Analysis of Scandinavian Airlines' Green Engine Decision

Craig Rouskey

Sustainable Business Practices

November 4, 2010

Summary

As the global demand for a green tourism industry grows, increasing numbers of airlines are

proactively altering internal policies to reflect their commitment to the environment. These

policy decisions are generated through the analysis of the financial cost-benefit, the

understanding of the regulatory setting, and through the desire to enhance corporate citizenship

and public image. Scandinavian Airlines, a Green Leader in the airline industry, has invested

corporate resources in technology and practices aimed at reducing their impact on the

environment. Here we analyze the decision of Scandinavian Airlines to procure green technology

allowing for the reduction of emissions and waste generated through their daily operations.
Introduction

As the desire of companies and governments to develop in a sustainable fashion

continues to grow, so does the debate over how to achieve this development. As a result, new

methods aimed at integrating the economy and environment have emerged. These new methods

incorporate market-based instruments to serve as supplements or as complete alternatives to

traditional approaches aimed at determining environmental standards through government

regulation. Both the traditional and market-based approaches are utilized in the airline industry.

Air travel is one of the fastest growing sectors in tourism carrying with it some of the

most significant environmental impacts (i.e. high levels of fuel consumption, noise, air pollution,

and waste production) (Penner et al., 2009). The number of tourists relying on air travel has

greatly increased over the past decade, as has the average length of each journey. Because of the

increased use of air travel, the demand on the environment has grown significantly.

Unfortunately, the increase in environmental demand is difficult to manage in a traditional,

regulatory fashion given the complex international setting in which many airlines operate.

Though the airline industry has been heavily regulated through traditional methods, there has

been an emergence of voluntary, market-based mechanisms seeking to encourage green

management practices in the airline industry (Lynes and Dredge, 2006).

This paper analyzes the decision making process and outcomes of Scandinavian Airlines'

(SAS) decision to improve its environmental management practices through the procurement of

green engine technology, thus better committing itself to environmental and economic

sustainability. In this analysis, we address the arguments for and against purchasing green

engines, the social-cultural environment surrounding the policy decision, and the external and

internal influences involved in the decision making process. We also address the benefits of
making such voluntary green policy decisions when the return on investment may only exist in

the long term.

Background

According to Lynes (2009), the decision to add or remove aircraft from a fleet is one of

the most important to be made within an airline due to the significant cost of replacement and the

long-term consequences associated with the choice of aircraft. In 1995, the senior management

team of SAS, led by Director of Aircraft and Engine Analysis Bengt-Olov Nas, were faced with

the decision to update the airlines' fleet. Nas had come up with an option for SAS to purchase a

“green” engine for its new fleet of 55 Boeing-737s. The two-stage dual annular combustor

(DAC) engine produced significantly lower NOx emissions and would represent a strong

commitment to the future environmental improvement of the airline. However, the engine

upgrade would add an extra US$388 thousand (kr3.5 million) to each aircraft (US$21.4 million,

kr12 billion total). Nas presented his idea with the notion that this purchase would have positive

financial payback for SAS as it minimized the risk of future, financial costs associated with

traditional regulations.

Based in Sweden, SAS is subject to regulation by the aviation agency “Luftfartsverket”

(Swedish Civil Aviation Administration, CAA). This agency has implemented a cap on NOx and

CO2 emissions stating that once levels of these compounds reach a certain level, the airport will

not allow an increase in traffic flow. As SAS's main hub is Stockholm's Arlanda Airport, this is a

significant factor affecting SAS's day-to-day operations. As the largest airline in Scandinavia at

the time, SAS desired to meet the rise of global travelers with service, and in order to do so, they

would have to alter their environmental approach to dealing with the cap on NOx and CO2
emissions.

Since the 1980s, the airline industry experienced a period of growth until the 1990s when

the industry began to deregulate. In mid-2001 the industry experienced an economic downturn as

a result of Terrorist Attacks and the SARS outbreak in Asia. The companies that were able to

maintain their market share during those times have been those that were able to adapt to those

challenges. The current turn toward sustainability coupled with governmental regulations

limiting in-flight and ground emissions could result in another period of turbulence for the airline

industry. It is therefore, in the long term, beneficial for a company to utilize resources efficiently,

and market a green image to maintain a footing in the highly competitive airline industry.

Internal and External Factors Influencing the Green Engine Decision

Drivers of environmental policy can be described along a continuum ranging from

internal to external drivers. Internal drivers are those that are company-specific and may not be

shared with similar businesses. For example, financing arrangements that determine

environmental policy are likely to be highly variable among companies in the airline industry.

External drivers are those over which the airline industry has very little control (i.e. regulations,

culture). Though the company has little to no control over external drivers, they are able to

influence the external drivers through associations and engagement with international agencies

(i.e. the International Air Transport Association) and other airlines (Lynes and Dredge, 2006).

But, the question remains: why participate in voluntary environmental initiatives?

According to Gilley et al. (2000), individual companies participate in environmental

initiatives to (i) reduce costs and increase efficiency by cutting resource use and waste

generation, (ii) gain a competitive advantage, (iii) enhance or reinforce a positive image in the
market place as a good corporate citizen, (iv) avoid or delay regulatory action, (v) comply with

pressures imposed by banks, insurers, clients and suppliers that do not wish to inherit

environmental liabilities, (vi) conform to pressures from community groups, environmental

organizations and community members, and to (vii) encourage employee pride and productivity

through enhancing corporate culture.

These factors provide an understanding of the drivers for environmental activity and can

be categorized based on four broad social subsystems as described in Table 1 (Renn, 2001). The

market system addresses the cost-benefit of participating in a voluntary environmental program.

Airline use is growing dramatically as is the increase is Revenue Passenger Kilometers (Figure

1) and with deregulation, many competitors have emerged providing low-cost services. With

these low-cost services, airline companies have lost revenue due to competition (Figure 2).

Many airlines, such as SAS, have met this challenge by offering their own low-cost services, and

developing a more efficient and competitive product. Also, other market factors (i.e. the rising

costs of jet fuel) influence air travel companies in their environmental policy-making (Figure 3).

The political-institutional system, manifests itself through large governmental agencies

that directly regulate the aviation industry. For example, the International Air Transportation

Association (IATA) observed that the largest environmental challenge to the industry is its rate

of gtowth (IATA, 2000). As mentioned earlier, the environmental impacts increase with the

increase use of air travel services since the available technology is not able to keep up with the

airline industry growth rate. The IATA and other regulating bodies, as a result of growing public

concern over noise and air emissions, have increasingly regulated the industry. Some standards

have been developed through a consensus-based approach (i.e. the International Civil Aviation

Organization), while others are decided on a more local level (i.e. Sweden has set its own
emission limits). No matter how they are decided, these regulations have a direct impact on the

cost of doing business for individual airlines.

The scientific system provides specific data on the impacts the airline industry has on the

environment. For example, the Intergovernmental Panel on Climate Change (IPCC) released a

report in 2007 detailing the historic and projected future CO2 emissions from air transportation

(Figure 4). The IPCC report is comprehensive for the aviation industry and includes data on

noise pollution, air emissions, accidents and climatic effects. The environmental impacts of

aviation are summarized in Table 2.

The social system highlights the importance of sharing knowledge and information in

motivating companies to make steps toward green policy-making. Though aviation companies

prefer voluntary initiatives, it is often unlikely that they will deliver results on their own

(Somerville, 1999). Somerville states that since environmental standards are unevenly

distributed, companies will always have the opportunity to avoid costs associated with improving

management of environmental issues. As a result of information sharing (i.e. the availability to

the public of data surrounding environmental issues), airlines have begun to enhance their

environmental policies.

The case of Scandinavian Airlines and the Green Engine Decision highlights how the

internal and external factors influence internal policy decision-making. Specifically, SAS was

presented with an option to “green their fleet.” The feasibility of the project was determined by

the internal financial structure and management of SAS. Both Nas and the CEO knew that the

environment had made its way up to a strategic level in the company. Utilizing the environment,

Nas was able to convince the senior management that the project was financially feasible.

Externally, factors such as fees associated with breaching emission caps, market turbulence, jet
fuel costs, etc. could be mitigated by this decision. By meeting the external factors head on and

designing a unique proposal that met the external pressure and placated internal nay-sayers, Nas

was able to convince senior management to purchase the DAC engine.

Arguments For and Against the Green Engine

In debating the purchase and utilization of DAC engines, SAS had to weigh several

factors that would directly impact their business. The DAC engines represented one of the many

options the company had for outfitting their new fleet. Arguments “For” the implementation of

Green Engines include (i) a reduction in fuel costs through increased fuel efficiency, (ii) a

minimization of risk associated with future operational limitations, (iii) an enhanced national and

international corporate image, (iv) increased productivity by employees who could take pride in

their corporate culture, (v) an enhanced ability to meet the rise in flight demand by an increasing

customer base, and (vi) a decrease in the likelihood of having regulatory action taken against

them for not complying with CO2 and NOx emission caps. The potential positive outcomes

detailed here can address any internal or external drivers that may cause senior management to

balk on the decision to purchase green engines.

As detailed earlier, costs associated with the procurement of jet fuel have risen sharply

over the past two decades (Figure 3). These costs have the potential to be greatly reduced with

the use of DAC engines. By reducing fuel costs, money can be recovered from the initially high

green engine implementation costs. Also, the potential, future operational limitations manifested

through financial constraints and probable regulatory action can be ameliorated by implementing

the DAC engines. For example, by offsetting the cost of DAC engines with fuel costs and a

viable, green public image that increases the customer base, SAS secures their place in the
market. Furthermore, the implementation of the DAC engines allows SAS to run more flights

before hitting the CAA CO2 and NOx emission caps, thereby increasing their service abilities.

Also, in an atmosphere of extreme price competition and by offsetting initial DAC costs, SAS

has the ability to maintain or reduce current pricing for service. These effects can compound to

generate sustainable profits for the airline while helping them maintain their competitive edge.

Another benefit of the airline implementing DAC engines is derived from the secondary,

social effects. Increasing productivity of employees by creating a corporate culture of which

employees can be proud, has the ability to impact financial losses associated with a lack of

productivity. Furthermore, given that Sweden is a nation that takes great responsibility for the

environment, by implementing DAC engines, citizens of Sweden will take pride in their national

airline, and possibly begin to prefer their services over those of competitors that offer cheaper

flights but with harmful environmental impacts. Though the Green Image of SAS is important to

the long-term sustainability of the company, it remains difficult to quantify. This is best achieved

through the potential increase in national business and customer base.

Though the positive outcomes detailed above seem convincing, there are still potentially

negative outcomes that must be addressed in the green engine decision-making process. The

prominent reason for voting against DAC engines is the cost associated with the initial DAC

engine procurement. The cost added to each Boeing-737 is initially shocking, however, in the

light of positive outcomes and offsets, the cost can be justified. Also, if SAS decided against

implementing the DAC engines based on cost, they could potentially lose their green image. In

the early 1990s, SAS established itself as a leader in environmental commitment. They

developed an environmental policy stating that they were committed to using the best available

environmental technology. If they failed to live up to their commitment, their work on branding
their airline as environmentally responsible would be significantly negated.

The Green Engine Decision Payback

As mentioned earlier, the ability for a company such as SAS to make decisions that do

not have immediate- or medium-term payback is determined by both internal and external

factors. Scandinavian Airline had access to the capital needed (internal driver), environmentally-

oriented management (internal driver), and the social and regulatory drive (external drivers) to

implement the DAC engine program. Without these factors coming together, the decision to

implement the DAC engines would not have been positive. Though the decision would not see

benefits within the short- or medium-term, it was wise for SAS to utilize green technology. The

benefits to the corporate image, establishment of a competitive advantage through anticipation of

social and regulatory requirements, and the establishment of eco-efficiencies in the form of water

and fuel saving make this decision positive in the long term.
 System Components
Social Discussion, knowledge sharing, resource building
Scientific Scientific knowledge and expertise of cause and consequence
Political-institutional Political culture, government, and regulatory setting
Market Cost-benefit analysis and marketability
Table 1. The external systems influencing corporate environmental policy commitments (Renn,
2001).

Environmental Issue Summary of Impact Factors affecting

management
Air Emissions Carbon dioxide, Carbon Airline's choice of aircraft,
Air transport accounts for 3% monoxide, Hydrocarbons, International standards,
of global CO2 emissions, and Nitrogen oxides, Sulphur Individual country-imposed
12% of transportation CO2 oxides, contrails taxes and emissions-related
emissions charges, Emissions of flights
do not fall under Kyoto
protocol
Noise Emissions Prominent under landing and Airline's choice of aircraft,
Exacerbated by the increased take off, affects residents and International standards,
residential development near wildlife landing charges for noise
airports and under flight paths emissions
Congestion Increased fuel use and Regional/National
Up to 10% of aircraft fuel use emissions caused by circling governments and their NGOs
could be reduced through more busy airports and taxiing develop more effective air
efficient traffic management traffic management systems,
partly caused by national
airspace rules that sometimes
prevent using most direct
routes
Waste Solid waste from inflight Local rules developed by each
Solid and hazardous wastes services and aircraft grooming, municipality or airport
waste generated from airline authority for waste
administration offices, disposal/treatment of tarmac
Hazardous was from aircraft run-off
maintenance and de-icing of
aircraft
Table 2. The environmental impacts generated by airlines. Adapted from Somerville (1999) and
Lynes and Dredge (2006).
Figure 1. Growth index of World Passenger Traffic (RPK) from 1970 to 2007. RPK (revenue
passenger kilometers) assess the distance traveled by aircraft around the world. As the number of
kilometers increases, so do the number of passengers. The airline industry must be able to meet
the continuing rise in global air travel demand in the presence of increasing regulations aimed at
reducing the environmental impacts derived my air travel. Scandinavian airlines, by
implementing DAC engines, is able to increase the number of flights, and thus passengers, by
reducing CO2 and NOx emissions associated with traditional combustor engines.

Figure 2. The percent changes in Net Profit Margins of World Scheduled Airlines. As a result of
deregulation, competition in the aviation industry has increased leading to the loss of revenues
for airlines. It is important to not that the airline industry is highly turbulent and succumbs to
many social setbacks. Scandinavian airlines, by enhancing their green fleet, reducing operational
costs over the long-term, and by increasing internal productivity, is able to circumvent any
turbulence due to environmental regulation.
Figure 3. The average international jet fuel costs per gallon. As the global costs for jet fuel
increase so do the operational costs of Scandinavian Airlines. By reducing fuel waste and
increasing fuel efficiency, SAS is able to offset the initial cost of DAC implementation and
restore earnings in the long-term.

Figure 4. The historical and projected CO2 emission generated through transportation (in
Gigatons of CO2). With the projected increase in CO2 emissions generated by air travel, it is
expected that the future of air travel will be increasingly regulated. To anticipate the effects of
regulation on operations, Scandinavian Airlines implemented DAC engines that will bring fuel
emissions to level below nationally-imposed CO2 caps/flight. (Source: IPCC Fourth Assessment
Report, Working Group III, page 36).
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