Hearing of the United States Senate Committee on Small Business

Small Business and Environmental Technologies:

The Challenges and Opportunities

June 14, 1999

Boston, MA

Thank you for the opportunity to participate in this hearing. The topic is an important one and you have assembled an excellent group of small business representatives to help you address it. I hope I can provide some useful context for your inquiry. The future of this industry should be of concern to all, considering the role it plays in meeting some of this Nation's key economic and social goals.

An Industry with A Record of Success

As you may know, the Technology Administration of the Department of Commerce recently published a profile of the U.S. environmental industry, looking at the structure of the industry, the forces shaping it and the challenges it faces. This was the first comprehensive look at this complex and important industry, and we were gratified by the positive response to our work. Let me share with you a few of the important findings of the report that are especially relevant here.

Looking back, the U.S. environmental industry has been an American success story. And it has played a vital role in our economy. In the past 25 years, the environmental industry has grown into a $181 billion industry that employs 1.3 million Americans. It is comprised of 30,000 companies in the private sector and generates $16 billion of revenues from exports, with a positive trade balance of $9 billion. Especially important for today's discussion, it appears that a majority of industry revenues are generated by firms with less than $100 million in annual sales. In fact, firms with less than $10 million in revenue appear to generate a very significant share of those total revenues.

The environmental industry's products and services have been used by every major U.S. industry. It has provided its customers the means to comply with the environmental regulations of the past 25 years. And, as a result, we have a cleaner, better environment.

An Industry in Transition

While successful in the past, today the environmental industry finds itself in a period of transition. The industry is at a critical crossroads--a time of great challenge and opportunity--for both the industry and those in government who care about the industry.

Where does the industry stand today? The industry is showing signs of maturing:

· Annual growth in the environmental industry has plummeted from 10-15 percent in the 1985-1990 period, to 1-5 percent between 1991 and 1996.

· Median profit margins that routinely exceeded 10 percent in the late 1980s are now in the 2-3 percent range.

· Venture capital investments in environmental technology companies have fallen steadily from more than $200 million in 1990 to less than $30 million in 1996.

· There is overcapacity in many segments of the industry (hazardous waste management, analytical services, consulting and engineering, and air pollution control equipment).

· With supply now exceeding demand, it's a buyers' market and prices are declining in real terms.

· The industry is in a period of consolidation. Many of the relatively few large environmental companies have accelerated their growth in the past few years through acquisition. Most segments are consolidating at the top, as large and mid-sized firms are merging.

Declining demand, declining prices and increased competition have all added up to declining financial performance for the industry. Viewed through the lens of Wall Street, during the period 1991-1996, the NASDAQ appreciated 22 percent annually and the Dow 16 percent annually. In contrast, the Environmental Business Journal Index of 240 environmental companies gained only 6 percent annually.

Our study identified a number of forces that are changing the environmental marketplace. Customers in both the private and public sectors are becoming increasingly sophisticated--moving away from traditional approaches to compliance and toward the integration of environmental concerns into broader business decisions. Overall customers are shifting from simple compliance to solutions that turn environmental costs into productive investments.

Equally important, the market for environmental products and services is increasingly a global one. In 1996 the global market was worth $452 billion, with $280 billion of that represented by overseas markets. And the global market is expected to total $600 billion by 2010. Yet, only 9 percent of the U.S. environmental industry's revenues are generated outside the United States. By comparison, Japan and Germany each exported more than 20% of industry revenues.

Much of the U.S. environmental industry is at a competitive disadvantage in overseas markets. Most of the industry's 30,000 private sector companies are small and these small firms have little capability or inclination to export, especially compared to their Western European and Japanese counterparts, many of which are subsidiaries of large parent corporations with deep pockets.

In the face of all these challenges in domestic and foreign markets, it is not clear how well the industry will respond. The industry cut its teeth on the "command and control" system of environmental regulation in our country. However, dependence on this system of regulation to create customer demand has narrowed the competitive strategies of the industry and channeled its products and services toward compliance objectives.

The industry leaders we spoke to believe that the pace of environmental improvement was being slowed by the "command and control" system. First, that system offers little incentive for technology innovations or investments that exceed acceptable performance under the environmental regulations. And it offers no reward for above average performance. Second, the system offers little encouragement to the linking of environmental and economic decisions--a key characteristic of emerging international demands. Instead, environmental compliance is regarded as a cost imposed by government.

The "command and control" system is also believed to discourage investment in the development of new technologies. The development of new technologies is a time-consuming process commonly expected to take at least 5-10 years to bring a new invention to market. It is a challenge to find capital for such a process since investors usually expect a return within 3-5 years. The environmental regulatory process stretches the time to market for environmental technologies even beyond the 5-10 year line, making it more difficult to find financial support for new technology development.

Moreover, single media, source-specific regulations force environmental decision-makers to focus on the trees rather than the forest. Each requirement covering each category of environmental release must be met in an independent process and on its own schedule. And each requirement is based on the performance of a technology that was commercially available when the rule was developed and promulgated. This type of regulatory approach crates disincentives for integrating environmental and economic decision-making and discourages innovation. It pushes managers to select end-of-pipe solutions to each separate problem.

The Future of the Industry

Industry leaders and many of their customers suggest that the industry is at a critical cross-roads in light of these changing domestic market needs, growing competition and rapid international market growth, which is generated by a qualitatively different regulatory approach than "command and control".

If the industry is to remain an essential and growing part of the U.S. economy, it must adapt to new market realities, and develop products and services that go beyond clean-up and compliance. Industry leaders believe they must emphasize both economic progress and environmental excellence in customers' operations, while continuing to help their customers make up for past negligence. In short, industry members must become resource managers as well as environmental mangers for their customers, more fully integrating their products and services with the core business interests of their clients.

The industry must also assume a more global posture. The industrializing world--the big emerging markets--have the potential to become the big emerging polluters or, hopefully, the big emerging customers for environmental products and services. Changing the export picture in the industry will require strong and effective cooperation between government and industry. Our own International Trade Administration is working with industry, directly and through the Environmental Trade Advisory Committee, to improve industry participation in foreign markets. ITA provides counseling to environmental companies, information concerning foreign market opportunities and support in carrying out domestic and foreign conferences and trade events. It has also created a new federal-state partnership, the States Environmental Exports Initiative, to strengthen the support available to exporters, especially small exporters.

Other changes are needed in the role of government. The government has played a significant role in shaping the domestic markets for environmental products and services. Can it shift its role to support the twin goals of growth and clean environment? Can it bring environmental regulation into greater harmony with economic goals?

Industry executives and many customers have identified three steps government must take: (1) reform of the regulatory mission of the EPA; (2) reform of government's own environmental management; and (3) revamped government support for technology development and diffusion.

With respect to regulatory reform, industry leaders suggest two guiding principles to ensure that polluting behavior will be penalized and excellence will be rewarded. First, maintain a regulatory baseline to define the "floor" for environmental progress. Second, rely on performance based policies (including market mechanisms) and information-based policies (like the Toxics Release Inventory) to reward environmental excellence and encourage integration of environmental and business decisions.

When government agencies are customers of the industry, industry leaders suggest they should procure performance, not hours and effort. Among their suggestions are the adoption of performance-based procurement and establishment of procurement cycles that are in sync with private sector investment cycles.

Third, industry leaders suggest that government reexamine its role in development and commercialization of environmentally beneficial technologies. They suggest that government restructure its R&D investments to facilitate private sector technology innovation, increase government-industry collaboration and seek technologies of sustainability.

This is a critical time for the environmental industry. As a country, we have made large gains in improving our environment, but much remains to be done. The "command and control" model is weakening as a driver in environmental markets and customers are demanding new, innovative solutions that focus on the environment and economics. Government and industry must work together to forge the win-win situation--merging economic and environmental considerations into policies that create real incentives for environmental excellence. This, in turn, will spur demand for innovative technology and services that will make our companies more competitive and help preserve our global environment for generations to come.

Thank you for giving me the opportunity to testify today. I hope this information helps the Committee in its analysis and I would, of course, be pleased to respond to any questions you may have.