Paying for usage instead of ownership? Circular revolution, but complex
Thursday 9 July 2020
We sent a team of journalists and experts out to talk to Open Call project owners about their grant project. We used their findings for internal evaluation, the start of an external impact analysis, and an article series about the lessons learned. This article is the fourth in that series.
Circular Flanders’ Open Call supports experimental projects related to circular economy. We’ve launched the Open Call for the third time, and are supporting around 200 projects, the support totalling 16 million euro. The projects are diverse: from civilian initiatives, through business projects, all the way up to local government innovation projects. ‘Well that’s all very well,’ you might think, ‘but what’s the result?’ In order to answer that question, we let loose a team of journalists and experts to talk to project owners about their subsidized projects. We used their findings for an internal evaluation, the start of an external impact analysis, as well as a blog series about lessons learned. This is the fourth in this series.
Today many businesses operating within circular economy see the social and environmental advantages of product-service system (PSS) or as-a-service models. But to actually take that step requires the conquering of many obstacles, which many different test cases have shown us.
What are PSSs exactly? In product-service systems, users pay for a service, while the product remains the property of the manufacturer or retailer. This model is interesting for circular economy, as they stimulate products being designed in a more sustainable way, according to the principles of ecodesign. In linear business models, it’s tempting to generate profit by selling as many products as possible, whereas the PSS model encourages manufacturers to design products in such a way that they last for a long time, are easy to repair, and can be easily reused or recycled. The longer the producer can rent out their products without interventions, repairs, or replacements - which the producer would contractually be responsible for - the bigger the profits.
In a PSS, manufacturers, who have the highest knowledge and knowhow about their product, will increasingly be responsible for reuse, through which smarter cycles can be created.
Take the following example from the construction sector: ‘You can see a building as a collection of tokens, of components, which can be owned by many different people or organisations, and which each have a different cycle. If the stakeholders with the most knowledge of those materials are also the people who have those materials move in a circle, this can lead to an improved use of those materials,’ Jeroen Poppe explains. He, together with the VUB, rolled out the project ‘Circular Retrofit Lab’, in which they completely renovated old student housing in the middle of the campus with circular construction materials, according to the principles of disassembly.
"If the stakeholders with the most knowledge of those materials are also the people who have those materials move in a circle, this can lead to an improved use of those materials." - Jeroen Poppe, VUB
Stefan Goemaere, of ‘Samenlevingsopbouw’, launched a project together with manufacturer Bosch: Papillon, which rents out household appliances to families in energy poverty. Goemaere points out how PSSs stimulate environmental design: ‘Imagine something’s wrong with a series of appliances. Then, Bosch has to revisit twenty of those appliances to fix them, and if they have to do that twice or thrice over the course of ten years, that won’t turn them any profits. And if a part in a difficult to reach place keeps breaking, such as a part behind the filter of a washing machine, and if it takes half an hour to take out the filter, they’ll place that part that keeps breaking in a more accessible place when they’re redesigning the product, so that it becomes easier to replace. It’s also the case that if the appliances return after ten years, Bosch will want to reuse the materials, so all parts have to be easy to disassemble to serve as a basis for new appliances.’ In this way, as-a-service models encourage smart designs where the priority lies in ease of disassembly, and a long lifecycle.
Stefan Goemaere: "For people living in poverty, paying for use is simple. This concept sells itself, there’s no concerns about expensive appliances that might break."
For Stefan Goemaere, however, the motivation to experiment with the PSS model was first and foremost social: people with low income who need a new appliance will often choose cheap, energy-inefficient models, or they keep their old model for as long as they can. But because of the inefficiency in energy use, their utility bills will skyrocket. Without the initial cost of investment, you can - partly - break through that negative cycle of energy poverty from the first month of use. Stefan notes: ‘For people living in poverty, paying for use is simple. This concept sells itself, there’s no concerns about expensive appliances that might break. To most families who are customers of ours, I explained that there’s also a social loan formula, to buy the appliance. But people in poverty are afraid of unexpected expenses. If the appliance is paid off after three years, and after five years something breaks, having a technician come will often set you back 75 euro, and that’s without any replacement parts. Using a washing machine rather than owning it poses fewer problems: they can estimate the energy costs. There’s nothing unexpected.’
The project received a lot of attention during the ‘Radicale Vernieuwers’ 2019 competition, and it got Goemaere & co the ‘Standaard Klimaat’ award. According to the jury, Papillon combined climate regulations with the battle against inequality.
The social and environmental advantages of PSSs are impossible to argue against, but there’s another side to that coin: product-service systems bring along with them a myriad of legal and financial difficulties, which we don’t yet have a clear-cut solution for.
Legal and fiscal advantages
First of all, revenue is more spread out (regular smaller income from ‘rent’), and there is no peak shortly after production just like in regular sales. This requires a new kind of financial management and accounting. Steven Vanden Brande from the construction firm Durabrik says: ‘when a company invests in a heat pump, but the customer pays it off for a long time, the supplier’s financial statement doesn’t add up anymore because it’s spreading income over the next thirty or forty years.’ Stefan Wauters from plastic recycling firm Eco-Oh! agrees: ‘if an auditor would look at our statements [with the PSS model], our debt position would continue to increase. The more successful, the larger the debt.’
Another question: how do you legally set where the property of the supplier ends and that of the building owner starts? With PSSs in buildings, there’s a grey area that quickly becomes visible. Jeroen Poppe from the VUBclarifies: ‘The example of a lift is relatively straightforward: you have a notary make a deed which describes that everything in the shaft remains the property of the manufacturer. But to, for example, define that a concrete beam, completely cast into a structure, remains the property of another party; that’s much more difficult to describe legally.
Fiscally as well, product-service combinations are often a tough nut to crack. Jeroen Poppe: ‘When a company says, for example, “we’re not going to buy lamps anymore; but light,” then they won’t be able to declare that as an investment, but as a monthly fee. It’s no longer deductible in the ordinary way as an investment.’
Aside from that, there are - certainly in the experimental phase - difficulties for a businesses with an endless list of small, monthly (in the case of monthly rent) transactions to process correctly, instead of one-time larger transactions when a product is being purchased or sold. In this case, a third party, or go-between, will often have to come into the picture. Stefan Goemaere from Papillon notes: ‘The first idea was that clients would rent directly from Bosch; that was naive. Finding payments of seven euro a month in the books of a multinational firm definitely requires extra staff. At this point, we’re operating as a go-between. People pay us, and rent from us. Once a year, we transfer the total of the rental fees to Bosch. At this moment a go-between is necessary, but ultimately it’s not our organisation’s main purpose.’
Finally, there are some questions regarding intellectual property in product-service models, which are essential. In these new product-service models, questions may pop up after the fact which should have been committed to paper at the start of a collaboration. Stijn Devaere, director of textile competence centre Centexbel notes: ‘If you, together with the partners in the chain, need a patent for a technology in order to improve the environmental impact of your product, who will own this patent? Is it the person who’s applying it, or the whole chain? We saw this question arise in many different projects. [...] We concluded that if you unleash a regular business model on a circular project, you’re confronted with attentional questions that you have to discuss and agree on in advance.’
Several projects in the Open Call struggled with finding financial means. The uncertainties around PSSs are significant.
For many products, it’s hard to determine the residual value throughout time. But it goes beyond residual value, Stefan Goemaere at Papillon thinks: ‘What’s difficult, is that Bosch has to take the technicians’ wages in ten years into account, as well as transport costs etc. when calculating the rental fees. In ten years’ time, are their vehicles going to be gasoline powered or electric? Is there going to be more air travel, and if so, how much will that cost?’
This financial uncertainty causes delays. Intervention from a financial vehicle can offer a solution - for example a Special Purpose Vehicle (SPV). Steven Vanden Brande at Durabrik considered this, but also had some questions: ‘When an SPV would enter into the picture, who would want to invest? What type of return do we have to have? Those are huge mountains we have to cross before we can offer ‘as-a-service.’’
Some prefer a return model where a customer pays a type of deposit on top of the product, which they get back when they return the product to the manufacturer. Essentially, you assign value to the residual product. Stefan Wauters at Eco-Oh!: ‘If we hike up the cost from a sofa from for example 1.000 euro to 1.075 euro, in which that extra 75 euro is a guarantee that we can recycle this sofa in ten years, people do want to pay that. And you can let go of that entire matter of who has ownership, and who is responsible for care, cleaning, and repair and so on. A return model is recognisable today. The customer, as a manner of speaking, buys absolution.’
Financial service provider Econocom conducted practical research into financing circular as-a-service models, with Open Call support from Circular Flanders. Their research noticed similar obstacles, and staunchly defends the crucial role of a leasing firm to unravel the knots. With their expertise, they can play a role in facilitating PSSs in society. Involving a third party - a leasing firm - ensures that entrepreneurs don’t have to remain the owners. They also don’t have to enter in loan contracts or put in their own capital.
With their expertise, [leasing firms] can play a role in facilitating PSSs in society
In this way, it becomes feasible for circular entrepreneurs to offer PSSs and as-a-service models. This provides lasting customer relationships, on top of more reliable revenue, better support for the increasing demand for use instead of ownership, decreasing of financial obstacles, subcontracting management of your assets, and administrative relief.
Changing your mindset
What consumers want can also get in the way of product-service combinations. Today, people are used to fully controlling the products they use, using them whenever they need to and perhaps selling them after use. If a mentality shift towards product-service systems can spread out to all sectors, is yet to be seen. For businesses, traders, and governments also, the PSS model takes some time to get used to. On top of that, for governments everything has to go according to pre-set, strictly outlined procedures, which are currently based on purchasing products, not renting them. This will take time to change.
On the work floor, PSSs did break down the walls between different sectors; a horizontal approach in collaboration within a company proved to be useful. ‘Traditionally, the different departments within Bosch work separately from each other: marketing, after-sales, planning, and legal. In our case, these employees had to start working together at the bottom rung of the ladder, which changed the internal way of working. Then, they discovered that their entire IT system was aimed at sales, and not at renting, which meant that employees would carry paper around from desk to desk.’ Stefan Goemaere at Papillon shares.
Product-service models are aimed at products with decent longevity. For products that can last up to ten years - such as the household appliances in the Papillon project or the sofas at Eco-Oh! - testing this model takes as long as the product lasts. We still have a bit of time to wait before we get practical insights about PSSs complete cycles for these products.
Although the social and environmental potential of PSSs is staggering, the Open Call projects prove that the challenges are still profound. Pilot projects and innovators within each sector can offer us more insight.