Business Model Typology

According FinanCE Working Group’s report (2016), each Business Model Typology has its own characteristics about its financing and therefore should be reviewed as its own entity when discussing financing CE. Generally in the result data, different kinds of CEBMs have been discussed varyingly: the more comprehensive approach to review different kinds of CEBMs have been applied only in a few practitioner research papers (FinanCE Working Group 2016; Sustainable Finance Lab 2018), whereas Prod-uct-as-a-Service(PaaS)-type of Business Models and their characteristics have been mentioned from the viewpoint of finance as individual notions on several different occa-sions across the data set (CICAT2025 2020; Circle Economy and Sustainable Finance Lab 2016b; Finnish Government Strategic CE Initiative Theme Group 2020d, 2020c; ING Bank 2015; Japan/EU Joint Workshop G20 Resource Efficiency Dialogue 2019). Most of the content of this chapter is based on the aforementioned practitioner research re-ports, especially the FinanCE Working Group’s report (FinanCE Working Group 2016), since other mentions in the data are only brief and general notions.

In the mentioned practitioner research reports (FinanCE Working Group 2016;

Sustainable Finance Lab 2018), Business Model Typologies are categorized into three groups, Circular Innovation Models (CIM), Circular Use Models (CUM) and Circular Out-put Models (COM), according to the following definitions:

• Circular Innovation Models focus on the development (pre-use) phase of the products to optimize the circularity of them: for example, products’ durability, re-usability, recyclability and repairability can be improved, new materials can be sourced for the products and by-product, side streams and waste streams can be taken into use.

• Circular Use Models in turn focus on the use phase of the products: in them prod-ucts’ usage period is optimized for circularity by optimally using the product and maintaining its value. This in turn is done by retaining the ownership of the prod-uct and preserving its value during its lifetime by for example repairing it and delivering it for reuse when needed. For example, PaaS-Business Models are included in the Circular Use Models.

• Circular Output Models focus on the output and the value of the product in its after-use phase: the income of the company is generated through transforming products into materials or renewed products after their initial use period to add value, reduce costs and reduce waste. For example, recycling facilities can be included to operate in Circular Output Model.

This categorization is used also in this study: each Business Model Typology’s relevant characteristics and their effects on financing CE are reviewed separately in the following subchapters.

Circular Innovation Models

Generally, there was not a lot of insights about CIM in the result data: the only discussion of it was in the FinanCE Working Group’s research report (2016). The effect of the inno-vativeness of CE business in general, on the other hand, was mentioned on a couple of occasions and discussed in this study already in Chapter 4.1.2: Private, where it was concluded that innovativeness is considered risky by external financiers (Japan/EU Joint Workshop G20 Resource Efficiency Dialogue 2019).

In the FinanCE Working Group’s research report (2016), it is discussed that Circular Innovation Models come with significant technological, operational and business risks. Technological risk derives from the development and implementation of new tech-nologies, which have no performance track record and therefore can result in uncertain investment costs, high upfront implementation costs and other risks. Operational risk in turn derives from the possible variations in the feedstock: some processes are based on the specific inputs and might be compromised if the feedstock is altered significantly.

Business risk is presented to be a result of multiple factors:

1. Competition with existing materials and products

2. Uncertainty of input specifications and flexibility in operations

3. Uncertainty about product specifications, performance, customer acceptance and related regulations

4. Uncertainty about the residual value of new products

5. Risk of failing to develop cost-effective repair, reuse and remanufacture scheme.

(FinanCE Working Group 2016).

It is also brought up that there is a significant difference in the risks of CIM depending on whether the innovation is product innovation or process innovation: product innovations often require additional investments, such as market research, new production technol-ogies and marketing, whereas process innovations are considered as smaller projects containing investments regarding only the process, making them less risky than product innovations (FinanCE Working Group 2016).

Circular Use Models

In the data, Circular Use Models were in turn mentioned more often than the other Busi-ness Model Typologies: in the FinanCE Working Group’s research report (2016) they were discussed significantly more in detail compared to Circular Input or Circular Output models, and especially the effect of PSS models in the financing of CE companies were mentioned as significant in numerous other data sources (CICAT2025 2020; Circle Economy and Sustainable Finance Lab 2016b; Finnish Government Strategic CE Initiative Theme Group 2020d, 2020c; ING Bank 2015; Japan/EU Joint Workshop G20 Resource Efficiency Dialogue 2019) as well. According to the analysis, PSS models were presented as the most significant Circular Use Models from the viewpoint of finance: in the FinanCE Working Group report (2016) all of financial implications of Circular Use Models were derived from the usage of PSS models, and all the other sources referred to only PSS models when discussing the effect of certain Circular Use Model on financing a company. Therefore, in this chapter the factors related to Circular Use Models are simultaneously the factors related to PSS models. According to the data, the factors af-fecting financing especially PSS models are balance sheet implications and working cap-ital requirements, cash flow implications, legal considerations, value of assets, end-client credit risk and market risk (CICAT2025 2020; FinanCE Working Group 2016;

Sustainable Finance Lab 2018). Balance sheet implications and working capital require-ments, cash flow implications and legal considerations are discussed in the following subchapters. Value of assets, client-related risk and market-related have been discussed in Chapters 4.2.1: Valuation of Circular Business and Circular Business Models and 4.2.2: Profitability of Circular Business and Circular Business Models, so they are not reviewed again in this chapter.

Regarding the balance sheets of PSS companies, in the data it was seen that PSS mod-els result in larger and lower quality balance sheets and increased working capital

requirements, increasing the capital-related expenses of a company when compar-ing to e.g. traditional sales models. The long-term ownership of the assets to be leased to the customers leads to a substantially larger balance sheet, which often cannot be financed by the company itself and therefore requires a third party financier. Also, as the cost of capital is usually a certain percentage of the borrowed capital, a growing balance sheet (i.e. growing working capital requirements) means increased capital expenses.

Regarding the lower quality of the balance sheet, it is noted that the assets to be written in the balance sheets are principally in the possession of the clients: therefore, they are highly illiquid to be used as collaterals. The illiquidity of the assets in the balance sheet in turn usually leads to an increased proportional cost of capital. (CICAT2025 2020;

FinanCE Working Group 2016; Sustainable Finance Lab 2018).

Regarding the cash flow implications included in PSS models, in the data it was pre-sented that PSS models can have both positive and negative effects regarding cash flows. On the other hand, it puts pressure on the CE company’s financing regarding high upfront costs (i.e. negative cash flows) resulting from the acquisition of the assets and technology etc. investments at the initialization of the business. The positive cash flows to make up for them in turn divide to a long period of time and contain some uncertainty.

But, on the other hand, after the initialization phase PSS model binds clients better in customer relationships and results in more secure longer-term cash flows. (CICAT2025 2020; FinanCE Working Group 2016; Sustainable Finance Lab 2018). To overcome the issue of slowly occurring positive cash flows and increase overall financeability, cash flow optimization was presented as a powerful means to both assess and control the risk of the business model. For example shortening the overall payback period or charging higher fees on the early stages of the payback period are mentioned as effective ways to decrease the risk of a PSS model. (ING Bank 2015).

Regarding the legal considerations, in the data it was presented that PSS models in-volve lengthier relationship with the client with more transactions related to the client and the asset than the regular sales model, which in turn leads to a need of more sophisticated contracts and legal interpretation and therefore increased le-gal risks. Examples of these transactions might be different kinds of situations in which the asset would have to be repaired or replaced, i.e. in what situations the customer is responsible and in what situations the company. (FinanCE Working Group 2016). To overcome this problem, in the data it has been presented that 1) making the PSS contract as robust as possible (reflecting all the possible incurring situations and costs) and 2) communicating it effectively to the clients will decrease the legal risk of PSS models (Circle Economy and Sustainable Finance Lab 2016b).

Circular Output Models

In the data, Circular Output Models and the factors affecting financing CE related specif-ically to them did not receive a lot of attention. Like Circular Innovation Models, they were discussed only in the FinanCE Working Group’s research report (2016), and even in the said report there were not a lot of insights related to them. Anyhow, in the report it is discussed that Circular Output Models sometimes contain technological risk related to the implementation and development of e.g. recycling facility or other machinery to ex-tract materials from used products. Also, it is noted that there is a business risk related to the cost of extraction: for COM to be profitable, the costs of the extraction must be lower than the costs of using virgin materials. Other mentionable financing problems specific to COM have not been mentioned in the data: “Besides the fact that these busi-ness models are different as they source their input materials from used products, no specific financing problems have been found for this business model category.”

(FinanCE Working Group 2016).