Scopes 1 and 2 emissions tend to be top of mind for organizations looking to reduce their carbon footprints. These cover company-owned and -controlled resources and indirect emissions from energy generation. Yet taking a strategic approach to addressing Scope 3 emissions (indirect emissions that arise across the value chain) often represents the bigger challenge.
That said, growing regulatory and investor pressure makes addressing Scope 3 emissions increasingly urgent. For example, as part of the Sustainable Finance Disclosure Regulation (SFDR), fund managers in Europe are required to report Scope 3 emissions in their portfolios starting in 2023. Moreover, the Science Based Targets initiative (SBTi) provides companies seeking validation for their Scope 3 targets with near-term criteria. For example, Scope 3 emissions targets are required for companies whose emissions are 40 percent or more of the combined total for Scopes 1, 2, and 3 emissions.
Previous McKinsey research has focused on how companies are pursuing the dual mission of profitability and sustainability. In particular, we showed that building data transparency and tracking across the value chain are prerequisites to identifying Scope 3 carbon sources and developing concrete plans to reduce emissions. We also showed that decarbonization can be a value-creating opportunity for companies that “play offense,” such as by capturing green premiums or building new green businesses. In this article, we focus on how organizations in several industries can start capturing that value by reducing Scope 3 emissions.
Upstream and downstream Scope 3 emissions strategies
Lowering life cycle emissions requires not only new operational processes and technologies but also collaboration with customers, suppliers, and other stakeholders. Lower emissions can lead organizations to radically transform business strategies by rethinking commercial models, making portfolio moves, and building partnerships across the value chain, as well as sourcing new low-carbon inputs and changes to product specifications to reduce emissions during the use stage.
Of course, approaches will vary depending on the industry and business model, both of which ultimately determine whether the bulk of emissions sit upstream or downstream. For instance, downstream Scope 3 emissions are not as high of a priority in steel production as they are in the automotive industry. Across industries, however, we have identified six levers for reducing Scope 3 emissions that can help companies that are playing offense capture value pools (exhibit).
1. Supplier and customer selection
Tackling emissions in the selection and engagement of suppliers requires lowering input emissions or securing low-carbon supply. Dual-mission sourcing—buying a product that minimizes both cost and carbon footprint—is emerging as the new standard across procurement teams. In the automotive sector, Volvo Trucks is designing vehicles made from fossil-free steel in collaboration with a Swedish steel player, while other commercial-vehicle companies are investing in green steel made with hydrogen to secure future supply.
Downstream, organizations can seek to work collaboratively with customers to encourage emissions reductions during product processing and use. For example, heavy-equipment manufacturer Komatsu collaborated with its customers in planning, developing, testing, and deploying zero-emissions mining equipment.
2. Product specification and solutions
Leading automotive OEMs are increasingly implementing dual-mission design to value, a concept that aims to reduce both costs and product life cycle emissions.
Emission-reduction approaches typically focus on adapting products to reduce input emissions. Some companies are reducing virgin-resource demand while still meeting specifications or safety requirements by changing historical formulations and specifications, such as for material thickness and the use of raw-material substitutes and filler materials. Other companies are shifting production to enable the use of bio-based inputs.
By contrast, downstream approaches include developing or adapting products that enable reduced emissions when customers use them. To meet the high-quality input requirements of low-carbon steel processing, mining company BHP is working with steel manufacturer HBIS to research how iron ore can be optimally processed for use in direct-reduced-iron (DRI) processes, a technology with lower emissions than traditional blast furnaces. In addition, automotive producers are replacing metals with plastics to cut costs and reduce use-phase emissions due to “lightweighting,” or improving fuel efficiency by building vehicles with lighter components.
It’s also worth noting that some products with a carbon footprint, such as insulation materials, can have a positive effect on global emissions. This has led to the introduction of Scope 4 emissions, defined as the amount of emissions mitigated by a product’s use.
Targeted partnerships across the value chain, particularly those focused on developing and leveraging new technologies, can help create low-carbon product lines and processes, which can in turn drive decarbonization actions. For example, mining company Vale and steelmaker Boston Metal partnered to develop molten-oxide electrolysis (MOE) technology, which can enable lower-carbon steel production by converting fine powders directly into high-purity molten iron via electrolysis. Similarly, mining company Anglo American and thyssenkrupp Steel plan to collaborate to develop high-quality input stock for lower-carbon steel production. In the consumer goods space, specialty-chemical company Evonik teamed up with Unilever to develop and scale bio-based rhamnolipid surfactants for use in dishwasher detergent, which can help lower the carbon intensity of inputs.
4. End-of-life solutions
Recycling and circular solutions can help reduce both downstream and upstream emissions. Specifically, circularity can reduce end-of-life emissions downstream and potentially secure recycled raw materials, thereby reducing emissions upstream. Several chemical players are developing advanced recycling capabilities. And Danish energy company Ørsted created a circularity partnership with German steel producer Salzgitter to use recycled wind turbine scrap in steel-production processes.
5. Green portfolio strategies
Companies with significant downstream emissions can consider building on existing capabilities to move into new green business segments. This move can help create significant value in addition to lowering the overall carbon footprint of their portfolios, particularly from processing and product use. For example, Schneider Electric pivoted from providing hardware to concentrating on energy management solutions. And Neste pledged to make significant investments to shift its portfolio from oil to biofuels.
6. Value chain integration
Integration upstream within the value chain can increase control over input-related emissions, while integration downstream can help increase control of emissions during processing and use. For example, mining company LKAB made the move downstream to process iron using DRI. Value chain integration can also lead to a shift from Scope 3 emissions to Scopes 1 and 2 emissions.
Scope 3 decarbonization levers: Industry examples
There’s no one-size-fits-all approach to reducing Scope 3 emissions. The relative importance of various emission-reduction levers is highly dependent on the specific industry, its position in the value chain, and the business model. These factors determine where emissions sit, where the green value pools are, and, consequently, where Scope 3 decarbonization needs to be focused (table).
For automotive producers, most Scope 3 emissions occur during the use phase of a vehicle, which is currently being addressed by the shift toward electrification and the growth of green electricity. As electrification increases, the decarbonization focus shifts to securing a low-carbon supply of input materials, notably steel, aluminum, and batteries. Leading players in the automotive sector are actively striving to achieve full transparency of emissions throughout the value chain, with many OEMs expanding their in-house knowledge because standards are lacking and suppliers have limited knowledge about CO2. This increased transparency is required for automotive companies to define concrete actions to abate emissions through finding and securing alternative energy sources across the value chain, expanding the use of recycled material, and designing products with lower-emission materials.
For example, the most promising levers in rim production focus on using renewable energy to smelt aluminum and increasing the share of recycled aluminum. However, additional levers can focus on tier-one suppliers, such as reducing energy use during the painting process. Suppliers in Asia have shown that several of these levers, including shifting to a different aluminum supplier with lower emission levels, are achievable at the same or even lower cost while reducing emissions by more than 50 percent.
Scope 3 emissions for chemical players are generally split between upstream and downstream. That said, the primary focus is typically on sourcing low-carbon feedstock or increasing the share of recycled or biobased feedstock (the latter of which would likely require some technical adaptations). These efforts can be achieved by partnering with low-carbon or recycled- or bio-based-feedstock providers, as well as moving into recycling to offer end-of-life solutions and secure recycled feedstocks.
For mining companies, most Scope 3 emissions are downstream, resulting from the processing of mined materials. Actions to reduce these emissions thus involve working with downstream players to develop and adopt lower-emission processing technologies and ensuring that the company’s own products are appropriately specified. Within commodities for which there is room for collaboration, such as iron ore, there are many examples of technology adoption via partnerships. Value integration downstream and selection of customers already adopting lower-emission technology are also possible.
For building-materials producers, an important part of upstream Scope 3 emissions comes from the use of raw materials such as aluminum, cement, clay, copper, glass, gypsum, steel, and timber—both in the production of building products and in customer use of those products. Addressing these emissions will likely entail long-term partnerships with suppliers to codevelop and coinvest in decarbonizing current production and building new capacity. Furthermore, there are benefits in reviewing (historical) product specifications and requirements, such as the thickness of end products, the potential use of filler materials, and the use of alternative binder materials in the case of cement. Depending on the product, this can require the expertise of real estate developers, design and engineering firms, or contractors.
How to tackle Scope 3 emissions
Many companies struggle to develop strategies to reduce Scope 3 emissions as self-standing, internal initiatives that rely on existing capabilities. Succeeding in this task is not easy; it requires organizations to define clear strategies, develop detailed plans, embed specific organizational capabilities, build emission-tracking approaches and systems, develop certifications for products, and explore ways to secure funding and financing.
The journey to successfully tackling Scope 3 emissions typically happens in three stages: a baselining phase to define the starting point and set a North Star (how a company defines its purpose and products and works toward its goals); a bottom-up planning phase to develop granular initiatives to reach the North Star, identify the key enablers to be successful, and start putting the organization in place; and, finally, a long-term delivery phase in which initiatives are implemented, carbon reduction and improvements are tracked, green products are certified, and capabilities are built at scale.
Based on our market analysis, we have identified seven critical success factors that can help companies create Scope 3 emissions plans that suit their circumstances:
- Create an understanding of your starting point. Develop a granular emissions baseline to understand the key areas and drivers of Scope 3 emissions. This can help determine targeted actions to take, particularly those related to allocating investments and resources in the most efficient and effective ways possible.
- Define your North Star. Take a value-creating lens when setting the target. In other words, don’t just look at Scope 3 emissions from a risk management perspective: develop an understanding of the areas in which customers are willing to pay a premium for greener products.
- Set up cross-functional teams to integrate efforts across the organization. Many Scope 3 strategies require extensive collaboration across business units and functions, including procurement, supply chain, R&D, and sales. For example, developing a range of plastic products with renewable feedstock can require close collaboration with suppliers to procure the appropriate feedstock, adaptations to production processes, product design, and a product launch strategy. With these points in mind, a clear strategic vision driven from the top and underpinned by a value-creation rationale is crucial to keep efforts on track.
- Go beyond the organization and embrace partnerships across the value chain to decarbonize. Collaborative efforts across the value chain are required to create green product lines that could even sell at a premium. Companies can create transparency around how partnerships can help achieve a North Star, including mapping the benefits for each stakeholder before setting up the ecosystem and bringing together key stakeholders. Furthermore, many automotive players are reconsidering their roles in the value chain to increase control—for example, by partnering or even integrating vertically upward in the value chain.
- Collaborate with suppliers, peers, and customers to set data and tracking standards. Although there are typically no clear industry standards for data and tracking, collaboration can help companies track information flows. Instead of waiting for standards to take shape, companies can act today to help determine future standards.
- Launch a capability academy to upskill the entire organization at scale. Scope 3 emissions touch on the whole organization and entail a range of new capabilities. For example, executives will need to understand the challenges and opportunities, sales will need to sell green products and get the fact base right, procurement will need to incorporate carbon in the supplier selection and negotiation process, and R&D will need to embrace the principle of dual-mission design to value and challenge historical product formulations and specifications. Regarding these points, best-in-class players are setting up academies and designing tailored learning journeys to develop sustainability capabilities across the entire organization at scale.
- Provide incentives to reduce carbon across the value chain. An internal carbon price can help institutionalize CO2 as part of the decision-making process. Assigning a monetary value to Scope 3 emissions can help teams make informed business cases and trade-off choices. For example, procurement teams can compare raw materials with different carbon footprints, and R&D or product teams can develop new products with the potential to reduce downstream emissions. Furthermore, successful companies link variable pay to achieving specified Scope 3 milestones.
Reducing Scope 3 emissions requires organizations to tackle big challenges boldly, through the lens of value creation and with the involvement of the entire organization. The high value at stake and the complex challenges of achieving it warrant starting now. Getting Scope 3 emissions right can lead to transformative industry innovations and result in significant strides toward net-zero pathways.