Hermes Microtech Inc.: A New MBA Case and Teaching Module on Entrepreneurial Leadership and Systems Innovation in “Greening” Buildings from Darden Business School Chris Lotspeich Second Hill Group WRI BELL Conference 18–19 July 2003 Fort Lauderdale, FL

2 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 Second Hill Group

3 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 Second Hill Group

4 Topical Overview Systems innovation and entrepreneurship Greening facilities can improve companies Green building strategies Overcoming obstacles to implementation Second Hill Group

5 Systems Innovation Article System dynamics of economy & environment Small factors cause big system changes Economic activity degrades ecosystems Transition to sustainable system condition Second Hill Group

6 Entrepreneurship and Innovation Schumpeterian creative destruction Entrepreneurs have new vision of the future Harness resources to realize their vision Innovate new methods, products, processes Second Hill Group

7 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 Second Hill Group

8 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 Second Hill Group

9 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 Second Hill Group

10 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 Second Hill Group

11 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 Second Hill Group

12 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? Second Hill Group

13 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 Second Hill Group

14 The Leverage of Downstream Savings Second Hill Group

15 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 Second Hill Group

16 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 Second Hill Group

17 Prioritization by Simple Payback Second Hill Group Source: EPA Energy Star® Small Business Guide

18 Common Obstacles to Efficiency Disincentives, split incentives and perverse incentives Lack of information Capital misallocation Organizational behavior Second Hill Group

19 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 Second Hill Group

20 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 Second Hill Group

21 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 Second Hill Group

22 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? Second Hill Group

23 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 Second Hill Group

24 Hermes Organizational Chart Second Hill Group

25 The Batten Institute and the Darden School ( Rocky Mountain Institute ( Contact the author: Chris Lotspeich Principal, Second Hill Group 37 Majus Dr, Coventry, CT USA Tel: Second Hill Group For More Information

26 Second Hill Group Payback vs ROI Appendix

27 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) Second Hill Group

28 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) Second Hill Group