20-Oct-14 11:00 PM CST

Two years ago, we decided to embed circular-economy thinking in our strategic vision and mission, both as a competitive necessity and with the conviction that companies solving the problem of resource constraints will have an advantage. We believe that customers will increasingly consider natural resources in their buying decisions and will give preference to companies that show responsible behavior—something we are already seeing. Designing products and services for a circular economy can also bring savings to a company. The first impression people always have is that it adds cost, but that’s not true. We find that it drives breakthrough thinking and can generate superior margins.

In our lighting business, for example, rapidly changing technology and the economic crisis made business and municipal customers reluctant to make big investments, because they felt uncertain. This led us to consider lighting as a service. After all, why do these customers buy light fixtures and luminaires? It’s not for the fixture but for the light itself.

For business customers, we therefore now sell lighting as a service: customers pay us only for the light, and we take care of the technology risk and the investment. In many cases, we also take the equipment back when it’s the right moment to recycle the materials or upgrade them for reuse.

A second place we are using circulareconomy principles is Philips Healthcare, where we establish leasing relationships with customers to take back equipment and upgrade it, then refurbish it and send it on to another customer. In the process, we might upgrade the first customer to a more state-of-the art technology, and in doing so we make both customers happy.

Meeting the external challenges

I don’t want to make this sound easy. In our health-care business, for example, a lot of customers initially thought: “A secondhand product? We don’t want it.” Of course, we are refurbishing it and guaranteeing it as new, but convincing customers is challenging and requires a major educational program. Similarly, for municipal-lighting customers, the thinking around the tendering process needs to change. These customers are used to looking at the initial purchase price, not the total cost of ownership and the ecological impact. Changing the ownership of the lights is also tricky, as it often gets into legislative issues with municipal governments. There are supply challenges in operating in this new way, as well. We need to get our products back. Streetlights are fairly simple because the lights don’t walk away, but consumer lamps are another story. Here we work with partners to organize for collection, but even then it’s very hard. Currently, in Europe we recover about 40 percent of our lamps, of which 85 percent are recycled for reuse.

Changing Minds at Philips

Above all, operating with circular-economy principles requires the people of Philips to challenge ourselves and to change. We can’t think in terms of designing products that we throw over the wall to customers. Instead we need to design products that are upgradable and maintainable and that can be mined for materials and components that can be reused. Our mindset needs to be 15 years out—not just “now”—and it requires us to think in an end-to-end way, involving our suppliers and sales force.

I’ll admit this was challenging at first. Even though we have a longstanding focus on sustainability—a natural stepping stone toward a circular economy—people still tested us when we initially stepped up our circular-economy work. They wanted to make sure this wasn’t “just words.” But after seeing the KPIs on the Philips “dashboard” and learning that if you were in the red you could expect a call from the CEO, people said OK. People become resourceful and inventive when you challenge them.

In our innovation process, we have a program we call Design for Excellence. It comes in a number of flavors, such as designing for recyclability, upgradability, and serviceability. As part of the effort, we set criteria for every product in order to challenge the business-unit managers. To reach the targets, the businesses need to meet criteria associated with the circular economy, and we continuously raise the targets. For example, in our Consumer Lifestyle group, where we make domestic appliances, we are asking for 10 percent recycled materials in our total portfolio by 2015, compared with a 2 percent target in 2012. Meeting goals like these often takes the form of multi-week workshops where we tear down the entire value proposition of a product to see what we might change and how. We involve our suppliers in this activity so that it becomes co-creative and so that we can learn to design our value chains better.

To help accelerate the transformation to circular principles, we created a center of expertise—a permanent internal group that helps with methodologies and programs. The center is networked through the entire organization, and every business unit has a flag bearer there. This is important because the circular economy needs to be intrinsic in our end-to-end value chain and embedded in all our processes, metrics, and structures. This is integral to our strategy.

Looking ahead

Even though we still have far to go, it’s rewarding to see how enthusiastic people can be when they learn what they can do from a circular-thinking point of view. That’s when you know you’ve reached the tipping point inside the company—when the enthusiasm and creativity are self-reinforcing—and I’m convinced that’s where we are headed.

Ultimately, we can do a lot on our own, but a circular economy on a worldwide scale will require a lot of players to change simultaneously, and that’s a bit of a chicken-and-egg problem. It would help tremendously if governments took the lead and changed their procurement policies so that a certain proportion of what they buy—be it 50 percent, 25 percent, or some other figure—represented products manufactured according to circulareconomy principles. We hope that we can play the role of catalyst and help to reach a much bigger tipping point by putting our weight on the entire value chain, as well as by educating customers and suppliers. We hope that by setting the right example, we can help encourage the right behavior. This is just the beginning.

– About the authors Frans van Houten is the CEO of Dutch-based Philips Corporation. This commentary is adapted from an interview with Thomas Fleming, a member of McKinsey Publishing who is based in the Chicago office, and Markus Zils, an alumnus of McKinsey’s Munich office.