Critical Thought

Critical Thought

The strategic imperative of integrated reporting

Date Released: Fri, 23 March 2012 15:27 +0200

By Professor Owen Skae, Associate Professor and Director of Rhodes Business School

 

This is, on the face of it, understandable as directors, the auditing and legal profession and other interested and affected parties scramble to get to grips with the detail of King III and reporting guidelines such as the Global Reporting Initiative’s (GRI) G3 guidelines, since IR became a mandatory listing requirement in South Africa.

However, the downside to this is that it has obscured, to some extent, the true value of what King III and the G3 guidelines are really meant to achieve. Ultimately it is not about reporting for reporting’s sake, but addressing, in a fundamental way, how organisations think and act, which in turn has potentially profound implications for how strategies are developed and implemented.

Underlying all of this is the recognition that if companies do the right things, then by corollary, good and hence better business strategies will emerge. This is where the ‘I’ comes to the fore.

But is this enough to justify a company’s stakeholders getting excited about the ‘integration’ part of Integrated Reporting?

The need for integrated reporting

In the book entitled One Report by Robert Eccles and Michael Krzus, they state:

‘One of the reasons for the urgent need for One Report is that it will make more apparent, to both the company and its many stakeholders, the relationship between financial and nonfinancial performance and the extent to which financial performance for shareholders imposes externalities on other stakeholders. The result is greater transparency about the company’s performance and how (my emphasis) it is being achieved-including its social costs and benefits. This function of reporting will change behaviour; it is as important as providing information on achieved performance in financial, environmental, social, and governance terms.’

The latter terms are essentially now being captured in a catch-all term, namely ‘embedded sustainability’.

The emphasis on non-financial measures is not new.

David Norton and Robert Kaplan have been arguing the importance of this for many years with the so-called Balanced Scorecard (BSC) and more latterly their strategy maps. Whilst this method of ensuring strategies get implemented is not without its critics, the underlying philosophy of the BSC is to ensure that companies avoid being in a situation of ‘not managing what they can’t measure, and not measuring what they can’t describe’.

Listed companies in South Africa will now be required more than ever to describe their intentions and actions, which essentially means articulating their strategy in a way that will enable them to manage it and ultimately measure it across a spectrum that encompasses many imperatives. This can only lead to better ways of doing business for the benefit of stakeholders and shareholders.

In undertaking an assessment of various companies who have generated integrated annual reports, Eccles and Krzus, noted that in their explanations of sustainability, the following common characteristics exist in varying degrees:

• New business model;
• Long term view;
• Multiple stakeholder perspective;
• Engagement processes;
• Value creation for all stakeholders;
• Risk of not adopting the new model; and
• Benefit of adopting the new model.

The message is clear, namely all the characteristics of a sound business strategy emerge.

However, before I get too excited about having ‘proved’ my point, perhaps we should reflect on what a ‘good’ business strategy actually means?

‘Good’ business strategy

Get 100 CEOs into a room and pose that question and you are likely to get a 100 different answers. On the one hand, there is bound to be similarity, such as successfully achieving the vision, clarifying your purpose, understanding the nature of the industry dynamics, positioning the company to compete effectively, managing resources optimally and so on.

However, scratch below the surface and challenge these in a critical way and perhaps some may come up short. Is the ‘good’ ultimately about ‘beating competition’, ‘generating returns to shareholders above the average returns’, ‘ finding new markets’, ‘operating sustainably’ or ‘providing an environment for motivated employees’? Or is it to go wider than the narrow confines of our shareholders and employees and into the realm of stakeholders (however this ‘constituency’ is defined or described)?

A recent article in McKinsey Quarterly, posed the question ‘Have you tested your strategy lately?’  The authors Chris Bradley, Martin Hirt, and Sven Smit identify 10 test questions which they believe help executives assess the strength of their company’s strategy. Most tellingly (and alarmingly) in a survey of 2,135 executives, results indicated that few strategies pass more than three of the ten tests.

Some of these tests are perhaps intuitive, for example will your strategy beat the market, does it tap a true source of advantage and have you translated your strategy into an action plan? Perhaps these are the basis of the 100 CEOs responses above.

However, some of the questions are less obvious. How about, is your strategy contaminated by bias? Is there conviction to act on your strategy? This probably explains why the pass rate is on average a meager 30%.

Reasons for most companies passing so few of the tests are not really discussed in much detail, but they do say, ‘Let’s face it: the basic principles that make for good strategy often get obscured’. Contributing factors to this are a ‘quest for the next new thing’ or ‘torrents of data, reams of analysis and piles of documents that can be more distracting than enlightening’.

If I was to undertake an academic exercise, I might state my null hypothesis to be ‘Integrated Reporting does not lead to better business strategies’. Then I would go out and test it. Certainly I would hope that the null hypothesis is rejected (ensuring that the conclusion is of course reached in a non-biased fashion).

Right now, it might be too early to tell. However, Bradley, Hirt and Smit hit the nail right on the head when they hint at the lack of integration that exists amongst many companies today. For them, ‘strategy is a way of thinking, not a procedural exercise or a set of frameworks’.

For many companies, the focus is often too much on the what, where and when and perhaps less so on the who, why and how! Perhaps once again this is understandable, the what, where and when are tangible.

The who, why and how brings murkiness and tough questions that are not easy to answer. For example, why should climate change be everybody’s business? How are we going to contribute to job creation? How is our company going to address the skills shortage and contribute to educational upliftment and poverty alleviation? How do we reconcile competing demands that are placed on us by our stakeholders? Who should be driving our sustainability agenda? How are we going to play a role? In fact, why should this be part of our focus when ultimately we are driven by serving our shareholders, customers and employees?

Clearly there are no easy answers to the above, but they all flow to addressing the most pressing conundrum of our time, which is achieving sustainable human development whilst preserving our planet.

The six key imperatives

In 2009, the World Economic Forum(WEF) and Deloitte & Touche prepared a report ‘The Business Case for Sustainability’ identifying six key imperatives.

In summary these are:

• Managing resource risk: Without a doubt we can expect increasing volatility and diminishing resources. In a recent article in the Sunday Times, Business Times, Money and Careers, Paul Stewart wrote that experts believe that, without oil, the planet can only sustain two billion people (according to our current consumption habits and how we use alternative energy sources). Consider that there will be an estimated nine billion people who will live on the planet by 2050.

• Shaping the regulatory environment: As we continue to live and operate in a world, which has now gone into ‘ecological overshoot’ (according to the Global Footprint Network, we are currently consuming one and quarter planet Earths and this is expected to be the equivalent of two planet Earths by 2040 at current consumption levels), increasing regulations will come, whether we like it or not. These regulations will govern how business operates along many different dimensions and for some; they will be too onerous to bear.

• Engaging consumers as citizens: Increased concerns about the impact of organisations on society will see consumer rights, employee interests and governments pressurising businesses more and more to act in a responsible and sustainable manner.

• Engaging consumers as customers: Customers will demand greater transparency from companies as to what they do and where they source products from. A global media platform as well as social media networks will drive this as customers download barcode ‘apps’ to interrogate company supply chains, post their experiences on face book and tweet their opinions and experiences.

• Driving innovation: Ultimately it is business that will drive the innovation agenda. Companies will have to make their own choice as to whether they are participants or spectators in this.

• Capturing opportunities: There are numerous opportunities to be had from a focus on ‘embedded sustainability’. However, as history has shown there will always be winners and losers, but those who are prepared to embrace the opportunities that sustainability challenges bring will get the so-called ‘first mover advantage’.

The six ‘tigers’

In 2010, the GRI and Volans released a report entitled ‘The Transparent Economy’ where they identified six ‘tigers’ that stalk the global recovery and gave suggestions on how companies might tame them after surveying the GRI community (447 responses from 2,292 survey invitations). These trends (tigers) are as follows:

• Traceability;
• Integrated Reporting;
• Government Leadership;
• Environmental Boundaries;
• Rating and Ranking; and
• Shadow Economies.

Conclusion

There is some overlap between the latter and the WEF and Deloitte & Touche report, especially in relation to traceability, government leadership and environmental boundaries. Insofar as integrated reporting is concerned, GRI and Volans are adamant that the ‘critical driver behind integrated reporting will be the cultural changes as business actively seeks sustainable business opportunities’. What is important to note is that of those surveyed, a total of 89% responded that integrated reporting is very important (59%) or important (30%).

In conclusion, I believe that it is also useful to reflect on McKinsey & Company’s ‘Global forces: An introduction’, which appeared in the June 2010, McKinsey Quarterly.

McKinsey suggest ‘five forces or crucibles, where the stresses and tensions will be greatest and thus offer the richest opportunities to innovate and change’. In between ‘the great rebalancing’ (emerging economies growing at substantially faster rates than developed ones), ‘the productivity imperative’ (developed economies having to dramatically ramp up economic productivity to fund their massive deficits), ‘the global grid’ (interconnectedness of information, goods and services which is both a source of innovation and instability) and the ‘the market state’ (governments having to balance economic imperatives with burgeoning social demands on health care, pension reform) is ‘pricing the planet’. Their prognosis; ‘What we do know is that the forces driving the emergence of this new world are too powerful to be denied and that running a 21st century company is exponentially more complex than running a 20th century one, of any size’.

Embracing the opportunity that Integrated Reporting brings will enable the 21st century company to better assess the impact of these global forces on their operations and in turn provide a keypad for strategic and responsible leadership to respond appropriately.

Whether a leap of faith is required, is in some respects immaterial. The impetus for it to change the way company disclosure is done, is now fait accompli.

However, rather than focusing on the negative, companies would do well to reflect on the reality that ‘business as unusual’ is now a permanent item on the strategy agenda. When the time comes to answer all the questions that this item brings, those companies that have followed the spirit of Integrated Reporting (seeing the two words as one) will be able to demonstrate their strategic insight as to what the real purpose of business is.

This article was published in The Corporate Report Facilitating Business in South Africa, Issue 1, Volume 1, May 2011. Editors ME King (Editor-in-Chief), A Van Wyk, MD Kuper. Published by Juta  & Co. It has been reproduced here with the permission of Juta & Co.

 Subscription enquiries should be directed to the publisher: JUTA Law, PO Box 24299, Landsdowne, 7779, Republic of South Africa. Telephone: 021 659 2300 E-mail: cserv@juta.co.za

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