Big changes are on the horizon as businesses face new regulations and global standards for reporting on their climate risks in financial terms.
Companies need to be able to report on both (i) the impact their businesses have on the climate and (ii) the impact climate change has on their businesses.
While it’s becoming increasingly clear to leaders in boardrooms across the world that they will need to make these disclosures, it’s pretty unclear how they will manage the mammoth task of data collection, analysis, and reporting that will be involved.
In this second installment of our series, we’re taking a closer look at the data and analysis challenges companies will face, how the solution space is evolving, and what this all means with our agri and investor hats on.
The first piece of the reporting challenge is perhaps the more familiar one: disclosing how a business is contributing to the climate crisis. Sustainability efforts in recent years, particularly those related to net-zero targets, have focused on getting businesses to first understand and quantify their Scope 1, 2, and 3 emissions, and then develop strategies for reducing and offsetting residual emissions.
While it may be a challenge that businesses are familiar with, it isn’t always an easy one to solve. This is especially true in food and agriculture, where Scope 3 emissions, which are outside of a company’s direct control, are a big driver of their overall footprint. For example, Scope 3 emissions are estimated to account for more than 90% of grocery retailers’ footprints.
Getting an accurate understanding of these Scope 3 emissions requires clarity around supply chains, including who is involved, what practices they implement, and with what outcomes. But, supply chains are often opaque and complex, and granular information about practices and outcomes can be difficult (and expensive) to glean.
The second part of the reporting challenge is likely to be newer territory for most businesses. Determining how climate change will impact their operations in real, financial terms (not just in theory) is a problem not many organizations have faced or are equipped to solve– yet.
Doing so would entail running climate models under different warming scenarios (e.g., 1.5°C or 2°C) and assessing what the impact might be to the company’s assets, operations, supply chain, and customer demand. Companies might also consider how imperatives for climate action (e.g., policy changes, changes in fuel costs, etc.) will put pressure on their current operating environments and model the potential impacts on their performance.
Running these types of analyses, especially in ag, requires systems-based approaches that cut across domains including climate science, statistical and predictive analytics, financial and operational modeling, and more.
Given these new and complex analysis challenges, companies are starting to look for solutions that can help streamline and simplify the task ahead. In response, we are seeing a range of vendors emerge in what is a young, but very active, market.
We’ve found it helpful to distinguish providers across two key dimensions: their offering and their focus. Some providers are developing software products and tools that organizations can use to manage data, run analyses, and prepare reports; while others are offering end-to-end consulting and advisory services, where they manage all of the analytics and reporting on behalf of their clients. At the same time, some providers are focused on developing purpose-built solutions that are focused specifically on climate risk reporting; while others are seeking to deliver integrated solutions that bring climate risk reporting capabilities into a broader offering.
The challenge of pulling together data to make robust climate-related financial disclosures is huge, and so it makes sense that the opportunity to solve this problem is also large. Over the last couple of years, we’ve seen hundreds of millions of dollars from venture investors and corporates flood in to back a range of climate-related reporting tools– and there are no signs of things slowing down.
As this space heats up, we’ve been thinking about what investment opportunities might exist, generally and with an ag-specific lens. We have a few hypotheses.
Early traction is more likely a mirage than proof of product market fit. In a nascent market where huge pain points make eager customers, investors would do well to beware of the awareness vs comparison challenge. There are lots of buyers out there looking for solutions, but few are sophisticated customers who are making decisions based on a robust understanding of their options and a view of where the tools market will go, not just where it is today.
There’s a role for ag-specific tools, but they are unlikely to get to venture scale on their own. Compared to other sectors, it can be much harder to quantify climate impacts in agriculture. For example, to estimate climate impacts within a bank’s retail portfolio, it’s relatively straightforward to translate utilities data into actual emissions outcomes. But in ag, it’s often infeasible or prohibitively expensive to directly measure outputs, and we ultimately need to be able to measure inputs. Among these inputs are both practices (e.g., no-till, rotational grazing, etc.) and nature itself, which is unpredictable, uncontrollable, and varies geographically.
To account for these nuances and complexities, it’s likely that ag-specific models and tools will have a role to play in the climate disclosure space. At the end of the day, however, organizations will need to report across their entire portfolio and/or supply chain. This means that tools that only focus on ag may not be sufficient to meet businesses needs and scale on their own; the ability to integrate with a more holistic set of tools will be critical.
*We could see this changing, however, when it comes to nature based disclosures , where we don’t currently have common measurements or metrics for impact.
Category creation will be really hard; most exits will come through acquisitions. There have been a number of acquisitions in this space already (e.g., BCG / Quantis, McKinsey / Planetrics, and S&P / The Climate Service, etc), and we believe this will remain the most likely path to returns. Though we can never say never, it seems challenging that a category-creating unicorn will emerge in this sector for a few reasons. For one, many applications, including ag, require a fair degree of customization and interpretation to get accurate and meaningful results. These use cases might be more suited to tech-enabled consulting, rather than productized software, given the amount of tailoring and technical expertise that is required. This has important implications for scalability, and Descartes Labs provides a cautionary tale of conflating the two models.
Secondly, for use cases where there is less variability and productized software might make more sense, new entrants taking a ‘climate-risk reporting first’ approach will face stiff competition from incumbents in enterprise software (e.g., Salesforce, Xero, etc.) who are likely to pivot into the space, either by buying or building climate-specific capabilities to complement their existing offerings.
We started our exploration of climate-related financial disclosures to understand what, if any, investment opportunities we should be thinking about from an ag-perspective. While the market for tools to support reporting efforts is no doubt buzzing with activity, we’ve come to realize that venture scale opportunities, especially with an ag focus, could be pretty challenging to come by.
What has gotten us really excited is thinking about what comes after the disclosures and reporting are in place: the action, and the actual impact, we can achieve when armed with a granular, digital-first, understanding of supply chains and portfolios. This is what we dive into in our third, and final, installment of the series.
Tenacious Ventures Management Pty Ltd (CAR 001275760), Tenacious Ventures Management Partnership, LP (CAR 001298484), Tenacious Ventures Fund II Management Partnership, LP (CAR 001298483), and Tenacious Ventures Fund II Staple Co Pty Ltd (CAR 001298487) are Corporate Authorised Representatives of Sandford Capital Pty Ltd (ABN 82 600 590 887), Australian Financial Services Licence No 461981, and are authorised to provide advisory and dealing in connection with investments to wholesale clients only.