing value. The business model addresses (but is not limited to):
| • | how the value proposition of the enterprise is defined | ||||
| • | to whom value is created | ||||
| • | how value is created (i.e. what are the value drivers of different stakeholders of the business, how the company's offering responds to these drivers and how does it convert to monetary value) | ||||
| • | what resources and competencies are utilized to create the defined value | ||||
| • | how revenue streams are created from the value that the company provides its customers | ||||
In mainstream construction the prevailing traditional earnings logic has been simple and similar across the value chain. Business models and earnings on different levels of the value chain are based on combining the outputs of previous steps of the value chain into an aggregated product or system, and the value added created in this step is seldom anything more than the value of the labour effort input to the process. This leads to a highly traditional cost-plus pricing model (the price of the delivered service is defined as the cost of all input resources multiplied by a targeted margin level). It is easy to see that differentiating price levels by delivered performance have traditionally not had much space in the construction value chain.
The most fundamental prerequisite for transforming the construction sector towards sustainability is changing the prevailing business model from a cost-plus-based earnings logic to a model or models where price and earnings are genuinely differentiated by performance delivered to the customer and to society. This requires both changes in the internal structure of the industry, but also in the way the construction industry's customers and stakeholders perceive and value the output created in construction projects, and in the different customer segments' willingness to pay for performance instead of volume.
Construction clients and owners have a potentially large role to play in business model transformation. Professional clients have the power to define challengingly high performance targets, and hence drive the supply industry to challenge both its structures and its ways of working and established business practices. The emerging interest of a large number of clients in future-proofing their investments by specifying required rating levels in building environmental assessment schemes – Leadership in Energy and Environmental Design (LEED), Building Research Establishment Environmental Assessment Method (BREEAM), Deutsche Gesellschaft für Nachhaltiges Bauen e.V. (DGNB), etc. – is a sign of this. This trend has already contributed to a shift towards more integrated design and construction approaches, and it has had a clear positive impact on the performance of individual buildings. However, no explicit evidence exists yet of the impact of environmental assessment schemes on permanent business model transformation.
National and local governments are, especially in Europe, among the largest construction clients and building owners. Public sector clients can make a considerable difference in the market place by transforming their building and construction service procurement policies towards performance-based models. Utilizing public expenditure as a steering mechanism would have a much larger and quicker market impact than utilizing legislative or regulatory means – especially since the latter tend to have an impact on technical and design solutions rather than construction industry business drivers.
Conclusions
The delivery and operation of a sustainable built environment requires more than technological innovation and increased regulation. The property and construction sector is facing a major dilemma due to the overarching need to deliver sustainable communities and buildings, but it does not have a set of appropriate incentives and delivery mechanisms. A fundamental prerequisite for sustainability is transforming the industry's business model(s) to reflect the value provided to the customer and to society by accepting the evaluation of realized performance levels and payment for success in reaching specified performance targets. Performance-based contracting and life cycle services delivery are potential models. However, the development of new, appropriate business models for the property and construction sector has not been a priority for the academic community. A significant challenge for the research community is to create more appropriate business models which capture and reflect the value-added in order to deliver and operate sustainable buildings (reduced consumption of resources and lower environmental impacts whilst maintaining appropriate utility to inhabitants). They must also consider how value is actually validated in practices, how performance data can be shared amongst stakeholders (feedback and feed-forward), and allow for ‘fine tuning’ or rectifying problems.
Business models that enable a transformation towards sustainability must meet three objectives simultaneously: (1) the provision of business incentives for the delivery of long-term service levels and performance; (2) the empowerment of professionals within the businesses to act according to long-term goals; and (3) adequate short-term returns for financing the two other objectives.
Acknowledgements
This paper is an expanded version of a presentation given at the opening session of Sustainable Building 2011 conference in Helsinki, Finland, October 2011.
Notes
For the purposes of this paper, ‘sustainability’ is defined in its broadest context, referring to a level of environmental, social, cultural and economic performance which positively contributes to or can be sustained by the carrying capacity of the Earth and its social and economic structures.
For example, see T. Lützkendorf and D. Lorenz (2007) Integrating sustainability into property risk assessment for market transformation, Building Research & Information, 35(6).
A growing literature exists to support this. See P. Eichholtz, N. Kok, and J.M. Quigley (2010) Sustainability and the Dynamics of Green – New Evidence on the Financial Performance of Green Office Buildings in the USA. Research Report, August, The Royal Institution of Chartered Surveyors (RICS), London; G. Pivo and J.D. Fischer (2010) Income, value, and returns in socially responsible office properties, Journal of Real Estate Research, 32(3); S, Sayce, A. Sundberg and B. Clements (2010) Is Sustainability Reflected in Commercial Property Prices?: An Analysis of the Evidence Base, Research Report, January, The Royal Institution of Chartered Surveyors (RICS), London.
This is articulated clearly from two different perspectives: T. Lützkendorf, W. Fan and D. Lorenz (2011) Engaging financial stakeholders: opportunities for a sustainable built environment, Building Research & Information, 39(5); J. Whyte and M. Sexton (2011) Motivations for innovation in the built environment: new directions for research, Building Research & Information, 39(5).
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