Attention enterprises – generative AI is sexy, but ESG has teeth

Historically, I haven’t had much patience for ESG. Annual sustainability reports come off like static PR exercises; carbon-neutral intentions seem more like greenwashing.

But I’ve had a big ESG attitude adjustment. Now I take a different position entirely: while customers are rightly interested in vendors’ generative AI plans, I believe ESG is the software category most are underestimating – and it has implications across enterprise roles. Why has my stance changed?

Regulatory pressures – regardless of what happens politically in the US, any company with global interests is looking ahead to waves of strengthened ESG regulations, loaded down with regional nuances and complexities. In short, ESG has teeth. Generative AI might have one heck of a carrot (and plenty of unanswered questions to boot), but ESG has a stick.

Software innovation (finally) – incumbent vendors and ESG startups alike are starting to pursue ESG in much more compelling ways – via real-time, granular energy/carbon tracking, and continuous ESG management.

Supply chain imperatives – ESG regulations that extend to Scope 3 have big implications for global supply chains, already a hot topic/pain point for most enterprises.

The person most responsible for my ESG outlook shift is diginomica contributor Brian Sommer. Sommer’s new book, the Executive’s ESG Playbook, is a must-read for pretty much anyone whose interests touch on this. In terms of the politics of ESG, Sommer’s book reflects my current view: for enterprises, ESG is no longer about politics. If you’re an enterprise leader, where you stand on climate change, or how ESG should be regulated, doesn’t affect your ESG imperative: get out in front of the flood of pending requirements. And, hopefully, find some bottom line savings for your trouble.

A couple weeks ago, Sommer joined a special edition of my enterprise video show to preview the book’s contents, and field pressing questions from a savvy LinkedIn audience (you can see the full replay on LinkedIn; I’ve embedded the YouTube version below).

The changing ESG regulatory environment – a massive wake up call

Even US-only companies may soon have their hands full, with California on the verge of passing ESG regulations that are more stringent than those the SEC is considering. As per InvestmentNews:

The bills, which have been sent to the state assembly, are significant for two main reasons. First, they would apply to more companies and mandate a higher level of emissions disclosure than the Securities and Exchange Commission’s forthcoming rule would. Second, given the size of California’s economy, if the bills are passed, they would effectively mean mandatory emissions and climate-risk disclosure for major U.S. companies, even if the SEC’s rule is delayed, watered down or faces legal challenges.

Two things are certain: any company with European interests has regulatory concerns ahead. And: those regulations are likely to push companies beyond their current compliance/reporting efforts. As Sommer writes in the Executive’s ESG Playbook:

Approved in November 2022 and scheduled to phase in from January 2024, the EU’s Corporate Sustainability Reporting Directive raises the number of businesses in the EU subject to sustainability reporting requirements from an estimated 11,700 to around 50,000… U.S.-based companies should pay particular attention to the fact that non-EU companies with significant operations within the EU will be subject to the CSRD, and that Scope 3 emissions, which include emissions produced by business travel, are within scope. In the U.S., businesses are usually required only to report on Scope 1 and 2 emissions. Pending regulation with the Securities & Exchange Commission may change that as new rules are expected this fall.

During the show, I told Sommer: I was struck by his documentation of the emerging “forever chemicals” statutes:

Regulators in many countries are requiring companies to cease the use of PFAS and other chemicals – some called forever chemicals. These compounds can be found in or on gaskets, fire retardant, printed circuit boards, seals, packaging and more. While your firm might not add these to your products, your suppliers might or they might be used in some aspect of your capital equipment. What you may have overlooked in your ESG efforts is an exposure risk for these (and other) compounds that could impact your production, production equipment, sourcing, recycling and other factors. This cannot be ignored.

“Forever chemicals” are a vivid example: future ESG regulations are going to challenge companies to change/monitor processes (and recycle/account for materials) throughout production and distribution. Sommer again:

For example, while the removal of certain ‘forever’ chemicals may have a minimal effect on the goods your firm produces, it could trigger some other adverse effects you were not expecting at all. In the forever chemical example, your ESG team might not realize just how many MRO supplies and parts that you may need have these chemicals as a coating or ingredient (e.g., PFAS chemicals that are used to make seals and to keep O-rings slick and pliable).

Add ethical supply chain regulations to this potent mix:

Your firm is in the middle of a long, complex value chain, it may not know much about the constituents within it. Worse, the constituents could change with amazing frequency. This lack of knowledge can be a significant difficulty factor in capturing Scope 3 environmental and social data. It can also act to obscure human condition issues (e.g., slave labor, non-livable wages, unsafe working environment, etc.) because the people affected are far back in the supply chain.

ESG’s executive challenge – are CXOs ready?

Another wake up call: how ESG regulations will impact across departments. In Sommer’s book intro, he explains how this new ESG era will impact CIOs, COOs, CFOs, and CHROs. CHROs? Yes – Sommer has already delivered a keynote on why HR executives are not ready for ESG. This is yet another nudge: yes, get on top of generative AI, but not at the expense of what is happening here. Sommer explains that HR leaders:

Will have a significant responsibility for acquiring and reporting ‘social’ aspects of ESG.
They’ll need to probe the social and governance matters of your firm’s suppliers (e.g., does this supplier provide livable wages and avoid the use of forced labor?).
The CHRO may be responsible for a material number of your firm’s total ESG data points and metrics. The numbers of systems an HR team may have to access could also be quite material, too.

Are CEOs ready? Brian’s book has a checklist of tough questions from board members (and shareholders) that would keep any CEO on their toes. Can your CEO answer these board/shareholder questions? Here’s just a sampling:

Which of our products trigger the greatest carbon consumption and what are we doing about this?
Which suppliers are the best/worst carbon consumers?
What practices are our competitors embracing that are delivering material improvements in their environmental efforts?
Should we move some of our production to plants that can utilize wind, geothermal and/or hydroelectric power and, if so, which ones?
What are our customers’ expectations of us regarding sustainability and what must we do to achieve these results?

For companies that want help addressing these issues, the plot thickens. As Sommer writes, most of the enterprise software customers are currently running falls short here. Tracking externalities is not a strength:

Most software technology today addresses business events within the four walls of an enterprise with some slight connections between the firm and its immediate suppliers and customers. This inwardly focused technology is not well-suited to providing visibility across the entirety of the value chain. Instead, businesses need solutions that monitor the movement of monies, goods, people, etc. from the extraction of natural resources, to the transportation of these items, through the various conversion/production processes they undergo, etc. Most of today’s technologies are designed to document a subset of these activities.

We are 1,300 words into this piece, and I am still in the ‘problem statement’ section. That’s one heck of a scope, and I’m leaving plenty out. Beyond the items laid out here, a genuine commitment to sustainable/organic products and supply chain transparency is starting to impact both consumer spend, and employee recruitment/retention. I consider that a fairly soft metric compared to some of the regulatory aspects, but when staking a competitive ESG edge, it’s not trivial.

My take – next-gen ESG vendors are emerging

But there is good news: while next-gen ESG vendors are still in early stages, there are plenty of them to consider. For his book research, Sommer kicked tired on a long list of vendors, from the familiar players to new challengers. From what I can see, most of today’s next-gen ESG vendors seem to excel in one or two areas, rather than a comprehensive solution. Or: there may be granular views at one level, but perhaps not at the individual product level (yet). But that might be good enough for the current agenda, where one priority area, such as supplier management, could surface intriguing vendors and capabilities.

Sommer, who is a staunch critic of many of SAP’s enterprise moves, notes SAP’s progress in this area:

They also produced a short video on the control tower that addresses granularity of data and how their ESG products can help capture water, gas, electric consumption, waste and emissions at each step along the production process. At the time of writing this, it is unknown whether this extends beyond the bill of materials or can get to an individual lot, batch or product level.

But I know, from talking to Sommer, he doesn’t see any one vendor as having a decisive edge here. To achieve this outside-in/granular/real-time ESG view, vendors have loads of work ahead. ESG is ultimately like AI: it needs to be integrated into every process managed by enterprise software. In the long term, just selling ESG bolt-on components isn’t going to be enough. I believe vendors should take heat for not vigorously addressing this sooner, but change is definitely afoot. In sum, it’s not too soon to kick tires – vendors have made notable progress here.

Though I juxtaposed the disproportionate marketing attention being paid to generative AI versus ESG software, obviously there isn’t an inherent conflict between the two. I see plenty of ways AI can enhance ESG, including AI-enabled energy management. But in the history of enterprise software, sexy tech often takes the back seat to regulatory tech. In a sense, ESG is kind of a rolling Y2K, with multiple deadlines that will force multiple areas of significant software spend. ESG has the kind of teeth Metaverse and blockchain cheerleaders can only dream about.

Obviously, the Y2K analogy only works to a point. In retrospect, Y2K was oversold and overdramatized. If anything, I think the opposite is true of ESG. During our one hour video show, Tom Raftery joined us for the final segment. Raftery has been documenting the urgency of green energy long before sustainability was remotely cool, and still does – including his Climate Confident podcast. Wrapping up, I asked Sommer and Raftery: what should customers be asking vendors about ESG? Sommer responded:

The solution the vendor is going to pitch me – is it about reporting ESG data? Or is it to help me do a better job of running my company in a better ESG kind of fashion? There’s a huge difference between the two. And if it’s strictly about the reporting, I’m going to yawn on that one – that just doesn’t move the needle. For me, it gets me out of a compliance problem, possibly, but it doesn’t change things materially for the long term.

Raftery added:

I would agree 100% with Brian. I would also say: I would want people I’m in business with to be looking at the standards that are out there for reporting, and not just for reporting. But things like the science-based targets initiative. If you have companies that say to you, ‘I’m working with a science-based targets initiative, so that my targets are science-based, realistic’. That they have been audited is too strong a word, but they’ve been checked. They are realistic, and have all these steps in place, then I can start to take them seriously. Before that, I’m kind of, to Brian’s point, a little skeptical.

There is more to say on how customers can respond, but that’s a good wrap for now. The video has more detail – as well as some slide reveals from Brian Sommer.