Climate technologies have the potential to significantly reduce the world’s carbon emissions. Many governments, corporations, and individuals are eager to adopt new climate tech products to combat global warming and help prevent a humanitarian crisis. But the high material, energy, and production costs commonly associated with climate tech are a major obstacle to wide adoption. These costs prompt many climate tech companies to add a “green premium” to the price of their products, which may discourage potential buyers.
Whether climate tech can be adopted at the necessary pace to get to net-zero emissions by 2030 will depend on how well companies tackle the high cost underlying the green premiums. Ideally, the cost target should be on par with more carbon-intensive alternatives and be best in class against similar green solutions. How can climate tech companies achieve this?
This question was posed to the participants in McKinsey’s recent Green Business Building (GBB) Global Summit in Stockholm. In its third year, the event gathered more than 500 leaders from corporates, start-ups, and investors for two days of keynotes, panel discussions, and breakout sessions on success factors for scaling green businesses. While the previous GBB Global Summits in Stockholm focused on formulas for hyperscaling green businesses and winning the green scale-up race through “out-execution,” this year’s insights related to ways climate tech companies can reduce costs by adopting an aggressive strategy centered on the following five key elements.
Ambitious target setting
“Tomorrow’s winners will be the ones who are obsessed with ramping down cost, and it starts with the right target setting. Companies should understand what’s theoretically possible and then set a target based on that,” says Tomas Nauclér, McKinsey senior partner and a global co-leader of McKinsey Sustainability.
By establishing theoretical minimum cost, companies can identify the sources of the most significant improvements, including the scale, pace, and source of any decreases (for instance, a specific location). In our experience, companies can quickly translate their theoretical goals into actionable plans for a cost ramp-down tailored to their needs, thereby driving innovation and efficiency throughout their organization.
Fast-paced innovation
Discovering the most efficient solutions can be costly and time-consuming. Across industries, leading companies are turning to artificial intelligence (AI) to expedite and refine the innovation process, and this, in turn, could lower costs. For instance, Google DeepMind has utilized deep learning to predict structures for 2.2 million new materials that might enhance solar cells, batteries, computer chips, and more. A European truck designer and manufacturer used Deep Learning Surrogates to achieve a thousandfold increase in the number of daily design simulations and more than a 50 percent reduction in the time required to set up new designs. Such early experiments with AI have already produced some tangible bottom-line improvements across industries.
End-to-end supply chain industrialization and integration
Vertical integration may be very effective in emerging industries, including climate tech. For example, companies might take control of feedstock or produce energy in-house to secure supply and control unit costs. Tesla has established lithium refinery plants to ensure a sufficient supply for battery production. This, in turn, allows the company to manufacture and sell automobiles at scale more efficiently. In addition to giving Tesla more control over the value chain, vertical integration allows the company to customize and refine production processes, from upstream elements such as batteries to downstream elements such as point of sale. From a cost perspective, vertical integration gives Tesla access to raw materials at a competitive rate even during shortages.
Design to value
As companies attempt to minimize unit costs while optimizing quality, they may benefit from design to value (DTV). “To minimize cost and maximize pace of scaling, every climate technology company should ask itself how to shape the design of its products in a way that maximizes the use of standard components with established supply chains that already operate at scale,” says McKinsey partner Anna Granskog. Companies begin the DTV process by establishing a cost baseline for a product, as well as possible levers for reducing it. The impact varies by industry, and the savings potential is generally higher for more complex products.
For green businesses, dual-mission DTV may be most appropriate. This approach not only pursues the cost improvements and feature enhancements that arise through routine DTV but also seeks to improve the carbon footprint of the product itself—for instance, by eliminating carbon-intensive components when possible.
Excellence in managing capital expenditures
Many green products are produced in facilities that are new or heavily retrofitted, so getting started requires a substantial capital investment. Making production cost competitive with traditional businesses therefore involves ensuring that climate tech companies’ capital projects follow best practices and avoid unnecessary expenditures.
One major consideration is plant location, which often is one of the greatest cost drivers. Another is size: companies that build small manufacturing plants will have relatively high unit costs. One way companies excel at capital expenditure management is by deploying a plant-as-a-product (PaaP) strategy. For example, at an automotive company that applied the PaaP approach, capital expenditures for the fourth plant were 75 percent lower than for the first. Simultaneously, the company increased design output threefold and halved its footprint and time to market. All of these levers directly decreased total cost.
Climate tech companies can scale up faster if they reduce costs so they can make their products more affordable. This ambitious approach calls for vision, courage, and discipline. At GBB 2024, Harald Mix, cofounder of Vargas and CEO of Altor, reminded participants that this approach also, at a fundamental level, requires the right company culture: “It’s all about people and talent. What’s really promising today is that there are so many smart young people around the world that want to be involved in trying to solve climate change. A great culture becomes like a magnet for people, globally”.
For more, read, “Accelerating cost decreases at climate tech companies.”
The authors wish to thank Daniel Nord for his contributions to this blog post.