The potential role of firm capabilities in driving the circular economy transition: comparative structural equation modeling of manufacturing firms

As a measure to maintain competitiveness, various firms strive to implement the circular economy (CE) principles defined by the Ellen MacArthur Foundation: “1. Eliminating waste and pollution, 2. Circulating products and materials (at their highest value), and 3. Regenerating nature.” Manufacturing firms, in particular, have sought to transform into ambidextrous organizations through the development of both exploration (e.g., creating shared value (CSV) initiatives) and optimization (exploitation) capabilities (e.g., sustainable procurement practices). The objective of this paper is to examine the dynamic relationships among CE practices, environmental costs, and firm capabilities in the Japanese manufacturing industry. The novelty of this study lies in its two key contributions. First, it adopts a longitudinal/panel-data perspective to investigate the CE transition across manufacturing firms using lagged predictor variables. Second, it clarifies how their CE transition processes changed between two consecutive periods. A comparative structural equation modeling (SEM) analysis was conducted using panel data from over 300 listed firms observed during both the early period of COVID-19 disruption and the recovery period. This will help us understand how effective and resilient firm capabilities are in improving CE performance. One of the results suggests that departmental knowledge gained through a series of environmental projects may not have been fully reflected in corporate-level circular strategies. This research enhances our understanding of how firm capabilities mutually reinforce each other in advancing the CE principles while seeking to establish an organizational structure that reduces environmental costs.