Ranjay Gulati: As a Deep Purpose listener, you know that truly game-changing businesses have a vision for society. Few of today’s challenges require greater vision and purpose than climate change. Which is why I’m excited to share an episode of Climate Rising, the award-winning podcast from my Harvard Business School colleague Mike Toffel.

Mike is a Professor of Environmental Management at HBS. And in each episode of Climate Rising, he sits down with some of the world’s best and brightest business leaders to discuss what they’re companies are doing, and what more they should do to confront climate change.

I think Deep Purpose listeners really enjoy this insightful conversation with Daniel Pacthod, Senior Partner and global co-leader of McKinsey Sustainability. The interview dives into how the firm and its clients address climate risks, and discover opportunities all while employing best practices including green business building, decarbonization transformation, and sustainable investing. 

If you like what you hear, follow Climate Rising on Apple Podcasts, Spotify, or your favorite podcast app. With that said, enjoy the episode.

Mike Toffel: Daniel, thanks so much for joining us here in Climate Rising.

Daniel Pacthod: Thank you. It's a pleasure being with you.

Mike Toffel: Can you just tell us a little bit about your role at McKinsey and how you got there?

Daniel Pacthod: I've been at McKinsey now for 27 years. I'm based in New York. I'm a senior partner. I do a lot of my client work in technology, industrials, basic materials. We spend the majority of our time with clients, but I've also had the opportunity to build new things in the firm. And so I was in the middle of a lot of our efforts to build our data analytics solutions capability. We had created a unit called McKinsey New Ventures five, six years ago.

A year and a half ago, we did the same thing on sustainability. We have now built this client platform called McKinsey Sustainability and that's what I globally co-lead and have been doing a lot of my work globally. So I have a chance, also, to interact with leadership teams, with CEOs across industries and globally.

Mike Toffel: Most folks who have heard of McKinsey will think of it as a global strategy and management consulting firm focused on maybe corporate acquisitions, restructurings. How did McKinsey get into sustainability consulting and how did that evolve into a focus of some of your work on climate change?

Daniel Pacthod: So we are two years away from our 100th anniversary as a firm. More than 20 years ago, several of our colleagues got really passionate about climate and sustainability. That's the moment in 2007, a bit before, where we published the carbon abatement cost curves. I think this was a bit of a seminal moment, which is really to put the power and the analytics of McKinsey behind the biggest problem of the planet, which is climate and also put some real analytics around the carbon abatement curves and the cost of carbon and what it means in every industry sector.

Since then, we've been very active in publishing and doing research and,, having colleagues dedicated to sustainability. And then a year and a half ago, we, I think, like the world, like our clients realized that sustainability is really moving mainstream and that there were always a lot of executives and companies interested in climate and ESG. That became in the last two years, a top one or two CEO subject. We said, "We are actually going to now take the power of McKinsey, and we're going to treat this as perhaps our biggest innovation priority." We created a client platform. We called it McKinsey Sustainability. The idea was that we would create something that will be embedded in every part of McKinsey, really work with every of our industry teams and become the partner of choice of all companies and help companies and industry get to net-zero.

I think the other part of the aspiration was that we want to actually be the biggest force for decarbonization in the private sector. We realized if we, as a planet, want to get to net-zero, we have to tackle the hard to abate sectors. That's where the carbon is. So how do we get into these sectors, oil and gas, mining, materials, electricity, industrial, and how do we team up with the leaders and,, the sectors and help them accelerate their path to net-zero?

I have not, in my 26, 27 years at McKinsey, I've not seen something move at that speed and scale ever. I think we're really on this inflection point where the private sector really did wake up in the last two years. I've not met one CEO that doesn't have sustainability at his or her top one or two subjects.

I think one of the things we've also learned is, is there's both a defensive play here for any company, which is you got to meet your disclosures, you got to work on scope one and two, you got to work on scope three. But then there's also an offense part of this, which is you got to reinvent your company and create, if you want, the sustainable version of your company for tomorrow. I think that's been really where we spend a lot of our energy and mobilized our almost 3000 partners to really make that also one of their biggest priorities.

Mike Toffel: So your big impetus, your development of McKinsey Sustainability is in response, sounds like, to your clients putting this at the top of their agendas. And you're working with CEOs already, this is where they say is a priority and you're jumping in. What do you think changed that led your clients to all of a sudden put these things as one or two?

Daniel Pacthod: So for the record, I would say that when we did the carbon abatement curves in 2007, we had a nucleus of 30 people that already, at that time, felt that every CEO in every industry should move, and that group was clearly ahead of its time. I think what has changed massively in the last, I think year, year and a half, first is the obligation to make a commitment. I think when we looked at the data, I think roughly 70%, 80% of all companies, all countries have actually made a version of a commitment to net-zero and that was not the case before.

I think the second thing is the realization that there is a massive climate risk that is really hitting us. In 2020 with the McKinsey Global Institute, we published a pretty seminal report on climate risk. Our sense was to actually put a spotlight on the fact that if we don't act, forget if you are for or against climate, or you don't believe in the net-zero theories, et cetera, but if you were just an investor looking at assets, we actually had created this point of view that there's an enormous climate risk that needs to be addressed and depending on how you cut the numbers, but one of the things that was staggering is that if we don't change anything on the global warming and the greenhouse gasses, we will have a billion people in the next 10 years that would live in arenas or areas that are not livable.

I think 2020 was a bit the seminal moment where climate risk really got factored in. To some extent, the financial sector has been leading the real world economy. a lot of the banks got ahead of this.

These two or three factors combined have actually been the biggest unlock. we then realized that we might have had a nucleus of people that were excited about it 15, 20 years ago, but now was the time to put the full power of the firm behind this. We have our new managing partner, Bob Sternfels, and he has made this one of his top priorities. He's been in the role now for a year. He feels that this will be the foundation of almost the next 100 years of McKinsey and the first word in there is sustainable and this idea that we have to work with all our clients, all industry, to help on this transition which is complicated. It was complicated six months ago, it became a lot more complicated now with what happened in Ukraine and the energy crisis.

Mike Toffel: The way that I understand McKinsey's organizing its climate work is into five pillars, the strategy and portfolio realignment, growth, the decarbonization transformation, net-zero financial institutions, which you're just starting to speak about, sustainable investing, let's talk through a couple of these and get a sense of what does the work actually look like? So for example, in the strategy and sustainability, and in particular, if you could focus on climate, what's an example of a typical client engagement in that space?

Daniel Pacthod: A large global diversified industrial came to us and said, "I just made a 2050 commitment. I don't really have a path to get there." So what we ended up doing is developing a pretty detailed strategy that started with a baseline assessment of where they are in terms of their carbon footprint, and then build a path towards net-zero in terms of very specific actions they had to take, which would include looking at some assets and say these assets will never make it, so we'll just shut them down, looking at some assets where we say we have a real opportunity to decarbonize and then also, looking at arenas where you could actually build new businesses, new green businesses. And then in some cases also exploring potentially offsets, but the first three were perhaps the biggest levers. So we ended up almost painting a picture of what the full potential assessment is to get to net-zero and then after that strategy phase ended up partnering with that client to help the client actually achieve these results.

One interesting learning in that first pillar, which is the net-zero strategy, is the winners of tomorrow are the companies that not only are playing defense, which is they're saying, "Okay, I just made a commitment to 2050 net-zero, I need a plan," but are the companies that go way beyond that and say, "Okay, so what are the new businesses that I need to build?" If you are an aerospace company, you could look at this and say, "I should actually build some of these next-gen green materials that will be critical to make plants." If you are a consumer good company or consumer food company, you might say, "You know what, I should build the next generation of plant-based protein products."

I think you can take a version of this in every industry sector. What's been a fascinating learning is, especially in the last six to 12 months, is the gap between the companies that have their head in the sand and saying, "I'm going to just play defense here. I'll just do what I need to do to get to net-zero and please my investors." And the companies who're saying, "You know what, I'll do all that. But actually what I'm going to do is I'm going to reinvent my company and create massive amount of values around new businesses," the gap is actually widening. It is really fascinating to see that some CEOs view this as a fantastic moment to reinvent and to innovate, to build new capabilities Now, one of the areas that I think could change that is the technology and the innovation.

We got very excited about this and we created the McKinsey Platform for Climate Technology, MPCT. We decided, you know what, we are going to start hiring some of the best PhD in the world around some of these technologies that we think could actually change the trajectory. Some of these technologies are well known. Hydrogen, which has been around for a long time, carbon capture, direct air capture, NextGen batteries, et cetera, et cetera. All these technologies are in a big inflection point now and we actually think some of that will actually change the trajectory in some specific industries to get to net-zero.

Mike Toffel: So how are you deploying these PhD scientists or engineers in McKinsey?

Daniel Pacthod: So I give you an example. We have hired a large group of battery experts. Some of these auto companies have been around for 50, 100 years and 80% of their engineers are mechanical engineers. They produce combustion-based engines. They almost have to reinvent themselves and say, "Hey, we have an engineering population that might need to be 70% software engineers, not mechanical engineers and we have to industrialize where we produce, not an engine, but batteries. We are partnering up with a lot of the incumbent players, but also with the, investors to help them build new battery businesses. To do that, we actually brought in some very experienced colleagues, either PhD background or actually background having worked in other battery companies before that can actually map out a trajectory in how to do that.

To some extent, the name of the game now is you want to build these batteries to make them carbon neutral. So you have to look for places where you can actually build batteries to do that and think about what technologies you would use to do that. So that would be one example on this McKinsey platform for climate technology.

I give you another one. Part of this platform is also next generation materials, green steel. So if someone had asked me to personally invest in green steel four or five years ago, I'm not sure I would've done it. I've been around the industrial world for 25 years. I just thought that the cost curve would never work. What happens today is, especially the ones in Europe and Scandinavia, some of these green steel companies have their order books filled up for the next five years and if you look at it from a microeconomic perspective, the supply and demand curves have completely changed. We are at 20, 30% price premium on green steel. And why? Because some of the large customers and OEMs have mandated that they want a certain percentage of green steel in their cars. We can leverage our colleagues who've done steel work for the last 30 years, but we also bring in some of our best experts on hydrogen, on new smelting technologies, et cetera, et cetera.

Mike Toffel: Yeah. It's so interesting. The idea of green steel coming from demand, coming from automakers, who are only recently making these now somewhat profound commitments to EVs by X date and phasing out ICEs, as we're seeing in some regulatory arenas like California, and Europe's in discussions about all this. It's not like consumers can tell the difference between green steel and gray steel. It looks exactly the same, it may have the same performance. We're talking about how it's produced.

Daniel Pacthod: That's right.

Mike Toffel: This is so important to these companies are willing to pay a premium. What do you attribute that to?

Daniel Pacthod: I would say this is the big unlock or disruption that we just see happening and have seen happening in the last 12 to 18 months. I think it's a combination of, first of all, some of these OEMs have investors that are going to have extremely high level scrutiny under path to net-zero. I think the second thing that's happening is everybody's realizing wow, scope one and two is pretty basic. It's kind of in my four walls in one way or the other. Scope three is the complicated dribble. What we're also seeing is the decarbonization transformation. Part of our innovation is we've built a software solution, which we call Catalyst Zero.

The idea is to create a solution that does, the track and trace of carbon. And again, scope one and two easy scope, three very difficult. I think what's happening now is a lot of these industrials and the incumbents are getting lots of scrutiny from investors and also from employees and from customers to make sure that they actually can trace the carbon and that have a plan to reduce it.

Another reason that's been very interesting if you look at the consumer research, we actually think that for for specific green products, there is actually a price premium. So that's also another reason why if you're an OEM, you're starting to say over time, this will be a competitive advantage.

Mike Toffel: Right. Yeah, and the 20% to 30% green premium on our premium on steel is already a good example of that,

Daniel Pacthod: Yeah, it's a great example. And by the way, it's interesting because it changes. I think I was with our mining team last week and they're trying to think about green copper and the premium is very different there. I also think it's because the demand and supply is very different there as well. So I think there's a bit of a dynamic, but we'll see the same thing on green batteries.

Mike Toffel: Right. So it's going to be really down to the application and what the attributes are that customers value.

Daniel Pacthod: Yeah.

Mike Toffel: So another one of your client pillars is called growth. I imagine that might be, how do we figure out how to embed climate and sustainability thinking into a growth strategy of the firm? What does that look like?

Daniel Pacthod: We call it Green Business Building. I mean, to some extent, it's this idea of how do we actually help the company back to the discussion we had a bit earlier around being on the front foot and playing offense, build new businesses. So for an automotive player, we actually had a whole discussion around first, how do you actually build the new company? So basically, today you're based on combustion engine. If you were to rebuild a company based on electric vehicles or electric engines, what would that look like? We almost went into a mindset that says you got to handle and manage and resource these two businesses very separately. I'm a big fan now, more and more of almost run the new as if it were a separate company and then get off capital invest and build it.

So that effort of building the new company based on new green energy, or I would say electric engines, et cetera, that's been an effort that we've done in several automotive industrial situations. That is almost like the growth side of what you could do in sustainability.

I was hosting a panel with several CEOs and a tech CEO told me and said, "Daniel, think about this. We haven't even scratched the surface. We haven't even leveraged all the material science engineers on the planet. If we were to put that whole engineering group globally to work on some of these next 10 materials, I mean, we would come up with amazing things that we're not doing today. And I think that's a bit this growth mindset that is, I think, really important.

Mike Toffel: Interesting. How does McKinsey support all this work? You mentioned in the past, you had 30, 35 people. Now, it sounds like you have a lot more.

Daniel Pacthod: Yes.

Mike Toffel: You already talked about hiring those PhDs. I imagine you're doing other types of hiring as well. And then you must have big plans for internal training programs and development rotating people through. Can you tell us a bit about how that works organizationally?

Daniel Pacthod: When we started our firm, our mission statement, which by the way, is the same as today, was really twofold. One, it was to deliver enormous impact to our clients and help our clients perform better, achieve higher results, et cetera. And not only financial results, by the way. We talk a lot about holistic impact today, which is the financials are just one element of the impact. And then the second part of our mission is to develop, attract, retain amazing people. When we got started on the sustainability journey, I mean, we as a team set the aspiration that we wanted McKinsey to be the destination for the best sustainability talent in the world. Today we are at 2,500 people that in the firm are dedicated to sustainability. I mean the zero to 60 on this in the last 18 months has just been absolutely massive.

We also have learned not everything has to grow within McKinsey and that we need to really build alliances and acquisitions muscle. And sustainability became a great example. We acquired 18 months ago, Vivid Economics, a terrific firm based in London, which had amazing expertise and assets around climate technology, net-zero strategy, also overall climate analytics. Then months ago, quite another firm called Material Economics based in Scandinavia that built a very unique methodology around circularity and material transition. And so that are colleagues that we've welcomed to the sustainability group and to McKinsey and these integrations have gone extremely well. So for us, it's also the beginning of us continuing to add very specific expertise.

Then another way that we've also delivered this, we realize that we need to partner. So we have announced partnerships with large tech companies, especially around the track and trace of carbon, because we actually think this is something really important to do. We also have realized that for us to take the planet to net-zero, we can't have companies and industries work in silos. We have to work across. So we've also built a real ecosystem muscle and we also said for us to be able to get this work done, we need to start convening across industry sectors, at some events like COP27 coming up, but we also do this continuously during the year where we try to gather oil and gas executives with automotive executives, with material executives to really compare notes on what is possible, what is the art of the possible. Frankly, that has been also a big unlock to raise the aspiration of executives and leadership teams on what to do in sustainability.

Mike Toffel: So they're learning from each other, hearing their stories or challenges?

Daniel Pacthod: Absolutely. Again, the example I gave earlier, which is the future of automotive company will be much more of a software company than a mechanical engineering company. The automotive leaders learn a lot from the software companies. There's a bit of this lesson learned and connecting different industry sectors. Scope three is actually also a fantastic opportunity for players across the value chain to work together. we're starting to see a lot more collaboration there. I think it's just the beginning, but you could argue that if everybody solves their scope one and two across all industries, all companies then scope three by definition gets solved, but that is still not the way it's happening.

Mike Toffel: Far from it, right? So Frontier is an example of McKinsey partnering with a variety of mostly high tech companies on carbon removal. Can you tell us a little bit about that project?

Daniel Pacthod: We got very excited to join a pretty impressive group of companies, Stripe, Alphabet, Shopify, Meta. To some extent it was like a $900 million plus commitment, advanced commitment to carbon removal. I think what got us really excited is to be part of this ecosystem and also help raise the number, both the number of companies, but also the scale of the commitments on carbon removal. Frontier's running process now. They've opened up RFPs. People are starting to engage. I think it's been a very exciting thing to watch. For us it's also one way to participate, if you want, in the ecosystem around carbon removal, which we think we're just getting started on.

The thread that we also picked up is the importance of nature based capital and biodiversity. So we just launched a few weeks ago, a big initiative on nature-based capital and biodiversity because we actually think that to some extent, they will create a lot of the carbon offsets and this will actually have important roles for continents like Africa and also for Asia. So this idea of connecting the dots between demand and supply of carbon offsets will be very important. So that's an arena that we've invested in as well.

Mike Toffel: Carbon removal's super interesting area. Lots of people speak favorably compared to abatement where we're trying to pay people not to pollute. The idea here of taking carbon out of the atmosphere and sequestering it in oceans and soil and vegetation underground, super interesting space. Seems very uncertain where those cost curves are going to go and permanence seems like another problem. If we put it in the soils, will it stay in the soils? If we put it in trees, will it stay in the trees? Are those the types of issues that you're tackling with that group?

Daniel Pacthod: Absolutely. To some extent it also links very nicely to our McKinsey platform for climate technology. Direct air captures, for example, an area that I think we have now have a large group of experts and I'm a technology person at heart, but you are right. There's still a ton of uncertainty on how these new technologies will scale but I think it's super exciting. And I think direct air capture will be part of the solution. I think the other part is going to have to be for us to build this new green energy infrastructure, We see this whole question around carbon sequestration, carbon markets as being one of the next big unlock.

I think a portfolio of these technologies will really, will absolutely take off. One thing we didn't talk about is when we did the work on, what does it take to close the equation? I mean, we came up with roughly $3 to $5 trillion per year, over 30 years of capital that will be required to build the new energy infrastructure and industrial infrastructure, which by the way, the one we have today has been built over the last 100 years.

That is the biggest capital reallocation ever. A lot of this will have to go into these technologies. So it's very interesting because right now the bottleneck is not capital. I think the real question is the supply and the technology, scale and building the expertise and finding the talent to go after it.

Mike Toffel: Yeah. Super interesting. So let's pivot to talk a little bit about the McKinsey Global Institute, which has been around for a long time and produces really interesting reports about a wide range of topics, including climate change. How does the McKinsey Global Institute fit into the work that we've been discussing?

Daniel Pacthod: We're 22 or 23 years into its existence. I think in the early days, this was the idea to create a bit of a think tank. It very quickly migrated to a group of amazing colleagues that could pick almost macro to micro topics. We're not going to just do economic forecast, but we're going to go after specific arenas that, or there will be massive disruption, dislocation opportunities to create value, et cetera. Two years ago, we teamed up with MGI, McKinsey Global Institute on climate and we felt it was very important to have a bit of a macro-micro view and then also the industry by industry view. That led to this report we published on climate risk. Then recently we published this seminal piece, around how to close this net-zero equation and what will it take on the nine requirements to do it. We actually felt it was really important to put almost the economic rigor against that work. I encourage you to read the executive summary because it's done, I think, with that level of detailed analysis overall by industry sector and by country.

One of the themes that comes out of this is the transition, everybody knows the destination, but the transition will be difficult They're super complicated and I think we're almost in this mindset now where we have to extend the core fossil fuel-based businesses for a while because people need energy and at the same time we have to build the new. The most important word in that sentence is the end, which is we got to do both at the same time.

That's been also bit the wake up call for a lot of the incumbents to say anybody who thinks that the crisis in Ukraine and the broader global energy crisis, will slow down the trajectory, I don't think that's the case. But what it does, it forces people to really do the end.

Mike Toffel: Right. A wide range of issues here. So we've been talking about decarbonization and mitigation. What type of work does McKinsey do on the adaptation and resilience side, which I imagine might be with governments might be with firms? Can you give an example of a company in particular?

Daniel Pacthod: Well, first of all, I think there's been acute realization that mitigation alone will not cut it. We're going to do everything we just talked about, but at the same time, we've got to build real muscles around that adaptation ranging from industrial companies, looking at their industrial footprint and working with us and saying, " You know what, let me think about where climate is overall and what actions do I build in to make sure that my supply chain is resilient to climate shocks and how do I then mitigate what happens," which I think is important, but this notion of adapting to that.

We have a pretty vibrant ag practice and if I look at the adaptation work that's happening in the agriculture sector right now, both by the way for the equipment providers, but also for the end customers, it's pretty significant. By the way, technology and data is becoming really the name of the game there in terms of really understanding how to constantly adapt.

We've launched a year ago, a new real estate practice. And again, we've had colleagues doing real estate work for a long time, but I think we had a new impetus with a new group of colleagues. To some extent there's a massive need to adapt there too, especially when it comes to where do you locate buildings, how do you manage the energy requirements, et cetera, et cetera.

Then perhaps the most important thing is at country and government levels where, to some extent, Bob Sternfels' our global managing partner, has been very passionate about the theme around resilience as a muscle. That really applies to any country needs to have a climate adaptation strategy. We work with some states here in the US, some countries globally, to help them actually put actions in place to do that. We've already had a few heat waves this year. I was in London when we hit that all time high, I think it was 104 degrees Fahrenheit. You could see that the infrastructure was just not equipped to deal with this. Put aside even the penetration of air conditioning, but just the broader infrastructure. So if you're a country like the UK, you got to get going with building that adaptation capability. This is going to be an area wheremore collaboration, interestingly enough, more private partnership or private public collaboration required.

Mike Toffel: A ton of work that needs to be done and it sounds like McKinsey's really jumping in with both feet to engage in a whole wide array of these topics. It's really interesting. One of the final questions we like to ask our guests is for some advice for those listeners who are thinking about either pivoting their career or dedicating their career to a business and climate change interface, where do you see the biggest opportunities and what advice do you have for them?

Daniel Pacthod: So the first thing I'd say is this is our time, this is the time for my generation, the younger generation, for us, I think as a society to tackle this. What's very interesting is we don't have any more clients that call us and ask us, "Hey, can you explain to us why climate is important?" Which by the way was not the case two years ago. So we're in this world where everybody understands what we need to do. I feel like we're in the same moment as the beginning of the digital wave 20 years ago and talk about how that changed our lives, changed technology, changed value pools. So I think the opportunities for people to enter the space are wide ranging. It depends what you're excited about. if you have a bit of a knack for technology and technology innovation, I would really go in these climate technology innovation that frankly will change the net-zero equation. That happens in startups, it happens with incumbents as well. A lot of incumbents are starting to deploy real capital and talent against that.

If what gets you really excited is to work at the intersection of the private and public sector, I think this crisis and what we need to do is going to call for a whole new set of public-private partnerships. I think we're seeing it, interestingly enough, at the city level now where CEOs are gathered either at state level, city levels and they are around the table with the governor or with the mayor and they're saying, "Okay, so how do we reposition our city for the future? And what kind of collaboration, what kind of things could we do?" Which I think is going to be really critical.

Third is if you are much more in the investor world, boy, that's going to be exciting. You can look at, if you're a bank you want to really build a portfolio that will take to net-zero and you will want to make some really bold decision on capital reallocation. If you're a private equity firm or a capital investor, this is the time to place bets. We've seen a lot of private equity firms behaving a lot more like VCs right now in terms of going for being a bit forward leading on some of these new technologies.

And then I'd say another category is if your passion is to invest in people and capability building, we will have a massive amount of upskilling to do around sustainability. And so we, for example, built a digital platform called McKinsey Academy. We're running this with CEOs and boards and we're just scratching the surface. So it’ll be a fantastic opportunity too, to actually upscale leaders and leaders in companies and leaders in countries.

Mike Toffel: Great. Well, that's a really interesting list of opportunities, a set that I haven't heard expressed in that way before. So Daniel, it's been really interesting hearing what McKinsey is doing in its sustainability practice and its focus on climate change. Thank you so much for joining us on Climate Rising.

Daniel Pacthod: Thank you very much for having us and it was a great conversation.