Dynamic market spells more consolidation for ESG reporting software

Dive into the trends shaping ESG reporting software industry consolidation and understand the implications for future business strategy.

In brief

• Up until now, the vendor landscape for environmental, social and governance (ESG) reporting and management software has consisted of small but growing vendors and larger entrants from adjacent spaces.
  
• That reality is changing as acquirers become more nuanced and consolidation looks to play out in three major waves that industry participants must lean in to understand — now. 

Despite the relative early stage of the market, software that supports environmental, social and governance (ESG) reporting and management has attracted a considerable amount of merger and acquisition (M&A) interest over the last 18 months. From where we stand, consolidation is only likely to continue over the next few years. Stakeholders across this space must understand exactly what that consolidation means if they’re going to make the most of this opportunity-rich environment.

Why is ESG reporting software seeing so much consolidation?

The market is growing, the space is digitizing and, in many cases, consultancies are transforming into SaaS platforms to capitalize on emerging opportunities. Over the last 18 months, the EY organization has acted as the sell-side advisor for 3 of 10 marquee transactions in this space and spoken to hundreds of companies and investors looking to acquire these solutions.

Three main forces are driving consolidation now:

Enormous tailwinds from global regulation are creating mandatory disclosure requirements around ESG. Reporting regulations of this scale and immediacy are reminiscent of the Sarbanes-Oxley Act (SOX) in 2002 and the more recent Global Data Protection Regulation (GDPR). Solution providers are seeing increased demand and higher contract values for mission-critical offerings — all of which is attracting interest from investors and strategic acquirers.
Complex ESG reporting is creating fragmented groups of specialists and point solutions. Meanwhile, very large strategic companies serving adjacent spaces with software solutions — think governance, risk and compliance (GRC) or environmental, health, safety and quality (EHSQ) — are looking to seize this market opportunity by converging into single-platform solutions.
Immediate customer needs are forcing a buy-over-build approach for many strategic acquirers. These acquirers can often justify an attractive valuation if the technology is strong, given many companies — especially those focused on GRC and EHSQ — have contracted customer bases proactively asking for these tools and can greatly expand the target’s sales distribution. From the company side, they’re exiting because their partners can accelerate distribution overnight in a land-grab opportunity, as customers pick their first tool to replace basic spreadsheets. Strong valuations or potential upside have also made this an attractive investment decision. 

Taken together, these shifts represent an initial wave of consolidation that’s characterized by growth. Strategic acquirers realize this is a growing space, and they want to get a foot in the door through comprehensive ESG reporting platforms that are focused on corporate carbon accounting. They’re flexible about the size of the target as long as the technology is strong. Strategic acquirers see ESG reporting tools as highly specialized, making them strong candidates for M&A. Many companies have already marketed corporate strategies on selling ESG software solutions, but don’t yet have their flagship offering. This has led to many of the leading ESG reporting and management providers being heavily targeted by companies at earlier stages in their lifecycle than they would expect to exit.

With customers already asking for solutions like these, acquirers can be flexible on the size of the company they buy. While each acquirer has a somewhat nuanced set of criteria, most are starting with tools that help with carbon accounting and climate-related metrics. Case in point: one vendor in the space told us while customers like to see an offering or roadmap that covers many aspects of ESG in their purchase criteria, what they’re using and paying for today is mostly environment-related metrics.

This is cultivating an environment in which many remaining acquirers will make their strategic M&A move in the next 12 to 24 months. This initial consolidation will continue, especially among point solutions in more mature markets like Europe, or as a handful of strategic acquirers pursue remaining leading private companies. But in parallel we see other distinct waves of consolidation emerging.

What will characterize future waves of consolidation?

In the second wave of consolidation, we expect to see an emergence of acquisition capabilities that align with regulatory roadmaps or solve specific pain points. Why? As new regulations come into effect and frameworks multiply or consolidate, solutions will need to address user needs while also enabling organizations to futureproof their reporting.

That aligns with what we’re seeing in the market and what we’re hearing from vendors about the growing importance of innovation. The pace of change and need for specialized knowledge will likely lead companies using M&A to drive their roadmap.

That’s already happening as acquisition wish lists become increasingly nuanced and expand to include capabilities like:

• Automation in terms of Scope 3 data collection, general data management through APIs or other means, and reporting through XBRL tagging technology
  Ability to manage supply chain data
  Physical climate risk assessment tools
  Ability to perform lifecycle assessments
  Ability to report nature-based and biodiversity indicators
  More comprehensive metrics and reporting around social and governance
  Strong benchmarking and strategy management tools
  Stakeholder engagement tools

This is generating a landscape in which a third wave of consolidation will likely be grounded in specialized reporting platforms capable of supporting industry-specific customer needs. Vendors are already looking to the horizon to prepare themselves for this direction, telling us that certain industries have a level of complexity that industry-agnostic tools can’t take on, and that specialization will be required in the long-run.

Most players in this space are marketing themselves as industry-agnostic solutions. But we have seen some distinction, as solutions with more of a mid-market customer base tend to be more turnkey and serve less complex industries. Others have had more of an enterprise focus, tending to serve more complex industries with highly configurable solutions.

That said, as the market grows, we believe this will further segment toward industry focus given the complexity of reporting and the need for strong data management. The bulk of consolidation around certain industry specializations is still a few years off. Still, we’ve seen early evidence of this, as companies pursue unique and large industries like real estate and financial services, and some very early-stage startups address other areas. Private equity or industries with robust supply chain reporting have also been seen as attractive targets, given their potential to accelerate distribution through network effects.

What does this consolidation mean for industry participants?

Consolidation is impacting all industry participants. What should stakeholders keep in mind?

1.     Customers, be patient as the space evolves. The meaningful investment being made will create a strong set of world-class solutions that solve pain points, meet regulatory requirements and meet the unique needs of each company.

2.     Acquirers, dig in to understand consolidation so far — and what’s to come. You may need to move quickly and be flexible or creative in entering this dynamic space, which will likely require a combination of buy and build.

3.    Software vendors, prepare for continued and meaningful disruption. Expect a constant stream of new and well-capitalized entrants able to spend significantly on marketing, and more players going to market with end-to-end offerings. For example, some EHSQ providers are offering ESG solutions for free to retain or win customers. Consider how you can best compete, whether by continuing your current trajectory, strategically repositioning, partnering or raising additional capital.