Why restoring natural capital is good for business

By guest authors Jake Bryant, Caroline De Vit, and Joshua Katz, all from McKinsey Consultancy.

April 21, 2023

Investing in nature is vital to our collective future—and it can also lead to both environmental and financial returns. Here’s how.

From regular water shortages in California to a nitrogen crisis in the Netherlands, the deterioration of natural capital has had tangible consequences—and has given rise to a reckoning within business and government. In this episode of The McKinsey Podcast, McKinsey associate partner Caroline De Vit and partner Josh Katz talk with global editorial director Lucia Rahilly about a recently published special report on natural capital: what it is, why it matters, and how Fortune 500 companies are moving now to create opportunities and mitigate rising risks.

The McKinsey Podcast is cohosted by Roberta Fusaro and Lucia Rahilly.

This transcript has been edited for clarity and length.

What is natural capital?

Lucia Rahilly: There’s this thing called natural capital, and it’s the subject of a recently published McKinsey report. McKinsey partner Josh Katz helps us make sense of what it is.

Josh Katz: A scientist would tell you that it’s things like air, water, or soil: living organisms.

Lucia Rahilly: OK, that’s the “natural.” But what about the “capital”? Well, think of it like a balance sheet that reports a company’s assets and liabilities—planet Earth’s balance sheet. One of its liabilities is soil pollution.

What risks are CEOs facing?

Josh Katz: Fifty percent of our habitable land is dedicated to agriculture, and our plants that grow on that land are dependent on the soil. So, if we deplete the health of that soil, it’s like depleting our balance sheet or undermining the strength of our assets.

Caroline De Vit: It can potentially decrease land productivity by 12 percent and increase food prices by 30 percent over the next 20, 30 years.

Lucia Rahilly: That’s McKinsey associate partner Caroline De Vit, showing the societal impact of one kind of diminished natural capital. Beyond soil degradation, depletion of natural capital includes . . .

Josh Katz: We’ve seen species collapse or are at risk of certain species collapse, biodiversity loss, freshwater consumption, our levels of chemical and plastic pollution, nutrient pollution, and others.

Lucia Rahilly: Continued deterioration of natural capital, according to the report, “could trigger extreme changes to the planet, undermining the conditions on which society and the economy have come to rely. For instance, if rainfall patterns and temperatures change so much that existing agricultural lands become unproductive, or cities lose access to water, scientific research suggests the result could be mass migration and humanitarian disaster.”

This is The McKinsey Podcast, where we help you make sense of the world’s toughest business challenges. I’m your host for today, Lucia Rahilly. What’s at stake for the C-suite if they don’t take action now?

Caroline De Vit: First of all, the business license to operate, be it the social license or the regulatory license, is at risk here. The competitive advantage of that company may also be at risk if nothing is done to address nature. And finally, even the business of the company may be at risk of what we call physical or transition risks.

Lucia Rahilly: Take Europe, for example. Recently, the EU parliament discussed the possibility that companies demonstrate the products they export to the EU are not contributing to deforestation.

Caroline De Vit: Which is extremely complicated to do, because you have to look at the entire value chain. But that could be potentially a risk for business.

Lucia Rahilly: While not a business, the Netherlands exposed itself to risk—and had to take drastic steps to comply with European legislation—on the reduction of nitrogen. The excess nitrogen it created killed marine life and drove biodiversity declines, affecting insects and birds. Consequences are that licenses for nitrogen-emitting activities such as construction are harder to obtain, causing project delays. Speed limits on Dutch roads were reduced to help ease short-term emissions of nitrogen. And some areas in the Netherlands are considering reducing livestock numbers by 30 %.

These actions have triggered widespread protests. Sharp course corrections can come with large societal costs. Taking action proactively to preserve natural capital can prevent such shocks.

Taking action proactively to preserve natural capital can prevent such shocks.

What can be done?

Lucia Rahilly: And some companies are heeding the call.

Caroline De Vit: Working a lot with investors, I’ve seen over the past months and even the past year there is definitely an appetite and a view that by investing in nature, you could achieve both environmental and financial returns.

Josh Katz: The vast majority of Fortune 500 companies have recognized climate change in their disclosures or set near net-zero targets. Being early can present opportunities.

Lucia Rahilly: Opportunity like, if your company is the first to create projects that will generate . . .

Josh Katz: . . . what may become biodiversity credits someday, or if you’re very early in addressing the risks that are in your supply chain because of nature, I think that will prove a competitive advantage in the medium term, maybe even sooner.

Lucia Rahilly: Another competitive advantage is tech innovation. There’s lots of it happening in agriculture.

Josh Katz: We’ve seen even in the past few years the ability to more specifically apply nutrients and more specifically place seeds, and what we call precision, or smart, agriculture. Policy makers have recognized the power of that, too. So, doing that should enable us to have even greater yields, for example, with even fewer resources or different types of resources.

We’ve even seen that methane reduction from using direct-seeded rice versus flood-irrigated rice is significant. We have hundreds of millions of farmers around the world, many of whom don’t have access yet to some of these technologies but will as we get there. I think that’s very exciting.

Lucia Rahilly: Also exciting? Tackling the risk around plastic.

Caroline De Vit: Actually, 85 percent of the ocean waste today is coming from plastic.

Lucia Rahilly: And some companies are seizing the opportunity to mitigate that kind of waste.

Josh Katz: We’ve seen many actions like changing the packaging, reducing the quantity of plastic in the packaging, finding ways to increase recycling rates of the collection and recycling rates of the packaging.

Lucia Rahilly: Other promising actions have to do with shrinking food loss.

Caroline De Vit: Reducing food loss at the manufacturing stage and then food waste at the end of the value chain is a big, big lever here if you want to decrease natural-capital depletion. It could be done with improved inventory management practices and some advanced analytics.

Lucia Rahilly: What about the approach to test and learn? Is that appropriate in this context?

Josh Katz: I think we absolutely will have to test and learn. We are going to have to recognize that we don’t have the perfect solution, but that doesn’t mean we can sit and wait for the perfect solution.

Lucia Rahilly: Thanks so much for joining today.

Josh Katz: It was a pleasure. Thank you.

Caroline De Vit: Merci.