Is the circular economy the next disruptor?

For decades, households and companies have been recycling trash for the good of the environment. Now there's an added incentive: It's also good for the bottom line.

A new report by Morgan Stanley's Sustainability Equity Research team argues that new technology and increasing climate-based legislation around the world is creating new business opportunities based on the circular economy.

A circular economy uses products, materials, and resources for as long as possible, by refurbishing, sharing, leasing, or recycling. The goal is to extend the life of all of the "stuff" people accumulate, generating environmental and economic benefits along the way.

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A disruptive trend

Pioneering companies in a number of sectors are already shifting in that direction. "The advantages for companies are numerous and center on increasing the amount of value they create and retain," according to Jessica Alsford, lead author of the report "The Shift to a Circular Economy."

"The circular economy is unlikely to be a key fundamental value driver for many stocks at this stage," she adds, "but we do think that the move to a more circular economy will be a disruptive trend in the next few years. Those companies that move first to innovate and adapt should be well placed."

Environmental concerns helped spark this shift. The global economy, driven by the consumer frenzy to have the latest, fastest, best new model, now must contend with climate change, water scarcity, and damage to the physical environment. A "sharing economy" mentality has flourished, with people sharing car rides and renting out space in homes rather than paying for hotels. Legislation, particularly in Europe, but also in parts of Asia and certain states in the U.S., has also increased requirements to waste not, want not.

Companies that embrace these trends can find new revenue streams and cut costs. "Minimizing waste reduces cost and changes in product design can make refurbishment and remanufacturing more viable," says Alsford in the report.

Some are adopting entirely new business models which profit from extending the use of new products and then recycling the materials. This could give them a first-mover advantage over their competitors, especially if a more economizing consumer base continues to grow.

Expanding the customer base

Extending the life of existing products seems counterintuitive for businesses, but it does make sense, according to Alsford.

Remanufacturing and reselling products can save on the cost of raw materials, and can expand market reach to include consumers unable to afford the latest new models of electronics like cell phones or high-end products like LED lighting.

The potential revenue benefit of selling refurbished goods is prompting some companies to redesign new products, to make them easier to break down and remanufacture.

Expensive health-care machinery like MRIs are targets for remanufacturing, to cut both production costs and to expand revenues through resales of refurbished units. "Remanufacturing retains much of the material and value included in the original product," Alsford says. "This saves costs for the manufacturer with the potential for higher profit margins and returns on capital. It also potentially creates new customer opportunities by making expensive products more affordable."

New innovations and technologies support the move toward a circular economy. In textiles, chemical processes are being developed to separate blended fibers and recycle the raw materials into new clothes. In the batteries market, economical recycling of lithium batteries is key as demand for hybrid and electric vehicles accelerates.

Winners and losers

The rise in a circular economy has macro implications because it boils down to using less finite resources. Having access to refurbished products means more spending power for the individual, which could boost gross domestic product, according to a McKinsey study cited in the Morgan Stanley report. Importers of finite resources would also benefit.

The potential losers are the exporters of primary metals and other finite resources, says the report, and they tend to be developing, rather than developed countries. "The net effect would largely depend on a country's ability to embrace new business models to offset any decline from primary raw materials," says Alsford.

Morgan Stanley Research is writing a series of reports on the impact of the circular economy on market sectors. Contact your Morgan Stanley representative or Financial Advisor for the report "The Shift to a Circular Economy" March 15, 2017. Plus, more Ideas.