Getting to the Green: Should a Profit-Maximizing Firm Buy Carbon Offsets or Invite Consumers to Buy Them?

Abstract

Many firms, such as American Airlines, Patagonia, Google, and Apple, have publicly stated their goal of becoming carbon neutral at some point in the future. These firms are pursuing multiple emissions reduction initiatives within their value chains, such as the use of renewable energy, zero-emissions vehicles, and low-carbon materials and supplies. But despite these efforts, some residual emissions cannot be further reduced, necessitating the purchase of carbon offsets, which increase firms’ costs. While environmentally conscious consumers may be willing to pay a higher price for a low-emissions product or service, a significant segment of climate change–disengaged consumers is not willing to do so, as demonstrated by multiple studies. In this article, we identify when it is optimal for a profit-maximizing firm to offer its consumers carbon-reduction offsets for purchase with the product, in addition to potentially purchasing offsets at the firm level. Through a stylized analytical model, we show that it is not optimal for firms to both buy offsets at the firm level and offer them to consumers for purchase at the same time. Rather, when the offset cost is low enough, the firm buys enough offsets to compensate for all of its emissions at the firm level, resulting in a higher overall product price; when the offset cost is in the middle range, the firm offers offsets to consumers for purchase at an offset price lower than offset cost, ensuring that green consumers buy offsets; and when the offset cost is high, offsets cannot be optimally used in any way. The thresholds depend on the green-segment size and disutility from emissions (at the consumer-consumption and firm levels), and on the product’s own carbon footprint. Providing offsets for purchase to consumers allows consumers to self-select into their preferred product/price bundle, thus providing the firm with a market-segmentation and price-discrimination mechanism that increases profits and reduces the firm’s carbon footprint.