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Great Potential for Green Innovation by SMEs in the Construction Sector

Lennard Duursema's picture

The role for small and medium-sized enterprises (SMEs) in the transitions towards the green economy is not to be underestimated, given that SMEs form 99% of European businesses and 66% of Europe’s labor force. The notion that small can be powerful has been emphasized too by McKinsey Global Institute (2007) as they concluded that the global residential sector (dwellings), which is responsible for 25 percent of global energy demand, has the largest potential to reduce CO2 emissions. Similarly, the Intergovernmental Panel on Climate Change (IPCC, 2007) concluded that the construction sector has the greatest and cheapest potential to reduce CO2 emissions through investments in energy efficient and low-emission dwellings and buildings.

The European Union has recognized the important role of the construction sector in meeting its 2020 climate and energy goals. This is reflected by the revision of the Energy Performance of Buildings Directive (EPBD) in 2010, requiring all new buildings to be nearly zero-energy buildings by 2020 (Ecofys, 2014). This entails that energy demand is minimized and that the remaining energy demand in new buildings is supplied with renewable energy. This type of building requires a radical change from current practice in the construction sector, which has been slow in adopting green innovations. In addition to a better energy (and climate) performance of new buildings, the construction sector can also play an important role in upgrading existing dwellings. Policy instruments to address existing dwellings have been formulated in EU member states, such as subsidies or labeling systems, but their effectiveness has been relatively low (APRAISE, 2014).

Overarching barrier: lack of demand in the market

This brings us to an interesting question of why, despite the economic and energy benefits or low-energy and climate-friendly investments in the residential sector, the adoption of green innovations in the construction sector has been rather slow. In order to answer this question, a research was performed among fifteen construction SMEs in the Netherlands, Germany and the United Kingdom. It concluded that the most important barrier to uptake of green innovations in the construction sector is lack of demand from owners or end users of dwellings.

This lack of demand is partly explained by the short-term focus of real estate developers and investors and their desire to maximize return on investment. Consequently, they look for the cheapest ways to adhere to governmental regulation and are not interested in green innovations beyond the standards set by regulation.

Another important reason, according the interviewed construction SMEs, is that private house owners experience problems in obtaining mortgages that fairly cover typically higher costs associated with green innovations. The SMEs also mentioned lack of willingness to pay for green innovations as they find the payback period for green innovations often too long. According to the SMEs, consumers only look at the first ten years of exploitation of a house, but many green innovations do not yet payoff in this period.

These findings also underline the issue that for construction companies there is often no real incentive to implement green solutions as the benefits of these (e.g. energy saving, improved living comfort) accrue to end users of the dwellings. With no direct benefit for the construction company, the introduction of green innovations in the construction sector therefore largely depends on the demand from the market. Therefore, policies encouraging green innovation in construction will need to focus on the consumer.

Part of the solution: tightened regulation along with financial benefits and assistance for consumers

The demand for green innovations could clearly be increased by tightening environmental regulations, forcing the market to demand higher environmental standards in order to comply to more ambitious standards. This, however, poses problems with the affordability of buildings for consumers, because tightened environmental regulations will drive up building costs. Precisely, this aspect is considered an important barrier for green innovation in construction. Tightening environmental regulations, therefore, also require policies that address the financial limitations for consumers. As an example, the German semi-governmental development bank KfW favoring sustainable loans, has proven effective in reducing these financial limitations for consumers.

Besides governmental support, consumers demand for greener dwellings could also be enabled by financial institutions adapting their mortgage calculations to the new emerging standards of dwellings. Initially higher construction costs can be partly offset by lower operating costs, and as a consequence consumers can spend more income on their monthly mortgage payments, justifying higher mortgages that cover green innovations.

Lastly, it is important to note that, although the lack of demand is clearly identified by construction SMEs as the overarching barrier, there are other barriers to green innovations in the construction sector, such as barriers concerning external financing, regulations and structures that actually hinder green innovations and uncertain return on investments, which may also differ between countries. Most of these barriers directly affect the demand for green innovation, but are not overcome by simply tightened regulation and financial benefits and assistance for consumers. The study recommends that, since a one-size-fits-all policy will be insufficient for overcoming all these barriers a more tailored policy is needed in order to account for these other barriers and the differences among countries.

This article is based on the master thesis by Jos Oosterom: Barriers to Green Innovation: Evidence from SMEs in the Residential Construction Sector