Strategic Business Leader- Revision Notes
Leadership
Agency relationships
The Board of Directors
Reporting to stakeholders
Two tier boards, Insider structures, CG Approaches
Stakeholders
Corporate Social Responsibility
Environmental and Social Footprints
Code of Ethics
Bribery, Ethical decision making and Public interest
Introduction to strategy and strategic planning
Strategic Analysis
Strategic Choice
Risk Management
Internal Control
Strategy in action
Financial Analysis
Developments in technology shaping business
E-Business
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Leadership
Leadership is the process of influencing an organisation (or group within an organisation) in its efforts towards achieving an aim or
goal. Without effective leadership the risk is that people in an organisation are unclear about its purpose or lack motivation to deliver
the strategy to achieve it
Leadership can be defined as the process by which an individual influences others. Within organisations it is to be hoped that leaders
have both power (the ability to influence) and authority (the right to influence). One without the other is never satisfactory.
An effective leader: Key leadership traits (essential for successfully forming strategy, implementing it and managing change)
Trait theories
Early theories of leadership were known as ‘trait theories’ and these suggested that all good leaders were born with certain identifiable
traits that were the ‘golden rules’ of good leadership. This was bad news for those whose genetic endowment lacked those traits.
Different researchers have conducted studies and research reviews linking a variety of different traits with effective leadership. For
example, Stogdill's 1974 review of leadership traits identified qualities that included Age, physique, and appearance, Intelligence,
Knowledge, Integrity, Emotional control, Social skills, Self-confidence
More modern theories, while recognizing that there tend to be traits or styles of behaviour, maintain that many of these styles can be
taught. For example, research tends to suggest that successful leaders exhibit: honesty, the ability to inspire, competence, intelligence
and the ability to look forward.
Behavioral/ style theories
The research unit at Ashridge Management College distinguished four different management styles.
Tells (autocratic) - the manager makes all the decisions and issues instructions which must be obeyed without question.
Sells (persuasive) - the manager still makes all the decisions, but believes that team members must be motivated to accept them in
order to carry them out properly.
Consults (participative) - the manager confers with the team and takes their views into account, although still retains the final say.
Joins (democratic) - the leader and the team members make the decision together on the basis of consensus.
Situation/Contingent approach
Modern thinking about leadership suggests a contingent approach: there are no golden rules that will fit every situation and how to
lead and manage is contingent on (depends on) the situation.
John Adair’s action-centered leadership approach
Good managers and leaders should have full command of the three main areas of the Action Centred Leadership model, and should
be able to use each of the elements according to the situation. Being able to do all of these things, and keep the right balance, gets
results, builds morale, improves quality, develops teams and productivity, and is the mark of a successful manager and leader.
John Adair's Action-Centred Leadership model is represented by Adair's 'three circles' diagram, which illustrates Adair's three core
management responsibilities:
 Achieving the task
 Managing the team or group
 Managing individuals
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TRANSACTIONAL AND TRANSFORMATIONAL LEADERS
Transactional leadership works within set established goals and organizational boundaries, while a transformational approach
challenges the status quo and is more future-oriented.
Transactional leaders/instrumental leadership: seek improvement rather than change so focus on systems and controls.
Transactional leaders focus on the short term, controlling, maintaining and improving the current situation, planning, organising,
defending the existing culture. They rely on rational/legal power so that subordinates obey because their manager is called ‘manager’.
It is sometimes said that such leaders concentrate on ‘doing things right’. Transactional leaders will form the majority of an
organisation’s managers and are useful to deal with the day-to-day running of the organisation.
Transformational leaders/charismatic leaders: build a vision of the future, energise people, and manage change.
Transformational leaders are very different. They concentrate on a long term vision and on re-engineering to change the organisation
radically, and they motivate their staff through a climate of trust, empowerment, change culture, and charisma. These people
concentrate on ‘doing the right things’. If an organisation faces serious challenges or opportunities which call for radical changes, then
it needs a visionary transformational leader at its head. Transactional leaders (managers) are unlikely to have the vision and, even if
they do, will find it difficult to persuade others to follow them enthusiastically.
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Role of a Leader
Entrepreneurship
Entrepreneurs are innovators, willing to take risks and generate new ideas to create unique and potentially
profitable solutions to modern-day problems. This innovation may result in new organizations or revitalize
mature organizations in response to a perceived opportunity. The most obvious form of entrepreneurship is
starting a new business (referred as a startup company). In recent years, the term has been extended to
include social and political forms of entrepreneurial activity, which are often referred to as social
entrepreneurship.
Entrepreneurial activities differ substantially depending on the type of organization and creativity involved.
Entrepreneurship ranges in scale from solo projects (that can even involve the entrepreneur working only
part-time) to major undertakings that create many job opportunities. Many high-value entrepreneurial
ventures seek venture capital or angel funding (seed money) to raise capital for building the business.
Intrapreneurship means behaving like an entrepreneur while working within a large organization;
introducing new technologies, increasing efficiency and productivity, and generating new products or
services are all qualities characteristic of intrepreneurs.
Develop and
communicate org’s
strategy
The intrapreneur acts as an “inside entrepreneur” who focuses on innovation and creativity while operating
within the goals and environment of an organization. Intrapreneurs bring their ideas to the firm to generate
new products, processes, or services and thereby act as a force for change within the organization.
Strategy: “ activities to achieve org objectives and adapt resources, operations, cope to changes in the
environment in the longer term’
Developing strategy
Strategy may be developed at three levels in an organization:
Corporate strategy: concerned with the overall objective and scope of business to fulfil stakeholder’s
expectation. When a business identifies opportunities outside its original industry, it might contemplate
diversification. When additional businesses become part of the company, the small business owner must
consider corporate-level strategy. To be effective, the umbrella company must contribute to the efficiency,
profitability and competitive advantage to each business unit. Compared to business strategy, corporate
strategy examines success from a higher level. Corporate strategy is focused on obtaining a mix of business
units that will allow the company to succeed as a whole.
Business strategy: The decisions a company makes on its way to creating, maintaining and using its
competitive advantages are business-level strategies. Business-level strategy focuses on how to attain and
satisfy customers, offer goods and services that meet their needs, and increase operating profits. To do this,
business-level strategy focuses on positioning itself against competitors and staying up to date on market
trends and technology changes.
Functional/operational strategy: refers to the methods companies use to reach their objectives. By
developing operational strategies, a company can examine and implement effective and efficient systems
for using resources, personnel and the work process. An operations strategy is typically driven by the overall
business strategy of the organization, and is designed to maximize the effectiveness of production and
support elements while minimizing costs
Generally speaking, the strategic planning process consists of three major components:
formulation (including setting objectives and assessing the external and internal environments) evaluation
and the selection of strategic alternatives implementation and control.
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Communicating the organization’s strategy
An organisation’s mission/vision is its basic purpose: What is it for? Why does it exist? What is its ‘raison
d’être’?
A mission statement formalises the organisation’s mission by writing it down.
Mission statements are usually assumed to address:
What business is the company in?
Whom does the organisation serve?
What benefits are to be delivered?
What are the organisation’s values and ethics?
Ashridge College Model of mission can be used to create or analyse a mission statement
Purpose: Why the company exists
Values: what the company believes in ( beliefs, moral principles)
Standards of behavior and policies: The rules that guide how the company operates
Strategy: The competitive position and distinctive competence of the company ( what is our business and
where should it be)
Mission is supported by more detailed objectives.
Objectives should be SMART and result-focused (focus on achieving results rather than simply administering
laid down processes!)
Specific; Measurable; Achievable; Realistic; Time-related.
Strategic management
Step 1: Evaluate the strategic position
Step 2: Evaluate strategic choices
Step 3: Formulate and implement strategy (strategy in action)- leader will also need to manage the change
that is likely to happen due to new strategies.
Culture: ‘ the way we do things around here’
Factors which influence culture ( The cultural web)
In order to understand the existing culture and its effects it is important to be able to analyse an
organisation’s culture. The cultural web is a means of doing this
1.
Symbols and titles: Symbols are objects, events, acts or people that convey, maintain or create
meaning over and above their functional purpose. For example, offices and office layout, cars and job
titles have a functional purpose, but are also typically signals about status and hierarchy.
2.
Power relations: Power is the ability of individuals or groups to persuade, induce or coerce others into
following certain courses of action. So power structures are distributions of power to groups of people
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3.
4.
5.
6.
7.
in an organisation. The most powerful individuals or groups are likely to be closely associated with the
paradigm and long-established ways of doing things.
Organizational structure: are the roles, responsibilities and reporting relationships in organisations.
These are likely to reflect power structures. Formal hierarchical, mechanistic structures may emphasise
that strategy is the province of top managers and everyone else is ‘working to orders’. Structures with
less emphasis on formal reporting relationships might indicate more participative strategy making.
Control systems: for example, highly centralized or de-centralized. Control systems are the formal and
informal ways of monitoring and supporting people within and around an organisation and tend to
emphasise what is seen to be important in the organisation. They include measurements and reward
systems.
Rituals and routines: Routines are ‘the way we do things around here’ on a day-to-day basis. These
may have a long history and may well be common across organisations. The rituals of organisational
life are particular activities or special events that emphasise, highlight or reinforce what is important in
the culture. Examples include training programmes, interview panels, promotion and assessment
procedures, sales conferences and so on.
Myths and stories: The stories told by members of an organisation to each other, to outsiders, to new
recruits, and so on, may act to embed the present in its organisational history and also flag up important
event and personalities.
Organizational assumptions: Paradigm ( basic assumptions and values, shared assumptions) for
example, that the organization exists to fulfil charitable values.
If an organization is not delivering the results its management wants, the web can be used to diagnose
whether the organizational culture is contributing towards the underperformance.
The management will evaluate the existing culture, think how they want the culture to be and then identify
what changes need to be made to the existing culture.
Strategic Values
-
Set tone from the top
Have a corporate code of ethics which is adhered to
Consider Corporate Social Responsibility: Provide benefit to the society in general rather than only
specific stakeholders.
Governance
-
Follow best practice guidelines
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Agency Relationships
Agency relationships underpin any governance situation, in which there is a separation of ownership and control of an organisation.
Agency involves two parties: the principal and the agent. In most situations, the agency is the director responsibility for the
performance of the organisation and this party reports to the principal in a fiduciary relationship. The principal is the shareholder in
the case of a public company but this is less straightforward in public sector organisations, involving taxpayers and a hierarchy of public
sector servants who intermediate on behalf of the state and the taxpayer.
Agency problem: The agents are granted both expressed and implied authority to deal with third parties on behalf of their principal,
and they are held accountable under corporate governance for their actions and outcomes.
Should a situation arise where the interests of the principal and agents are not necessarily aligned, an agency problem arises.
Agency cost
Agency costs can include:
- The time and expense of reviewing published information, and then attending meetings to monitor and scrutinise the board’s
performance;
- Paying for the services of independent experts and advisers;
- External auditor’s fees; and
transaction costs associated with managing the shareholding
An agency cost is a cost incurred by the shareholder (the principal) in monitoring the activities of company agents (i.e. directors).
Agency costs are normally considered as ‘over and above’ existing analysis costs (such as those involved in making an initial investment
decision) and are the costs that arise because of compromised trust in agents (directors).
They can be classified under two headings; costs associated with monitoring the agent, and those termed residual loss.
Monitoring costs
This type of agency cost includes costs associated with attempts to control or monitor the organization. The most important of these
will be the provision of information to shareholders, such as financial statements and annual reports detailing company operations.
Large organizations are required, usually as part of listing rules, to communicate effectively with major shareholders. Meetings
attended by the key board members including the chief executive can be arranged and institutional shareholders invited, although
these will take time and money both to organize and deliver.
The AGM is a regular meeting that can be utilized by shareholders to ask questions of the company.
Many companies utilize performance-related incentive schemes to encourage directors to make decisions that are in the best interest
of the shareholders. The most effective of such schemes is that of offering directors share options, usually with a specified period of
time (several years) in which the shares cannot be sold. This provides the incentive for their decision making to reflect the
requirements of shareholders for long-term share price growth.
Residual loss
Residual loss costs are a part of agency costs. These are costs that attach to the employment of high caliber directors (generally outside
of salary) and the trappings associated with the running of a successful company. The packages of the board members may include
benefits in kind such as company cars, medical insurance and school fee payments and would be considered a residual loss to
shareholders.
Reducing agency costs
These agency costs could be reduced when direct action is taken to resolve the alignment of interest problem, which would improve
board accountability. The employment of sufficient independent non-executive directors to monitor and scrutinise the executive
members of the board should have a positive influence on their behaviour and inspire confidence from shareholders.
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Types of Organisations
1.
Private/listed/quoted/ floated/public companies
For profit origanisations
Often categorized as 1st sector origanisations
2.
Public sector organizations/ state controlled
Goods/services that CANNOT be or SHOULD NOT be provided by for profit organizations
Often categorized as 2nd sector origanisations
Public sector organisations can be at various levels:
At National level:
Based in capital city; divided into Central Government departments such as treasury, interior department, foreign office,
defence, education.
Led by a political minister of governing party.
Ministers are ‘advised’ or ‘helped’ by civil servants/ permanent government employees
At Sub-national level (below national)
Some countries are sub-divided into regional authorities/ regional assemblies/ states/ municipalities/ local authorities/
department (whatever term used!)
Selected powers given by national government due to belief that these areas are best handled by local people, due to
knowledge, efficiency or cost effectiveness E.g. panning of roads, new housing permission, utilities, local schools, rubbish
collection etc.
Led by elected representatives and advised by permanent officials/civil servants
Supranational
A multi-national organisation where power is delegated to the organisation by the government of member states. E.g.
European Union, World Trade Organisation, World Bank
3.
Charities and NGOs
Not make profit; not deliver services on behalf of the state.
Provide benefits that cannot be easily provided by profit making or public sector organizations
Often categorized as 3rd sector organisations
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Strategic Objective
Public companies
Public sector organisations
-
Primarily to make a financial return for the
investors (shareholders)
-
Value is added by the creation of shareholder
wealth and this is measured in terms of profits,
cash flows, share price movements and
price/earnings
-
Concerned with social purposes
and delivering their services
efficiently, effectively and with
good value for money.
Charities/NGOs
-
Support the charitable cause for
which the organisation was set
up. It is likely to be a social or
benevolent cause and funds are
donated specifically to support
that cause.
Agency Relationship
Public companies
Principal: Shareholders/Investors
Public sector organisations
Principal: Taxpayers and service
users
Agent: Directors
Charities/NGOs
Principal: Donors
Agent: Trustees
Agent: Government officials
Fiduciary duty:



Act in Principal’s economic interest;
transparency in communication;
avoid conflict of interest (director owes a duty to
all shareholders not to place him/herself in a
situation where personal self-interest conflicts
with the interests of the company, and its
shareholders. Conflict of interest is when one’s
personal interest is at variance with one’s
professional duty of care.)
Fiduciary duty: Duty to the benefit of
society rather than just a duty to one
particular party
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Fiduciary duty: Duty to the donorsensure funds spent for the
benevolent purpose of the charity.
Governance
Public companies
Regulations: Company law, listing rules
Governance: Formal governance arrangements (
BOD, General meetings etc.)
Public sector organisations
Charities/NGOs
There is no single way in which public
sector organisations are governed.
NGOs and charities may have an
executive and non-executive board,
but these are subject to a higher
board of trustees whose role it is to
ensure that the NGO or charity
operates in line with its stated
purpose or terms of reference.
Public sector organization tend to be
highly bureaucratic.
Charities receive recognition by a
country’s charity authority to
operate and they then
receives the concessions that
charitable status gives (favourable
tax treatment and different
reporting requirements) depending
upon the country’s rules, they may
be subject to audit and have some
reporting requirements
Accountability
Public companies
Public sector organisations
Charities/NGOs
Directors,
individually
and
collectively, have a duty under
corporate governance to provide
entrepreneurial leadership and
run the company to the
betterment of the shareholders.
Public accountability
The board of a public sector organisation has a duty and
obligation to ensure that they make best use of the limited
public resources.
In a charity, the operating board
is usually accountable to a
board of trustees. It is the
trustees who act as the
interpreters and guarantors of
the fiduciary duty of the charity
(because the beneficiaries of
the charity may be unable to
speak for themselves).
The agents are granted both
expressed and implied authority
to deal with third parties on
behalf of their principal, and they
are held accountable under
corporate governance for their
actions and outcomes.
The board is accountable for both the financial and social
outcomes of the work they undertake.
A public sector organization needs to demonstrate they have
used the public money for the purposes intended.
Accountability is gained in part by having a system or reporting
and oversight of one body over others.
Because there is no market mechanism of monitoring
performance, other ways must be found to ensure that
organisations achieve the objectives and service delivery
targets established for them.
In some cases, then, a head of service or a board of directors
must report to an external body of oversight.
Oversight body’s role is to hold the management of the
service to account for the delivery of the public service and to
ensure that the organisation is run for the benefit of the
service user
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The trustees ensure that the
board is acting according to the
charity’s stated purposes and
that all management policy,
including salaries and benefits,
are consistent with those
purposes.
Performance Measurement
Public companies
Public sector organisations
Market mechanism for
performance measurement
(i.e the share price).
Performance measurement is more complex than for a private sector
‘for profit’ business. With a business, relatively straightforward financial
measures are usually good signifiers of success or failure, including, for
example, return on equity or return on sales, efficiency measures and
productivity measures. For a public sector organisation, financial
measures are only one type of many other relevant objectives including
the availability and quality of service delivery.
Relatively straightforward
financial measures are
usually good signifiers of
success or failure- for
example, return on equity or
return on sales, efficiency
measures and productivity
measures.
Charities/NGOs
Value for money (The 3
Es).
Because public sector objectives are often contested by a range of
different stakeholders in society, public sector outcomes are often
expressed in terms of value for money or in the delivery of public
services such as the provision of public housing, health services, refuse
collection, provision of jobs or learning opportunities.
The 3 Es framework is a way in which public sector objectives can be
considered.
Economy
This entails obtaining suitable quality inputs at the lowest price
available.
Efficiency
Efficiency is defined as the amount of work achieved for a given level of
input. Being efficient involves optimal utilization of resources (delivering
the required works to an appropriate standard at minimum cost, time
and effort).
Effectiveness
This criterion is primarily concerned with delivering desired predetermined objectives. A public sector organisation must deliver its
required services to a high quality and meet the expectations of service
users
Focus of Corporate Governance
(Corporate Governance is the system by which organisations are configured, co-ordinated and controlled)
Public companies
Public sector organisations
Charities/NGOs
Focus on:
Delivering acceptable long-term economic
returns to investors.
alignment of director’s remuneration with
shareholder priorities
Enforcement of professional and ethical
behaviour to maximise investor confidence.
Focus on:
Balancing the quality and
effectiveness of service delivery
with cost constraints.
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Focus on:
Ensuring the funds are spent for
the benevolent purpose of the
charity.
Stakeholders
Public companies
Public sector organisations
Charities/NGOs
Stakeholders in a business often
have an economic incentive to
engage with the organisation.
Taxpayers have different objectives and views but do
not have a choice in paying tax.
Most stakeholders in a charity have
claims more concerned with its
benevolent aims.
Society typically expects a business
to be efficient in order to be
profitable so that, in turn, it can
create jobs, wealth and value for
shareholders. Society expresses its
support for a business by
participating in its resource or
product markets, i.e. by supplying its
inputs (including working for it or
buying its products)
Assessment of validity of stakeholder claims depends
on political stance of the existing government!
Public interest
Public interest is concerned with delivering benefit
for the general public at large, as opposed to solely
serving the interests of a company and its
shareholders. As the society as a whole has a stake in
publicly funded ventures, it warrants protection by
the government.
A charity’s social acceptability is tied
up with the charity’s achievement of
benevolent aims.
Corporate governance
A set of relationships between a company’s directors, its shareholders and other stakeholders.(OECD)
Corporate governance is the system by which organisations are configured, co-ordinated and controlled. This usually involves the
characteristics of leadership, the structures, particularly at board level, to help facilitate desirable outcomes, and the behaviours of
senior management in the pursuit of those outcomes.
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The Board of Directors
Executive directors are full time members of staff, have management positions in the organisation, are part of the executive structure
and typically have industry or activity-relevant knowledge or expertise, which is the basis of their value to the organisation.
Non-executive directors are engaged part time by the organisation, bring relevant independent, external input and scrutiny to the
board, and typically occupy positions in the committee structure.
Non-Executive Directors (NED)
The board should consist of a balance of executive and non-executive directors and should be of sufficient size that there is a balance
of skills and experience in order to effectively manage the company.
Roles of NEDs
Higgs Report: Summary of the role of non-executive directors
1.
Strategy: as part of the board, they assist with determining the strategy of the company. It is likely that this is led by the executive
directors but NEDs are involved in this process by challenging strategy and questioning other options before the strategy is
implemented.
2.
Performance: NEDs should scrutinize the performance of the executive directors in meeting goals and objectives. The NEDS lead
the process of replacing and recruiting directors through the nomination committee.
3.
Risk: NEDs should satisfy themselves that the financial information is accurate and the financial controls and risk management
systems are effective. They play a role in ensuring that the company’s systems of financial reporting, internal control and risk
management are operating satisfactorily through the audit committee.
4.
People role:
a) Directors and managers: NEDS are responsible for determining appropriate levels of remuneration for executives and are key
figures in appointment and removal of senior managers and succession planning
b) Shareholders: should take responsibility for shareholders concerns and attend regular meetings with shareholders.
Independence
NEDs operate as a ‘corporate conscience’ and therefore need to be independent.
1. They should not have been an employee within the last five years.
2. No business, financial or other connections with the company during the past few years (again, the period varies by country). This
means that, for example, the NED should not have been a shareholder, an auditor, an employee, a supplier or a significant
customer.
3. They should not have any family members in senior positions at the company.
4. Any NED who has been on a board for more than nine years is assumed to no longer be independent. (Directors’ appointments
are voted on by shareholders on a three-yearly cycle, so nine years is relevant as it gives three terms as a director).
5. NEDs are only remunerated with a fee for director duties – no profit share or share options.
6.
7.
They cannot hold cross-directorships this term is used to explain a potential relationship between the executive directors of two
companies. It occurs when an executive director of one company operates as a non-executive in another company, and there is
an identical reciprocal arrangement. Hence the directors are non-executives in each other’s companies. This being the case, both
directors are in a position to influence the others’ executive rewards assuming they are both serving members of the
remuneration committee (as is common for all non-executive directors).
NED contracts sometimes allow them to seek confidential external advice (perhaps legal advice) on matters on which they are
unhappy, uncomfortable or uncertain.
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NEDs with experience from the same industry
-
Higher technical knowledge of issues in that
industry
A network of contacts
An awareness of what the strategic issues are
within the industry
Might reduce the ned’s ability to be objective
NEDs with experience from a different industry
-
-
A fresh pair of eyes to a given problem
A lack of previous material business relationships will usually mean
that a NED will not have any previous alliances or prejudices that will
affect his or her independence
They will be lesser biased towards people, policies and practices in
that industry
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The International Corporate Governance Network (ICGN)
Standards of corporate governance to which all companies should aspire.
Corporate objective
-
Must manage effectively the governance, social and environmental aspects of its activities as well as the financial.
Must also include the effective management of its relationships with stakeholders such as employees, suppliers, customers, local
communities and the environment as a whole.
Corporate board
Directors fulfil fiduciary duty
Effective board behavior
-
Act in investors’ economic interest
Transparency
Avoid conflict of interest
Be accountable to the shareholders
Chairman of the board works to create and maintain a culture of openness and constructive
challenge which allows a diversity of views to be expressed.
-
There is a sufficient mix of relevant skills, competence, and diversity of perspectives within the
board to generate appropriate challenge and discussion.
-
NEDs are sufficiently objective in relation to the executives and dominant shareholders to
provide robust challenge.
-
NEDs have enough knowledge of the business and sources of information about its operations
to understand the company sufficiently to contribute effectively to its development.
-
The board is provided with enough information about the performance of the company and
matters to be discussed at the board, and enough time to consider it properly.
-
The board is conscious of its accountability to shareholders for its actions.
Beyond ICGN
Diversity means having a range of many people that are different from each other. There is, however,
no uniform definition of board diversity. Traditionally speaking, one can consider factors like age,
race, gender, educational background and professional qualifications of the directors to make the
board less homogenous. Some may interpret board diversity by taking into account such less tangible
factors as life experience and personal attitudes.
In short, board diversity aims to cultivate a broad spectrum of demographic attributes and
characteristics in the boardroom. A simple and common measure to promote heterogeneity in the
boardroom – commonly known as gender diversity – is to include female representation on the
board.
Benefits of Diversity in the Workplace
 More effective decision making: by reducing the risk of 'groupthink', paying more attention to
managing and controlling risks as well as having a better understanding of the company’s
consumers.( group think: a psychological behaviour of minimising conflicts and reaching a
consensus decision without critically evaluating alternative ideas in a cohesive in-group
environment.)
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
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Better utilisation of the talent pool: One of the problems of searching for suitable directors lies
on the limited number of candidates – there is especially a tendency to search for board
members with typical characteristics, such as male directors. If directors expand the pool of
potential candidates by considering more diversified attributes, like women and ethnic
minorities to be included in the boardroom, it will alleviate the problem of 'director shortage'
and therefore better utilise the talent pool.
Enhancement of corporate reputation and investor relations by establishing the company as
a responsible corporate citizen. It can enhance corporate reputation through signalling
positively to the internal and external stakeholders that the organisation emphasises diverse
constituencies and does not discriminate against minorities in climbing the corporate ladder.
This may somehow indicate an equal opportunity of employment and the management’s
eagerness in positioning the organisation as a socially responsible citizen.
A board with a broad range of experience is more likely to develop independence of mind and
a probing attitude. It can also enhance corporate decision-making by having sensitivity to a
wider range of risks to its reputation.
Studies suggest that female non-executive directors contribute more effectively than male
nonexecutives, preparing more conscientiously for board meetings and being more prepared to
ask awkward questions and to challenge strategy. Studies also suggest that a gender-balanced
board is more likely to pay attention to managing and controlling risk.
Surveys suggest that in the UK women hold almost half the wealth and are responsible for about
70% of household purchasing decisions. As women are often the customers of the company’s
products, having more women directors can improve understanding of customer needs. Large
companies in consumer-facing industries have a higher proportion of women on their boards
than big companies in other sectors.
COSTS OF DIVERSIFYING THE BOARD
Diversifying the board is not without costs. Though a board is inherently subject to conflict as it is
formed by individuals collectively, having a diverse board may potentially increase friction between
members, especially when new directors with different backgrounds are stereotyped by existing
members as atypical. This may split the board into subgroups, which reduces group cohesiveness
and impairs trust among members, leading to reluctance to share information within the board.
Another danger of board diversity is sometimes referred to as tokenism. Theoretically, as mentioned
in the previous section, the minorities in the boardroom are said to contribute to value creation of
the organisation by their unique skills and experiences; however, in practice, they may feel that their
presence is only to make up the numbers required by the external stakeholders. They may then tend
to undervalue their own skills, achievements and experiences, which demeans their potential
contribution to the organisation.
Further, the board may potentially ignore the underlying important attributes of successful directors
as a sacrifice to meet the requirement of board diversity. The board needs to pay special attention
to these costs when implementing measures to diversify the board.
Page 16
Responsibilities of the board
The board’s duties and responsibilities and key functions, for which they are accountable, include:
Reviewing, approving and guiding corporate strategy, major plans of action, risk policy, annual
budgets and business plans; setting performance objectives; monitoring implementation and
corporate performance; and overseeing major capital expenditures, acquisitions and
divestitures.
Overseeing the integrity of the company’s accounting and financial reporting systems, including
the independent audit, and that appropriate systems of control are in place; in particular,
financial and operational control, and compliance with the law and relevant standards.
Ensuring a formal and transparent board nomination and election process.
Selecting, remunerating, monitoring and, when necessary, replacing key executives and
overseeing succession planning.
Aligning key executive and board remuneration with the longer term interests of the company
and its shareholders.
Overseeing a formal risk management process, including holding an overall risk assessment at
least annually.
Monitoring and managing potential conflicts of interest of management, board members,
shareholders, external advisors and other service providers, including misuse of corporate
assets and related party transactions.
Monitoring the effectiveness of the company’s governance practices and making changes as
needed to align the company’s governance system with current best practices.
Carrying out an objective process of self-evaluation, consistently seeking to enhance board
behaviour and effectiveness.
Overseeing the process of disclosure and communications, and being available for dialogue with
shareholders.
Composition and structure of
the board
Skills and experience :The board should consist of directors with the requisite range of skills,
competence, knowledge, experience and approach, as well as a diversity of perspectives, to set the
context for appropriate board behavior and to enable it to discharge its duties and responsibilities
effectively
Time commitment: All directors need to be able to allocate sufficient time to the board to perform
their responsibilities effectively.
Composition of board
committees
Independence: Have a majority of independent NEDs to exercise judgments in the best interest of
the company, without any influence
By establishing such subcommittees, a board does not delegate its obligations in respect of the issues
covered.
Subcommittees are established to assist the board to consider effectively these issues which require
special competence and independence. Thus the subcommittees should report regularly and
formally to the board as a whole, and the board as a whole will need to challenge and debate key
issues in order to assure itself that the issues are handled appropriately.
Page 17
Beyond ICGN
NOMINATION COMMITTEE-ROLES
1.
Oversees board appointments to maintain a balance in the board.
2.
Establishes desirable size of the board (bearing in mind the current and planned size and
complexity of the operations, skills needs, cost constraints, strategies etc.)
3.
It needs to consider a balance between executives and independent NEDs And skills, knowledge
and expertise of the current board
4.
It considers the need to attract board members from diverse backgrounds so that the board
represents the society in which the organization operates(diversity in the board)
5.
Succession planning: It acts to meet the needs for continuity and succession planning, especially
among the most senior members of the board. CEO succession: The search for a potential
replacement CEO begins immediately after a new CEO is appointed!)
6.
To ensure continuity of required skills and retention of directors, the nomination committee:
- Arranges induction training of all directors
- Arranges CPD activities for all directors
REMUNERATION COMMITTEE-ROLES
1.
Determines remunerations policy on behalf of the board and the shareholders(pay scales
applied to directors’ packages, the proportions of different types of reward within the overall
package and the periods in which performance related elements become payable)
2.
Makes individual director’s packages (ensure fair but not excessive-Contents of the package
have been discussed separately later)
3.
It reports to the shareholders on the outcomes of their decisions, usually in the corporate
governance section of the annual report (usually called Report of the Remunerations
Committee). This report, which is auditor reviewed, contains a breakdown of each director’s
remuneration and a commentary on policies applied to executive and nonexecutive
remuneration.
4.
They may also be asked to make severance packages.
5.
Where appropriate and required by statute or voluntary code, the committee is required to be
seen to be compliant with relevant laws or codes of best practice.
RISK COMMITTEE-ROLES
The primary function of a risk committee is to recommend to the board a sound system of risk
oversight, management and internal control.
Its roles include:
1. The recommendation to the board of a risk management strategy which identifies, assesses,
manages and monitors all aspects of risk throughout the company.
2. Reviewing reports on key risks prepared by business operating units, management and the
board, and then assessing the effectiveness of the company’s internal control systems in dealing
with them.
Page 18
3.
4.
5.
Advising the board on risk appetite and acceptable risk tolerances when setting the company’s
future strategic direction.
Advising the board on all high-level risk matters and monitoring overall exposure to risk and
ensuring it remains within limits set by the board.
Informing shareholders, and other key stakeholders, of any significant changes to the company’s
risk profile.
Although not a prescribed requirement in corporate governance codes and legislation, a risk
committee would ensure the robust oversight of the management of risk throughout the company.
In its absence, its duties and responsibilities would be discharged by the mandatory audit committee.
AUDIT COMMITTEE-ROLES
( entirely NEDs)- At least one NED with recent relevant financial experience
- monitors integrity of financial statements
1. Monitoring the integrity of the
(including reviewing significant judgments)
financial statements and any formal - checks the clarity and completeness of the
announcements relating to financial
disclosures in the financial statements.
performance.
2.
Reviewing internal financial controls and, unless there is a separate board risk committee,
reviewing the company’s internal control and risk management systems.
3.
Monitoring and reviewing the
effectiveness of the internal audit
function.
If there are no internal auditors, the committee
should review each year whether there is a need for
such a service; if it concludes there is not, it should
explain why in the annual report.
Should approve the appointment and removal of the
head of internal audit.
Monitors effectiveness of Internal audit department,
review their plan and ensure their recommendations
are actioned
Ensures Internal Auditors are accountable to AC and
preserve their independence.
4.
Making recommendations to the
board
in
relation
to
the
appointment, re-appointment and
removal of the external auditor and
approve the remuneration and
terms of engagement of the auditor;
Page 19
The committee has some specific duties in relation to
external auditors. It recommends the appointment
of auditors to the board and approves their fees and
the other terms on which they are retained. If there
is dissatisfaction with their performance, it may
recommend their replacement. In the very unlikely
event that the board disagrees with the committee,
the arguments on both sides need to be put forward
to shareholders in the annual report and AGM
papers.
Role of the chair
o
o
Independent NED
NOT a part of
remuneration
committee
5.
Reviewing
the
auditor’s
independence and objectivity;
6.
Developing and implementing the
non-audit services policy.
7.
Whistleblowing arrangements
The committee must keep a close check on the
external auditors’ independence and objectivity. Is it
time for a change, if only to get fresh thinking and a
new perspective on some old issues? Are the auditors
getting too close to management?
Where non-audit services are performed, disclosures
are required in the annual report, and the committee
must explain how auditor objectivity and
independence are to be preserved.
It needs to be confident that there are opportunities
throughout the company for employees to act as
‘whistleblowers’ and report improprieties and
abuses. This may mean giving employees contact
details for committee members for use if other
avenues fail.
To enable the directors to generate the effective board debate and discussion and to provide the
constructive challenge which the company needs, the Chairman of the board should:
Set the right context in terms of board agenda,
Be responsible for the provision of information to directors, and open boardroom discussions
Work to create and maintain the culture of openness and constructive challenge which allows a
diversity of views to be expressed.
The chair should be available to shareholders for dialogue on key matters of the company’s
governance and where shareholders have particular concerns.
Beyond ICGN
An effective non-executive chairman:
- Would bring scrutiny to the executive management and corrupt activities;
- Would ensure the board focuses on pursuing value for money for the shareholders;
- Would encourage the establishment of internal controls and an internal audit function;
- Would hold other directors to account;
Lead independent director
-
Would be able to influence the culture and ‘tone from the top’, making a higher standard of
ethical behaviour feel more normal in the company
-
Would promote openness and debate about strategic ideas and ensure that accurate and clear
information was freely circulated in the company.
-
Would give concerned directors, someone to communicate with about their concerns and give
them someone to confide in.
Even where the chair was independent on appointment, the scale of the role brings him or her closer
to the executive management than the rest of the board, and the lead independent director’s role is
to ensure that the independent element of the board has leadership where this raises issues.
The lead independent is also a crucial conduit for shareholders to raise issues of particular concern
and should make him- or her-self available to shareholders appropriately in order to fulfil this role.
Page 20
Company secretary
All board members must receive the information that they need properly to understand the
company’s operations and progress, and also need a channel to seek independent expertise and
advice where appropriate.
The company secretary acts as a crucial resource for the chair and for the board as a whole, providing
practical guidance as to their duties and responsibilities under relevant law and regulation and
playing a critical role in ensuring that the board receives the information and independent advice
that it needs.
Appointment of directors
Board and director
development
and evaluation
-
Retirement by rotation: Retirement by rotation is an arrangement in a director’s contract that
specifies his or her contract to be limited to a specific period (typically three years) after which
he or she must retire from the board or offer himself (being eligible) for re-election.
-
The director must be actively re-elected back onto the board to serve another term. The default
is that the director retires unless re-elected.
-
Shareholders should have a separate vote on the election of each director, with each candidate
approved by a simple majority of shares voted.
-
Information on the appointment procedure should also be disclosed at least annually.
-
Shareholders should be able to nominate directors to the board both by proposing prospective
candidates to the appropriate board committee.
-
Information on board nominees: Companies should disclose, at least annually, information on
the identities, core competencies, professional or other backgrounds, recent and current board
and management mandates at other companies, factors affecting independence, board and
committee meeting attendance and overall qualifications of board members as well as their
shareholding in the company so as to enable investors to weigh the value they bring.
-
Companies should also disclose the process of succession planning.
-
Have in place a formal process of induction for each new director so that they are wellinformed about the company early in their tenure and are able to perform effectively from as
early as possible.
-
Directors should also be enabled and encouraged to participate in ongoing training and
education to assist them to fulfil their role most effectively.
-
Every board of directors should evaluate rigorously its own performance, the performance of
its committees and the performance of individual directors on a regular basis. It should
consider engaging an outside consultant to assist in the process.
-
The performance of individual directors should be assessed at least prior to each proposed renomination.
-
Companies should disclose the process for such evaluations and the principal lessons learned
from the evaluation of the board and its committees.
Page 21
Beyond ICGN
Performance Appraisal
Appraisal should be carried out once a year and measured against the following criteria
- Performance against objectives
- Contribution to development strategy
- Contribution to effective risk management
- Contribution to development of corporate philosophy (values, ethics, social responsibilities)
- Appropriate composition of boards and committees
- Responses to problems or crises
- Quality of information
- Fulfilling legal requirement
Induction of Directors
Induction is a process of orientation and familiarisation that new members of an organisation
undergo upon joining. It is designed to make the experience as smooth as possible and to avoid
culture or personality clashes, unexpected surprises or other misunderstandings.
The chairman should ensure that new directors receive a full, formal and tailored induction on joining
the board.
If a non-executive director is joining the board, the company should invite major shareholders to
meet the director.
Objectives of induction
 Enable the new director to become familiar with the norms and culture
 To give the directors an understanding of the nature of the company and its business model
 To communicate practical procedural duties to the new director including company policies
relevant to a new employee
 To reduce the time taken for an individual to become productive in their duties.
 To help them gain an understanding of key stakeholders and relationships including those with
auditors, regulators, key competitors and suppliers
 To establish and develop the new director’s relationships with colleagues, especially those with
whom he or she will interact on a regular basis. The importance of building good relationships
early on in a director’s job is very important as early misunderstandings can be costly in terms
of the time needed to repair the relationship.
Elements of induction training
• Brief outline of the role of a director and a summary of responsibilities;
• Company guidelines on directors’ share dealings, procedure for obtaining independent advice,
and policies and procedures of the board;
• Current strategic plan, budgets and forecasts for the year together with the three and five year
plans;
• Latest annual report and accounts;
• Key performance indicators;
• Corporate brochures, mission statement, and other reports issued by the company;
• Minutes of the last few board meetings;
• Description of board procedures;
• Details of all directors, company secretary and other key executives;
• Details of board subcommittees and minutes of meetings if the director is to join any committee.
Page 22
Continuing professional development (CPD)
CPD is the systematic maintenance, improvement and broadening of knowledge and skills, and the
development of personal qualities necessary for the execution of professional and technical duties
throughout an individual’s working life.
Objectives of CPD
- Maintain knowledge and skills bases ( and so improve overall performance in their roles)
- By keeping professional qualifications up-to-date, directors can improve their competence in a
wider context benefiting both themselves and professional roles. CPD can improve and broaden
knowledge and skills to support future professional development ( Can get latest skills and
knowledge about laws and regulations, best practices, new developments etc.)
- By updating his knowledge and skills on existing and new areas of business practice, like tackling
internet fraud, directors are able to contribute towards the development of the company. In
effect, CPD can act as a catalyst for improving and enhancing business performance.
By undertaking CPD, directors demonstrate a commitment to their professions and their
company.
Features of effective CPD
Individual professionals should be responsible for organising and conducting their own CPD so that
it meets their particular needs. This can be achieved by determining what form of training or other
intervention delivers the necessary output.
ACCA operates a professional development matrix to assist its members analyse their roles and
responsibilities, and then prioritise learning needs.
The matrix comprises four elements:
Planning. The individual should analyse his current role and then identify the competencies which
are needed to deliver the required level of performance for that role. A development plan is then
devised which involves prioritising elements of the role which need most attention, but also
addressing any emerging areas.
Action (inputs). The actual CPD undertaken should satisfy the following requirements:
– Relevance of the actual learning activity to the role;
– Understanding how the learning outcomes will apply to the workplace;
– Providing evidence that the learning activity was undertaken, and in part independently verified.
Results (outputs). On completion the individual should compare the results of his learning activities
against his development plan, and self-assess whether the CPD has met his pre-determined
objectives.
Reflection. The individual should examine the evolving requirements of his role, as these will become
a key feature of future planning. This ensures that all CPD he undertakes in the future remains
relevant to his role and the needs of the company and its clients.
Related party transactions
and conflicts
-
Have a process for reviewing and monitoring any related party transaction.
-
A committee of independent directors should review significant related party transactions to
determine whether they are in the best interests of the company and if so to determine what
terms are fair.
Page 23
Remuneration
-
The company should disclose details of all material related party transactions in its annual
report/integrated report.
-
Companies should have a process for identifying and managing conflicts of interest directors
may have. If a director has an interest in a matter under consideration by the board, then the
director should not participate in those discussions and the board should follow any further
appropriate processes.
-
Executive Management: appropriately aligned with the drivers of value-creation over timescales appropriate both or a company’s business and for its shareholders.
-
Pay for non-executive directors: Normally a fixed fee-No performance based awards!
Transparency: The Company should make substantive disclosure of all significant aspects of
remuneration policies and structures for key executives, and in particular the performance
metrics which are in place to incentivise value-creation, to incorporate risk management
considerations and to align the interests of executives with those of shareholders. Disclosure
should include how the awards made in a given year were determined and how they are
appropriate in the context of the company’s underlying financial performance. The company
should also disclose any advisers to the remuneration committee and whether they are deemed
independent.
-
Share ownership: have and disclose a policy concerning ownership of shares of the company by
senior managers and executive directors
-
Shareholder approval and dialogue: The equity-linked remuneration for key executives should
always be subject to shareholder approval. Where a significant change to remuneration
structures is proposed or where significant numbers of shareholders have opposed a
remuneration resolution, the board should proactively seek dialogue with shareholders with the
aim of addressing their concerns.
Beyond ICGN
Components of an ED’s remuneration package
Key points to consider:
Remuneration should be sufficient to Attract, Retain and Motivate
No individual should have a say in setting his/her own remuneration
DO NOT reward for failure
Basic salary
When setting a director’s salary, the remuneration committee should
consider what other directors doing similar jobs in similar setting are
getting paid.
Performance-related
elements
Directors’ bonus schemes can be useful as a motivating tool. They are a
means of ensuring that directors are working towards the company’s
objectives. For example, if the company is trying to grow, then a bonus
scheme should be set up to reward directors for company growth.
Bonuses are often given for increased profits, increased market share,
increased sales, reduced costs, increased margins and so on. However,
bonuses could also be given for non-financial measures, for example,
reducing employee turnover or better customer service or
Page 24
environmental targets such as reducing pollution. This may avoid the
focus on inflating short-term profits.
Bonus schemes tend to be short term in nature and focus on one
financial year. This may not be sufficient a time frame for the directors
to achieve what shareholders want them to.
Share options
Benefits in
kind/perks
(transport, health
provisions, holidays,
loans)
Retirement benefits
Share options are contracts that allow the executive to buy shares
at a fixed price or exercise price.
- If the stock rises above this price the executive can sell the shares at
a profit.
- Share options give the executive the incentive to manage the firm in
such a way that share prices increase, therefore share options are
believed to align the managers' goals with those of the shareholders.
The remuneration committee should consider the benefit to the
directors and the cost to the company of the complete package.
-
All awards are ultimately given by the shareholders and should be viewed
in relation to performance achieved by the director. A retirement benefit
such as lifetime use of the company plane or a sizeable pension payout
could be awarded. The company makes payments into directors’ pension
schemes so on retirement the director will have an income. Usually
contributions are a fixed percentage of the directors’ salary. The
Combined Code suggests that only a director’s basic salary is
pensionable.
COMPENSATION
In some situations a director’s contract will be terminated before the end of its term. This may be
the case if a director is not performing as the company would expect. A company must consider the
compensation commitments if this were to happen. There have been many cases in the past where
poorly performing directors have received large payouts when their contracts have been terminated
and companies must avoid rewarding poor performance. The notice period of a director’s contract
should be set at one year or less.
Why do shareholders support a link between rewards and performance?
The agency problem is reduced when the interests of directors and shareholders are aligned. One
way of doing this is to make the rewards of directors linked to the performance of the business they
are managing. Shareholders tend to prefer this approach for several reasons.
It motivates the directors in that they make more income (usually in performance bonuses or share
options) when the company does well. Typical measures upon which performance bonuses are
based include return on equity or performance based on the nature of the company’s operations
such as sales, internal control compliance or other, context-specific measures. In each case,
improvement is in line with the interests of shareholders in creating shareholder value.
It encourages directors to think about creating shareholder value, as it is this which provides directors
with higher bonuses or the maximisation of the value of share options. This includes retaining talent,
operating efficiently in resource markets and innovating to produce efficiencies and controlling
internal activities. Any increase in organisational efficiency or effectiveness will serve the interests
of shareholders and also potentially add to the bonus for the director and, accordingly, performancerelated rewards serve the interests of both shareholders and directors.
It makes directors more accountable to shareholders. The issue of how directors remain strongly
accountable to shareholders is one of the key challenges in corporate governance. By forcing
Page 25
directors to create shareholder value, the accountability link is strengthened as they are motivated
to think in terms of maximising shareholder value. Directors are less likely to behave in ways which
reduce shareholder value, and are more likely to think about how to maximise their own value to
shareholders.
Corporate Culture
-
The board is responsible for overseeing the implementation and maintenance of a culture of integrity.
-
Companies should develop a code of ethics and/or a code of conduct which will apply across the organisation. There should be
appropriate training programmes in place to enable staff to understand such codes and apply them effectively and sufficient
support and compliance assessments to assist employee performance in these matters.
-
Bribery and corruption: the board should create and sustain appropriately stringent policies and procedures to avoid company
involvement in any such behaviour.
-
Employee share dealing: should have clear rules regarding any trading by directors and employees in the company’s own
securities. Among other issues, these must seek to ensure that individuals do not benefit from knowledge which is not generally
available to the market.
-
Compliance with laws and regulations.
-
Whistle-blowing :The board should ensure that the company has in place a mechanism whereby an employee, supplier or other
stakeholder can without fear of retribution raise issues of particular concern with regard to potential or suspected breaches of
a company’s code of ethics or conduct, or any other failure to comply with laws or standards.
Risk management
-
Boards need to understand and ensure that proper risk management is put in place for all material and relevant risks that the
company faces.
-
Risk identification should adopt a broad approach and not be limited to financial reporting; this will require consideration of
relevant financial, operational and reputational risks.
-
The board should also determine the company’s risk-bearing capacity and the tolerance limits for key risks, to avoid the company
exceeding an appropriate risk appetite.
-
If necessary the board should seek independent external support to supplement internal resources.
-
Board oversight: Companies should maintain a documented risk management plan. At least annually, the board should approve
the risk management plan which it is then the responsibility of management to implement.
-
Disclosure: Companies should disclose sufficient information about their risk management procedures to reassure their
shareholders that they are appropriately robust. Disclosures should include the handful of particularly key risks which the
company faces.
Page 26
Audit
Companies should aspire to robust, independent and efficient audit processes using external auditors in combination with the
internal audit function.
Where the board decides not to establish an internal audit function, full reasons for this should be disclosed in the annual report, as
well as an explanation of how adequate assurance has been maintained in its absence.
The internal audit function should have a functional reporting line to the audit committee chair. The audit committee should be
ultimately responsible for the appointment, performance assessment and dismissal of the head of internal audit or outsourced
internal audit provider.
Audit committee:
The company’s interaction with the external auditor should be overseen by the audit committee of the board on behalf of the
shareholders.
The audit committee seeks to assure itself and shareholders of the quality of the audit carried out by the auditors as well as
overseeing their independence.
The audit committee should maintain oversight of key auditing decisions as well as key accounting decisions.
The audit committee should recommend to the board for consideration and acceptance by shareholders the appointment,
reappointment and, if necessary, the removal of the external auditors.
The board should disclose and explain this process and the process by which the audit committee assures itself of the ongoing
independence of the external auditors.
Disclosure and transparency
The company should ensure there is transparent and open communication about its aims, its challenges, its achievements and its
failures.
In addition to financial and operating results, company objectives, risk factors, stakeholder issues and governance structures, the
disclosures should include a description of the relationship of the company to other companies in the corporate group, data on major
shareholders and any other information necessary for a proper understanding of the company’s relationships with its public
shareholders
Companies should disclose relevant and material information concerning themselves on a timely basis, in particular meeting market
guidelines where they exist, so as to allow investors to make informed decisions about the acquisition, ownership obligations and
rights, and sale of shares.
The reporting of relevant and material non-financial information is an essential part of the disclosure required to enable shareowners
and investors to make informed decisions on their investments
Shareholder rights
Companies should publicly disclose their corporate charter or articles of association in which, among other things, the rights of
shareholders are clearly set out. Any changes to these should be subject to shareholder approval.
Boards should treat all the company’s shareholders equitably.
Boards should do their utmost to enable shareholders to exercise their rights, especially the right to vote, and should not impose
unnecessary hurdles.
Unequal voting rights : Companies’ ordinary or common shares should feature one vote for each share. Divergence from a ‘oneshare, one-vote’ standard which gives certain shareholders power disproportionate to their equity ownership should be both
disclosed and justified.
Shareholder participation in governance: Shareholders should have the right to participate in key corporate governance decisions,
such as the right to nominate, appoint and remove directors on an individual basis and also the right to appoint the external auditor.
Page 27
Pre-emption: New issues of shares should be made on a pre-emptive basis that is offered proportionately to existing shareholders.
Shareholders should be provided with the right to ask questions of the board, management and the external auditor both before
and at meetings of shareholders, including questions relating to the board, its governance and the external audit.
The exercise of ownership rights by all shareholders should be facilitated, including giving shareholders timely and adequate notice
of all matters proposed for shareholder vote.
Equal effect should be given to votes whether cast in person or in absentia and meeting procedures should ensure that all votes are
properly counted and recorded.
Companies should make a timely announcement of the outcome of a vote and publish voting levels for each resolution promptly
after the meeting.
Shareholders should be afforded rights of action and remedies which are readily accessible in order to redress conduct of a company
which treats them inequitably.
Every company should maintain a record of the registered owners of its shares or those holding voting rights over its shares.
Shareholders should be able to review this record of registered owners of shares or those holding voting rights over shares.
Shareholder responsibilities
Institutional shareholders must recognise their responsibility to generate long term value on behalf of their beneficiaries, the savers
and pensioners for whom they are ultimately working.
Institutional shareholders should be ready, where practicable, to enter into a dialogue with companies in order to achieve a common
understanding of objectives.
Pension funds and those in a similar position of hiring fund managers should insist that fund managers put sufficient resource into
governance analysis and engagement which deliver long term value.
Shareholders should take governance factors into account and consider the riskiness of a company’s business model as part of their
investment decision- making. Moreover, shareholders should develop and improve their capacity to analyse and influence
governance risks and opportunities at investee companies for the benefit of their own beneficiaries, as well as acting with fiduciary
responsibility to promote better governance at those companies.
Shareholders should contribute to the improvement in the functioning of boards of directors, to strengthening the accountability of
management and to promoting information disclosure and transparency.
Where appropriate, shareholders should collaborate where this will enable them to achieve results most effectively.
Shareholders should actively vote at Annual and Extraordinary General Meetings.
Institutional shareholders should publicly disclose their voting policies and practices.
They should recognise that they lose their voting rights when they lend stock. In order for votes to be cast, lent stock needs to be
recalled.
Institutional shareholders should consider their own internal corporate governance, ensuring the proper oversight of their
management, acting in the interests of their beneficiaries and managing conflicts of interest.
Page 28
The Concepts Underpinning Governance
Corporate governance is based on a series of underlying concepts
Fairness: It suggests that a business respects the rights and views of all stakeholders with legitimate interests. To be fair is to recognise
many interests and to weigh each one against others in an equitable and transparent way.
Transparency: Transparency is a default position of openness and full information provision rather than concealment. A
transparent organisation is one in which all available information is provided unless there is a strong and defensible reason
for hiding a part or all of it.
Independence: Objectivity is a state or quality that implies detachment, lack of bias, not influenced by personal feelings, prejudices or
emotions.All those in a position of monitoring should be independent of those/what they are monitoring. It requires an action to be
based on objective criteria which service the interests of the firm, its shareholders and other legitimate stakeholders.
 Non-executive directors should be independent of the executive directors, and of company operations as their role is to monitor
performance.
 External auditors should be independent of the company, especially its accounting department and processes.
 Internal auditors should be independent of the company, as they are likely to be involved in monitoring systems throughout the
company’s operations.
Honesty: This is not just telling the truth, it also means finding out the truth, not ignoring it and not ‘turning a blind eye’. Overall,
corporate governance involves organizations being transparent and honest in all their dealings, be it customers, suppliers, investors,
employees or any type of stakeholder and shareholder. Honesty is important in building stakeholders’ confidence that their interests
are protected. Probity means honesty and making decisions based on integrity.
Probity: Probity means honesty and making decisions based on integrity. Probity is a fundamental corporate governance principle and
is concerned with telling the truth and thereby not misleading shareholders or any other stakeholders. For an individual, it suggests
that they should act ethically with integrity, by always conducting their business dealings in an honest and straight forward manner.
Responsibility: Responsibility means to accept liability for one’s actions. This liability relates to an acceptance of a penalty that is
deemed necessary in order to atone or pay for the action carried out. Responsibility also relates to accepting a duty to act on behalf
of an external party Directors should understand and accept their responsibility to shareholders and other stakeholders. They should
act in their best interests and be willing to accept the consequences if they fail in this responsibility.
Accountability: Directors must be willing to be held accountable for their actions so they must accept responsibility for the roles
entrusted to them. Accountability is a key relationship between two or more parties. It implies that one party is accountable to, or
answerable to, another. This means that the accountable entity can reasonably be called upon to explain his, her or its actions and
policies.
Reputation: Reputation concerns the perceptions with which an organisation is viewed by a range of stakeholders. A strong reputation,
perhaps for service delivery and robust governance, can be a strategic asset, whilst a weak reputation can be a strong disadvantage.
Reputation is one of the important underlying principles in corporate governance. Because there is a separation of ownership and
control in many organisations, the reputation which the management of an organisation enjoys with its principals is important in
directors or trustees being given the licence to manage the organisation as they see fit, for the long-term strategic benefit of the
principals. Reputation is also important for the positioning of an organisation in its environment in terms of society’s trust in the
organisation as a buyer, supplier, employer, etc.
Judgment: Because corporate governance is based on decision-making, the ability to make sound and balanced judgements is an
important underlying principle. In many cases, judgement is the ability to decide between two credible courses of action, and making
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finely-tuned calculations in so doing. The decision-maker’s personal attitudes to risk, ethics and the timescale of likely returns are
likely to be important factors in how a person judges a given decision.
Integrity: This is quite a general term and has a crossover with some of the other terms above. Integrity means honesty, fair-dealing,
presenting information without any attempt to bias opinion and in a more general sense ‘doing the right thing’.
Integrity goes beyond honesty and the law and brings moral and ethical issues into play. Cadbury Report Summary: ‘Integrity means
straightforward dealing and completeness. What is required for financial reporting is that it should be honest and should present a
balanced picture of the state of the company’s affairs. The integrity of reports depends on the integrity of those who prepare and
present them’ At times accountants will have to use judgment or face a situation which is not covered by regulations or guidance and
on those occasions integrity is particularly important.
Innovation: this means discovering new idea, developing them and commercializing them for profit. This requires long term
commitment of resources .Although innovation is risky, it is necessary for the business to grow and compete successfully.
Skepticism: this means a critical assessment of information, challenging information and being alert to possibilities of
manipulation/fraud.
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Reporting to stakeholders
Annual Report
Several corporate governance codes of practice prescribe the content for a report as part of an annual report. Although these vary
slightly, the following are prominent in all cases.
1.
2.
3.
4.
5.
6.
7.
8.
Financial statements
Independent Auditor’s report
Chairman’s statement / Operating and financial review statement (a narrative statement about the organiisation’s past
performance and future plans)
Statement of compliance with corporate governance
Information on the board and its functioning. Usually seen as the most important corporate governance disclosure, this concerns
the details of all directors including brief biographies and the career information that makes them suitable for their appointment.
Information on how the board operates, such as frequency of meetings and how performance evaluation is undertaken is also
included in this section. This section is particularly important whenever unexpected or unanticipated changes have taken place
on the board. Investors, valuing transparency in reporting, would always expect a clear explanation of any sudden departures of
senior management or any significant changes in personnel at the top of the company. Providing investor confidence in the board
is always important and this extends to a high level of disclosure in board roles and changes in those roles.
The committee reports provide the important non-executive input into the report. Specifically, a ‘best practice’ disclosure includes
reports from the non-executive-led remuneration, audit, risk and nominations committees. In normal circumstances, greatest
interest is shown in the remuneration committee report because this gives the rewards awarded to each director including
pension and bonuses. The report on the effectiveness of internal controls is provided based in part on evidence from the audit
committee and provides important information for investors.
There is a section on accounting and audit issues with specific content on who is responsible for the accounts and any issues that
arose in their preparation. Again, usually a matter of routine reporting, this section can be of interest if there have been issues of
accounting or auditor failure in the recent past. It is often necessary to signal changes in accounting standards that may cause
changes in reporting, or other changes such as a change in a year-end date or the cause of a restatement of the previous accounts.
These are all necessary to provide maximum transparency for the users of the accounts.
There is usually a section containing other papers and related matters which, whilst appearing to be trivial, can be a vital part of
the accountability of directors to the shareholders. This section typically contains committee terms of reference,
AGM matters, NED contract issues, etc.
Mandatory and voluntary disclosures
Annual reports contain both mandatory and voluntary components.
Mandatory disclosures are those which are required, either by statute (e.g. company law), reporting standard or listing rule. The main
financial statements, with their related disclosure notes, and the audit report fall into this category. These are the statement of profit
or loss, the statement of financial position (balance sheet), the statement of changes in equity and the statement of cash flows. Some
parts of the directors’ report are also mandatory in some jurisdictions as are notes on the composition of the board and the
remuneration of directors. Listing rules in some jurisdictions have increased with regard to disclosure requirements. In many countries,
for example, a substantial amount of corporate governance disclosure is required, as is the ‘comply or explain’ statement. The
presence of the ‘comply or explain’ statement is often mandatory but the content is used to convey the extent of non-compliance
with the relevant corporate governance code.
Voluntary disclosures are those not required by any regulatory constraint but are often made nevertheless. Some of these are made
because of tradition and shareholder expectation (such as the chairman’s statement) whilst others are thought to be concerned with
managing the claims of a company’s wider stakeholders. Some companies include disclosure on objectives so that shareholders can
understand the board’s ideas for the future, possibly including a mission statement or similar. Likewise, social and environmental
Page 31
information is often included, detailing, for example, the company’s policy and objectives with regard to a range of social and
environmental measures. Some risk disclosures are also voluntarily supplied, for example, when a company is adopting an integrated
reporting approach.
Reasons and motivations behind voluntary disclosure
Can help attract capital and maintain confidence in the company
Can act as a marketing tool and help company in a positive light
They help improve public understanding of the structure, activities, corporate policies and performance
Provide regular, reliable and comparable information for shareholders and potential investors
Decrease chances of unethical behaviour
Integrated Reporting<IR>
The aim is to give investors and shareholders a broader picture of how companies make their money and their prospects in the
short, medium and long term.
Designed to be an approach to reporting which accurately conveys an organisation’s business model and its sources of value creation
over time, the IR model recognises six types of capital, with these being consumed by a business and also created as part of its business
processes. It is the way that capitals are consumed, transformed and created which is at the heart of the IR model.
Definition: <IR> demonstrates how organisations really create value:
 It is a concise communication of an organisation’s strategy, governance and performance
 It demonstrates the links between its financial performance and its wider social, environmental and economic context
 It shows how organisations create value over the short, medium and long term
Integrated reporting is about integrating material financial and non-financial information to enable investors and other
stakeholders to understand how an organisation is really performing. An integrated report looks beyond the traditional time frame
and scope of the current financial report by addressing the wider as well as longer-term consequences of decisions and action
and by making clear the link between financial and non-financial value. It is important that an integrated report demonstrates the
link between an organisation's strategy, governance and business model
An Integrated Report should be a single report which is the organization’s primary report – in most jurisdictions the Annual Report or
equivalent.
What does integrated reporting mean for companies?
The IIRC defines the following guiding principles for preparing integrated reports which it argues should:
Convey a company's
strategic focus
Designed to be an approach to
reporting which accurately conveys
an organisation’s business model
and its sources of value creation
over time, the IR model recognises
six types of capital, with these
being consumed by a business and
also created as part of its business
processes. It is the way that
capitals
are
consumed,
transformed and created which is
at the heart of the IR model.
IR is designed to make visible the capitals (resources and
relationships) on which the org depends, how the org uses them and
its impact upon them!
Financial capital: This comprises the pool of funds available to the
business, which includes both debt and equity finance. This
description of financial capital focuses on the source of funds.
Manufactured capital. This is the human-created, productionoriented equipment and tools used in production or service provision,
such as buildings, equipment and infrastructure. Manufactured
capital draws a distinction is between inventory
(as a short-term asset) and plant and equipment (tangible capital).
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Human capital: Is understood to consist of the knowledge, skills and
experience of the company’s employees and managers, as they are
relevant to improving operational performance.
Intellectual capital. This is a key element in an organisation’s future
earning potential, with a close link between investment in R&D,
innovation, human resources and external relationships, as these can
determine the organisation’s competitive advantage.
Natural capital. This is any stock of natural resources or
environmental assets which provide a flow of useful goods or services,
now and in the future.
Social and relationships capital. Comprises the relationships within
an organisation, as well as those between an organisation and its
external stakeholders, depending on where social boundaries are
drawn. These relationships should enhance both social and collective
well-being.
Provide information
that "connects the
dots" across all types
of risk they face from
financial
to
environmental and
social
Be responsive and
inclusive
to
stakeholders
and
their concerns
Contain
concise,
reliable and material
information.
Interrelatedness between the factors that affect the ability to create value
Quality of relationships with key stakeholders and how their legitimate needs and interests are taken into
account
Which should be consistent over time and comparable with other organisations
Benefits of <IR>
Increasingly, businesses are expected to report not just on profit but on their impact on the wider economy, society and the
environment. Integrated reporting gives a ‘dashboard’ view of an organisation’s activities and performance in this broader context.
Systems and Accountability. The need to report on each type of capital would create and enhance a system of internal measurement
which would record and monitor each type for the purposes of reporting. So the need to report on human capital, for example, would
mean that the company must have systems in place to measure, according to the IIRC guidelines, ‘competences, capabilities and
experience and their motivations… including loyalties [and]… ability to lead, manage and collaborate’. These systems would support
the company’s internal controls and make the company more accountable in that it would have more metrics upon which to report.
Decision-making. The connections made through <IR> enable investors to better evaluate the combined impact of the diverse factors,
or ‘capitals’, affecting the business. This in turn should result in better investment decisions by the shareholders, and more effective
capital allocation by the firm.
Reputation. The greater transparjency and disclosure of <IR> should result in a decrease in reputation risk, which in turn should result
in a lower cost of, and easier access to, sources of finance.
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Harmonisation. <IR> provides a platform for standard-setters and decision-makers to develop and harmonise business reporting. This
in turn should reduce the need for costly bureaucracy imposed by central authorities.
Communications. The information disclosed, once audited and published, would create a fuller and more detailed account of the
sources of added value, and threats to value (i.e. risks), for shareholders and others. Rather than merely recording financial data in an
annual report, the IR guidelines would enable the company to show its shareholders and other readers, how it has accumulated,
transferred or disposed of different types of capital over the accounting period. So it would have to report, for example, on the social
capital it has consumed, transformed and created. It might include, for example, the jobs it has created or sustained in its supply chain
and the social value of those jobs in their communities, or how it might operate a system of cultural values for its employees. In
addition and in the same way as for added value, IR would help the organisation to identify, assess and manage its key risks, with this
bringing further benefit to shareholders and others.
Relationships. The information will lead to a higher level of trust from, and engagement with, a wide range of stakeholders. This
emphasis on stakeholder engagement should lead to greater consultation with stakeholder groups and enable the company to handle
their concerns more effectively.
Challenges in IR
– Progress towards IR will happen at different speeds in different countries as regulations and directors duties vary across the globe
– Directors liability will increase as they will be reporting on the future and on evolving issues
– A balance will need to be created between benefits of reporting and the desire to avoid disclosing competitive information
– It will take time to convince management to overcome focus on short term rewards.
The Global reporting Initiative (GRI)
It is a reporting framework which arose from the need to address the failure of the current governance structures to respond to the
changes in the global economy.
It aims to develop transparency, accountability, reporting and sustainable development.
Its vision is that reporting on economic, environmental and social importance should become as routine as financial reporting.
Contents of such a report
1. Vision and strategy(with regards to sustainability)
2. Profile (organizational structure and operations)
3. Governance structures and management systems
4. GRI content index ( to state where the info listed in the guidelines is located in the report)
5. Performance indicators
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Two- Tier Boards
Unitary
In a unitary board, all directors, including all
executive and non-executive directors, are
members.
Two-tier
In a two-tier board, responsibilities are split between a supervisory or oversight
board (chaired by the company chairman), and an operational board (usually chaired
by the chief executive).
All directors are of equal ‘rank’ in terms of
their ability to influence strategy and they
also all share the collective responsibility in
terms of legal and regulatory liability.
The supervisory board decides on strategic issues and the operational board
becomes responsible for executing the strategy determined by the supervisory
board.
There is no distinction in constitution or law
between strategic oversight and operational
management.
Why?
1.
All directors have equal legal status
(equal accountability and responsibility).
This also ensures that the directors work
together and leads to better decision
making.
2.
NEDs are empowered (independent
scrutiny, experience and expertise). They
protect shareholder’s interest.
3.
Lesser likelihood of power abuse by a
small number of directors. This may also
reduce chances of fraud as the directors
are involved in actual management.
4.
Greater intellectual strength (strategies
scrutinized more)
5.
Investor confidence increased through
the above.
1.
2.
Responsibilities between the boards are clearly defined with the supervisory board
responsible for many legal and regulatory compliance issues (such as financial
reporting). Directors on the lower tier (operational board) do not have the same
levels of responsibility or power as those on the supervisory board.
Why?
1. Direct power over management.
2. More stakeholder involvement(therefore their interests protected
3. Clear separation between management and monitoring.
4. Acts as a deterrent to management fraud.
5. The supervisory board is separated from management therefore may be more
independent.
6. As the supervisory board is relatively a smaller board, it may be more effective
in turbulent environments where quicker decision making is required ( it will be
easier and cheaper to arrange meetings!)
Why not?
1.
Lack of accountability of supervisory board.
2.
Slower decision making as there are different stakeholders involved (whose
interest might be in conflict with each other at times)
3.
Owners’ power is diluted as more stakeholders involved.
4.
Agency problems and conflict between the two boards (e.g. management
board doesn’t give complete info to supervisory board etc)
5.
Management board demotivated as they are not involved in decision making
6.
Supervisory board may not understand the operations in detail as they are
isolated from management meetings.
7.
Responsibility is divided (as compared to unitary board where entire board is
held accountable)
Suitability of the board structure depends on the organizational culture, the country it operates in and the size of the organization.
For example, in Germany, employees have a legal right to have a representative in the supervisory board.
Questions may have Anglo/Dutch companies which leads to investor unrest! You will need to analyze which one is suitable. You
may be asked to give a convincing argument in favour of either unitary or two-tier board
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Approaches to Corporate Governance/ Regulating Corporate Governance
Rules based approach
Principles based approach
In a rules-based approach to corporate governance,
provisions are made in law and a breach of any
applicable provision is therefore a legal offence. This
means that companies become legally accountable for
compliance and are liable for prosecution in law for
failing to comply with the detail of a corporate
governance code or other provision.
A principles-based approach works by (usually) a stock market making
compliance with a detailed code a condition of listing.
It is the judiciary rather than investors which monitors
and punishes transgression and this means that there is
no theoretical distinction drawn between major or
minor compliance failures. This is sometimes seen,
therefore, to be clumsy or un-nuanced as a means of
enforcement.
In a rules-based approach such as Sarbanes-Oxley
(‘Sarbox’ or ‘Sox’), the legal enforceability of the Act
requires total compliance in all details. This places a
substantial compliance cost upon affected companies
and creates a large number of compliance advice
consultancies to help companies ensure compliance.
For rules based
Clarity in terms of what you must do
Standardization for all companies
Minimizes chances of going against the rule as noncompliance results in penalties.
If the law is good then it will give shareholders
assurance that a company is being run effectively
Against rules based
Rigidity of law-companies will try to look for loopholes.
Compliance is seen to be an inflexible ‘box ticking’
exercise and this can sometimes mean that companies
lose perspective of what are the most important
aspects of governance and what can sometimes be a
less important provision to comply with.
Disproportionate amounts of management time can be
used in ensuring compliance in an area which may be
less important to shareholders, but which is
nevertheless an important ‘box’ to have ticked.
Costs are incurred in ensuring and demonstrating
compliance. It can be convincingly argued that a
substantial proportion of this cost adds very little value
to shareholders, especially in small companies, and
resources are diverted to demonstrating minor areas of
compliance which could be used more effectively
elsewhere (such as in company operations). Because
compliance on the ‘big’ issues is accorded equal weight
in law to compliance with ‘small’ issues, costs are
Shareholders are then encouraged to insist on a high level of compliance in
the belief that higher compliance is more robust than lower compliance.
When, for whatever reason, a company is unable to comply in detail with
every provision of a code, the listing rules state that the company must
explain, usually in its annual report, exactly where it fails to comply and the
reason why it is unable to comply. The shareholders, and not the law, then
judge for themselves the seriousness of the breach.
If the shareholders are not satisfied with the explanation for lack of
compliance, they can punish the board by several means including holding
them directly accountable at general meetings, by selling shares (thereby
reducing the value of the company) or by direct intervention if a large
enough shareholder.
For principles based
Flexibility:. A principles-based approach is flexible and allows companies to
develop their own approach, perhaps with regard to the demands of their
own industry or shareholder preferences. This places the emphasis on
investor needs rather than legal demands. There may be no reason, for
example, why companies in lower risk industries should be constrained by
the same internal control reporting requirements as companies in higher
risk industries. As long as shareholders recognise and are satisfied with this,
the cost advantages can be enjoyed.
It enables the policing of compliance by those who own the entity and have
a stronger vested interest in compliance than state regulators who monitor
compliance in a legal sense. This places the responsibility for compliance
upon the investors who are collectively the legal owners of the company. It
makes the company accountable directly to shareholders who can decide
for themselves on the materiality of any given non-compliance.
Regulations can be changed more quickly as compared to law
By avoiding laws, businesses may be more willing to contribute to the
ongoing corporate governance debate
By requiring explanations of non-compliance, companies are required to
think carefully about their reasons for not complying and this may make
them decide to follow the code after all.
It reduces the costs of compliance and recognises that ‘one size’ does not fit
all. There may be legitimate reasons for temporary or semi-permanent noncompliance with the detail of a corporate governance code, perhaps
because of size or the company adopting its own unique approach for highly
specific and context-dependent reasons.
Page 36
disproportionately
incurred
in
demonstrating
compliance in some non-critical areas.
Infringements and transgressions are punished by the
state through its judiciary and not by those most
directly affected by such transgressions: the
shareholders. Those in favour of principles-based
approaches argue that there is a greater economic
efficiency in having governance monitored by those
with the strongest stake in gains and losses (the
shareholders), rather than the (in comparison)
inefficient and undiscerning agents of the state. In
many cases, agents of the state are unable to
distinguish between major and minor infringements,
merely noticing that a ‘box’ is ‘unticked’ and pursuing
punishment as a result.
Against principles based
Some companies may present weak or untrue explanations justifying their
actions.
Without the law to back it up, corporate governance becomes harder to
enforce.
There may be confusion over what is compulsory under law and what is
principles-driven under listing rules. A lack of clarity might be present,
especially where compliance expertise is not available to management
(such as in some smaller companies) between legally-required compliance
and listing rules which are subject to comply or explain. This may confuse
some management teams and cause non-compliance borne of lack of advice
and information.
A rules-based approach provides standardisation and prevents any
individual companies gaining competitive or cost advantages with lower
levels of compliance. This creates a ‘level playing field’ in which all
competitors in an industry understand what is required.
Sarbanes Oxley Act (SOX)
In 2002, following a number of corporate governance scandals such as Enron and WorldCom, tough new corporate governance
regulations were introduced in the US by SOX.
SOX is extremely detailed and carries the full force of the law. It includes requirements for the Securities and Exchange Commission
(SEC) to issue certain rules on corporate governance.
Key points
 SOX requires the Chief Executive Officer and Chief Financial Officer to personally attest to the accuracy of the annual report,
quarterly reports, and to the effectiveness of internal control systems. If subsequently it is discovered that the accounts are not
accurate and have to be restated, any bonuses paid to those directors have to be repaid.
 SOX has very detailed requirements on internal control. Companies must have a sound system of internal control and they must
also have suitable documentation in place to provide evidence that the system is working. The directors must do a full review of
the internal control system on an annual basis and report the results of that review in their annual report.
 The auditors have to provide a report to say they have checked the internal control systems over financial reporting and give their
opinion as to whether they are working – this is called an attestation report. The auditors have to do a full audit of internal controls
over the financial reporting system at the company.
 SOX makes audit partner rotation the law
 SOX has a ban on auditors providing a range of other services to their audit clients.
 Under SOX, no loans can be made by a public company to its directors or other senior executives.
 In SOX there is greater protection of whistleblowers. A whistleblower is someone who reports bad practice to those inside or
outside the company so it can be dealt with. This was the case in Enron and WorldCom.
 Must have an audit committee
 Complete transparency and minority interest protection
 Complete disclosure of off-balance sheet transactions.
Page 37
Negative reaction re. Sarbanes Oxley:
Doubling of audit fee costs to organizations.
Onerous documentation and internal control costs.
Reduced flexibility and responsiveness of companies.
Reduced risk taking and competitiveness of organizations.
Limited impact on the ability to stop corporate abuse.
Legislation defines a legal minimum standard and little more.
Insider vs Outsider Systems
OUTSIDER SYSTEM
An outsider system is one where those that own the company are separate from those that run the company.
• Ownership is largely in the hands of non-participating shareholders, e.g. institutions such as pension funds and investment trusts.
• There is a clear gap between those who run the company and those who own it, hence the agency problem.
• Investors have traditionally played a passive role, leaving directors alone to run the company. Over the last 10 years, institutional
investors require more accountability from the board on strategy and how they are running the company. The more involved
these shareholders become, the less of an agency problem there is.
• They have more formal organizational and reporting structures and systems for accountability to external shareholders.
• Generally, larger companies (public companies in particular) are more highly regulated and have more stakeholders to manage
than privately owned, smaller family businesses.
INSIDER SYSTEM
An insider system is one where there are strong links between those that run the company and major stakeholders.
The major shareholders may also feature on the board, for example bankers or employees may have representatives on the board.
Family dominated companies often have a similar structure with family members sitting on the board.
(There are a small number of major shareholders who both own and control the company e.g. government, family members, banks)
Pros
 There are usually lower agency costs associated with insider-dominated businesses owing to there being fewer agency trust issues.
Less monitoring is usually necessary because the owners are often also the managers
 Ethics – it could be said that threats to reputation are threats to family honour and this increases the likely level of ethical
behaviour. Principals (majority shareholders) are able to directly impose own values and principles (business or ethical) directly
on the business without the mediating effect of a board.
 Fewer short-term decisions – the longevity of the company and the wealth already inherent in such families suggest long-term
growth is a bigger issue.
 Decision making may be quicker as there are relatively lesser number of people and they are likely to have the same mindset
Cons
 Minority shareholders and non-included stakeholders may lack protection from the dominant insiders as they have little
representation within the company.
 There is a potential lack of transparency as information is kept inside the company.
 No need to account to public shareholders for either the performance of the company or its postures on such issues as ethics.
 There are relatively lesser formal governance structure, systems, policies and procedures.
 lack of external expertise in the form of an effective non-executive presence (however, some companies employ non-executive
directors (NEDs) on a voluntary and ‘best practice’ basis)
Page 38


‘Gene pool’ and succession issues are common issues in family businesses. It is common for a business to be started off by a
committed and talented entrepreneur but then to hand it on to progeny who are less equipped or less willing to develop the
business as the founder did.
‘Feuds’ and conflict resolution can be major governance issues in an insider-dominated business. Whereas a larger bureaucratic
business is capable of ‘professionalising’ conflict (including staff departures and disciplinary actions) this is less likely to be the
case in insider-dominated businesses. Family relationships can suffer and this can intensify stress and ultimately lead to the
deterioration of family relationships as well as business performance.
Important discussion to be read
Compare family businesses with listed companies
A family business, when incorporated as a company, is an example of a private limited company. This means that the shares are
privately held and are not available for members of the investing public to buy and sell. This is in contrast to a public company,
which is listed on a stock exchange and in which members of the public, including private and institutional shareholders, can
purchase or sell shares. Being a public listed or public limited company carries a number of requirements, imposed either by statute
or the stock exchange, which do not apply to private companies. These requirements include compliance with a number of
corporate governance provisions which include the adoption of certain governance structures, adherence with internal control and
internal audit standards, and the external reporting of some types of information. A private limited company, in contrast, must
comply with company law and tax regulations, but is not subject to listing rules.
There are a number of differences between the governance arrangements for a privately-owned family business like and a public
company.
In general, governance arrangements are much more formal for public companies than for family businesses. This is because of the
need to be accountable to external shareholders who have no direct involvement in the business. In a family business that is
privately owned, shareholders are likely to be members of the extended family and there is usually less need for formal external
accountability because there is less of an agency issue.
Linked to this, it is generally the case that larger companies, and public companies in particular, are more highly regulated and have
many more stakeholders to manage than privately-owned, smaller or family businesses. The higher public visibility that these
businesses have makes them more concerned with maintaining public confidence in their governance and to seek to reassure their
shareholders. They use a number of ways of doing this.
The more formal governance structures that apply to public companies include the requirement to establish a committee structure
and other measures to ensure transparency and a stronger accountability to the shareholders. Such measures include additional
reporting requirements that do not apply to family firms.
Page 39
Stakeholders
Any group or individual who can affect or [be] affected by the achievement of an organisation’s objectives’.
An organisation’s stakeholders are likely to include: Shareholders; Directors/management; Employees; Customers; Suppliers; The local
community; the wider community; the environment.
Why should stakeholders be identified?
 To assess the validity of their claims
 To identify source of risk/disruption
 To identify blockers and facilitators to the organization’s strategies
Stakeholders are important to an organization as they make demands of it – this is known as a stakeholder claim. Some stakeholders
wish to influence the organization and others are concerned with how the organization affects them.
For Example
- Trade union’s claim/expectations: To be consulted and involved in decisions which affect their members.
- Employees claim: Regular salary, pleasant working conditions, job security, interesting work and career progression.
Direct stakeholder claims are made by those with their own ‘voice’. These claims are usually unambiguous, and are often made directly
between the stakeholder and the organisation. Stakeholders making direct claims will typically include trade unions, shareholders,
employees, customers, suppliers etc.
Indirect claims are made by those stakeholders unable to make the claim directly because they are, for some reason, inarticulate or
‘voiceless’. Although this means they are unable to express their claim direct to the organisation, it is important to realise that this
does not invalidate their claim. Typical reasons for this lack of expression include the stakeholder being (apparently) powerless (e.g.
an individual customer of a very large organisation), not existing yet (e.g. future generations), having no voice (e.g. the natural
environment), or being remote from the organisation (e.g. producer groups in distant countries). This raises the problem of
interpretation. The claim of an indirect stakeholder must be interpreted by someone else in order to be expressed, and it is this
interpretation that makes indirect representation problematic. How do you interpret, for example, the needs of the environment or
future generations? What would they say to an organisation that affects them if they could speak? To what extent, for example, are
environmental pressure groups reliable interpreters of the needs (claims) of the natural environment? To what extent are terrorists
reliable interpreters of the claims of the causes and communities they purport to represent? This lack of clarity on the reliability of
spokespersons for these stakeholders makes it very difficult to operationalise (to include in a decision-making process) their claims
Stakeholder Theory Proposes That There Should Be Corporate Accountability To A Broad Range Of Stakeholders.
The basis for stakeholder theory is that companies are so large and their impact on society so pervasive that they should discharge
accountability to many more sectors of society than solely their shareholders.
Private and institutional shareholders
Shares in public listed companies are held by a range of individuals and institutions. In most stock exchanges, it is convenient and
relatively cheap to buy or sell shares (usually on an internet-based application) and many individual people often buy and sell shares
in companies in this way.
A second type of shareholder is the institutional shareholder. This is an organisation, rather than an individual, and accordingly, the
number of shares held is usually much higher than individual ‘private’ shareholders hold. Some investors buy shares directly in
companies through the stock exchange whilst others purchase a small part of a larger fund. Institutional shareholders tend to be large
financial institutions with large capital sums and include pension funds, insurance companies, banks, and specialised investment
companies. They have many clients buying into a certain fund and this fund is then managed in some way with the agreement of the
clients who have placed money into that fund. The fund attracts a management cost (to pay for the transactions and the fund
management costs) which is deducted from the gains (or losses) made.
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When should institutional shareholders intervene?
Specifically, an institutional investor may intervene in the following circumstances:
 The company’s performance is consistently poor;
 The company is engaged in unethical practices or has a poor reputation;
 There is excessive risk taking or perhaps not enough risk taking;
 There is a breakdown of communication between directors and shareholders;
 They have a loss of faith in the management running the company;
 There is consistent fail in the company’s systems or repeated fraud.
 The neds are ineffective
 There are inappropriate remuneration policies
 Law and regulations are not being followed
How institutional shareholders should monitor their client companies
1. A formal documented process through which client companies are monitored. Monitoring tends to include a formal review of
company accounts, resolution, voting and accompanying disclosure such as press releases.
2. The Institutional Investor must provide adequate resources to allow this to happen and must train analysis and other staff in
company procedures.
3. Following investigation the shareholder must intervene as necessary. Intervention can involve dialogue through meetings with
the Chairman or senior non-executive directors.
4. Extending the active participation in corporate management may include the need to discuss client cases with other large
shareholders or, in extreme cases calling on the company to explain its position through an extraordinary general meeting.
5. The process of monitoring is one of continuous review and improvement steadily increasing the responsibilities of the Institutional
Investor in taking an active interest. The extent to which this is actually done in part depends on the company’s attitude towards
ownership of the company.
Managing Stakeholder Relations
UNDERSTANDING THE INFLUENCE OF EACH STAKEHOLDER (MENDELOW)
In strategic analysis, the Mendelow framework is often used to attempt to understand the influence that each stakeholder has over
an organisation’s objectives and/or strategy. The idea is to establish which stakeholders have the most influence by estimating each
stakeholder’s individual power over – and interest in – the organisation’s affairs. The stakeholders with the highest combination of
power and interest are likely to be those with the most actual influence over objectives. Power is the stakeholder’s ability to influence
objectives (how much they can), while interest is the stakeholder’s willingness (how much they care).
Influence = Power x Interest
There are issues with this approach, however. Although it is a useful basic framework for understanding which stakeholders are likely
to be the most influential, it is very hard to find ways of effectively measuring each stakeholder’s power and interest. The ‘map’
generated by the analysis of power and interest (on which stakeholders are plotted accordingly) is not static; changing events can
mean that stakeholders can move around the map with consequent changes to the list of the most influential stakeholders in an
organisation.
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Level Of Interest
Low
High
Minimum effort
Keep informed
e.g. community reps &
charities
(give them reasons as they
might be able to influence
more important
stakeholders!)
Keep satisfied
e.g. institutional
shareholders
(they can move to key players
at any time)
Key players
e.g. major customer
(strategy should be acceptable
to them)
Power
Low
High
Power is the ability to bring pressure to bear over the objectives and policies of the project and interest is the capital which a
stakeholder has invested in the organisation or project (or, an assessment of how much they care or are interested in the development)
Low interest – low power
Those with neither interest nor power (top left) can, according to the framework, be largely ignored, although this does not take into
account any moral or ethical considerations. It is simply the stance to take if strategic positioning is the most important objective
These stakeholders include small shareholders, the unskilled element of the labour force and the general public. They have low interest
in the organization primarily due to lack of power to change strategy.
High interest – low power
Stakeholders with high interest (ie they care a lot) but low power can increase their overall influence by forming coalitions with other
stakeholders in order to exert a greater pressure and thereby make themselves more powerful. By moving downwards on the map,
because their power has increased by the formation of a coalition, their overall influence is increased. The management strategy for
dealing with these stakeholders is to ‘keep informed’.
Low interest – high power
Those in the bottom left of the map are those with high power but low interest. All these stakeholders need to do to become influential
is to re-awaken their interest. This will move them across to the right and into the high influence sector, and so the management
strategy for these stakeholders is to ‘keep satisfied’.
High interest – high power
These stakeholders have a high interest in the organization and have the ability to affect strategy. Stakeholders include the directors,
major shareholders and trade unions.
Those in the bottom right are the high-interest and high-power stakeholders, and are, by that very fact, the stakeholders with the
highest influence. The question here is how many competing stakeholders reside in that quadrant of the map. If there is only one (eg
management) then there is unlikely to be any conflict in a given decision-making situation. If there are several and they disagree on
the way forward, there are likely to be difficulties in decision making and ambiguity over strategic direction.
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Corporate Social Responsibility (CSR)
Definition
CSR REFERS TO ORGANISATIONS CONSIDERING AND MANAGING THEIR IMPACT ON A VARIETY OF STAKEHOLDERS.
CSR is a term used to include a series of measures concerned with an organisation’s stance towards ethical issues. These include the
organisation’s social and environmental behaviour, the responsibility of its products and investments, its policies (over and above
compliance with regulation) towards employees, its treatment of suppliers and buyers, its transparency and integrity, how it deals
with stakeholder concerns and issues of giving and community relations.
Behaviour in all of these areas is largely discretionary and it is possible to adopt a range of approaches from being very concerned
about some or all of them, to having no such concern at all..
CSR Strategy: A strategy is a long-term plan primarily focused on delivering a prescribed outcome. To have a CSR strategy involves
making choices in support of a specific cause, and implementing policies and procedures which will help to deliver the objectives.
This means that some causes or areas of activity are favoured over others, in line with the strategy adopted. So, for example, a
company might have a policy to invest in some communities or charitable causes and not others. The policy or strategy may be agreed
based on a number of issues: perhaps the preferences of the employees, the preferences of senior people in a business, or the
preferred outcomes may be chosen based on strategic concerns.
Strategic CSR: Since CSR normally requires the commitment of significant financial resources, many companies try to reflect the core
values and beliefs of the company’s shareholders in CSR matters. Therefore, when CSR activities are undertaken with the motive of
maximising the long-term economic benefit of the company, it can be better described as strategic CSR. The underlying assumption
underpinning strategic CSR is that all company assets belong to the shareholders and so all activities, including CSR, should be
configured in such a way as to enhance shareholder value.
So a financial company such as a bank might favour financial education causes whilst a medical supplies company might prefer medical
or nursing research causes or overseas medical efforts. It would be seen as strategically wasteful to use CSR to support activities which
are not aligned to the core activities. An assumption underpinning strategic CSR is that all assets in a company belong to the
shareholders and so all activities, including CSR, should be configured in such a way as to support shareholder value.
Archie Carroll’s model of social responsibility
(Suggests there are 4 levels of social responsibility)
Economic responsibilities
Shareholders demand a reasonable return.
Employees want safe and fairly paid jobs. Customers demand quality at a fair
price.
Legal responsibilities
Since laws codify society’s moral views, obeying those laws must be the
foundation of compliance with social responsibilities.
Ethical responsibilities
Businesses should act in a fair and just way even if law does not compel them to
do so.
Philanthropic responsibilities (behavior to
improve the lives of others)
This includes charitable donations, contributions to the local community and
providing employees with opportunities
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Corporate Citizenship
Corporate citizenship is an approach which can be adopted by any business with the aim of shaping its core values so that they more
closely align the decisions made each day by its directors, managers and employees with the needs of the society in which the business
operates.
There are three principles which take into account successful corporate citizenship:
(i)
Minimising any harm caused to society by the decisions and actions of a business, which could include avoiding harm to the
natural environment as well as the social infrastructure.
(ii)
Maximising any benefit created for society as a consequence of normal business activity. Any successful business will
stimulate local economic activity and increase employment, but a good corporate citizen will do this with greater sensitivity
to its environmental and social impacts.
(iii)
Remaining clearly accountable and responsive to a wide range of its stakeholders, thereby combining business self-interest
with a greater sense of responsibility towards society at large.
By embracing the corporate citizenship agenda, an organisation is able to recognise its fundamental rights and acknowledge that it
has responsibilities towards the wider community.
Rights of the business as a corporate citizen
A business has the right to exist as a separate legal entity and carry out its lawful business within a society
A business has the right to be protected by the law in the pursuit of its normal business activities.
It has the right to receive the support of society in the pursuit of business in terms of its investors, employees and customers. It has
the right, in other words, to have customers free to purchase products without feeling bad about it, and have employees happy to
work for the company without fear of criticism from people believing themselves to be in a superior moral position.
Responsibilities of the business as a corporate citizen
Just as an individual has the responsibility to obey the law, fit in with the social and ethical norms of society, and behave in an
appropriate way, so does a business.
Its responsibility is to always comply with the laws and social norms which apply in each country it deals with. This extends to being
a good employer, maintaining prompt payment of payables accounts, encouraging good working conditions at supplier companies
and similar areas of good business practice.
The 3 perspectives are:
1. limited view: stakeholders considered when in business’ interest (main groups considered are employees and local community)
2. Equivalent view: self-interest is not primary motivation. Organization is focused on legal requirements and ethical fulfillment.
3. Extended view: Combination of self-interest promoting the power that organizations have and wider responsibility towards
society.
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Environmental Footprint
An exam focused overview
Environmental footprint
Positive and negative impacts of the organization’s activities on the environment in terms of inputs
and putputs.
Inputs: resources and energy ( fuel, land, water, non-sustainable resources)
Outputs: Emissions, wastage, chemical spillage, water pollution, land pollution etc.
Need of internal control
re. environment
Environmental
Management System
(EMS)
Operations management
a sound system of internal control needed to:
Measure input consumption
Measure outputs like emissions etc
Serve as early warning signs if negative impacts
Ensure better internal and external reporting on the environment
Have a formal system in place to:
Minimize negative environmental footprints
Comply with laws, regulation and best practices re. environment
Continuously improve the above.
Process design
Minimize waste
Reduce energy use
-
Reduce emissions
Product design
Recycled inputs
Sustainable inputs
Safe disposal
-
Minimum waste
Supply chain management - Purchases from ethical suppliers
Quality management - Better quality results in more efficiency and lesser waste
Environmental reporting
External reporting can be done through Annual Report, Integrated Report, website or even a
standalone report.
Narrative: objectives re. the environment, why targets not met, address stakeholders concerns (if
any)
Numerical: for example emissions in tonnes, resources in litres, land in square meters etc.
Environmental audit
1.
2.
3.
Agree metrics for the organization ( what should be measured and how)
Measure actual performance against metrics
Report level of compliance or variance
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ISO 14000/14001
-
Eco Management Audit
Scheme (EMAS)
HAVE an environmental management system (EMS)
Top level commitment essential
The board should have a monitoring system in place to ensure compliance with internal
policies as well as external laws and regulation re. to the environment
Plan: the org. should establish objectives, goals, targets, processed
Do: policies and procedures implemented
Check: monitor processes and report results
Act: improve performance based on results
A scheme which recognizes and rewards organisations that go beyond the minimum legal compliance
and continuously improve their environmental performance.
Key elements
1. Implement ISO 14000/14001
2. Evaluate environmental impact at ALL levels
3. Environmental reports made publically available ( report against set of core indicators like
energy, waste, emissions, material efficiency)
4. Environmental reports independently verified
5. Laws and regulations complied with
It is the impact that a business’s activities have on the environment including its resource environment and pollution emissions.
A company’s environmental footprint assesses its impact on the natural environment in a variety of ways, including:
– Its resource and energy consumption, with particular concern for unsustainable resources;
– The amount of waste produced and disposed of; and
– The harm or damage caused by emissions to the environment.
Ideally every organisation, commercial or otherwise, should work towards attaining a zero environmental footprint by conserving,
restoring and replacing those natural resources used in its operations whilst at the same time taking necessary measures to eliminate
pollution and emissions.
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Examples of footprints
Consumption of exhaustible natural resources
Pollution
Wastage
Use of land
Water
Negative impacts can be reduced by:
Better resource management(e.g.use different resources)
‘green; procurement policies
Waste management (recycling)
Carbon neutrality
Examples of environmental costs
Waste management
Compliance costs
Permit fees
Environmental training
R& d regarding environment
Legal costs and fines
Record keeping and reporting
Public opinion
Employee health and safety
Risk posed by future regulatory changes
Uncertain future compensation costs
Internal controls and environmental footprint
One of the most obvious ways in which internal controls are necessary for controlling environmental footprints is in the operational
controls which measure and determine the input consumption and the production of emissions. It is only by the accumulation of
accurate environmental consumption and emissions data that the footprint can be identified and therefore monitored, scrutinised
and improved. Internal controls capable of making these measurements (say in terms of energy, water and raw material consumption,
and waste emissions) are therefore essential in measuring and therefore controlling the environmental footprint.
Internal controls can also be used in the management of the plant and equipment Sound internal controls are a key part of the normal
efficient management of operations. They are also necessary for producing accurate information upon which regular reporting is
based. These make internal controls able to act as an ‘early warning system’ for any inefficiency in environmental systems which help
to control the environmental footprint.
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Social Footprint
An exam focused overview
Social footprint
Negative and positive impact of the organization’s activities on:
Workers
Society
Wellbeing of communities
Infrastructure etc.
Examples of positive impacts
Charitable donations
Job creation
Contribution towards financial stability of a region
Transparency in reports
Timely tax payments
Examples of negative impacts
Plant emissions affecting health
Plant closure leading to loss of jobs
Social audit
Identify and evaluate effect of org’s policies and practices on the society.
A way for the org. to see if its actions are being viewed as positive or negative.
Helps in evaluating how effective the org’s CSR strategy is!
KPIs/targets may be set ( for example create 40,000 jobs in the next 5 years, 100% organic ingredients,
renewable energy at all stores)
Reports are primarily for internal use. The org. can publish them if they want.
The term ‘footprint’ is used to refer to the impact or effect that an entity (such as an organisation) can have on a given set of concerns
or stakeholder interests. A ‘social footprint’ is the impact on people, society and the wellbeing of communities. Impacts can be positive
(such as the provision of jobs and community benefits) or negative, such as when a plant closure increases unemployment or when
people become sick from emissions from a plant or the use of a product...
Examples of social footprint
 Obtaining supplies from sustainable sources and companies following appropriate social and environmental practices.
 Enhancing social capital e.g. business/community relationships to provide on-the-job training to assist some social groups
'return to work'
 Allowing employees paid time off to provide community services.
 Fair trade
 Diversity in employees
 Lesser injury rate
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Sustainability
Ensure that development needs of the present are met without compromising the ability of the future generations to meet their own
needs.
Importantly, it refers to both the inputs and outputs of any organisational process. Inputs (resources) must only be consumed at a rate
at which they can be reproduced, offset or in some other way not irreplaceably depleted. Outputs (such as waste and products) must
not pollute the environment at a rate greater than can be cleared or offset. Recycling is one way to reduce the net impact of product
impact on the environment. The business activities must take into consideration the carbon emissions, other pollution to water, air
and local environment, and should use strategies to neutralise these impacts by engaging in environmental practices that will replenish
the used resources and eliminate harmful effects of pollution. A number of reporting frameworks have been developed to help in
accounting for sustainability including the notion of triple-bottom-line accounting and the Global Reporting Initiative (GRI). Both of
these attempt to measure the social and environmental impacts of a business in addition to its normal accounting
Environmental sustainability means that resources should not be taken from the environment or emissions should not be made into
the environment, at a rate greater than can be corrected, replenished or offset
Economic sustainability
This is how countries and companies use resources optimally to achieve responsible and long term economic growth and wealth.
Economic development is often put ahead of environmental sustainability as it involves people’s standards of living. However, quality
of life can decline if people live in an economic place with a poor environmental quality because of economic development
The balance between environmental conservation and economic development is a longstanding one, and one which applies to all
parts of the world in which business activity takes place. A lot of business activity takes place at a net cost to the environment and so
the sustainability of one (environment or economy) may be achieved only at a net cost to the other. Some believe that a lot of business
activity can be made more environmentally sustainable but the economic costs of this, possibly by accepting a lower rate of economic
growth with its associated effects, are often unpopular.
Environmental Audits
Environmental audits are structured investigations which can quantify an organisation’s environmental performance and position by
a systematic and objective evaluation of how well the company, its management and equipment are performing with respect to the
primary aim of aiding the natural environment.
An environmental audit enables an organisation to demonstrate its commitment to the reduction of its environmental footprint.
Environmental audits are voluntary and typically contain the following elements:
The first stage is agreeing suitable metrics for the organisation, which detail what specifically should be monitored and the best way
this is to be achieved. For example, this could be concerned with the measurement of any chemical leakages from a company’s
manufacturing processes and storage facilities.
This selection is important because it will determine what will be measured against, how costly the audit will be and how likely it is
that the company will be criticised for ‘window dressing’ or ‘green washing’..
The second stage is measuring actual performance against the metrics -the audit team then measures actual performance against
the agreed metrics using a representative sample related to the level of risk and the confidence required in the results. A mixture of
compliance and substantive testing will provide the necessary evidence.
Whilst many items will be capable of numerical and/or financial measurement (such as energy consumption or waste production),
others, such as public perception of employee environmental awareness, will be less so.
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The third stage is reporting the levels of compliance or variances. The auditors then compile a report to the board on their findings,
detailing the levels of compliance achieved together with any significant breaches they identified. They would use the evidence
gathered to determine and recommend improvements to the internal control systems.
Areas which can be covered within the environment audit include:
 Waste management and waste minimization
 Emissions to air
 Energy and utility consumption
 Environmental emergencies
 Protection of environmentally sensitive areas
Benefits of an environmental audit
The benefits will vary depending on the objectives and scope of the environmental audit, but include:
Improved decision making ( as better understanding of legal obligations, environmental risks and their assessment etc)
Resource consumption. Understanding how the company interacts with its natural environment allows it to more efficiently use
its resource, particularly non-renewables. This clearly demonstrates that the company is environmentally responsible
Compliance. An environmental audit will provide independent evidence that the organisation is meeting its specific statutory
requirements
Environmental Reporting
Environmental reporting: narrative and numerical info on organization’s environmental footprint.
Narrative: objectives, reasons for not meeting previous targets, specific stakeholder concerns addressed etc
Numerical: report on measures such as emissions in tonnes, resources consumed in litres, land used in square meters etc.
Ways of Reporting: as a part of annual report, a stand-alone report, on website, in advertising material
Why should a company report its footprints? Better accountability to stakeholders, can address specific challenges through these
reports (esp. oil companies), society’s perception improves esp. when environmental errors/accidents occur, helps in environmental
risk assessment, encourages internal efficiency in operations as a proper system for information communication and measurement
will need to be created.
In broad terms, environmental reporting is the production of narrative and numerical information on an organisation’s environmental
impact or ‘footprint’ for the accounting period under review.
In most cases, narrative information can be used to convey objectives, explanations, aspirations, reasons for failure against previous
years’ targets, management discussion, addressing specific stakeholder concerns, etc.
Numerical disclosure can be used to report on those measures that can usefully and meaningfully be conveyed in that way, such as
emission or pollution amounts (perhaps in tonnes or cubic metres), resources consumed (perhaps kWh, tonnes, litres), land use (in
hectares, square metres, etc) and similar.
Guidelines for Environmental Reporting
In most countries, environmental reporting is entirely voluntary in terms of statute or listing rules.Because it is technically voluntary,
companies can theoretically adopt any approach to environmental reporting that they like, but in practice, a number of voluntary
reporting frameworks have been adopted. The best known and most common of these is called the Global Reporting Initiative (or
GRI).
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Where does environmental reporting occur?
Environmental reporting can occur in a range of media including in annual reports, in ‘stand alone’ reports, on company websites, in
advertising or in promotional media. To some extent, there has been social and environmental information in annual reports for many
years. In more recent times, however, many companies – and most large companies – have produced a ‘stand alone’ report dedicated
just to environmental, and sometimes, social, issues. These are often expensive to produce, and contain varying levels of detail and
information ‘quality’.
Advantages and Purposes of Environmental Reporting
Environmental reporting is a useful way in which reporting companies can help to discharge their accountabilities to society and to
future generations (because the use of resources and the pollution of the environment can affect future generations).
In addition, it may also serve to strengthen a company’s accountability to its shareholders. By providing more information to
shareholders, the company’s is less able to conceal important information and this helps to reduce the agency gap between a
company’s directors and its shareholders.
Academic research has shown that companies have successfully used environmental reporting to demonstrate their responsiveness
to certain issues that may threaten the perception of their ethics, competence or both. Companies that are considered to have a high
environmental impact, such as oil, gas and petrochemicals companies, are amongst the highest environmental disclosers. Several
companies have used their environmental reporting to respond to specific challenges or concerns, and to inform stakeholders of how
these concerns are being dealt with and addressed.
One example of this is the use of environmental reporting to gain, maintain or restore the perception of legitimacy. When a company
commits an environmental error or is involved in a high profile incident, many stakeholders seek reassurance that the company has
learned lessons from the incident and so can then resume engagement with the company. For the company, some environmental
incidents can threaten its licence to operate or social contract. By using its environmental reporting to address concerns after an
environmental incident, society’s perception of its legitimacy can be managed.
In addition to these arguments based on accountability and stakeholder responsiveness, there are also two specific ‘business case’
advantages. The first of these is that environmental reporting is capable of containing comment on a range of environmental risks.
Many shareholders are concerned with the risks that face the companies they invest in and where environmental risks are potentially
significant (such as travel companies, petrochemicals, etc) a detailed environmental report is a convenient place to disclose about the
sources of these risks and the ways that they are being managed or mitigated.
The second is that it is thought that environmental reporting is a key measure for encouraging the internal efficiency of operations.
This is because it is necessary to establish a range of technical measurement systems to collect and process some of the information
that comprises the environmental report. These systems and the knowledge they generate could then have the potential to save costs
and increase operational efficiency, including reducing waste in a production process.
In conclusion, then, environmental reporting has grown in recent years. Although voluntary in most countries, some guidelines such
as the GRI have helped companies to frame their environmental reporting. It can take place in a range of media including in ‘stand
alone’ environmental reports, and there are a number of motivations and purposes for it including both accountability and ‘business
case’ motives
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Code of Ethics
Corporate code of ethics
Companies should develop a code of ethics and/or a code
of conduct which will apply across the organisation. The
code should stipulate the ethical values of the
organisation as well as include more specific guidelines
for the company in its interaction with its internal and
external stakeholders.
Professional ethics
Fundamental principles
1.
Integrity: Integrity requires accountants to be straightforward and
honest in all their professional and business relationships.
2.
Objectivity: Objectivity requires that an individual should not allow
bias, conflicts of interest or the undue influence of others to
compromise their professional or business judgement, and infers
independence of action
3.
Professional competence & due care: All accountants have a
continuing duty to maintain their professional knowledge and skill
at a level required to ensure that employers receive competent
professional service, and at the same time they must act diligently
in accordance with applicable technical and professional standards
when providing professional services.
4.
Confidentiality: Accountants must respect the confidentiality of
information acquired as a result of professional and business
relationships, and shall not disclose any such information to third
parties without proper and specific authority or unless there is a
legal or professional right or duty to disclose. Similarly, confidential
information acquired as a result of professional and business
relationships shall not be used to the personal advantage of
members or third parties.
5.
Professional behavior: Accountants must comply with all relevant
laws and regulations and shall avoid any action which may discredit
the profession.
Such codes must be actively and effectively
communicated across the company, and should be
integrated into the company’s strategy and operations.
There should be appropriate training programmes in
place to enable staff to understand such codes and apply
them effectively and sufficient support and compliance
assessments to assist employee performance in these
matters.
Purpose
The first is communicating the organisation’s values into
a succinct and sometimes memorable form. This might
involve defining the strategic purposes of the
organisation and how this might affect ethical attitudes
and policies.
Second, the code serves to identify the key stakeholders
and the promotion of stakeholder rights and
responsibilities. This may involve deciding on the
legitimacy of the claims of certain stakeholders and how
the company will behave towards them.
Third, a code of ethics is a means of conveying these
values to stakeholders. It is important for internal and
external stakeholders to understand the ethical positions
of a company so they know what to expect in a given
situation and to know how the company will behave. This
is especially important with powerful stakeholders,
perhaps including customers, suppliers and employees.
Fourth, a code of ethics serves to influence and control
individuals’ behaviour, especially internal stakeholders
such as management and employees. The values
conveyed by the code are intended to provide for an
agreed outcome whenever a given situation arises and to
underpin a way of conducting organisational life in
accordance with those values.
Fifth, a code of ethics can be an important part of an
organisation’s strategic positioning. In the same way that
an organisation’s reputation as an employer, supplier,
Threats/Conflict of interest
1. Self-interest
2. Self-review
3. Advocacy
4. Familiaruty
5. Intimidation
Safeguards
1. created by profession (CPD, corporate governance, disciplinary
proceedings)
2.
Work environment(code of ethics, ICS, review procedures)
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etc. can be a part of strategic positioning, so can its ethical
reputation in society. Its code of ethics is a prominent way
of articulating and underpinning that.
3.
Individual(contact professional bodies, mentor, comply with
professional standards)
Contents
Values of the company. This might include notes on the
strategic purpose of the organisation and any underlying
beliefs, values, assumptions or principles. Values may be
expressed in terms of social and environmental
perspectives, and expressions of intent regarding
compliance with best practice, etc.
Shareholders and suppliers of finance. In particular, how
the company views the importance of sources of finances,
how it intends to communicate with them and any
indications of how they will be treated in terms of
transparency, truthfulness and honesty.
Employees. Policies towards employees, which might
include equal opportunities policies, training and
development, recruitment, retention and removal of
staff.
Customers. How the company intends to treat its
customers, typically in terms of policy of customer
satisfaction, product mix, product quality, product
information and complaints procedure.
Supply chain/suppliers. This is becoming an increasingly
important part of ethical behaviour as stakeholders
scrutinise where and how companies source their
products (e.g. farming practice, fair trade issues, etc).
Ethical policy on supply chain might include undertakings
to buy from certain approved suppliers only, to buy only
above a certain level of quality, to engage constructively
with suppliers (e.g. for product development purposes) or
not to buy from suppliers who do not meet with their own
ethical standards.
Community and wider society. This section concerns the
manner in which the company aims to relate to a range of
stakeholders with whom it does not have a direct
economic relationship (e.g. neighbours, opinion formers,
pressure groups, etc). It might include undertakings on
consultation, ‘listening’, seeking consent, partnership
arrangements (e.g. in community relationships with local
schools) and similar.
Implementation(The process by which the code is finally
issued and then used. Implementation will also include
some form of review function so the code is revisited on
an annual basis and updated as necessary)
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Bribery and Corruption
Corruption:. Corruption can be loosely defined as deviation from honest behaviour but it also implies dishonest dealing, self-serving
bias, underhandedness, a lack of transparency, abuse of systems and procedures, exercising undue influence and unfairly attempting
to influence. It refers to illegal or unethical practices which damage the fabric of society.
Bribery: The act of taking or receiving something with the intention of influencing the recipient in some way favorable to the party
providing the bribe. In simple words, bribery is giving or receiving something of value to influence a transaction. Bribery is a form of
corruption.
Examples of form of bribery
Money
Tangible gift
Granting a privilege
“facilitation payments” paid to foreign government officials in the course of routine business
Parties who may be held responsible:
The payer
The recipient
Those who knew about the bribe but didn’t report it
People with authority who don’t take actions to prevent bribery
Why bribery and corruption are problems
Lack of honesty
Those with authority and responsibility will not be acting impartially and violating a duty of service.
Conflict of interest
Their personal interest will conflict with their legitimate duties and responsibilities. Furthermore, if they
are threatened with public exposure, they might take actions that are not in the best interest of the
organization.
Economic issues
Misallocation of resources will occur. Contracts will go to those who paid the bribe rather than those who
are the most efficient.
Professional
It brings a bad name to the profession as a whole.
reputation
Measures to combat bribery
1. Top-level commitment. The board must foster a culture in which bribery is never acceptable and it is understood that the
achievement of business objectives should never be at the expense of unethical and corrupt behaviour.
2.
Proportionate procedures. Procedures should be implemented which are proportionate to the bribery risks faced by the
organisation and its activities. These should also be transparent, practical, accessible, effectively implemented and enforced by
management.
3.
Risk assessment. A formal and documented audit of both the internal and external risks of bribery and corruption should be
periodically undertaken. This should be incorporated into the organisation’s generic risk management procedures and reported
upon annually to shareholders.
4.
Due diligence procedures. Bribery risks can be mitigated by exercising due diligence. Any personnel operating in sensitive areas
require greater vigilance; this includes all board members and any personnel involved in procurement and contract work.
5.
Communication. Internal and external communications ensure that bribery prevention policies and associated procedures are
embedded into the organisation’s culture and understood by everyone. Employees at all levels should undertake regularly antibribery compliance training so that they remain constantly aware of the risks.
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6.
Monitoring and review. Internal audit, tasked by the audit committee, should monitor and review bribery prevention procedures
and recommend improvements where necessary.
How can an anti-corruption culture be established?
Set a zero tolerance policy and communicate the consequences that employees may face
The senior manager should be involved in development and implementation of bribery prevention procedures
Training: general training on threat of bribery at the time of induction as well as specific training to those involved in higher risk
activities such as purchasing and contracting
Do not send a conflicting message by focusing on short term profits
Unachievable targets should not be set
A formal code of conduct should be established
Effective recruitment and human resource procedures in areas where bribery is more likely to be a risk.
Tucker’s 5-question model (To evaluate organization’s decisions)
The decision should be:
1. Is it profitable? This is a difficult question, because it does not address for whom the decision is profitable and it doesn’t
compare the profitability of other options, which may be better.
2.
Is it legal?
3.
Is it fair? The company has to consider if it is fair to all stakeholders and the effect the decision has on them.
4.
Is it right? What is right will depend on the ethical view of the organization.
5.
Is it sustainable or environmentally sound?
It might be the case that not all of Tucker’s criteria are relevant to every ethical decision.
Tucker: Scenario
Big Company is planning to build a new factory in a developing country. Analysis shows that the new factory investment will be more
profitable than alternatives because of the cheaper labour and land costs. The government of the developing country has helped the
company with its legal compliance, which is now fully complete, and the local population is anxiously waiting for the jobs which will,
in turn, bring much needed economic growth to the developing country. The factory is to be built on reclaimed ‘brownfield’ land and
will produce a lower unit rate of environmental emissions than a previous technology.
Is it profitable? Yes. The investment will enable the company to make a superior return than the alternatives. The case explains that
these are ‘because of the cheaper labour and land costs’.
Is it legal? Yes. The government of the developing country, presumably very keen to attract the investment, has helped the company
with its legal issues.
Is it fair? As far as we can tell, yes. The only stakeholder mentioned in the scenario is the workforce of the developing country who,
we are told, is ‘anxiously waiting’ for the jobs. The scenario does not mention any stakeholders adversely affected by the investment.
Is it right? Yes. The scenario explains that the factory will help the developing country with ‘much needed economic growth’, and no
counter - arguments are given.
Is it sustainable or environmentally sound? Yes. The scenario specifically mentions an environmental advantage from the investment.
So in this especially simplified case, the decision is clear as it passes each decision criteria in the 5-question model. In more complex
situations, it is likely to be a much more finely balanced decision.
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PUBLIC INTEREST
All professionals, including professional accountants, have a primary duty to the public interest. Professionals enjoy a privileged
position of high esteem in society, and in return, it is important that they act in such a way as to maintain that position of trust. This
includes a commitment to high social values such as human welfare, fairness, justice, integrity and probity, and the wellbeing of
society.
The International Federation of Accountants (IFAC) in its code of ethics states that the accountancy profession accepts its responsibility
to act in the public interest. This means that a professional accountant’s responsibility is not just to meet the needs of an employer or
client but to act in a manner that is for the good of the profession and society.
Public interest does not have a set definition.
To act in the public interest is to recognise a fiduciary duty to the benefit of society rather than just a duty to one particular party.
Public interest concerns the overall welfare of society as well as the sectional interest of the shareholders in a particular company. It
is generally assumed, for example, that all professional actions, whether by medical, legal or accounting professionals, should be for
the greater good rather than for sectional interest.
THE ROLE OF THE ACCOUNTANT IN SOCIETY
Accountants are responsible for acting in the public interest.
This means that accountants need to act in accordance with an agreed set of professional values, always maintain the highest levels
of integrity, and deal fairly with all parties they engage with. Accountants, along with other professionals in society, are expected to
demonstrate unswerving support for these professional values and be beyond reproach, and act independently at all times.
This may involve disclosing confidential client information to the authorities if it is in the public interest to do so, e.g. if the client is
involved in fraudulent or criminal activities.
In addition, accountants have the skills to be able to provide benefit for society as a whole. This may be that they are involved in the
development of new reporting requirements that will enhance financial reporting. For example, many governments do not require
environmental and social reporting. It is the accounting profession that has promoted this reporting as voluntary information that
should be disclosed alongside the annual report.
Accountants have a role to play in influencing the distribution of power and wealth in society. They may use their skills to help set up
social security systems to distribute state benefits to those in need. They have a wealth of skills which are readily transferable so can
assist governments in designing new financial reporting rules and tax regimes that may benefit those less well off.
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Introduction to Strategy
Strategy is about key issues for the future of organisations. For example, how should Apple, primarily a devices company, compete in
the computer and tablet market with Google, primarily a search company? Should universities concentrate their resources on research
excellence or teaching quality or try to combine both? How should a small video games producer relate to dominant console providers
such as Microsoft and Sony? What should an arts group do to secure revenues in the face of declining government subsidies?
All these are strategy questions, vital to the future survival of the organisations involved.
Strategy is the long-term direction of an organisation . Thus the long-term direction of Amazon is from book retailing to internet
services in general. The long-term direction of Disney is from cartoons to diversified entertainment.
All organisations are faced with the challenges of strategic direction: some from a desire to grasp new opportunities, others to
overcome significant problems, as at Yahoo!
In 2006 Yahoo! manager Brad Garlinghouse issued a memo that directly challenged the senior management of the Internet giant.
Leaked to the media as ‘The Peanut Butter Manifesto’, his memo accused Yahoo!’s leadership of lacking strategic direction. Growth
had slowed, Google had overtaken Yahoo! in terms of online advertising revenues, and the share price had fallen by nearly a third
since the start of the year. According to Brad, Yahoo! Was spread too thin, like peanut butter. It was time for strategic change.
Remember, in the exam, the focus will be on Strategic decisions
They are about:
 The long-term direction of an organisation. Strategy at Yahoo! involved long-term decisions about what sort of company it should
be, and realising these decisions would take plenty of time.

The scope of an organisation’s activities. For example, should the organization concentrate on one area of activity, or should it
have many? Brad believed that Yahoo! was spread too thinly over too many different activities.

Advantage for the organisation over competition. The problem at Yahoo! Was that it was losing its advantage to faster-growing
companies such as Google.

Strategic fit with the business environment. Organisations need appropriate positioning in their environment, for example in terms
of the extent to which products or services meet clearly identified market needs. This might take the form of a small business
trying to find a particular niche in a market, or a multinational corporation seeking to buy up businesses that have already found
successful market positions. According to Brad, Yahoo! was trying to succeed in too many environments.
The organisation’s resources and competences. Following ‘the resource-based view’ of strategy, strategy is about exploiting the
strategic capability of an organisation, in terms of its resources and competences, to provide competitive advantage and/or yield
new opportunities. For example, an organization might try to use resources such as technology skills or strong brands.


The values and expectations of powerful actors in and around the organisation. The beliefs and values of these stakeholders will
have a greater or lesser influence on the strategy development of an organisation, depending on the power of each.
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Levels of strategy
Inside an organisation, strategies can exist at three main levels.
Corporate-level strategy is concerned with the overall scope of an organisation and how value is added to the constituent
businesses of the organisational whole. Corporate-level strategy issues include geographical scope, diversity of products or services,
acquisitions of new businesses, and how resources are allocated between the different elements of the organisation.
Business-level strategy is about how the individual businesses should compete in their particular markets
(for this reason,
business-level strategy is often called ‘competitive strategy’). These individual businesses might be standalone businesses, for instance
entrepreneurial start-ups, or ‘business units’ within a larger corporation.
Operational strategies are concerned with how the components of an organisation deliver effectively the corporate- and businesslevel strategies in terms of resources, processes and people.
Organizations often summarise their organisation’s strategy with a ‘strategy statement’.
Strategy statements should have three main themes: the fundamental goals (mission, vision or objectives) that the organisation
seeks; the scope or domain of the organisation’s activities; and the particular advantages or capabilities it has to deliver all of
these.
These various contributing elements of a strategy statement are explained as follows, with examples
Mission. This relates to goals, and refers to the main purpose of the organisation. It is sometimes described in terms of the question:
‘what business are we in? ’
The mission statement helps keep managers focused on what is central to their strategy.

Vision. This too relates to goals, and refers to the desired future state of the organisation. It is the org’s aspiration which can
affects the energy and passion of employees. The vision statement, therefore, should answer the question: ‘what do we want to
achieve? ’.

Objectives. These are more precise and ideally quantifiable statements of the organisation’s goals over some period of time.
Objectives might refer to profitability or market share targets for a private company, or to examination results in a school.
Objectives introduce discipline to strategy. The question here is: ‘what do we have to achieve in the coming period? ’.

Scope. An organisation’s scope or domain refers to three dimensions: customers or clients; geographical location; and extent of
internal and external activities (‘vertical integration’).

Advantage. This part of a strategy statement describes how the organisation will achieve the objectives it has set for itself. In
competitive environments, this refers to the competitive advantage: for example, how a particular company or sports club will
achieve goals in the face of competition from other companies or clubs. In order to achieve a particular goal, the organisation
needs to be better than others seeking the same goal.
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The Strategic Planning Process: A Brief Overview
The term strategic management underlines the importance of managers with regard to strategy. Strategies do not happen just by
themselves. Strategy involves people, especially the managers who decide and implement strategy
It is important to keep in mind that strategies are often developed through formal planning processes.
But sometimes the strategies an organisation actually pursues are emergent– in Other words, accumulated patterns of ad hoc
decisions and rapid responses to the unanticipated.
Understand the strategic
position
The strategic position is concerned with the impact on strategy of the external environment, an
organisation’s strategic capability (resources and competences), the expectations and influence of
stakeholders and culture
The environment: The organisation exists in the context of a complex political, economic, social,
technological, environmental (i.e. green) and legal world. This environment changes and is more complex
for some organisations than for others
Many of those variables will give rise to opportunities and others will exert threats on the organisation –
or both.
THE SBL syllabus provides key frameworks to help in focusing on priority issues in the face of
environmental complexity and changes.
Strategic capability: The strategic capability of the organisation – made up of resources(e.g. machines and
buildings) and competences(e.g. technical and managerial skills). One way of thinking about the strategic
capability of an organization is to consider its strengths and weaknesses (for example, where it is at a
competitive advantage or disadvantage). The aim is to form a view of the internal influences – and
constraints – on strategic choices for the future. It is usually a combination of resources and high levels of
competence in particular activities (as core competences) that provide advantages which competitors find
difficult to copy.
The SBL syllabus provides tools and concepts for analysing such capabilities.
Expectations and influence of stakeholders: the SBL syllabus explores the major influences of stakeholder
expectations on an organisation’s purposes. Here the issue of corporate governance is important: who
should the organisation primarily serve and how should managers be held responsible for this? This raises
issues of corporate social responsibility and ethics.
These positioning issues were all important for Yahoo! as it faced its crisis in 2006. The external
environment offered the threat of growing competition from Google. Its strong Internet brand and existing
audience were key resources for defending its position. The company was struggling with its purposes,
with top management apparently indecisive. The company none the less had inherited a strong culture,
powerful enough to make Brad Garlinghouse shave a Y on his head and believe that his blood bled in the
corporate colours of his employer
Culture . Organisational cultures can also influence strategy. So can the cultures of a particular industry
or particular country. These cultures are typically a product of an organisation’s history.
The consequence of history and culture can be strategic drift; a failure to create Necessary change.
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Assess strategic
choices
Strategic choices involve the options for strategy in terms of both the directions in which strategy might move
and the methods by which strategy might be pursued.
For instance, an organization might have a range of strategic directions open to it: the organisation could diversify
Into new products; it could enter new international markets; or it could transform its existing Products and
markets through radical innovation.
These various directions could be pursued By different methods: the organisation could acquire a business
already active in the product
Or market area; it could form alliances with relevant organisations that might help its new strategy; or it could try
to pursue its strategies on its own.
Business level strategy: There are strategic choices in terms of how the organisation seeks to compete at the
indivudal business level. Typically these involve pricing and differentiation strategies, and decisions about how to
compete or collaborate with competitors.
For example, a business unit could choose to be the Lowest cost competitor in a market, or the highest quality.
Corporate level strategy: The highest level of an organisation is typically concerned with issues of corporate
scope; in other words, which businesses to include in the portfolio. This relates to the appropriate degree of
diversifi cation , with regard to products offered and markets served.
International strategy is a form of diversification, but into new geographical markets. Here the fundamental
question is: where internationally should the Organization compete and how to enter them, by export, licensing,
direct investment or acquisition
Innovation and entrepreneurship: Most organisations have to innovate constantly simply to survive. A
fundamental question, therefore, is whether the organisation is innovating appropriately. Innovation choices
involve issues such as being first-mover into a market, or simply a follower, and how much to listen to customers
in developing new products or services.
Strategy methods: Organisations have to make choices about the methods by which they pursue their strategies.
Many organisations prefer to grow ‘organically’, in other words by building new businesses with their own
resources.
Other organisations develop by acquiring other businesses or forming alliances with complementary partners.
Strategy evaluation: a discussion of the success criteria according to which different strategic choices can be
evaluate
Strategy performance and evaluation . Managers have to decide whether existing and forecast performance is
satisfactory and then choose between options that might improve it.
The fundamental evaluation questions are as follows: are the options suitable in terms of matching opportunities
and threats; are they acceptable in the eyes of significant stakeholders; and are they feasible
Students need to know a range of financial and non-financial techniques for appraising performance and evaluating
strategic options.
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Manage Strategy in action
Once a strategy is developed, the organisation needs to organise for successful implementation.
Organizing for success: Each strategy requires its own specific configuration of structures and
systems
The fundamental question, therefore, is: what kinds of structures and systems are required for the
chosen strategy?
SBL introduces a range of structures and systems and provides frameworks for deciding between
them.
According to Brad Garlinghouse, s matrix organisation and bureaucracy were all big problems for
Yahoo!.
Managing strategic change: Managing strategy very often involves strategic change, and We will
need to look at the various issues involved in managing change. This will include the need to
understand how the context of an organisation should influence the approach to change and the
different types of roles for people in managing change. It also looks at the styles that can be adopted
for managing change and the levers by which change can be effected.
Best talent management strategy
Improve retention plus motivate plus build high performance teams!
Improve retention: align employees with corporate goal and objectives so better buy in to company
success. Clarify job roles, better engagement by employees, better performance- emoployees have
a specific purpose and objective; one which they know is contributing to org success. Take action to
do this! So more productive workforce, less turnover, positive impact on bottom line profit
Performance excellence
Know the world class management criteria for performance excellence
(customer focus, workforce focus, leadership)
Those who have used this have seen improvement in:
Customer satisfaction...improved engagement with customer, more loyalty
Improved service outcome
Role model process efficiencies
Improved revenue, market share, financial results
how well performing companies achieve sustainable results; people, processes, resources aligned
Fourteen fundamental questions in strategy
Strategic choices
Strategic position




What are the environmental
opportunities and threats?
What are the organisation's
strengths and weaknesses?
What is the basic purpose of the
organisation?
How does culture fit the
strategy?





How should business units compete?

Which businesses to include in a portfolio?
Where should the organisation compete 
internationally?
Is
the
organisation
innovating 
appropriately?
Should the organisation buy other 
companies, ally or go it alone?

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Strategy in action
Are strategies suitable, acceptable and
feasible?
What kind of strategy-making process is
needed?
What are the required organisation
structures and systems?
How should the organisation manage
necessary changes?
Who should do what in the strategy
process?
Strategic Analysis
The environment is what gives organisations their means of survival. It creates opportunities and it presents threats. Business needs
to respond to threats and take advantage of opportunities-so changes in marco environment can act as drivers for change.
Although the future can never be predicted perfectly, it is clearly important that entrepreneurs and managers try to analyse their
environments as carefully as they can in order to anticipate and – if possible – influence environmental change.
Macro Environment: board factors which could affect all businesses-PESTLE
The macro-environment is the highest-level layer. This consists of broad environmental factors that impact to a greater or lesser
extent on almost all organisations. Here, the PESTEL framework can be used to identify how future issues in the political, economic,
social, technological, ecological and legal environments might affect organisations. This PESTEL analysis provides the broad ‘data’ from
which to identify key drivers of change. These key drivers can be used to construct scenarios of alternative possible futures.
Micro environment: factors which affect the org’s ability to operate effectively in its own industry/ market sector. Porter’s 5 Forces.
Industry, or sector, forms the next layer within this broad general environment. This is made up of organisations producing the same
sorts of products or services. Here the five forces framework is particularly useful in understanding the attractiveness of particular
industries or sectors and potential threats from outside the present set of competitors.
Competitors and markets are the most immediate layer surrounding organisations. Here the concept of strategic groups can help
identify different kinds of competitors. Similarly, in the marketplace, customers’ expectations are not all the same, which can be
understood through the concept of market segments.
Organizations need to avoid strategic drift. Strategic Drift usually occurs when organizations are unable to keep pace with the changes
that happen in their immediate environment which in turn leads to their slow and gradual demise. Strategic drift usually arises from
a combination of factors, including:
Business failing to adapt to a changing external environment (for example social or technological change)
A discovery that what worked before (in terms of competitiveness) doesn’t work anymore
Complacency sets in – often built on previous success which management assume will continue
Senior management deny there is a problem, even when faced with the evidence
Macro Environment: PESTEL Analysis
The other framework, which should be applied when surveying the external environment, is PESTEL factors:
 Political
 Economic
 Social
 Technological
 Environmental/ Ecological
 Legal
Again all of these factors will not necessarily apply but provide a useful checklist against which you can compare in an exam situation.
They are explained more fully below:
Political environment
The organisation must react to the attitude of the political party that is in power at the time. The government is the nation’s largest
supplier, employer, customer and investor and any change in government spending priorities can have a significant impact on a
business, eg the defence industry.
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Political influence will include legislation on trading, pricing, dividends, tax, employment, as well as health and safety.
Economic environment
It refers to macro-economic factors such as exchange rates, business cycles and differential economic growth rates around the world.
It is important for a business to understand how its markets are affected by the prosperity of the economy as a whole. Other economic
influences include:
 Taxation levels.
 Inflation rate.
 The balance of trade and exchange rates.
 The level of unemployment
 Interest rates and availability of credit.
 Government subsidies.
One should also look at international economic issues, which could include:
 The extent of protectionist measures.
 Comparative rates of growth, inflation, wages and taxation.
 The freedom of capital movement.
 Economic agreements.
 Relative exchange rates.
The social environment (affects workforce and consumers)
Social influences include changing cultures and demographics. Thus, for example, the ageing populations in many Western societies
create opportunities and threats for both private and public sectors.
 Changing values and lifestyles.
 Changing values and beliefs.
 Changing patterns of work and leisure.
 Demographic changes.
 Changing mix in the ethnic and religious background of the population.
The technological influences
This is an area in which change takes place very rapidly and the organisations need to be constantly aware of what is going on.
Technological change can influence the following:
 Changes in production techniques.
 The type of products that are made and sold.
 How services are provided.
 How we identify markets.
Environmental/Ecological
Ecological
stands specifically for ‘green’ environmental issues, such as pollution, waste and climate change. Environmental
regulations can impose additional costs, for example with pollution controls, but they can also be a source of opportunity, for example
the new businesses that emerged around mobile phone recycling.
Legal environment
How an organisation does business:
 Law of contract, law on unfair selling practices, health and safety legislation.
 How an organisation treats its employees, employment laws.
 How an organisation gives information about its performance.
 Legislation on competitive behaviour.
 Environmental legislation.
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As can be imagined, analysing these factors and their interrelationships can produce long and complex lists. Rather than getting
overwhelmed by a multitude of details, it is necessary to step back eventually to identify the key drivers for change. Key drivers for
change are the environmental factors likely to have a high impact on the future success or failure of strategy. Typical key drivers will
vary by industry or sector. Thus a retailer may be primarily concerned with social changes driving customer tastes and behaviour, for
example forces encouraging outof-town shopping, and economic changes, for example rates of economic growth and employment.
Public-sector managers are likely to be especially concerned with social change (e.g. rising youth unemployment), political change
(e.g. changing government priorities) and legislative change (new training requirements).
Building scenarios
When the business environment has high levels of uncertainty arising from either complexity or rapid change (or both), it is impossible
to develop a single view of how environmental influences might affect an organisation’s strategies – indeed it would be dangerous to
do so. Scenario analyses are carried out to allow for different possibilities and help prevent managers from closing their minds to
alternatives. Thus scenarios offer plausible alternative views of how the business environment might develop in the future.
Scenarios typically build on PESTEL analyses and key drivers for change, but do not offer a single forecast of how the environment will
change. The point is not to predict, but to encourage managers to be alert to a range of possible futures. Effective scenario-building
can help build strategies that are robust in the face of environmental change.
While there are many ways to carry out scenario analyses, five basic steps are often followed:
Defining scenario scope is an important fi st step. Scope refers to the subject of the scenario analysis and the time span. For example,
scenario analyses can be carried out for a whole industry globally, or for particular geographical regions and markets. While businesses
typically produce scenarios for industries or markets, governments often conduct scenario analyses for countries, regions or sectors
(such as the future of healthcare or higher education). Scenario time spans can range from a decade or so or for just three to five years
ahead. The appropriate time span is determined partly by the expected life of investments. In the energy business, where oil fields,
for example, might have a life span of several decades, scenarios often cover 20 years or more.
Identifying the key drivers for change comes next. Here PESTEL analysis can be used to uncover issues likely to have a major impact
upon the future of the industry, region or market. In the fashion industry, key drivers range from demographics to technology. In the
oil industry, for example, political stability in the oil-producing regions is one major uncertainty; another is the capacity to develop
major new oil f elds thanks to new extraction technologies. These could be selected as key drivers for scenario analysis because both
are uncertain and regional stability is not closely correlated with technological advance.
Developing scenario ‘stories’: as in films, scenarios are basically stories. Having selected opposing key drivers for change, it is necessary
to knit together plausible stories that incorporate both key drivers and other factors into a coherent whole.
Identifying impacts of alternative scenarios on organisations is the next key stage of scenario building.
Establishing early warning systems: once the various scenarios are drawn up, organisations should identify indicators that might give
early warning about the final direction of environmentalchange, and at the same time set up systems to monitor these. Effective
monitoring of well-chosen indicators should facilitate prompt and appropriate responses.
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Micro/Industry/Sector analysis
An industry is a group of firms producing products and services that are essentially the same.
Examples are the automobile industry and the airline industry. Industries are also often described as ‘sectors’, especially in public
services (e.g. the health sector or the education sector). Industries and sectors are often made up of several specific markets.
A market is a group of customers for specific products or services that are essentially the same (e.g. A particular geographical
market). Thus the automobile industry has markets in North America, Europe and Asia, for example.
Competitive forces – the Five Forces Framework
Porter’s 5 forces model: Analyse the attractiveness and profitability of an industry or market segment. The application of Porter’s five
forces model will increase management understanding of an industrial environment which they may want to enter.
Industries vary widely in terms of their attractiveness, as measured by how easy it is for participating fi rms to earn high profits. One
key determinant of profitability is the extent of competition, actual or potential. Where competition is low, and there is little threat
of new competitors, participating firms should normally expect good profits.
The framework helps identify the attractiveness of an industry in terms of five competitive forces. His essential message is that
where the five forces are high, industries are not attractive to compete in. Excessive competitive rivalry, powerful buyers and suppliers
and the threat of substitutes or new entrants will all combine to squeeze profitability.
Although initially developed with businesses in mind, the five forces framework is relevant to most organisations. It can provide a
useful starting point for strategic analysis even where profit criteria may not apply. In the public sector, it is important to understand
how powerful suppliers can push up costs; among charities, it is important to avoid excessive rivalry within the same market.
The model has similarities with other tools for environmental audit, such as political, economic, social, and technological (PEST)
analysis, but should be used at the level of the strategic business unit, rather than the organisation as a whole. A strategic business
unit (SBU) is a part of an organisation for which there is a distinct external market for goods or services. SBUs are diverse in their
operations and markets so the impact of competitive forces may be different for each one.
Porter says that five forces together determine the long-term profit potential of an industry
Threat of new
entrants
How easy it is to enter the industry influences the degree of competition. The greater the threat of entry,
the worse it is for incumbents in an industry. An attractive industry has high barriers to entry in order to
reduce the threat of new competitors. Barriers to entry are the factors that need to be overcome by new
entrants if they are to compete in an industry.
Five important entry barriers are:
Economies of scale and experience
Access to supply or distribution channels
Expected retaliation through price war for example
Legislation or government action. Legal restraints on new entry vary from patent protection (e.g.
pharmaceuticals), to regulation of markets (e.g. pension selling), through to direct government action
(e.g. tariffs).
Differentiation. Differentiation means providing a product or service with higher perceived value
than the competition. Cars are differentiated, for example, by quality and branding. Steel, by contrast,
is by and large a commodity, undifferentiated and therefore sold by the tonne. Steel buyers will simply
buy the cheapest. Differentiation reduces the threat of entry because of increasing customer loyalty.
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Power of suppliers
Suppliers are those who supply the organisation with what it needs to produce the product or service. As
well as fuel, raw materials and equipment, this can include labour and sources of finance. The factors
increasing supplier power are the converse to those for buyer power. Thus supplier power is likely to be
high where there are:


Concentrated suppliers. Where just a few producers dominate supply, suppliers have more power
over buyers. The iron ore industry is now concentrated in the hands of three main producers, leaving
the steel companies, still relatively fragmented, in a weak negotiating position for this essential raw
material.
High switching costs. If it is expensive or disruptive to move from one supplier to another, then the
buyer becomes relatively dependent and correspondingly weak. Microsoft is a powerful supplier
because of the high switching costs of moving from one operating system to another.
Buyers are prepared to pay a premium to avoid the trouble, and Microsoft Knows it.

Power of buyers
Supplier competition threat. Suppliers have increased power where they are able to cut out buyers
who are acting as intermediaries. Thus airlines have been able to negotiate tough contracts with travel
agencies as the rise of online booking has allowed them to create a direct route to customers. This is
called forward vertical integration, moving up closer to the ultimate customer.
Buyers are the organisation’s immediate customers, not necessarily the ultimate consumers. If buyers are
powerful, then they can demand cheap prices or product or service improvements liable to reduce profits.
Buyer power is likely to be high when some of the following three conditions prevail:
Concentrated buyers. Where a few large customers account for the majority of sales, buyer power is
increased. This is the case on items such as milk in the grocery sector in many European countries,
where just a few retailers dominate the market.
Low switching costs. Where buyers can easily switch between one supplier and another, they have a
strong negotiating position and can squeeze suppliers who are desperate for their business. Switching
costs are typically low for weakly differentiated commodities such as steel.
Buyer competition threat. If the buyer has the capability to supply itself, or if it has the possibility of
acquiring such a capability, it tends to be powerful. In negotiation with its suppliers, it can raise the
threat of doing the suppliers’ job themselves. This is called backward vertical integration, moving back
to sources of supply, and might occur if satisfactory prices or quality from suppliers cannot be obtained.
For example, some steel companies have gained power over their iron ore suppliers as they have
acquired iron ore sources for themselves.
It is very important that buyers are distinguished from ultimate consumers. Thus for companies like Procter
& Gamble or Unilever (makers of shampoo, washing powders and so on), their buyers are retailers such as
Carrefour or Tesco, not ordinary consumers. Carrefour and Tesco have much more negotiating power than
an ordinary consumer would have. The high buying power of such supermarkets is a strategic issue for the
companies supplying them.
Threat of substitutes
Substitutes are products or services that offer a similar benefit to an industry’s products or services, but
have a different nature. For example, aluminium is a substitute for steel; a tablet computer is a substitute
for a laptop; charities can be substitutes for public services. Managers often focus on their competitors in
their own industry, and neglect the threat posed by substitutes.
Substitutes can reduce demand for a particular type of product as customers switch to
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Alternatives – even to the extent that this type of product or service becomes obsolete. However, there
does not have to be much actual switching for the substitute threat to have an effect.
The simple risk of substitution puts a cap on the prices that can be charged in an industry.
Competition and
rivalry
Thus, although Eurostar has no direct competitors in terms of train services from Paris to London, the prices
it can charge are ultimately limited by the cost of flights between the two cities.
At the centre of five forces analysis is the rivalry between the existing players – ‘incumbents’ in an industry.
The more competitive rivalry there is, the worse it is for incumbents. Competitive rivals are organisations
with similar products and services aimed at the same customer group (i.e. not substitutes). In the European
airline industry, Air France and British Airways are rivals; high-speed trains are a ‘substitute’
Five factors tend to define the extent of rivalry in an industry or market:

Competitor balance. Where competitors are of roughly equal size there is the danger of intensely
rivalrous behaviour as one competitor attempts to gain dominance over others, through aggressive
price cuts for example. Conversely, less rivalrous industries tend to have one or two dominant
organisations, with the smaller players reluctant to challenge the larger ones directly (e.g. by focusing
on niches to avoid the ‘attention’ of the dominant companies).
Industry growth rate. In situations of strong growth, an organisation can grow with
the market, but in situations of low growth or decline, any growth is likely to be at the
Expense of a rival, and meet with fi erce resistance. Low-growth markets are therefore often associated
with price competition and low profitability. The industry life cycle influences growth rates, and hence
competitive conditions
High fixed costs. Industries with high fixed costs, perhaps because they require high investments in capital
equipment or initial research, tend to be highly rivalrous. Companies will seek to spread their costs (i.e.
reduce unit costs) by increasing their volumes: to do so, they typically cut their prices, prompting
competitors to do the same and thereby triggering price wars in which everyone in the industry suffers.
Similarly, if extra capacity can only be added in large increments (as in many manufacturing sectors, for
example a chemical or glass factory), the competitor making such an addition is likely to create short-term
over-capacity in the industry, leading to increased competition to use capacity.
High exit barriers. The existence of high barriers to exit – in other words, closure or disinvestment
– Tends to increase rivalry, especially in declining industries. Excess capacity persists And consequently
incumbents fight to maintain market share. Exit barriers might be high for a variety of reasons: for
example, high redundancy costs or high investment in specific assets such as plant and equipment
which others would not buy.

Low differentiation. In a commodity market, where products or services are poorly differentiated,
rivalry is increased because there is little to stop customers switching between competitors and the
only way to compete is on price.
In some industries, complementors can also be considered; they enhance your business’ attractiveness to customers or suppliers. For
example, app developers are complementors to smartphones as these apps make the device more useful.
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Industry life cycle
The power of the five forces typically varies with the stages of the industry life cycle. The industry life-cycle concept proposes that
industries start small in their development stage, then go through a period of rapid growth (the equivalent to ‘adolescence’ in the
human life cycle), culminating in a period of ‘shake-out’. The final two stages are first a period of slow or even zero growth (‘maturity’),
and then the final stage of decline (‘old age’). Each of these stages has implications for the five forces.
The development stage is an experimental one, typically with few players, little direct rivalry and highly differentiated products. The
five forces are likely to be weak, therefore, though profits may actually be scarce because of high investment requirements.
The next stage is one of high growth, with rivalry low as there is plenty of market opportunity for everybody. Low rivalry and keen
buyers of the new product favour profits at this stage, but these are not certain. Barriers to entry may still be low in the growth stage,
as existing competitors have not built up much scale, experience or customer loyalty. Suppliers can be powerful too if there is a
shortage of components or materials that fast-growing businesses need for expansion.
The shake-out stage begins as the market becomes increasingly saturated and cluttered with competitors. Profits are variable, as
increased rivalry forces the weakest competitors out of the business.
In the maturity stage, barriers to entry tend to increase, as control over distribution is established and economies of scale and
experience curve benefits come into play. Products or services tend to standardise, with relative price becoming key. Buyers may
become more powerful as they become less avid for the industry’s products and more confident in switching between suppliers.
Profitability at the maturity stage relies on high market share, providing leverage against buyers and competitive advantage in terms
of cost.
Finally, the decline stage can be a period of extreme rivalry, especially where there are high exit barriers, as falling sales force remaining
competitors into dog-eat-dog competition. However, survivors in the decline stage may still be profitable if competitor exit leaves
them in a monopolistic position
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Market segments
Examples of basis of market segmentation
A market segment is a group of customers who have similar needs that are different from customer needs in other parts of the market.
Where these customer groups are relatively small, such market segments are often called ‘niches’. Dominance of a market segment
or niche can be very valuable.
For long-term success, strategies based on market segments must keep customer needs firmly in mind.
Two issues are particularly important in market segment analysis, therefore:
1. Variation in customer needs. Focusing on customer needs that are highly distinctive from those typical in the market is one
means of building a long-term segment strategy. Customer needs vary for a whole variety of reasons; any of these factors could
be used to identify distinct market segments. However, the crucial bases of segmentation vary according to market. In industrial
markets, segmentation is often thought of in terms of industrial classificationof buyers: steel producers might segment by
automobile industry, packaging industry and construction industry, for example. On the other hand, segmentation by buyer
behaviour (e.g. direct buying versus those users who buy through third parties such as contractors) or purchase value (e.g. highvalue bulk purchasers versus frequent low-value purchasers) might be more appropriate. Being able to serve a highly distinctive
segment that other organisations find difficult to serve is often the basis for a secure long-term strategy.
2. Specialisation within a market segment can also be an important basis for a successful segmentation strategy. This is sometimes
called a ‘niche strategy’. Organisations that have built up most experience in servicing a particular market segment should not
only have lower costs in so doing, but also have built relationships which may be difficult for others to break down. Experience
and relationships are likely to protect a dominant position in a particular segment. However, precisely because customers value
different things in different segments, specialised producers may find it very difficult to compete on a broader basis. For example,
a small local brewery competing against the big brands on the basis of its ability to satisfy distinctive local tastes is unlikely to find
it easy to serve other segments where tastes are different, scale requirements are larger and distribution channels are more
complex.
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Critical success factors
A strategy canvas compares competitors according to their performance on key success factors in order to establish the extent of
differentiation.
CSFs are those factors that either are particularly valued by customers (i.e. strategic customers) or provide a significant advantage in
terms of cost. Critical success factors are therefore likely to be an important source of competitive advantage or disadvantage.
For example, critical success factors in the electrical components market coild include cost, after-sales service, delivery reliability,
technical quality, testing facilities, design advisory services etc.
National Environment
( assess threats and opportunities in different countries)-Porter’s Diamond
It is a model that is designed to help understand the competitive advantage nations or groups possess due to certain factors available
to them. The tool is often used to analyse the external competitive environment or marketplace, which helps companies to determine
the relative strength and explain why certain industries have become competitive or possess regional advantages.
In this model, the regional advantages can be assessed by four factors, which includes:
1. Factor conditions
2. Firm strategy, structure and rivalry
3. Demand conditions
4. Related and supporting industries.
Government policy: Government policy on investing in infrastructure, and higher education along with tax regime and government’s
attitude to foreign investors etc. could also affect a company’s decision to invest in a country.
What do the four factors mean?
Factor conditions (country’s resources/supply side factors):
Basic pre-conditions needed for an industry to be successful but cannot give a sustainable competitive advantage by themselves
(natural resources, climate, semi-skilled or unskilled labour.
Advanced factors: Can help to promote competitive advantage (infrastructure and communications, higher education, skilled
employees like engineers to support hi-tech industries)
Demand Conditions
A country with sophisticated homebuyers that have awareness and demand for advanced, quality, and innovative products can create
international competitiveness. The experience a business gains from meeting domestic customers’ needs will allow it to compete
successfully on an international scale
Related and Supporting Industries
Industries need to be supported by a good local supply chain which contributes to quality and cost advantages. For example, the raw
material from fabric suppliers in Italy helps to drive the success of the Milan fashion industry.
Firm Strategy, structure and Rivalry
Competition in the home market that drives innovation and quality. When there’s lots of competition and lots of rivalry, this keeps
companies on their toes, and so they try to out-compete each other by continually developing more innovative and quality products
and or services. Cultural factors, social attitudes and management style all lead to competitive advantage in certain industries.
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It is important to remember that changes in the industry environment (for example mergers between existing competitors, innovation
leading to new substitutes etc) can change the strength of competitive forces. These changes could affect profitability and hence the
business might need to reconsider its future strategy. If the organization does not respond to these changes, there would be strategic
drift.
Scenario planning
As the external environment is quite complex, it becomes difficult to predict the future.
Organisations can however, develop different scenarios to help them plan and assess threats and opportunities.
It is important that organizations try to make some projections of what might happen as their strategy will need to take account of
this.
A scenario is a detailed and consistent view of how the environment might develop in the future. They are
Particularly useful when two possibilities cannot both occur.
Scenario planning can be done at the marco-environmental level (relating to changes in PESTEL factors) as well as at an industry level
(relating to changes in Porter’s 5 forces).
For example – there is a possibility that a new government policy could be passed which will make trading conditions more difficult for
a company.
Three scenarios could be prepared. What to do if:
The new policy is introduced
The new policy is not introduced
A compromise law is passed
Note that only one of the above three can happen.
Scenario planning is useful as it forces managers to consider what might happen. Scenarios can then be drawn up for those situations
which would have the most effect on the organisation.
The problems with this approach are:
The time and cost of preparing scenarios and most of the scenarios will not actually occur.
There may still be unexpected major environmental influences.
Steps Scenario construction (For Exam Questions)
1. Identify drivers of change
2. Arrange drivers in a viable framework
3. Produce 7-9 mini-scenarios
4. Group mini scenarios into 2-3 comprehensive scenarios
5. Write up the scenarios
6. Identify issues arising
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Strategic capability
Strategic capabilities are the capabilities of an organisation that contribute to its long-term survival or competitive advantage.
There are two components of strategic capability: resources and competences. Resources are the assets that organisations have or
can call upon and competences are the ways those assets are used or deployed effectively. A shorthand way of thinking of this is that
resources are ‘what we have’ (nouns) and competences are ‘what we do well’ (verbs).
Strategic capability: adequacy and suitability of the org’s resources (tangible and intangible) and competences.
Resources and competences can be threshold (the minimum needed to compete) or unique/core (which provide a competitive
advantage)
Dynamic capabilities: an org’s ability to change and develop competences to meet the needs of rapidly changing environments.
Threshold capabilities are those needed for an organisation to meet the necessary requirements to compete in a given market and
achieve parity with competitors in that market. Without such capabilities the organisation could not survive over time. Identifying
and managing threshold capabilities raises a signifi can’t challenge because threshold levels of capability will change as critical success
factors change while threshold capabilities are important, they do not of themselves create competitive advantage or the basis of
superior performance.
Distinctive capabilities are required to achieve competitive advantage. These are dependent on an organisation having distinctive
or unique capabilities that are of value to customers and which competitors find difficult to imitate.
Core competences: activities and processes through which resources are used in such a way that they achieve competitive advantage
that others cannot imitate or obtain Unique resources: resources that critically underpin competitive advantage and that others can’t
imitate obtain.
How do strategic capabilities contribute to competitive advantage and sustainable performance?
Competitive advantage: is what makes an entity better than opponents in the long term. A competitive advantage is an attribute that
allows a company to outperform its competitors. Competitive advantages allow a company to achieve superior margins compared to
its competition and generates value for the company and its shareholders.
Bringing these concepts together, a supplier that achieves competitive advantage in a retail market might have done so on the basis
of a distinctive resource such as a powerful brand, but also by distinctive competences such as the building of excellent relations with
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retailers. The distinctive competences that are likely to be most difficult for competitors to match and form the basis of competitive
advantage will be the multiple and linked ways of providing products, high levels of service and building relationships.
A competitive advantage must be difficult, if not impossible, to duplicate. If it is easily copied or imitated, it is not considered a
competitive advantage. Examples of Competitive Advantage include
1. Access to natural resources that are restricted to competitors
2. Highly skilled labor
3. A unique geographic location
4. Access to new technology
5. Ability to manufacture products at the lowest cost
6. Brand image recognition
If competitive advantage is to be achieved, resources and competences much has 4 qualities (VRIO)
1. Value: Strategic capabilities are valuable when they create a product or a service that is of value to customers and if, and only
if, they generate higher revenues or lower costs or both.
2. Rarity: Rare capabilities, on the other hand, are those possessed uniquely by one organisation or by a few others. It can be
dangerous to assume that resources and capabilities that are rare will remain so. So it may be necessary to consider other bases
of sustainability.
3. Imitability: inimitable capabilities – those that competitors find difficult and costly to imitate or obtain or substitute; mainly
linked to competences rather than resources ( so activities and processes which satisfy customer priorities and are difficult to
copy)
4. Organizational support: the organisation must also be suitably organised to support these capabilities including appropriate
organisational processes and systems. This implies that to fully take advantage of the capabilities an organisation’s structure and
formal and informal management control systems need to support and facilitate their exploitation. In brief, even though an
organisation has valuable, rare and inimitable capabilities some of its potential competitive advantage may not be realised if it
lacks the organisational arrangements to fully exploit these.
Knowledge as a resource and a competence
As accountants, you will need to understand that knowledge – its management, optimisation and valuation – requires focus if it is to
be the basis of market success or failure. It is already an area that is being measured in terms of its contribution to the existence of an
organisation, and it is therefore a critical success factor, if not already an unrecognised core competence. Talent and knowledge are
an organisation’s capabilities and abilities.
Knowledge therefore contributes to the strategic capability of an organization.
What is knowledge?
You must be familiar with the distinction drawn between data and information. Data is observations of facts outside of any context,
the information is data within a meaningful context. One way of understanding what is meant by knowledge is to think of it as being
‘information-plus’ or information combined with experience, context, interpretation, reflection and is highly contextual. It is a highvalue form of information that is ready for application to decisions and actions within organisations.
Knowledge management
Knowledge management is the attempt to improve/maximise the use of knowledge which exists in an organisation. More specifically
it aims to stimulate its creation and encourage its capture, sorting, sifting, access, linking, storage and distribution. In short, it addresses
itself to the processes identified above. Traditionally economics textbooks emphasise the quantity, quality and combination of ‘factors’
of production (land, labour, capital and enterprise) in competitive advantage. Nowadays, however, it is argued that the creation and
exploitation of ‘difficult-to-replicate’ assets such as knowledge is crucial if competitive advantage is to be gained and retained.
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THE ORGANISATION, ITS COMPETITIVE ADVANTAGE, AND KNOWLEDGE
The basis of competition is shifting from having a unique raw material or production system in manufacturing, to differentiation though
the building of knowledge. ‘Having knowledge can be regarded as even more important than possessing the other means of production
– land, buildings, labour, and capital – because all the other sources are readily available in an advanced global society, while the right
leading-edge knowledge is distinctly hard to obtain.’
Companies have already moved from being labour intensive to process intensive, to carry out tasks most efficiently, effectively,
economically and productively as possible while all the time introducing new techniques or elements to the process, product or service.
The core issue when considering knowledge management is how to get people to share their knowledge.
The easiest methods are through traditional rewards, such as pay, incentives, benefits, stocks, profits, and commissions or
alternatively, through learning opportunitie
The role of information and communication technologies (ICT)
An ICT infrastructure has a contribution to make in the following areas:
 Capturing knowledge.
 Defining, storing, categorising, indexing, and linking digital objects that correspond to knowledge units.
 Searching for ('pulling') and subscribing to ('pushing') relevant content.
 Presenting content with sufficient flexibility to render it meaningful and applicable across multiple contexts of use.
In terms of technologies the following are important:
 Intranet: to support access and exchange both within an organisation and between it and close allies such as customers and
suppliers.
 Data warehousing/repositories: the storage and making available knowledge wrapped in various degrees of context.
 Decision support systems: incorporating relevant knowledge.
 Group-ware to support collaboration: facilitating the sharing of ideas in a free-flowing manner including discussion between
participants.
 Desktop video-conferencing: for person-to-person contact important for the exchange of tacit knowledge.
 E-mail: as for desktop video-conferencing.
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Understanding and diagnosing strategic capability
Benchmarking is used as a means of understanding how an organisation compares with others– typically competitors. Many
benchmarking exercises focus on outputs such as standards of product or service, but others do attempt to take account of
organisational capabilities.
The value chain and value system
The value chain describes the categories of activities within an organisation which, together, create a product or service. Most
organisations are also part of a wider value system, the set of inter-organisational links and relationships that are necessary to create
a product or service.
Both are useful in understanding the strategic position of an organisation and where valuable strategic capabilities reside.
Porter’s Value chain : assess strategic capability ( a summary of what the org does and how its activities/processes add value to the
end customer)
If organisations are to achieve competitive advantage by delivering value to customers, managers need to understand which activities
their organisation undertakes that are especially important in creating that value and which are not. This can then be used to model
the value generation of an organisation. The important point is that the concept of the value chain invites the strategist to think of an
organisation in terms of sets of activities.
M. Porter introduced the generic value chain model in 1985. Value chain represents all the internal activities a firm engages in to
produce goods and services. VC is formed of primary activities that add value to the final product directly and support activities that
add value indirectly.
Primary activities: are directly concerned with the creation or delivery of a product or service.
For example, for a manufacturing business:
 Inbound logistics are activities concerned with receiving, storing and distributing inputs to the product or service including
materials handling, stock control, transport, etc.
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
Operations transform these inputs into the fi nal product or service: machining, packaging, assembly, testing, etc.

Outbound logistics collect, store and distribute the product or service to customers; for example, warehousing, materials
handling, distribution, etc.

Marketing and sales provide the means whereby consumers or users are made aware of the product or service and are able to
purchase it. This includes sales administration, advertising and selling.

Service includes those activities that enhance or maintain the value of a product or service, such as installation, repair, training
and spares.
Support activities: assistance to primary activities (provide support in terms of purchased inputs, human resources, technology and
infrastructure) can play an important role in respect of corporate social responsibility and sustainability!
Each of these groups of primary activities is linked to support activities which help to improve the effectiveness or efficiency of primary
activities:
Procurement. Processes that occur in many parts of the organisation for acquiring the various resource inputs to the primary activities.
These can be vitally important in achieving scale advantages. So, for example, many large consumer goods companies with multiple
businesses none the less procure advertising centrally.

Technology development. All value activities have a ‘technology’, even if it is just know-how.
Technologies may be concerned directly with a product (e.g. R&D, product design) or with processes (e.g. process development)
or with a particular resource (e.g. raw materials improvements).

Human resource management. This transcends all primary activities and is concerned with recruiting, managing, training,
developing and rewarding people within the organisation.

Infrastructure.
organisation.
The formal systems of planning, finance, quality control, information management and the structure of an
Although, primary activities add value directly to the production process, they are not necessarily more important than support
activities. Nowadays, competitive advantage mainly derives from technological improvements or innovations in business models or
processes. Therefore, such support activities as ‘information systems’, ‘R&D’ or ‘general management’ are usually the most important
source of differentiation advantage. On the other hand, primary activities are usually the source of cost advantage, where costs can
be easily identified for each activity and properly managed.
The value chain can be used to understand the strategic position of an organisation and analyse strategic capabilities in three ways:
-
As a generic description of activities it can help managers understand if there is a cluster of activities providing benefit to
customers located within particular areas of the value chain. Perhaps a business is especially good at outbound logistics linked
to its marketing and sales operation and supported by its technology development. It might be less good in terms of its
operations and its inbound logistics.
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-
In analyzing the competitive position of the organisation using the VRIO criteria as follows:
V Which value -creating activities are especially signifi can’t for an organisation in meeting customer needs and could they be
usefully developed further?
R To what extent and how does an organisation have bases of value creation that are rare? Or conversely are all elements of
its value chain common to its competitors?
I What aspects of value creation are difficult for others to imitate, perhaps because they are embedded in the activity systems
of the organisation?
O What parts of the value chain support and facilitate value creation activities in other sections of the value chain? For example,
firm infrastructure support activities including particular formal and informal management control systems can be necessary to
fully exploit value creation in the primary activities.
-
To analyse the cost and value of activities of an organisation. This can be done by following these steps:
Value network
A single organisation rarely undertakes in-house all of the value activities from design through to the delivery of the final product or
service to the final consumer. There is usually specialization of roles soany one organisation is part of a wider value system of different
interacting organisations.
Value networks recognise that few companies stand alone and that what is ultimately supplied to and paid for by customers depends
on activities carried on by many suppliers, distributors and, indeed, logistical companies. Ultimately, customer satisfaction and value
added depend on all parties working well together.
In addition to managing its own value chain, organizations can get competitive advantage by managing the linkages/relationships with
the value chain of its suppliers and customers.
If relationships in the value network care carefully managed, they can promote innovation and creation of knowledge between
organisations.
SWOT Analysis
SWOT provides a general summary of the Strengths and Weaknesses explored in an analysis of strategic capabilities and the
Opportunities and Threats explored in an analysis of the environment.
This analysis can also be useful as a basis for generating strategic options and assess future courses of action.
The aim is to identify the extent to which strengths and weaknesses are relevant to, or capable of dealing with, the changes taking
place in the business environment
Internal: strengths and weaknesses; resources and capabilities
External: opportunities and threats; environment, industry structure
Strengths and Weaknesses
Strengths and weaknesses are the factors of the firm’s internal environment. When looking for strengths, ask what do you do better
or have more valuable than your competitors have? In case of the weaknesses, ask what could you improve and at least catch up with
your competitors?
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Where to look for them?
Some strengths or weaknesses can be recognized instantly without deeper studying of the organization. But usually the process is
harder and managers have to look into the firm’s:
 Resources: land, equipment, knowledge, brand equity, intellectual property, etc.
 Core competencies
 Capabilities
 Functional areas: management, operations, marketing, finances, human resources and R&D
 Organizational culture
 Value chain activities
Strength or a weakness?
Often, company’s internal factors are seen as both, strengths and weaknesses, at the same time. It is also hard to tell if a characteristic
is a strength (weakness) or not. For example, firm’s organizational structure can be a strength, a weakness or neither! In such cases,
you should rely on:
Clear definition. Very often factors which are described too broadly may fit both strengths and weaknesses. For example, “brand
image” might be a weakness if the company has poor brand image. However, it can also be a strength if the company has the most
valuable brand in the market, valued at $100 billion. Therefore, it is easier to identify if a factor is a strength or a weakness when it’s
defined precisely.
Benchmarking. The key emphasize in doing swot is to identify the factors that are the strengths or weaknesses in comparison to the
competitors. For example, 17% profit margin would be an excellent margin for many firms in most industries and it would be
considered as a strength. But what if the average profit margin of your competitors is 20%? Then company’s 17% profit margin would
be considered as a weakness.
VRIO framework. A resource can be seen as a strength if it exhibits VRIO (valuable, rare and cannot be imitated) framework
characteristics. Otherwise, it doesn’t provide any strategic advantage for the company.
Opportunities and threats
Opportunities and threats are the external uncontrollable factors that usually appear or arise due to the changes in the macro
environment, industry or competitors’ actions. Opportunities represent the external situations that bring a competitive advantage if
seized upon. Threats may damage your company so you would better avoid or defend against them.
Where to look for them?
PESTEL. PEST or PESTEL analysis represents all the major external forces (political, economic, social, technological, environmental and
legal) affecting the company so it’s the best place to look for the existing or new opportunities and threats.
Competition. Competitor’s react to your moves and external changes. They also change their existing strategies or introduce new
ones. Therefore, the company must always follow the actions of its competitors as new opportunities and threats may open at any
time.
Market changes. The most visible opportunities and threats appear during the market changes. Markets converge, starting to satisfy
other market segment needs with the same product. New geographical markets open up allowing the firm to increase its export
volumes or start operations in a new country. Often niche markets become profitable due to technological changes. As a result,
changes in the market create new opportunities and threats that must be seized upon or dealt with if the company wants to gain and
sustain competitive advantage.
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Opportunity or threat?
Most external changes can represent both opportunities and threats. For example, exchange rates may increase or reduce the profits
gained from exports. This depends on the exchange rate, which may rise (opportunity) or fall (threat) against the home country
currency. The organization can only guess the outcome of the change and count on analysts’ forecasts. In such cases, when
organization cannot identify if the external factor will affect it positively or negatively, it should gather unbiased and reliable
information from the external sources and make the best possible judgement.
SWOT analysis example A
This is a basic example of the analysis:
SWOT analysis of Company "A"
Strengths
1.
Second most valuable brand in the world valued at $76
1.
billion
2.
2. Diversified income (5 different brands earning more than
3.
$4 billion each)
4.
3. Strong patents portfolio (15,000 patents)
5.
4. Investments in R&D reaching 4 billion a year.
6.
5. Competent in mergers & acquisitions
7.
6. Have an access to cheap cash reserves
7. Effective corporate social responsibility (CSR) projects 8.
8. Localized products
9.
9. Highly skilled workforce
10.
10. Economies of scale or economies of scope
Opportunities
1.
2.
3.
Market growth for the main firm's product
1.
Growing demand for renewable energy
2.
New technology, that would drive production costs by
3.
20% is in development
4.
4. Our country accession to EU
5.
5. Changing customer habits
6. Disposable income level will increase
6.
7. Government's incentives for 'specific' industry
7.
8. Economy is expected to grow by 4% next year
8.
9. Growing number of people buying online
9.
10. Interest rates falling to 1%
10.
Weaknesses
Investments in R&D are below the industry average
Very low or zero profit margins
Poor customer services
High employee turnover
High cost structure
Weak brand portfolio
Rigid (bureaucratic) organizational culture impeding fast
introduction of new products
High debt level ($3 billion)
Brand dilution (the firm has too many brands)
Poor presence in the world's largest markets
Threats
Corporate tax may increase from 20% to 22% in 2013
Rising pay levels
Rising raw material prices
Intense competition
Market is expected to grow by only 1% next year
indicating market saturation
Increasing fuel prices
Aging population
Stricter laws regulating environment pollution
Lawsuits against the company
Currency fluctuations
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Strategic Choice
This part is concerned with the strategic choices, or options, potentially available to an organisation for responding to the positioning
issues discussed earlier. There are three overarching choices to be made:
1. Choices as to how an organisation at a business level positions itself in relation to competitors. This is a matter of deciding how to
compete in a market. For example, should the business compete on the basis of cost or differentiation? Or is competitive
advantage possible through being more flexible and fleet-of-foot than competitors? Or is a more cooperative approach to
competitors appropriate? These are business strategies.
2.
Choices of strategic direction: in other words, which products, industries and markets to pursue. Should the organisation be very
focused on just a few products and markets? Or should it be much broader in scope, perhaps very diversified in terms of both
products (and services) and markets? Should it create new products or should it enter new territories? These questions relate to
corporate strategy, international strategy and innovation and entrepreneurial strategy.
3.
Choices about methods by which to pursue strategies. For any of these choices, should they be pursued independently by organic
development, by acquisitions or by strategic alliances with other organisations?
Business strategy: what strategy should a business unit (or other organisational subunit) adopt in its market?
Business strategy questions are fundamental both to standalone small businesses and to all the many business units that typically
make up large diversified organisations. Thus a restaurant business has to decide a range of issues such as menus, décor and prices in
the light of competition from other restaurants locally.
Similarly, in a large diversified corporation such as Unilever or Nestlé, every business unit must decide how it should operate in its own
particular market. For example, Unilever’s ice-cream business has to decide how it will compete against Nestlé’s ice-cream business
on a range of dimensions including product features, pricing, and branding and distribution channels.
These kinds of business strategy issues are distinct from the question as to whether Unilever should own an ice-cream business in the
first place: this is a matter of corporate strategy, which will be discussed later.
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Business strategy is not just relevant to the private business sector. Charities and public-sector organisations both cooperate and
compete. Thus charities compete between each other for support from donors. Public-sector organisations also need to be
‘competitive’ against comparable organisations in order to satisfy their stakeholders, secure their funding and protect themselves
from alternative suppliers from the private sector. Schools compete in terms of examination results, while hospitals compete in terms
of waiting times, treatment survival rates and so on.
Identifying SBUs
The starting point for business strategy is identifying the relevant business unit. A strategic business unit
services for a distinct domain of activity
(SBU) supplies goods or
A small business focused on a single market, such as a restaurant or specialist retailer, would count as a Strategic business unit. More
commonly, though, SBUs refer to the distinct businesses within a large diversified corporation (sometimes these SBUs are called
‘divisions’ or ‘profit centres’).
For example, Nestlé has SBUs focused on Confectionery products, Beverage products and Dairy products, among others. Typically
within a large diversified corporation, each SBU will have responsibility for its own business strategy and profit performance. In a large
public-sector organisation, such as a local authority, individual schools might be considered as SBUs, with their domain of activity being
education in a geographical area.
Generic competitive strategies
Porter’s generic strategies
Michael Porter argues that there are two fundamental means of achieving competitive advantage. An SBU can have structurally
lower costs than its competitors. Or it can have products or services that are ‘differentiated’ from competitors’ products in ways that
are so valued by customers that it can charge higher prices.
In defining competitive strategies, Porter adds a further dimension based on the scope of customers that the business chooses to
serve.
Businesses can choose to focus on narrow customer segments, for example a particular demographic group such as the youth market.
Alternatively they can adopt a broad scope, targeting customers across a range of characteristics such as age, wealth or geography.
Porter’s distinctions between cost, differentiation and scope define a set of ‘generic’ strategies: other words, basic types of strategy
that hold across many kinds of business situations.
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Cost-leadership strategy involves becoming the lowest-cost organisation in a domain of activity. There are four key cost drivers
that can help deliver cost leadership, as follows:
Input costs are often very important, for example labour or raw materials. Many companies seek competitive advantage through
locating their labour-intensive operations in countries with low labour costs.
Economies of scale refer to how increasing scale usually reduces the average costs of operation over a particular time period, perhaps
a month or a year. Economies of scale are important wherever there are high fixed costs. Fixed costs are those costs necessary for a
level of output: for example, a pharmaceutical manufacturer typically needs to do extensive R&D before it produces a single pill.
Economies of scale come from spreading these fixed costs over high levels of output: the average cost due to an expensive R&D project
halves when output increases from one million to two million units. Economies of scale in purchasing can also reduce input costs. The
large airlines, for example, are able to negotiate steep discounts from aircraft manufacturers. For the cost-leader, it is important to
reach the output level equivalent to the minimum efficient scale
Note, though, that diseconomies of scale are possible.
Large volumes of output that require special overtime payments to workers or involve the neglect of equipment maintenance can
soon become very expensive.
Experience can be a key source of cost efficiency. Cumulative experience gained by an organisation with each unit of output leads to
reductions in unit costs; there are gains in labour productivity as staff simply learn to do things more cheaply over time plus costs are
saved through more efficient designs or equipment as experience shows what works best.
Product/process design also influences cost. Efficiency can be ‘designed in’ at the outset. For example, engineers can choose to build
a product from cheap standard components rather than expensive specialised components. Organisations can choose to interact with
customers exclusively through cheap web-based methods, rather than via telephone or stores.
Porter underlines two tough requirements for cost-based strategies. First of all, the principle of competitive advantage indicates that
a business’s cost structure needs to be lowest cost (i.e. lower than all competitors’). Porter’s second requirement is that low cost
should not be pursued in total disregard for quality. To sell its products or services, the cost-leader has to be able to meet market
standards.
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For example, low-cost Chinese car producers seeking to export into Western markets need to offer not only cars that are cheap, but
cars that meet acceptable norms in terms of style, service network, reliability, resale value and other important characteristics.
Differentiation
Differentiation involves uniqueness along some dimension that is sufficiently valued by customers to allow a price premium.
Relevant points of differentiation vary between markets. Within each market too, businesses may differentiate along different
dimensions. Thus in clothing retail, competitors may differentiate by store size, locations or fashion. In cars, competitors may
differentiate by safety, style or fuel efficiency. Where there are many alternative dimensions that are valued
For Porter, the principal alternative to cost leadership is differentiation. by customers, it is possible to have many different types of
differentiation strategy in a market.
Thus, even at the same top end of the car market, BMW and Mercedes differentiate in different ways, the first typically with a sportier
image, the second with more conservative values
There is an important condition for a successful differentiation strategy. Differentiation allows higher prices, but usually comes at a
cost. To create a point of valuable differentiation typically involves additional investments, for example in R&D, branding or staff
quality. The differentiator can expect that its costs will be higher than those of the average competitor.
Differentiation strategies require clarity about two key factors:

The strategic customer. It is vital to identify clearly the strategic customer on whose needs the differentiation is based. For
example, for a newspaper business, the strategic customers could be readers (who pay a purchase price), advertisers (who pay
for advertising), or both. Finding a distinctive means of prioritising customers can be a valuable source of differentiation.
Key competitors. It is very easy for a differentiator to draw the boundaries for comparison too tightly, concentrating on a particular
niche. Thus specialist Italian clothing company Benetton originally had a strong position with its specialist knitwear shops. However,
it lost ground because it did not recognise early enough that general retailers such as Marks & Spencer could also compete in the same
product space of colourful pullovers and similar products.
Focus strategies
Porter distinguishes focus as the third generic strategy, based on competitive scope. A focus strategy targets a narrow segment or
domain of activity and tailors its products or services to the needs of that specific segment to the exclusion of others.
Focus strategies come in two variants, according to the underlying sources of competitive advantage, cost or differentiation.
In air travel, Ryanair follows a cost focus strategy, targeting price-conscious holiday travelers with no need for connecting flights.
In the domestic detergent market, the Belgian company Ecover follows a differentiation focus strategy, gaining a price premium over
rivals on account of its ecological cleaning products.
The focuser achieves competitive advantage by dedicating itself to serving its target segments better than others which are trying to
cover a wider range of segments. Serving a broad range of segments can bring disadvantages in terms of coordination, compromise
or inflexibility.
Focus strategies are able to seek out the weak spots of broad cost-leaders and differentiators:
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
Cost focusers identify areas where broader cost-based strategies fail because of the added costs of trying to satisfy a wide range
of needs. For instance, in the United Kingdom food retail market, Iceland Foods has a cost-focused strategy concentrated on
frozen and chilled foods, reducing costs against generalist discount food retailers such as Aldi which have all the complexity of
fresh foods and groceries as well as their own frozen and chilled food ranges.

Differentiation focusers look for specifi c needs that broader differentiators do not serve so well.
Focus on one particular need helps to build specialist knowledge and technology, increases commitment to service and can
improve brand recognition and customer loyalty. For example, ARM Holdings dominates the world market for mobile phone chips,
despite being only a fraction of the size of the leading microprocessor manufacturers, AMD and Intel, which also make chips for
a wide range of computers.
Sustaining competitive advantage through the marketing mix
Once a generic strategy has been chosen, the marketing strategy will be driven by the generic strategy.
Creating a marketing strategy involves developing the elements of the marketing mix
The marketing function aims to satisfy customer needs profitably through an appropriate marketing mix.
The marketing mix comprises product, price, place and promotion. For services, this is extended to include people, processes and
physical evidence.
The marketing mix can be useful when answering questions that require you to advice on courses of action. While it is unlikely that
you will be required to discuss all of the variables, thinking about the relationship between two or three of them may give some useful
insights.
Product
Place
Promotion
From the firm's point of view, the product element of the marketing mix is what is being sold. From the Customer’s
point of view, a product is a solution to a problem or a package of benefits. Many products might satisfy the
same customer need.
Product issues in the marketing mix will include such factors as:
 Design (size, shape)
 Features
 Quality and reliability
 After-sales service (if necessary)
 Packaging
Place deals with how the product is distributed, and how it reaches its customers.
(a) Channel. Where are products sold?
(b) Logistics. The location of warehouses and efficiency of the distribution system.
A firm can distribute the product itself (direct distribution) or through intermediary organisations such as retailers.
Promotion
Many of the practical activities of the marketing department are related to promotion. Promotion is the element
of the mix over which the marketing department generally has most control.
Promotion in the marketing mix includes all marketing communications which let the public know of the product
or service.
 Advertising (newspapers, billboards, TV, radio, direct mail, internet)
 Sales promotion (discounts, coupons, special displays in particular stores)
 Direct selling by sales personnel
 Public relations
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Price
The price element of the marketing mix is the only one which brings in revenue. Price is influenced by many factors
including economic factors (supply and demand), competitor's prices and payment terms
The extended marketing mix
This is also known as the service marketing mix because it is specifically relevant to the marketing of services, rather than physical
products. The intangible nature of services makes these extra three Ps particularly important.
people
Employees are particularly important in service marketing. Front-line staff must be selected, trained and
motivated with particular attention to customer care and public relations.
Processes
Physical
evidence
In some services, the physical presence of people performing the service is a vital aspect of customer satisfaction.
The staff involved are performing or producing a service, selling the service and also liaising with the customer to
promote the service, gather information and respond to customer needs.
Efficient processes can become a marketing advantage in their own right. If an airline, for example, develops a
sophisticated ticketing system, it can offer shorter waits at check-in or a wider choice of flights through allied
airlines. This both increases customer satisfaction and cuts down on the time it takes to complete a sale
Services are intangible: they have no physical substance. The customer has no evidence of ownership and so may
find it harder to perceive, evaluate and compare the qualities of service provision, and this may therefore dampen
the incentive to consume
Protecting/sustaining competitive advantage
Business strategies should ideally be sustainable over time. This may involve having competitive advantages that rivals cannot match.
Strategies are more likely to be sustained if underpinned by capabilities that combine all the VRIO characteristics of value, rarity,
inimitability and non-substitutability. Another approach to sustaining business strategies is creating ‘lock-in’.
Strategic lock-in is where users become dependent on a supplier and are unable to use another supplier without substantial
switching costs. Under conditions of lock-in, imitators and substitutes are unable to attract customers. This is particularly valuable
to differentiators. With customers securely locked in, it becomes possible to keep prices well above costs.
Lock-in can be achieved in two main ways:
Controlling complementary products or services. This is often known as the ‘razor and blade’ strategy: once a customer has bought a
particular kind of razor, he or she is obliged to buy compatible blades to use it. Apple originally applied a similar strategy when it used
Digital Rights Management to ensure that music bought on its iTunes store could only be played on its own iPod players. To switch to
a Sony player would mean losing access to all the iTunes music previously purchased.
Creating a proprietary industry standard. Sometimes companies are so successful that they create an industry standard under their
own control. Similar to the razor and blade effect, as customers invest in training and systems using that standard, it becomes more
expensive to switch to another product or service. However, with industry standards, network effects also operate: as other members
of the network also adopt the same standard, it becomes even more valuable to stay within it. Microsoft built this kind of proprietary
standard with its Windows operating system, which holds more than 90 per cent of the market. For a business to switch to another
operating system would mean retraining staff and translating fi les onto the new system, while perhaps creating communications
problems with network members (such as customers or suppliers) who had stuck with Windows.
The above discussion related to competitive strategy – the ways in which a single business unit (SBU) or organisational unit can
compete in a given market space, for instance through cost leadership or differentiation.
However, organisations may choose to enter many new product and market areas.
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Tata Group, one of India’s largest companies, began as a trading organisation and soon moved into hotels and textiles. Since that time
Tata has diversified further into steel, motors, consultancy, technologies, tea, chemicals, power, and communications. As organisations
add new units and capabilities, their strategies may no longer be solely concerned with competitive strategy in one market space at
the business level, but with choices concerning different businesses or markets. These related choices include which business unit(s)
to buy, the direction(s) an organisation might pursue and how resources may be allocated efficiently across multiple business activities.
These
Choices affect decisions about how broad an organisation should be. This ‘scope’ of an organisation is central to corporate strategy.
Scope is concerned with how far an organisation should be diversified in terms of products and markets. Another way of increasing
the scope of an organisation is vertical integration, it allows an organisation to act as an internal supplier or a customer to itself (as for
example an oil company supplies its petrol to its own petrol stations). The organisation may decide to outsource certain activities – to
‘dis-integrate’ by subcontracting an internal activity to an external supplier – as this may improve organisational efficiency. The scope
of the organisation may therefore be adjusted through growth or contraction.
If an organisation has decided to operate in different areas of activity, head office executives, the ‘corporate level’, need to manage
these to add value to the group. we need to be aware of the value-adding effect of head office, termed parenting advantage , to
the individual business units that make up the organisation’s portfolio.
STRATEGY DIRECTIONS
The Ansoff product/market growth matrix is a corporate strategy framework for generating four basic directions for organisational
growth
Market penetration implies increasing share of current markets with the current product range. This strategy builds on established
strategic capabilities and does not require the organisation to venture into uncharted territory. The organisation’s scope is exactly the
same. Moreover, greater market share implies increased power vis-à-vis buyers and suppliers (in terms of Porter’s five forces), greater
economies of scale and experience curve benefits.
Product development is where organisations deliver modified or new products (or services) to existing markets. For Apple,
developing its products from the original iPod, through iPhone to iPad involved little diversifi cation: although the technologies
differed, Apple was targeting the same customers and using very similar production processes and distribution channels.
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Market development
Product development can be risky and expensive. Market development can be more attractive by being potentially cheaper and
quicker to execute. Market development involves offering existing products to new markets. New markets could mean
: New users . Here an example would be aluminium, whose original users, packaging and cutlery manufacturers are now
supplemented by users in aerospace and automobiles.
New geographies . The prime example of this is internationalisation, but the spread of a small retailer into new towns would also be
a case.
Conglomerate diversification
Conglomerate (or unrelated) diversification takes the organisation beyond both its existing markets and its existing products. In this
sense, it radically increases the organisation’s scope. Conglomerate diversification strategies can create value as businesses may
benefit from being part of a larger group.
This may allow consumers to have greater confidence in the business unit’s products and services than before and larger size may also
reduce the costs of finance. However, conglomerate strategies are often not trusted by many observers because there are no obvious
ways in which the businesses can work together to generate additional value, over and above the businesses remaining on their own.
In addition, there is often an additional bureaucratic cost of the managers at headquarters who control them. For this reason,
conglomerate companies’ share prices can suffer from what is called the ‘conglomerate discount’ – in other words, a lower valuation
than the combined individual constituent businesses would have on their own.
Typically an organisation starts in the zone around point A, the top left-hand corner.
According to Ansoff, the organisation may choose between penetrating still further within its existing sphere (staying in zone A) and
increasing its diversity along the two axes of increasing novelty of markets or increasing novelty of products. This process of increasing
the diversity of the range of products and/or markets served by an organisation is known as ‘diversification’.
Diversification involves increasing the range of products or markets served by an organisation.
Related diversification involves expanding into products or services with relationships to the existing business.
Thus on Ansoff’s axes the organisation has two related diversification strategies available: moving to zone B, developing new products
for its existing markets or moving to zone C by bringing its existing products into new markets
In each case, the further along the two axes, the more diversified is the strategy.
Alternatively, the organisation can move in both directions at once, following a conglomerate diversification strategy with altogether
new markets and new products (zone D). Thus conglomerate (unrelated) diversification involves diversifying into products or
services with no relationships to existing businesses.
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The BCG Matrix
One of the most common and longstanding ways of considering of the balance of a portfolio of businesses is the Boston Consulting
Group (BCG) matrix
The BCG matrix
portfolio
uses market share and market growth criteria for determining the attractiveness and balance of a business
High market share and high growth are, of course, attractive. However, the BCG matrix also warns that high growth demands heavy
investment, for instance to expand capacity or develop brands. There needs to be a balance within the portfolio, so that there are
some low-growth businesses that are making sufficient surplus to fund the investment needs of higher-growth businesses.
The growth/share axes of the BCG matrix define four sorts of business:

A star is a business unit within a portfolio that has a high market share in a growing market.
The business unit may be spending heavily to keep up with growth, but high market share should yield sufficient profits to make
it more or less self-sufficient in terms of investment needs.

A question mark (or problem child) is a business unit within a portfolio that is in a growing market, but does not yet have high
market share. Developing question marks into stars, with high market share, takes heavy investment. Many question marks fail
to develop, so the BCG advises corporate parents to nurture several at a time. It is important to make sure that some question
marks develop into stars, as existing stars eventually become cash cows and cash cows may decline into dogs.
A cash cow is a business unit within a portfolio that has a high market share in a mature market. However, because growth is low,
investments needs are less, while high market share means that the business unit should be profitable. The cash cow should then
be a cash provider, helping to fund investments in question marks.


Dogs are business units within a portfolio that have low share in static or declining markets and are thus the worst of all
combinations. They may be a cash drain and use up a disproportionate amount of managerial time and company resources. The
BCG usually recommends divestment or closure.
The BCG matrix has several advantages. It provides a good way of visualising the different needs and potential of all the diverse
businesses within the corporate portfolio. It warns corporate parents of the financial demands of what might otherwise look like a
desirable portfolio of high-growth businesses. It also reminds corporate parents that stars are likely eventually to wane.
Finally, it provides a useful discipline to business unit managers, underlining the fact that the corporate parent ultimately owns the
surplus resources they generate and can allocate them according to what is best for the corporate whole.
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This model uses relative market share and market growth to suggest what should be done with products or subsidiaries. If a company
identifies a product as a ‘problem child’ BCG says that the appropriate action for the company is either to divest itself of that product
or to invest to grow the product towards a ‘star’ position on the grid. This requires money to be spent on promotion, product
enhancement, especially attractive pricing and perhaps investment in new, efficient equipment.
Assessing rate of market growth as high or low depends on the conditions in the market. No single percentage rate can be set,
since new markets may grow explosively while mature ones grow hardly at all. High market growth rate can indicate good
opportunities for profitable operations. However, intense competition in a high growth market can erode profit, while a slowly
growing market with high barriers to entry can be very profitable.
Relative market share is assessed as a ratio: it is market share compared with the market share of the largest competitor. Thus,
a relative market share greater than unity indicates that the SBU is the market leader.
The portfolio should be balanced, with cash cows providing finance for stars and question marks; and a minimum of dogs.
a) In the short term, stars require capital expenditure in excess of the cash they generate, in order to maintain their position in their
competitive growth market, but promise high returns in the future. Strategy: build.
b) In due course, stars will become cash cows. Cash cows need very little capital expenditure, since mature markets are likely to be
quite stable, and they generate high levels of cash income. Cash cows can be used to finance the stars. Strategy: hold or harvest
if weak.
c) Question marks must be assessed as to whether they justify considerable capital expenditure in the hope of increasing their
market share, or should they be allowed to die quietly as they are squeezed out of the expanding market by rival products?
Strategy: build or harvest.
d) Dogs may be ex-cash cows that have now fallen on hard times. Although they will show only a modest net cash outflow, or even
a modest net cash inflow, they are cash traps which tie up funds and provide a poor return on investment. However, they may
have a useful role, either to complete a product range or to keep competitors out. There are also many smaller niche businesses
in markets that are difficult to consolidate that would count as dogs but which are quite successful. Strategy: divest or hold.
The public sector portfolio matrix
Montanari and Bracker proposed a matrix for the analysis of services provided by public sector bodies.
This might be applied at the level of local or national government, or an executive agency with a portfolio of services. The axes are an
assessment of service efficiency and public attractiveness: naturally, political support for a service or organisation depends to a great
extent on the degree to which the public need and appreciate it.
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(a) A public sector star is something that the system is doing well and should not change. They are essential to the viability of the
system.
(b) Political hot boxes are services that the public want, or which are mandated, but for which there are not adequate resources or
competences.
(c) Golden fleeces are services that are done well but for which there is low demand. They may therefore be perceived to be
undesirable uses for limited resources. They are potential targets for cost cutting.
(d) Back drawer issues are unappreciated and have low priority for funding. They are obvious candidates for cuts, but if managers
perceive them as essential, they should attempt to increase support for them and move them into the political hot box category.
International Strategy
International strategy refers to a range of options for operating outside an organisation’s country of origin.
Global strategy is only one kind of international strategy. Global strategy involves high coordination of extensive activities dispersed
geographically in many countries around the world.
International diversification: a specific but important kind of market development, operating in different geographical markets.
There are of course the large traditional multinationals such as Nestlé, Toyota and McDonald’s. But recent years have seen the rise of
emerging-country multinationals from Brazil, Russia, India and China. New small fi rms are also increasingly ‘born global’, building
international relationships right from the start. Public-sector organisations too are having to make choices about collaboration,
outsourcing and even competition with overseas organisations. European Union legislation requires public-service organisations to
accept tenders from non-national suppliers.
Drivers for international diversification. Drivers include market demand, the potential for cost advantages, government pressures and
inducements and the need to respond to competitor moves.
Given the risks and costs of international strategy, managers need to know that the drivers are strong to justify adopting an
international strategy in the first place.
Geographical and firm-specific advantages. In international competition, advantages might come from firm-specific and geographical
advantages. Firm-specific advantages are the unique strategic capabilities exclusive to an organization. Geographical advantages might
come both from the geographic location of the original business and from the international configuration of their value network.
Managers need to appraise these potential sources of competitive advantage carefully: if there are no competitive advantages,
international strategy is liable to fail.
Countries and regions within them, and organisations originating in those, often benefit from competitive advantages grounded in
specific local conditions. They become associated with specific types of enduring competitive advantage: for example, the Swiss in
private banking, the northern Italians in leather and fur fashion goods, and the Taiwanese in laptop computers.
Michael Porter has proposed a four-pointed ‘diamond’ to explain why some locations tend to produce firms with sustained competitive
advantages in some industries more than others.
Porter’s Diamond suggests that locational advantages may stem from local factor conditions; local demand conditions; local
related and supporting industries; and from local firm strategy structure and rivalry . These four interacting determinants of
locational advantage work as follows:
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1.
Factor conditions . These refer to the ‘factors of production’ that go into making a product or service (i.e. raw materials, land and
labour). Factor condition advantages at a national level can translate into general competitive advantages for national firms in
international markets. For example, the linguistic ability of the Swiss has traditionally provided a significant advantage to their
banking industry. Cheap energy has traditionally provided an advantage for the North American aluminium industry.
2.
Home demand conditions . The nature of the domestic customers can become a source of competitive advantage. Dealing with
sophisticated and demanding customers at home helps train a company to be effective overseas. For example, America’s long
distances have led to competitive strength in very large truck engines. Sophisticated local customers in France and Italy have
helped keep their local fashion industries at the leading edge for many decades.
3.
Related and supporting industries . Local ‘clusters’ of related and mutually supporting industries can be an important source of
competitive advantage. These are often regionally based, making personal interaction easier. In northern Italy, for example, the
leather footwear industry, the leatherworking machinery industry and the design services which underpin them group together
in the same regional cluster to each other’s mutual benefit. Silicon Valley forms a cluster of hardware, software, research and
venture capital organisations which together create a virtuous circle of high-technology enterprise.
4.
Firm strategy , industry structure and rivalry . The characteristic strategies, industry structures and rivalries in different countries
can also be bases of advantage. German companies’ strategy of investing in technical excellence gives them a characteristic
advantage in engineering industries and creates large pools of expertise. A competitive local industry structure is also helpful: if
too dominant in their home territory, local organisations can become unworried and lose advantage overseas. Some domestic
rivalry can actually be an advantage, therefore. For example, the long-run success of the Japanese car companies is partly based
on government policy sustaining several national players (unlike in the United Kingdom, where they were all merged into one)
and the Swiss pharmaceuticals industry became strong in part because each company had to compete with several strong local
rivals.
International strategy . If drivers and advantages are sufficiently strong to merit an international strategy, then a range of strategic
approaches are opened up, from the simplest export strategies to the most complex global strategies.
Market selection . Having adopted the broad approach to international strategy, the question next is which country markets to
prioritise and which to steer clear of. The issues here range from the economic to the cultural and political.
Entry mode . Finally, once target countries are selected, managers have to determine how they should enter each particular market.
Again, export is a simple place to start, but there are licensing, franchising, joint venture and wholly owned subsidiary alternatives to
consider as well.
Perlmutter identifies four orientations in the management of international business.
Ethnocentrism is a home country orientation; The company focuses on its domestic market and sees exports as secondary to
domestic marketing.
Polycentrism adapts totally to local environments; objectives are formulated on the assumption that it is necessary to adapt
almost totally the product and the marketing programme to each local environment. Thus, the various country subsidiaries of a
multinational corporation are free to formulate their own objectives and plans.
Geocentrism adapts only to add value. It 'thinks globally, acts locally'
Regiocentrism recognises regional differences
Geocentrism and regiocentrism are mixtures of the two previous orientations. They are based on the assumption that there are both
similarities and differences between countries that can be incorporated into regional or world objectives and strategies.
Geocentrism and regiocentrism differ only in geographical terms: the first deals with the world as a unity, while the second considers
that there are differences between regions.
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Geocentrism treats the issues of standardisation and adaptation on their merits so as to formulate objectives and strategies that
exploit markets fully while minimising company costs. The aim is to create a global strategy that is fully responsive to local market
differences. This has been summed up as: 'think globally, act locally'.
How to grow: Methods of growth/development
Entry modes
Once a particular national market has been selected for entry, an organisation needs to choose how to enter that market. Entry modes
differ in the degree of resource commitment to a particular market and the extent to which an organisation is operationally involved
in a particular location. In order of increasing resource commitment, the four key entry mode types are:
Exporting; is the baseline option, and is suitable where the product or services are easily transported from country to country and
where the home-based competitive advantages are sufficiently broad to minimise reliance on local companies.
Contractual arrangement through licensing and franchising to local partners, as McDonald’s does to restaurant operators;
Joint ventures, in other words the establishment of jointly owned businesses;
Wholly owned subsidiaries, through either the acquisition of established companies or ‘greenfield’ investments, the development of
facilities from scratch.
Decision that have been made: which products to sell and in which markets
Next steps: how do we go about doing this? Methods of development to be decided; internal development; acquisitions and mergers
etc.
We will now discuss mergers, acquisitions and alliances as key methods for pursuing strategic options, alongside the principal
alternative of ‘organic’ development, in other words the pursuit of a strategy relying on a company’s own resources.
Diversification, internationalisation and innovation can all be achieved through mergers and acquisitions, alliances and organic
development.
Organic growth
The default method for pursuing a strategy is to ‘do it yourself ’, relying on internal capabilities.
Thus organic development is where a strategy is pursued by building on and developing an organisation’s own capabilities
For example, Amazon’s entry into the e-books market with its Kindle product was principally organic, relying on its own subsidiary
Lab126 and drawing on its expertise in book retailing, internet retail and software. For Amazon, this do-it-yourself (DIY) diversification
method was preferable to allying with an existing e-book producer such as Sony or buying a relevant hi-tech start-up such as the
French pioneer Bookeen as it could work within its own ecosystem for greater synergy gain
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Organic growth involves strategies such as:
- Developing new product ranges
- Launching existing products directly into new international markets (e.g. exporting)
- Opening new business locations – either in the domestic market or overseas
- Investing in additional production capacity or new technology to allow increased output and sales volumes
There are five principal advantages to relying on organic development:
Knowledge and learning. Using the organisation’s existing capabilities to pursue a new strategy can enhance organisational
knowledge and learning.
Spreading investment over time. Acquisitions typically require an immediate upfront payment for the target company. Organic
development allows the spreading of investment over the whole time span of the strategy’s development. This reduction of
upfront commitment may make it easier to reverse or adjust a strategy if conditions change.
No availability constraints. Organic development has the advantage of not being dependent on the availability of suitable
acquisition targets or potential alliance partners. There are few acquisition opportunities for foreign companies wanting to enter
the Japanese market, for example. Organic developers also do not have to wait until the perfectly matched acquisition target
comes onto the market.
Strategic independence. The independence provided by organic development means that an organisation does not need to make
the same compromises as might be necessary if it made an alliance with a partner organisation. For example, partnership with a
foreign collaborator is likely to involve constraints on marketing activity in external markets and may limit future strategic choices.
Culture management. Organic development allows new activities to be created in the existing cultural environment, which
reduces the risk of culture clash.
The reliance of organic development on internal capabilities can be slow, expensive and risky. It is not easy to use existing capabilities
as the platform for major leaps in terms of innovation, diversification or internationalisation, for example.
Corporate entrepreneurship
capabilities.
refers to radical change in the organisation’s business, driven principally by the organisation’s own
Inorganic growth (mergers and acquisitions)
Mergers and acquisitions are typically about the combination of two or more organisations.
In an acquisition (or takeover) this generally means an acquirer taking control of another company through share purchase. Thus ‘
acquisition ’ is achieved by purchasing a majority of shares in a target company
Most acquisitions are friendly, where the target’s management recommend accepting the acquirer’s deal to its shareholders. This is
good for acquirers as the target management are more likely to work with them to complete the deal and remain to integrate both
companies. Sometimes acquisitions are hostile, where target management refuse the acquirer’s offer. The acquirer therefore appeals
directly to the target’s shareholders for ownership of their shares. These deals can be very unfriendly with target company
management blocking efforts to obtain key information and not helping integrate the two organisations post-deal. Acquirers are
generally larger than target companies although occasionally there may be ‘reverse’ takeovers, where acquirers are smaller than
targets.
A merger is different in character to an acquisition as it is the combination of two previously separate organisations in order to
form a new company. For example, in 2012 Random House and Penguin, two big publishers, announced a merger to form Penguin
Random House to reduce costs and increase their negotiating power with distributors such as Amazon. Merger partners are often of
similar size, with expectations of broadly equal status, unlike an acquisition where the acquirer generally dominates. In practice, the
terms ‘merger’ and ‘acquisition’ are often used interchangeably.
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Mergers and acquisitions can also happen in the public and non-profit sectors: for example, the Finnish government created the new
Aalto University in 2010 by merging the Helsinki School of Economics, the Helsinki University of Art and Design and the Helsinki
University of Technology.
Strategic motives for M&A involve improving the competitive advantage of the organisation.
Extension. M&A can be used to extend the reach of a firm in terms of geography, products or markets. Acquisitions can be speedy
ways of extending international reach.
Consolidation. M&A can be used to consolidate the competitors in an industry. Bringing together two competitors can have beneficial
effects like increasing market power, increasing efficiency through shared resources and an increase production efficiency or increase
bargaining power with suppliers, forcing them to reduce their prices.
Capabilities. The third broad strategic motive for M&A is to increase a company’s capabilities.
High-tech companies such as Cisco and Microsoft regard acquisitions of entrepreneurial technology companies as a part of their R&D
effort. Instead of researching a new technology from scratch, they allow entrepreneurial start-ups to prove the idea, and then take
over these companies in order to incorporate the technological cap ability within their own portfolio
Financial motives concern the optimal use of financial resources, rather than directly improving the actual business.
Financial efficiency. It may be efficient to bring together a company with a strong balance sheet (i.e. it has plenty of cash) with another
company that has a weak balance sheet (i.e. it has high debt). The company with a weak balance sheet can save on interest payments
by using the stronger company’s assets to pay off its debt, and it can also get investment funds from the stronger company that it
could not have accessed otherwise. The company with the strong balance sheet may be able to drive a good bargain in acquiring the
weaker company.
Tax efficiency. Sometimes there may be tax advantages from bringing together different companies. For example, profits or tax losses
may be transferrable within the organization in order to benefit from different tax regimes between industries or countries. Naturally,
there are legal restrictions on this strategy.
Asset stripping or unbundling. Some companies are effective at spotting other companies whose underlying assets are worth more
than the price of the company as a whole. This makes it possible to buy such companies and then rapidly sell off (‘unbundle’) different
business units to various buyers for a total price substantially in excess of what was originally paid for the whole. Although this is often
dismissed as merely opportunistic profiteering (‘asset stripping’), if the business units find better corporate parents through this
unbundling process, there can be a real gain in economic effectiveness.
Franchising
Franchising is a business relationship in which the franchisor (the owner of the business providing the product or service) assigns to
independent people (the franchisees) the right to market and distribute the franchisor's goods or service, and to use the business
name for a fixed period of time.
It is simply a method for expanding a business and distributing goods and services through a licensing relationship. In franchising,
franchisors not only specify the products and services that will be offered by the franchisees, but also provide them with an operating
system, brand and support.
Strategic alliances could range from a formal joint venture to looser collaborations.
Strategic alliances
M&A bring together companies through complete changes in ownership. However, companies also often work together in strategic
alliances that involve collaboration with only partial changes in ownership, or no ownership changes at all as the parent com panies
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remain distinct. Thus a strategic alliance is where two or more organisations share resources and activities to pursue a common
strategy
.
An oil and natural gas company might form a strategic alliance with a research laboratory to develop more commercially viable
recovery processes. A clothing retailer might form a strategic alliance with a single clothing manufacturer to ensure consistent quality
and sizing. A major website could form a strategic alliance with an analytics company to improve its marketing efforts.
Alliance strategy challenges the traditional organisation-centred approach to strategy. Practitioners of alliance strategy need to think
about strategy in terms of the collective success of their networks as well as their individual organisations’ self-interest.
Collective strategy is about how the whole network of alliances, of which an organisation is a member, competes against rival
networks of alliances.
Thus for Microsoft, competitive success for its Xbox games console relies heavily on the collective strength of its network of
independent games developers such as Bungie Studios (makers of Halo), Crystal Dynamics
(Tomb Raider), Rockstar North (Grand Auto Theft Auto V) and Crytek Studios (Crysis 3). Part of Microsoft’s strategy must include
developing a stronger ecosystem of games developers than its rivals such as Sony and Nintendo. Collective strategy highlights the
importance of effective collaboration. Thus success involves collaborating as well as competing. Collaborative advantage is about
managing alliances better than competitors. For Microsoft to maximise the value of the Xbox, it is not enough for it to have a stronger
network than rivals such as Sony and Nintendo, but it must be better at working with its network in order to ensure that its members
keep on producing the best games.
Buy, have an alliance or do it yourself?
Acquisitions and strategic alliances have high failure rates. Acquisitions can go wrong because of excessive initial valuations,
exaggerated expectations of strategic fit, underestimated problems of organizational fit etc. Alliances also suffer from
miscalculations in terms of strategic and organizational fit, but, given the lack of control on either side, have their own particular
issues of trust and co-evolution as well. With these high failure rates, acquisitions and alliances need to be considered cautiously
alongside the default option of organic development (Do-It-Yourself).
The best approach will differ according to circumstances. Some key factors that can help in choosing between acquisitions, alliances
and organic development are:
Urgency. Acquisitions are a rapid method for pursuing a strategy. It would probably take decades for Tata to build up on its own
two international luxury car brands equivalent to Jaguar and Land Rover. Tata’s purchase of the two brands gave an immediate kickstart to its strategy. Alliances too may accelerate strategy delivery by accessing additional resources or skills, though usually less
quickly than a simple acquisition.
Typically organic development (DIY) is slowest: everything has to be made from scratch.
Uncertainty. It is often better to choose the alliance route where there is high uncertainty in terms of the markets or technologies
involved. On the upside, if the markets or technologies turn out to be a success, it might be possible to turn the alliance into a full
acquisition, especially if a buy option has been included in the initial alliance contract. If the venture turns out a failure, then at least
the loss is shared with the alliance partner. Acquisitions may also be resold if they fail but often at a much lower price than the
original purchase.
On the other hand, a failed organic development might have to be written off entirely, with no sale value, because the business unit
involved has never been on the market beforehand.
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Type of capabilities. Acquisitions work best when the desired capabilities (resources or competences) are ‘hard’, for example
physical investments in manufacturing facilities. Hard resources such as factories are easier to put a value on in the bidding process
than ‘soft’ resources such as people or brands. Hard resources are also typically easier to control post-acquisition than people and
skills. As with the Disney takeover of Marvel, acquisitions pose the risk of significant cultural problems. Sometimes too the acquiring
company’s own image can tarnish the brand image of the target company.
Acquisition of soft resources and competences should be approached with great caution.
Indeed, the DIY organic method is typically the most effective with sensitive soft capabilities such as people.
Internal ventures are likely to be culturally consistent at least. Even alliances can involve culture clashes between people from the
two sides, and it is harder
To control an alliance partner than an acquired unit.
Modularity of capabilities . If the sought-after capabilities are highly modular, in other words they are distributed in clearly distinct
sections or divisions of the proposed partners, then an alliance tends to make sense. A joint venture linking just the relevant sections
of each partner can be formed, leaving each to run the rest of its businesses independently. There is no need to buy the whole of the
other organization. An acquisition can be problematic if it means buying the whole company, not just the modules that the acquirer
is interested in.
The DIY organic method can also be effective under conditions of modularity, as the new
business can be developed under the umbrella of a distinct ‘new venture division’
CRITERIA USED BY MANAGEMENT TO SELECT STRATEGIES
Once all the alternative options have been generated we need to evaluate their appropriateness before making a choice. A useful
framework to apply when considering the appropriateness of an option is:
 Suitability
 Feasibility
 Acceptability.
Suitability
Suitability identifies the extent to which the proposed strategy enhances the situation identified in the strategic analysis. The following
questions need to be addressed about the strategic options:
 Does it address threats and weaknesses?
 Does it build on identified strengths (unique resources and core competences) and exploit opportunities?
 Does it fit in with the organization’s mission and corporate culture?
Acceptability
The final issue to address is whether the selected strategy will meet the expectations of the key stakeholders in the firm and typical
issues to be looked at would include the level of risk and return resulting from the option.
Feasibility
The issue of feasibility evaluates whether the chosen strategy can be implemented successfully (The organization’s strategic capability
(The resources the organization has at its disposal) will obviously determine this (money, machinery, manpower, material, markets,
skills etc.)
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Risk Management
Risk is the ‘chance of exposure to the adverse consequences of uncertain future events’. If and when those risks actually occur, they
can have an adverse impact on the organization’s objectives.
Risk awareness: Risk awareness describes the ability of an investor to recognise and measure the risk associated with it
Risks vary by sector
Risks do not apply equally to all companies. This is because risks are associated with particular activities, and companies in different
industrial sectors are exposed to different risks because of what they do. So, for example, banks are more exposed to a range of
financial risks whilst manufacturing and mining are usually more concerned with health and safety risks.
This is because of the different environments, and the business models, strategies and financial structures adopted by companies in
different industries.
Sectors exist in different environments. This means that the external factors which affect businesses and give rise to risks are different.
Some industries, for example, are mainly located within a certain geographical area whilst others are international, thereby giving rise
to such risks as exchange rate risk, etc. Some exist in relatively simple and stable environments whilst others are in more turbulent
and changeable environments. Thus, in more unstable and complex environments, perhaps with greater levels of regulation, changing
consumer patterns and higher technology, companies will be subject to greater risks than those in more stable and simple
environments.
Companies in different sectors adopt different business models. This means that the ways in which value is added will differ
substantially among companies in different sectors. In a service industry, for example, value is added by the provision of intangible
products, often with the direct intervention of a person. In a manufacturing company, there will be risks associated with inventory
management which a service industry will not be exposed to. Conversely, a company in a service industry such as insurance or banking
is more likely to be exposed to certain technical skill shortages and fraud risks.
Different sectors have different financial structures, strategies and cost bases. Some companies, by virtue of their main activity, rely
heavily on short or long-term loan capital whereas others have lower structural gearing. Others have even more complex financial
structures. These financial structures give rise to different costs of capital and differential vulnerabilities to such external factors as
monetary pressure. So whereas a traditional manufacturing company might have very little debt, a civil engineering business
undertaking individual large projects might take on large amounts of medium-term debt to finance the project. This means that risks
are greater in such a business because of the financial gearing which is lower in the traditional company funded mainly by shareholders’
equity or retained surpluses. Banks rely on a range of funding sources and become vulnerable to losses when these become difficult
or the price of gaining these funds rises for any reason. Some companies have different cost structures which make them more risky
in different economic circumstances. Companies with high operational gearing, such as those having very high fixed costs compared
to variable costs, have more volatile returns simply because of the structure of their cost base.
IMPORTANCE OF RISK MANAGEMENT
Risk, in a business sense, is uncertainty. If uncertainty is not properly managed, then forward planning will be almost impossible, and
there is a greater risk of business catastrophe. Directors who fail to manage risk are failing in their duty to shareholders.
Risk is not always negative. By taking on risk, organizations may increase their returns. If an organization chooses to take no risk at all,
it is unlikely that business will grow.
The amount of risk that an organization needs to take, or wants to take,will depend on a number of factors that will be looked at in
this summary!
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RISK STRATEGY
A company’s risk strategy will be tied into its corporate strategy - what the company is trying to achieve as an organization. For
example, if an organization is seeking rapid growth, it is likely that it will have to take more risks than an organization that is seeking
to maintain its position in the market.
RISK APPETITE
An organization’s risk appetite is the amount of risk an organization is willing to accept.
The risk appetite will vary amongst organizations. Often small businesses in startup situations will be willing to take on high levels of
risk to achieve growth. Large, well established companies with a position to protect may be less willing to take on very risky projects
as they do not want to erode their position.
Risk-averse entities will tend to be cautious about accepting risk, preferring to avoid risk, to share it or to reduce it. In exchange, they
are willing to accept a lower level of return. Those with an appetite for risk will tend to accept and seek out risk, recognising risk to be
associated with higher net returns.
Risk appetite has an important influence on the risk controls that the organization is likely to have in place. Organizations that actively
seek to avoid risks, perhaps found more in the public sector, charitable sector and in some ‘process’-oriented companies, do not need
the elaborate and costly systems that a risk seeking company might have. Organizations such as those trading in financial derivatives,
volatile share funds and venture capital companies will typically have complex systems in place to monitor and manage risk. In such
companies, the management of risk is likely to be a strategic core competence of the business.
Therefore, Risk appetite can be explained as the nature and strength of risks which an organisation is prepared to accept or seek. It
comprises two key elements:
(i)
The level of risk which the company’s directors consider desirable; and
(ii)
The capacity of the company to actually bear the level of risk.
RISK ATTITUDE: Risk strategy is affected by the directors’ attitudes to risk. Some directors will be willing to take on more risks than
others. This can be down to their own personalities, but directors may take risks if they believe that the shareholders want them to and
vice versa. Shareholders may invest in companies or select directors who are willing to take the amount of risk they wish for.
RISK CAPACITY: Risk capacity is about having the resources available to deal with risks. A company cannot always take high risks if
they do not have the resources to deal with those risks.
EMBEDDING RISK
Risk awareness: is the knowledge of the nature, likelihood and potential costs of risks facing an organization.
Senior management will have an awareness of risks, but this awareness needs to be embedded throughout the organization at all
levels in order to manage risk effectively.
Awareness and acceptance of risk management is needed at all levels
Risk management is not a stand-alone activity- it is normal behavior
The methods by which risk awareness and management can be embedded in organizations are as follows:
1.
Establish a visible policy on risk awareness, and have this unreservedly supported by management, trade unions and staff. This
should encourage everybody to identify risks, including those arising from the behaviour of management, and bring them to the
attention of appropriate people without fearing a negative or hostile response. A philosophy and culture of risk awareness would
be developed so that everybody recognises the importance of all risks and seeks to address them as far as possible.
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2.
Linked to this is the encouragement of open communication and a supportive culture. No-one should think themselves too junior
or uninformed to raise a risk issue with management. It is often at the operational levels where risks can have the most
unfortunate effects and so many previously unnoticed risks can arise from there. Similarly, management should welcome all
discussion of risk as a normal part of their responsibilities and should never dismiss an idea, even if it is something of which
management is already aware.
3.
It is always good practice to establish formal systems such as a risk committee and a risk auditing procedure. The establishment
of a risk audit forces the company to identify all risks affecting the business, both internal and external. Once listed on a risk
register, each of these can then be assessed according to their perceived probability of being realised and their likely impact. A
risk strategy can then be assigned to each risk and any changes to the risk environment can be ‘fed’ into the system to ensure
that it remains current. This also provides a reporting mechanism by which individual managers, including the most senior, can
be held accountable for their behaviour in respect of risks.
4.
Human resource management: Culture is often described as the way we do things around here, so for greater risk awareness, it
needs to be instilled in all aspects of human resource management, including
Individual job descriptions which should be drawn up with a greater emphasis on the duty of all employees to recognize and
act on risks which may arise in their area of operations.
Induction programmes for new employees to include detail of organisation’s ERM initiatives so that risk becomes ingrained
in employee behaviours from the outset.
Regular training workshops for existing staff to reinforce the key elements of the risk management philosophy and ERM
processes.
Individual performance appraisals to evaluate objectives relating to risk. This way risk management will be considered a key
feature of staff appraisal and reward systems, and so become more important to all of the employees.
5.
Maintain a risk register: A risk register which lists and prioritises the main risks which the company faces can help employees
decide which risks need most attention. The register can then be used as an objective and consistent basis to manage risk,
committing sufficient resources as necessary and providing a holistic view of how risk is being managed throughout the
organization.
6.
Another way to embed risk awareness in general is to publicise success stories in the company and to reward risk awareness
behaviour through whatever mechanisms are appropriate. It would be welcomed if the discovery of a new risk or a change in its
assessment was something which employees thought to be an exciting thing and something which might attract an additional
day’s holiday, a one-off cash payment or a weekend break away somewhere
RISK MANAGEMENT
1. Identify risk
2. Assess/analyse risk
3. Manage
4. Report
5. Monitor
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Identify risks
1.
2.
3.
4.
How to identify risk?
The use of models such as:
– SWOT analysis (strengths, weaknesses, opportunities and threats);
– PESTLE analysis (political, economic, social, technological, legal and environmental).
Brainstorming sessions from the board of directors and senior management.
The use of risk questionnaires for staff throughout the organisation who are closer to operations than
the directors.
The use of external risk consultants who have industry experience but can bring a fresh perspective.
Types of risk
Strategic Risk
It is the current and prospective impact on earnings or capital arising from adverse business decisions,
improper implementation of decisions, or lack of responsiveness to industry changes
These arise from the overall strategic positioning of the company in its environment. Some strategic positions
give rise to greater risk exposures than others. Because strategic issues typically affect the whole of an
organization and not just one or more of its parts, strategic risks can potentially involve very high stakes –
they can have very high hazards and high returns. Because of this, they are managed at board level in an
organization and form a key part of strategic management.
The factors contributing to the strategic risks are:
– Types of industry / markets within which the business operates
– Competitors’ strategy and new products coming into the market
– Political state of the economy in which the company operates
– Capacity of the company to operate in a highly dynamic environment
– Fluctuating prices of the inputs upon which the business is dependent
– The company readiness to adapt to changing technologies
Operational Risk
Operational risks refer to potential losses arising from the normal business operations which are more likely
to affect a part of the business rather than the whole organisation. Accordingly, they affect the day-to-day
running of operations and business systems in contrast to strategic risks that arise from the organization’s
strategic positioning.
Operational risks are managed at risk management level (not necessarily board level) and can be managed
and mitigated by internal control systems
Directors and senior management need to ensure they do not ignore operational issues because they are
focusing on higher level strategy.
Distinguishing features between strategic and operational risk
Strategic risks take time to affect the business whereas operational risks have an immediate impact.
Therefore events that lead to operational risks usually require immediate action .
Strategic events, generally provide management with time to assess the new position, choose an appropriate
strategy and implement it(although sometimes may also require an immediate response)
Although operational risks may have a combined impact on strategic risk they are usually related to day-today operations such as buying, supplier logistics, manufacture, delivery of products and services, marketing
and selling and after-sales service.
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Business risks ( financial, operational and compliance)
These are risks which can threaten the survival of the business as a whole and they can arise from many
sources. Essentially though, they arise because of the business model which an organisation operates and the
strategies it pursues. Some business activities, by their nature, give rise to certain risks which can threaten
the business as a whole. Some business risks can affect the ‘going concern’ status and threaten the survival
of the business. This is when the continuation of a business in its present form is uncertain because of external
threats to the business at a strategic level, or a failure of the business’s strategy.
Financial risks
These are the risks which arise from the way a business is financially structured, its management of working
capital and its management of short and long-term debt financing. Cash flow can be strongly influenced by
how much debt to equity a business has, its need to service that debt and the rate at which it is borrowed.
Likewise, the ability of a business to operate on a day-to-day basis depends upon how it manages its working
capital and its ability to control payables, receivables, cash and inventories. Any change which makes its cash
flow situation worse, such as poor collection of receivables, excessive borrowing, increased borrowing rates,
etc, could represent an increased financial risk for the business.
Credit Risk : This is the risk that customers fail to pay their bills on time, or do not pay at all. This can be
minimized by not offering credit, doing credit checks on customers before giving credit, and debt factoring.
Market Risk: Market risks are those arising from any of the markets that a company operates in. Most
common examples are those risks from resource markets (inputs), product markets (outputs) or capital
markets (finance).
Financial Market Risk: Financial market risk is the risk that the fair value or cash flows of a financial instrument
will fluctuate due to changes in market prices. Market risk reflects interest rate risk, currency risk, and other
price risks’.]
Liquidity Risk: Liquidity risk refers to the difficulties that can arise from an inability of the company to meet
its short-term financing needs, i.e. its ratio of short-term assets to short term liabilities. Specifically, this refers
to the organisation’s working capital and meeting short-term cash flow needs. The essential elements of
managing liquidity risk are, therefore, the controls over receivables, payables, cash and inventories.
Exchange rate risk: Most international transactions involve a currency exchange (unless the countries are in
a single currency trading block).Because currencies rise and fall against each other as a result of supply and
demand for those currencies, an adverse movement of one against the other can mean that the cost of a
transaction in one currency becomes more expensive because of that adverse movement. The loss incurred
by that adverse movement multiplied by the company’s financial exposure is the impact of exchange rate
risk.
Interest Rate Risk: This is similar to currency risk. As interest rates change, the ability to borrow cheaply and
the returns received on investments will change.
Derivative Risk: Derivative risk arises from the use of derivative financial instruments such as options, futures
and forward contracts in order to manage the business.
Legal and Compliance Risk: This is the risk of breaching laws and regulations and being fined (or even closed
down) as a result. The cost is not necessarily just financial, the time taken in dealing with an investigation can
be distracting to the board. Compliance with legal regulations also creates reputation risk.
Political Risk: Political risk refers to a potential failure on the part of the state to fulfil all or part of its functions.
It can also relate to any potential influence a government has on the business environment in the country
concerned. The state’s role is to legislate, to formulate and implement public policy, to enforce justice through
regulation and statutes, and to administer the functions of the state (such as education, local services, health,
etc). A change in government or sudden imposition of new laws could make it difficult for companies to
operate.
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Technology Risk: The risk of technological failure. Failures could be caused by weather, water damage,
overheating or a badly designed system that fails, or is corrupted. Additionally, a lack of computer controls
could lead to a virus or staff with a grudge deliberately placing false transactions on the system. Another
aspect of technological risk is that competitors could have better technology and the company falls behind.
People often associate technology with computers but it need not be so – it could also be engineering,
designs, etc.
Health and Safety Risk: These are risks to individuals, employees or others, arising from any failure in our
operations giving rise to compromised human welfare...
Environmental Risk: Environmental risk can be described as a loss or liability which arises from the effects of
the natural environment on an organisation, or a loss or liability arising out of the environmental effects of
the organisation‘s operations. Risk can thus arise from natural phenomena affecting the business such as the
effects of climate change, adverse weather, resource depletion, and threats to water or energy supplies.
Similarly, liabilities can result from emissions, pollution, and waste or product liability.
Fraud Risk: This is the risk of fraud by employees, customers, suppliers or other parties.
Intellectual Property Risk: Intellectual property is the knowledge, skills and experience that a company’s staff
have built up. If those staff leave the company, they may take company secrets, designs and strategies on to
their new employer.
Reputation Risk: A bad reputation can wreck a business (for example, Andersens after Enron) although
sometimes a bad reputation can actually improve profits (any song banned by the radio stations).
Business Probity Risk: This is the risk that a company is seen to be doing the wrong thing. For example
company paying bonuses to directors when the business is not performing well or company using child labour.
Entrepreneurial risk: Entrepreneurial risk is the necessary risk associated with any new business venture or
opportunity.It is expressed in terms of the unknowns of the market/customer reception of a new venture or
of product uncertainties, for example product design, construction, etc. There is also entrepreneurial risk in
uncertainties concerning the competences and skills of the entrepreneurs themselves.
Trading risk
International trade presents its own special risks due to the increased distances and times involved. The types
of trading risk include:
1. Physical risk of goods being lost, stolen or damaged in transit, or the legal documents accompanying the
goods going missing;
2. The customer refusing to accept the goods on their delivery; and
3. Cancellation of an order whilst in transit.
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Analyze risks
Once risks are identified the next steps are to measure and manage those risks.
There are two main variables that make a risk important – its impact and its likelihood. The impact relates to
the effect it will have on the organization and the likelihood is the chance that the outcome will occur.
These can be mapped in diagrammatic form as follows:
Tools and techniques for analyzing risks
A number of tools can be used to quantify the impact of risks on the organization, some of which are described
below.
Scenario planning: in which different possible views of the future are developed, usually through a process
of discussion within the organization.
Sensitivity analysis: in which the values of different factors which could affect an outcome are changed to
assess how sensitive the outcome is to changes in those variables.
Decision trees: often used in the management of projects to demonstrate the uncertainties at each stage and
evaluate the expected value for the project based on the likelihood and cash flow of each possible outcome.
Software packages: designed to assist in the risk identification and analysis processes.
Risk perceptions: objective and subjective risk perceptions.
Risk perception is the belief held by an individual or collectively by a group, about the chance of a risk occurring
and/or about the extent, magnitude, and timing of its effects.
Some risks can be assessed (which involves establishing the likelihood and impact) with a very high degree of
certainty.
If likelihood and/or impact can be measured with scientific accuracy then we can say that the risk can be
objectively assessed.
In many cases, however risk problems can be ‘messy’ and it can be difficult to accurately assign a value to a
likelihood or an impact. This is where subjective judgements can be used although there are obvious
limitations with such judgments.
Why should risk assessment be on-going?
The first reason why there needs to be a continuous and ongoing risk assessment is because of the strategic
importance of many risks and because of the dynamic nature of those risks being assessed. Some risks reduce
over time and others increase, depending upon changes in the business environment that organizations exist
in. Accordingly, it should not be seen as a ‘once and for all’ activity. If there is a risk that companies who
borrow money become less able to repay their loans than previously, this is a negative change in the business
environment (thereby affecting liquidity risk). When business recovers and bank customers’ ability to repay
large loans improves, the liquidity risk for the banks is reduced.
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Second, it is necessary to always have accurately assessed risks because of the need to adjust risk
management strategies accordingly. The probabilities of risk occurring and the impacts involved can change
over time as environmental changes take effect. In choosing, for example, between accepting or reducing a
risk, how that risk is managed will be very important. In reducing their lending, the banks have apparently
decided to reduce their exposure to liquidity risk. This strategy could change to an ‘accept’ strategy when the
economy recovers.
Manage risks
A useful mnemonic to remember this process is TARA, which is:
Transfer risk
Avoid risk
Reduce risk
Accept risk
TRANSFERRING RISK
This would involve the company accepting a portion of the risk and seeking to transfer a part to a third party.
- Insurance
- Joint venture to spread risk
- Franchising
- Outsourcing production can transfer risk as if there are problems with the quality of a product, the
company can refer back to the supplier with any problems.
AVOIDING RISK
Not engage in the activity or area in which the risk is incurred. Some risks can be totally avoided. If a business
has identified that opening a subsidiary in a foreign country appears to be high risk, then not opening the
subsidiary solves the problem.
However, to totally avoid a business opportunity is often a rather extreme reaction as the company avoids
the risk and the potential returns. If no risks are taken, the chance of returns being earned is small.
REDUCING RISK
A risk reduction strategy involves seeking to retain a component of the risk (in order to enjoy the return
assumed to be associated with that risk) but to reduce it and thereby limit its ability to create liability.
- Primarily through Internal controls
- Lesser of the activity which causes risk
If it is decided that the risk cannot be transferred nor avoided, it might be asked whether or not something
can be done to reduce or mitigate the risk. This might mean, for example, reducing the expected return in
order to diversify the risk or re-engineer a process to bring about the reduction.
ACCEPTING RISK
A risk acceptance strategy involves taking limited or no action to reduce the exposure to risk and would be
taken if the returns expected from bearing the risk were expected to be greater than the potential liabilities.
Some businesses will accept risks as they want to receive potential returns. However others will be accepted
because there is nothing that can be done about them. In this case the organization must know the potential
costs and the probability of the risk occurring.
For example, if a profitable product has a high return rate, costing the company warranty and refund costs,
they may decide that it is worth putting up with these costs as they want to earn the profits from the product.
Risk diversification.
Diversification of risk means adjusting the balance of activities so that the company is less exposed to the
risky activities and has a wider range of activities over which to spread risk and return.
Risks can be diversified by discontinuing risky activities or reducing exposure by, for example, disposing of
assets or selling shares associated with the risk exposure.
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Risk is the uncertainty caused by variable returns. One way to deal with uncertainty in the business is to
diversify.
This spreads a company’s risk in many areas. By operating in many different sectors, it is likely that when one
sector is performing badly, another will be doing well, leading to a smoothing of profits.
A common example of diversification is a business that sells umbrellas and ice creams. If the weather is bad,
umbrellas will sell well and if it is good ice creams will sell well.
Methods of diversifying risks are as follows:
Diversifying risks through financial management techniques such as hedging
Investing in different businesses and geographical locations so that the loss incurred at one location
/business can be offset by the profit made in another
Sharing the risk by entering into partnerships and joint ventures so that risk is spread over other parties
When is diversification appropriate?
1. Companies may diversify in various businesses that complement each other. These businesses are
generally different lines of investment in the same profession. By investing in similar businesses,
companies guard against the risk of loss from one area by the gain that will incur in another.
Companies might also diversify their business in the same line of business but in different geographical
locations. This may mitigate any risk since low results in one location might be offset by better results in
another. Location-specific marketing strategies may result in variable sales results.
2.
Diversification, however, does not work in situations where two business lines are positively related. In
this case, an adverse change in one of the businesses will lead to an adverse change in the other.
3.
Diversification involves a risk when it comes to diversifying into areas that are not related at all. In these
situations adverse changes in one business may coincide with either adverse or favourable changes in
the other. The outcomes are very unpredictable in each business since the products are totally unrelated.
This only leads to partial diversification of risks since risks are only reduced to a certain extent. However
if each business faces adverse change then losses increase.
The ALARP (as low as reasonably practical) principle in risk assessment
Risks and their acceptability
It is normally perceived that there is an inverse relationship between risks and their acceptability i.e. lower
risk is more acceptable as compared to a higher risk. This is demonstrated in diagram.
It would be irrational simply to say that higher risks should never be taken because higher return is often
associated with higher risk: risk and return are usually positively associated. It is also the case that many risks
are unavoidable in a given situation and must be accepted, at least in part.
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ALARP relates to the level of risks which are unavoidable and so should be controlled. An example of the
ALARP principle is in incurring health and safety risk
Employees are often exposed to personal injury in work place on account of oil spillage, gas leaks, loss of
limbs due to operating unsafe machinery, etc. These are some health and safety risks (caused due to
occupational hazards) which are inherent risks faced by many entities. As the returns associated with the
exposure of health and safety risk are high, the risks cannot be totally avoided. That is why ALARP is a
commonly used risk assessment technique to mitigate health and safety risks.
ALARP technique involves incurring certain risk mitigating costs like installation of anti-pollution equipment
at the work place, compliance costs like providing safety equipment like shoes, helmets to employees, etc. In
short the investment in health and safety risk mitigation is a trade-off between the costs incurred and
assessment of the likelihood and impact of the risk assessed.
Therefore the risk must be ‘as low as reasonably practicable’ (ALARP). Here there must be a reasonable
proportion between the quantum of risk and the costs incurred for mitigating the risk. On the other hand if
there is a significant disproportion between the two variables the cost incurred cannot be considered as
“ALARP”.
Related and correlated risk factors
Related risks are risks that vary because of the presence of another risk or where two risks have a common
cause. This means when one risk increases, it has an effect on another risk and it is said that the two are
related.
Risk correlation is a particular example of related risk. Risks are positively correlated if the two risks are
positively related in that one will fall with the reduction of the other, and increase with the rise of the other.
They would be negatively correlated if one rose as the other fell..
Correlated risks can be:
Positively correlated (i.e. both risks
move in the same direction either
upward or downward). For example
environmental risk and reputation risk
move in the same direction.
Negatively correlated (i.e. both risks
move in the opposite direction one
upward and the other downward).
Reporting risks
Persons who suffer from high level of diabetes run the risk of
the degeneration of eyes and the risk of kidney failure. However
if the level of diabetes is reduced, risk of eye diseases or risk of
kidney failure is reduced.
Therefore risk of eye diseases or risk of kidney failure are
positively correlated.
An entity which borrows money to install anti pollution
equipment will reduce its environmental risk. However if the
amount of borrowing is high its financial risks are increased on
account of high gearing. Higher gearing exposes the company
to the risk of higher interest rates which in turn affects the cash
flow. Therefore environmental risk and financial risk are
negatively correlated.
Summary:
Reporting of risks
a) A summary of the measures that the board has taken to address risks such as environmental risk and
corporate social responsibility should be reported in the annual accounts.
b) Risks that result in a material error in the financial statements are reported by the auditor in the audit
report.
c) The audit committee usually reports on the risks internally to management.
Details:
Process of externally reporting on internal controls and risks
The Turnbull Guidance
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1.
Narrative statement: How annual review of effectiveness of internal controls has been conducted
2.
The board should disclose that there is an ongoing process for identifying, evaluating and managing the
significant risks faced by the company and that this process was in place for the entire year.
3.
The board should take full responsibility for the maintenance and review of the internal control systems
and state that these have been installed to manage the risks
4.
Monitor risks (
BOD’s
responsibility)
The steps taken to mitigate the significant failings reported in the annual report and accounts should
be reported
In the US, the Sarbanes-Oxley Act requires the company directors as well as the auditors of all the
companies listed on an exchange to report on the risk management techniques in place in the company.
The risk committee monitors risks.
It has the right to appoint independent external parties to identify and assess the various risks that the
business faces. Risk committees may involve a person external to the company in the planning stage as a risk
auditor who will analyse the existing risk management processes and suggest better methods of dealing with
the existing and future risks.
RISK AUDITING
A risk audit will provide an organization with an independent, external view of the risks facing the organization
and the controls in place to mitigate those risks.
The auditor will review the identification and assessment of risks that the board undertook as part of the risk
management process and will review the controls in place over the identified risks.
There are four stages to a risk audit
Risk audit
a) Risk identification
b) Risk assessment
c) Review of controls over risk
d) Report
1.
The first stage in a risk audit is risk identification. It is especially important that all relevant risks are
identified because it is only when risks are identified that subsequent stages of the audit can be
conducted. The maintenance of a risk register is one way in which companies achieve this, with new risks
being added and obsolete ones being deleted if they no longer apply
2.
Once identified, each risk must then be assessed. This requires estimating the probability of each risk
materialising and the impact of such a risk realisation. For some risks, these might be relatively
straightforward to calculate but for others, more subjective estimates must be made
3.
The review of controls is the third stage of the audit. Once a risk has been identified and assessed, this
stage considers the effectiveness with which it is controlled or mitigated. Those risks with higher
probabilities or higher impacts may, for example, require more effective mitigation strategies than those
assessed as less so. If a control is found to be inadequate, this stage of the risk audit will highlight the
need for strengthening the control. If a control is currently more than is necessary (perhaps costing a
disproportionate amount given the probability or the impact), it can be reduced.
4.
The final stage is to issue a report to management for future planning and decision-making. This report
will highlight the key risks, those requiring the most immediate and urgent attention, and a comment on
the quality of existing assessment procedures. Any assessment shortcomings or resource constraints will
be clarified and barriers to subsequent risk audits highlighted
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Internal risk audit and external risk audit
Internal risk audit is one undertaken by employees of the company being audited and is usually carried out
by the internal audit function. It involves an identification of the risks within given frames of reference (the
whole company, a given area of activity, a given department or location) and advice on managing those risks
in terms of a risk assessment
Externally, consultants provide this service to clients. In some cases, this is a non-audit service offered by
accounting practices and other consultancies specialise more specifically on risk including the provision of risk
audit services.
External risk auditing is an independent review and assessment of the risks, controls and safeguards in an
organization by someone from outside the company.
Why is external risk auditing preferable?
– ‘Fresh pair of eyes’
– Unbiased view
– Reassures external stakeholders
– current thinking and best practice can be more effectively transferred
The process is a continuous cycle. As risks will change on a regular basis a company cannot afford to design solutions and then relax.
COSO Has Suggested An Eight-Stage Method For Managing Risks.
The COSO Enterprise Risk Management (ERM) framework describes a way of linking a company’s objectives to what it needs to do to
actually achieve them, namely manage its risks.
ERM considers risk management in the context of business strategy, but applying it to every level of the organisation. Therefore
everyone in the organisation has some responsibility for ERM, but the board is ultimately responsible and should assume ownership
of risk management. ERM is primarily designed to identify potential events which, if they occur, could harm an organisation and to
manage risk within its defined risk appetite.
ERM is process which comprises eight discrete stages:
1. Control environment: This is essentially the general tone from the top which the company adopts towards risk management, and
so provides the basis for how risk is viewed and addressed. Originating from the top of the organisation, the control environment
is embedded in the company’s culture and defines its risk appetite.
2. Objective setting: The Company’s risk appetite must be aligned to its business strategy, which is achieved by the setting of suitable
risk-adjusted objectives. The objectives must be agreed before management is able to identify any potential events which may
affect their achievement.
3. Event identification: These are the internal and external events, sometimes triggered by uncontrollable sources, which can
ultimately affect the company’s ability to achieve its objectives. Some of the events may present the business with positive
opportunities whereas other present risks.
4. Risk assessment: Risks are analysed, considering likelihood and impact, as a basis for determining how they should be managed.
Since likelihood can be measured in terms of probabilities and impact in terms of its financial consequences, it is possible to
quantify the risk assessed and then prioritise relative importance to the operations.
5. Risk response: Although not an automated process, management can then select an appropriate response to the individual risks
assessed. Responses include avoiding the risk altogether, reducing it to an acceptable level, transferring it to a third party or
accepting the risk if it falls within the pre-determined appetite.
6. Control activities: The Company then devises policies and procedures, which are implemented to help ensure the risk responses
are effectively carried out.
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7.
8.
Information and communication: Relevant risk information must be communicated in a manner which is readily understood, and
in a timeframe which enables people throughout the company to carry out their responsibilities.
Monitoring: Finally the whole process of ERM is monitored and modified as necessary. Like any system, it requires periodic update
to reflect the changing operational environment, regulatory framework and the specific risks faced.
RISK MANAGER: manages the risk management process!
This role will report to the risk committee, or the audit committee if the organisation doesn’t have a risk committee.
1. Providing overall leadership, vision and direction, involving the establishment of risk management (RM) policies, establishing RM
systems etc. Seeking opportunities for improvement or tightening of systems.
2.
Developing and promoting RM competences, systems, culture, procedures, protocols and patterns of behaviour. It is important
to understand that risk management is as much about instituting and embedding risk systems as much as issuing written
procedure
3.
Reporting on the above to management and risk committee as appropriate. Reporting information should be in a form able to be
used for the generation of external reporting as necessary
4.
Ensuring compliance with relevant codes, regulations, statutes, etc. This may be at national level (e.g. Sarbanes Oxley) or it may
be industry specific. Banks, oil, mining and some parts of the tourism industry, for example, all have internal risk rules that risk
managers are required to comply with
The necessity of incurring risk as part of competitively managing a business organisation.
The risks faced by organisations present different levels of profit opportunities to the organisation. The decision to undertake these
risks depends on the risk return trade-off.
The profit opportunities that the organisation gets are known as competitive advantages. Business choices can be aided with the help
of some simple analysis using a modified version of Mendelow’s matrix. The matrix is used to assess risk levels and the ensuing
competitive advantages, as shown below. Each business opportunity is categorised into a cell of the matrix and analysed accordingly.
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Internal Control and Review
COSO: Contents of a sound system of internal control
At its simplest, an internal control is any action or system put in place by management which will increase the likelihood that
organisational objectives will be met and assets safeguarded. Internal control measures are put in place to control the internal
activities in an organisation so that they achieve the purposes intended. By having internal activities co-ordinated and configured
appropriately, with means of measuring and reporting on compliance levels, waste (i.e. non value-adding activity) is minimised and
efficiencies are gained which increase the effectiveness of the organisation in meeting its strategic purposes.
Internal controls can be at the strategic or operational level. At the strategic level, controls are aimed at ensuring that the
organisation ‘does the right things’; at the operational level, controls are aimed at ensuring that the organisation ‘does things right’.
Those controls that operate at the strategic level are capable of influencing activities over a longer period.
COSO: Committee of Sponsoring Organisations--- an
American voluntary organisation with the aim of
guiding executive management towards the
establishment of more effective, efficient and ethical
business operations. It provided detailed advice on
application of controls
The Turnbull Report (1999)-provided guidance on creating strong
internal control systems. This has now been incorporated into the
Combined Code.
The Turnbull guidance is still available as a stand alone document (last
revised in October 2005).
Important terms
Internal control at strategic level: aimed at ensuring that the organisation is going in the right direction and is doing the right things.
Strategy will be tracked as it is implemented to detect problem areas that may indicate that the strategy is incorrect and needs to be
adjusted.
Internal control at operational level: aimed at doing things the right way ( focussed on executing the strategy)
Financial controls: policies, procedures, processes implemented to manage finances, ensure accurate reporting, prevent and detect
fraud etc. Having strong financial controls will help the board achieving its financial goals and fulfil its fiduciary duty.
Objectives of internal control
An internal control system comprises the whole network of systems established in an organisation to provide reasonable assurance
that organisational objectives will be achieved.
Specifically, the general objectives of internal control are as follows:
 To ensure the orderly and efficient conduct of business in respect of systems being in place and fully implemented. Controls
mean that business processes and transactions take place without disruption with less risk or disturbance and this, in turn, adds
value and creates shareholder value.
 To safeguard the assets of the business. Assets include tangibles and intangibles, and controls are necessary to ensure they are
optimally utilised and protected from misuse, fraud, misappropriation or theft.
 To prevent and detect fraud. Controls are necessary to show up any operational or financial disagreements that might be the
result of theft or fraud. This might include off-balance sheet financing or the use of unauthorised accounting policies, inventory
controls, use of company property and similar.
 To ensure the completeness and accuracy of accounting records. Ensuring that all accounting transactions are fully and
accurately recorded, that assets and liabilities are correctly identified and valued, and that all costs and revenues can be fully
accounted for.
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 To ensure the timely preparation of financial information which applies to statutory reporting (of year end accounts, for
example) and also management accounts, if appropriate, for the facilitation of effective management decision-making.
 To ensure compliance ( with laws and regulations as well as internal policies)
 To ensure better quality of internal and external reporting ( this requires maintenance of records and processed that generate
timely, relevant, reliable information from internal and external sources)
 To ensure efficiency and effectiveness of operations.
To conclude that your system of internal control is effective, the five components of internal control and all relevant principles must
be:
1. Present and functioning
2. Operating together in an integrated manner
If a relevant principle is not present and functioning, a major deficiency exists in the system of internal control
An exam focused overview
What is a sound system of internal control?
A. A strong control environment:
1. Integrity and ethical values
2. BOD oversees internal control performance (through Audit Committee and Internal Audit)
3. Establishment of appropriate reporting lines, authorities, responsibilities
4. Attract, develop, retain competent employees
5. Employees held accountable for their internal control responsibilities
B. Risk Assessment:
6. Objectives clearly identified
7. Risks to achievement of these objectives identified ( operational risks, compliance risks, reporting risks, changes in
external and internal environment related risks)
8. Fraud risk also considered.
9. Changes in environment identified that can affect internal control
C. Control Activities:
10. Policies and procedures established to mitigate risks
11. General IT controls developed
12. Policies and procedures implemented ( Policies: what is expected, Procedures: that put policies into action
D. Information and communication ( internal and external communication):
13. Quality information generated or obtained
14. Internal communication of info regarding objective and responsibilities done effectively
15. Org. communicated with external parties regarding matters of internal control functioning
E. Monitoring activities:
16. On-going evaluation to see if internal control present and functioning
17. Internal control deficiencies communicated to BOD for corrective action in a timely manner.
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Detailed explanation
Control environment
Points of focus:
• Sets the tone at the top
• Establishes standards of conduct
• Evaluates adherence to standards of
conduct
• Addresses deviations in a timely manner
Risk assessment
A precondition to risk assessment is the
establishment of objectives, linked at different
levels of the entity. Management specifies
objectives within categories relating to
operations, reporting, and compliance with
sufficient clarity to be able to identify and
analyze risks to those objectives. Management
also considers the suitability of the objectives
for the entity. Risk assessment also requires
management to consider the impact of
possible changes in the external environment
and within its own business model that may
render internal control ineffective.
Control activities
Control activities are the actions established
through policies and procedures that help
ensure that management’s directives to
mitigate risks to the achievement of objectives
are carried out. Control activities are
performed at all levels of the entity, at various
stages within business processes, and over the
technology environment.
Information & communication
Information is necessary for the entity to carry
out internal control responsibilities to support
the
achievement
of
its
objectives.
Management obtains or generates and uses
relevant and quality information from both
internal and external sources to support the
functioning of other components of internal
control. Communication is the continual,
iterative process of providing, sharing, and
obtaining necessary information. Internal
communication is the means by which
information is disseminated throughout the
organization, flowing up, down, and across the
entity. It enables personnel to receive a clear
message from senior management that
control responsibilities must be taken
1.
The organization demonstrates a commitment to integrity and ethical values.
2.
The board of directors demonstrates independence from management and
exercises oversight of the development and performance of internal control.
3.
Management establishes, with board oversight, structures, reporting lines, and
appropriate authorities and responsibilities in the pursuit of objectives.
4.
The organization demonstrates a commitment to attract, develop, and retain
competent individuals in alignment with objectives.
5.
The organization holds individuals accountable for their internal control
responsibilities in the pursuit of objectives.
6.
The organization specifies objectives with sufficient clarity to enable the
identification and assessment of risks relating to objectives.
7.
The organization identifies risks to the achievement of its objectives across the
entity and analyzes risks as a basis for determining how the risks should be
managed.
8.
The organization considers the potential for fraud in assessing risks to the
achievement of objectives.
9.
The organization identifies and assesses changes that could significantly impact
the system of internal control.
10. The organization selects and develops control activities that contribute to the
mitigation of risks to the achievement of objectives to acceptable levels.
11. The organization selects and develops general control activities over
technology to support the achievement of objectives.
12. The organization deploys control activities through policies that establish what
is expected and procedures that put policies into action
13. The organization obtains or generates and uses relevant, quality information
to support the functioning of internal control.
14. The organization internally communicates information, including objectives
and responsibilities for internal control, necessary to support the functioning
of internal control.
15. The organization communicates with external parties regarding matters
affecting the functioning of internal control.
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seriously. External communication is twofold:
it enables inbound communication of relevant
external information, and it provides
information to external parties in response to
requirements and expectations.
Monitoring activities
Ongoing evaluations, separate evaluations, or
some combination of the two are used to
ascertain whether each of the five
components of internal control, including
controls to effect the principles within each
component, is present and functioning.
Ongoing evaluations, built into business
processes at different levels of the entity,
provide timely information. Separate
evaluations, conducted periodically, will vary
in scope and frequency depending on
assessment of risks, effectiveness of ongoing
evaluations,
and
other
management
considerations. Findings are evaluated against
criteria established by regulators, recognized
standard-setting bodies or management and
the board of directors, and deficiencies are
communicated to management and the board
of directors as appropriat
16. The organization selects, develops, and performs ongoing and/or separate
evaluations to ascertain whether the components of internal control are
present and functioning.
17. The organization evaluates and communicates internal control deficiencies in
a timely manner to those parties responsible for taking corrective action,
including senior management and the board of directors, as appropriate.
Possible causes of internal control failures (also limitations of internal controls or reasons for ineffective controls)
1. Failures in human judgement when assessing a control, or fraud in measuring or reporting a control. Where a control relies upon
human measurement, error is always a possibility either through lack of training, incompetence, wilful negligence or having a
vested interest in control failure
2.
Human error can cause failures although a well-designed internal control environment can help control this to a certain extent.
3.
Control processes being deliberately circumvented by employees and others.
4.
Management overriding controls, presumably in the belief that the controls put in place are inconvenient or inappropriate and
should not apply to them.
5.
Non-routine or unforeseen events can render controls ineffective if they are intended to monitor a specific process only. Most
internal controls are unable to cope with extraordinary events and so need to be adapted or circumvented when such events
occur.
6.
Previous or existing controls can become obsolete because they are not updated to meet changed conditions. A control introduced
to monitor a process or risk that has changed, reduced or been discontinued will no longer be effective. Changes to key risks, for
example, need to modified if they are to continue to remain effective in controlling the risk.
7.
The control can be over or under-specified. An under-specified control is one which is not capable of actually controlling the risk
or activity intended. Conversely, an over-specified control is one which over-controls and may have the effect of losing the
confidence of employees and others influenced by the control. An over-specified control is one which is poor value for money and
may constrain activity if the control does not adequately allow normal levels of performance. Controls which do not enjoy the
support of those affected are sometimes ignored or bypassed, thereby rendering them less effective than they might be
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Internal Audit
Internal audit is an independent appraisal function established within an organisation to examine and evaluate its activities as a service
to that same organisation. The objective of internal audit is to assist members of the organisation in the effective discharge of their
responsibilities. To this end, internal audit furnishes them with analyses, appraisals, recommendations, advice and information
concerning the activities reviewed. The main functions of concern to internal audit are reviews of internal controls, risk management,
compliance and value for money.
Internal auditors: can be in-house or outsourced. Should not design or implement controls as this affects their independence!
Functions of Internal Audit Department
1. Setting the tone for internal environment: Internal audit is integral to the organisation’s internal control system. Accordingly, it
helps directors set the tone for the internal environment and will become part of the culture of the organisation. The effective
functioning of the audit committee and the internal audit process leads staff to expect certain organisational norms. Internal audit
signals the tone from the top and what is expected from staff in terms of performance and the types of behaviour which are
acceptable and which are not.
2.
Evaluating controls and advising managers at all levels: Internal audit’s role in evaluating the management of risk is wide ranging
because everyone from the mailroom to the boardroom is involved in internal control. The internal auditor’s work includes
assessing the tone and risk management culture of the organisation at one level through to evaluating and reporting on the
effectiveness of the implementation of management policies at another.
3.
Evaluating risks: Internal auditors will ensure that risks are regularly assessed, meaning that risks are monitored and then assessed
in terms of probability and impact. It is management’s job to identify the risks facing the organisation and to understand how they
will impact the delivery of objectives if they are not managed effectively. Managers need to understand how much risk the
organisation is willing to live with and implement controls and other safeguards to ensure these limits are not exceeded. Some
organisations will have a higher appetite for risk arising from changing trends and business/economic conditions. The techniques
of internal auditing have therefore changed from a reactive and control based form to a more proactive and risk based approach.
This enables the internal auditor to anticipate possible future concerns and opportunities providing assurance, advice and insight
where it is most needed.
4.
Analysing operations and confirm information: Achieving objectives and managing valuable organisational resources requires
systems, processes and people. Internal auditors work closely with line managers to review operations then report their findings.
The internal auditor must be well versed in the strategic objectives of their organisation and the sector in which it operates in, so
that they have a clear understanding of how the operations of any given part of the organisation fit into the bigger picture
5.
Promote Ethics –raise red flags when they discover improper conduct.
6.
Monitor Compliance: assess the organization’s compliance with applicable laws, regulations
7.
8.
Investigate Fraud: investigate possible fraudulent behavior throughout the organization
Other Assignments as deemed necessary by the Audit Committee
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Factors to consider when determining the need of internal audit
 The scale, diversity and complexity of the company’s activities.
 The number of employees.
 Cost-benefit considerations.
 Changes in the organisational structures, reporting processes or underlying information system(as they affect risk)
 Problems with existing internal control systems.
 An increased number of unexplained or unacceptable events.
 Ability of current management to carry out assignments which would normally be carried out by internal auditors
 Need of special assignments that normally internal audit carries out (IT audits for example)
Independence of Internal Audit
Typically internal auditors report on the company they work for so they can never be completely independent as they are reliant on
the company for their employment.
As such, their independence is bound to be questionable. For example:
• They may ignore frauds because they trust workplace colleagues, or feel sympathy for them;
• They may decide not report problems for fear of upsetting their ultimate bosses, the directors;
• They may decide not to report problems for fear that the company may get into trouble and they might lose their jobs;
• As internal staff, they may be pressured or intimidated into keeping quiet;
• If they report to directors and directly criticise them, the report may be ignored.
As a result of the independence issues above, the internal audit function could be outsourced to experts (e.g. a firm of accountants)
although this will bring with it the need for independence in the same manner as with external audit.
REPORTING STRUCTURE
 The internal audit function should report to the Audit Committee, made up entirely of independent NEDs.
 The head of the internal audit department, the Chief Internal Auditor, should have access to the Chairman so if anything serious
has been discovered, such as a material fraud then it can be quickly reported to the top of the organisation.
 Where the internal audit team are internal employees:
o They should have no operational duties, nor should they have had in the recent past to avoid the possibility that the internal
auditor may have to review work they have been responsible for (self-review threat);
o Ideally, they should have no major family or personal ties to operational staff or departments on whom they report (familiarity
threat).
 When internal audit is outsourced, independence can be improved by following similar guidelines as with external auditors:
o The same outsource firm should not act as internal auditor for a company for too many years in a row.;
o The outsource firm should not be performing too many other services for the company (as a self-review or self-interest threat
may arise);
o Fee levels should be monitored to ensure that the outsource firm is not too dependent on a single internal audit client.
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Audit committee overseeing internal audit
There are several reasons why internal audit is overseen by, and has a strong relationship with, the audit committee.
The first reason is to ensure that internal audit’s remit matches the compliance needs of the company. The internal audit function’s
terms of reference are likely to be determined by strategic level objectives and the risks associated with them. The audit committee,
being at the strategic level of the company, will frame these for implementation by the internal audit function.
Second, the audit committee will be able to ensure that the work of the internal audit function supports the achievement of the
strategic objectives of the company. Whilst this applies to all functions of a business, the supervisory role that the audit committee
has over the internal audit function means that this responsibility rests with the audit committee in the first instance.
Third, oversight by the audit committee provides the necessary authority for the internal audit function to operate effectively. This
means that no-one in the company can refuse to co-operate with the internal audit function and that members of that function, whilst
not being necessarily senior members of staff themselves, carry the delegated authority of the audit committee in undertaking their
important work.
Fourth, by reporting to the audit committee, internal auditors are structurally independent from those being audited. Because they
and their work is sanctioned and authorized by the audit committee, the IA function should have no material links with other
departments of similar hierarchical level which might compromise independence.
Reporting on Internal Controls to Shareholders
Shareholders, as owners of the company, are entitled to know whether the internal control system is sufficient to safeguard their
investment. To provide shareholders with the assurance they require, the board should, at least annually, conduct a review of the
effectiveness of the group’s system of internal controls and report to shareholders that they have done so.
The review should cover all material controls, including financial, operational and compliance controls and risk management systems.
The annual report should also inform members of the work of the audit committee. The chair of the audit committee should be
available at the AGM to answer queries from shareholders regarding their work.
External reports on the effectiveness of internal controls are intended to convey the robustness of a company’s internal controls to
an external audience (usually the shareholders). As with other reports, however, the company must make preparations and institute
systems to gather the information to report on. This in itself is capable of controlling behaviour and constraining the professional and
ethical behaviour of management.
Contents of the Report to Shareholders on Internal Controls
1.
Firstly, the report should contain a statement of acknowledgement by the board that it is responsible for the company’s system
of internal control and for reviewing its effectiveness. This might seem obvious but it has been shown to be an important starting
point in recognising responsibility. The ‘tone from the top’ is very important in the development of my proposed reporting changes
and so this is a very necessary component of the report.
2.
Secondly, the report should summarise the processes the board (or where applicable, through its committees) has applied in
reviewing the effectiveness of the system of internal control. These may or may not satisfy shareholders, of course, and weak
systems and processes would be a matter of discussion at AGMs for non-executives to strengthen.
3.
Thirdly, the report should provide meaningful, high level information that does not give a misleading impression. Clearly, internal
auditing would greatly increase the reliability of this information but a robust and effective audit committee would also be very
helpful.
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4.
Finally, the report should contain information about any weaknesses in internal control that have resulted in error or material
losses.
Reporting under SOX
In the UK, the Combined Code provides guidance on internal control, but SOX is law and therefore must be complied with or penalties
will be incurred.
Under UK guidance on internal controls directors are expected to:
 Maintain a sound internal control system (Combined Code);
 Regularly monitor the internal control system;
 Ensure there is a full annual review of the system;
 Report this process in the annual report.
The external auditors do not report on the work the directors have done on the internal control system, but they will review the
system themselves when planning their audit work and establishing the amount of testing that is required on the system. Any
weaknesses in the system will be reported to the board. There is no report to the shareholders on internal control from the external
auditors; this is the responsibility of the directors and the audit committee.
Under the SOX, directors are expected to ensure that there is a reliable internal control system, but as this is a law it must be
documented and recorded to prove it exists. On an annual basis it must be reviewed and assessed against performance criteria to
ensure it is working. Any problems discovered as part of this review must be dealt with. The appraisal of the system must be
documented and the process is reported to the shareholders along with the key results from the process. The company’s external
auditors must then report to shareholders on whether the directors have carried out the annual review of the system properly.
This is a lot of additional work for both directors and auditors. The external auditors have two audits to run -one on the financial
statements and one on the internal control system. It is not surprising that audit costs have risen since the introduction of SOX.
As a result of this, directors will want to put a lot more effort into their internal control systems as they are breaking the law if they
are not in place and working properly. There has been a huge focus on complying with the law but there may not be a cost benefit of
having excellent internal control when very good controls would have sufficed.
Advantages of an external report on internal controls
With any report required by regulation, the board must take control of the process and acknowledge its responsibility for the
company’s system of, in this case, internal controls. This means that it would be unable to knowingly circumvent or undermine the
internal controls
Any reporting (including one on internal controls) creates greater accountability because stakeholders can hold to account those
making those statements. Any stakeholder can then point to what was said in the report and hold the board to account for its
performance against any given statement.
A report on the effectiveness of internal controls (such as Sarbanes Oxley s.404) typically requires the inclusion of a statement on the
processes used by the directors to assess the effectiveness of internal controls. This includes the disclosure of any material internal
control weaknesses or any significant problems which the company encountered in its internal controls over the period under review.
The value of the report as a means of reassuring investors is to use this statement to demonstrate the robustness of the processes.
An unconvincing disclosure on this would potentially undermine investor confidence.
Because the report is subject to an auditor’s review (or full audit in some jurisdictions), the auditors can demand evidence of any
statement on the report and follow any claim made back along the relevant audit trail. It is a serious and often easily detectable
offence to deceive an auditor or to make a knowingly false statement in an audited or auditor-reviewed report. Such a deceit (of the
auditors) would result in an immediate loss of confidence in management on the part of the auditors and, in consequence, also on the
part of shareholders and regulators.
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Characteristics of Effective, Useful Information
Good quality information is necessary so that management can monitor business performance. For this to be possible, the information
used would require certain distinguishing characteristics
Relevant: The information obtained and used should be relevant for specific decision-making rather than producing too much
information simply because the information systems can ‘do it’.
Reliable and transparent: free from errors, trustworthy (Information should come from authoritative sources to ensure its reliability.
It is good practice to quote the source used – whether it be internal or external sources. If estimates or assumptions have been applied,
these should be clearly stated and explained)
Timely: Information needs to be timely for decision making if it is to be useful.
Understandable: clear, no unexplained jargon. Often, the decision makers do not have time to trawl through masses of information,
so it should be clearly presented, not too long and communicated using an appropriate medium.
Cost beneficial: the cost of generating the information should be less than the benefits to be gained from that information (for example
a simple report may be as useful as a long complicated one!)
Management information systems
Level
Strategic
Tactical
Operational/
Functional
-
-
-
Description
Senior management
Fewest members
strategic management of the
organisation including setting
its mission and long term
objectives and making
fundamental decisions
-
Info needs
from internal and external sources
less frequent
less precise
Examples of information
include: the need for and availability of finance, details about competitors,
analysis of the profitability of the business
and information on external threats and opportunities facing the organisation.
middle management
develops
the
strategies
outlined
by
strategic
management and find ways to
realize them.
-
Internal sources mainly
More frequent
Slightly more detailed and precise
supervisors and junior
management
largest group
management day to day
operations and implement
tactical plans
Operational information is used to make sure that specific operational tasks
are carried out as planned. Examples include: results of quality control checks
and information about labour hours used to perform a certain task, process or
job.
Examples of information required at a tactical level include:working capital
requirements, cash flow and profit forecasts and information about business
productivity.
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Strategy in action
Now that a strategy has been selected, what next?
Practicalities associated with implementation of chosen strategy!
1. Enabling success through organizing: Organizational structures and internal relationships: types of org structures that can be
adopted,
2. Enabling success through performance excellence and talent management: Improving performance: The Baldrige model,
empowerment, talent management
3. Strategic change: key issues related to strategic change incl process redesign and project management
Enabling success: organizing
Organizational structures
Organizations are set up in specific ways to accomplish different goals, and the structure of an organization can help or hinder its
progress toward accomplishing these goals. Organizations large and small can achieve higher sales and other profit by properly
matching their needs with the structure they use to operate.
Functional (people are
organized according to
the type of work they do)
Appropriate for:
Company
growing,
simple structure not
appropriate, need for
specialist skills in a
number of areas
Also commonly called a bureaucratic organizational structure, the functional structure divides the
company based on specialty. This is your traditional business with a sales department, marketing
department, customer service department, etc.
The advantage of a functional structure is that individuals are dedicated to a single function. These clearly
defined roles and expectations limit confusion. The downside is that it’s challenging to facilitate strong
communication between different departments.
One of the most common types of organizational structures, the functional structure departmentalizes
an organization based on common job functions.
So an organization with a functional structure would group all of the marketers together in one
department, group all of the salespeople together in a separate department, and group all of the
customer service people together in a third department.
The functional structure allows for a high degree of specialization for employees, and is easily scalable
should the organization grow.
Divisional
( can be based on
geography, product or
market)
Appropriate for:
Larger companies with a
diverse range of
strategies.
The downsides: The structure also has the potential to create barriers between different functions -and it can be inefficient if the organization has a variety of different products or target markets.
Divisional structure typically is used in larger companies that operate in a wide geographic area or that
have separate smaller organizations within the umbrella group to cover different types of products or
market areas.
The divisional structure refers to companies that structure leadership according to different products or
projects. Gap Inc. is a perfect example of this. While Gap is the company, there are three different
retailers underneath the heading: Gap, Old Navy, and Banana Republic. Each operates as an individual
company, but they are all ultimately underneath the Gap Inc. brand.
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Another good example is GE, which owns dozens of different companies, brands, and assets across
many industries. GE is the larger brand, but each division functions as its own company.
Matrix
Appropriate for:
Organizations which
have lots of project
work.
Transnational structure
Holding company structure: These divisions are separate legal entities.
The matrix structure is a bit more confusing, but pulls advantages from a couple of different formats.
Under this structure, employees have multiple bosses and reporting lines. Not only do they report to a
divisional manager, but they also typically have project managers for specific projects.
While matrix structures come with a lot of flexibility and balanced decision-making, this model is
also prone to confusion and complications when employees are asked to fulfill conflicting responsibilities
is a hybrid of divisional and functional structure. Typically used in large multinational companies, the
matrix structure allows for the benefits of functional and divisional structures to exist in one organization.
This can create power struggles because most areas of the company will have a dual management--a
functional manager and a product or divisional manager working at the same level and covering some of
the same managerial territory.
Combines some independence for national units with certain functions that are run globally. For
example, R&D may be based in one country but used across all territories.
Corporate parenting style
Many businesses end up with a corporate structure that comprises a head office and various SBUs (strategic business units); although
the legal nature of these may vary, some may be set up as divisions, while others may be subsidiaries with a group structure.
Corporate parenting looks at the relationships between head office and SBUs and how these relationships add value to individual
SBUs. These questions are particularly important if growth has been achieved through acquisition rather than organically.
Goold and Cambell identified 3 broad approaches or parenting styles reflecting the extent to which the management at the head office
becomes involved in the process of business strategy development. The approach will have a significant impact on the role of central
departments such as accounts & finance.
Strategic planning style (Cadbury and BP): Under this style the role of the corporate parent is to enhance synergies across the business
units. This may be achieved through: envisioning to build a common purpose, facilitating cooperation across businesses and providing
central services and resources.
Strategic control style (ICI): Under this style the corporate parent leverages its resources and competences to build value for its
businesses. For example a corporate could have a valuable brand or a specialist skill. The corporate parent uses its parenting
capabilities to seize opportunities for growth.
Financial control style ( Marconi/GEC): Under this style the role of the corporate parent is to monitor and evaluate the financial
performance of investment portfolio of the respective business units. The corporate managers act as agents on behalf of shareholders
and financial markets to identify and acquire viable assets and businesses. The business unit managers are given the autonomy to
carry out business activities and make decisions at their level. However the corporate parent sets performance standards for
control purposes.
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Emergent Structures
Boundary-less organizations: organizations which have structured their operations to allow for collaboration with external parties
Hollow structure: the management will separate core and non-core functions of the business and focus on core functions while
outsourcing all non-core functions.
Modular structure: Certain production processes are outsourced to specialist outsourcers. The core company then assembles
outsources components to produce the final product ( e.g. in aircraft manufacture).
Virtual structure: Here, the main organization is linked to outside firms (such as vendors, clients, associates) with a computer
connection to achieve collective growth and profitability. This structure allows them to work as a unit.
Networks: Groups of organizations/individuals who co-operate to deliver services to customer ( e.g. a building contractor).
Other important terms
Outsourcing & Offshoring: Outsourcing and offshoring involve external providers taking on activities previously carried out in-house.
Offshoring involves using external providers in different countries.
Shared servicing: An alternative to outsourcing is shared servicing, where shared service centres consolidate the transactionprocessing activities of many operations within a company. Shared service centres aim to achieve significant cost reductions whilst
improving service levels through the use of standardized technology and processes. Many large organisations have moved to centralise
their IT support functions.
It is common now for one IT helpdesk to serve the entire organisation, as opposed to individual divisions or departments having their
own designated IT support.
Global business services: For more than two decades, organisations around the world have been using shared services and outsourcing
to improve service delivery and reduce costs within defined parts of their businesses. Now leading organisations are taking the next
step. Instead of operating numerous shared service centres and managing outsourcing vendors independently, they are implementing
Global Business Services (GBS), providing integration of governance, locations and business practices to all shared services and
outsourcing activities across the enterprise.
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Enabling success: performance management
We now move on to see how organizations can ensure high levels of performance.
The Baldrige Criteria (can be used for NFPO as well as for profit organizations)
The framework does not tell how an organization should operate. It is used to ASSESS the performance so tha strengths and
opportunities for improvement can be identified and prioritized.
Organizations that have demonstrated that they applied the Baldrige Criteria have reported improved performance across a range of
areas; better financial results, customer satisfaction and loyalty, improved product and services and a engaged workforce.
Organizations can assess their performance in relation to the following core values and concepts:
Leadership: How the org’s leadership guides, governs, sustains org performance.
Examines how senior executives guide and sustain the organization and how the organization addresses Governance, ethical, legal
and community responsibilities
Strategy/strategic planning: the ability to plan, develop, implement strategies successfully
Examines how the organization sets strategic directions and how it determines and deploys key action plans
Customers/customer focus: success in building and sustaining strong lasting relationship with customers.
Examines how the organization determines requirements and expectations of customers and markets; builds relationships with
customers; and acquires, satisfies, and retains customers
Measurement, analysis and knowledge management: systems to provide feedback to strategic leaders about the performance
results.
Examines how data and information are used, managed, analyzed, and improved to support key organization processes as well as
how the organization reviews its performance
Workforce focus
Examines how the organization engages, manages, and develops all those actively involved in accomplishing the work of the
organization to develop full potential and how the workforce is aligned with the organization’s objectives
Operations/process management
Examines aspects of how key production/delivery and support processes are designed, managed, and improved
Results – The above six shape org’s ability to achieve results!
Examines the organization’s performance and improvement in its key business areas: customer satisfaction, financial and
marketplace performance, workforce, product/service, and operational effectiveness, and leadership. The category also examines
how the organization performs relative to competitors
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Empowering organizations
Empowerment means workers are made responsible for achieving work targets with the freedom to make decisions about how the
targets are achieved.
Jack Welch, former CEO of General Electric, focused his years at GE transforming the company into an empowered organization, what
he called a “boundaryless organization.” Welch aimed to remove anything that got in the way of the flow of information and ideas
within the company. Instead of sales, research and production divisions operating separately under directives sent from higher
executives, Welch encouraged teamwork across divisions and autonomy in deciding operations, maintenance and results. This type of
empowered company structure enables a trust-based work environment where meeting customer needs and creating opportunities
to advance the company are part of everyone’s job.
Chiefs Create
As head of an empowered organization, you pave the way for the company by plotting its course, and keeping all managers and
employees going in the same direction. The CEO trains managers to take over day-to-day company operations. Managers might
regularly report progress, and get insight from the CEO, but the CEO isn’t micro-managing every daily detail. For example, according
to Entrepreneur, an empowered organization’s CEO might require managers to implement their own department plans and budgets
as well as hire their own employees. The CEO’s role is also to create a safe work environment and provide the resources needed to let
decision-making thrive.
Managers Lead
Managers are leaders in an empowered organization. The role of a manager in an empowered organization is to guide the direction
of the company by enabling employees to create, take risks and work interdependently with other parts of the organization. A manager
in this environment is less a person of authority and more a person of support. For example, according to Harvard Business Review,
Roger Sant, founder and former chairman of Applied Energy Services, organized his company around small teams to avoid levels of
hierarchy. Under his leadership, each of the company’s power plants had one manager overseeing five to 20 teams, with each team
completely self-directed, but working interdependently with all other teams.
Employees Decide
Empowered organizations are driven by teamwork. Employees proven to be capable are made responsible for making decisions that
impact the company, and are held accountable for the results of their decisions. In larger empowered organizations, employees form
teams to control various aspects of the organization. Employees may move around to different teams over time, which can increases
their expertise in various roles and their value as employees overall. An empowered work environment attracts future leaders who
are trustworthy, self-confident, always learning, and passionate about helping customers and the company overall.
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Talent management
The CIPD (Chartered Institute of Personnel and Development, UK) defines talent management as “…Systematic attraction,
identification, development, engagement, retention and deployment of those individuals who are of particular value to an organisation,
either in view of their ‘high potential’ for the future or because they are fulfilling business/operation-critical roles.”
Johns Hopkins University defines talent management as, “a set of integrated organizational HR processes designed to attract, develop,
motivate, and retain productive, engaged employees.”
Human resource management would ideally include talent management, however some organisations have human resource
departments, which are highly transactional, instead of also being strategic and transformational. This means that organisations might
be meeting immediate needs, however are not allocating time to strategically predicting what their people needs will be in the future.
Talent management is a business strategy that organizations hope will enable them to retain their top most talented and skilled
employees.
Below are some of the top reasons why talent management is important and why origanisations need to invest in it.
Employee motivation: create more reasons for employees to be attracted to the organization, such as a higher purpose or
meaning for employees.
Attract top talent: Recruit the most talented and skilled employees available. When you have strategic talent management, you
are able to create an employer brand, which organically attracts your ideal talent, and in turn contributes to higher levels of
business performance and results.
Continuous coverage of critical roles: an organization will be prepared for gaps in critical skills and have a plan to address the
critical roles and highly specialized roles in the workforce. This means that an organization will have a continuous flow of
employees to fill critical roles, which ensures operations run smoothly and your clients and stakeholders are satisfied. It also
means that other employees are not left with extra workloads, which could eventually lead to burnout.
Increase employee performance: It is easier to identify ‘good fit’ employees, rather than making decisions in recruitment which
do not work towards the ideal organizational strategy. This can lead to less performance management issues and grievances. It
will also ensure that the top talent within the organization stays longer.
Engaged employees: an organization can make systematic and consistent decisions about development of staff, ensuring that the
people you require it have the skills and development necessary, and saving money on unnecessary development. Additionally,
when there is a fair process for development, employees feel more engaged and this again increases retention rates and also
ensures that the organization can meet its operational requirements..
Retain top talent: well-structured on-boarding practices create higher levels of retention. This means that an organization saves
on recruitment and performance management costs in the long run.
Improve business performance: when employees are engaged, skilled and motivated, they will work towards your business goals,
which in turn increases client satisfaction and business performance.
Higher client satisfaction: a systematic approach to talent management means that there is organizational wide integration and
a consistent approach to management1. This in turn translates to general communication and dissolving of silos within the
business. When systems are more integrated, client satisfaction rates are usually higher, since they are dealing with less people
and their needs are met faster.
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Talent Management Model
Talent management can include; talent acquisition (and recruitment), learning and development, organisational values and vision,
performance management, career pathways and succession planning.
While there are many talent management models, the elements of talent management can generally be categorised into five areas;
planning, attracting, developing, retaining and transitioning.
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Strategic change
The need for change may arise due to:
Changes in environment
A review of strategic capability
A decision to implement a new strategy etc.
Change can be discussed in terms of:
1. Type of change required: Balogun and Hope Hailey
2. Wider context of change: Balogun and Hope Hailey, POPIT
3. Implementing change: Lewin’s 3 stage model
Types of change
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Contextual features of change
There is
no
one right for the management of change. The success of managing change will also be
the wider context in which that change is taking place. Balogun and Hailey therefore build a
of important contextual features that need to be taken into account in designing change programmes.
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dependent
on
number
The Four-view POPIT Model-closely linked to process redesign and project management
The POPIT model is a quick and easy tool used to ensure that that all internal business aspects are considered at the outset and
throughout any business change.
The POPIT model can be used to ensure that a holistic approach has been taken to the change process and considered other aspects
of the business, in addition to the more obvious business processes and IT systems. In so doing, it is easier to uncover where problems
lie and what improvements might be possible.
The model should be viewed as a simple and quick approach to understand the business and its operating environment.
 During the investigation of potential changes, it provides an analysis framework, highlighting the areas where problems and/or
opportunities for improvement may be found.
 During the definition and development of solutions, it indicates the areas in which changes may be needed and helps to identify
the projects within the overall change programme.
The different aspects noted below can be considered when identifying areas for improvement:
People: (Roles, job description, skills, competence, management activities, culture and communication) think about the staff in the
organisation. For example, think about what kind of skills they have or whether they are motivated.
Organisation: (business model, external environment, capabilities) Think about the organisation itself. For example, think about what
the culture is like or whether teams collaborate well.
Processes: (Value proposition, value chain and core business processes) Think about the business processes. For example, think about
whether the processes are documented well or whether people stick to them. Do they need updated?
Information Technology: Think about the information and technology aspects of the organisation. For example, think about whether
the systems provide the right information the business requires.
For each of the four aspects above, you should consider how change will affect the current situation.
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Implementing change
Lewin’s three-stage model
Kurt Lewin
Argued that, in order for change to occur successfully, organisations need to progress through three stages.
The process of change comprises three stages.
Unfreezing: unfreeze current state of affairs and create motivation to change
In this stage, managers need to make the need for change so obvious that most people can easily understand and accept it. Unfreezi
ng also involves creating the initial motivation to change by convincing staff of the undesirability of the present situation. Ways of de
-stabilising the present stability could include:
 Identifying and exploiting existing areas of stress or dissatisfaction.
 Creating or introducing additional forces for change, such as tighter budgets and targets or new personnel in favour of the chan
ge.
 Increasing employee knowledge about markets, competitors and the need for change.
 Removing individuals from routines, social relationships so that old behavior is not reinforced
 Confronting the perceptions and emotions of worker about change
 Consulting individuals about proposed changed
 Reinforcing a willingness to change, validating efforts and suggestions with praise and maybe added responsibility in the change
process.
Change: learning new ways of working/the transition stage
The change process itself is mainly concerned with identifying what the new behaviour or norm should be. This stage will often invol
ve
 Identifying new patterns of behavior or norms
 Communicating them clearly and positively
 Setting up new reporting relationships
 Creating new reward / incentive scheme
 introducing a new style of management
It is vital that new information is communicated concerning the new attitudes, culture and concepts that the organization wants to b
e adopted, so that these are internalised by employees.
Refreezing: set policies to embed new behaviours , establish new standards.
Refreezing or stabilising the change involves ensuring that people do not slip back into old ways. As such it involves reinforcement of
the new pattern of work or behaviour by:
• Larger rewards (salary, bonuses, promotion) for those employees who have fully embraced the new culture
• Publicity of success stories and new "heroes" – e.g. through employee of the month
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Process redesign
Process redesign: how processes can be improved and made more effective
Modern organisations face a lot of competition in delivering innovative products every year. Take the smartphones manufacturers for
example. Imagine if these companies have inefficient processes with many reject parts that needs to be reworked after many hours
of valuable factory time in producing them in the first place. This could result in months of delay of the product rollout to the market.
This would give its competitors enough room to take up their market share during the period of delay. In conclusion, there are three
"quality mantra" of organisation's of the day which are to provide 1. Quality products valued by customers; 2. Done right the first time;
and 3. Introduce products fast to the market.
Business processes are fundamental to an organisation’s success in producing its goods and services. For an organisation to maximize
its competitiveness it needs to have processes which are both well designed and which work effectively.
Alongside the overall goal of delivering value for the customer, the process improvement contributes to the strategic impact of a
business in four ways:
1. Cost control – keeping costs under control by ensuring process efficiency.
2. Revenue – enhancing a business’s ability to generate revenue through the quality of the products and services it produces.
3. Investment – maximising the return on investments by ensuring that they operate as they are intended to.
4. Capabilities – embedding the capabilities that will form the basis of the business’s ongoing future competitiveness.
Process-oriented organisations also break down the barriers of structural departments and try to avoid functional ‘silos’ (that is, each
department concentrating only on its own function rather than understanding how it contributes to overall value creation in an
organisation).
However, the strategic value of a process perspective comes from not only analyzing current processes, but also identifying areas
where they can be improved. Business process improvement – aligning processes in order to realise organisational goals – lies at the
heart of the process perspective. As we have already identified, business processes should be designed to add value and so should not
include unnecessary activities. The outcome of a well-designed business process is increased effectiveness (value for the customer)
and increased efficiency (lower costs for the business).
Process improvement is often seen as being synonymous with automation and job losses. But this is not necessarily the case. Even if
they are outcomes of process improvement, they should not ultimately be the reasons for it.
Once the need for process redesign has been established, a gap analysis will need to be done between the current position of the
processes and the targeted state.
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Harmon Process-Strategy Matrix: Which processes to change and how to change them
Harmon’s Process Strategy Matrix provides very useful guidance about which processes can be safely outsourced and which should
be kept in-house, but subject to automation or other improvement.
It uses two axes:
 Complexity/dynamism of the process. Dynamism is a measure of how much the process changes.
 Strategic importance of the process
Notice that in the right-hand pair of quadrants, where strategic importance of the process is high, outsourcing is not recommended.
If a process is strategically important it is likely to be a source of competitive advantage. If that were to be outsourced, then the
company would be telling the supplier about its most valuable secrets and competences. What would then be left for the outsourcer
to do? If a process is relatively stable and non-complex, then automation would be feasible and worthwhile. If, however, the process
were very complex and subject to many changes, then automation will be difficult to achieve and even more difficult to keep up to
date.
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Process redesign options
A process redesign pattern is an approach or solution that has often worked in the past. There are several patterns that have proved
popular in redesign efforts. For example:
• Re-engineering – start with a clean sheet of paper and question all assumptions.
• Value-added analysis – try to eliminate all non-value-adding activities.
 Simplification – try to simplify the flow of the process, eliminating duplication and redundancy.
Gaps and disconnects – a process redesign pattern that focuses on checking the handoffs between departments and functional grou
ps in order to assure that flows across departmental lines are smooth and effective. Many of the problems affecting process
performance result from a failure in communication between functions or business departments. The focus of this redesign pattern is
to ensure that the appropriate checks and controls are in place so that efforts are coordinated between functions and departments.
For example, if the production department builds a product and ships it to the customer, then the finance department needs to be
aware of this so that they can raise an invoice to the customer.
BPR
Process re-engineering – this is used at the strategic level, when major threats or opportunities in the business’s external environment
prompt a fundamental re-think of the large-scale core processes critical to the operation of the value chain.
Business Process Reengineering (BPR) is the structured, process-driven approach to improving the performance of a company in areas such as
cost, service, quality, and speed. This radical change methodology starts at the highest level of companies, and works down to the minutest
details to overhaul the system in a short time. This complete redesign distinguishes BPR from other methodologies where incremental
improvements are made through regular process improvements. Companies performing BPR must reassess their fundamentals and reform their
processes to standardize and simplify them. Ambitious companies that start BPR do so with the intent of doing whatever it takes to improve
performance in all aspects of the business. Some examples of company-specific goals through BPR include:
 Taking a decentralized process and making one person responsible for it
 Redeveloping the company’s goals so improvement plans are consistent
 Taking a department-specific process and assigning it to coordinate and integrate cross-functionally
 The term “reengineering” suggests that something has already been developed and is being re-developed. In most businesses, change to a
pre-existing process happens relatively slowly and incrementally. Within the context of BPR however, the most modern tools are put to use
in a way that uses them from the ground up. The fundamentals of already existing processes, ideas, and designs are rethought.
 The term process focuses on how things are done, not on the specific people, their job descriptions, or the specific tasks that they perform.
BPR is more interested in the series of steps that produce the product or service, from its conceptual stage through the final creation.
 Business Process Reengineering (BPR) is also known as business process redesign, business transformation, or business process change
management.
Process redesign – this is an intermediate scale of change operation, appropriate for medium-sized processes that require extensive
improvement or change. Redesign efforts often result in changed job descriptions and the introduction of some automation.
Process improvement – this is a tactical level, incremental technique that is appropriate for developing smaller, stable, existing
processes.
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The feasibility of re-design options will need to be assessed.
Technical feasibility: will innovation be needed in technology or maybe it exists but just needs further development.
Social feasibility: impact on employee motivation, project teams will need to be created, training and work patterns might change,
and there may be staff redundancies etc.
Environmental concerns: environmental footprint needs to be considered
Financial feasibility: cost-benefit analysis
Process redesign methodology
1. Planning a process redesign effort




Identify goals
Define scope
Identify personnel
Develop plan and schedule
2.
Analysis of an existing process



Document workflow
Identify problems
Devise a general plan for the redesign
3.
Design of a new or improved process

Explore alternatives and choose best redesign to achieve goals
4.
Development of resources for an
improved process


Make products better, easier to manufacture and maintain
Redesign managerial and supervisory jobs and develop measurement system to
monitor new process
Redesign jobs, work environment and incentive systems; develop training; hire
new employees if necessary

5.
Managing the implementation of the
new process



Integrate and test
Train employees, arrange management
Maintain process and modify as needed
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Project Management
A strategic plan (typically long term and corporate-wide) can never be implemented as a single, monolithic task. A strategy of
expanding abroad, for example, would consist of a series of smaller tasks such as finding premises, recruiting, training, equipping the
factory, marketing, and establishing a distribution network. Each of these smaller tasks can be regarded as a project, with a start, end,
objectives, deadline, budget, and required deliverables. Realising a strategic plan therefore depends on carrying out a complex jigsaw
of projects, and if one piece goes missing the whole strategic plan will be in jeopardy. Therefore, successful project management is at
the heart of successful strategic planning.
A project is an activity that:
is temporary having a start and end date
is unique
brings about change
has unknown elements, which therefore create risk
A project is a temporary undertaking performed to produce a unique product, service, or result. Large or small, a project always has
the following three components:
 Specific scope: Desired results or products; closely linked to quality as well.
 Schedule: Established dates when project work starts and ends
 esources allocated specifically to the project although often on a shared basis: Necessary number of people and funds and other
resources (money, facilities, supplies, servies).
Each component affects the other two! For example:
Expanding the type and characteristics of desired outcomes may require more time (a later end date) or more resources. Moving up
the end date may necessitate paring down the results or increasing project expenditures (for instance, by paying overtime to project
staff)
Project management can be a core strategic competence for some industries (like consulting and construction).
Projects are generally considered successful if they meet the triple constraint; scope, time cost.
WHY DO PROJECTS FAIL?
1. Poor project and program management discipline
2. Lack of executive-level support
3. Wrong team members
4. Poor communication
5. No measures for evaluating the success of the project
6. No risk management
7. Inability to manage change
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THE PROJECT LIFECYCLE
All projects will start from an initial idea, perhaps embedded in the strategic plan. A project will then progress to the initiation stage
when a project manager will be appointed. The project manager will choose a project team and they will carry out a feasibility study.
The feasibility study is necessary to establish the following:
Commercial feasibility – will the likely benefits exceed the cost?
Technical feasibility – do we think this project has a good chance of working? Operational feasibility – will it help the organisation
reach its objectives?
Social feasibility – will our employees, customers and other stakeholders tolerate it?
A feasibility report should be produced and this will have to be studied by senior managers, because if the project goes ahead
substantial expenditure might be required.
Note that the feasibility report does not merely have to present management with simple ‘yes’ or ‘no’ options, but can set out a range
of options, each with particular benefits, costs and time frames. Where there is some doubt as to the potential benefits that will arise
from the project, it is particularly valuable to offer a range of choices which allow the organisation to first try out a modest project
and later allow the project to be extended. This approach is a useful way to reduce risk. If you are not sure about something, start in
a small way and extend later if worthwhile.
Successful organizations create projects that produce desired results in established time frames with assigned resources.
Every project, whether large or small, passes through the following four stages:
 Starting the project: This stage involves generating, evaluating, and framing the business need for the project and the general
approach to performing it and agreeing to prepare a detailed project plan. Outputs from this stage may include approval to
proceed to the next stage, documentation of the need for the project and rough estimates of time and resources to perform it
(often included in a project charter), and an initial list of people who may be interested in, involved with, or affected by the project.

Organizing and preparing: This stage involves developing a plan that specifies the desired results; the work to do; the time, the
cost, and other resources required; and a plan for how to address key project risks. Outputs from this stage may include a project
plan documenting the intended project results and the time, resources, and supporting processes to help create them.

Carrying out the work: This stage involves establishing the project team and the project support systems, performing the planned
work, and monitoring and controlling performance to ensure adherence to the current plan. Outputs from this stage may include
project results, project progress reports, and other communications.

Closing the project: This stage involves assessing the project results, obtaining customer approvals, transitioning project team
members to new assignments, closing financial accounts, and conducting a postproject evaluation. Outputs from this stage may
include final, accepted and approved project results and recommendations and suggestions for applying lessons learned from this
project to similar efforts in the future.
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Project initiation
All projects begin with an idea. Perhaps the organization’s client identifies a need; or maybe the management thinks of a new market
to explore; or maybe the management thinks of a way to refine the organization’s procurement process.
Sometimes the initiating process is informal. For a small project, it may consist of just a discussion and a verbal agreement. In other
instances, especially for larger projects, a project requires a formal review and decision by organization’s senior management team.
Decision makers consider the following two questions when deciding whether to move ahead with a project:
 Should we do it? Are the benefits we expect to achieve worth the costs we’ll have to pay? Are there better ways to approach the
issue?
 Can we do it? Is the project technically feasible? Are the required resources available?
Project selection: As organizations have limited resources, they should assess suitability, acceptability and feasibility of projects before
they choose one to proceed with.
Pre-initiating tasks:
Project objectives and constraints are determined ( i.e. set scope, identify time and cost constraints)
Select project manager ( who takes responsibility that desired results are achieved on time and within budget);
Identify project sponsor ( who provides and is accountable for the resources invested in the project; will NOT be involved in the
management of the project normally; the project sponsor ( say the senior management) may appoint a project owner to review
project plans and progress at regular intervals)
Initiating tasks:
Preparation of a business case document ( why the project is needed, what it will achieve and how it will proceed)
Explains the need for work on the project to start.
Typical contents:
1. Description of current information/issues ( problems to be solved)
2. Cost benefit analysis(including intangible costs and benefits), any assumptions undertaken
3. Impact on organization other than cost ( changes in org structure for example)
4. Key risks and actions to mitigate them
5. Recommendations
Project costs and benefits ( part of the business case document)
Within the business case document, benefits should be mentioned before the costs!
A benefit-cost analysis is a comparative assessment of all the benefits anticipated from the project and all the costs to introduce the
project, perform it, and support the changes resulting from it.
Some anticipated benefits can be expressed in monetary equivalents (such as reduced operating costs or increased revenue). For
other benefits, numerical measures can approximate some, but not all, aspects. If the project is to improve staff morale, for example,
you may consider associated benefits to include reduced turnover, increased productivity, fewer absences, and fewer formal
grievances. Whenever possible, express benefits and costs in monetary terms to facilitate the assessment of a project’s net value
Identifying the costs ( capital and operating )
Consider costs for all phases of the project.
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Such costs may be nonrecurring (such as labor, capital investment, and certain operations and services) or recurring (such as changes
in personnel, supplies, and materials or maintenance and repair). In addition, consider the following:
 Potential costs of not doing the project
 Potential costs if the project fails
 Opportunity costs (in other words, the potential benefits if you had spent your funds successfully performing a different project)
Cost-benefit evaluation
One the costs and benefits have been quantified, an investment appraisal can be undertaken using techniques like
Accounting rate of return
Payback period
Net present value
Internal rate of return
Project initiation document/project charter
Give authorization for work to be done and resources to be used.
Complements the business case document
Can be used for internal communication to keep staff informed of what is happening
One of the main outputs of the initiation stage should be the project initiation document, or PID. The term is poor because it implies
that the PID is used only at the start of a project, when the project is being proposed, and ‘document’ might suggest a couple of pages
only. In fact, the PID is of key importance both initially and throughout the duration of the project
Typical contents: It should address the following questions:
What should the project achieve? What are its deliverables? These should be specified in detail so that the project and its scope
are well defined from the outset.
Why is the project is needed (including a cost benefit analysis)? How will the quality or acceptability of outputs be assessed?
Who will lead the project?
Who will be on the project team and what will be the role and responsibility of each team member? What are the risks? How
have they been assessed and prioritised, and how will they be managed?
Who will carry out the work on the project? Which actions will be assigned to in-house staff and which to sub- contractors?
By when should the project and its various stages be completed? What are the constraints on the project?
What are the assumptions on which the project depends? How much budget has been allocated to the project?
What other resources are needed by the project, and have been allocated to it?
Who sponsors or owns the project? (generally the department or client who is paying) What are the reporting arrangements?
As this shows, the PID is the key reference document and it will be extensive and detailed, containing all the planning information
required about the project.
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WHAT DETERMINES RISK?
Project risk can be said to depend on three variables:
1. How well defined is the project? A well-defined project will set out in detail exactly what the project is to accomplish (the
deliverables), when each stage should be completed, and how each stage will be appraised (quality). These qualities can be
summed up in the phrase ‘project scope’. Additionally, it is important to set a cost budget in advance. We will see later that there
can be tensions between cost, time, quality and scope, but if these have not been defined in the first place, the project will run
into difficulties quickly as each member of the project team is likely to be pursuing different goals. A poorly defined project will
be short on detail but long on grand ambition. For example, stating that the new IT system will improve inventory management
is almost useless. Is the firm moving to just-in‑time? Is it going to develop sophisticated demand‑forecasting algorithms? Is the
warehouse to be automated? Will labour and machine use be part of the system? In addition, if the project is not well defined,
even if most participants happen to have a similar vision initially, the project will be susceptible to drift. This means that as the
project progresses, ideas change and the project deliverables change. To some extent, project drift is inevitable because as the
project is worked on, more information is discovered and it would be foolish not to take note and alter the project where
necessary. However, altering projects part way through is usually expensive in terms of time and money if work has to be redone
or abandoned. What must be avoided is ongoing, ‘nice-to-have’ project drift, in which new features are added little by little
without proper evaluation of costs and benefits. By defining the project in detail at the start, the firm will have thought carefully
about deliverables and the need for subsequent amendments should be minimised.
2. The size of the project. It is pretty obvious that there will be more risk associated with large projects. More stakeholders will be
involved, possibly including customers and suppliers. There will be more coordination problems and the financial investment will
be greater. Project failure, will cause great disruption and many people will be affected. By contrast, small projects will be easier
to control and if they go wrong, damage is likely to be confined to a smaller number of stakeholders.
3. The technical sophistication of the project. A project which depends on well understood solutions is much less likely to go wrong
than a project which is attempting to use cutting edge, experimental technology.
So, if you are put in charge of a large, poorly defined, sophisticated project, you might like to look round for another job, as if the
project fails to deliver (and it probably will) you could be the number one scapegoat.
Of course, there can be a good business case for embarking on large sophisticated projects, as these can allow companies to
differentiate their products and services. If standard, hesitant, safe solutions are always used then more ordinary performance will
result. It might be part of a business’s strategy to adopt radical solutions to gain competitive advantage. However, there can never be
any excuse for a project being ill defined at the start.
Risks must be managed and the following approach can be used:
Define the risks. What could go wrong?
Assess the risks. This will be a combination of estimating the financial effect if the risk event occurs, and the probability of the risk
occurring. Some risks would have large financial consequences but could be very unlikely to happen. Others might have trivial
financial consequences.
Prioritise the risks. What are the really serious events that need to be addressed first?
Deal with the risks. Generally, there are four approaches:
1.
2.
3.
4.
Tolerate the risk, either because the event is unlikely to happen and/or the consequences will be immaterial.
Treat the risk, or do something to ameliorate it. For example, if the consequences of missing a deadline are serious, have additional
resources available that can be used to speed up the process if necessary.
Transfer the risk. Insurance is a form of risk transfer, as is sub-contracting. So if you are worried about an IT project missing
important deliverables, consider sub‑contracting part of it and build in penalty clauses.
Terminate the risk. In other words, the event would be so serious that you do not want to risk it occurring at all. For example, if
there were a security breach during a project that requires sensitive data to be held, this could be devastating to a company, so
the company might decide not to hold that data, despite it possibly yielding good marketing information.
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Project planning
Include the following in the project-management plan:
 An overview of the reasons for your project
 A detailed description of intended results
 A list of all constraints the project must address
 A list of all assumptions related to the project
 A list of all required work
 A breakdown of the roles you and your team members will play
 A detailed project schedule
 Needs for personnel, funds, and non-personnel resources (such as equipment, facilities, and information)
 A description of how you plan to manage any significant risks and uncer- tainties
 Plans for project communications
 Plans for ensuring project quality
PROJECT PLANNING AND MANAGEMENT TOOLS
Typically, projects consist of a number of separately identifiable steps which can be broken down, hierarchically, until manageable
work packages are produced which can be assigned to the appropriate people. This is the process of deriving the work breakdown
structure for the project. Each work package, or task, will have four components:
task name and description
costs, both marginal and any fixed element
duration
who is responsible and, in particular, whether the work will be carried out internally or externally.
So now the project manager knows who is doing what and how much each element should cost. Using a relatively simple cost
accounting system, material, labour, overheads and third party costs can be coded to the work packages, hence to the project, and
actual costs can be compared to budget for control purposes.
Still to be taken into account is the time that each work package will take, but whereas costs are cumulative, times need not be as
often several tasks can be undertaken simultaneously. A more sophisticated approach is needed which sets out the relationship of the
tasks or activities to one another, identifying those tasks which can be concurrent and those which can only be consecutive. For
example, if the project was to set up a new website for the company, the task of choosing the internet service provider to host the
website can be undertaken at the same time as designing the graphics and layout of the web pages. However, the layout and graphics
couldn’t be finalised before the company has decided what information the web pages should show. These three tasks could be set
out in a network diagram, or critical path analysis
Network diagram / Critical path analysis
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The numbers represent the time that each activity takes (let’s say in days). The project cannot proceed further until both content and
layout have been decided. These are consecutive steps, one taking eight days and the next five days, so this small part of the project
cannot be accomplished in less than 13 days. It does not matter that it takes only nine days to choose the ISP: everything has to wait
for the content and design activities to be completed. These are critical activities, and if either were to take another day, completion
of the whole project would be delayed by a day.
Therefore, the project manager has to monitor critical activities very carefully. Choosing the ISP is a non- critical activity and it could
be delayed by up to four days before impacting on project completion.
Once project slippage is likely, the project manager has a number of choices, all of which should be discussed and perhaps negotiated
with the project sponsor:
live with the slippage
reduce project scope
reduce project quality
bring in more resources, such as hiring sub-contractors to help out (which will, of course, increase costs)
move resources from non‑critical to critical activities if skills are interchangeable.
Even small projects can be broken down into many tasks, each with its own definition, personnel assigned, costs, start time, finish
time and defined relationships with other tasks. Controlling this manually can be very arduous and project management software can
be very useful in tracking each activity and, therefore, the progress of the project as a whole.
Work breakdown structure
The Work Breakdown Structure (WBS) is a grouping of the work involved in a project oriented towards the deliverables that defines
the total scope of the project. The WBS can be imagined as a roadmap of the project which breaks down the total work required for
the project into separate tasks and helps group them into a logical hierarchy (see example below)Different levels of detail assure the
project managers that all products and work tasks are identified in order to integrate the project with the current organisation and
to establish a basis for control. Furthermore, the WBS organizes and divides the work into logical parts based on how the work will
be performed. This is important as usually a lot of people are involved in a project and many different deliverables are set to reach
one main objective to fulfill the project.
In addition tothis, the WBS serves as a framework for tracking cost and work performance because every element which is defined
and described in it can be estimated with reference to its costs and time needed. Consequently, the WBS enables the project
managers to make a solid estimation of costs, time, and technical performance at all levels in the organisation through all phases of
the project life-cycle.
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Project execution and control
After the project-management plan has been developed, it’s time to get to work and start executing the plan.
This is often the phase when management gets more engaged and excited to see things being produced.
Preparing
Preparing to begin the project work involves the following tasks
 Assigning people to all project roles: Confirm the individuals who’ll perform the project work, and negotiate agreements with
them and their managers to assure they’ll be available to work on the project team.
 Introducing team members to each other and to the project: Help people begin developing interpersonal relationships with each
other.
Help them appreciate the overall purpose of the project and how the different parts will interact and support each other.

Giving and explaining tasks to all team members: Describe to all team members what work they’re responsible for producing
and how the team members will coordinate their efforts.
 Defining how the team will perform its essential functions: Decide how the team will handle routine communications, make
different project decisions, and resolve conflicts. Develop any procedures that may be required to guide performance of these
functions.
 Setting up necessary tracking systems: Decide which system(s) and accounts you’ll use to track schedules, work effort, and
expenditures, and set them up.
 Announcing the project to the organization: Let the project audiences know that your project exists, what it will produce, and
when it will begin and end.
Performing
Finally, project work begin! The performing subgroup of the executing processes includes the following tasks
 Doing the tasks: Perform the work that’s in your plan.
 Assuring quality: Continually confirm that work and results conform to requirements and applicable standards and guidelines.
 Managing the team: Assign tasks, review results, and resolve problems.
 Developing the team: Provide needed training and mentoring to improve team members’ skills.
 Sharing information: Distribute information to appropriate project audiences.
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The monitoring and controlling processes
As the project progresses, it needs to be ensured that plans are being followed and desired results are being achieved. The monitoring
and controlling processes include the following tasks:
 Comparing performance with plans: Collect information on outcomes, schedule achievements, and resource expenditures;
identify deviations from your plan; and develop corrective actions.
 Fixing problems that arise: Change tasks, schedules, or resources to bring project performance back on track with the existing
plan, or negotiate agreed-upon changes to the plan itself.
 Keeping everyone informed: Tell project audiences about the team’s achievements, project problems, and necessary revisions to
the established plan.
Project slippage: when a project is running behind schedule.
Project completion
Finishing the assigned tasks is only a part of bringing the project to a close.
In addition, the following must be done:
 Get approvals of the final results.
 Close all project accounts
 Help team member’s move on to their next assignments.
Hold a post-project review with the project team to recognize project achievements and to discuss lessons can be applied to the next
project.
This happens at the end of the project and allows the project team to move on to other projects. It can often be the last stage of the
project, with the review culminating in the sign-off of the project and the formal dissolution of the project team. The focus of the po
st-project review
is
on
the
conduct
of
the
project
itself, not the product it has delivered. The aim is to identify and understand what went well and what went badly in the project and
to feed lessons learned back into the project management standards with the aim of improving subsequent project management in t
he organisation.
Post
implementation
review:
A post
implementation review focuses
on
the
product
delivered by the project. It usually takes place a specified time after the product has been delivered. This allows the actual users of t
he product an opportunity to use and experience the product or service and to feedback their observations into a formal review. The
post-implementation review will focus on the product’s fitness for purpose. The review will not only discuss strategies for fixing or a
ddressing identified faults, but it will also make recommendations on how to avoid these faults in the future. In this instance these le
ssons learned are fed back into the product production process. Without a PIR, a business cannot demonstrate that its investment in
the project was worthwhile.
PIRs can sometimes be an on-going element of project management that may be used at project gateways to examine changes impl
emented to date.
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Project manager
You will see from the contents of the PID that there are a number of classes of stakeholder in projects, typically:
The sponsor
The project team
Other employees, sub‑contractors and regulatory authorities, such as health and safety inspectors.
Funds from the sponsor flow through the project team and on to other departments and sub‑contractors. In return, project
deliverables should flow back towards the sponsor.
The project team will often be multi-disciplinary and it will be led by a project manager. The project manager is enormously influential
as to whether or not the project ends in success, and he or she must combine technical knowledge, leadership ability, and project
management skills.
Relationships between project manager and stakeholders
The tasks of the project manager can be summarised as:
Ensuring that the PID is comprehensive. This can be a complex task because it will mean ensuring that deliverables, budget,
resources, project team, deadlines and so on have been determined. As was emphasised earlier, there is no point embarking on
a semi-defined project, so the project manager should be strong enough to resist management pressure to be seen to be doing
something. If the project is started before the PID is complete, things will be done but they will probably be the wrong things.
Communication with the sponsors. Even when projects run smoothly, sponsors will expect updates on progress. Often, however,
even in well planned projects, problems will be encountered and it is then that communication with the sponsors is particularly
important. This will keep the sponsors informed but will also give the sponsors opportunities to make choices, for example to
spend more or to cut back on deliverables.
Team leading. The project team is likely to consist of people from a number of departments with different skills and priorities.
The project manager should be capable of creating a cohesive, well-motivated team where participants work well together.
Communication with sub-contractors and regulatory authorities.
Technical appreciation of project issues. For example, someone running a construction project will need to understand relevant
technical issues when these are raised in meetings.
Organisational ability, including the ability to delegate tasks.
Technical competence in project management. For example, an understanding of critical path analysis (to monitor and control
progress through time), and cost reports to monitor and control expenditure.
An ability to balance project cost, time, scope, and quality. All projects have targets relating to cost, time, scope, and quality;
these should be defined in the PID. However, certain priorities or pressures are likely to apply to each variable, depending on the
nature of the project. For example, a project involving safety- critical systems will rightly put great emphasis on quality because
the consequence of technical failure will be very serious. However, managers need to be aware of the impact of the following
compromises:
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



Increased emphasis on quality places the project in danger of taking longer and costing more.
Increased emphasis on meeting the cost budget may compromise quality, the project may take longer, or the scope could be
narrowed.
Increased emphasis on meeting time deadlines may also compromise quality, cost over-runs are more likely (perhaps because
overtime has to be paid), or scope could be narrowed.
If the emphasis is to ensure that the project scope is not reduced, then cost and time might increase, and quality might
decrease. Naturally, if scope is increased, whether through project drift or through more pre-meditated changes to the project,
costs, time and quality will all be severely jeopardised.
None of these compromises is bound to happen, but project managers should be aware that such tensions exist and that a balance
has to be maintained by management action, if necessary negotiating with the project sponsors to gain approval for changes.
Project sponsor
The project sponsor or project facilitator will normally be a senior member of the management team.
They are often chosen as the person with the most to gain from the success of the project and the most to lose from the failure of it.
Their job is to direct the project, and allow the project manager to manage the project.
The roles taken on by project sponsors in organisations include:
gatekeeper – choosing the right projects for the business means ensuring that only projects that support the business strategy a
re started and that they are of sufficiently high priority and have clear terms of reference
sponsor and monitor – steering the project by requesting regular meetings with the project leader and giving advice and guidan
ce
supporter and coach – provides practical support for the project leader, especially if they are taking on a project that is larger or
more significant than they have handled before
decision-maker – if decisions are required that are outside the scope of the project then the project sponsor will make the decis
ion on behalf of the organization
champion or advocate – involves informal communication with other senior managers to ensure that they continue to have an
objective view of the importance of their project in relation to other projects within the business
problem solver – when the team faces problems that it is unable to solve or does not have the skills or experience to solve
Resource negotiator – a project’s success will depend on the availability of the right resources at the right time. In cross-fun
ctional projects the sponsor may provide assistance in negotiating resources around the company
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Financial Analysis
Tools of financial analysis that can be used to evaluate opportunities and determine whether they are financially
beneficial or not
Knowledge from earlier exams
Advancements in technology mean that accountants are expected to:
Understand and interpret information in a wide range of formats ( published F/S, budget reports, KPIs, investment appraisals)
Understand the links between different types of information and its impact on the organization
Use management accounting techniques to support decision making (using financial and non- financial information)
SBL: students should be able to analyze numerical and descriptive information and draw appropriate conclusions
Financial factors to be considered while assessing strategy
1. Financial Risk: These are the risks which arise from the way a business is financially structured, its management of working capital
and its management of short and long-term debt financing. Cash flow can be strongly influenced by how much debt to equity a
business has, its need to service that debt and the rate at which it is borrowed. Likewise, the ability of a business to operate on a
day-to-day basis depends upon how it manages its working capital and its ability to control payables, receivables, cash and
inventories. Any change which makes its cash flow situation worse, such as poor collection of receivables, excessive borrowing,
increased borrowing rates, etc., could represent an increased financial risk for the business.
2.
Financial Return: Analysis of returns can be done through approaches like ROCE, NPV analysis, IRR and payback.
3.
Funding: organizations need to deliver value for money, keeping in mind that risk has to be kept at an acceptable level.
Management will need to decide what the appropriate funding model would be; venture capital, equity, debt and equity, secured
debt etc.
Investment appraisal
Net present value (NPV)
Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a
period of time. (NPV=PV of inflows-PV of outflows)
Present value describes how much a future sum of money is worth today.
For example, $1000 received three years from now is not worth as much as $1000 received today.
Why is that?
1) Inflation
2) Lost opportunity to invest today to earn return in future
3) Credit risk
Present Value=PV=future Value (1+r)^n
Where r = discount rate
(higher the r lower the PV)
n= No of years
(higher the n lower the PV)
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NPV is used in capital budgeting to analyze the profitability of a projected investment or project. A positive NPV indicates that the
projected earnings generated by a project or investment (in present dollars) exceeds the anticipated costs (also in present dollars).
Typically, if an investment has a positive NPV it will add value to the company and benefit company shareholders. Decision rule is that
projects with “+”ve NPV should only be taken. For those with NPV=0 non-financial factors should be considered.
It gives net returns in absolute terms (in $ terms) so preferred to other methods of investment appraisals.
Pay Back Period
Payback period is the time in which the initial cash outflow of an investment is expected to be recovered from the cash inflows
generated by the investment. Shorter payback periods are preferable to longer payback periods. For companies facing liquidity
problems, it provides a good ranking of projects that would return money early. However it does not take into account, the cash flows
that occur after the payback period hence may reject projects with higher total cash flows
Payback Period =
Initial Investment
Cash Inflow per Period
When cash inflows are uneven, we need to calculate the cumulative net cash flow for each period and then use
the following formula for payback period:
Payback Period = A +
B
C
In the above formula,
A is the last period with a negative cumulative cash flow;
B is the absolute value of cumulative cash flow at the end of the period A;
C is the total cash flow during the period after A
V
Decision Rule
Accept the project only if it’s payback period is LESS than the target payback period.
Discounted Pay Back Period
Discounted payback period is more reliable than simple payback period since it accounts for time value of money. All other advantages
and disadvantages are same for both payback periods. It is interesting to note that if a project has negative net present value it won't
pay back the initial investment.
The rest of the procedure is similar to the calculation of simple payback period except that we have to use the
discounted cash flows as calculated above instead of actual cash flows. The cumulative cash flow will be
replaced by cumulative discounted cash flow.
Payback Period =
PV of Initial Investment
PV of Cash Inflow per Period
When cash inflows are uneven, we need to calculate the cumulative net cash flow for each period and then use
the following formula for payback period:
Payback Period = A +
B
C
In the above formula,
A is the last period with a negative cumulative Discounted cash flow;
B is the absolute value of cumulative Discounted cash flow at the end of the period A;
C is the total Discounted cash flow during the period after A
V
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Decision Rule
Accept the project only if it’s payback period is LESS than the target payback period.
Internal Rate of return
Internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to
zero. Corporations use IRR in capital budgeting to compare the profitability of capital projects in terms of the rate of return. In theory,
any project with an IRR greater than its cost of capital is a profitable one, and thus it is in a company’s interest to undertake such
projects
IRR can also be compared against prevailing rates of return in the securities market. If a firm can't find any projects with IRR greater
than the returns that can be generated in the financial markets, it may simply choose to invest its retained earnings into the market.
The IRR is an indicator of the profitability, efficiency, quality, or yield of an investment. This is a relative measure (in % form) so easy
to understand and use. As a relative measure it ignores absolute returns (more/ less absolute $) and as a result may give inappropriate
decision.
The IRR of a new capital project needs to be higher than the Cost of Capital. This is
because an investment with an IRR which exceeds the cost of capital has a positive
net present value.
Risk and uncertainty
Every decision have some degree of uncertainty and risk including investment decisions.
Risk is measurable uncertainty where probabilities can be assigned to uncertain events based on past experience.
Uncertainty
Risk
A state of having limited knowledge where it is
impossible to exactly describe the future outcome
Too little information is available about expected
future.
Cannot list all possible outcomes
It results when randomness cannot be expressed in
probabilities
Not measurable
Not all uncertainties are risks.
A subset of uncertainty where a possible outcome have an
undesired effect.
Some information is available based on past data/experience
Can list all possible outcomes
Mathematical probabilities can be assigned.
Measurable
All risks are uncertainties are risks.
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Methods to reduce risk and uncertainty
While it is almost impossible to eliminate uncertainty in project management, there are ways to reduce the elements. When there are
only fewer elements to be considered in the estimation, the estimate becomes more reliable, and uncertainty becomes lower.
Examples to reduce uncertainty and risk could include
● Market research
● Identifying most likely/worst/best possible outcome from a range of outcomes using results of market research.
● Sensitivity analysis
● Simulation
● Expected value
● Decision Tree
Sensitivity analysis
The technique used to determine how independent variable values (i.e. Sales price/cost) will impact a particular dependent variable
(i.e. Contribution/Profit) under a given set of assumptions is defined as sensitive analysis.
A Sensitivity Analysis is a "what-if" tool that examines the effect on a company's budgeted Net Income/NPV (bottom line) when
variables (such as sales price & volume ,material / labour costs etc.) are increased or decreased.
It consider one variable’s uncertainty at a time. It provide a detail insight into which variable is more sensitive and where most of the
monitoring and control efforts are needed.
It measures % change in value of variable to make net income “0”
Numerically:
NPV
* 100
Value of variable
Expected Value
It is essentially an average, based on probabilities.
An expected value is a weighted average of all possible outcomes, and used by risk neutral investor. It calculates the average return
that will be made if a decision is repeated again and again hence used for longer run and repetitive project. For each decision option
it provide a single average return estimate and by comparing this average return decision become easier. However for one off project
it is not suitable as chances of obtaining returns equal to EV (average return) are minimal.
It is obtained by multiplying the value of each possible outcome (x) by the probability of that outcome (p), and
summing the results.
The formula for the expected value is EV = Σpx
The accuracy of EV is dependent upon accuracy of x and p
Decision Tree
A decision tree is a graphical representation of possible outcomes of an uncertain decision. It's called a decision tree because it starts
with a single box (or root), which then branches off into a number of outcomes, just like a tree.
Probabilities and Expected Values (EV) can be represented diagrammatically using decision trees. The financial outcomes and
probabilities are shown separately, and the decision tree is 'rolled back' by calculating expected values and making decisions.
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Decision trees are helpful, not only because they are graphics that help you 'see' what you are thinking, but also because making a
decision tree requires a systematic, documented thought process. Often, the biggest limitation of our decision making is that we can
only select from the known alternatives. Decision trees help formalize the brainstorming process so we can identify more potential
solutions.
Decision trees should be used where a problem involves a series of decisions being made and several outcomes arise during the
decision-making process. Decision trees force the decision maker to consider the logical sequence of events. A complex problem is
broken down into smaller, easier to handle sections.
A decision tree typically starts with a single node, which branches into possible outcomes. Each of those outcomes
leads to additional nodes, which branch off into other possibilities. This gives it a treelike shape.
There are three different types of nodes: chance nodes, decision nodes, and end nodes. A chance node,
represented by a circle, shows the probabilities of certain results. A decision node, represented by a square,
shows a decision to be made, and an end node shows the final outcome of a decision path.
Steps involved in decision making using decision tree:
Step 1: Draw the tree from left to right, showing appropriate decisions and events / outcomes.
Label the tree and relevant cash inflows/outflows and probabilities associated with outcomes.
Step 2: Evaluate the tree from right to left (Rollback analysis) carrying out these two actions:
a.
Calculate an expected value (EV) at each outcome point.
b.
Choose the best option at each decision point.
Step 3: Recommend a course of action to management.
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Organization’s performance and position
Most common way to assess performance and position is ratio analysis.
Ratio analysis
The ratio is the numerical relationship between 2 financial items and the relationship can be expressed as: %, times (i.e. 2 times) or
ratio(x: y). Ratio analysis is used to evaluate various aspects of a company’s operating and financial performance such as its efficiency,
liquidity, profitability and solvency.
Ratio analysis can provide an early warning of a potential improvement or deterioration in a company’s financial situation or
performance.
Ratios are usually only comparable across companies in the same sector, since an acceptable ratio in one industry may be regarded as
too high in another. As ratios are based on financial data which is based on accounting standards and estimates the result of this
analysis should be used with caution. Other non-financial data should be another aspect of analyzing these ratios.
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Ratios can be divided into following types
Liquidity Ratios
The ratio between the liquid assets and the liquid liabilities.
A liquidity ratio is an indicator of whether a company's current assets will be sufficient to meet the company's
obligations when they become due.
Types
●
Current assets
Current liabilities
It signifies a company's ability to meet its short-term liabilities with its short-term assets. A current ratio greater
than or equal to one indicates that current assets should be able to satisfy near-term obligations.
●
Current ratio
=
Quick/ Liquid Ratio = Current assets – Prepaid expenses – inventories
Current liabilities
The quick ratio is a tougher test of liquidity than the current ratio. It eliminates certain current assets such as
inventory and prepaid expenses that may be more difficult to convert to cash. Like the current ratio, having a quick
ratio above one means a company should have little problem with liquidity.
Gearing Ratios
The ratio between the borrowed capital and the shareholder’s capital.
Looks at how much capital comes in the form of debt (loans).Also known as “Leverage Ratios”. The ratios used to
determine about the companies' financing methods, or the ability to meet the obligations. The financial leverage
ratios measure the overall debt load of a company and compare it with the assets or equity.
Types
●
Debt equity ratio
= Long term debt
Total equity
The debt/equity ratio measures how much of the company is financed by its debt holders compared with its
owners. Assuming everything else is identical, companies with lower debt/equity ratios are less risky than those
with higher such ratios.
●
Debt to capital ratio
=
●
Interest Coverage=
Operating Income
Interest Expense
Long−term debts
Capital employed
It helps in establishing a link between total long-term funds available in the business and funded debt. Companies
with lower debt/capital ratios are less risky than those with higher such ratios
It measures a company's ability to meet its interest obligations with income earned from the firm's primary source
of business. Higher interest coverage ratios are typically better, and interest coverage close to or less than one
means the company has some serious difficulty paying its interest.
Profitability
Ratios
The ratio between returns/costs and revenues “And” the ratio between returns and resources.
How good is a company at running its business? Does its performance seem to be getting better or worse? Is it
making any money? How profitable is it compared with its competitors? All of these very important questions can
be answered by analyzing profitability ratios.
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Examples
● Gross Margin = Gross Profit
Sales
Gross margin shows how much cost is being incurred on a product comparing to products per dollar of sales. The
higher the gross margin, the more of a premium a company charges for its goods or services. Keep in mind that
companies in different industries may have vastly different gross margins.
●
Operating Margin =
Operating Income or Loss
Sales
Operating margin captures how much a company makes or loses from its primary business per dollar of sales. It is
a much more complete and accurate indicator of a company's performance than gross margin, since it accounts
for not only the cost of sales but also the other costs incurred in primary course of business
●
Net Margin =
●
Return on Assets = Net Income + After tax Interest Expense
Total Assets
Net Income or Loss
Sales
Net margin considers how much of the company's revenue it keeps when all expenses or other forms of income
have been considered, regardless of their nature.
Return on assets measures a company's ability to turn assets into profit. The higher the ratio the more the
company is able to generate profits.
●
Return on Capital Employed (ROCE)=
Profit before interest and tax
Total Capital employed
It is a financial ratio that measures a company's profitability and the efficiency with which its capital is employed.
The higher the ratio the more the company is efficient
●
Return on Equity =
Net Income
Shareholders' Equity
Return on equity is a straightforward ratio that measures a company's return on its investment by shareholders.
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Budgeting and Financial Forecasting
A budget is a quantified expectation for what a business wants to achieve. Conversely, a forecast is an estimate of what will actually
be achieved. Thus, the key difference between a budget and a forecast is that the budget is a plan for where a business wants to go,
while a forecast is the indication of where it is actually going.
Techniques of Financial Forecasting
Qualitative Techniques of Financial Forecasting
1) Executive Opinions
In this method, the expert opinions of key personnel of various departments, such as production, sales, purchasing and operations,
are gathered to arrive at future predictions.
2) Delphi Technique:
Here, a series of questionnaires are prepared and answered by a group of experts, who are kept separate from each other. Once
the results of the first questionnaire are compiled, a second questionnaire is prepared based on the results of the first. This second
document is again presented to the experts, who are then asked to reevaluate their responses to the first questionnaire. This
process continues until the researchers have a narrow shortlist of opinions about forecasts
3) Sales Force Polling:
Some companies believe that salespersons have close contact with the consumers and could provide significant insights regarding
customer behavior. In this method of forecasting, the estimates are derived based on the average of sales force polling.
4) Consumer Surveys:
Businesses often conduct market surveys of consumers. The data is collected via telephonic conversations, personal interviews
or survey questionnaires, and extensive statistical analysis is conducted to generate forecasts.
5) Scenario Writing:
In this method, the forecaster generates different outcomes based on diverse starting criteria. The management team decides on
the most likely outcome from the numerous scenarios presented.
6) Reference Class Forecasting:
Reference class forecasting or comparison class forecasting is a method of predicting the future by looking at similar past
situations and their outcomes.
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Quantitative Techniques of Financial Forecasting
1) Linear regression Forecasting:
Three major uses for regression analysis are (1) determining the strength of predictors, (2) forecasting an effect, and (3) trend
forecasting.
The center of regression is the relationship between two variables called the dependent and independent variable. For instance,
suppose you want to forecast sales for your company and you've concluded that your company's sales go up and down depending on
changes in GDP.
The sales you are forecasting would be the dependent variable because their value "depends" on the value of GDP and the GDP would
be the independent variable. You would then need to determine the strength of the relationship between these two variables in order
to forecast sales. If GDP increases/decreases by 1%, how much will your sales increase or decrease?
If one variable increases and the other variable tends to also increase, the covariance (relationship) would be positive. If one variable
goes up and the other tends to go down, then the relationship would be negative.
This strength is measured by Correlation coefficient (often shown as “r”) a statistical measurement which can range from +1(perfect
positive relation) through 0(no relationship) to -1(perfect negative relationship).
The coefficient of determination explains the proportion of change in dependent variable due to independent variable which is
calculated as r^2.
The Linear regression technique is used for calculating the anticipated value of dependent variable when the values of
independent variable are known. This is in the form of a straight line which “best fits” the past data available presented on a
chart The Linear Regression line shows the principal past trend with respect to time.
The trend is determined by calculating a Linear Regression Trend Line
using the "least squares fit" a statistical measurement. The least
squares method helps in plotting a straight line that minimizes the
distance between the resulting line and the data points (in this case the
sales) in order to reveal a trend.
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Calculation of Linear regression Forecasts:
Linear regression attempts to model the relationship between two variables by fitting a linear equation to observed data. A
linear regression line has an equation of the form Y = a + b(X)
Where X is the independent variable (here GDP) and Y is the dependent variable (here sales). The slope (trend) of the line is b,
and a is the intercept (the value of y when x = 0
The higher the coefficient of determination the stronger the relationship and the more the forecasting accuracy. However it
should be noted that the correlation may be incidental or just because of another variable which can affect accuracy of
forecasts.
2) Time-Series Forecasting:
A time series is a series of data recorded or graphed in time order. A time series can be taken on any variable that changes over
time.ie daily closing stock prices, weekly interest rates, national income etc.
Components of a Time Series: Trend (long term pattern over time)……Cyclical Variation (Rises and Falls over periods longer than
one year)……Seasonal Variation (Patterns of change within a year, typically repeating themselves)………Residual Variation(irregular
but short term variations)
Time series analysis aims to understand patterns evolving over time and use these patterns to predict future behavior (i.e. monthly
sales). Time series are very helpful in study of past behavior of business. On this basis, we can invest our money in that type of
business.
Time series predictions needs large but past data which in itself not a good predictor of future and may not available in large
amount.
In equation form Time series= Y =T +C +S +R +
Where Y= Time series
T= Trend
C= Cyclical Variation(assumed to be Zero)
S= Seasonal Variation
R= Residual Variation(assumed to be Zero)
Trend is calculated using moving averages i.e. 2 moving average(average of 2 values) for 5 years’ time series can be calculated
by averaging year 1 and year 2 values, then year 2 and year 3 values, then year 3 and year 4 values and lastly year 4 and year
5.total 4 averages will be produced in this way.
Trend per time interval= 1st average-last average (where n=number of averages in above case 4)
n-1
Seasonal Variation can be calculated by Subtracting trend values (moving average values) from actual time series values for
each season. it could be + or -.The more these variations the more the time series forecasting is useful.
Seasonal Variation= Time series – trend
Residual Variation= Time series – trend- Seasonal Variation- Cyclical Variation
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The more the residual variation the more the irregularities and the less the chances of accurate forecasts.
Based on above calculations forecasted time series can be calculated as
Y=S+C+R+T
Where S will be for required season and T will be up to forecasted Y(Last moving average + Trend per time interval*number of
time intervals needed after last moving average)
Budgets
Modern formal budgets not only limit expenditures; they also predict income, profits, and returns on investment a year ahead. They
have evolved into tools of control and are also used as a means of determining such rewards as profit-sharing and bonuses.
Budgets could be prepared by senior management “Top-down” approach or in collaboration with both senior and operational
management “Bottom-up” approach.
Types of Budgets
A business creates a budget when it wants to match its actual future performance to an ideal scenario that incorporates its best
estimates of sales, expenses, asset replacements, cash flows, and other factors. There are a number of alternative budgeting models
available.
The following list summarizes the key aspects of each type of budgeting model:
1) Fixed Budget: A fixed budget is a budget that does not change or flex when sales or some other activity increases or decreases.
Main problem with this budget is that it assume everything will happen as per plan.
2) Flexible Budget: A flexible budget is a budget for more than one level of expected activity. The flexible budget is more
sophisticated and useful than a fixed/static budget which remains at one amount regardless of the volume of activity. However
actual activity level may not be one of the budgeted activity level so not a fair basis of managerial performance evaluation.
3) Flexed Budget: Budget reflecting actual activity level by flexing only those items that vary with output and is used to assess
managerial performance.
4) Rolling budget: Method in which a budget established at the beginning of an accounting period is continually amended to reflect
variances that arise due to changing circumstances. By employing a rolling budget, a business or entity can add an extra degree
of flexibility. This may allow them to better react to changes in costs and revenue. With rolling budgets, performance is assessed
against realistic and rationalized targets.
Example of a Rolling Budget
ABC Company has adopted a 12-month planning horizon, and its initial budget is from January to December. After a month passes,
the January period is complete, so it now added a budget for the following January, so that it still has a 12-month planning horizon
that now extends from February of the current year to January of the next year.
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Techniques of preparing budget
Budget is a formal way of allocation of available resources. Appropriate basis should be used to allocate these valuable and perhaps
scarce resources to get maximum benefit.
Following techniques can be used as a basis of resource allocation:
1) Incremental budgeting: Resources are allocated based on last year budget or actual figures by adjusting them for known but
future changes only .i.e. inflation, redundancies etc. It is useful for committed costs OR where environment is relatively stable.
2) Zero-based budgeting: Zero-based budgeting (ZBB) is a method of budgeting in which all expenses must be justified for each new
period. ZBB forces managers to scrutinize all spending and requires justifying every expense item that should be kept. It allows
companies to radically redesign their cost structures and boost competitiveness.
3) Rolling budget: Rolling budgets repeatedly extend the original budget period. Allocated resources are reassessed in each period
and reallocated to reflect changes in resource requirements as per up to date knowledge of circumstances.
Standard Costing
An estimated or predetermined cost of performing an operation or producing a good or service, under normal conditions. Standard
costs are used as target costs (or basis for comparison with the actual costs), and are developed from historical data analysis
The core reason for using standard costs is that there are a number of applications where it is too time-consuming to collect actual
costs, so standard costs are used as a close approximation to actual costs.
Since standard costs are usually slightly different from actual costs, the management periodically calculates variances that break out
differences caused by such factors as labor rate changes and the cost of materials.
Some potential uses of standard costs are: Budgeting, Inventory costing, overhead application, Price formulation and Cost Control
.
Variance Analysis
Once the standard/budget has been set actual figures need to be matched with these estimtes to assess whether any variations have
arised and if yes, to what extent. This is called variance analysis.
Some of the factors caused these variances are within the control of managers however some are not. Careful considerations should
be given to both of these types of factors while assessing managerial performance. It should be noted that some variances are
interrelated which need careful interpretations. For example lower actual prices paid for material will result in favourable material
price variance but may affect sales volume variance negatively as quality of cheaper material purchased and hence the resulting
product may be inferior then budgeted.
Variances can be calculated for each item of budget i.e. Sales price & volume, Labour hours & rate, Material price & quantity, Fixed &
variable overheads ec
Sometimes circumstances changed during budget period outside the control of managers which make budgetary assumptions
inappropriate. A revision to original budget is needed to fairly assess managerial performance.
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There are three types of variances:
1) Basic Variance: Difference between original budget (Standard) and actual figures. This is the total of planning and operational
variance. Assessing performance based on these variances is only appropriate when management is able to control changed
circumstances over budget period (planning variance=0).
2) Planning Variances: Difference between original budget (Standard) and revised budget (Standard).These variances are fed back
to budget planning process to make future planning better and up to date.
3) Operational Variances: Difference between revised budget and actual figures. The aim of separating this variance is to fairly assess
managerial performance based on controllable factors only.
Example: Labour Efficiency(hour) Variance
Basic Variance
Per unit =(Original St hrs/unit-Actual hrs/unit)*Rate per hr
Total=Actual units produced * Per unit Variance
Planning Variances
Per unit=(Original St hrs/unit-Revised St hrs/unit)*Rate per hr
Total=Actual units produced * Per unit Variance
Operational Variances
Per unit =(Revised St hrs/unit-Actual hrs/unit)*Rate per hr
Total=Actual units produced * Per unit Variance
Variance need to be reported in monetary terms that is why above variances are multiplied by Rate per hr
St hrs/unit=budgeted hr per unit (total budgeted hrs/total budgeted production units)
Managerial Accounting
Managerial accounting is the process of identifying, analyzing, recording and presenting financial information so internal management
can use it for the planning, decision making and control of a company. This is in contrast to financial accounting, which is the process
of preparing and presenting quarterly or yearly financial information for external use, such as a company's audited financial statements
for the public.
Managerial Cost accounting
The recording of all the costs incurred in a business in a way that can be used to improve its management.
Common types of cost accounting are:
Full costing: Full costing is used to determine the complete and entire cost of something including both fixed and variable costs. It can
be used to set sales price based on per unit full cost. However allocation of fixed cost to each unit may be difficult and time consuming.
It can also be used to report inventory valuation externally.
Allocation of fixed cost can be performed based on:
Absorption costing: Where fixed overheads are absorbed based on total budgeted production or budgeted machine/labour hours.
Activity-Based-Costing (ABC):It assigns manufacturing overhead costs to products in a more logical manner than the traditional
approach of simply allocating costs on the basis of machine/labour hours. Activity based costing first assigns costs to the activities that
are the real cause of the overhead. It then assigns the cost of those activities only to the products that are actually demanding the
activities.
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Marginal Costing: Marginal cost is the additional (variable) cost incurred in the production of one more unit of a good or service.
Marginal costing is the accounting system in which variable costs are charged to cost units and fixed costs of the period are written
off in full against the aggregate contribution.
The contribution concept lies at the heart of marginal costing. Contribution gives an idea of how much 'money' there is available to
'contribute' towards paying for the overheads of the organisation.
Contribution can be calculated as follows.
Contribution = Sales price - Variable costs
It is principal management tool in decision making as it draws management's attention on additional contribution from a decision. The
more the contribution the more the profit as in theory fixed costs remain same at whatever level of production.
Relevant Costing: A relevant cost is a cost that only relates to a specific management decision, and which will change in the future as
a result of that decision. The concept of relevant cost is used to eliminate unnecessary data that could complicate the decision-making
process.
It is often important for businesses to distinguish between relevant and irrelevant costs when analyzing alternatives because
erroneously considering irrelevant costs can lead to unsound business decisions. It assigns future costs and revenues to the decision
being made. It includes only those cash flows which will be affected by the decision.
Typical managerial decision making selects one of two or more alternatives. Costs that remain the same no matter which alternative
the manager chooses are not relevant to the decision. Examples of irrelevant costs are: Committed costs, sunk costs none cash costs
etc. However opportunity costs are considered as relevant.
It can be used in decision such as:
● Make or buy decisions
● Accepting or declining special contracts
● Closure or continuation decisions
● Effective use of scarce resources
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Developments in technology shaping business
It’s important for companies to remember that business technology can have an impact that extends well beyond a simple return
on investment. Adopting new technology is one way to drive growth and profitability, and it can even transform the business for the
better. Yet with an increased rate of change comes increased business risk. While advancements in big data analytics and business
management systems can help organisations in all industries cut costs and gain a competitive edge, it is critical for business leaders
and their technology project partners to work strategically and methodically.
Innovative technologies can help businesses reduce price and lower barriers to entry, change the ‘go-to-market’ strategy and even
transform processes and culture.
Key rewards
1. Early adoption puts the business ahead of competitors. Adopting innovative technology early means management has time to
learn how to leverage the technology to its best advantage and can begin claiming market share while competitors are still
considering whether to go ahead.
2. Successful implementation increases value for stakeholders. Successfully implementing the right technology can deliver business
performance benefits to the bottom line.
3. Improved performance includes the ability to operate more effectively. When the new technology is in place it should enable an
organisation to operate more effectively.
4. Increased productivity leads to improved efficiency. Ideally the new technology will increase productivity, leading to improved
efficiencies.
5. New technologies can help organizations analyze and store the data that they have.
Big Data
Big data: 'Extremely large collections of data (data sets) that may be analysed to reveal patterns, trends, and associations, especially
relating to human behaviour and interactions.'
Big data is a term that describes the large volume of data – both structured and unstructured – that floods a business on a day-to-day
basis. But it’s not the amount of data that’s important. It’s what organizations do with the data that matters. Big data can be analyzed
for insights that lead to better decisions and strategic business moves.
Organizations can analyze big data to make decisions about new product development, marketing and pricing strategies.
Big data: Opportunities
- Errors within the organisation are known instantly. Real-time insight into errors helps companies react quickly to mitigate the
effects of an operational problem. This can save the operation from falling behind or failing completely or it can save the
organization’s customers from having to stop using the company’s products.
- New strategies of the org’s competition are noticed immediately. With Real-Time Big Data Analytics, the business can stay one
step ahead of the competition or get notified the moment a direct competitor is changing strategy or lowering its prices for
example.
- Organizations can identify new trends and patterns which can help in understanding customer needs
- Organizations can respond to changing conditions faster and can use this speed to generate competitive advantage
Organizations can manage their performance better as they will have an increased amount of performance data.
- Service improves dramatically, which could lead to higher conversion rate and extra revenue. When organisations monitor the
products that are used by its customers, it can pro-actively respond to upcoming failures. For example, cars with real-time sensors
can notify before something is going wrong and let the driver know that the car needs maintenance.
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-
-
Cost savings: The implementation of a Real-Time Big Data Analytics tools may be expensive, it will eventually save a lot of money.
There is no waiting time for business leaders and in-memory databases (useful for real-time analytics) also reduce the burden on
a company’s overall IT landscape, freeing up resources previously devoted to responding to requests for reports.
Better sales insights, which could lead to additional revenue. Real-time analytics tell exactly how the sales are doing and in case
an internet retailer sees that a product is doing extremely well, it can take action to prevent missing out or losing revenue.
Dangers of big data
Cost: It is expensive to establish the hardware and analytical software needed, though these costs are continually falling.
Regulation: Some countries and cultures worry about the amount of information that is being collected and have passed laws
governing its collection, storage and use. Breaking a law can have serious reputational and punitive consequences.
Loss and theft of data: Apart from the consequences arising from regulatory breaches as mentioned above, companies might find
themselves open to civil legal action if data were stolen and individuals suffered as a consequence.
Incorrect data (veracity): If the data held is incorrect or out of date incorrect conclusions are likely. Even if the data is correct, some
correlations might be spurious leading to false positive results.
Employee monitoring: data collection methods allow employees to be monitored in detail every second of the day. Some companies
place sensors in name badges so that employee movements and interactions at work can be monitored. The badged monitor to whom
each employee talks and in what tone of voice. Stress levels can be measured from voice analysis also. Obviously, this information
could be used to reduce stress levels and to facilitate better interactions but it could easily be used to put employees under severe
pressure
Using real-time insights requires a different way of working within the organisation: if the organisation normally only receives insights
once a week, which is very common in a lot of organisations, receiving these insights every second will require a different approach
and way of working. Insights require action and instead of acting on a weekly basis this action is now in real-time required. This will
have an effect on the culture. The objective should be to make the organisation an information-centric organisation.
Cloud Computing
Cloud computing: In the simplest terms, cloud computing means storing and accessing data and programs o ver the
Internet instead of the computer's hard drive. The cloud is just a metaphor for the Internet. So cloud computing is the
delivery of computing services—servers, storage, databases, networking, software, analytics and more—over the Internet (“the
cloud”). Companies offering these computing services are called cloud providers and typically charge for cloud computing services
based on usage, similar to how individuals are billed for water or electricity at home.
Cloud benefits
Cloud computing provides a scalable online environment that makes it possible to handle an increased volume of work without
impacting system performance. Cloud computing also offers significant computing capability and an economy of scale that might not
otherwise be affordable, particularly for small and medium-sized organisations, without the IT infrastructure investment. Cloud
computing advantages include:
 Lower capital costs — Organisations can provide unique services using large-scale computing resources from cloud service
providers, and then nimbly add or remove IT capacity to meet peak and fluctuating service demands while only paying for actual
capacity used.
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 Lower IT operating costs — Organisations can rent added server space for a few hours at a time rather than maintain proprietary
servers, without worrying about upgrading their resources whenever a new application version is available. They also have the
flexibility to host their virtual IT infrastructure in locations offering the lowest cost.
 Improved operations — Organisations can reduce the need to handle hardware or software installation or maintenance.
 Organisations may control the process to create better disaster recovery and business continuity features and services, if properly
managed.
 Higher efficiency — Organisations may be able to optimize their IT infrastructure and gain quick access to the computing services
required.
The risks
 Environmental security — the concentration of computing resources and users in a cloud computing environment represents a
concentration of security threats. Because of their size and significance, cloud environments are often targeted by malware other
attacks.
 Data privacy and security — Hosting confidential data with cloud service providers involves the transfer of a considerable amount
of an organization's control over data security to the provider. Make sure the vendor understands the organisation’s data privacy
and security needs. Also, make sure the cloud provider is aware of relevant data security and privacy rules and regulations that
apply in a particular jurisdiction.
 Data availability and business continuity — a major risk to business continuity in the cloud computing environment is loss of internet
connectivity. Ask the cloud provider what controls are in place to ensure internet connectivity. Ensure that there is a backup plan
for when the service is not available.
 Record retention requirements — if the business is subject to record retention requirements, make sure the cloud provider
understands what they are so it can meet them. This should include litigation preparedness and litigation hold requests.
 Data management — many organisations do not know where the data is and where it flows so it becomes difficult to manage.
Organisations are often unaware of any subcontractor arrangements, which increases the complexity and the need to manage and
control the processes.
 Disaster recovery — Hosting computing resources and data at a cloud provider makes the cloud provider’s disaster recovery
capabilities vitally important to the company’s disaster recovery plans. Know the cloud provider’s disaster recovery capabilities and
ask the provider if they have been tested.
 Transitioning — Organisations seem to be less well prepared in the event that they want to cease or change the contractual
relationship. Ensure it is clear how the business will get the information back and what the associated costs might be.
Mobile technology
Mobile technology is exactly what the name implies - technology that is portable. Examples of mobile IT devices include:
 laptop, tablets and netbook computers
 smartphones
 global positioning system (GPS) devices
 wireless debit/credit card payment terminals
Portable devices utilise many different communications technologies, including:
 wireless fidelity (Wi-Fi) - a type of wireless local area network technology
 Bluetooth - connects mobile devices wirelessly
 'third generation' (3G), 'fourth generation' (4G), global system for mobile communications (GSM) and general packet radio service
(GPRS) data services - data networking services for mobile phones
 dial-up services - data networking services using modems and telephone lines
 virtual private networks - secure access to a private network
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These technologies enable us to network mobile devices, such as phones and laptops, to our offices or the internet while
travelling.
Advantages of mobile technology
Benefits of using mobile technology for business can manifest in:
 higher efficiency and productivity of staff
 the quality and flexibility of service offered to customers
 the ability to accept payments wirelessly
 increased ability to communicate in and out of the workplace
 greater access to modern apps and services
 improved networking capabilities
Mobile devices can link individuals directly into the office network while working off site. For example, an individual could
remotely:
 set up a new customer's account
 access existing customer records
 check prices and stock availability
 place an order online
Rapid developments in cloud technologies are boosting the use of mobile devices in business, supporting more flexible working
practices and accessing services over the internet. For more information, see cloud computing.
Disadvantages of mobile technology
Main disadvantages that come with the use of mobile technology in business include:
 Costs - new technologies and devices are often costly to purchase and require ongoing maintenance and upkeep.
 Workplace distractions - as the range of technologies and devices increases, so does the potential for them to disrupt productivity
and workflow in the business.
 Additional training needs - staff may need instructions and training on how to use new technology.
 Increased IT security needs - portable devices are vulnerable to security risks, especially if they contain sensitive or critical business
data.
Predictive analytics
Predictive analytics is the practice of extracting information from existing data sets in order to determine patterns and predict future
outcomes and trends. Predictive analytics does not tell what will happen in the future. It forecasts what might happen in the future
with an acceptable level of reliability, and includes what-if scenarios and risk assessment. Applied to business, predictive models are
used to analyze current data and historical facts in order to better understand customers, products and partners and to identify
potential risks and opportunities for a company. It uses a number of techniques, including data mining, statistical modeling and
machine learning to help analysts make future business forecasts.
FinTech
Fintech, a combination of the words “financial” and “technology,” is a relatively new, and often nebulous term that applies to any
emerging technology that helps consumers or financial institutions deliver financial services in newer, faster ways than was
traditionally available. Everything from a consumer’s ability to go online and see their financial transactions to apps that track spending
to tools that allow financial institutions to make quick lending decisions are all part of the evolution of financial services. The ability
for investors to do their own research, choose stocks and see their portfolio performance in real time is also an example of fintech in
action.
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IT systems security and control
Information system: The term information system describes the organized collection, processing, transmission and spreading of
information in accordance with defined procedures, whether automated or manual.
IS strategy: information system strategy involves aligning information system development with business needs. It is the long term
plan regarding system to use information in order to support organizational strategies or create new strategic options.
From a strategic perspective, it is essential that organizations have a robust controls over information systems because:
- information is a source of competitive advantage for most organizations
- IS involve high costs when IT is used
- Information affects all levels of management AND external stakeholders
- Customer service is affected by quality of information flows
- Information is critical to the success of many organizations
IT and system security controls
IT poses particular risks to organisations’ internal control and information systems. This can lead to their operations being severely
disrupted and subsequently to lost sales, increased costs, incorrect decisions and reputational damage.
Security controls are measures taken to safeguard an information system from the attacks against the confidentiality, integrity, and
availability of the information system.
Example of controls include:
Physical Security Controls
Physical security controls are means and devices to control physical access to sensitive information and to protect the availability of
the information. All types of computers, computing devices and associated communications facilities must be considered as sensitive
assets and spaces and be protected accordingly. Examples of physical security controls are physical access systems including biometric
machines, guards and receptionists, door access controls, restricted areas, closed-circuit television (CCTV), physical intrusion detection
systems etc.
Technical Security Controls (Logical controls)
They refer to restriction of access to system ( through passwords for example). Logical security elements consist of those hardware
and software features provided in a system that helps to ensure the integrity and security of data, programs and operating systems.
Administrative Security Controls
Administrative security controls (also called procedural controls) are primarily procedures and policies which put into place to define
and guide employee actions in dealing with the organizations’ sensitive information. They inform people on how the business is to be
run and how day to day operations are to be conducted. Laws and regulations created by government bodies are also a type of
administrative control because they inform the business
Administrative security controls in the form of a policy can be enforced with technical or physical security controls. For instance,
security policy may state that computers without antivirus software cannot connect to the network, but a technical control, such as
network access control software, will check for antivirus software when a computer tries to attach to the network.
Application controls
Application controls include both automated and manual procedures that ensure that only authorized data are completely and
accurately processed by that application.
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Application controls can be classified as input controls, processing controls, and output controls.
Input controls check data for accuracy and completeness when they enter the system.
There are specific input controls for input authorization, data conversion, data editing, and error handling.
Processing controls establish that data are complete and accurate during updating. Output controls ensure that the results of
computer processing are accurate, complete, and properly distributed.
Cybersecurity
Cybersecurity is the practice of protecting systems, networks, and programs from digital attacks. These attacks are usually aimed at
accessing, changing, or destroying sensitive information; extorting money from users; or interrupting normal business processes.
Cyber-attacks can disrupt and cause considerable financial and reputational damage to even the most resilient organisation.
If the business suffers a cyber-attack, it stands to lose assets, reputation and business, and potentially face regulatory fines and
litigation – as well as the costs of remediation.
A successful cybersecurity approach has multiple layers of protection spread across the computers, networks, programs, or data that
one intends to keep safe. In an organization, the people, processes, and technology must all complement one another to create an
effective defense from cyber-attacks.
People: Users must understand and comply with basic data security principles like choosing strong passwords, being wary of
attachments in email, and backing up data.
Processes: Organizations must have a framework for how they deal with both attempted and successful cyber-attacks.
Technology: Technology is essential to giving organizations and individuals the computer security tools needed to protect themselves
from cyber-attacks. Three main entities must be protected: endpoint devices like computers, smart devices, and routers; networks;
and the cloud. Common technology used to protect these entities include next-generation firewalls, malware protection, antivirus
software, and email security solutions.
Promoting cyber security in organizations
Establish a governance framework: A governance framework needs to be established that enables and supports a consistent and
empowered approach to risk management across the organization, with ultimate responsibility residing at board level. The board
should regularly review risks that may arise from an attack on technology or systems used. To ensure senior ownership and oversight,
the risks resulting from attack should be documented in the corporate risk register and regularly reviewed.
Apply recognized standards: Consider the application of recognized sources of security management good practice, such as the
ISO/IEC 27000 series of standards.
Educate users and maintain awareness: All users have a responsibility to help manage security risks. Provide appropriate training and
user education that is relevant to their role and refresh it regularly. Encourage staff to participate in knowledge sharing exchanges
with peers across the organization.
Network security
The connections from the organization’s networks to the Internet, and other partner networks, expose the systems and technologies
to attack. By creating and implementing some simple policies and appropriate architectural and technical responses, we can reduce
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the chances of these attacks succeeding (or causing harm to the organisation). An organisation's networks almost certainly span many
sites and the use of mobile or remote working, and cloud services, makes defining a fixed network boundary difficult. Rather than
focusing purely on physical connections, think about where the data is stored and processed, and where an attacker would have the
opportunity to interfere with it.
Managing user privileges
If users are provided with unnecessary system privileges or data access rights, then the impact of misuse or compromise of that users
account will be more severe than it need be. All users should be provided with a reasonable (but minimal) level of system privileges
and rights needed for their role. The granting of highly elevated system privileges should be carefully controlled and managed. This
principle is sometimes referred to as ‘least privilege’.
Incident management
Most organisations will experience security incidents at some point. Investment in establishing effective incident management policies
and processes will help to improve resilience, support business continuity, improve customer and stakeholder confidence and
potentially reduce any impact. The management should identify recognised sources (internal or external) of specialist incident
management expertise.
Malware prevention
Malicious software, or malware is an umbrella term to cover any code or content that could have a malicious, undesirable impact on
systems. Any exchange of information carries with it a degree of risk that malware might be exchanged, which could seriously impact
the systems and services. The risk may be reduced by developing and implementing appropriate anti-malware policies as part of an
overall 'defence in depth' approach
Monitoring
System monitoring provides a capability that aims to detect actual or attempted attacks on systems and business services. Good
monitoring is essential in order to effectively respond to attacks. In addition, monitoring allows the management to ensure that
systems are being used appropriately in accordance with organisational policies. Monitoring is often a key capability needed to comply
with legal or regulatory requirements.
Removable media controls
Removable media provide a common route for the introduction of malware and the accidental or deliberate export of sensitive data.
The management should be clear about the business need to use removable media and apply appropriate security controls to its use.
Home and mobile working
Mobile working and remote system access offers great benefits, but exposes new risks that need to be managed. Management should
establish risk based policies and procedures that support mobile working or remote access to systems that are applicable to users, as
well as service providers. Train users on the secure use of their mobile devices in the environments they are likely to be working in.
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E-Business/Digital Business
An e-business can run any portion of its internal processes online, including inventory management, risk management, finance, human
resources.
Electronic Business, shortly known as e-business, is the online presence of business. e-business is not confined to buying and selling
of goods only, but it includes other activities that also form part of business like providing services to the customers, communicating
with employees, client or business partners can contact the company in case if they want to have a word with the company, or they
have any issue regarding the services, etc.




Email marketing to existing customers and prospects is an ebusiness activity, as it electronically conducts a business process
-- in this case marketing.
An online system that tracks inventory and triggers alerts at specific levels is also ebusiness. Inventory management is a
business process. When facilitated electronically, it becomes part of ebusiness.
A content management system that manages the work flow between content-developer, editor, manager, and publisher is
another example of ebusiness. In the absence of an electronic work flow, the physical movement of paper files would
conduct this process. By electronically enabling it, we are now in the realm of ebusiness.
An online induction program for new employees automates part of the whole of its offline counterpart.
As with all other aspects of strategy, e-business can be evaluated using the Suitability ( does e-business support the existing
overall strategy), Acceptability (is the new strategy acceptable to stakeholders) and Feasibility ( commercially viable? skills?
finance available?) model
E-business strategy is driven by the vision and objectives of the organization as a whole.
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The organization needs to make key decision about:
Digital business
channel priorities
Market and
development
strategies
Consider the mix of having a physical and an on-line presence.
Bricks and mortar: physical presence only
Bricks and clicks: Mix of physical and on-line presence
Clicks: Online only
What is sold and who is it sold to?
Positioning and
differentiation
strategies
How will the online offering be positioned as compared to competitors in terms of product and
service quality, price, delivery time?
This is similar to the marketing mix.
Business, service
and revenue
models
e-business can provide an opportunity to make changes to the business and revenue models (i.e. on how
a company will generate revenue, identifying its product offering, value added services, revenue sources
and target customer
Marketplace
restructuring
Technology can change market structures themselves and organizations can take advantage of this.
This may take the form of:
Disintermediation: reduction in the use of intermediaries between producers and consumers, for
example by investing directly in the securities market rather than through a bank.
Re-intermediation: creation of new intermediaries such as search engines and comparison sites
Counter mediation: when companies set up their own intermediaries The whole idea is to control
key elements of a supply chain on to prevent the competitor to gain a competitive advantage
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Supply chain
management
capabilities
Internal
knowledge
management
capabilities
Organizational
resourcing and
capabilities
Companies can use technology to integrate more closely with their suppliers or participate in online
marketplaces. Questions that they need to consider are:
• Integrate more closely with suppliers?
• Which materials and interactions should we support through e-procurement?
• Can we participate in online marketplaces to reduce costs?
Organizations should consider whether technology can help in creation and dissemination of
knowledge.
Adopting these strategies will require organizational change. Management has to decide how organization
needs to change to achieve the priorities set for e-business.
Stages in adoption of e-business
Michael Earl’s analysis of how organisations’ use of e-business evolves.
Earl suggested that business use of e-business technology progresses through the following stages:
External communication
A web presence
Internal communication
An intranet
Ecommerce
E-business
E-enterprise
Buying and selling
Buying and selling, plus the capabilities to match
Management processes and business processes are redesigned. Transactions can be
monitored and analysed real-time.
New business and management models required for the new economy are embedded.
Transformation
As is said by Earl: ‘The six stages are ‘ideal types’, stylistic phrases which capture – even caricature – the experiential learning of these
companies; thus they are not necessarily definitive periods of evolution from old economy to new economy corporations. However
we do find most companies identify with the model.’
The particularly interesting elements of these steps are:
 E-commerce/e-business. It is recognised that companies often try to run before they can walk. Their website promises efficient
transactions but their systems simply cannot deliver so that the dispatch of goods is unreliable and errors are made. All this
manages to do is advertise the firm’s incompetence to an international clientele.
 E-enterprise. Management processes and business processes are redesigned. Transactions can be monitored and analysed realtime. It’s the ‘real-time’ element that’s important here. For example, analysing sales as they happen and adjusting purchasing
and production in response.
 Transformation. New business and management models required for the new economy are embedded. For example, iTunes as
mentioned above.
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Technology and value chain analysis
The value chain sets out all the groups of activities that a business performs, and seeks to identify what the business does to give it
the right and ability to earn profits. The value chain is therefore perhaps the most fundamental model there is: value has to be added
if any profits are to be made at all. Value chain theory emphasises how important it is to identify linkages between activities. For
example, better technology development is likely to result in more efficient operations and fewer units needing after-sales service
and repair.
Firm infrastructure
Technology development
HR management
Procurement
Inbound logistics
Operations
Outbound logistics
Marketing and sales
Service
Cloud based enterprise planning systems, predictive analytics, Big data
Enables all other changes
Self service portal for employees
EDI links and online purchasing
Inventory control, material requirements planning, automated delivery tracking
Use of robots in manufacturing, 3D printing
Tracking progress of goods from pick up to delivery in real time
e-marketing
Use of FAQ web pages, online chat and internet-enabled devices
The 6 Is of marketing
This model summarizes ways in which the internet can add customer value.
This model is particularly useful when analysing the downstream side of businesses (the marketing, distribution and sales functions)
but can also be relevant elsewhere.
Interactivity
Interactivity allows visitors
to engage with the website
and brand on a higher level,
contributing
to
their
marketing efforts and
providing social proof.
The power of the Internet allows consumers to become interactive with marketing
collateral.
Interactivity starts with the ads themselves. Google has pioneered TrueView ads
in YouTube. TrueView ads allow the user the option to skip a video ad after
watching 5 seconds. Advertisers only pay for ads that are not skipped. This level of
interactivity provides benefits to both the advertiser and the audience. For the
advertiser, their ad buys are more efficient and they get a feedback loop about the
effectiveness of their creation. For the audience, they make the decision about the
ads that are interesting and presumably will be served more ads that meet their
interests.
The video phenomenon on both YouTube and Facebook also opens up other
interactive options. Facebook users can engage with ads by liking the publisher
and even commenting on the ad and responding to friends or strangers. This type
of interaction and engagement was never possible with TV, Radio or Print.
In addition to ads, advertisers can now invest in one-to-one post-click experiences.
Many advertisers will create landing pages that directly relate to the ad that was
displayed. This could either be landing the user directly on a product page that
explains the particular product or a service page with relevant testimonials. In the
traditional print world, there was often friction in finding the specific product or
service being advertised.
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Intelligence
Individualization
Intelligence refers to the
data gained through market
research and how a
company
may
use
information
such
as
customer demographics to
their advantage.
Internet marketing provides a level of intelligence due to the fact that extensive
market research is conducted in a cost effective manner. The Internet provides
information about consumers and companies are able to gather this information
and use it for their benefit.
Individualisation refers to
how dynamic the content of
a website is to suit an
individuals needs.
Advertisements and other marketing activities on the Internet can be customized
to an individual's location, demographic, age, gender, interests, and more; the
ability to target a certain demographic or geographic area is also how Internet
marketing excels in individualization.
Programmatic
In recent years there has been an explosion in how advertisers are using
intelligence from the web. Programmatic advertising is based on user level data
aggregated from first and third-party sources. Larger advertisers are able to use
the behavior of their current customers to find “similar to” or “lookalike”
audiences. Programmatic advertising is powered by the rise of Big Data. Agencies
and large advertisers are assembling data troves from multiple sources to make
their targeting even more efficient.
Retargeting
The individualization enabled by digital marketing is the best chance for a marketer
to cut through the clutter of digital ads. The best example of the individualization
allowed by the digital marketing is retargeting ads. Advertisers can code their
website to automatically generate ads based browsing history or specific actions.
Ecommerce websites will use browsing history to automatically generate ads that
show items that a consumer recently viewed on their website. Advertisers can
increase their ROI by leading people back to a shopping card pre-populated with
the products that customer viewed. These ads reduce the friction in completing
transactions.
Intent
Advertising platforms develop rich profiles of the consumer and then enable
advertisers to use this information to better target ads. Google Adwords has
generated billions in revenue for Google. Advertisers see large ROI because Google
allows advertisers to tap into “in market” events triggered by what people are
searching. When someone is searching for a “emergency plumber in atlanta,”
advertisers can read into that search query to understand 1) where the person
needs the service 2) when they need it (emergency… now) and 3) the type of
service. Ad platforms go above the specific search and can also provide the
advertiser information about the specific location of the person searching,
demographic information and even if they had previously been to the advertisers
website.
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Integration
Integration refers to the
combining of different
media channels to provide a
more
wholesome
marketing approach. This
allows
for
greater
interactivity
and
intelligence as users should
easily be able to move from
one channel to another via
the integrations.
The integration of traditional and online marketing methods such as a billboard or
magazine with a QR code is evolving and marketers are utilizing the concept of
integration daily; combining different media channels via Internet marketing also
allows the point of interactivity and intelligence to occur.
Big Data
As marketers were able to collect richer customer profiles, a new segment of
software began to emerge. Modern marketers rely on marketing automation
platforms for both consumer and B2B companies. Marketing automation
platforms are part data warehouse, part email marketing platforms and part
reporting platforms. There has always been a continuum of analytical to creative
in marketing roles, but the Internet has brought the data geeks from the back room
to the front room. Marketing automation allows marketers to build journeys to
help educate customer pre-purchase as well as provide post-purchase support.
In addition to marketing automation, consumers expect unified experiences across
devices and channels. As an example, in 2017 Domino’s Pizza offers 15 different
channels for ordering Pizza. The name of the game for marketers is to be where
their customer is and make the user experience seamless between channels. It is
easy to forget but in the late 1990’s many call centers could not access orders or
information conducted through the Internet. This type of siloed operations would
never be accepted today.
Industry
structure
Independence of
location
Industry
Restructuring refers to how
marketing methods are
continuously evolving to
suit the times and this
causes waves in the
industry as more marketing
tasks
are
automated
through new technologies.
Independence
of
Location refers
to
consumers having the
ability to access the website
no matter where they are
located or what device they
are using as long as they
have
an
internet
connection. This means
that the marketing can also
be done independent of
location
The marketing industry as previously mentioned is continuously evolving. The
disintermediation occurs in Internet marketing and is continuing as the middleman
is constantly being removed from the marketing process.
The Internet has been brutal in this regard. Travel agents, local retailers, brokers,
cab companies and many more middlemen companies have all but vanished. They
are replaced by direct booking and ordering or more efficient intermediaries
operating more efficiently.
Being able to do the marketing of a product or service from a personal computer
at home is a great advantage of Internet marketing, as well as the ability to be
reached as a consumer from anywhere with a wifi connection whether it be via
mobile device or computer.
Other differences/advantages that Internet marketing has over traditional marketing is accountability,
testing, flexibility, micro-targeting, and cost-control. All of these aspects combined can help you run a
successful Internet marketing campaign. Independence of location ties back to Data and Targeting.
Rather than targeting people in monolithic blocks like “what TV show they watch” or “which zip code
they live in,” the Internet can target people based on much richer profiles of what they are interested
in and what they need at a particular time. For example, take a person planning a vacation. They might
be in one marketing researching the vacation and planning but then while on vacation need help with
reservations or events. Sites like Trip Advisor will change their content based on the profile they built.
Trip Advisor knows the dates you are interested in travelling because you often provide them in your
searches. They then know how close that trip is and know that people often buy tickets and hotel
reservations several months before the trip but then plan tours and other events closer to the trip date.
Trip Advisor will tailor their emails and even continue emailing while you are vacation. This is a level of
marketing and targeting that would be impossible in the offline world.
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Branding
A brand is a name, term, design, symbol, or other feature that distinguishes an organization or product from its rivals in the eyes of
the customer. The brand is the entire range (not only the name, trademark, graphics, etc.), which seeks to assure buyers of something
unique - either in its size, utility or symbolically, and thus influence the selection process
E-branding, like traditional branding ( through TV, press, outdoor advertising, media relations), aims to create a specific brand image,
but to create it and manage it by using the tools and opportunities offered by the internet. It has the same objectives as traditional
branding but both forms are different in many aspects. E-branding, unlike traditional branding is characterized by:
- Constant presence ( through social media, websites etc)
- Interactivity (Social media users can follow the channels of individual brands, they are kept informed about the activities of their
favourite brands, have the opportunity to ask questions, evaluate, provide feedback on products and services so that businesses
or individuals can react more quickly on user ratings, and then match up their actions and branding strategies to the needs and
expectations of their customers).
- Speed (On the Internet it is possible to have an effect immediately and any information sent over the network (a new post on a
blog, newsletter, a new post on social media) goes to the audience right away.
- Constantly expanding audience( We are seeing a gradual decrease in the number of traditional media consumers, for example
TV or the press. Meanwhile, the number of Internet users is constantly increasing).
Important of e-branding
Once you establish a company, branding is one of the most important things you can do. "Making a name for yourself" is more
than a few billboards and commercials; you have to build up a reputation. If you want to become a household name, or anything
close to it, a lot of hard work and dedication has to be put into your efforts. Nowadays, people are moving towards pull
marketing as opposed to push marketing. Push meaning you're going to the consumer; pull meaning the consumer is coming
to you. Naturally people see push methods as traditional ways of doing things, like using print. A lot of pull tactics are used
online. More companies should now be focusing on pull branding, or online branding.
When people are unsure of a company name they've heard, rarely do they go to the pho ne book anymore. The main source of
information now is searching for the company's online presence. If they don't have a presence, or you can tell they set up th eir
profiles and left them to rot, you're less likely to engage any further with them. This is the 21st century; we're living in what I
like to call the "tech times" and companies that aren't hopping on the bandwagon are being left in the dust. Here are a few
reasons why online branding is important:
- To increase the visibility of your business
- To connect with the customers and keep them updated
- To cope up with the competition
- It is good for research and development: Proper keyword usage allows you to drive potential traffic to your site. this is the best
way to win new customers.
- Legitimate yourself: By establishing and maintaining the presence online, business can show their customers that their business
is active, dynamic and working to improve and is trying to grow. The Internet allows local businesses to legitimate themselves as
successful companies.
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Acquiring and managing customers through e-business technologies
Every business needs new and loyal customers to succeed - and as customer needs change so do the means and ways of attracting
and retaining them. With digital technologies pervading every aspect of our lives and the society, businesses need to have a solid
strategy in place to both acquire and retain a customer base.
1.
2.
3.
4.
5.
6.
Search marketing: Search engine optimization ( growing visibility in unpaid search engine results). , paid search and pay per click
campaigns
Online PR: Publisher outreach, community participation, media alerting
Online partnership: Affiliate marketing, sponsorship, co-branding.
Interactive ads: Behavioural targeting, data mining ( to identify trends, patterns and relationships in data)
Opt-in email: co-branded and ads in third party newsletters
Social media marketing: Audience participation, viral campaigns, social presence management and customer feedback
Acquiring and managing suppliers through e-business technologies
E-procurement is the electronic purchase and sale of goods and services, usually through an Internet-based platform. It is a tool
designed to improve the purchasing process transparency and efficiency and help companies capture savings.
Traditional procurement methods involve running requests primarily over the phone, through the post, or via face-to-face meetings.
In the past couple decades, companies have begun using email as well. Traditional procurement methods, including email are
notoriously inefficient due to the time requirements needed for manual data entry. Lack of process transparency and data visibility
are also problems with traditional procurement methods; information on current and past requests is hard to access and audit.
Modern e-procurement tools make the process vastly more efficient; buyers save time and management can easily access the data
from a centralized and visualize the outcome based on information from past events.
While e-procurement does include electronic purchases performed via an EDI (electronic data interchange) or ERP (enterprise resource
planning) system, the most efficient and cost-effective tools available today are cloud-based. Also known as software as a service
(SaaS) solutions, these tend to have a shorter time to value since nothing needs to be installed on premise, and implementation can
occur within hours or days, rather than weeks or months.
The e-procurement value chain consists of e-Tendering, e-Auctioning, vendor management, catalogue management, Purchase Order
Integration, Order Status, Ship Notice, e-invoicing, e-payment, and contract management.
Disruptive innovation and technologies
Disruptive Innovation refers to a technology whose application significantly affects the way a market or industry functions. An example
of a modern disruptive innovation is the internet, which significantly altered the way companies did business and which negatively
impacted
companies
that
were
unwilling
to
adopt
it.
Disruptive technologies are those that significantly alter the way businesses or entire industries operate. Often times, these
technologies force companies to alter the way they approach their business, or risk losing market share or becoming irrelevant. Recent
examples
of
disruptive
technologies
include smartphones and e-commerce.
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FinTech
Fintech may be understood as the use of innovative information and automation technology in financial services. 1) New digital
technologies automate a wide range of financial activities and may provide new and more cost-effective products in parts of the
financial sector, ranging from lending to asset management, and from portfolio advice to the payment system.
With the generation of new business models based on the use of big data, fintech has the potential to disrupt established financial
intermediaries and banks in particular. For example, fintech facilities may help to better assess the creditworthiness of loan applicants
when an institution screens them,. The main developments in the application of digital technology have occurred so far in lending,
payment systems, financial advising, and insurance. In all those segments of business fintech has the potential to lower the cost of
intermediation and broaden the access to finance increasing financial inclusion (that is, is fintech could be a door for unserviced parts
of the population and for less developed countries).
Technology has become the driving force behind many changes to society and the global economy. That technology has caused the
rapid and continuous disruption of a succession of industries is a given. In the financial services industry, with the growth of financial
technology (FinTech), we are witnessing significant transformations to systems and processes that had stood the test of time. What
makes FinTech so potentially transformative is the scope for materially altering the fundamentals underpinning the applications that
make up the backbone of our commercial lives. A range of systems and processes in areas including payment, lending, retail banking,
asset management, fraud protection and regulatory compliance are now populated not just by well-known and established institutions
but also by challenger start-ups vying for a say in the future. These new entrants, alongside reconfiguring incumbents, are
reformulating service design and delivery through technological developments and advancements in software, user experience and
data mining. At the same time, regulators around the world, operating in countries whose financial services sector is in varying stages
of development, must find the right balance between harnessing the possibilities offered by FinTech and the right level of forward
looking
legislation
to
give
it
the
best
chance
of
flourishing.
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