McKinsey Global Institute

Taking the first steps toward net-zero emissions

The path to net-zero emissions is full of challenges. Leadership must understand the risks and commit to change now—or face an even thornier transition down the road.

Companies must answer a number of tough questions to meaningfully move toward net-zero emissions. On this episode of The McKinsey Podcast, McKinsey partner Mekala Krishnan speaks with executive editor Roberta Fusaro about how to manage a diverse set of risks and how best to capture opportunities. After, McKinsey senior partner Lareina Yee shares that sometimes asking for help is a must, even if you don’t want to, from our My Rookie Moment series. The following transcript is edited for clarity.

The McKinsey Podcast is cohosted by Roberta Fusaro and Lucia Rahilly.

 

Defining net zero

Roberta Fusaro: To ground our listeners, what does it mean “to get to net zero”?

Mekala Krishnan: What we mean by getting to net zero is reducing the buildup of greenhouse-gas emissions in the atmosphere. There are various kinds of greenhouse gases, everything from carbon dioxide to methane.

What climate science tells us is that the buildup of greenhouse gases in the atmosphere is associated with an increase in temperature of the planet. To date, what we see is that the Earth has warmed about 1.1 degrees Celsius relative to preindustrial times. And with that warming comes everything from increased severity of flooding to increased prevalence of things like heat waves—a whole range of physical changes to the environment around us.

The net-zero imperative commitments that we’ve seen across companies and countries is to prevent the buildup of these greenhouse-gas emissions that are resulting in the warming of the Earth.

Roberta Fusaro: In your experience, which companies in which sectors are thinking about net zero the most?

Mekala Krishnan: We have seen net-zero commitments on the part of companies across many different sectors. There are certainly parts of the economy that contribute directly to greenhouse-gas emissions—things like the power system and the mobility and transportation system. There’s a whole set of energy and land use systems, ranging from power to mobility to industry, that all contribute directly to emissions.

Let’s take transportation and mobility as an example. That system is essentially composed of an entire set of sectors, an entire set of companies, and an entire set of countries, as well as individuals and consumers participating in that system.

Transforming and reducing emissions of that mobility system will involve the participation of automotive manufacturers, upstream suppliers, and downstream consumers. The reason I give this example is to say that, as we think about the transformation to net zero and the economic shifts that would involve, it is really a whole-of-economy universal transformation.

It is really across sectors that we’re starting to see companies engage in this debate. This could mean thinking about their own direct emissions—what is often referred to as Scope 1 emissions—or the emissions in their products, the emissions in their supply chains, or the emissions in the electricity they buy and consume.

Net zero is more than decarbonization

Roberta Fusaro: The research says, “The transition will have universal, significant, and uneven effects across sectors, geographies, communities.” But at the same time, there’s the opportunity for growth depending on how companies approach it. I’d like to hear about some of those decision points. For instance, what are some of the questions that business leaders face in terms of strategy and growth?

Mekala Krishnan: Often, when people think about the net-zero transition, they start thinking about decarbonization actions. And that’s certainly the first and a very crucial part of the net-zero transition agenda.

Companies will need to think about how they can reduce their own direct emissions, their own Scope 1 emissions, and how they can reduce emissions in the electricity that they buy and consume, what are often called Scope 2 emissions.

And then [companies will need to think about] their own Scope 3 emissions, whether it’s automotive manufacturers thinking about the emissions of their products, or consumer goods companies that have long supply chains thinking about the supply chain’s emissions.

As you rightly pointed out, it is a much more holistic agenda than just decarbonization alone. Companies will also need to think about how they manage the risks that they may experience as the world transitions. So, for example, certain sectors that have high emissions may see lower demand for their products. They may see cost increases in certain areas. Accessing capital may become more challenging.

And we identify a whole set of opportunities in our research: entirely new markets that open up for low-emissions products under a net-zero world. So think markets for things like hydrogen, electric vehicles, solar power, and other forms of renewable-based power.

There’s also a whole set of opportunities as we think about the broader ecosystem that needs to be built around low-emissions products. These are things like markets for an entirely new set of raw materials and minerals that may be needed for the transition and entirely new supply chains that may need to be built up.

One of the things that we often say to companies is, “As you think about the net-zero transition, it’s certainly an important imperative to think about decarbonization actions, but it’s also about managing your risks and capturing opportunities.”

And [we also talk] a little bit about the buildup of physical risks: some amount of warming is almost guaranteed, regardless of what we do on decarbonization actions.

So along with thinking about the net-zero economy and the net-zero transition, companies will also need to think about the set of adaptation actions: things they need to do to manage the buildup of physical risks and the impact on their own business and operations as a result of that. It’s a much more holistic and broader agenda than decarbonization alone.

Asking the big questions

Roberta Fusaro: I think that’s a great distinction to make. Because when I hear folks talk about net zero and the transition, they are really focused on decarbonization without thinking about everything that cascades from that. What basic questions should leaders ask themselves as they venture toward net zero?

Mekala Krishnan: One of the ways we often talk about it is that the sustainability agenda actually needs to be the CEO’s agenda because of the breadth of business impacts that it has.

If I’m an organization that is navigating a net-zero transition, there are fundamental questions that it raises for me. Are there markets that I previously thought were attractive that are no longer attractive? Are there entirely new opportunities that are created as a result of the transition? What should my strategic posture be in a world where the pace of change, the nature of change, is still uncertain while we have a net-zero target, say by 2050 in many parts of the world? The exact pathway that’s going to take is still uncertain.

Roberta Fusaro: Earlier you mentioned risks. What should leadership be investigating around risks?

Mekala Krishnan: There’s a whole set of questions around risk management that [the transition to net zero] raises. How do I integrate both physical as well as transition risks into my approach and appetite for risk? It also raises a whole set of capital-planning and capital-allocation questions: Where do I raise capital? What is my cost of capital going to be, depending on the nature of my business?

Roberta Fusaro: What about operations?

Mekala Krishnan: There’s a whole set of questions [the transition to net zero] raises around operations. What should the nature of my operations look like? How do I most effectively decarbonize? Where does decarbonization raise costs? Where does it lower costs? Who are the suppliers that I do business with? One of the things that we highlight in the research is the breadth of business decisions that are changed as a result of a net-zero transition and moving to a net-zero world.

One of the things that we highlight in the research is the breadth of business decisions that are changed as a result of a net-zero transition and moving to a net-zero world.

Mekala Krishnan

Roberta Fusaro: I imagine leaders have to take a closer look at their talent and how to evolve it for a net-zero transition?

Mekala Krishnan: There’s an entire upskilling exercise that many organizations will need to undertake to navigate this transition successfully. Above and beyond that, when we then think about the implications for middle management and for upper management, I think these constituencies and companies in particular will need to upskill themselves to understand both the case for change and how their organizations are affected under a net-zero world so that they’re able to successfully navigate the organizations through the transformations that lie ahead.

Training talent for the net-zero transition

Roberta Fusaro: You mentioned upskilling is necessary to support net-zero transitions. What are some companies doing in that regard?

Mekala Krishnan: What we see organizations starting to think about is almost university curriculum: What is the 101, the 201, the 301 set of skills that employees need? 101 skills are every employee having some degree of proficiency around what the imperative to get to net zero looks like and what the net-zero transformation entails.

Then we start to also see organizations think about: Do I understand the levers at my disposal in my organization to reduce emissions? Do I understand the relative costs of different types of levers? Do I understand how to interact with my suppliers? There’s both a set of basic knowledge that almost everyone in an organization will need and a set of function-specific know-how that we’re also starting to see companies start to internalize across different functions.

Physical and transitional risks

Roberta Fusaro: How should business leaders be thinking about risk differently in the wake of the net-zero transition?

Mekala Krishnan: With a changing climate and the net-zero imperative, it is important to recognize that there’s a whole set of new risks that companies will need to face, whether they are the physical risks from a changing climate or transition risks, which are risks that ensue as the world undertakes a net-zero transformation—much in the same way as cybersecurity risk, which was not on the radar of companies ten, 15, 20 years ago, but now is on every company’s radar. We’re going to see that happen, and we’re already seeing it happen with both physical risks and with transition risks.

Now, hand in hand with that will be the need to build an entirely new set of capabilities, infrastructure, and data to be able to assess these risks on the one hand, and then take steps to manage them on the other.

As a result of that, we think it’s important for all companies to develop the ability to conduct these scenario-based modeling exercises that allow them to understand how their organizations will be affected.

And as they build these capabilities to do scenario-based modeling, they need to take a probabilistic view of potential outcomes, how they may vary across sectors, across geographies, and how they may differentially affect their own businesses.

Now there is also rising momentum as companies measure their risks, to not just measure them but to also disclose them. There are efforts such as the Task Force on Climate-Related Financial Disclosures, [which are] guidelines for how companies should think about both measuring and managing their risks and which encourage companies to disclose them.

This will allow for better capital planning and better investment decisions and will also allow companies to benchmark their performance, their actions relative to their peers. Therefore, the hope is that it will only improve [companies’] ability to manage these risks.

How to efficiently invest in net zero

Roberta Fusaro: As business leaders are also making the transition to net zero, how should they be thinking about capital allocation?

Mekala Krishnan: We use an external scenario from what is called the Network for Greening the Financial System. It’s a consortium of central banks that has created scenarios for the transition. We use that as an input to then quantify how much would be spent on physical assets going forward to 2050 to reach this net-zero [target].

What we’ve found today is that we’re spending about $5.7 trillion on these systems. But fast-forward to the transition, and we need to increase that spending from $5.7 trillion today to $9.2 trillion every year for the next 30 years.

There’s a substantial increase in spending, about $3.5 trillion, that would be needed to get us to net zero. Now, if we take another counterfactual, where we factor in things like the policies that have been already committed to today by governments; if we factor in things like income growth and population growth, which would contribute to increased spending, that $3.5 trillion reduces to $1 trillion.

There’s another aspect to it, which is what we call in the research “a reallocation of capital.” By that I mean today we’re spending about 70 percent of that $5.7 trillion on what I would call high-emissions assets.

For example, it’s the internal combustion engine–based car that you and I buy; it’s investments in fossil-based-power assets. If we are to get to net zero by 2050, 70 percent actually needs to go to low-emissions assets.

There’s not just a fundamental increase in capital that we need to undertake but also a reallocation of capital from high-emissions to low-emissions spending: things like electric vehicles [EVs] instead of internal combustion engine–based cars; or solar-based power instead of fossil-based power.

What our research also finds is that much of the spending that we need to undertake for the transition actually needs to happen not over 30 years but in the next ten years.

All of this has implications for when we think about how to deploy this capital effectively. It will mean that financial institutions have a crucial role to play in raising and deploying the capital that we need for the transition. But we also have to think about the role that entirely new financial products might play.

We’ve heard a lot of discussion about things such as voluntary carbon markets to raise some of the capital that is needed for the transition, new finance products that include instruments for negative emissions, special-purpose vehicles to allow us to ramp down high-emissions assets effectively, and things like green bonds. So there’s a whole range of innovations needed in financial products to allow us to send capital to the sectors and geographies where it’s most needed.

And we will certainly have a role for public finance. When we think about some of the types of investments we need, many of them are what would typically be considered “public infrastructure” investments: things like EV-charging infrastructure. Many of the technologies that we’ve talked about for the transition are still in relatively early stages and may need forms of guarantees to reduce their risks. And then, almost most important is the role for collaborative action between providers of capital and users of capital to allow for capital to flow effectively. So companies will need to work hand in hand with their investors to effectively communicate the decarbonization agenda that they are about to embark on and allow for investors to feel comfortable with the risk profile of their investments.

We’re starting to see some interesting models, where financial institutions are partnering with companies in the real economy to build an effective business case around certain types of decarbonization investments, and do that at a pilot scale before then scaling up across organizations.

Can companies go it alone?

Roberta Fusaro: Are there recommendations in the report about being part of a broader initiative? If you’re a single company, what do you need to do to collaborate in order for everyone to meet their net-zero goals?

Mekala Krishnan: Companies can think about collaborating with their suppliers. For example, if they need to transform their own operations through reduced emissions, this may involve changing the kinds of inputs they receive.

We’re also seeing really interesting efforts on the part of entire industry associations—companies across sectors coming together to identify net-zero initiatives.

It will involve establishing a set of best practices, for example around decarbonization. It will involve, in many instances, setting entirely new standards: What does “green steel” even mean? What does it mean, in a certain sector, to be “at net zero”? How do you effectively measure emissions? There are a lot of unanswered questions when it comes to how we actually measure and how we set standards. So industry groups coming together to do standard-setting is an important step.

The third kind of cross-industry—or cross-company collaboration within an industry—that is important is making investments in some of the technologies that we need for the transition. Especially in industries where some of the technological pathways are still uncertain, collaborations across industry to finance and fund R&D, as well as deploy capital, could become very interesting.

Roberta Fusaro: Are there key industry associations in this regard? Or does it run the gamut?

Mekala Krishnan: It varies across industries. Some industries tend to be more global in nature, others more local in nature. There are some examples in finance, for instance, where we’re starting to see collective commitments on the part of banks or investors to get to net zero.

We’re seeing commitments when it comes to the steel industry and collective platforms. We’re seeing this when it comes to hydrogen, where a group of companies have come together to think about a road map for hydrogen deployment. This is certainly an important direction to travel in.

Selling the story of net zero

Roberta Fusaro: How should business leaders talk about net zero with investors, employees, suppliers—any key stakeholders?

Mekala Krishnan: It’s important for companies to recognize that unlike other business decisions, the net-zero transition is one that will oftentimes require engagement with external stakeholders of a kind that is not typical. If we think about a company looking to reduce its emissions, they will need to collaborate with suppliers to reduce potentially upstream emissions, to change the nature of the inputs that they use. If they are looking to adjust their downstream emissions, they will need to make a clear case to their consumers for why a green product is a better product than a more traditional product. If they are to make the kinds of investments that we’ve been talking about in physical assets, they will need to engage with their investors.

Now, having said that, it’s very important for companies to recognize that this needs to be part of the CEO agenda, given the breadth of transformation that is needed and the range of functions that are affected as a result of the transition.

Second, as companies build this case for change, it’s important to recognize there are certain, what I call, “no regret actions,” and [it’s important] for companies to understand what those no-regret actions look like for themselves and communicate them effectively.

As an example, decarbonization actions that increase energy efficiency are no-regret actions. If there are actions everyone across the industry has committed to, a momentum in the industry, that may be a no-regret action for a certain company.

In other instances, companies will need to make decisions about what their strategic posture looks like. Do they seek to lead? Do they seek to follow? Do they seek to collaborate? These are very real strategic questions that companies are going to have to grapple with. And as they engage with the external world, they need to build a case for the type of strategic posture that they are taking.

CEOs’ first steps toward net zero

Roberta Fusaro: You mentioned the need for the CEO to own the agenda. What is the easy first step that any executive could take?

Mekala Krishnan: The first step really needs to be building that understanding of how a net-zero world will affect the organization. Armed with that knowledge, CEOs and boards need to plan for the future. That will involve building some of the capabilities to do scenario-based risk assessments and opportunity analyses that we talked about earlier.

But that first step is really building the understanding of how an organization is affected by the transition and by physical risks, as well as an understanding of the role that the organization can play in contributing to a net-zero world: What is the scale of its own emissions footprint? And how can reduction of that emissions footprint best contribute to this net-zero world?

Roberta Fusaro: You speak to the need for companies to understand this larger role that they play. That’s why we’re glad that you could join us on the podcast today, to help us figure this all out. Thank you for joining.

Mekala Krishnan: Great. Thanks for having me, Roberta.

Segment Two: My Rookie Moment with Lareina Yee

Lareina Yee: I was up really late one night in the office, and I had tons of PowerPoints around me, tons of Excel spreadsheets around me. The fluorescence of the computer was blaring in my face, and it was clear I wasn’t able to solve the problem. I just thought if I try harder, if I work harder, if I work a little later, I’ll figure this out.

I sat there way into the evening, almost torturing myself. It was as if I was back in grad school, trying to cram for exams or figure something out late at night. And I thought, “Gosh, this just can’t be so difficult. Why is it so hard?” At the end of the evening, I couldn’t figure it out. I went home feeling terrible about it and thought, “What am I going to do the next morning?”

I woke up the next morning. Obviously little fairies didn’t come and solve the problem for me. I walked to the office thinking, “I’m just going to have to go into the partner’s office and say I couldn’t figure it out.” A little of a tail-between-your-legs moment. So, I did, and I wasn’t feeling great.

I said, “I’m sorry, I haven’t been able to crack this.” And he sat down, pulled his chair over and said, “Let’s take a look at what you have.” And we walked page by page through it. And in that moment he did something so important, which is he realized that I was asking for help. And what I didn’t realize is that I needed help, and that the act of being vulnerable and saying you need help is actually when you start to crack the problem, so to speak, when you actually start to figure things out.

What I didn’t realize is that I needed help, and that the act of being vulnerable and saying you need help is actually when you start to crack the problem.

Lareina Yee

I had forgotten the cardinal rule of how we work, which is we work in teams, we work together. I really just needed to drop that student mindset that I had to pass the test. So, he sat down, we walked through the materials, and of course, through working together, we figured it out. Then the other thing he did was later that week, he brought me to the client and said, “Hey, we’re having a little trouble with figuring this out. What do you think?” He was vulnerable in front of the client.

And I thought, “Oh my gosh, aren’t we always supposed to be super buttoned up and have four-levels-deep answers?” And what he showed me was, no you don’t. In fact, that actually is a stronger way to go in many cases. So we talked to the client about it.

And of course, by the end of the week, we had cracked the problem, or at least the thing that we were trying to figure out, which I can hardly even remember because what I remember now is the emotion of being there by myself, trying to do something. And then the much better experience of saying, “Look, I need some help.” And then getting that help and working together with the clients and the team members at McKinsey to figure it out.

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