ESG has become one of the most important topics of our time. Currently, no day passes without new ambitious announcements by businesses to reduce their carbon footprint or increase transparency in their supply chain. Covid-19 has accelerated the ESG momentum across industries and has put the private sector’s role in helping to solve today’s biggest challenges in the spotlight. Overall, the relevance of ESG is growing due to four key drivers.
Companies increasingly utilize the ESG framework to assess and reconfigure strategy and operation and improve their impact on our environment, societies, and corporate governance. The framework includes subjects beyond environmental protection and considers questions of social and societal welfare as well as the adequate governance of our industries. Responding to global challenges within the ESG framework increases business opportunities – and demand for ESG services. The large variety of challenges that the ESG spectrum entails, results in different priorities and applications for individual companies. Complexity and ambiguity within the ‘ESG alphabet soup’ thus remain omnipresent and the demand for data, tools, and advice is at an all-time high.
‘ESG professional services’ is a newly emerging industry that is well-positioned to benefit strongly from new regulations and the above-mentioned private sector demand for ESG data, reporting tools, and general advice on how to reduce complexity and tackle ESG challenges in practice. Based on the Strategy& ‘where to play’ ESG impact assessment, five attractive and positively impacted sub-sectors have been identified. The ESG impact score indicates how positively or negatively a sub-sector is impacted by ESG and its underlying trends. Naturally, these trends materialize differently for the different sub-sectors. The value of the score is the sum of all trends which have different ‘impact values’. The value ‘-2’ indicates a negative tipping point of a trend while ‘+2’ shows a positive one. Subsequently, the values are weighted with the ‘trend probability’: 20% indicates an unlikely occurrence and 100% a certain occurrence.
In a recent Strategy& analysis, more than 40 European standalone ESG professional services firms have been identified across all sub-sectors. Approximately 80% of them are early-stage start- or scale-ups. Only a few mature businesses exist in an overall fragmented market. Yet, the search for well-positioned targets with relevant sizes is intensifying given the attractive margins of these sub-sectors. The ESG consulting branch, for example, typically realizes an EBITDA margin between 30% and 40%. SaaS and data-based businesses even reach more than 40%. Leading private equity houses have already conducted significant ESG transactions to capitalize on the momentum. The New York City-based private equity house KKR, for instance, recently acquired a majority stake in the sustainability consultancy firm ERM valuing the firm at nearly USD 2.7 billion1.
1) KKR to Buy Sustainability Consultancy ERM From Canada Funds, Bloomberg, May 17 2021.
Given the industry’s attractiveness but lack of sizable players, the question of how GPs should capitalize on the ESG momentum remains highly relevant. Depending on whether a GP is already active in the industry or any associated sub-sector, two strategic approaches exist.
A) Buy and build strategy
In case GPs are not active in any associated sub-sectors, Strategy& recommends a ‘buy and build’ strategy. At first, this requires a rigorous search for a well-positioned ‘platform’ company that has the potential to become the basis for many ‘add-ons’. After the acquisition of the platform company, the search for add-ons should be intensified to execute the positioning strategy while at the same time consolidating the market.
B) Add-on strategy
In case GPs are already active in associated sub-sectors, Strategy& recommends an ‘add-on’ strategy. At first, a thorough platform feasibility check should be conducted to determine whether the platform company is well-positioned to become a market leader in one of the segments. Secondly, the search for ‘add-on’ companies should be intensified to execute the positioning strategy while again at the same time consolidating the market.
Both strategies are common in the private equity industry. However, as the ESG professional services industry is fairly new, GPs are currently searching for platform companies depending on the sub-sector. The two sub-sectors ESG reporting software and data providers are still very early stage and determined for a platform strategy. ESG education, certification, and consulting, on the other hand, are maturing, and established players start to search for ‘add-ons’.
In conclusion, the ESG professional services industry is determined to grow significantly in the next decades and the consolidation of the industry has not yet started. Depending on the sub-sector, first-mover advantages in building platforms and starting the consolidation process can yet be realized by GPs. By nature, large corporations in associated industries (e.g., rating agencies) are strong competitors for GPs when entering and consolidating this industry.
Carina von Heimendahl, Marius Lorenz, and Levi Baier also contributed to this article.