Better Strategic Management Frameworks for All
By Paul Barnett
This article is a look at initiatives to improve the quality of business reporting, making it more useful to investors.
“Strategic management evolved, out of long-range planning, in the late 1950’s and early 1960s.”
“Every investor would understand the value in a unique business model that is hard to copy and offers competitive advantage.”
Business reporting is instigated by governments and other institutions, and driven primarily by professional bodies in finance and accounting, with some influence from the environmental, social and governance (ESG) lobby. Business reporting also includes requirements related to the reporting on business models and strategies. Surprisingly, the strategy community has neither been engaged in the process of developing or introducing such reports nor has it shown much interest in being engaged essentially because there is a lack of awareness of these developments.
There really are no large and widely recognised professional bodies associated with strategic management, in the way that there is in the accounting profession. That is because management, relative to finance and accounting, is a very young discipline and strategic management is younger still. Strategic management evolved, out of long-range planning, in the late 1950’s and early 1960s.
Advancing the professional practice of strategic management is a professional goal I work towards. I do believe that improving the quality of business reporting in that regard offers a great opportunity to achieve our purpose as it provides management frameworks rather than reporting frameworks.
Of the business plan, it is often said that the greatest value is not derived from the document, but from the thinking that goes into it. I believe the same is true of reporting initiatives. If the reports are to be holistic and integrated narratives on the future prospects and current performance of the business, it will necessitate the kind of integrated thinking that rarely happens in large corporations. It will lead to the breaking down of functional silos, ideally, or at least entail a better dialogue and understanding between.
For me the initiatives have a misguided focus on a product, the annual report. They focus on the ‘end’, rather than the ‘means to an end’. I see the report as not the only product, and perhaps the least important product. It is certainly not the product that will deliver the greatest value. Being directed to serve the interests of investors may produce benefits in the longer-term, but more important will be the immediate and short-term benefits that can be gained from better, more integrated, strategic management thinking. The impact will be better performance and more robust business models. This is likely to lead to greater, and faster, adoption than an initiative focused on annual reporting which will be viewed as additional cost and a greater burden.
Being focused on annual reports published by larger listed companies is also a lost opportunity in many respects. My view is that the greatest beneficiaries of an integrated management framework, (which is a better way of looking at it than an integrated reporting framework), would be small and medium-sized businesses who are less likely to have good management frameworks and systems in place. The reports generated should focus on their internal use as management reports to facilitate better strategic decision-making and improved performance.
All of this is not to say that external reporting is unimportant. It is very important. But there again the businesses that would benefit most are not the large listed companies who have little trouble finding capital. The bigger winners will be the SMEs that struggle to find money, may have to give a share of ownership away for it, or pay higher rates of interest. Within this category are the medium-sized businesses (MSBs) that face the need to raise capital whilst still private, prior to listing. Their requirements often require that they give away a share of ownership, put assets at risk, or pay large interest rates because of the higher perceived risk. Alternatively they choose not to grow or they fail. I believe that a period of integrated management reports based on a recognised framework would mitigate some of these limitations and open up more financing options. In fact I went to a director of a bank and asked if they would be more likely to lend and if the loan would be at a lower cost. The answer in both cases was yes. We are now discussing a test case.
The two reporting initiatives that I am most familiar with are the work by the International Integrated Reporting Council (IIRC), and the Financial Reporting Council (FRC). The IIRC has a global focus and the FRC is a UK institution responsible for promoting high quality corporate governance and reporting to foster investment. It sets the UK Corporate Governance and Stewardship Codes as well as UK standards for accounting, auditing and actuarial work. It also monitors and takes action to promote the quality of corporate reporting and auditing. Both have created reporting frameworks and offer guidelines to support them, and the principles behind both are, in their opinion, aligned.
In the case of the FRC the organisation was requested to provide non-mandatory guidance in support of new Government regulations introduced in August 2013 that required certain entities, mostly larger listed companies, to prepare a strategic report as part of their annual report. The aim of the report being, to “provide shareholders with a holistic and meaningful picture of an entity’s business model, strategy, development performance, position and future prospects” including potential risks. The latest version of the Guidance on the Strategic Report was published in June 2014.
Both frameworks aim to be holistic and offer a report that provides an integrated picture. I think that is great. But, in both cases the new framework focuses on the “usefulness to investors”. I would much prefer to view them as integrated management frameworks that focus on “usefulness to management”. If management finds them useful they will also be useful to investors. Just as importantly, there will be a better relationship between internal and external reporting.
To get to the real point, I think that to focus on reporting is to “put the cart before the horse” as we say. Reporting is a product, and a bi-product at that, in my mind. The focus should be integrated thinking that helps design a framework for integrated strategic management. But, there is one caveat. The framework should provide a guide. The story it helps people to tell must be unique, but within this lies something of a perceived paradox. One of the aims of most annual reports is the idea of “comparability” to make the investors life easier. At the same time every investor would understand the value in a unique business model that is hard to copy and offers competitive advantage.
Some might argue that a standard reporting framework won’t work. That is nonsense of course. The business plan template is a pretty standard document, but it allows plenty of scope for a business to tell its story. The integrated reporting framework offers similar scope.
Unlike a business plan, or most annual reports to date, it allows a company to report on the non-financial drivers of the business, the source of upward of eighty per cent of the value of many businesses in the knowledge economy, where tangible asset values are negligible, and are certainly no indication of future value potential.
The values in an integrated report are measured in financial and non-financial terms, under the headings of six capital categories in the case of the IIRC framework. They are Financial, Manufactured, Intellectual, Human, Social & Relationship and Natural capitals.
As the IIR explains, “the capitals are stocks of value that are affected or transformed by the activities and outputs of an organization” and, “An organization’s business model draws on various capital inputs and shows how its activities transform them into outputs”.
Making use of these capitals within the framework, “The primary purpose of the Framework itself is to provide guidance on the practicalities of producing an integrated report and to explain the concepts behind <IR>, namely strategic focus and future orientation, stakeholder and materiality focus, conciseness, connectivity and reliability of information, and consistency and comparability”. And “any communication claiming to be an integrated report should apply these principles” argues the IIRC.
Interestingly, they are also mindful of the need to ensure there is flexibility rather than just conformity in the reports. To that end they do reflect what is unique to a business and its business model. They say, “It identifies the type of information to include and how to present it, but strikes a balance between flexibility and prescription as necessitated by the wide variation in circumstances of different organizations”.
To conclude, I would argue that the IIRC Framework and the FRC Report Guidance are very useful strategic management tools, with a use that goes far beyond reporting. The benefits of using them may also be felt far beyond just better reporting if rightly seen for what they are, which is better management frameworks.
They are “a tool for the better articulation of strategy” according to Mervyn King, Chairman of the IIRC. I would argue that they are also a tool for better thinking and decision-making about strategy too, and that these uses of it must come first anyway. To focus on one output is, in my view, to miss a big opportunity. To focus only on the use for listed companies is also a missed opportunity.
I think these frameworks could have a transformative impact on the performance of many companies of all sizes, but particularly those that could benefit from better management frameworks.
