LEED's Certification

Judging the value of anything on the basis of its carbon-footprint or toxic byproducts as much as on its inherent utility may well help to re-define the provisioning of public goods. After all, businesses survive and prosper by meeting consumer needs and preferences. Traditional welfare economics, though, preaches that problems like global warming are the direct result of market failures that only government intervention can reverse. Yet, business may nonetheless play a major role provided that it convinces policymakers and consumers alike of its environmental bona fides. Industry self regulation in general and third-party accreditation schemes like the construction industry's LEED certification program in particular may well do exactly that.

Keywords Business Case; Eco-Efficiency; Industrial Organization Theory; Information Asymmetries; LEED; Product Differentiation; Public Goods; Return On Investment (ROI); Social Dividend; Theory of the Firm; Voluntary Self-Regulation

Economics > LEEDs Certification

Overview

The not-for-profit U.S. Green Building Council (USGBC) has devised a multidimensional rating system that judges the proposed Leadership in Energy and Environmental Design (LEED) which promotes construction that is environmentally responsible, profitable and, in the words of its mission-statement, creates healthy places to live and work. Its worthwhile goal aside, of interest to economists is the way the Council is going about this. LEED certification promotes the voluntary private-provisioning of public goods via non-enforceable industry self-regulation. Builders willfully submit the details of proposed projects to a third-party trade association which reviews the specs and publically vouches for the project's environmental bona fides. The award of a LEED certification first and foremost objectively evaluates the energy efficiency and eco-friendliness of a developer's latest project, elements that investors and tenants would otherwise have to take entirely on faith. The working definitions and standards of measurement applied benefit the industry, too, by technically 'raising the bar' participants aspire to and by increasing public awareness of and confidence in 'green' construction. Indeed, LEED certification may well become a widely accepted brand in itself, denoting environmental 'added value' to buyers. This, in turn, fosters a viable private-sector marketplace for green products.

A proposed building's design can be awarded, in ascending order, a LEED rating of certified, silver, gold, or platinum depending upon a composite score given to it based upon its overall energy efficiency, conservation of materials and resources during construction, indoor environmental quality afterwards, and preservation and safeguarding of fresh water supplies throughout ("Greening construction," 2003). The exact criteria reviewers may apply differ slightly depending on the proposed building's type. In fact, a particular project is eligible for one of six LEED certifications: New Construction and Major Renovations (LEED-NC), Existing Buildings (LEED-EB), Commercial Interiors (LEED-CI), Core and Shell (LEED-CS), Homes (LEED-H) and Neighborhood Development (LEED-ND). Reviewers thoroughly examine a proposed project's documentation (blueprints, site plans, materials-lists, etc.), evaluate these in light of established criteria and award points in a range of categories.

For example, the sustainability of the construction and post-construction site can earn an applicant for LEED-NC certification up to 14 points. A high score here rewards builders for their care in conserving the surrounding ecosystem during construction and restoring affected areas after. The planned building's energy efficiency and resulting lower carbon footprint, when finished, along with its other pollution control measures can receive a maximum score of 17 points. A full 15 points, meanwhile, will be awarded when builders reduce vapor-emitting volatile organic compounds in indoor paints, primers, sealants and pipe-joints to an absolute minimum. The use of recycled and environmentally friendly building materials on the one hand and landscaping on the other (to lower ambient temperatures) can earn a full 13 points, roof and groundwater collection systems to conserve water 5 points; and a project's innovative design another 5 points. A top composite score of 69 is thus achievable. To warrant a platinum LEED-NC certification, the highest available, a project's composite score must be 52 or greater; a score of between 39 and 51, alternatively, merits a gold certification. A silver certificate is granted to any building with a composite score of between 33 and 38 points. A building with a score of less than 33 but greater than 25, lastly, wins LEED-NC certification (Dolash, 2005).

Applications

A passing familiarity with welfare economics, industrial organization theory, the neoclassical theory of the firm and marketing strategy are all necessary perquisites to adequately explain why, in principle at least, LEED certification should work. That's because it's premised on the idea that non-enforceable, standards-based industry self-regulation can turn the voluntary provisioning of public goods into a profitable enterprise. It's a novel construct, and its concise summation here gives us an inkling of the breadth of ideas it draws upon. Ideas that answer two related questions central to the business case for LEED certification: Why do industries of their own volition impose rules on themselves and why, so far at least, have they not shown much inclination to go green for green's sake?

Industry Self Regulation

An industry regulates itself either to lessen a threat or to leverage an opportunity. By policing itself, an industry pre-empts potentially severer forms of government regulation; inspiring greater public confidence in its products in the process. The fiercest of rivals, meanwhile, will find common cause if their mutual interests are served either by enlarging an industry's revenue base or reducing its cost structure (Lewis, 2002). Naturally, individual firms want nothing more than to be left alone, to be free to compete in the marketplace as they see fit. Governments looking to stimulate economic growth are of like mind in this respect. Excessive regulation stifles innovation, increases the costs of doing business, and blunts a firm's long-term competitiveness.

Any government that becomes too lax in safeguarding the well-being of its citizenry loses legitimacy. Unfortunately, moral persuasion alone will never keep greed entirely at bay; given the opportunity, the truly unscrupulous among us will always exploit the gullible, rig market outcomes and otherwise seek an unfair advantage, usually at others' expense. When taken to extremes, governments can and do intervene directly in the marketplaces. Sometimes, in fact, they break up anti-competitive monopolies that set artificially high prices; at other times they require truth in advertising, safe food and drugs, or limits to the emission of pollutants. Not all regulations are inherently bad, then; by setting standards for safety, quality or fair practices, some actually benefit virtually everyone, even the firms directly affected. Regulation ensures that companies compete on a more level playing field and gives customers added confidence in the value of the goods and service they sell.

Given a choice, though, a firm would rather adhere to industry guidelines than government rules. The latter of course are enforceable by law; the former by the threat of suppliers and buyers withholding business from a non-compliant party. Legal actions are long, drawn-out affairs that divert management's attention and attorney fees, much less fines, are costly expenses. Not having the necessary raw and intermediate materials to make a product, much less, having the customers to buy it are far more immediate measures; provided of course, enough companies honor this unofficial embargo. Standards developed through consultation within an industry, moreover, reflect its priorities, concerns and problems better than regulations imposed from above by politicians and bureaucrats.

From an industry stand point, then, self-regulation is the better option theoretically, but its adoption in practice varies significantly from market to market. Industrial Organization Theory tells us this is to be expected; the way a market is structured effects virtually all its aspects: Price, product differentiation, entry and exit barriers, intra-industry collaboration and competition, etc. A market comprised of a number of small firms for instance finds adopting self-regulation more difficult than one comprised of fewer, larger firms compete. Research suggests it's also embraced more frequently by industries that otherwise face higher externally-imposed compliance-costs (Gupta & Lad, 1983). Apparently, having a trade association to facilitate the free flow of information and house the apparatus necessary to reach industry-wide consensus helps too.

Provisioning of Public Goods

As the term suggests, everyone uses public goods: They're the air we breathe, the water we drink and other things no private firm can afford to own or maintain. For the sake of the social dividend they pay, governments invest in their development and oversee their upkeep. If it were not for the 'free rider' problem, moreover, this arrangement would probably always work reasonably well. Unfortunately, sometimes many of us, companies and countries included, ask ourselves "why should I pay for a public resource that others will foot the bill for?" When too many opt out, the resource goes begging. Now, efforts to slow global warming belong in the category of public goods if for no other reason than the harm it will do if not addressed quickly. In the final analysis, moreover, naysayers, foot-draggers and free riders alike will either have to be forced or encouraged to 'get with the program' more for it to succeed. Traditional welfare economics says only government-intervention in the form of regulation and/or market based systems can ensure this. Only the hand of government, in effect, can brandish the stick of emissions quotas and carbon taxes and/or proffer the carrot of tax subsidies and sanctioned carbon-trading schemes. Markets created the problem, the logic goes, so why should anyone believe they can fix them on their own accord? More to the point, perhaps, how can a firm absorb the additional costs and still survive in a perfectly competitive market? (Reinhardt, 1999). Any firm electing to unilaterally provide public goods will be hard pressed indeed when others don't follow suit. For, it must pass along these provisioning costs to customers to stay in business. Firms that don't assume these costs can continue to charge existing prices, which are now lower than those of firms that do.

If it weren't for the fact that perfect competition hardly ever exists in real-world markets, the case for government provisioning of public goods would be unassailable. Very few though are actually made up of competitors of equal size, free to enter or exit the market at will, all of whom possess of the same amount and quality of information. Some markets are dominated by a few large firms; others far less so. Larger firms have market reach and thus can leverage economies of scale to lower costs and, so, compete successfully on price. Smaller firms do not and succeed or fail by selling specialized goods and services at a premium to fewer customers. But, no firm large or small can know everything about its customers or competitors. At any one moment, there will be gaps or information asymmetries that give a firm a competitive advantage. Information in this respect is no different than land, labor or capital; the convertible factors of production that the time-honored Theory of the Firm singles out as the source of all profits.

The Business Case for LEED Certification

The business case for LEED certification rests entirely on the perceived benefits builders, owners and tenants associate with it. That and, of course, consumers' willingness to pay a premium for products that improve something we all share: The environment. Until very recently, there was scant evidence to suggest much prospect for the latter. If the sudden uptick in demand for 'hybrid' cars is any indication, the public-at-large may well be beginning to change its mind. Much as, ironically, the World Business Council (populated by the likes of DuPont, Con Agra and Chevron) started to very tentatively ten years ago by publically subscribing to the notion of eco-efficiency (McDonough & Braungart, 1998). Eco-efficiency endorses the use of fewer resources and emitting less pollution, not more, in a firm's quest to remain competitive. Ten years ago, by comparison, the value in going 'green for green's sake' was largely moral. Climate change's existence was still open to considerable doubt and its possible long-term ramifications chiefly of concern to individuals, academics and non-governmental organizations.

Basically, the whole point to initiatives like LEED is that private-sector competition can improve the quality of public goods, meet the greater society's needs in the process and make a profit through market mechanisms. Builders with a LEED certificate for example, can pursue what marketers refer to as a premium pricing strategy. Customers looking to 'go green' should be willing in effect to pay more for proven expertise in what's still, after all, a collection of emerging technologies. Not doing so exposes them to a much higher risk of ending up on the wrong side of some potentially expensive information asymmetries. Now some may calculate that the cost savings are well worth the risk, others not. But costs are only one side of the equation; revenues count as much if not more. Accordingly, how LEED certification figures into the value proposition builders pitch to developers, and they in turn pitch to renters and buyers, matters a great deal.

The more favorable the cost-benefit analysis of owning or renting a LEED-certified facility look, essentially, the more attractive its appeal. High oil prices and the likelihood of carbon taxes on greenhouse emissions make going 'green' an increasingly attractive investment. Tax breaks and other incentives might defray some of the additional upfront costs involved as well. Once completed, a green building's lower operating costs should pay dividends for years to come. And that sways many a purchase-decision because what counts the most is Return-On-Investment (ROI), the discounted present value of future cash flows. The promise of greater net income over the long-term improves a building's initial valuation and its eventual worth on the resale market. When it comes to product positioning, 'softer' factors such as the health of occupants protected from indoor particulates, the built-in cushion against unexpected oil shocks and, now, the innate appeal of 'going green' as a social value count as well. LEED certification will be a success when and if people strongly associate said benefits in exactly the same manner as popular brand names connote value and inspire customer loyalty. The price-tag might be a higher order of magnitude, but the principle's the same: Building trust in the quality of one's products makes many a sale.

Viewpoints

For all it might do to further the environmental cause, the real value of LEED certification may ultimately lie in the precedent it and like programs establish. Overturning conventional thinking about how best to provision public goods, LEED posits that for-profit solutions coming from the private sector may, in certain circumstances, be as (if not more) efficient than government-imposed ones. It's a daring assumption, not least because it looks to harness the very same market forces many see as the source of our current woes. This last assessment is an oversimplification, though; it ignores the trend towards voluntary industry self-regulation over the past fifty years. More importantly, it fails to take sufficient stock of perhaps the most fundamental of all business principles: Firms sell what consumers want.

Increasingly, customers want to reverse global warming, improve the quality of our air and water and preserve and protect bio-diversity. Problems of enforcement, voluntary or otherwise, will begin to recede as soon as firms realize that they stand to profit more by heeding this growing consumer preference. Provided, naturally, a market of sufficient size and promise materializes. Business, understandably, cannot fully commit the enormous upfront investment required on faith alone. There must be tangible evidence of an emerging marketplace. For that to happen, though, consumers must first have confidence in the quality and reliability of the solutions on offer. Accreditation programs like LEED provide the necessary assurances. So in very real ways, a great deal hinges on the how widely-known and accepted such standards become. The day LEED certification becomes a respected brand, in effect, could well be a very auspicious day; it could be months, years, perhaps decades hence, but, hopefully, it will happen.

Terms & Concepts

Business Case: The logic behind the decision to invest in a new or ongoing operation arrived at after carefully weighing its costs and projected benefits. More loosely-speaking, an explanation of how a proposed venture will make money.

Eco-Efficient: A term coined by the World Business Council to denote the need for firms to use fewer resources and pollute less, as it adds value to its products.

LEED: Leadership in Energy and Environmental Design.

Industrial Organization Theory: The field of economics that studies how markets are structured and the effects this has on price, product differentiation, entry and exit, intra-industry collaboration and competition.

Information Asymmetries: Contrary to classical and neoclassical theory, perfect 'information' does not exist in real-world marketplaces; some buyers and sellers know more than others.

Product Differentiation: The basis of much of modern marketing. Here firms' stress some unique benefit in their product formulation and subsequent advertising that distinguishes it from competitors.' If the value proposition is unique enough, the firm can charge a premium price.

Public Goods: A term from welfare economics used to describe commonly shared commodities that no one can claim as private property; development and upkeep is paid for by the government.

Return On Investment (ROI): In finance, the discounted current value of future cash flows an investment will generate; in accounting, a ratio arrived at by subtracting dividends paid from a firm's net income and then dividing the difference by its total capital.

Social Dividend: An unconditional benefit; something everyone has a right to.

Theory of the Firm: How a firm uses the factors of production — land, labor, capital, etc. — to earn a profit. Also known as the Theory of Production.

Bibliography

Baker, G. (2006). Certification impacts private sector. Environmental Design & Construction, 9(6), s80-s82. Retrieved December 30, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=21640089&site=ehost-live

DeLisle, J., Grissom, T., & Högberg, L. (2013). Sustainable real estateAn empirical study of the behavioural response of developers and investors to the LEED rating system. Journal of Property Investment & Finance, 31(1), 10-40. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=85204451&site=ehost-live

Dermisi, S. (2013). Performance of downtown Chicago's office buildings before and after their LEED Existing Buildings' Certification. Real Estate Finance (Aspen Publishers Inc.), 29(5), 37-50. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=85706642&site=ehost-live

Dolash, S. (2005). Taking the LEED. Electrical Wholesaling, 86(3), 34-34. Retrieved December 30, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=16801698&site=ehost-live

Greening construction. (2003). Pollution Engineering, 35(10), 20-25. Retrieved December 30, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=11298985&site=ehost-live

Gupta, A., & Lad, L. (1983). Industry self-regulation: An economic, organizational, and political analysis. Academy of Management Review, 8(3), 416-425. Retrieved January 22, 2008, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=4284383&site=ehost-live

Haxton, B., Beckstead, G., Kabus, A., Shahriari, P., McLaughlin, P., Carmichael, C., et al. (2006). Strategy for analyzing the financial impacts of sustainable design options for LEED. Environmental Design & Construction, 9(11), 44-50. Retrieved December 30, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=23503296&site=ehost-live

Lewis, M. (2002). Explaining the need for LEED. Environmental Design & Construction, 5(4), S8. Retrieved December 30, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=7347361&site=ehost-live

McDonough, W. & Braungart, M. (1998). The next industrial revolution. Atlantic Monthly, 282(4), 82-91. Retrieved December 28, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=1135179&site=ehost-live

Reinhardt, F. (1999). Market failure and the environmental policies of firms: Economic rationales for beyond compliance behavior. Journal of Industrial Ecology, 3(1), 9-21. Retrieved December 28, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=5337504&site=ehost-live

Top 10 LEED states. (2013). Buildings, 107(3), 15. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=86230180&site=ehost-live

Suggested Reading

Brill, E. & Saulson, G. (2005). The paradox of green retail. Environmental Design & Construction, 8(6), s30-s35. Retrieved December 30, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=17666162&site=ehost-live

Gack, J. & Greene, J. (2003). A guide to cost-effective green design for public building owners. Environmental Design & Construction, 6(6), 62. Retrieved December 30, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=10889686&site=ehost-live

Lash, J. & Wellington, F. (2007). Competitive advantage on a warming planet. Harvard Business Review, 85(3), 94-102. Retrieved December 24, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=23926966&site=ehost-live

Packard, K. & Reinhardt, F. (2000). What every executive needs to know about global warming. Harvard Business Review, 78(4), 129-135. Retrieved December 24, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=3261450&site=ehost-live

Potoski, M. & Prakash, A. (2004). The regulation dilemma: Cooperation and conflict in environmental governance. Public Administration Review, 64(2), 152-163. Retrieved January 24, 2008, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=12564790&site=ehost-live

Streamlined LEED certification process goes online. (2006). Engineered Systems, 23(4), 77-78. Retrieved December 30, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=20538100&site=ehost-live

Yudelson, J. (2005). Marketing LEED. Environmental Design & Construction, 8(10), 94-95. Retrieved December 30, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=19983023&site=ehost-live