When it comes to climate action, private equity firms and portfolio companies need progress over perfection. With limited time and resources, the idea of greenhouse gas data gathering and carbon footprinting can seem daunting, but a rough estimate of the baseline is good enough to make progress where it counts: setting a credible target and making real progress on decarbonization.
What a carbon footprint is, and isn’t
Corporate carbon emissions change over time for many reasons. Company growth, operational changes and regional expansion/consolidation can all have major impacts on GHG emissions, irrespective of a company’s climate agenda.
For example, moving operations from Western Europe to Eastern Europe for labor cost savings can increase emissions by a factor of 20x simply due to more carbon-intensive power grids. That’s like taking 20 steps backward when your target requires 10 steps forward, making it far more difficult to reach corporate climate goals.
Source: Electricity Maps
But it’s not all bad news: ambitious national policies and supply chain decarbonization activity can create tailwinds to reach GHG targets in certain regions and sectors. These trends may appear subtly today but can gather speed and help contribute to much of the decarbonization needed by certain companies to align with a 1.5°C target pathway.
With emissions changing dynamically over time for all kinds of reasons, it doesn’t make sense to focus on getting that baseline snapshot perfect. Instead, get it ‘good enough’ for setting a target and forming an initial sense for where the key decarbonization opportunities lie – this will get you ahead with real progress, not stuck in analysis paralysis with a footprint that will never be perfect.
A basic carbon footprint only needs to be good enough to identify the GHG hotspots. These are the emissions sources that dominate. This will vary with business operations; for example, the most relevant emission categories for food & beverage companies tend to be purchased goods & services, transportation/distribution, business travel and waste treatment:
Source: CDP
The examples above are all from within a company’s value chain which means they are considered Scope 3 emissions. These emissions can be difficult to quantify accurately due to the nature of Scope 3 data, in that it requires engaging directly with actors within the supply chain to access their data.
As an example, Scope 3 emissions often arise from shipping & logistics. A basic way to start estimating these emissions would be based on the company’s spend for each mode of shipment. Over time, by collaborating with suppliers to get details of shipping distances and weights, these granular details can be used to estimate emissions more accurately. Eventually the company could then strive for best practice by collecting data on the type and quantity of fuels used in its transport vehicles for the highest possible accuracy – but this is not necessary to get started. Many software platforms now exist to support this process, often specializing in different sectors and use cases, so rest assured there are tools to help reduce the workload on your sustainability team.
For small and medium-sized enterprises this process is even more straightforward. The Science-Based Targets initiative (SBTi) has guidelines for SMEs that do not require a strong understanding of its Scope 3 emission baseline, simply a commitment to measure and reduce them over time. Instead, SMEs are encouraged to focus on near-term Scope 1 & 2 emissions which can be quantified with relative ease, often from simply getting access to utility (power and fuel) invoices. Scope 1 & 2 decarbonization opportunities are also relatively easy to identify and can be prioritized and optimized for a given company to make immediate progress toward its near-term target.
Ambitious and achievable targets
Credible GHG reduction targets for investees must strike a balance between ambition (by aligning with climate science / Paris Agreement) and achievability (by having a real plan for how the target will be reached). Armed with an understanding of its carbon footprint hotspots, a company can tackle this head on.
Financial institutions such as funds have up to two years after a deal closes before its portfolio company’s targets count toward its own target progress, so this timeframe should be used to support investees with gathering GHG data, identifying hotspots and developing a roadmap for cost-effective decarbonization.
Portfolio company target-setting can also benefit funds-of-funds and private credit investors who are further removed from company management, as these targets will improve a company’s score using the Temperature Rating Approach for target setting, and thus improve a financial institution’s portfolio score as well.
Science-Based Targets can be set by SMEs1 almost immediately once their Scope 1 & 2 emissions are calculated. This can be of great benefit for private equity firms who are setting their own targets using the widely popular Portfolio Coverage Approach, with progress measured by how many of the firm’s investees have their own targets set.
This streamlined approach has enabled a huge uptick in targets set by SMEs, especially within emerging markets. Over 1400 Science-Based Targets were set by SMEs in 2023, which exceeds all previous years combined. Across all companies, the highest annual growth in target-setting was seen in the healthcare, manufacturing and apparel sectors. By region, the highest annual growth increases were seen in Europe and Asia. This growth is illustrated below:
Source: SBTi
Why now and what next?
Near-term targets must be reached within 5 to 10 years giving precious little time to identify, evaluate and select between competing options for GHG reduction. Management teams need to be both opportunistic with quick wins to build momentum, and strategic with larger capital projects and supplier procurement decisions to drive deep decarbonization.
This strategy can be complex when the necessary climate technologies and solutions are not yet commercially mature. Growth-stage companies already face a lot of uncertainty and must be careful with testing, integration and rollout of new innovations to unlock carbon savings. The technology readiness level (TRL) of these innovations is important to consider:
It can help to approach this by understanding which decarbonization decisions are reversible, allowing for an easy switch if things don’t work out – and which are not, causing a company to be locked in with an unsuitable solution for many years before the end of its useful/economic lifetime. This understanding can take time to develop, which underscores the importance of starting now.
Fast track to climate action
Limited resources don’t need to be a barrier to immediate climate action. By managing the process carefully, funds and portfolio companies can quickly set ambitious and achievable GHG reduction targets aligned with best practice, and make immediate progress toward these targets with quick wins and strategic decisions on how to embrace low-carbon technology and procurement.
To make a real impact, these decisions must address the carbon hotspots, which can be identified with basic data screening and estimation. Start with the basics, choose progress over perfection, and realize the benefits as carbon footprints quickly begin to shrink.
Footnotes
- Full SME eligibility criteria is available at <https://sciencebasedtargets.org/small-and-medium-enterprise-sme-target-setting-process>
Glossary
Carbon footprint: An inventory of greenhouse gas (GHG) emissions produced directly and indirectly by a company’s operations. These emissions are categorized into Scopes 1, 2 and 3.
Scope 1: Direct emissions from sources that an organization owns or controls – for example, combustion of fuels
Scope 2: Indirect emissions from purchased energy – for example, grid electricity
Scope 3: All other indirect emissions from activities within a company’s value chain – for example, purchased goods & services or transport/logistics