Hermes Microtech Inc.:A New MBA Case and Teaching Module on Entrepreneurial Leadership and Systems

Innovation in “Greening” Buildingsfrom Darden Business School

Chris Lotspeich

Second Hill Group

WRI BELL Conference

18–19 July 2003

Fort Lauderdale, FL

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Batten Fellowship

• The Batten Institute at Darden at UVA

• Chris a visiting Batten Fellow 2002–2003

• Sponsor Prof. Andrea Larson

• MBA module based on consulting experience

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MBA Teaching Module

• Article on systems innovation theory

• Fictional case on implementation challenges– Champion greening company facilities– Change strategies & organizational dynamics

• Two technical notes– Whole-systems design & management– LEED green building rating system

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Topical Overview

• Systems innovation and entrepreneurship

• Greening facilities can improve companies

• Green building strategies

• Overcoming obstacles to implementation

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Systems Innovation Article

• System dynamics of economy & environment

• Small factors cause big system changes

• Economic activity degrades ecosystems

• Transition to sustainable system condition

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Entrepreneurship and Innovation

• Schumpeterian creative destruction

• Entrepreneurs have new vision of the future

• Harness resources to realize their vision

• Innovate new methods, products, processes

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Systems Innovation

• Organizational systems produce technical systems– Design-build process makes buildings

• Entrepreneur innovates systemic change

• Coordinates incremental changes at leverage points

• Creates big changes in both system & outcome

• Organizational learning via product improvement

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Greening Facilities: A Good First Step

• Every business uses buildings, pays overhead costs

• The design-build-operate process is wasteful

• Proven improvements are well understood

• Learning integrates many functions and disciplines

• Early wins free resources, build buy-in

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Green Building Benefits

• Healthier indoor & outdoor environments

• Cost reductions

– Capital costs can be same or lower

– Operating cost reductions typically ~50%

• Potential labor productivity increases

• Promotes innovation

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LEED Rating System Tech Note

• Voluntary standard of US Green Building Council– Industry-wide stakeholder association

– Power to transform market

• Defines “green” based on accepted best practices

• Flexible menu of opportunities– Promotes innovation, economy

• Credible third-party certification

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Resource Efficiency Strategies

• Integrated, whole-systems design– Big savings can cost less than small ones

• Appropriate technology– Low-impact materials and energy use

• Management Techniques – Money, information, organizational behavior

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End-Use, Least-Cost Analysis

• Historical supply-side focus: How to get more resources?

• But users want end-use services, not resources– Hot showers, cold beer, light, comfort, torque…– … not oil , electricity, wood, etc.

• Demand-side focus: what is the least expensive, least polluting way to deliver those services?

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Whole-Systems Design Approach

• Life-Cycle Analysis (LCA), total cost of ownership

• Consider interactions and synergies

• Compounding leverage of downstream savings

• “Charrette” stakeholder group design process

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The Leverage of Downstream Savings

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Building The Business Case• Use total cost of ownership

– Capital and operating costs– Credit savings from reduced infrastructure

• Turn cost centers into profit centers– Cost reductions add directly to bottom line– Less risk, more return than earning on sales margin

• Investment criteria: Payback vs. ROI

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Payback vs. Return On Investment

• Payback period calculation is the inverse of ROI

• Capital asset ROI criteria based on marginal cost of capital– 15% COC = ~7 year payback

• Most retrofit investments capped at 2-year payback period– 2-year payback = 50% annual ROI

• Bias vs energy efficiency, not a level playing field

• Asking efficiency to pay >3 more than COC hurts profits

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Prioritization by Simple Payback

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Source: EPA Energy Star® Small Business Guide

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Common Obstacles to Efficiency

• Disincentives, split incentives and perverse incentives

• Lack of information

• Capital misallocation

• Organizational behavior

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Differing Incentives in Building (I)

• Consider the owner, architect, builder, and tenant

• Owner: May not know about efficient methods– If he doesn’t ask for efficiency, he won’t get it

• Architect: Not trained in resource-efficient techniques, and not asked to prioritize them– No incentive to work harder and argue for efficiency– Traditionally, architects and engineers are compensated

for what they spend, not what they save

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Differing Incentives in Building (II)

• Contractor: Wants maximum profit from his bid

- He’s rewarded for the lowest bid, and won’t pay the bills

- Incentive to install cheap (and inefficient) equipment

- Electric heaters, inefficient fridge, incandescent bulbs...

Tenant: Had no say, and is stuck with the bills

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Improving Building Efficiency

• Increase awareness of efficient techniques

• Specify building performance, efficiency

• Performance-based fees – Reward the architect for what she saves

• Integrated design workshop, or “charrette”– All involved meet with experts to optimize the design

• Share savings with building energy managers

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Hermes Microtech Case Study• CEO and VP of EHS want green building

• Young manager tasked with implementation

• Has CEO support, but not full authority over project

• Consider lessons of prior efforts, consultant input

• Assess goals & incentives of process participants

• What should be her strategy for new project?

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Hermes Dramatis Personae• CEO• VP of Production

Department• VP of Environment and

Facilities Department• Special Assistant to VP

of Environment & Facilities (protagonist)

• Comptroller

• Construction Manager from Production Dep’t

• Product Engineer from Facilities Division

• Site Facilities Director• Architect vendor• Construction vendor• Green building NGO

consultant• Green engineering

consultant

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Hermes Organizational Chart

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Regina ShinelleProject Manager

Susan LegumeComptroller

OperationsDivision

Chip SmithExec VP

Production Department

Heather GlenSpecial Assistant to EVP

for Environmentand Facilities

Tom DowitProject Chief Engineer

Steve SparksFacilities Director

FacilitiesDivision

EnvironmentDivision

Sandy StrandExec VP

Environment and FacilitiesDepartment

Alden TorusCEO

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• The Batten Institute and the Darden School

(www.darden.virginia.edu/batten)• Rocky Mountain Institute (www.rmi.org)• Contact the author:

Chris LotspeichPrincipal, Second Hill Group

37 Majus Dr, Coventry, CT 06238 USATel: + 1.970.948.3280

E-mail: chrislot@secondhill.com

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For More Information

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Payback vs ROI Appendix

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Return on Investment (ROI)• Many capital investments assessed in terms of ROI

• Department of Energy method:

– CA = Annual energy cost after implementation

– CB = Annual energy cost before implementation

– CI = Cost of implementation

• Annual return on investment (ROI)*, expressed as a percentage:

CB – CA CI (*This approach ignores certain tax effects and depreciation)

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Simple Payback• Payback period calculation is the inverse of ROI, where:

– CA = Annual energy cost after implementation

– CB = Annual energy cost before implementation

– CI = Cost of implementation

• Simple payback*, expressed as the number of years needed to recover costs:

CI__ CB – CA

(*This approach ignores certain tax effects and depreciation)

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