1.1SBL Revision Notes PDF

ACCA - SBL
Strategic Business Leader
Study Notes
CONTENTS

Sr # Topics Page #
01 Introduction to SBL & Recommended Study Approach 01
02 Case Study Tips and Techniques (and professional marks) 04

03 Leadership 07
04 Agency Relationships 12
05 The Board of Directors 19
06 Reporting to Stakeholders 41
07 Two Tier Boards, Insider Structures, CG Approaches 46

08 Stakeholders 52
09 Corporate Social Responsibility 56
10 Environmental and Social Footprints 59
11 Code of Ethics 67
12 Bribery, Ethical Decision Making and Public interest 70

13 Introduction to Strategy and Strategic Planning 74
14 Strategic Analysis 80
15 Strategic Choice 102
16 Sources of Finance 122
17 Risk Management 134

18 Internal Control 151
19 Strategy in Action 162
20 Financial Analysis 190
21 Developments in Technology Shaping Business 206
22 E-Business 214

INTRODUCTION TO SBL

Strategic Business Leader
The Syllabus

About the Exam

- An integrated case study containing a number of assignments which will vary at each examination.
- 100 mark (including 20 Professional Skills marks).
- All tasks must be completed.
- 4 hours duration
- One main business scenario (12‐18 pages of case study)
- Exhibits given(Information about an organization will be given from a range of sources) interview with
staff, survey results, reports from the board or org, press articles, website extracts, integrated report
extracts, emails, memos, spreadsheets, pictures, figures, tables, diagrams etc.
- Candidate will have to take on various roles: organizational leaders, consultants/advisers
- No specified number of tasks ( specimen 1 has three tasks with sub parts and specimen two has five
tasks with sub parts)
- Each requirement
 Role
 Audience
 Verb ( task based)
 Professional marks
pg. 1

Skills Needed to Pass SBL

- Technical knowledge‐80 marks‐study text, recordings
- Five Professional skills‐20 marks‐ Support senior management in leading organisations: professional
skills!‐ NOT a separate element‐ doorway to the technical marks!
- Exam techniques/skills

Professional Marks

- Overall professionalism
- 5 skills
1. Communication
2. Commercial acumen
3. Evaluation
4. Scepticism
5. Analysis

Ethics and Professional Skills Module

Comprising six interactive units, the module covers:
- Ethics and professionalism
- Personal effectiveness
- Innovation and scepticism
- Commercial awareness, analysis, evaluation and problem solving
- Leadership and team work
- Communication and interpersonal skills

Assumed knowledge Finance in Planning and decision making
‐ F5 knowledge is crucial ( financial analysis and decision making; cost and management accounting)
‐ No detailed techniques will be tested in SBL BUT analytical skills needed for solving issues based on
this knowledge
 Forecasting techniques
 Expected values
 Financial ratios
 Break‐even
 Cost volume profit relationships
 Investment appraisal techniques

pg. 2

Recommended study approach using these notes
- Use these notes to prepare a ‘toolkit’ of models/theories/concepts you can use in the exam
- Remember: There are NO marks for explaining these models/theories/concepts; the focus has to be
on using them by linking them to the case study
- Attempt ALL case studies on the ACCA website
- Use an approved content provider’s revision kit for more practice.

pg. 3

Case Study‐ Tips & Techniques

The recommended approach
 Read info in the sequence given ( Background, List of exhibits, tasks, exibits)
 Link tasks to exhibits when reading exhibits
 Highlight relevant and useful information
 Once scenario read, read requirements again
 Be certain about what is being asked‐Translate
 Verb
 Rule of AND
 NO professional marks if technical answer incorrect

Writing skills
 Sentences should be short and to the point ( 2‐4 sentences for each point)
 Each point in a separate paragraph
 Leave space between the paragraphs
 Include headings and sub‐headings but not excessively so
 Answer questions in Numerical order(preferred)
 Don’t define the framework
 THE FORMAT: Cant get full professional marks if formats not useds correctly.

PROFESSIONAL MARKS‐ 20

Overall professionalism in writing the answers
 Making the most important or crucial points.
 Only making relevant points and not including extra information or wrong or unsupported points.
 Not repeating points already made.
 Use short sentences
 Use headings to break down information into clearly identifiable sections

pg. 4

The five professional skills‐ How to apply these while writing the answers:

1 Communication  Required format
 With a professional tone and use of language
 Avoiding ambiguity, unnecessary explanations and repetition.
 Language concise, clear and factual
 Use 'justifying' words, such as 'because': for example, 'I recommend you
do this because…'
2 Sceptisism Establish the real picture
 compare with other info given in the question: Is it contracting other
areas? Who has prepared it; do they have a reason to manipulate the
information, is the source reliable?
 What’s missing? Have all impacts been considered?Recongise other
impacts of decisions too (rather than simply what’s given in the question)

For example, if a management accountant is offering an explanation of a
variance between actual figures and budget, are you satisfied their
explanation properly explains the variance?
3 Commercial acumen  Use the case, consider variety of aspects, exercise judgment( for
example commercial/profitability impact, competitive position impact,
stakeholders acceptability, , risks, ethics, environment, governance,
fiduciary duty etc )

 Demonstrate awareness of underpinning knowledge from earlier papers
BUT in the context of the scenario. NO dumping of technical knowledge
without referencing to the scenario!
4 Evaluation  Possible courses of action are examined from different perspectives
including points both for and against (impact on key stakeholders,
organization’s performance etc.)

 Impact on different aspects explained in the context of the question ( key
stakeholders, performance of the organization, costs, risks, benefits and
opportunities considered before making or recommending solutions or
decisions.)
5 Analysis  Review and investigate all information thoroughly; Identify relevant data
from different places within a scenario
 Give reasons for
 Cause—effect/implication
 Don't simply repeat points from the scenario; explain why they are
significant and/or what their implications are

pg. 5

In the words of the examiner….
Time management 240 minutes available
‐ 40 minutes: read the case study, plan the answer
( read ALL the pages end to end, know where to find relevant
information easily when writing)
‐ 200 minutes: individual requirements: prepare for and answer ( 100
marks so 2 minutes per mark)‐ allocate time for each part.
Effective reading ‐ No point in skimming through the paper‐ no choice in the exam
‐ Read info in the sequence given
‐ Link tasks to exhibits when reading exhibits
‐ Highlight relevant and useful information
Analyzing the requirements ‐ Be certain about what is being asked
‐ NO professional marks if technical answer incorrect
‐ Verb
‐ Rule of AND
‐ Translate
Planning ‐ Plan the whole exam before answering any part of the paper because
of the integrated nature of the case information
‐ One requirement may directly or indirectly relate to the next one
‐ Can cross reference answer instead of wasting time
‐ Decide how may points need to be made ( 1 mark for 1 point usually
in SBL‐ another mark for the same point possibly if fully developed)
‐ Use syllabus and previous knowledge when identifying points you will
later write but link it to the case
‐ Be aware of the professional marks

Writing skills ‐ ‘get into the character’ of the task
‐ Be aware of what you are being asked to do and who the answer is for
( the audience)
‐ Answer the requirement
‐ Breadth of issues ( depth of discussion by applying syllabus knowledge
to the scenario BUT not excessive)
‐ Sentences should be short and to the point ( 2‐4 sentences for each
point)
‐ Each point in a separate paragraph
‐ Leave space between the paragraphs
‐ Include headings and sub‐headings but not excessively so

pg. 6

Requirement verbs
Analyse
Actual meaning: Break into separate parts and discuss, examine, or interpret each part
Key tips: Give reasons for the current situation or what has happened..

Assess
Actual meaning: To judge the worth, importance, evaluate or estimate the nature, quality, ability, extent,
or significance Key tips: Determine the strengths/weaknesses/importance/ significance/ability to
contribute.

Compare
Actual meaning: Examine two or more things to identify similarities and differences  
Key tips: Clearly explain the resemblances or differences.

Conclusion
Actual meaning: The result or outcome of an act or process or event, final arrangement or settlement Key
tips: End your answer well, with a clear decision.

Criticise
Actual meaning: Present the weaknesses/problems; evaluate comparative worth. Don’t explain the
situation. Instead, analyse it Key tips: Criticism often involves analysis.

Evaluate
Actual meaning: Determine the scenario in the light of the arguments for and against
Key tips: Mention evidence/case/point/issue to support evaluation.

Interpret
Actual meaning: Comment on, give examples, describe relationships Key tips: Include explanation and
evaluation.

Outline
Actual meaning: Describe main ideas, characteristics, or events Key tips: Briefly explain the highlighted
points.

Recommend
Actual meaning: Advise the appropriate actions to pursue in terms the recipient will understand
Key tips: Give advice or counsel

Summarise
Actual meaning: Give a brief, condensed account. Include conclusions. Avoid unnecessary details
Key tips: Remember to conclude your explanation.
pg. 7

Leadership SBL Revision Notes
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.

pg. 7

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

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, and 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.

pg. 8

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.

Entrepreneurship 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 entrepreneurs.

The entrepreneur acts as an “inside entrepreneur” who focuses on innovation and creativity
while operating within the goals and environment of an organization. Entrepreneurs bring
their ideas to the firm to generate new products, processes, or services and thereby act as a
force for change within the organization.
Develop and Strategy: “ activities to achieve org objectives and adapt resources, operations, cope to
communicate changes in the environment in the longer term’
org’s strategy
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.
pg. 9

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.

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
pg. 10

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 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.
3. 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.
4. 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.
5. 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, and sales
conferences and so on.
6. 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.
7. 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

pg. 11

Agency Relationships SBL Revision Notes
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.
pg. 12

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.
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

pg. 13

Strategic Objective

Public companies Public sector organisations Charities/NGOs

‐ Primarily to make a financial ‐ Concerned with social purposes and ‐ Support the charitable
return for the investors delivering their services efficiently, cause for which the
(shareholders) effectively and with good value for organisation was set up. It
money. is likely to be a social or
‐ Value is added by the creation benevolent cause and
of shareholder wealth and this funds are donated
is measured in terms of profits, specifically to support that
cash flows, share price cause.
movements and
price/earnings

Agency Relationship


Principal: Shareholders/Investors Principal: Taxpayers and service Principal: Donors
users
Agent: Directors Agent: Trustees
Agent: Government officials
Fiduciary duty: Fiduciary duty: Duty to the
Fiduciary duty: Duty to the benefit of donors‐ ensure funds spent for
 Act in Principal’s economic interest; society rather than just a duty to one the benevolent purpose of the
 transparency in communication; particular party charity.
 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.)

pg. 14

Governance


Regulations: Company law, listing rules There is no single way in which public NGOs and charities may have an
sector organisations are governed. executive and non‐executive
Governance: Formal governance board, but these are subject to
arrangements (BOD, General meetings Public sector organization tend to be a higher board of trustees
etc.) highly bureaucratic. whose role it is to ensure that
the NGO or charity operates in
line with its stated purpose or
terms of reference.

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
Directors, individually and Public accountability In a charity, the operating board is usually
collectively, have a duty under The board of a public sector accountable to a board of trustees. It is the
corporate governance to organisation has a duty and trustees who act as the interpreters and
provide entrepreneurial obligation to ensure that they guarantors of the fiduciary duty of the
leadership and run the make best use of the limited charity (because the beneficiaries of the
company to the betterment of public resources. charity may be unable to speak for
the shareholders. themselves).
The board is accountable for both
The agents are granted both the financial and social outcomes The trustees ensure that the board is acting
expressed and implied of the work they undertake. according to the charity’s stated purposes
authority to deal with third and that all management policy, including
parties on behalf of their A public sector organization needs salaries and benefits, are consistent with
principal, and they are held to demonstrate they have used those purposes.
accountable under corporate the public money for the purposes
governance for their actions intended.
and outcomes
pg. 15

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

Performance Measurement
Market mechanism for Performance measurement is more complex than for a Value for money (The
performance private sector ‘for profit’ business. With a business, relatively 3 Es).
measurement (i.e the straightforward financial measures are usually good signifiers
share price). of success or failure, including, for example, return on equity
or return on sales, efficiency measures and productivity
Relatively measures. For a public sector organisation, financial
straightforward measures are only one type of many other relevant objectives
financial measures are including the availability and quality of service delivery.
usually good signifiers
of success or failure‐ for Because public sector objectives are often contested by a
example, return on range of different stakeholders in society, public sector
equity or return on outcomes are often expressed in terms of value for money or
sales, efficiency in the delivery of public services such as the provision of
measures and public housing, health services, refuse collection, provision of
productivity measures. jobs or learning opportunities.

The 3 Es framework is a way in which public sector objectives
can be considered.
pg. 16

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
pre‐determined 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)

Focus on: Focus on: Focus on:
‐ Delivering acceptable long‐ ‐ Balancing the quality and ‐ Ensuring the funds are
term economic returns to effectiveness of service delivery spent for the benevolent
investors. with cost constraints. purpose of the charity.
‐ alignment of director’s
remuneration with shareholder
priorities
‐ Enforcement of professional
and ethical behaviour to
maximise investor confidence.

pg. 17

Stakeholders


Stakeholders in a business Taxpayers have different objectives and Most stakeholders in a charity
often have an economic views but do not have a choice in paying have claims more concerned with
incentive to engage with the tax. its benevolent aims.
organisation.
Assessment of validity of stakeholder A charity’s social acceptability is
Society typically expects a claims depends on political stance of the tied up with the charity’s
business to be efficient in order existing government! achievement of benevolent aims.
to be profitable so that, in turn,
it can create jobs, wealth and Public interest
value for shareholders. Society Public interest is concerned with
expresses its support for a delivering benefit for the general public
business by participating in its at large, as opposed to solely serving the
resource or product markets, interests of a company and its
i.e. by supplying its inputs shareholders. As the society as a whole
(including working for it or has a stake in publicly funded ventures, it
buying its products) warrants protection by the government.

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.
pg. 18

The Board of Directors SBL Revision Notes
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.
pg. 19

6. 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).
7. NED contracts sometimes allow them to seek confidential external advice (perhaps legal advice) on matters on
which they are unhappy, uncomfortable or uncertain.

NEDs with experience from the same industry NEDs with experience from a different industry

- Higher technical knowledge of issues in that - A fresh pair of eyes to a given problem
industry - A lack of previous material business relationships will
- A network of contacts usually mean that a NED will not have any previous
- An awareness of what the strategic issues alliances or prejudices that will affect his or her
are within the industry independence
- Might reduce the ned’s ability to be - They will be lesser biased towards people, policies and
objective practices in that industry

pg. 20

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 ‐ Act in investors’ economic interest
‐ Transparency
‐ Avoid conflict of interest
‐ Be accountable to the shareholders
Effective board behavior ‐ 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.

pg. 21

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.)

 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.

pg. 22

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.

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.
pg. 23

‐ Overseeing the process of disclosure and communications, and being available
for dialogue with shareholders.

Composition and structure of Skills and experience :The board should consist of directors with the requisite range
the board 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.

Independence: Have a majority of independent NEDs to exercise judgments in the
best interest of the company, without any influence

Composition of board By establishing such subcommittees, a board does not delegate its obligations in
committees 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.

pg. 24

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.

pg. 25

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.
3. Advising the board on risk appetite and acceptable risk tolerances when setting
the company’s future strategic direction.
4. 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.
5. 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
1. Monitoring the integrity of the - monitors integrity of financial
financial statements and any statements (including reviewing
formal announcements significant judgments)
relating to financial - checks the clarity and completeness
performance. of the disclosures in the financial
statements.
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 If there are no internal auditors, the
effectiveness of the internal committee should review each year
audit function. whether there is a need for such a service;
if it concludes there is not, it should
explain why in the annual report.
pg. 26

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 committee has some specific duties in
the board in relation to the relation to external auditors. It
appointment, re‐appointment recommends the appointment of auditors
and removal of the external to the board and approves their fees and
auditor and approve the the other terms on which they are
remuneration and terms of retained. If there is dissatisfaction with
engagement of the auditor; 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.

5. Reviewing the auditor’s The committee must keep a close check on
independence and objectivity; 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?

6. Developing and implementing Where non‐audit services are performed,
the non‐audit services policy. disclosures are required in the annual
report, and the committee must explain
how auditor objectivity and independence
are to be preserved.

7. Whistleblowing arrangements 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.

pg. 27

Role of the chair 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
o Independent NED the board should:
o NOT a part of ‐ Set the right context in terms of board agenda,
remuneration ‐ Be responsible for the provision of information to directors, and open
committee 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;
- 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.

Lead independent director 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.

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.

pg. 28

Appointment of directors ‐ 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.

Board and director ‐ Have in place a formal process of induction for each new director so that they
development are well‐informed about the company early in their tenure and are able to
and evaluation 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 re‐nomination.

‐ Companies should disclose the process for such evaluations and the principal
lessons learned from the evaluation of the board and its committees.

pg. 29

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.

pg. 30

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.

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.
pg. 31

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 ‐ Have a process for reviewing and monitoring any related party transaction.
and conflicts
‐ 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.

‐ 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.

Remuneration ‐ Executive Management: appropriately aligned with the drivers of value‐
creation over time‐scales 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
pg. 32

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‐ Directors’ bonus schemes can be useful as a motivating
related elements 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
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
pg. 33

frame for the directors to achieve what shareholders want
them to.

Share options - 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.
Benefits in The remuneration committee should consider the benefit
kind/perks to the directors and the cost to the company of the
(transport, health complete package.
provisions,
holidays, loans)
Retirement All awards are ultimately given by the shareholders and
benefits 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
pg. 34

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,
performance‐related 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 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.

pg. 35

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.

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.

pg. 36

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 ‘one‐share, 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.

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.
pg. 37

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.

pg. 38

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.

pg. 39

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 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.

pg. 40

Reporting to Stakeholders SBL Revision Notes
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. Financial statements
2. Independent Auditor’s report
3. Chairman’s statement / Operating and financial review statement (a narrative statement about the
organiisation’s past performance and future plans)
4. Statement of compliance with corporate governance
5. 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.
6. 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, and 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.
7. 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.
8. 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
pg. 41

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 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

pg. 42

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 Designed to be an IR is designed to make visible the capitals (resources and
strategic focus approach to reporting relationships) on which the org depends, how the org uses
which accurately them and its impact upon them!
conveys an
organisation’s business Financial capital: This comprises the pool of funds available
model and its sources of to the business, which includes both debt and equity finance.
value creation over time, This description of financial capital focuses on the source of
the IR model recognises funds.
six types of capital, with
these being consumed Manufactured capital. This is the human‐created,
by a business and also production‐oriented equipment and tools used in
created as part of its production or service provision, such as buildings,
business processes. It is equipment and infrastructure. Manufactured capital draws a
the way that capitals are distinction is between inventory
consumed, transformed (as a short‐term asset) and plant and equipment (tangible
and created which is at capital).
the heart of the IR
model. 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.
pg. 43

Provide information Interrelatedness between the factors that affect the ability to create value

that "connects the dots"
across all types of risk
they face from financial
to environmental and
social
Be responsive and Quality of relationships with key stakeholders and how their legitimate needs and
inclusive to interests are taken into account
stakeholders and their
concerns
Contain concise, reliable Which should be consistent over time and comparable with other organisations
and material
information.

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.

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.

pg. 44

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

pg. 45

Two – Tier Boards SBL Revision Notes
Two‐ Tier Boards

Unitary Two‐tier
In a unitary board, all directors, In a two‐tier board, responsibilities are split between a supervisory or
including all executive and non‐ oversight board (chaired by the company chairman), and an operational
executive directors, are members. board (usually chaired by the chief executive).

All directors are of equal ‘rank’ in terms The supervisory board decides on strategic issues and the operational
of their ability to influence strategy and board becomes responsible for executing the strategy determined by the
they also all share the collective supervisory board.
responsibility in terms of legal and
regulatory liability. Responsibilities between the boards are clearly defined with the
supervisory board responsible for many legal and regulatory compliance
There is no distinction in constitution or issues (such as financial reporting). Directors on the lower tier
law between strategic oversight and (operational board) do not have the same levels of responsibility or
operational management. power as those on the supervisory board.
Why? Why?
1. Direct power over management.
1. All directors have equal legal 2. More stakeholder involvement(therefore their interests protected
status (equal accountability and 3. Clear separation between management and monitoring.
responsibility). This also ensures 4. Acts as a deterrent to management fraud.
that the directors work together 5. The supervisory board is separated from management therefore may
and leads to better decision be more independent.
making. 6. As the supervisory board is relatively a smaller board, it may be more
effective in turbulent environments where quicker decision making
2. NEDs are empowered is required ( it will be easier and cheaper to arrange meetings!)
(independent scrutiny, experience
and expertise). They protect Why not?
shareholder’s interest. 1. Lack of accountability of supervisory board.
2. Slower decision making as there are different stakeholders
3. Lesser likelihood of power abuse involved (whose interest might be in conflict with each other at
by a small number of directors. times)
This may also reduce chances of 3. Owners’ power is diluted as more stakeholders involved.
fraud as the directors are involved 4. Agency problems and conflict between the two boards (e.g.
in actual management. management board doesn’t give complete info to supervisory
board etc)
4. Greater intellectual strength 5. Management board demotivated as they are not involved in
(strategies scrutinized more) decision making
6. Supervisory board may not understand the operations in detail as
5. Investor confidence increased
they are isolated from management meetings.
through the above.
7. Responsibility is divided (as compared to unitary board where

entire board is held accountable)

1. 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.
pg. 46

2. 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

Approaches to Corporate Governance/ Regulating Corporate Governance

Rules based approach Principles based approach

In a rules‐based approach to corporate governance, A principles‐based approach works by (usually) a stock
provisions are made in law and a breach of any market making compliance with a detailed code a
applicable provision is therefore a legal offence. This condition of listing.
means that companies become legally accountable for
compliance and are liable for prosecution in law for Shareholders are then encouraged to insist on a high level
failing to comply with the detail of a corporate of compliance in the belief that higher compliance is more
governance code or other provision. robust than lower compliance. When, for whatever
reason, a company is unable to comply in detail with
It is the judiciary rather than investors which monitors every provision of a code, the listing rules state that the
and punishes transgression and this means that there is company must explain, usually in its annual report,
no theoretical distinction drawn between major or exactly where it fails to comply and the reason why it is
minor compliance failures. This is sometimes seen, unable to comply. The shareholders, and not the law,
therefore, to be clumsy or un‐nuanced as a means of then judge for themselves the seriousness of the breach.
enforcement.
If the shareholders are not satisfied with the explanation
In a rules‐based approach such as Sarbanes‐Oxley for lack of compliance, they can punish the board by
(‘Sarbox’ or ‘Sox’), the legal enforceability of the Act several means including holding them directly
requires total compliance in all details. This places a accountable at general meetings, by selling shares
substantial compliance cost upon affected companies (thereby reducing the value of the company) or by direct
and creates a large number of compliance advice intervention if a large enough shareholder.
consultancies to help companies ensure compliance.
For rules based For principles based
‐ Clarity in terms of what you must do Flexibility:. A principles‐based approach is flexible and
‐ Standardization for all companies allows companies to develop their own approach,
‐ Minimizes chances of going against the rule as non‐ perhaps with regard to the demands of their own industry
or shareholder preferences. This places the emphasis on
compliance results in penalties.
investor needs rather than legal demands. There may be
‐ If the law is good then it will give shareholders no reason, for example, why companies in lower risk
assurance that a company is being run effectively industries should be constrained by the same internal
control reporting requirements as companies in higher
Against rules based risk industries. As long as shareholders recognise and are
Rigidity of law‐companies will try to look for loopholes. satisfied with this, the cost advantages can be enjoyed.

Compliance is seen to be an inflexible ‘box ticking’ It enables the policing of compliance by those who own
exercise and this can sometimes mean that companies the entity and have a stronger vested interest in
lose perspective of what are the most important compliance than state regulators who monitor
aspects of governance and what can sometimes be a compliance in a legal sense. This places the responsibility
less important provision to comply with. for compliance upon the investors who are collectively
Disproportionate amounts of management time can be the legal owners of the company. It makes the company
used in ensuring compliance in an area which may be accountable directly to shareholders who can decide for
less important to shareholders, but which is themselves on the materiality of any given non‐
nevertheless an important ‘box’ to have ticked. compliance.

pg. 47

Costs are incurred in ensuring and demonstrating Regulations can be changed more quickly as compared to

compliance. It can be convincingly argued that a law
substantial proportion of this cost adds very little value
to shareholders, especially in small companies, and By avoiding laws, businesses may be more willing to
resources are diverted to demonstrating minor areas of contribute to the ongoing corporate governance debate
compliance which could be used more effectively
elsewhere (such as in company operations). Because By requiring explanations of non‐compliance, companies
compliance on the ‘big’ issues is accorded equal weight are required to think carefully about their reasons for not
in law to compliance with ‘small’ issues, costs are complying and this may make them decide to follow the
disproportionately incurred in demonstrating code after all.
compliance in some non‐critical areas.
It reduces the costs of compliance and recognises that
Infringements and transgressions are punished by the ‘one size’ does not fit all. There may be legitimate reasons
state through its judiciary and not by those most for temporary or semi‐permanent non‐compliance with
directly affected by such transgressions: the the detail of a corporate governance code, perhaps
shareholders. Those in favour of principles‐based because of size or the company adopting its own unique
approaches argue that there is a greater economic approach for highly specific and context‐dependent
efficiency in having governance monitored by those reasons.
with the strongest stake in gains and losses (the
shareholders), rather than the (in comparison) Against principles based
inefficient and undiscerning agents of the state. In Some companies may present weak or untrue
many cases, agents of the state are unable to explanations justifying their actions.
distinguish between major and minor infringements,
merely noticing that a ‘box’ is ‘unticked’ and pursuing Without the law to back it up, corporate governance
punishment as a result. 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.

pg. 48

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.

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.

pg. 49

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)
 ‘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.

pg. 50

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.

pg. 51

Stakeholders SBL Revision Notes
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.
pg. 52

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.

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

pg. 53

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.

Level Of Interest
Low High
Low
Minimum effort Keep informed
e.g. community reps &
charities (give them reasons
as they might be able to
Power
influence more important
stakeholders!)
High
Keep satisfied Key players
e.g. institutional e.g. major customer
shareholders (strategy should be acceptable
(they can move to key players to them)
at any time)

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’.

pg. 54

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.

pg. 55

Corporate Social Responsibility SBL Revision Notes
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.

pg. 56

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 This includes charitable donations, contributions to the local
improve the lives of others) community and providing employees with opportunities

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.

pg. 57

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.

pg. 58

Environmental Footprint SBL Revision Notes
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 outputs.

Inputs: resources and energy ( fuel, land, water, non‐sustainable resources)

Outputs: Emissions, wastage, chemical spillage, water pollution, land pollution etc.
Need of internal control a sound system of internal control needed to:
re. environment ‐ 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
Environmental Have a formal system in place to:
Management System ‐ Minimize negative environmental footprints
(EMS) ‐ Comply with laws, regulation and best practices re. environment
‐ Continuously improve the above.
Operations management 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.

pg. 59

Environmental audit 1. Agree metrics for the organization ( what should be measured and how)
2. Measure actual performance against metrics
3. Report level of compliance or variance

ISO 14000/14001 ‐ 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
Eco Management Audit A scheme which recognizes and rewards organisations that go beyond the minimum

Scheme (EMAS) 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.

Examples of footprints
‐ Consumption of exhaustible natural resources
‐ Pollution
‐ Wastage
‐ Use of land
‐ Water

pg. 60

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.

pg. 61

Social Footprint


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
pg. 62

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.

pg. 63

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.

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.

pg. 64

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).

Where does environmental reporting occur?
Environmental reporting can occur in a range of media including in annual reports, in ‘standalone’ 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 ‘standalone’ report dedicated just too 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
pg. 65

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 ‘standalone’ environmental reports, and there are a number of motivations and purposes
for it including both accountability and ‘business case’ motives

pg. 66

Code of Ethics SBL Revision Notes
Code of Ethics

Corporate code of ethics Professional ethics

Companies should develop a code of ethics and/or a code Fundamental principles
of conduct which will apply across the organisation. The
code should stipulate the ethical values of the 1. Integrity: Integrity requires accountants to be
organisation as well as include more specific guidelines straightforward and honest in all their professional
for the company in its interaction with its internal and and business relationships.
external stakeholders.
2. Objectivity: Objectivity requires that an individual
Such codes must be actively and effectively should not allow bias, conflicts of interest or the
communicated across the company, and should be undue influence of others to compromise their
integrated into the company’s strategy and operations. professional or business judgement, and infers
independence of action
There should be appropriate training programmes in
place to enable staff to understand such codes and apply 3. Professional competence & due care: All
them effectively and sufficient support and compliance accountants have a continuing duty to maintain
assessments to assist employee performance in these their professional knowledge and skill at a level
matters. required to ensure that employers receive
competent professional service, and at the same
time they must act diligently in accordance with
Purpose applicable technical and professional standards
The first is communicating the organisation’s values into when providing professional services.
a succinct and sometimes memorable form. This might
involve defining the strategic purposes of the 4. Confidentiality: Accountants must respect the
organisation and how this might affect ethical attitudes confidentiality of information acquired as a result
and policies. of professional and business relationships, and
shall not disclose any such information to third
Second, the code serves to identify the key stakeholders parties without proper and specific authority or
and the promotion of stakeholder rights and unless there is a legal or professional right or duty
responsibilities. This may involve deciding on the to disclose. Similarly, confidential information
legitimacy of the claims of certain stakeholders and how acquired as a result of professional and business
the company will behave towards them. relationships shall not be used to the personal
advantage of members or third parties.
Third, a code of ethics is a means of conveying these
values to stakeholders. It is important for internal and 5. Professional behavior: Accountants must comply
external stakeholders to understand the ethical positions with all relevant laws and regulations and shall
of a company so they know what to expect in a given avoid any action which may discredit the
situation and to know how the company will behave. This profession.
is especially important with powerful stakeholders,
perhaps including customers, suppliers and employees.

pg. 67

Fourth, a code of ethics serves to influence and control Threats/Conflict of interest
individuals’ behaviour, especially internal stakeholders 1. Self‐interest
such as management and employees. The values 2. Self‐review
conveyed by the code are intended to provide for an 3. Advocacy
agreed outcome whenever a given situation arises and to 4. Familiaruty
underpin a way of conducting organisational life in 5. Intimidation
accordance with those values.
Safeguards
Fifth, a code of ethics can be an important part of an 1. created by profession (CPD, corporate governance,
organisation’s strategic positioning. In the same way that disciplinary proceedings)
an organisation’s reputation as an employer, supplier,
etc. can be a part of strategic positioning, so can its ethical 2. Work environment(code of ethics, ICS, review
reputation in society. Its code of ethics is a prominent way procedures)
of articulating and underpinning that.
3. Individual(contact professional bodies, mentor,
Contents comply with professional standards)
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
pg. 68

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)

pg. 69

Bribery and Corruption SBL Revision Notes
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.
pg. 70

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 anti‐bribery compliance training so that they remain constantly aware of the risks.

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.
pg. 71

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.

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
pg. 72

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.
pg. 73

Introduction to Strategy SBL Revision Notes
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.

pg. 74

 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.

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 business‐level 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.
pg. 75

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 The strategic position is concerned with the impact on strategy of the external
position 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.
pg. 76

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.

Assess strategic Strategic choices involve the options for strategy in terms of both the directions in which
choices 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.
pg. 77

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.

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
pg. 78

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 position Strategic choices Strategy in action
 What are the  How should business units  Are strategies suitable, acceptable

environmental compete? and feasible?
opportunities and threats?  Which businesses to include in a  What kind of strategy‐making
 What are the portfolio? process is needed?
organisation's strengths  Where should the organisation  What are the required organisation
and weaknesses? compete internationally? structures and systems?
 What is the basic purpose  Is the organisation innovating  How should the organisation
of the organisation? appropriately? manage necessary changes?
 How does culture fit the  Should the organisation buy other  Who should do what in the strategy
strategy? companies, ally or go it alone? process?

pg. 79

Strategic Analysis SBL Revision Notes
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

pg. 80

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.
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.
pg. 81

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.

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.

pg. 82

While there are many ways to carry out scenario analyses, five basic steps are often followed:

Defining scenario scope is an important first 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 fields 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 environmental change, and at the same time set
up systems to monitor these. Effective monitoring of well‐chosen indicators should facilitate prompt and appropriate
responses.

pg. 83

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 firms 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.

pg. 84

Porter says that five forces together determine the long‐term profit potential of an industry

Threat of new How easy it is to enter the industry influences the degree of competition. The greater the
entrants 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.
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.

 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.
Power of buyers 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.

pg. 85

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
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.

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.
Competition and At the centre of five forces analysis is the rivalry between the existing players – ‘incumbents’
rivalry 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’

pg. 86

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 fierce 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.

pg. 87

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
pg. 88

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

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 classification of 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. high‐value bulk
pg. 89

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 customer’s 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.

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.

pg. 90

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.

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.
pg. 91

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

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
pg. 92

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 significant 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 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.
pg. 93

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 high‐value 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.

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.’

pg. 94

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.

pg. 95

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.
pg. 96

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.

 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. The formal systems of planning, finance, quality control, information management and the
structure of an organisation.

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.

pg. 97

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.

‐ 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.

pg. 98

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?

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.

pg. 99

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.

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 Weaknesses
Second most valuable brand in the world valued at $76 Investments in R&D are below the industry average
billion Very low or zero profit margins
Diversified income (5 different brands earning more than Poor customer services
$4 billion each) High employee turnover
Strong patents portfolio (15,000 patents) High cost structure
pg. 100

Investments in R&D reaching 4 billion a year. Weak brand portfolio
Competent in mergers & acquisitions Rigid (bureaucratic) organizational culture impeding fast
Have an access to cheap cash reserves introduction of new products
Effective corporate social responsibility (CSR) projects High debt level ($3 billion)
Localized products Brand dilution (the firm has too many brands)
Highly skilled workforce Poor presence in the world's largest markets
Economies of scale or economies of scope
Opportunities Threats
Market growth for the main firm's product Corporate tax may increase from 20% to 22% in 2013
Growing demand for renewable energy Rising pay levels
New technology, that would drive production costs by Rising raw material prices
20% is in development Intense competition
Our country accession to EU Market is expected to grow by only 1% next year
Changing customer habits indicating market saturation
Disposable income level will increase Increasing fuel prices
Government's incentives for 'specific' industry Aging population
Economy is expected to grow by 4% next year Stricter laws regulating environment pollution
Growing number of people buying online Lawsuits against the company
Interest rates falling to 1% Currency fluctuations
pg. 101

Strategic Choice SBL Revision Notes
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.

pg. 102

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.

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 (SBU)
supplies goods or services for a distinct domain of activity

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.

pg. 103


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.
pg. 104

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.

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.

pg. 105

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:

 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.

pg. 106

Product 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 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 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
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.

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.
Processes 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
Physical Services are intangible: they have no physical substance. The customer has no evidence of
evidence 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
pg. 107

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.

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.
pg. 108

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.

pg. 109

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.

pg. 110

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 uses market share and market growth criteria for determining the attractiveness and balance
of a business portfolio

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
pg. 111

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.

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.

pg. 112


(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.

pg. 113

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:

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
pg. 114

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.

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:

pg. 115

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.

In terms of the SBL syllabus,
‐ 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

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.
pg. 116

‐ 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 refers to radical change in the organisation’s business, driven principally by the
organisation’s own capabilities.

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.

pg. 117

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.
pg. 118

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 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 kick‐start to its strategy. Alliances too may accelerate strategy delivery by accessing
additional resources or skills, though usually less quickly than a simple acquisition.

pg. 119

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.

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’

pg. 120

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.)

pg. 121

Sources of Finance SBL Revision Notes
Sources of Finance

Extracted from a Technical Article

Evaluating financial performance
Whether you are evaluating recent or forecast financial performance, key areas to consider include the growth in
turnover, the growth in operating profit, and the growth in profit after or before tax and the movement in profit
margins. Return on capital employed and return on equity could be calculated. A key point for students to remember
is that they only have limited time and it is better to calculate a few key ratios and then move on and complete the
question than it is to calculate all possible ratios and fail to satisfy the requirement.

Evaluating the current financial position
The key consideration when evaluating the current financial position is to establish the financial risk of the company.
Hence, the key ratios to calculate are the financial gearing, which shows the financial risk using data from the
statement of financial position and interest cover, which shows the financial risk using data from the income
statement. Equally, the split between short and long‐term financing, and the reliance of the company on overdraft
finance, should also be considered.

When evaluating financial performance and financial position, due consideration should be given to any comparative
sector data provided. Indeed, if no such data is provided, I would recommend that you state in your answer that you
would want to consider such comparative data. This is what you would do in real life and stating it shows that you
are aware of this. If the examiner has not provided such data, it is simply because he is constrained by the need to
examine many topics in just three hours.

Recommendation of a suitable financing method
When recommending a financing method, consideration should be given to a number of factors. These factors are
key to justifying your choice of method and the examiner has in the past asked students to discuss these factors in
an exam question. The factors include:

Cost – Debt finance is cheaper than equity finance and so if the company has the capacity to take on more debt, it
could have a cost advantage.

Cash flows – While debt finance is cheaper than equity finance, it places on the company the obligation to pay out
cash in the form of interest. Failure to pay this interest can result in action being taken to wind up the company.
Hence, consideration should be given to the ability of the company to generate cash. If the company is currently
cash‐generating, then it should be able to pay its interest and debt finance could be a good choice. If the company
is currently using cash because it is investing heavily in research and development for example, then the cash may
not be available to service interest payments and the company would be better to use equity finance. The equity
providers may be willing to accept little or no cash return in the short term, but will instead hope to benefit from
capital growth or enhanced dividends once the investment currently taking place bears fruit. Also, equity providers
cannot take action to wind up a company if it fails to pay the dividend expected.

Risk – The directors of the company must control the total risk of the company and keep it at a level where the
shareholders and other key stakeholders are content. Total risk is made up of the financial risk and the business risk.
Hence, if it is clear that the business risk is going to rise – for example, because the company is diversifying into
pg. 122

riskier areas or because the operating gearing is increasing – then the company may seek to reduce its financial risk.
The reverse is also true – if business risk is expected to fall, then the company may be happy to accept more financial
risk.

Security and covenants – If debt is to be raised, security may be required. From the data given it should be possible
to establish whether suitable security may be available. Covenants, such as those that impose an obligation on the
company to maintain a certain liquidity level, may be required by debt providers and directors must consider if they
will be willing to live with such covenants prior to taking on the debt.

Availability – The likely availability of finance must also be considered when recommending a suitable finance
source. For instance, a small or medium‐sized unlisted company will always find raising equity difficult and, if you
consider that the company requires more equity, you must be able to suggest potential sources, such as venture
capitalists or business angels, and be aware of the drawbacks of such sources. Furthermore, if the recent or forecast
financial performance is poor, all providers are likely to be wary of investing.

Maturity – The basic rule is that the term of the finance should match the term of the need (the matching principle).
Hence, a short‐term project should be financed with short‐term finance. However, this basic rule can be flexed. For
instance, if the project is short term – but other short‐term opportunities are expected to arise in the future – the
use of longer‐term finance could be justified.

Students should always consider the maturity dates of debt finance in questions of this nature.

For instance, in a past question the company was considering raising more finance but at the same time the existing
long‐term borrowings were scheduled to mature in just two years and, hence, consideration needed to be given to
this issue. Equally, as an example, say a company had been considering raising finance for a period of perhaps eight
years and an examination of the company’s statement of financial position shows that the existing debt of the
company would also mature in eight years. Obviously it is unwise for a company to have all its debt maturing at once
as repayment would put a considerable cash strain on the company. If the debt could not be repaid, but was to be
refinanced, this could be problematic if the economic conditions prevailing made refinancing difficult.

Control – If debt is raised then there will be no change in control. However, if equity is raised control may change.
Students should also recognise that a rights issue will only cause a change in control if shareholders sell their rights
to other investors.

Costs and ease of issue – Debt finance is generally both cheaper and easier to raise than equity and, hence, a
company will often raise debt rather than equity. Raising equity is often difficult, time‐consuming and costly.

The yield curve – Consideration should be given to the term structure of interest rates. For instance, if the curve is
becoming steeper this shows an expectation that interest rates will rise in the future. In these circumstances, a
company may become more wary of borrowing additional debt or may prefer to raise fixed rate debt, or may look
to hedge the interest rate risk in some way.

While this list is not meant to be exhaustive, it hopefully provides much for students to think about. Students should
not necessarily expect to use all the factors in an answer.

pg. 123

Suitable financing sources
Students must ensure that they can suggest suitable financing sources. For each source, students should know how
and when it could be raised, the nature of the finance and its potential advantages and disadvantages. Combined
with a consideration of the factors given above, this knowledge will allow students to recommend and justify a
source of finance for any particular scenario.

The article will first consider a business’s formation and initial growth, then a company that is well‐established and
mature, and will look at the financing choices and decisions that could face it at various stages.

Formation and initial growth
Many businesses begin with finance contributed by their owners and owners’ families. If they start as
unincorporated businesses, the distinction between owners’ capital and owners’ loans is almost irrelevant. If it starts
as an incorporated business, or turns into one then there are important differences between share capital and loans.
Share capital is more or less permanent and can give suppliers and lenders some confidence that the owners are
being serious and are willing to risk significant resources. If the owners’ friends and families do not themselves want
to invest (perhaps they have no money to invest) then the owners will have to look for outside sources of capital

The main sources are:
‐ Bank loans and overdrafts
‐ Leasing/hire purchase
‐ Trade credit
‐ Government grants, loans and guarantees
‐ Venture capitalists and business angels
‐ Invoice discounting and factoring
‐ Retained profits.

Bank loans and overdrafts: In the current economic climate, start‐up businesses are likely to find it difficult to raise
a bank loan, particularly if the business and its owners have no track record at all. Banks will certainly require:
‐ A business plan, including cash flow forecasts.
‐ Personal guarantees and charges on personal assets.

The personal guarantees and charges on personal assets get round the company’s limited liability which would
otherwise mean that if the company failed, the bank might be left with nothing. This way the bank can ask the
guarantors to pay back the loans personally, or the bank can seize the charged assets that were used for security.

Note that overdrafts are repayable on demand and many banks have a reputation of pre‐emptively withdrawing
overdraft facilities, not when a business is in trouble, but when the bank fears more difficult times ahead.

On a more positive note, where it is known that the need for finance is temporary, an overdraft might be very
suitable because it can be repaid by the borrower at any time.

Leasing and hire purchase: In financial terms, leasing is very like a bank loan. Instead of receiving cash from the loan,
spending it on buying an asset and then repaying the loan, the leasing company buys the asset, makes it available to
the lessee and charges the lessee a monthly amount. Leasing can often be cheaper than borrowing because:
‐ Large leasing companies have great bargaining power with suppliers so the asset costs them less than it would
cost the lessee. This can be partially passed on to the leasee.
pg. 124

‐ Leasing companies have effective ways of disposing of old assets, but lessees normally do not.

If the lease payments are not made, the leasing company has a form of built‐ in security insofar as it can reclaim its
asset.

The cost of finance to a large, established leasing company is likely to be lower than the cost to a start‐up company.
It is important for businesses to try to decide whether loan finance or a lease would be cheaper.

Trade credit: This simply means taking credit from suppliers – typically 30 days. That is obviously a very short period,
but it can be very helpful to new businesses. Typically, credit suppliers to new businesses will want some sort of
reference, either from a bank or from other suppliers (trade references). However, some will be prepared to offer
modest credit initially without references, and as trust grows this can be increased.

Government grants, loans and guarantees: Governments often encourage the formation of new businesses and,
from time to time and from region to region, help is offered. Government grants are usually very small, and direct
loans are rare because governments see loan provision as the job of financial institutions.

Currently in the UK, the Government runs the Enterprise Finance Guarantee Scheme (EFGS). This is a loan guarantee
scheme intended to facilitate additional bank lending to viable small and medium‐sized entities (SMEs) with
insufficient security for a normal commercial loan. The borrower must be able to demonstrate to the lender that
they should be able to repay the loan in full. The Government provides the lender with a guarantee for which the
borrower pays a premium.

The scheme is not a mechanism through which businesses or their owners can choose to withhold the security a
lender would normally lend against; nor is it intended to facilitate lending to businesses which are not viable and
that banks have declined to lend to on that basis.

EFGS supports lending to viable businesses with an annual turnover of up to £25m seeking loans of between £1,000
and £1m.

Venture capitalists and business angels: These are either companies (usually known as venture capitalists) or
wealthy individuals (business angels) who are prepared to invest in new or young businesses. They provide equity
(private equity as opposed to public equity in listed companies), not loans.

The equity is not normally secured on any assets and the private equity firm faces the risk of losses just like the other
shareholders. Because of the high risk associated with start‐up equity, private equity suppliers typically look for
returns on their investment in the order of 30% pa. The overall return takes into account capital redemptions (for
example preference shares being redeemed at a premium), possible capital gains on exiting their investment (for
example through sale of shares to a private buyer or after listing the company on a stock exchange), and income
through fees and dividends.

Typically, venture capitalists will require 25%–49% of the equity and a seat on the board so that their investment
can be monitored and advice given. However, the investors do not seek to take over management of their
investment.

pg. 125

Invoice discounting and factoring: Before these methods can be used turnover usually has to be in the region of at
least $200,000. Amounts due from customers, as evidenced by invoices, are advanced to the company. Typically
80% of an invoice will be paid within 24 hours. In addition to this service, factors also look after the administration
of the company’s receivables ledger.

Fees are charged on advancing the cash (roughly at overdraft interest rates), and also factors will charge about 1%
of turnover for running the receivables ledger (the exact amount depends on how many invoices and customers
there are). Credit insurance can be taken out for an additional fee. Unless that is taken out the invoicing company
remains liable for any bad debts.

Retained profits: Retained profits are no good for start‐ups, and often no good for the first few years of a business’s
life when only losses or very modest profits are made. However, assuming the business is successful, profits should
be made and retaining those in the business can allow the company to repay debt capital and to invest in expansion.

How much capital is needed?
Capital is needed:
‐ for investment in non‐current assets
‐ to sustain the company through initial loss‐making periods
‐ for investment in current assets.

Cash‐flow forecasts are an essential tool in planning capital needs. Typically, suppliers of capital will want forecasts
for three to five years. One of the biggest dangers facing new successful businesses is overtrading, where they try to
do too much with too little capital. Most businesses know that capital will be needed to finance non‐current assets,
but many overlook that finance is also needed for current assets.

Look at this example:

pg. 126

This company starts with a healthy liquidity position (Stage 1). Business then doubles, without investing in more non‐
current assets and without raising more equity capital. It is a reasonable assumption that if turnover doubles then
so will inventory, receivables and payables (Stage 2). But here this forces the company to rely on an overdraft
(probably unexpected and unplanned) to finance its net current assets. Relying permanently on overdraft finance is
precarious and the company would be advised to seek some more permanent form of capital.

When capital is raised, the company has to decide what to do with it, and there are two main uses:
‐ Invest in non‐current assets
‐ Invest in current assets, including leaving it as cash.

The more capital invested in non‐current assets, the greater should be the profit‐ earning potential of the business.
However, leaving too little cash in current assets increases the risk that the company will have liquidity problems.
On the other hand, leaving too much capital in current assets is wasteful: cash will earn modest interest (but
investors want higher returns from a company), and cash tied up in inventory often causes costs (storage, damage,
obsolescence). So, the company has to decide on its working capital policy. An aggressive policy is one which
maintains relatively low working capital compared to another company; a conservative policy is one which maintains
relatively high working capital. Which policy is appropriate partly depends on the nature of the business. If the
business is one where trading cash flows are very predictable then it should be able to survive with an aggressive
policy. If, however, cash flows are erratic and unpredictable the company would be wise to build a margin of safety
into its cash management.

Additionally, if the company foresees a period of losses, it will need to keep cash available (probably earning interest
in a deposit account) to see it through its lean years.

Note that companies do not have to have actually raised capital to have it available for emergency use. What they
need is a pre‐ agreed right to borrow a certain amount on demand. That is known as a line of credit. Many of us
make use of lines of credit in our personal lives, but there we call them credit cards. So we don’t have to have $1,000
sitting in the bank in case our car needs a major repair, but it’s comforting to know that if repairs are necessary, we
can pay for them immediately. Of course, the credit card debt will have to be repaid at some time, but repayments
can be spread.

Long, medium and short‐term capital
Capital can be short, medium or long‐term. Definitions vary somewhat, but the following are often seen:
‐ Short term – up to two years. For example, overdrafts, trade credit, factoring and invoice discounting
‐ Medium term – two to five or six years. For example, term loans, lease finance.
‐ Long term – over five years, or so, to permanent.

In general, it makes sense to match the length of the finance to the life of the asset (the matching principle) and,
again, we often apply this in our own lives, where we would use a 25‐year mortgage to buy an apartment, a 3–5‐
year loan to buy a car, and a credit card to pay for a holiday.

pg. 127


Note that long‐term capital (equity and bonds) can be used to fund all classes of asset. Although each piece of
inventory and each receivable are very short‐life assets, in total there will normally be fairly stable amounts of each
that have to be permanently funded. Therefore, it makes sense to fund most of those assets by long‐term capital
and to use short‐term capital to fund seasonal peaks. One of the problems with short‐term finance is that is comes
to an end quickly and if finance is still needed then more has to be renegotiated. Long‐term capital is either
permanent or comes up for renewal relatively rarely.

Mature companies
Once a company has existed profitably for some time and grown in size, additional sources of finance can become
available, in particular:
‐ Public equity
‐ Public debt
‐ Bonds.

Public equity: Some stock exchanges provide different sorts of listings. For example:
London Stock Exchange: The Main Market and the Alternative Investment Market (AIM). AIM focuses on helping
smaller and growing companies raise the capital they need for expansion.

NASDAQ: This is an electronic stock exchange in the US and has the NASDAQ National Market for large, established
companies (market value at least $70m) and the NASDAQ Capital market for smaller companies.
pg. 128


An initial public offering is the first occasion on which shares are offered to the public. A company seeking a listing
has to issue a prospectus, which is a legal document describing the shares being offered for sale, and including
matters such as a description of the company's business, recent financial statements, details of the directors and
their remuneration.

Shares can be listed via:
‐ An offer for sale at fixed price: a company offers shares for sale at a fixed price directly to the public, for example
in newspaper advertisements. In fact, the shares are usually first sold to an issuing house which sells them on
to the public.
‐ An offer for sale by tender: investors are asked to bid, and all who bid more than the minimum price that all
shares can be sold at will be sold shares at that minimum price.
‐ A placing: shares are offered to a selection of institutional investors. Because less publicity is needed, these are
cheaper than offers for sale and are therefore suited to smaller IPOs.
‐ An introduction: this is rare and only happens when shares are already widely held publically. No money is
raised.

Subsequent issues of equity will be rights issues where existing shareholders are offered new shares in proportion
to existing holdings. The shares are offered at below their current market value to make the offer look attractive,
but in theory, no matter at what price right issues are made and no matter whether shareholders take up or dispose
of their rights, shareholders will end up neither better nor worse off. Wealth is neither created nor destroyed just
by moving money from a shareholder’s bank account to the company’s.

Gaining a listing opens up a huge source of potential new capital. However, with listing come increased scrutiny,
comment and responsibility. Although this will help the standing and respectability of the company the founders of
the company, having been used to running their own company in their own way, often resent outside interference
– even though that is to be expected now that ownership of their shares is more widespread.

pg. 129

Public debt: This refers to quoted bonds or loan notes: instruments paying a coupon rate of interest and whose
market value can fluctuate. Usually the bonds will be secured either by fixed or floating charges and can be
redeemable or irredeemable. Well‐ secured bonds in companies that are not too highly geared are low risk
investments and bonds holders will therefore require relatively low returns. The cost of the bonds to the borrower
falls even more after tax relief on interest is taken into account.

Convertible bonds: Convertibles start life as loan capital and can later be converted, at the lenders’ option, into
shares. They are a clever and useful device, particularly for younger companies, because:
‐ In the very early days of the company’s life, investors might not want to risk investing in equity, but might be
prepared to invest in the less risky debentures. However, debentures never hold out the promise of massive
capital gains
‐ If the company does not do so well, the investors can stick with their safe convertible loan stock.
‐ If the company does well, the investors can opt to convert and to take part in the capital growth of the shares.

Convertible bonds therefore offer a ‘wait and see’ approach. Because they allow later entry to what might turn out
to be a growth stock, the initial interest rate they have to offer is lower than with pure bonds – and that’s good for
the company that is borrowing.

Gearing: When deciding what sorts of finance to issue, companies must always bear in mind the average cost of
their finance. This article does not go into gearing considerations in any detail except to point out that some
borrowing can lower the cost of capital.

If there is no borrowing, all finance will be equity and that is high cost to compensate for the high risk attaching to
it. Debt finance is cheap because it has lower risk and enjoys tax relief on interest.

Therefore, introducing some debt into the finance mix begins to pull down the average cost of capital. However, at
very high levels of gearing the increased risk of default pushes up both the cost of debt and the cost of equity, and
the average cost of finance starts to rise. Somewhere, there is an optimum gearing ratio with the cheapest mix of
finance.

The previous paragraph briefly described the traditional theory of gearing. Modigliani and Miller suggested an
alternative view, but the very precise conditions and restrictions their theories require are not often found in
practice.

Initial coin offering as a source of finance
The age‐old system of fundraising includes the selling of stake to a Venture Capitalist in exchange for money. The VC
invests in the company believing that the new investments will fetch higher wealth in the future than the cash they
are investing right now.

However, in recent times, a new craze has overtaken the age old system, wherein, the company can raise funds in a
faster, transparent, and beyond demographics in a democratic way by exchanging virtual currency for the real ones.

The digital currency monster has just woken up, and there are examples where the companies have raised over a
million dollars in few seconds compare to the long process of the age‐old system.

pg. 130

This phenomenon is known as the Initial Coin Offerings. Let’s understand it in a simple way:

What are ICOs?
An initial coin offering (ICO) is when a company raises funds for a new project by selling crypto currency coins or
tokens to their investors. Companies run ICOs because it allows them to increase their capital, connect with their
community and accelerate their growth.

ICO tokens are usually tokens built on another blockchain, such as Ethereum’s. These are the tokens that are sold
for Bitcoin, Ethereum, and fiat to fund new blockchain or crypto‐based projects.

Perhaps, the most famous ICO so far is that of Ethereum, which raised US$18 million in 2014 by selling tokens that
facilitate online contracts. Today, Ethereum‐powered contracts are booming, and the tokens have a market cap of
approximately US$60 billion as of mid‐April 2018.

ICOs typically vary in nature. But organizations usually sell coins/tokens to obtain capital for software development,
business operations, business development, community management, or other initiatives.

The buyer can redeem the token for a unit of currency or goods, the right to receive a share of future earnings, the
right to vote on decisions made by the organization, and more. Anyone with access to the internet can launch or
invest in an ICO.

Proponents believe that ICOs are a transformative approach to fundraising that enables consumers to benefit more
directly from the popularity of new technologies than they would if they owned a traditional stock. On the other
hand, critics fret that ICOs occupy a regulatory grey area that could leave investors vulnerable to fraud and land
startups in legal trouble.

The major difference between IPO and ICO is that the ICO neither offers rights of ownership to the investors nor
entitles the owner to cash flows like dividends. The investors in the crypto currency range from a college kid to
venture capitalist and from a homemaker to business tycoons.

Therefore, ICO is crowd funding tool for startups which accepts the digital currency as against the real currency.
These funding events are also known as the token sales. During the token sale period, the investors receive token in
exchange for the digital currency. These tokens offer a promise of future profits to the investors.

HOW DOES IT WORK?
Almost all the token sale follows similar steps:
‐ A development team proposes a viable blockchain project.
‐ The team offers a white paper outlining the technical specs, revenue streams, business model, and future
opportunities.
‐ Sometime, the team may also provide a working prototype to understand the project, however, it is not a
necessary condition.
‐ The team starts marketing their Initial Coin Oering through social media, blogs, reviews, and other online
marketing avenues.
‐ The team provides the fine prints of the token sale which includes information regarding the number of available
tokens for distribution, price & utility of tokens, and max target amount.
‐ The token sale is launched and coins are distributed to the bidders.
‐ After successfully completing the token sales, the tokens trading is made available on the exchanges.
pg. 131

TAKING PART IN THE ICO
There are basically two ways to take part in the startups. Just like an IPO, you can buy the ICO tokens during the
crowd sale on the Ethereum platform or you can also buy it through exchanges once they get listed.

To buy tokens during the crowd sale on the Ethereum platform, you need to have an Ethereum wallet and a balance
of ether tokens. The Initial Coin Oerings are linked to a specic Ethereum address and one needs to send their Ether
to receive the ICO tokens. You can send your Ether as soon as the crowd sale beings and you will receive the tokens
after the end of ICO.

The successful ICO tokens make it to the Crypto currency exchanges and become available for trading. If you have
missed the ICO during the crowd sale, then you can participate by purchasing the tokens at the market price from
such exchanges.

How are ICOs different from traditional IPOs?
IPO ICO
Ownership of issuing company Investor obtains ownership based Investor usually does not obtain
on the number of shares acquired ownership, only rights to a
particular project
Decision making Centralized, with the CEO and the Decentralized, giving the investor a
board involved in the business’ day‐ material decision‐making position
to‐day operations
Financial data Released in accordance with the By way of the blockchain or as
rules of the exchange on which the outlined within the agreement with
IPO took place the investors
Taxes Issuing company must pay taxes, Issuing company may not be subject
with investors having to pay capital to direct tax, only the investor being
gains tax required to pay capital gains tax
Rounds of fundraising One‐time sale, with multiple Multiple rounds of fundraising, with
intermediaries few intermediaries (if any)
Regulation Heavily regulated by the exchange Regulation is comparatively laxed
on which the IPO took place

Benefits of ICOs
‐ ICOs facilitate the exchange of value without the need for a trusted central authority or intermediary
(government, bank) which allows for efficiency gains.

‐ It could be argued that the disintermediation that occurs in ICOs could “democratise” SME financing, distributing
control among SMEs and participants/token‐holders instead of concentrating decision power in the hands of
financiers, as is the case with banks in traditional debt financing.

‐ At the same time, SMEs diversify their financing options, allowing them to appeal on not just their profit
potential but other characteristics of their project, which in turn could encourage banks to look into seeking
alternative ways to determine their SME financing methods, too.

‐ In addition to cost savings, financing through ICOs offers SMEs and entrepreneurs direct access to an unlimited
investor pool. At their current form, ICOs are directly communicated and addressed to the public on a global
pg. 132

scale and without any restriction or limitation on the type of investor, including retail investors. Access to
unlimited funding pools has enormous potential for SMEs gaining funding, but carries very significant risks for
investors when financial consumer protection safeguards are not applicable, as is the case for most ICOs.

‐ A company issuing tokens effectively enrols future users of its product (before the actual product/service is even
operational) and creates an inclusive network of investors whose active participation in the network has an
impact on the company's viability. Depending on the structure of the ICO, token‐holders may become active in
the governance of the company and be asked to decide on strategic issues around the advancement of the
project.

‐ From a business strategy perspective, ICOs can allow the entrepreneur to generate buyer competition which
reveals consumer value without the need to know ex ante the willingness of consumers to pay for the
product/service (Catalini and Gans, 2018).

‐ ICOs are faster to implement when compared to other public offerings, at least in the current state of the
cryptocurrency market. The examples of Bancor (USD 150 million raised in 3 hours) or BAT (USD 34 million raised
in less than a minute) are prominent examples of the speed of execution for the raising of financing, and the
pre‐ICO phase is similarly shorter compared to other financing instruments. This, however, cannot be exclusively
attributed to the benefits of the technology employed, as it is also due to limited disclosure requirements and
due diligence performed in many of the current ICOs. Such practices, however, have a detrimental effect on the
credibility and viability of the project and on investor protection.

‐ ICOs have the potential to overcome some of the impediments to the financing of early stage SMEs in an
innovative way. The unwillingness of entrepreneurs to give away equity ownership or control in their company
restrains the use of public equity funding by SMEs (Nassr and Wehinger, 2016). Depending on how token
offerings are structured, companies can raise risk capital without necessarily conferring ownership rights. In
other words, the entrepreneur can publicly raise finance without risking dilution.

pg. 133

Risk Management SBL Revision Notes
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.

pg. 134

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!

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.
pg. 135

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.

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.
pg. 136

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

Identify risks How to identify risk?
1. The use of models such as:
– SWOT analysis (strengths, weaknesses, opportunities and threats);
– PESTLE analysis (political, economic, social, technological, legal and environmental).
2. Brainstorming sessions from the board of directors and senior management.
3. The use of risk questionnaires for staff throughout the organisation who are closer to
operations than the directors.
4. 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

pg. 137

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‐to‐day operations such as buying, supplier logistics, and manufacture, delivery
of products and services, marketing and selling and after‐sales service.

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.

pg. 138

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.

pg. 139

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.

pg. 140

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.

pg. 141

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.

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.

pg. 142

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.

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.

pg. 143

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.

pg. 144


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.

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.

pg. 145

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 Persons who suffer from high level of diabetes run
risks move in the same direction the risk of the degeneration of eyes and the risk of
either upward or downward). For kidney failure. However if the level of diabetes is
example environmental risk and reduced, risk of eye diseases or risk of kidney failure
reputation risk move in the same is reduced.
direction.
Therefore risk of eye diseases or risk of kidney failure
are positively correlated.
Negatively correlated (i.e. both An entity which borrows money to install anti
risks move in the opposite pollution equipment will reduce its environmental
direction one upward and the risk. However if the amount of borrowing is high its
other downward). 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.

Reporting risks 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
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
pg. 146

4. 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.
Monitor risks ( The risk committee monitors risks.
BOD’s It has the right to appoint independent external parties to identify and assess the various
responsibility) 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.
pg. 147

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

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.
pg. 148

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.

7. 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.

8. 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
pg. 149

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.

pg. 150

Internal Control and Review SBL Revision Notes
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 The Turnbull Report (1999)‐provided guidance on
American voluntary organisation with the aim of creating strong internal control systems. This has now
guiding executive management towards the been incorporated into the Combined Code.
establishment of more effective, efficient and ethical
business operations. It provided detailed advice on The Turnbull guidance is still available as a stand alone
application of controls 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.

pg. 151

 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.

 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

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

pg. 152

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.

Detailed explanation
Control environment 1. The organization demonstrates a commitment to integrity
and ethical values.
Points of focus:
• Sets the tone at the top 2. The board of directors demonstrates independence from
• Establishes standards of conduct management and exercises oversight of the development
• Evaluates adherence to standards of and performance of internal control.
conduct
• Addresses deviations in a timely manner 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.

Risk assessment 6. The organization specifies objectives with sufficient clarity
A precondition to risk assessment is the to enable the identification and assessment of risks relating
establishment of objectives, linked at different to objectives.
levels of the entity. Management specifies
objectives within categories relating to 7. The organization identifies risks to the achievement of its
operations, reporting, and compliance with objectives across the entity and analyzes risks as a basis for
sufficient clarity to be able to identify and determining how the risks should be managed.
analyze risks to those objectives. Management
also considers the suitability of the objectives 8. The organization considers the potential for fraud in
for the entity. Risk assessment also requires assessing risks to the achievement of objectives.
pg. 153

management to consider the impact of 9. The organization identifies and assesses changes that could

possible changes in the external environment significantly impact the system of internal control.
and within its own business model that may
render internal control ineffective.
Control activities 10. The organization selects and develops control activities that
Control activities are the actions established contribute to the mitigation of risks to the achievement of
through policies and procedures that help objectives to acceptable levels.
ensure that management’s directives to
mitigate risks to the achievement of objectives 11. The organization selects and develops general control
are carried out. Control activities are activities over technology to support the achievement of
performed at all levels of the entity, at various objectives.
stages within business processes, and over the
technology environment. 12. The organization deploys control activities through policies
that establish what is expected and procedures that put
policies into action
Information & communication 13. The organization obtains or generates and uses relevant,
Information is necessary for the entity to carry quality information to support the functioning of internal
out internal control responsibilities to support control.
the achievement of its objectives.
Management obtains or generates and uses 14. The organization internally communicates information,
relevant and quality information from both including objectives and responsibilities for internal control,
internal and external sources to support the necessary to support the functioning of internal control.
functioning of other components of internal
control. Communication is the continual, 15. The organization communicates with external parties
iterative process of providing, sharing, and regarding matters affecting the functioning of internal
obtaining necessary information. Internal control.
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
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 16. The organization selects, develops, and performs ongoing
Ongoing evaluations, separate evaluations, or and/or separate evaluations to ascertain whether the
some combination of the two are used to components of internal control are present and
ascertain whether each of the five functioning.
components of internal control, including
controls to effect the principles within each
component, is present and functioning.
pg. 154

Ongoing evaluations, built into business 17. The organization evaluates and communicates internal
processes at different levels of the entity, control deficiencies in a timely manner to those parties
provide timely information. Separate responsible for taking corrective action, including senior
evaluations, conducted periodically, will vary management and the board of directors, as appropriate.
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

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

pg. 155

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. Investigate Fraud: investigate possible fraudulent behavior throughout the organization
pg. 156

8. Other Assignments as deemed necessary by the Audit Committee

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.
pg. 157

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.

pg. 158

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.

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.
pg. 159

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.

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.

pg. 160

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 Description Info needs
Strategic ‐ Senior management ‐ from internal and external sources
‐ Fewest members ‐ less frequent
‐ strategic management of the ‐ less precise
organisation including setting
its mission and long term Examples of information
objectives and making Include: the need for and availability of finance, details about
fundamental decisions competitors, analysis of the profitability of the business and
information on external threats and opportunities facing the
organisation.

Tactical ‐ middle management ‐ Internal sources mainly
‐ develops the strategies ‐ More frequent
outlined by strategic ‐ Slightly more detailed and precise
management and find ways to
realize them. Examples of information required at a tactical level include:
working capital requirements, cash flow and profit forecasts
and information about business productivity.

Operational/ ‐ supervisors and junior Operational information is used to make sure that specific
Functional management operational tasks are carried out as planned. Examples
‐ largest group include: results of quality control checks and information
‐ management day to day about labour hours used to perform a certain task, process
operations and implement or job.
tactical plans

pg. 161

Strategy in Action SBL Revision Notes
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 Also commonly called a bureaucratic organizational structure, the functional structure
organized according to divides the company based on specialty. This is your traditional business with a sales
the type of work they do) 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
Appropriate for: departmentalizes an organization based on common job functions.
Company growing,
simple structure not So an organization with a functional structure would group all of the marketers
appropriate, need for together in one department, group all of the salespeople together in a separate
specialist skills in a department, and group all of the customer service people together in a third
number of areas department.

The functional structure allows for a high degree of specialization for employees, and
is easily scalable should the organization grow.

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 ( can be based Divisional structure typically is used in larger companies that operate in a wide
on geography, product geographic area or that have separate smaller organizations within the umbrella group
or market) to cover different types of products or market areas.

pg. 162

Appropriate for: The divisional structure refers to companies that structure leadership according to
Larger companies with a different products or projects. Gap Inc. is a perfect example of this. While Gap is the
diverse range of company, there are three different retailers underneath the heading: Gap, Old Navy,
strategies. and Banana Republic. Each operates as an individual company, but they are all
ultimately underneath the Gap Inc. brand.

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.

Holding company structure: These divisions are separate legal entities.
Matrix 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
Appropriate for: lines. Not only do they report to a divisional manager, but they also typically have
Organizations which project managers for specific projects.
have lots of project
work. 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.

Transnational structure 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.

pg. 163

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.

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
transaction‐processing 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.
pg. 164

Deloitte defines Global Business Services as:
Instead of operating numerous Shared Service Centers and managing outsourcing vendors independently, Global
Business Services provide integration of governance, locations and business practices to ALL shared services and
outsourcing activities across the enterprise.

Global Business Services covers multiple aspects of sourcing: Internal shared services, supporting multiple
functions/service lines, across multiple business units/regions/countries/jurisdictions, optimizing use of locations
(onshore/nearshore/offshore), with the best mix and use of third party outsourcing relationships.

The key point is that GBS works towards true end‐to‐end processing and service provision, supported by effective
and best practice technology, all operating under one global delivery framework.

GBS groups focus on managing many of the general and administrative tasks that happen on the back end of a
transaction, leaving the business units more time to focus on customer‐ or product‐specific activities. Traditional
shared‐services organizations focus on supporting tasks associated with a single function only. By contrast, GBS
groups comprise specialists from multiple functional areas—IT, finance, human resources, and the like. They handle
a range of end‐to‐end tasks, such as procurement‐to‐payment. GBS groups’ main instruction is to provide the
business with a comprehensive set of services at a low cost and at agreed‐upon levels of quality.

However, for a number of reasons, many companies are reexamining—and, in some cases, backing away from—
their commitment to GBS. Some argue that the model has introduced greater organizational complexity but not
necessarily better performance. Specifically, we’ve heard the following from executives:
 The value that GBS groups create for organizations has not been clearly established, so some companies are left
wondering whether their investments in new technologies and processes will really pay off.
 Governance of GBS groups remains cumbersome, and team outcomes are not well tracked. As a result, in some
companies, GBS teams are perceived as unresponsive, neither addressing the current needs of the business nor
introducing innovations.
 GBS teams are not attracting the right talent; it can be difficult to find staffers who have both the required
functional expertise and a strong focus on customer service.
 Digital technologies such as process automation, robotics, and machine learning allow companies to address
their business units’ service requirements quickly and efficiently without having to go through the arduous work
of implementing a GBS structure.
 Companies are under increasing pressure to be more agile, and senior leaders are questioning whether GBS
groups can be responsive enough.

pg. 165

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 that
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

pg. 166

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

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.

pg. 167

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.
pg. 168

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.

pg. 169

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

pg. 170

Contextual features of change
There is no one right for the management of change. The success of managing change will also be dependent on
the wider context in which that change is taking place. Balogun and Hailey therefore build a number
of important contextual features that need to be taken into account in designing change programmes.

pg. 171

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.

pg. 172

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. Unfreezing 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 f
avour of the change.
 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 sta
ge will often involve
 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 organ
ization wants to be 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

pg. 173

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.

pg. 174

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.

pg. 175

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 an
d functional groups 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.

pg. 176

Process improvement – this is a tactical level, incremental technique that is appropriate for developing smaller,
stable, existing processes.

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  Make products better, easier to manufacture and maintain
improved process  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  Integrate and test
new process  Train employees, arrange management
 Maintain process and modify as needed

pg. 177

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

pg. 178

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.

pg. 179

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
pg. 180

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.

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 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?
pg. 181

‐ 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.

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.

pg. 182

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. Tolerate the risk, either because the event is unlikely to happen and/or the consequences will be immaterial.
2. 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.
3. 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.
4. 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.

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.

pg. 183

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

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
pg. 184

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.

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.
pg. 185


 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.

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.

pg. 186

This happens at the end of the project and allows the project team to move on to other projects. It can often be th
e last stage of the project, with the review culminating in the sign‐off of the project and the formal dissolution of t
he project team. The focus of the post‐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 i
n the project and to feed lessons learned back into the project management standards with the aim of improving s
ubsequent project management in the 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 th
e actual users of the product an opportunity to use and experience the product or service and to feedback their ob
servations into a formal review. The post‐implementation review will focus on the product’s fitness for purpose. Th
e review will not only discuss strategies for fixing or addressing identified faults, but it will also make recommendat
ions on how to avoid these faults in the future. In this instance these lessons learned are fed back into the product
production process. Without a PIR, a business cannot demonstrate that its investment in the project was worthwhi
le.

PIRs can sometimes be an on‐going element of project management that may be used at project gateways to exam
ine changes implemented to date.

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

pg. 187

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:
 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 fro
m the failure of it.

Their job is to direct the project, and allow the project manager to manage the project.

pg. 188

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 b
usiness strategy are 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 guidance
‐ supporter and coach – provides practical support for the project leader, especially if they are taking on a proje
ct 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 decision on behalf of the organization
‐ champion or advocate – involves informal communication with other senior managers to ensure that they con
tinue to have an objective view of the importance of their project in relation to other projects within the busi
ness
‐ problem solver – when the team faces problems that it is unable to solve or does not have the skills or experie
nce to solve
‐ Resource negotiator – a project’s success will depend on the availability of the right resources at the right time
In cross‐functional projects the sponsor may provide assistance in negotiating resources around the company

pg. 189

Financial Analysis SBL Revision Notes
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)

pg. 190

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)

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

Initial Investment
Payback Period =
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:
B
Payback Period = A +
C
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

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.
pg. 191

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.
PV of Initial Investment
Payback Period =
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:
B
Payback Period = A +
C
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

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.

pg. 192

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 A subset of uncertainty where a possible outcome
impossible to exactly describe the future outcome have an undesired effect.
Too little information is available about expected Some information is available based on past
future. data/experience
Cannot list all possible outcomes Can list all possible outcomes
It results when randomness cannot be expressed in Mathematical probabilities can be assigned.
probabilities
Not measurable Measurable
Not all uncertainties are risks. All risks are uncertainties are risks.

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

pg. 193

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.

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.

pg. 194

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.

pg. 195

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.

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 ratio = 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.

● 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.

pg. 196

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 = 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

● Interest Coverage= Operating Income
Interest Expense

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 The ratio between returns/costs and revenues “And” the ratio between returns and resources.
Ratios
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.
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 = Net Income or Loss
Sales
pg. 197

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 = Net Income + After tax Interest Expense
Total Assets

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.

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.

pg. 198

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.

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.
pg. 199

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.

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.
pg. 200

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

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
pg. 201

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.

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
.

pg. 202

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.

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
Operational Variances Per unit =(Revised St hrs/unit‐Actual hrs/unit)*Rate per hr
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.
pg. 203

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.

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.

pg. 204

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

pg. 205

Developments in Technology Shaping Business SBL Revision Notes
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.
pg. 206

- 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.
- 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.

pg. 207

Cloud Computing

Cloud computing: In the simplest terms, cloud computing means storing and accessing data and
programs over 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.
 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.
pg. 208

 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
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.

pg. 209

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.

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
pg. 210

- 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.

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.
pg. 211


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.

Cyber Security

Cyber security 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 cyber security 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.
pg. 212

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 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.

pg. 213

E‐Business/Digital Business SBL Revision Notes
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.

The organization needs to make key decision about:

Digital business Consider the mix of having a physical and an on‐line presence.
channel priorities
Bricks and mortar: physical presence only
Bricks and clicks: Mix of physical and on‐line presence
Clicks: Online only
Market and What is sold and who is it sold to?
development
strategies

pg. 214

Positioning and How will the online offering be positioned as compared to competitors in terms of
differentiation product and service quality, price, delivery time?
strategies This is similar to the marketing mix.

Business, service e‐business can provide an opportunity to make changes to the business and revenue
and revenue models (i.e. on how a company will generate revenue, identifying its product offering,
models value added services, revenue sources and target customer

Marketplace Technology can change market structures themselves and organizations can take
restructuring 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
pg. 215

Supply chain Companies can use technology to integrate more closely with their suppliers or
management participate in online marketplaces. Questions that they need to consider are:
capabilities •  Integrate more closely with suppliers?
•  Which materials and interactions should we support through e‐procurement?
•  Can we participate in online marketplaces to reduce costs?
Internal Organizations should consider whether technology can help in creation and
knowledge dissemination of knowledge.
management
capabilities

Organizational Adopting these strategies will require organizational change. Management has to decide
resourcing and how organization needs to change to achieve the priorities set for e‐business.
capabilities

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 Buying and selling
E‐business Buying and selling, plus the capabilities to match
E‐enterprise Management processes and business processes are redesigned. Transactions can be
monitored and analysed real‐time.
Transformation New business and management models required for the new economy are embedded.

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 real‐ time. 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.

pg. 216

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 Cloud based enterprise planning systems, predictive analytics, Big data
Technology development Enables all other changes
HR management Self‐service portal for employees
Procurement EDI links and online purchasing
Inbound logistics Inventory control, material requirements planning, automated delivery tracking
Operations Use of robots in manufacturing, 3D printing
Outbound logistics Tracking progress of goods from pick up to delivery in real time
Marketing and sales e‐marketing
Service 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 The power of the Internet allows consumers to become
to engage with the website interactive with marketing collateral.
and brand on a higher level,
contributing to their Interactivity starts with the ads themselves. Google has
marketing efforts and pioneered TrueView ads in YouTube. TrueView ads allow the
providing social proof. 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.

pg. 217

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.

Intelligence Intelligence refers to the Internet marketing provides a level of intelligence due to the fact
data gained through market that extensive market research is conducted in a cost effective
research and how a manner. The Internet provides information about consumers
company may use and companies are able to gather this information and use it for
information such as their benefit.
customer demographics to
their advantage. 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.

Individualization Individualisation refers to Advertisements and other marketing activities on the Internet
how dynamic the content of can be customized to an individual's location, demographic, age,
a website is to suit an gender, interests, and more; the ability to target a certain
individual’s needs. demographic or geographic area is also how Internet marketing
excels in individualization.

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.

pg. 218

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.

Integration Integration refers to the The integration of traditional and online marketing methods
combining of different such as a billboard or magazine with a QR code is evolving and
media channels to provide a marketers are utilizing the concept of integration daily;
more wholesome combining different media channels via Internet marketing also
marketing approach. This allows the point of interactivity and intelligence to occur.
allows for greater
interactivity and Big Data
intelligence as users should As marketers were able to collect richer customer profiles, a new
easily be able to move from segment of software began to emerge. Modern marketers rely
one channel to another via on marketing automation platforms for both consumer and B2B
the integrations. 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.

pg. 219

Industry Industry The marketing industry as previously mentioned is continuously

structure Restructuring refers to how evolving. The disintermediation occurs in Internet marketing and
marketing methods are is continuing as the middleman is constantly being removed
continuously evolving to from the marketing process.
suit the times and this
causes waves in the The Internet has been brutal in this regard. Travel agents, local
industry as more marketing retailers, brokers, cab companies and many more middlemen
tasks are automated companies have all but vanished. They are replaced by direct
through new technologies. booking and ordering or more efficient intermediaries operating
more efficiently.

Independence of Independence of Being able to do the marketing of a product or service from a
location Location refers to personal computer at home is a great advantage of Internet
consumers having the marketing, as well as the ability to be reached as a consumer
ability to access the website from anywhere with a wifi connection whether it be via mobile
no matter where they are device or computer.
located or what device they
are using as long as they Other differences/advantages that Internet marketing has over
have an internet traditional marketing is accountability, testing, flexibility, micro‐
connection. This means targeting, and cost‐control. All of these aspects combined can
that the marketing can also help you run a successful Internet marketing campaign.
be done independent of Independence of location ties back to Data and Targeting. Rather
location 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.

pg. 220

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 phone 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 their 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.

pg. 221

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. Search marketing: Search engine optimization (growing visibility in unpaid search engine results). , paid search
and pay per click campaigns
2. Online PR: Publisher outreach, community participation, media alerting
3. Online partnership: Affiliate marketing, sponsorship, co‐branding.
4. Interactive ads: Behavioural targeting, data mining ( to identify trends, patterns and relationships in data)
5. Opt‐in email: co‐branded and ads in third party newsletters
6. 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.

pg. 222

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.

What is crypto currency?
Cryptocurrency is designed to take advantage of the internet and how it works. Instead of relying on traditional
financial institutions who verify and guarantee your transactions, crypto currency transactions are verified by the
user's computers logged into the currency's network. Since the currency is protected and encrypted, it becomes
impossible to increase the money supply over a predefined algorithmic rate. All users are aware of the algorithmic
rate. Therefore, since each algorithm has a roof limit, no crypto currency can be produced or "mined" beyond that.

Since Crypto currency is completely in the cloud, it does not attain a physical form but have a digital value, and can
be used for digital equivalent of cash in a steadily increasing number of retailers and other businesses. Bitcoin was
the first crypto currency that was ever created, and while there is a small fee for every crypto currency transaction,
it is still considerably lesser than the usual credit card processing fees.

Bitcoin is the most popular crypto currency which has seen a massive success. There are other crypto currencies
such as Ripple, Litecoin, Peercoin, etc. for people to transact in. But for every successful crypto currency, there are
others which have died a slow death because no one bothered to use them, and a crypto currency is only as strong
as its users.

pg. 223

Some of the salient features of Crypto currency include ‐
‐ Crypto currency can be converted into other forms of currency and deposited into user's accounts at a lightning
speed
‐ Most Crypto currency can be transacted anonymously, and can be used as discreet online cash anywhere in the
world. Users therefore do not have to pay for any currency conversion fees
‐ While not 100% immune from theft, Crypto currency is generally safe to use and difficult for malicious hackers
to break
‐ Bitcoin and other Crypto currency can be saved offline either in a "paper" wallet or on a removable storage hard
drive which can be disconnected from the internet when not in use

2016 was the year of Bitcoin, and saw this digital currency grow almost 79% as compared to Russia's Ruble and
Brazil's Real, the world's foremost hard currencies. As a result, it emerged as a better bet for investors while beating
foreign exchange trade, stock exchange trade, and commodity contracts.

There are many reasons why the impact of Bitcoin is exceptionally relevant today, and why the Crypto currency of
2018 is now here to stay. These include:

1. Reduced Remittance: Many governments around the world are implementing isolationist policies which restrict
remittances made from other countries or vice versa either by making the charges too high or by writing new
regulations. This fear of not being able to send money to family members and others is driving more people towards
digital Cryptocurrency, chief amongst them being Bitcoin.

2. Control Over Capital: Many sovereign currencies and their usage outside of their home country are being
regulated and restricted to an extent, thereby driving the demand for Bitcoin. For example, the Chinese government
recently made it tougher for people as well as businesses to spend the nation's currency overseas, thereby trapping
liquidity. As a result, options such as Bitcoin have gained immense popularity in China.

3. Better Acceptance: Today, more consumers are using Bitcoins than ever before, and that is because more
legitimate businesses and companies have started accepting them as a form of payment. Today, online shoppers
and investors are using bitcoins regularly, and 2016 saw 1.1 million bitcoin wallets being added and used.

4. Corruption Crackdown: Although unfortunate, digital Crypto currency such as Bitcoin are now also seeing more
usage because of the crackdown on corruption in many countries. Both India and Venezuela banned their highest
denomination and still‐circulating bank notes in order to make it tougher to pay bribes and make accumulated black
money useless. But that also boosted the demand for Bitcoins in such countries, enabling them to send and receive
cash without having to answer to the authorities.

Blockchain
At the heart of the surge in cryptocurrencies is excitement surrounding blockchain technology, which is the
foundation that virtual currencies are built upon. Blockchain is the digital and decentralized ledger technology that
records all transactions without the need for a financial intermediary like a bank. It appears to offer distinct
advantages over existing payment facilitation networks that could make it a go‐to technology for the financial
services industry (and other industries) in the future.

pg. 224

Here are, in no particular order, five of the biggest advantages of blockchain technology.

1. Transparency
One of the prime reasons blockchain is intriguing to businesses is that this technology is almost always open
source. That means other users or developers have the opportunity to modify it as they see fit. But what's most
important about it being open source is that it makes altering logged data within a blockchain incredibly difficult.
After all, if there are countless eyes on the network, someone is probably going to see that logged data has been
altered. This makes blockchain a particularly secure technology.

2. Reduced transaction costs
Blockchain allows peer‐to‐peer and business‐to‐business transactions to be completed without the need for a
third party, which is often a bank. Since there's no middleman involvement tied to blockchain transactions, it
means they can actually reduce costs to the user or businesses over time.

3. Faster transaction settlements
When it comes to traditional banks, it's not uncommon for transactions to take days to completely settle. This
is due to protocols in bank transferring software, as well as the fact that financial institutions are only open
during normal business hours, five days a week. You also have financial institutions located in various time zones
around the world, which can delay processing times. Comparatively, blockchain technology is working 24 hours
a day, seven days a week, meaning blockchain‐based transactions process considerably more quickly.

4. Decentralization
Another central reason blockchain is so exciting is its lack of a central data hub. Instead of running a massive
data center and verifying transactions through that hub, blockchain actually allows individual transactions to
have their own proof of validity and the authorization to enforce those constraints. With information on a
particular blockchain piecemealed throughout the world on individual servers, it ensures that if this information
fell into unwanted hands (e.g., a cyber‐criminal), only a small amount of data, and not the entire network, would
be compromised.

5. User‐controlled networks
Lastly, crypto currency investors are tend to be really encouraged by the control aspect of blockchain. Rather
than having a third party run the show, users and developers are the ones who get to call the shots. For instance,
an inability to reach an 80% consensus on an upgrade tied to bitcoin's blockchain is what necessitated a fork
into two separate currencies (bitcoin and bitcoin cash) more than four months ago. Having a say goes a long
way with investors and developers.

But in spite of these pretty clear advantages, the success of blockchain is no sure thing.

However, the major worry that can't be overlooked is that investors have, time and again throughout history,
overestimated how quickly new technology will be adopted. Whether we're talking about internet‐based business‐
to‐business commerce, electric vehicles, 3D printing, and so on, none of these game‐changers were immediate
winners, despite investors sending the valuations of associated companies through the roof. It takes time to lay the
groundwork for new technologies like blockchain, and it could be years before we see business adopt this technology
as a major component of their payment networks.

pg. 225

Because we don't know how quickly blockchain will be adopted, or even which blockchain technology businesses
are likely to prefer, attempting to put a value on what blockchain is worth is meaningless. This also suggests that
most crypto currency valuations at the moment, which have been driven higher by the promise of blockchain
success, might make no sense whatsoever.
Long story short, blockchain might have a bright future as a core payment facilitator for the financial services
industry.

Below are the likely scenarios that may happen to companies and businesses if crypto currencies become more
prominent in financial transactions.

‐ “Accepted payments: Cash, Credit Cards, and Crypto currencies: Today, thousands of merchants are accepting
Bitcoin as a legitimate form of payment. One art gallery in London now accepts digital currencies, and this
concept of “old meets new” may soon trickle down to more businesses. Some of the biggest companies today
that accept Bitcoins are Microsoft and Shopify. If they continue to be used as a viable currency, it is likely that
in the near future they will be widely used in the retail industry.

‐ Contracts made through blockchain: One of the biggest breakthroughs of crypto currency is blockchain
technology. Blockchain smart contracts work like this: once both parties agree to the set of conditions, the
mutually agreed upon crypto currency payment will be transferred. Once a smart contract has been submitted,
it cannot be altered, and copies will be given across all the nodes of the blockchain. It has been suggested that
that the system used by crypto currencies are immutable meaning that once the transactions are recorded, they
cannot be erased. Since blockchain is both decentralized and immutable, it protects merchants from those who
would seek to cheat the merchants. IBM and Microsoft are already offering “blockchain solutions to enterprise
clients”. In the near future business could be offering secure contracts without the need for lawyers or
middlemen

How Crypto currency is Disrupting the Global Economy

The trends that are set up through crypto currency have impacted financial markets in many different variations.
These technologies are paving away a new landscape, which creates more room for small businesses, and big
financial institutions to take charge, and create more change in using Blockchain technology, and overall creating
more fluidity in the entire industry altogether.

Seeing the fluctuation in the crypto markets over the past years, central banks and governments have been doing
all that they can to create order within this financial system. There are varying amounts of measures being taken to
regulate the supply and tax system within this set of crypto markets.

pg. 226

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ACCA - SBL

Strategic Business Leader

02 Case Study Tips and Techniques (and professional marks) 04

07 Two Tier Boards, Insider Structures, CG Approaches 46

12 Bribery, Ethical Decision Making and Public interest 70

17 Risk Management 134

An operations strategy is typically driven by the overall business strategy of the organization,

Should approve the appointment and

Provide information Interrelatedness between the factors that affect the ability to create value

Costs are incurred in ensuring and demonstrating Regulations can be changed more quickly as compared to

Eco Management Audit A scheme which recognizes and rewards organisations that go beyond the minimum

 What are the  How should business units  Are strategies suitable, acceptable

management to consider the impact of 9. The organization identifies and assesses changes that could

Present value describes how much a future sum of money is worth today.

The rest of the procedure is similar to the calculation of simple payback period except that we have to use the

Industry Industry The marketing industry as previously mentioned is continuously

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