Mumbai

l
ear
ningpar
tner-

Mumbai Del
hi

STRATEGI
CPROFESSI
ONALLEVEL
602,
EcoSpaceITPark,OldNagar dasRoad, St
rat
egi
cBusi
nessLeader(SBL)
_______________
MograVil
lage,Nat
warNagar ,AndheriEast
,
Mumbai,Maharashtr
a-400069
STUDYNOTES
r
eachus@zel
leducat
ion.
com
www.
zel
leducat
ion.
com
Sept
'22t
oJune'23
+919004935888
 “
“

Weekday Weekend Sel

f-Paced
 Foreword 1

Table of Contents

Foreword............................................................................................................................................. 2
Introduction to Professional skills: ................................................................................................... 15
1. Leadership and ethics ............................................................................................................... 17
2. Strategy and Business environment ......................................................................................... 39
3. Internal capabilities and strategic choices ................................................................................ 63
4. Agency, governance and board of directors ............................................................................. 80
5. Stakeholder analysis, reporting to stakeholders, Public sector governance .......................... 103
6. Risk .......................................................................................................................................... 121
7. Technology and data analytics ................................................................................................ 142
8. Organisational control and audit ............................................................................................ 164
9. Finance in planning and analysis............................................................................................. 176
10. Enabling success and fintech .............................................................................................. 191
11. Change and project management....................................................................................... 207
 Foreword 2

Foreword
‘By the ACCA, for the ACCA’

These notes are designed with a simple mission, to fill the gap for Indian students who don’t find
comfort in studying from notes that are framed in a complex manner. Our priority at Zell is to improve
the results our students achieve by providing all that they need, be it quality education, state of the
art infrastructure and techniques or the next step, the content that perfectly fits in making the trifecta
or the winning formula.

Here at Zell, we don’t worry about the background, prior knowledge or preferences someone has. The
aim is simple, by the time a student is done with a paper, they are on the same page as anyone else
and that for us, should be enough knowledge to be able to call them a professional truly.

Keeping all this in mind, we bring to you these notes, created by us, for you, to truly help make the
difference and turn your journey of ACCA into an even better one. This is just the beginning; there is
more in store.

Thank you

Credits

Authored By:

Kalpesh Naik

Divij Bhatia

Designed By:

Ritik Sanghrajka

Harshita Shah
 Foreword 3

Best way to study

Planning how to study

Before starting the preparation for any paper, you should always make a macro level plan on how to
go about preparing for the exam. Understand what is expected of you to be able to clear the exam
with high scores. It is important to set targets and stick to them, to ensure that you stay on track and
progress in your ACCA journey.

Have a plan from the beginning about where you want to be at the end of the month or two months,
then work backwards and understand what you must do to stay on track. Then, at the start of every
week, make a brief plan about how much needs to be covered every day, resulting in the timely
completion of the exam.

Break your macro plan intro studying along with the professor/recordings, examination month and
final revision. Plan how many hours can you give every day and make a schedule accordingly. Ensure
that you can give quality hours without distractions. The quantity of hours doesn’t matter.

How to approach the exam

Knowing how much importance ACCA places on application-based learning is important. You must
understand that rote learning in any exam for any concept will mostly amount to zero marks being
scored.

Students leave minimal time to their core exam preparation and directly jump into mock exams
without finishing the exam kit. Leave the exam month for core practice of questions available to you,
ensure you finish the conceptual understanding before starting to do so.

The ideal approach is to watch/attend lectures and keep up with the pace, practising 40% of the
question bank alongside, to cement conceptual understanding. Once classes conclude, ensure the
remaining 60% of the question bank is solved, followed by at least three mock examinations before
attempting the main exam.
 Foreword 4

Exam month

• In the exam month, ensure that you finish the portion as soon as possible and shift all focus
to completing the question bank. Remember, completing the textbook alone is not enough,
whereas completing the question bank gives you a higher chance of clearing the exam.
• If you are done with your question bank, repeat the question bank or key questions you
marked before the exam. Only 40% of your total time should be allocated to building a
conceptual understanding, the remaining 60% to solve questions.
• You must practice newly launched past exam questions available on the ACCA website at the
end to ensure you can solve questions of the rigour expected from you.
• Ensure you do not get into the habit of reading a question and then reading the answer. This
approach will make you seek answers in the exam and not seek solutions on your own. Read
a question, solve it on your own, check the answer. Do not simply read the answer and make
notes. Type the answer or solve it on a spreadsheet before checking the solution. Practising
on a computer for a computer-based exam can make the difference for you in finishing the
exam.
• Familiarise yourself with the scientific calculator, the CBE exam platform and other tools to
ensure you are comfortable with the same in the actual exam.
• Ensure you complete 100% of the portion. Do not skip anything as the exam will test you on
a range of interconnected topics, and leaving parts of the portion will guarantee you are
losing certain marks.
Exam strategy

There are certain things to be kept in mind before attempting the main exam.

1. Remain calm before the exam. Do not study at the last moment, as going into the exam with
a fresh mind will allow you to tackle the questions more easily.
2. The examination is 3hours 15minutes long, which means you have 195 minutes for 100
marks, or simply 1.95 minutes per mark. Ensure you don’t get overboard with the time you
take to solve a question at hand. The following approach can also be implemented – 90
minutes for Section A and 50 minutes for each Section B question.
3. Read the requirements carefully. Pay attention to the verb used, Define, explain, calculate,
evaluate etc., to understand what the examiner is seeking to ensure you answer on those
lines.
4. Do not go for quantity when you are answering questions. The examiner will award one
mark per valid statement and one mark only per valid point. Do not elaborate on points to
simply write more.
Do not sit and recalculate the answer you got more than twice, as you are likely to calculate it in the
same way you did previously, by repeating the same mistake if any. This is a massive waste of your
crucial time. Rather move faster and revisit key questions at the end, recalculating your answers at
that point will possibly reveal mistakes and allow you to rectify them, thus scoring more marks.
 Foreword 5

Elements

Syllabus wise study material

The study material is curated in a manner where the syllabus provided by ACCA has been covered in
vast depth, and the order is set in a way that the flow of concepts within the material suits a
student.

Apply Your Knowledge

Various AYK style questions test the student on their ability to remember and understand concepts
thoroughly before moving to analytical questions.

Quiz

Further, there are primarily application-based quiz questions, introducing the student to analytical
and evaluative questions to bring the student one step closer to actual exam-style questions.

Recap

After the end of every main chapter, there is a recap page summarising all the important topics,
formulae etc., to enable ease of revision for the student.

Mind Maps

Mind maps are flowcharts that summarise the information visually, making it more likely for a
student to retain the knowledge and build upon it. These are present at the end of the book to
enable last-minute revision by simply spending time on those pages.
 Foreword 6

Nimbus™ Preparation tools

Interactive notes with gamification

The articulated version of the notes is available on the platform, allowing students to get fully
immersed in their learning and complete more in less or equivalent time they spend reading the
book.

Case studies

Case studies are specifically tailored to address the audience commonly using these notes. Having
interesting case studies based on current affairs, covering key organisations etc., contribute to
further professional development.

Technical articles

ACCA’s technical articles are placed strategically in the material, allowing students to understand
when they are supposed to go through these all-important technical articles.

Exam experience

The system mimics the exam experience to ensure that the student has conceptually and technically
mastered the paper before appearing for the exam. This includes various objective questions, live
spreadsheets and word processors to practice typing, presentation and most importantly, time
management.

Question Bank & Test Series

The students have access to unit tests, half portion tests, progressive tests, mock tests and unlimited
practice tests with all performance data allowing them to know where they stand, the
improvements required before the exam day arrives.

Flashcards and Interactive mind maps for revision

Flashcards help students quiz themselves, which is more effective as a revision technique than
simply reading through pages. Interactive mind maps allow the student the power to take a detailed
glance through a whole chapter or large concept in minutes while revising at the same time.

Check the last page of this book for more information on Nimbus™ LMS by Zell
 Foreword 7

ACCA support

Examining team guidance/Exam technique & reports

The examiners’ reports are an essential study resource. Read them to learn about mistakes that
students commonly make in exams and how to avoid them.

Practice tests

Practice Tests are an interactive study support resource that will replicate the format of all the
exams available as on-demand computer-based exams (CBEs). They will help you to identify your
strengths and weaknesses before you take an exam.

As well as giving you an insight into a live exam experience, Practice Tests will also provide feedback
on your performance. Once you complete the test, you will receive a personalised feedback diagram
showing how you have performed across the different areas of the syllabus.

Specimen exams

The specimen exam indicates how the exam will be assessed, structured and the likely style and
range of questions that could be asked. Any student preparing to take this exam should familiarise
themselves with the exam style.

Technical articles

There is a range of technical articles available on ACCAs website under ‘Study support resources’.
These include a range of simplified articles on complex topics, study support videos, articles on exam
technique etc. making it an important tool to be practised when nearing the exam.

FAQs

Various commonly asked questions about the style of the examination, the coverage, computer-
based exam setup etc., are covered here to allow a student to stay up to date and ensure their
understanding is aligned with that of the ACCA body.

Question practice – ACCA practice platform

Question practice is a vital part of exam preparation. Practising in the CBE environment provides a
fantastic opportunity to get fully prepared for the real exam.

The ACCA Practice Platform contains a range of content that allows you to attempt questions to time
and then mark and debrief your answers. It also contains a blank workspace that allows you to
answer constructed response questions from other sources in the CBE environment.

Past Exam library

Past exams are made available to view and become familiar with the styles of questions that you
may face in your exam.

Make sure you log into the ACCA Practice Platform early in your studies - completing your practice in
the CBE environment is the only way to prepare for your exam fully.

CBE Support
 Foreword 8

Getting ready for your CBE includes getting familiar with the CBE functionality and how to use it to
your advantage in the exam. You should be thinking about your exam approach well before exam
day itself.

There are series of videos that will help you get ready for your exam. It includes what to think about
before your exam day, exam strategy, how to manage your CBE workspace effectively and
techniques you could use to plan and complete your answers.
 Foreword 9

Syllabus

The aim of the syllabus is to demonstrate organisational leadership and senior consultancy or advisory
capabilities and relevant professional skills, through the context of an integrated case study.
The syllabus for Strategic Business Leader acts as the key leadership syllabus at the Strategic
Professional level and is a substantial integrated examination. The examination requires candidates
to demonstrate a range of professional skills demanded by effective leaders or in advising or
supporting senior management in directing organisations. The syllabus therefore combines the main
functions of organisations in the context of leadership capability.

The main capabilities of the Strategic Business Leader syllabus assume essential technical skills and
knowledge have been acquired in theApplied Knowledge and Applied Skills examinations where some
of the core capabilities of Strategic Business Leader will have been introduced in a subject-specific
context, such as governance, internal audit, control, risk, finance, and management. The examination
also draws upon a range of ethical and professional skills acquired in the Ethics and Professional Skills
module, which should be completed before attempting any of the Strategic Professional
examinations.

The Strategic Business Leader syllabus is covered in nine main sections with leadership,
professionalism and ethics and corporate governance used as the initial focus for the rest of the
syllabus. Excellent leadership involves having a team of capable and responsible directors, setting an
appropriate ‘tone from the top’ and embedding appropriate corporate and cultural values within the
[Link] is supported by a sound governance structure and effective management structures.
The syllabus begins by examining leadership and having in place responsible and ethical leaders,
having an awareness of who they are responsible to This section also covers personal and professional
ethics, ethical frameworks – and professional values – as applied to a senior manager or adviser’s role
and as a guide to appropriate behaviour and conduct in a variety of situations. Clearly linked to
organisational leadership is the existence of an effective governance structure within organisations in
the broad context of the agency relationship. This aspect of the syllabus focuses on the respective
roles and responsibilities of directors, the relevant committee structures and the effective scrutiny of
the performance of senior management, demonstrating their accountability by reporting more widely
and holistically to stakeholders under an integrated reporting <IR> framework.

It is only after the fundamental organisational leadership and governance structures and values are in
place thatstrategy can be determined and the strategic position of the organisation can be assessed
and strategic options evaluated and implemented.

Evaluating strategic options, making strategic choices and implementing strategy requires the
organisation’s leaders, or their advisers, to fully understand the risks involved so the syllabus then
examines the identification, assessment, and control of risk as a key aspect of responsible leadership
and management. The syllabus also includes a section relating to and applying IT and security controls
at all levels of the organisation from strategic considerations including big data, machine learning, e-
business, cloud computing and smart technology through to using IT in the management of
information, controlling organisations, and in financial and organisational [Link] section also
focuses on the growing importance of ‘cyber security’
To support the management of risk the syllabus also addresses organisational control in its wider
context, including internal audit, review, internal control, and appropriate reporting to implement and
support effective governance, including compliance issues related to the safeguard of assets including
data security, and and decision-support functions.

The syllabus includes financial aspects of managing an organisation, including evaluating available
sources of finance and key financial and management accounting techniques to analyse performance
 Foreword 10

and to support decision-making. Candidates need to be aware of legal issues and of the financial
reporting and taxation implications of strategic and investment decisions.

The syllabus finally focuses on innovation, performance excellence and change management to enable
organisational success and to implement change through effective organisational processes, IT
solutions and project management, including the role of new and disruptive technologies in
transforming the nature of business analysis and transactions.

The professional skills section of the syllabus links to all others and provides a range of professional
skills that the candidate must demonstrate in the exam which will make them more employable, or if
already in work, will enhance their opportunities for advancement.

The last section which closely links to the professional skills section is the demonstration of
appropriate digital and employability skills in preparing for and taking the SBL examination. This
includes being able to use computer functionality and technology to access information and present
responses in a professional manner during live examinations.

Main Capabilities

On successful completion of this exam, candidates should be able to:

a. Apply excellent leadership and ethical skills to set the ‘tone from the top’ and promote a
positive culture within the organisation, adopting a whole organisation perspective in
managing performance and value creation.
b. Evaluate the effectiveness of the governance and agency system of an organisation and
recognise the responsibility of the board or other agents towards their stakeholders, including
the organisation’s social responsibilities and the reporting implications.
c. Evaluate the strategic position of the organisation against the external environment and the
availability of internal resources, to identify feasible strategic options.
d. Analyse the risk profile of the organisation and of any strategic options identified, within a
culture of responsible risk management.
e. Select and apply appropriate information technologies and data analytics, to analyse factors
affecting the organisation’s value chain to identify strategic opportunities and implement
strategic options within a framework of robust IT security controls.
f. Evaluate management reporting and internal control and audit systems to ensure compliance
and the achievement of organisation’s objectives and the safeguarding of organisational
assets
g. Apply high level financial techniques from the Applied Skills exams in the planning,
implementation and evaluation of strategic options and actions.
h. Enable success through innovative thinking, applying best in class strategies and disruptive
technologies in the management of change; initiating, leading and organising projects,while
effectively managing talent and other business resources.
i. Apply a range of Professional Skills in addressing requirements within the Strategic Leader
examination and in preparation for, or to support, current work experience.
j. Demonstrate other employability and digital skills in preparing for and taking SBL
examinations.
 Foreword 11

ACCA Performance Objectives

Objective Chapter in Text

PO1 Ethics and professionalism Leadership and Ethics

PO2 Stakeholder relationship management Stakeholder analysis, reporting to
stakeholders, public sector governance
PO3 Strategy and innovation Strategy and Business environment
PO4 Governance, risk and control Agency, Govenance and board of directors
PO5 Leadership and management Leadership and Ethics
PO9 Evaluate investment and financing decisions Finance in planning and analysis
PO11 Identify and manage financial risk Risk
PO12 Evaluate management accounting systems Organisational control and audit
PO13 Plan and control performance Strategy and Business environment
PO20 Review and report on the findings Organisational control and audit
of an audit or assurance engagement
PO21 Business advisory Strategy and Business environment
PO22 Data analysis and decision support Finance in planning and analysis
 Foreword 12

Examination Structure

The Strategic Business Leader syllabus is examined using a 100% integrated case study, examining
across a breadth of organisational functions. The case content of each exam may use or draw upon
some or all of the main elements of the Integrated Reporting <IR> Framework.

The examination assesses the technical and digital capabilities that potential leaders need to
demonstrate in senior positions within organisations but will also be focused on the following
professional skills and behaviours:

• Communication – Inform, Persuade, Clarify

• Commercial acumen – Demonstrate awareness, Use judgement, Show insight

• Analysis – Investigate, Enquire, Consider

• Scepticism – Probe, Question, Challenge

• Evaluation – Assess, Estimate, Appraise

Each exam will therefore assess both technical skills and the above professional skills. Whilst marks
will be awarded for the relevant technical points that candidates make, up to 20% of the total marks
within each exam will be allocated to these professional Skills, as determined by the requirements.

The broad structure of each case will give candidates information about an organisation from a
range of sources, such as the following:

• Interviews with staff

• Survey results

• Board or organisation reports

• Press articles/website extracts

• Organisation reports and <IR> extracts

• Emails

• Memos

• Spreadsheets

• Pictures

• Figures

• Tables

• Diagrams
 Foreword 13

The basic structure of each exam will require the candidate to take on various roles of organisational
leaders, consultants or advisers to senior management. Therefore the examination could include
requirements such as found in the following list:

• Analyse the external environment, the organisation model and the internal governance structures,
culture and capabilities of the organisation.

• Assess the position and evaluate the performance of the organisation

• Consider the future outlook for the organisation

• Identify strategic problems and opportunities

• Manage risks and identify appropriate controls

• Make strategic choices

• Evaluate strategic choices using forecasting or decision-making techniques

• Decide on feasible and sustainable solutions using appropriate technologies

• Implement change and innovate responsibly

The examination requires demonstration of appropriate digital and employability skills in accessing
relevant sources of information for carrying out various tasks and being able to use the relevant
functionality and technology to prepare and present answers in a professional manner. These skills
are specifically developed by practicing and preparing for the SBL exam, using the learning support
content for computer-based exams available via the practice platform and the ACCA website.

Guide to exam structure

The examination is based on an integrated case study containing a number of assignments which will
vary at each examination. These assignments or tasks may require the candidate to take on different
roles, depending on the situation. The number of marks allocated to all these assignments or the
sub-parts of these will add up to 100 in total. Within the total marks available, there are 20
Professional Skills marks. Usually each task will contain some professional skills marks which may
vary by examination, depending on the requirements. All tasks must be completed.

The examination is of 4 hours duration, but this includes Reading, Planning and Reflection time
(RPRT). This time can be used flexibly at any time during the exam.

Guidance on learning hours

The Strategic Business Leader examination has a broader syllabus than other exams at the
Professional Qualifying Level. The assessment style as a fully integrated exam and the substantial use
of Professional Skills marking to support technical marks, requires more teaching and learning time
than in the other exams.

The additional time is required for the following:

1. To cover the broader syllabus content

2. To allow adequate practice time for case study assessment and revision.

3. To encourage and develop the demonstration of professional skills to support the award of
Professional Skills marks.
 Foreword 14

Introduction to SBL
Style of examining:
Strategic business leader is a recently introduced exam in the strategic professional level of ACCA.
This exam tries to replicate real life scenarios and work-related tasks through an integrated case
study. The aim of SBL is to demonstrate organisational leadership and senior level advisory skills.

The exam will be of four hours in which students will need to solve a case study which will involve
various tasks. The information required to complete these tasks will be provided in the form of
exhibits. The total information will not be more than 12-18 pages in total. The information provided
may take any form such as annual report, news report, spreadsheets, briefing notes etc.

Students will be required to assume various roles in the organisation while completing the given
tasks. E.g. you may be asked to advise on the organisations expansion strategy as a Non-Executive
Director or to discuss the pro’s and con’s of a new accounting software as an external consultant.
You may be asked to assume different roles for different tasks or a single role for the entire case
study.

Exam structure:
The total marks available are divided as 80-20 with 80 marks relating to the technical skills(actual
answer) and 20 marks relating to the 5 professional skills(Style of the answer), which we will discuss
further in detail. The case study is relatively bigger than questions of other exams and hence four
hours are given to students to complete it. Within these four hours a student has to divide time
between RPRT:

R-Reading

P-Planning

RT-Reflection time.

To summarize the real essence of SBL lies in visualising yourself holding a responsible senior level
role which is given to you and acting accordingly. Throughout your SBL syllabus, you will be required
to study various real life cases and do some external reading to become a Strategic Business Leader!
 Introduction to Professional skills: 15

Introduction to Professional skills:

1. Communication:
To summarize, this means the candidates have to express themselves clearly and convincingly
through the appropriate medium while being sensitive to the needs of the intended audience.

Checklist:

• Use appropriate formats (Reports, Memos, PPT etc.)

• Prioritize the most important issues first and maintain a logical flow to the answer.
• Avoid making repetitive points and use an appropriate tone.
• Keep in mind to whom are you communicating and decide the degree of detail accordingly.
 Introduction to Professional skills: 16

2. Commercial acumen:

To summarize, this means the candidates have to show awareness of the wider business
and external factors affecting business, using commercially sound judgement and insight to
resolve issues and exploit opportunities.
Checklist:

• Think beyond numbers and look at other factors.

• Be practical in your answer and give appropriate consideration to the industry and
the environment in which the business operates.
• Think about both long and short term costs and benefits
• Consider an organisation as a corporate citizen and give recommendations
accordingly.
3. Analysis:
To summarize, this means the candidates have to thoroughly investigate and research information
from a variety of sources and logically process it with a view to considering it for recommending
appropriate action.

Checklist:

• Wherever possible, use models and frameworks to give a structure to your answers.
• Try to gather information from as many exhibits as possible.
• Perform calculations and compare data to external benchmarks and past data.
• Give recommendation if required

4. Scepticism:
To summarize, this means the candidates have to probe, question and challenge information and
views presented to them, to fully understand business issues and to establish facts objectively,
based on ethical and professional values.

Checklist:

• Don’t take anything at face value. Always look for supporting evidence when someone
makes a claim.
• Have a questioning mind and try to challenge any assumptions made.

5. Evaluation:
To summarize, this means the candidates have to carefully assess situations, proposals and
arguments in a balanced way, using professional and ethical judgement to predict future outcomes
and consequences as a basis for sound decision-making.

Checklist:

• Perform comparative calculations if possible.

• Consider non-financial factors.
• Compare the pros and cons of all decisions.
• Give an unbiased opinion and recommendation if asked.
 Leadership and ethics 17

1. Leadership and ethics

1.1 Qualities of Leadership

a) Explain the role of effective leadership and identify the key leadership traits effective in the
successful formulation and implementation of strategy and change management.
b) Apply the concepts of entrepreneurship and ‘intrapreneurship to exploit strategic opportunities
and to innovate successfully.
c) Apply in the context of organizational governance and leadership qualities, the key ethical and
professional values underpinning governance.

Introduction:

Leadership is all about influencing an organisation or groups in an organisation in its effort towards
achieving a common goal. Hence, we can see that any leader:

1) leads more than one person,

2) Has the power to influence or affect others,

3) Has a specific goal to attain.

A leader needs to have both the ability to influence people and the power to do so in an
organisation. Leadership is said to be effective only when both of the above factors are present.

Ineffective leadership often results in unclear goals, lack of motivation of employees and eventually
the failure of an organisation. There have been many examples where ineffective leadership has
resulted in corporations been wound up.

For e.g. The Kingfisher airlines could not sustain itself due to the ineffective leadership and incorrect
decisions taken by its chairman Mr. Vijay Mallya and therefore had to wind up its operations. This
explains the need to have an effective leader.

An example of good leadership will be of Sundar Pichai, who has helped Goole grow by being
innovative and being involved in the developments of apps such as chrome etc.

Who is an effective leader?

Leadership is a subjective concept, and there are no perfect coaching manuals to become or decide
who is an effective leader. Hence, there are various theories developed after research which help us
in determining how an ideal manager would be. These are as follows:

1) Trait theories
2) Style theories
3) Contingency theories
 Leadership and ethics 18

1. Trait theories:

The early theories of leadership, which believed that all good leaders had certain identifiable traits,
are known as trait theories. According to these theories, leaders often possess certain characteristics
such as charisma, honesty, integrity, decision making capability etc. Earlier theorists also believed
that good leaders also had some physical traits such as height, strength and energy etc.

The problem with this theory is that effective leaders may not possess all the traits, and possessing
all the traits doesn’t necessarily guarantee an effective leader.

This theory puts the people without such traits at a disadvantage which is unfair as a person having
short height may be an effective leader than a taller one.

Trait theory was really a dead end: it proved to be no good whatsoever by predicting who the good
managers might be.

2. Style theories:

Style theories are based on what leaders do rather than who leaders are. Leadership style is based
on how the leader interacts with the people whom he is leading.

In every style theory, the two opposite styles of leadership, which are people focused or task
focused, are considered.

E.g. Ashridge model considered four main management styles:

1) Tells – Autocratic
2) Sells – Persuasive
3) Consults – Participative
4) Joins – Democratic

In this model, the Consults style was considered to be the best. However, just like trait theories, style
theories also have contradictions. For e.g. in a crisis situation, rather than consults, a tells(autocratic)
style of leadership would be more appropriate.

For example: At the time of war, an autocratic style of leadership will be more effective as compared
to the democratic style of leadership
 Leadership and ethics 19

In another model developed by Lewin and White which categorised the styles such as

1) Democratic
2) Autocratic
3) Laissez faire

It was found that employees liked a more democratic style of the leader, and hence that style was
chosen as the best. However, there have been many examples where an autocratic leader has been
more effective. E.g. Apple enjoyed great success under Steve Jobs, who was considered to be
autocratic in nature.

McGregor Theory X and Y

X and Y are two styles of management

Theory X managers often take a pessimistic view regarding people and believe that employees are
naturally unmotivated and dislike work. Hence, employees need to be constantly rewarded or
punished to ensure they complete their work. This is also known as the carrot and stick method.
Here, performance appraisals are used to control the employees.

Theory Y managers believe that people are motivated and do like to work, and hence they should be
given sufficient freedom and responsibility. Managers encourage employees to develop skills and
participate in decision making. Here, appraisals are used as a tool to encourage open communication
rather than to control staff.

3. Contingency/contextual theory:

Both the above theories fail to consider the situation in which leaders operate. Hence, to overcome
those limitations, a contingency theory was developed. According to it, there was no one best
leadership style in practice, and the most effective style was dependent on the circumstances in
which the leader had to operate.

E.g. Hitler’s autocratic or dictator type style of leadership was appropriate at the time of the second
world war, but it would be inappropriate in the present scenario. We can similarly say that in the 21st
century, a democratic leader would be better than a dictator, but he would not have been effective
in the second world war.

Adair’s Action centred leadership:

According to Adair, any leader needs to adapt to three competing needs, which are:

1) The needs of individuals

2) The needs of the group
3) Task needs
 Leadership and ethics 20

How shall we manage? Well, according to Adair, it depends. On some occasions, there may be a very
urgent task, and we have to reduce our concern for individuals and the group and concentrate on
the task. Sometimes there may be crisis within a group; perhaps their leader has left, perhaps there
is disagreement within it, and then the manager or leader should pay more attention to making sure
that the group operates properly. Of course, sometimes the proper approach to leadership will
mean concentrating on an individual and seeing to their needs, perhaps like giving advice or training.

Handy’s best-fit theory:

This theory identified four variables which were

• Leader
• Subordinates
• Task
• Environment

According to Handy, no leadership style is perfect for all situations. While choosing a style, the above
four factors should be considered. The best fit, according to Handy, occurs when all the factors
demand a similar style to be adopted and thus, with this style, all factors will perform more
efficiently and effectively.

(It should be noted that leadership and management are different. Being a good manager does not
necessarily mean being a good leader and vice versa)

Difference between Entre and Intrapreneurship:

Entrepreneurship is about borrowing or using own funds to start an individual business, take risks
and try to exploit the opportunities in the market by selling goods or services.

Intrapreneurship is also about exploiting business opportunities but by being a part of the
organisation.

E.g. When an individual develops some product and creates a business to sell, it is considered as
entrepreneurship. Whereas when a company’s employee develops a new product, and then the
company sells, it is considered as intrapreneurship.
 Leadership and ethics 21

In the modern world, companies are focusing more on creating ‘Intrapreneur’s’ who will come up
with ground breaking ideas which will help the company in gaining a competitive advantage.

Traditional managers Intrapreneur

Primary motivation Promotion, salary and Freedom to pursue own ideas;
traditional employee rewards self-motivated

Action Tends to delegate to Action-orientated

subordinates

Attitude to risk Risk avoiding Moderate risk sought

Skills Professional management and Greater business acumen;
administration skills good at innovation

Market research Has market research carried Intuitive market assessment;

out by others carries out own research

There have been many instances where the employees of an organisation have come up with ideas
which have enabled the company to deliver a new or a better product. E.g. the like button on
Facebook was an idea of one such intrapreneur working in the company.

How to promote intrapreneurship?

• Employees should be able to communicate their ideas to their managers. Some companies
organise innovation week’s so that their employees can pitch in their innovative ideas to the
management.
• Bureaucracy and administrative barriers should be reduced to promote a more free
environment which enables the flow of ideas.
• The concept of intrapreneurship should be embedded within the organisational culture. This
would make conveying of new ideas a norm in the company.

1.2 Leadership and organisational culture

a) Discuss the importance of leadership in defining and managing organisational culture.

b) Advise on the style of leadership appropriate to manage strategic change.
c) Analyse the culture of an organisation to recommend suitable changes, using appropriate
models such as the cultural web.
d) Assess the impact of culture on organisational purpose and strategy.
a) Discuss the importance of leadership in defining and managing organisational culture.
b) Advise on the style of leadership appropriate to manage strategic change.
c) Analyse the culture of an organisation to recommend suitable changes, using appropriate
models such as the cultural web.
d) Assess the impact of culture on organisational purpose and strategy.

Organisational culture, in simple words, is the way in which things are done in an organisation.
Culture can also be defined as a system of shared assumptions, values and beliefs. As leadership
 Leadership and ethics 22

always acts as the head of any organisation or any group in an organisation, it influences the culture
over there.

How do leaders influence culture?

According to Bennis, there are basically two types of leaders: Transactional & Transformational

Transformational leadership – Transactional leadership –

change (leadership) (management)
Creating agenda Establishing direction Planning and budgeting
Developing HR Aligning people Organizing & staffing
Execution Motivating & inspiring Controlling & problem solving
Outcomes Produces changes – often Produces predictability and
dramatic order

1) Transactional:
• These types of leaders mainly focus on the short-term. They like to plan, control and
improve the current situation and hence defend the existing culture.
• They believe in the rational power structure meaning subordinates should obey
them just because they are managers and are superior to them. These leaders
believe in ‘doing things right’.
• These types of leaders are useful for managing day to day operations.

2) Transformational:
• These are charismatic leaders and focus on building a vision of the future,
motivating people and managing change.
• They focus on long term vision and try to empower their subordinates by creating an
environment of trust. They expect subordinates to follow them as they share a
common vision. Hence the belief in ‘doing the right things’
• Transformational leaders lead with charisma and are good with managing people
and change in an organisation.

Analysis of organisations culture:

To understand an organisations culture and the importance of the same, we need to use a model
known as ‘Cultural Web’. The cultural web tries to breakdown a company’s culture into various
elements, which are as follows:
 Leadership and ethics 23

1) Symbols and titles Symbols are objects or acts that are ever present and convey a symbolic meaning
over and above their functional purpose. For example, the floor plan of an office,
job designations have a basic purpose, but they also convey information regarding
status and hierarchy.

2) Power structures Power is the ability of individuals or groups to persuade, induce or coerce others
into following certain courses of action. Power structures explain how power is
divided in the organisation. E.g. A self-proprietor will have complete power in his
business.

3) Organisational Organisational structures are responsibilities and reporting relationships in an

structure organisation. These closely reflect the power structures. E.g. a new start-up may
have a flat structure having only two layers of hierarchy.

4) Routines and Routines depict what is done on a day to day basis. E.g. A managers day starts with
Rituals a prep talk with his subordinates.
The rituals of organisations are activities performed to emphasize what is
important in the culture. For e.g. giving a trophy to the employee of the month,
scheduling monthly team events.

5) Myths and stories Events of history or present reality which is passed on from one employee to
another or to new recruits etc. E.g. Stories of how a particular person saved the
company etc.

6) Control systems Control systems are the formal and informal ways of monitoring people and
getting things done. This also signifies the degree of freedom. E.g. there may be a
centralized or decentralised control system.
 Leadership and ethics 24

7) Paradigm Paradigm are all the assumptions which are taken for granted by the people in the
organisation. E.g. A normal work day is of 8 hours at least.

Cultural web is a framework which can be used to frame your answer in a better manner if
there is a question regarding analysis of an organisations culture. To use models and
frameworks such as these you should understand what each element of the model states.

2. Analyse the culture of the FAANG tech companies using cultural web

Apply Your Knowledge (AYK) 1

Introduction

Frigate Limited is based in the country of Egdon. It imports electrical components from other
countries and distributes them throughout the domestic market. The company was formed twenty
years ago by Ron Frew, who now owns 80% of the shares. A further 10% of the company is owned by
his wife and 5% each by his two daughters.

Although he has never been in the navy, Ron is obsessed with ships, sailing and naval history. He is
known to everyone as ‘The Commander’, and this is how he expects his employees to address him.
He increasingly spends time on his own boat, an expensive motor cruiser, which is moored in the
local harbour twenty minutes drive away. When he is not on holiday, Ron is always at work at 8.00
am in the morning to make sure that employees arrive on time, and he is also there at 5.30 pm to
ensure that they do not leave early. However, he spends large parts of the working day on his boat,
although he can be contacted by mobile telephone. Employees who arrive late for work have to
immediately explain the circumstances to Ron. If he feels that the explanation is unacceptable, then
he makes an appropriate deduction from their wages. Wages, like all costs in the company, are
closely monitored by Ron.

Employees, customers and suppliers: Frigate currently has 25 employees primarily undertaking
sales, warehousing, accounts and administration. Although employees are nominally allocated to
one role, they are required to work anywhere in the company as required by Ron.

They are also expected to help Ron in personal tasks, such as booking holidays for his family, filling in
his personal tax returns and organising social events.

Egdon has laws concerning minimum wages and holidays. All employees at Frigate Ltd are only given
the minimum holiday allocation. They have to use this allocation not only for holidays but also for
events such as visiting the doctor, attending funerals and dealing with domestic problems and
emergencies. Ron is particularly inflexible about holidays and work hours. He has even turned down
requests for unpaid leave. In contrast, Ron is often away from work for long periods, sailing in
various parts of the world.
 Leadership and ethics 25

Ron is increasingly critical of suppliers (‘trying to sell me inferior quality goods for higher prices’),
customers (‘moaning about prices and paying later and later’) and society in general (‘a period
working in the navy would do everyone good’). He has also been in dispute with the tax authority,
who he accused of squandering his ‘hard-earned’ money. An investigation by the tax authority led to
him being fined for not disclosing the fact that significant family expenditure (such as a holiday for
his daughters overseas) had been declared as a company expenditure.

Company accountant: It was this action by the tax authority that prompted Ron to appoint Ann Li as
the company accountant. Ann had previously worked as an accountant in a number of public sector
organisations, culminating in a role as a compliance officer in the tax authority itself. Ron felt that
‘recruiting someone like Ann should help keep the tax authorities happy. After all, she is one of
them’.

Ann was used to working in organisations which had formal organisational hierarchies, specialised
roles and formal controls and systems. She tried to install such formal arrangements within Frigate.
As she said to Ron, ‘we cannot have everyone working as if they were just your personal assistants.
We need structure, standardised processes and accountability’. Ron resisted her plans, at first
through delaying tactics and then through explicit opposition, tearing up her proposed
organisational chart and budget in front of other employees. ‘I regret the day I ever made that
appointment’, he said. After six months, he terminated her contract. Ann returned to the tax
authority as a tax inspector.

Required:

Analyse Frigate Ltd using the cultural web framework for understanding organisational culture.

1.3 Professionalism, ethical codes and the public interest

a) Critically evaluate the concept of responsible leadership and the creation of public value by
acting in the public interest.
b) Assess management behaviour against the codes of ethics relevant to accounting professionals,
including the IESBA (IFAC) or professional body codes.
c) Analyse the reasons for and resolve conflicts of interest and ethical conflicts in an organisation.
d) Assess the nature and impacts of different ethical threats and recommend appropriate
safeguards to prevent or mitigate such threats
e) Recommend best practices for reducing and combating fraud, bribery and corruption to create
greater public confidence and trust in organisations.

A Professional is a person who possesses specialist knowledge about a particular subject through
intense education and experience. E.g. Accountants.

Professionalism is a very fundamental skill or competence expected from professionals.

Professionalism, in simple words, is behaviour to support public interest. Accepting the responsibility
of serving public interest is a key distinguishing factor that differentiates professionals from any
other occupation.

Public interest:
 Leadership and ethics 26

Public interest means working for the benefit of the entire society rather than just for shareholders.
This will include protecting the interest of customers, suppliers, employees, government and society
etc.

How can accountants act in the public interest?

The Accountancy profession as a whole plays a very vital role in upholding public interest by the
provision of information. Individual accountants can act in the best interest by:

• Having high ethical standards

• Fair dealing with all stakeholders
• Sound and factual reporting
• Independent and reliable audits
• Reporting and stopping fraud and corruption.

Professional code of ethics:

ACCA’s code of ethics is based on the International Ethics Standards Boards for Accountants(IESBA).
These codes are principle based and try to ensure that accountants act in the best interest of the
public. These principles are as follows:
 Leadership and ethics 27

1) Integrity: Integrity requires accountants to be honest and straightforward in all professional

and business relationships.
2) Objectivity: Objectivity requires that an individual should not allow bias, conflicts of interest
or the undue influence of others to compromise their professional or business judgement and
infers independence of action.
3) Professional competence and due care: All accountants have a continuing duty to maintain
their professional knowledge and skill at a level required to ensure that employers receive
competent professional service, and at the same time, they must act diligently in accordance
with applicable technical and professional standards when providing professional services.
4) Confidentiality: Accountants must respect the confidentiality of information acquired as a
result of professional and business relationships and shall not disclose any such information
to third parties without proper and specific authority or unless there is a legal or professional
right or duty to disclose. Similarly, confidential information acquired as a result of professional
and business relationships shall not be used to the personal advantage of members or third
parties.
5) Professional behaviour: Accountants must comply with all relevant laws and regulations and
shall avoid any action which may discredit the profession.

Threats to Ethical Behaviour of Accountants:

Ethical threats are situations where professionals are tempted not to follow the ethical principles
stated above.
 Leadership and ethics 28

1) Self-interest threat: Occurs as a result of financial and other interests of members or close
family members. E.g. Owning shares in client, Partner on client board, overdue fees,
contingent fees etc.
2) Self-review threat: Occurs when a previous judgement needs to be re-evaluated by the
same person who passed the judgement. E.g. Recent service with assurance client, providing
other services such as preparing accounting records, taxation, valuation services etc.
3) Advocacy threat: Occurs when members promote a position or opinion which compromises
their objectivity. E.g. representing a client in a deal.
4) Familiarity threat: Occurs when judgement gets biased towards people having a close
personal relationship. E.g. When a close family member or friend is the client.
5) Intimidation threat: Occurs when individuals may be deterred from acting objectively by
threats, actual or perceived. E.g. When clients threaten a professional mentally or physically.

Safeguards against threats to Professional Ethics:

Safeguards protect individuals from threats to professional ethics. It also helps in maintaining
confidence in the profession and upholding the public interest. The following safeguards can be
used:

• Training and experience requirements for gaining membership in profession.

• Continuous Professional Developments (CPD)
• Corporate governance regulations and high standards of professionalism
• Education of employees regarding ethics and professionalism and having disciplinary
positions in place.
• Timely communication of organisations policies and procedures.
• Having good internal controls and whistle-blowing provisions.
• Emphasising an open door culture where employees are free to communicate with senior-
level managers without fear of retribution
 Leadership and ethics 29

Apply your knowledge (AYK 2) (mj18)

Harry Larsen, a qualified accountant, is leading an internal audit team at Bedruch Co investigating
why a major project is currently incurring high costs and overrunning its planned deadlines for
completion. Larsen’s girlfriend is the project manager, although no-one else in the company knows
about their relationship.

The project is critical to moving customers from a slow and old computer system to a new customer
relationship management (CRM) system where all data held on customers can be integrated and
more easily accessed and analysed. If the project looks likely to incur further significant cost
overruns, it is likely to be cancelled by the board, as it will not represent value for money. However,
if the project is not completed, many members of staff, including Larsen’s girlfriend, are likely to lose
their jobs.

Larsen is under pressure to report to the audit committee on his team’s evaluation of the project.
Should he conclude and report that the project is no longer viable, it will be immediately terminated.
Larsen’s girlfriend is very aware of his predicament and is putting immense pressure on him to
misrepresent the true status of the CRM project. She expects her boyfriend to write a favourable
report to the audit committee and recommend that the project should be allowed to complete as
planned.

Bedruch Co does not have its own corporate code of conduct. However, as a qualified accountant,
Harry Larsen is reliant on his professional judgement when deciding what to do next

Required:

Evaluate the ethical threats currently faced by Harry Larsen, and discuss possible safeguards which
could have helped to prevent this situation.

Corporate code of ethics

Corporate code of ethics is about applying ethical values while taking business related decisions.
Companies should develop their own code of ethics, which will be applicable for the entire
organisation.

Purpose:

• To communicate organisations values in a memorable form.

• To identify key stakeholders and the organisations responsibilities towards them.
• To convey the values of the company to the stakeholders.
• To influence and control the behaviour of employees.
• To convey the strategic position of the company.

Some examples of circumstances which are in violation of the corporate Code of ethics are:

• Child labour
• Exploitation and discrimination of employees
• Providing hazardous products to customers
• Depletion of natural resources
 Leadership and ethics 30

Research Activity: Read and analyse TATA groups code of conduct statement.

Often in the SBL case study you will be required to point out whether there has been a
violation of corporate code of ethics and explain why. For this you will need to go beyond
numbers and think whether a particular thing is actually good or bad for the society.

FRAUD

AN INTENTIONAL act of dishonesty to gain an unjust or illegal advantage is known as fraud.

The two basic types of fraud are:

1) Fraudulent financial reporting (e.g. overstating revenue and profits)

2) Misappropriation of assets (e.g. stealing of cash and inventory)

The Fraud Triangle

This triangle identifies the three fundamental elements which lead to fraud being committed.

1) Incentive: High contingent pay, financial pressure etc.

2) Opportunity: Weak internal control and corporate governance etc.
3) Rationalization: Justification for committing fraud.

Risk factor Examples relating to Examples relating to the

fraudulent financial reporting misappropriation of assets
Incentive • Pressure from • Personal financial
shareholders to pressure
perform • Greed
• Fear of losing a job • Dislike of the employer
• Incentives related to (I’ll get my own back!)
performance

Opportunity • Poor internal control • Poor internal control

• Poor corporate • High-value portable
governance e.g., a inventory
dominant chief • Cash-based business
executive who is also a • Poor supervision
chairman
• Results are dependent
on many estimates
and a high degree of
judgement

Attitude • Poor ethics • Poor ethics

• Poor morale • Dislike of the employer
 Leadership and ethics 31

• Excessively aggressive • Other employees’

targets behaviour (and you
become convinced
that the ‘fiddle’ is
normal and therefore
acceptable)

Example: Wells Fargo

A very big fraud was committed in a financial services MNC called Wells Fargo. Employees at Wells
Fargo were given impossibly high sales goals, which rose year on year. But to meet these quotas,
employees at the bank were incentivized to open fake accounts under customers’ names — if a
customer opened a savings account at the bank, employees might surreptitiously open a credit card
under that customer’s name as well. This resulted in a boost in short term profits which were
achieved due to more than 2 million fake accounts. This led to Wells Fargo being charged $3 billion
in fines by the U.S Securities and Exchange Commission. This also led to a huge loss of reputation.

Incentive: Pressure from management to achieve sales targets.

Opportunity: Incentive to open fake accounts showing lack of controls.

Rationalisation: No retribution from the higher-level managers.

Reducing the risk of frauds

Fraud can be reduced in three different stages:

1) Prevention:
• Having sound corporate governance and the right organisational culture.
• Robust system of internal controls.
• Appropriate screening procedures while hiring employees.
• Continuous monitoring and training of employees.

2) Detection:
• Flying squads are making surprise checks.
• Internal audit function
• Whistle blowing provisions

3) Response:
• No tolerance towards fraud
• Strict action being taken on employees as well as managers
• Legal prosecution

Research Activity: Write a report on the fraud committed in Satyam scandal

 Leadership and ethics 32

Bribery and Corruption:

Bribery: It refers to the offering, giving or receiving of any item of value to influence the actions of
an individual holding a position of power.

Corruption: It refers to dishonest or fraudulent conduct by those in power, typically involving

bribery.

Offences under the UK bribery Act 2010

• Offering or giving bribes directly or through a third party.

• Demanding or receiving bribes, whether directly or indirectly.
• Offering or giving bribes to Foreign Public Officials (FPO)
• Organisations are failing to prevent bribery due to inadequate controls.

Provisions and procedures under the above act to prevent bribery/corruption /fraud:

This may be directly asked in the exam that the company’s procedures are adequate to
prevent bribery / corruption / fraud

• Proportionate procedures (i.e. procedures which are proportionate to the bribery risks
which the organisation faces given its activities)

• Top-level commitment (i.e. the senior management should develop a culture of anti-bribery
and set a tone from the top for the entire organisation to follow)

• Risk assessment (i.e. regular assessment and documentation of risk of bribery)

• Due diligence (i.e. taking extra care of employees who are most vulnerable towards
committing bribery)

• Communication (i.e. anti-bribery and corruption policies are well communicated to people
inside and outside the organisation)

Monitoring and review (i.e. monitoring how effective the policies are and reviewing them regularly)
 Leadership and ethics 33

Summary:

Theories of leadership:

1) Trait theory-Physical and personality traits

2) Style theory- Focus on what leaders do rather than what they are

3) Contingency theory- Depends on the situation

Types of leaders:

1) Transactional: Control focused. Worry about doing things right.

2) Transformational: Visionaries. Worry about doing the right things.

Elements of cultural web:

Symbols and titles, Power structures, Organisational structure, Routines and Rituals, Myths and
stories, Control systems and Paradigm

Ethical codes of conduct:

1) Integrity
2) Confidentiality
3) Professional behaviour
4) Objectivity
5) Professional competence and due care

Ethical Threats

1) Self-interest
2) Self-review
3) Advocacy
4) Intimidation
5) Familiarity

Answers to Apply Your Knowledge:

Tutorial note: The answers provided for the apply your knowledge questions are very
comprehensive. Students are not expected to write such extensive answers in the exam, and hence
these should be used only for reference purposes.
 Leadership and ethics 34

AYK1

The cultural web is a representation of the taken-for-granted assumptions, or paradigm, of an

organisation. The question specifically references the cultural web, but any framework that is
appropriate for understanding the culture of an organisation can be used.

Symbols such as logos, offices, cars, titles, language and terminology are a shorthand representation
of the nature of the organisation. At Frigate, the adoption of the term ‘Commander’ by its managing
director, Ron Frew, and his use of naval terminology is indicative of how he wishes to be perceived
and the way he wants the company to run. Indeed, the name of the company itself reflects his naval
obsession. The main symbol of his success is the motor cruiser that Frew owns and moors at the
local port. The irony is that Frew actually has no naval experience. He is acting out a stereotype of
how he perceives naval life to be.

Power structures are also likely to influence the key assumptions of an organisation. The most
powerful groupings within the organisation are likely to be closely associated with core assumptions
and beliefs. At Frigate, power is centred on one person. Leadership comes from a person who holds
strongly held views, opinions and beliefs.

The organisational structure is likely to reflect the power and shows important roles and
relationships. At Frigate, there is little formal structure, and Ann Li’s attempt to put one in place was
opposed.

Control systems, measurements and reward systems emphasise what is important to monitor in the
organisation. Frew is primarily concerned with cost control. Emphasis is on punishment (making
deductions from wages for late arrival) rather than reward, which fits his naval stereotype. There
appear to be few formal process controls, and relationships with both customers and suppliers are
confrontational. Ann Li’s attempt to install formal controls throughout the organisation was resisted
by Frew.

Routines and rituals define the ‘way we do things around here’. For Frew, there is a distinction
between the routines of staff (must arrive on time, minimum holidays with no flexibility) and the
rules that apply to himself – flexible working, long holidays, the expectation that employees will help
him with his personal life.

The stories told by members of an organisation are usually concerned with success, disasters,
heroes, villains and mavericks. It appears that Frew is the hero, seeing off lazy staff, unscrupulous
suppliers (trying to sell me inferior quality goods for higher prices), problematic customers (moaning
about prices and paying later and later) and bureaucratic officials (squandering my hard-earned
money). These are identified as villains. He even extends his stories to society as a whole, believing
that a period working in the navy would do everyone good.

Finally, the company paradigm summarises and reinforces the other elements of the cultural web.
Underpinning all of this is Frew’s belief that the company is run for his own gratification and that of
his immediate family. The benefits he receives and the lifestyle he enjoys is his reward for being a
risk taker in a hostile environment, which is always trying to limit him. He appears to see
expenditure on his family (such as share gifts and holidays) as perfectly acceptable.
 Leadership and ethics 35

AYK 2

Harry Larsen faces the following ethical threats to his independence from the dilemma:

Self-interest threat

This threat to Larsen’s independence arises from his close personal relationship with the project
manager, as it clearly presents a conflict of interest to him. As the project manager is his girlfriend,
he may feel an emotional responsibility towards her and believe that he needs to act primarily in her
best interests. So, should the report conclude that the CRM project is no longer viable, it would be
cancelled, and his girlfriend would lose her job, and she is likely to end her relationship with Harry
Larsen, which is clearly not in his personal interest.

Intimidation threat

The intimidation threat also arises from Larsen’s relationship since his girlfriend is apparently
pressurising him to misrepresent the viability of the CRM project, if necessary so that it can
continue. However, the inference from the scenario is that the internal audit report is likely to
recommend stopping the project because of delays and over-spending, but because of her status in
Larsen’s life, his girlfriend can exert considerable influence over him. Her power is intensified
because no-one in the company is aware of their personal relationship, so I would not infer that she
could intimidate him.

Familiarity threat

Apart from concerns for his girlfriend’s job security, Harry Larsen may be friendly with other
colleagues who are also dependent on the CRM project for their continued employment in Bedruch
Co. This apparent familiarity could also pose a threat to his independence and objectivity. This could
make him inclined to recommend the continuation of the project, even if this is not in the best
interests of Bedruch Co and its shareholders. The threats presented to Harry Larsen will bring into
question his professionalism as an accountant bound by a code of ethics. If he opts to recommend
the continuation of the CRM project for any improper reasons, then his action will bring him into
disrepute, cause harm to his employer and its shareholders, and potentially damage the reputation
of the accounting profession.

Consequently, there are several safeguards which should be put in place to reduce this risk.

Establishing culture

It is the responsibility of the board to inculcate a culture throughout Bedruch Co which encourages a
sense of professionalism among all staff. If this becomes the norm, then staff behaviour and actions
should always be in the best interest of the company. If Harry Larsen had been immersed in such a
professional culture, then the current situation he faces would not have been such an issue to him.

Corporate code of conduct

The most meaningful reason for a corporate code of conduct is to communicate the company’s
shared purpose and values with its employees and key stakeholders. This should be a values-based
approach, providing the tools to support learning and decision making. Bedruch Co could publish a
code of conduct which explicitly states what behaviour the company expects from its staff. However,
rather than simply prohibiting undesirable actions, such as Harry Larsen offering the wrong
recommendation about the CRM project, the code should promote the positive values which form
part of the desired culture. To be effective, explicit board-level endorsement of the code is required.
 Leadership and ethics 36

Internal controls

To complement the control environment promoted through the corporate culture, it is essential
that certain control procedures are established and operating at Bedruch Co. These will ensure that
employees do not act inappropriately with measures in place to actively discourage such behaviours.
Internal controls which would have helped to mitigate the threats to independence posed to Harry
Larsen could include:

1. Employment contract terms and conditions relating to the disclosure of relationships between
members of staff. Such openness would have deterred Larsen’s girlfriend from putting pressure on
him to save her job, as everyone would know she might be influencing him, or he would not be put
in a situation where he had to recommend a decision that would affect her future.

2. Internal audit procedures to prevent and detect fraud and errors. This could involve the head of
internal audit independently reviewing the findings of the CRM report and validating the resultant
recommendations. This would have removed the likelihood of, and opportunity for, Larsen acting
inappropriately.

3. Proper project management systems, including regular progress reports, would have alerted
senior management to the need to take appropriate action early and removed the requirement for
internal audit to intervene.
 Leadership and ethics 37

PO1 – ETHICS AND PROFESSIONALISM

Description

The fundamental principles of ethical behaviour mean you should always act in the wider public
interest. You need to take into account all relevant information and use professional judgement, your
personal values and scepticism to evaluate data and make decisions. You should identify right from
wrong and escalate anything of concern. You also need to make sure that your skills, knowledge and
behaviour are up-to-date and allow you to be effective in your role.

Elements

a. Act diligently and honestly, following codes of conduct, taking into account – and keeping up-
to-date with – legislation.
b. Act with integrity, objectivity, professional competence and due care and confidentiality. You
should raise concerns about non-compliance.
c. Develop a commitment to your personal and professional knowledge and development. You
should become a life-long learner and continuous improver, seeking feedback and reflect on
your contribution and skills.
d. Identify, extract, interrogate and evaluate complex data to make reliable, informed decisions.
e. Interrogate, critically analyse and assess data and other information with professional
scepticism. You should challenge opinion and facts through corroboration and robust testing.

Example activities

• Applying legislation appropriately to client needs.

• Continually reviewing legislation and regulation that affects your working environment.
• Briefing a team on a new standard and how to apply it.
• Keeping sensitive information confidential and disclosing only to those who need it or when
disclosure is legally required.
• Recognising unethical behaviour and telling your line manager about what you have seen.
• Avoiding situations where there may be any threat to your professional independence.
• Deciding what information is important and reliable, using it to support your decision making.
• Completing all the code of conduct and/or professional ethics training provided by your
organisation.
• Checking transactions and supporting documents to verify the accuracy of accounting records.
• Use digital technology responsibly to analyse and evaluate data from a variety of sources,
ensuring the integrity and security of this data.
 Leadership and ethics 38

PO5 – LEADERSHIP AND MANAGEMENT

Description

You manage yourself and your resources effectively and responsibly. You contribute to the
leadership and management of your organisation – delivering what’s needed by stakeholders and
the business.

Elements

a. Show initiative with your team – working towards organisational goals, collaborating with and
supporting others.
b. Manage time and tasks effectively to meet business needs and professional commitments.
You are capable of working under pressure.
c. Manage resources – including teams – to deliver your objectives to agreed deadlines. You
motivate other people and you’re actively involved in helping them to develop.
d. Work with others to recognise, assess and improve business performance. You use different
techniques and appropriate technologies to support business improvement.
e. You negotiate effectively and can justify solutions logically and persuasively to colleagues and
clients.

Example activities

• Effectively managing or leading a group of people.

• Identifying and allocating resources.
• Coordinating activities involving more than one team or department.
• Creating a project plan with timelines.
• Participating in a project team using project management methodology.
• Learning from and influencing others positively, to reach acceptable and desirable results.
• Sharing best practice with colleagues.
• Supporting a positive, inclusive and respectful work environment.
• Training others on an area of work.
• Being a role model to others.
• Allocating work effectively to other team members or suppliers.
•
 Strategy and Business environment 39

2. Strategy and Business environment

2.1 Concepts of strategy

a) Explain the fundamental importance of strategy and strategic decisions within different
organisational contexts.
b) Apply the Johnson, Scholes and Whittington model of strategic management – the strategic
position, strategic choices and strategy into action.

What is Strategy?

In simple words, strategy is a long-term plan to achieve a particular goal.

If a goal is where you want to reach and resources is what you have, how you use those resources to
reach that goal will be your strategy.

E.g. If Boat co. wants to become the leading headphone manufacturer in the world by using its
technological developments, the way in which it uses its technology to beat its competitors to reach
its goal will be its strategy.

A Corporate Strategy is a long-term plan undertaken by an organisation to achieve sustainable

competitive advantage.

A strategy:

• Is long-term direction and scope of a company.

• Helps in achieving competitive advantage.
• Gives direction on the use of resources.
• Helps in meeting shareholders expectations.
• Addresses how to succeed in challenging environments.

Levels of Strategy:

Corporate
strategy

Business Strategy

Functional Strategy
 Strategy and Business environment 40

Corporate Strategy: E.g. Strategy of TATA sons as a whole.

This will consider the entire organisation and include:

• How and where it wishes to grow- Directional Strategy

• Diversification of products and markets – Portfolio Strategy
• The way in which resources and capabilities are transferred between business units – Parenting
Strategy

Business Strategy: E.g. Strategy of TATA Motors

This strategy will focus on a single strategic business unit and will include:

• Steps to be taken to satisfy customers and gain a sustainable competitive advantage.

• Establishment of firms position in the industry.
• Exploiting core competencies and supporting the corporate strategy.

Functional Strategy: E.g. Marketing division of TATA Motors

This relates to a single function within the SBU. This will include:

• Allocation of resources within the division.

• Gaining, retaining and developing resources to support the business strategy.

*It is important that the strategies at different levels are consistent with each other and support the
strategies of levels above them.

Example:

Let us look at the various levels of strategies with the example of TATA co.

Corporate strategy (TATA SONS):

It will deal with which kind of products and services should the company produce and sell. E.g. Salt,
tea, cars, metals etc.

Business strategy (TATA Motors):

To produce cost-efficient cars and target mid-range income people.

Functional strategy (Marketing division of TATA Motors)

This will deal with on which channels of marketing should the division spend money on.
 Strategy and Business environment 41

Strategic planning process- Base Model

The strategic planning process can be broken down into three steps

1) Strategic position analysis

2) Strategic choice
3) Strategic implementation/action.

➢ Strategic analysis/position:
• External environment analysis(PEST etc.)
• Strategic capability analysis
• Stakeholder analysis
• Strengths and weaknesses analysis (SWOT etc.)
➢ Strategic choice
• Generation of strategic options
• Evaluation of the selected strategic options
• Selection of the strategy which suits the best
➢ Strategic implementation
• Implementation of selected strategies
• Monitoring of results
• Amending strategies if results are not acceptable

We follow a logical process while planning and implementing strategies. In the first part, we try to
analyse our strategic position by analysing our external environment, internal resources and
stakeholder analysis. This helps us in understanding where we stand in the market, what are our
strengths and weaknesses and what our shareholders want from us.

In the second stage, we are provided with strategic options. We need to evaluate these options and
select the option which suits us the best.
 Strategy and Business environment 42

After selecting the appropriate option, we need to implement the strategy. The process does not
end here. After implementation, we need to constantly take feedback and compare the desired
results and actual results.

Johnson, Scholes and Whittington (JSW) model:

This model is used for the strategic planning process.

This model states that there are three stages to the strategic planning process. These three stages,
which are strategic analysis, choice and implementation, need not be in a linear way, and they can
be interlinked to each other.

Interdependence between the stages:

In contrast to general beliefs of strategic planning that it should go in the order of Strategic Analysis
> Strategic Choice > Strategic implementation JSW argued that all the three elements are
independent and do not follow a linear path.

E.g. A firm may only be able to understand its strategic position only after launching a product that
is after its strategic implementation.

After the implementation, a company may discover the various strategies which are available to it
and then choose the best one.

This again shows that all the elements are interdependent. In the following sub-sections, we will
learn about these elements in detail.

Strategic analysis:

This is mainly the analysis of where the firm stands with respect to its business environment,
competition and what all resources does it have.

Firstly, let us begin by analysing the business environment of the company.

 Strategy and Business environment 43

Analysis of Business Environment:

3a) Assess the macro-environment of an organisation using appropriate models such as PESTEL.
4a) Evaluate the sources of competition in an industry or sector using Porter’s five forces
framework
d) Apply Porter’s Diamond to explore the influence of national competitiveness on the strategic
position of an organisation.

We commonly believe that any business is affected by its macro-environment and micro-
environment. Let us understand what we mean by both these terms.

Macro-environment is the general environment of the entire economy and affects all industries and
businesses within it. Here we consider factors such as political, social, economical etc.

Micro-environment is an environment which relates more closely to the business or the industry of
the company and has a direct effect on the operations of the business. Here we consider factors
such as customers, suppliers, competitors etc.

Example: If Infosys wanted to analyse its business environment. Its micro-environment would be the
IT industry in particular, and its macro-environment would be the economy of India as a whole.

There are two very important models which we can use to analyse the micro and macro
environment of an organisation which are:

1) PEST for macro environment and

2) Porters five forces for micro environment

PEST/ PESTEL Model:

We need to consider the following factors in each element.

1. Political: Taxation policy, government stability, foreign trade regulations, government

policies etc.
 Strategy and Business environment 44

2. Economic: Inflation, business cycle, interest rates, disposable income, unemployment etc.
3. Social: Social mobility, income distribution, population demographics, lifestyle, literacy
level, consumerism etc.
4. Technological: Technology infrastructure, new discoveries and development, government
spending on technology etc.
5. Ecological/environmental: Awareness regarding environmental problems, regulations on
carbon emission etc.
6. Legal: Laws regarding taxation, unemployment, competition (monopoly) etc.

In the above elements, we need to understand which factors will be favourable for our
organisation and which factors are unfavourable for our organisation. These will reflect the
opportunities and threats.

Illustration:

PESTEL analysis for Amul in India:

Political:

• Support is given by the government for the development of dairy sector.

• Restrictions on export of milk powder suggesting a shortage of supply in the domestic market.
• Reduction in import duties of milk resulting in the entrance of foreign competitors.

Economical:

• High growth rate of GDP in India suggesting higher per capita income and higher consumption of
goods produced by Amul.
• Government grants and interest free loans given by the government.
• High level of Foreign Direct Investment is allowed.

Social:

• Growing fast food culture in India resulting in increased demand of cheese and ice-cream.
• Customary culture of having morning tea, increasing the demand for milk.
• Ever growing youth population which can be exploited by offering savvy products.

Technological:

• Increase in automation resulting in faster processing of milk products.

• Development of cold storage facilities increasing the shelf life of products.
• Developments in e-commerce driving demand for products.
 Strategy and Business environment 45

Ecological:

• Various legislations regarding waste disposal.

• Constructive obligation to reduce carbon emission.
• Requirement to take care of cattle resulting in higher costs.

Legal:

• Various legislations regarding the safety of food products.

• Certain tax exemptions for the particular industry.

Overall, the PESTEL factors suggest that the macro environment is favourable for a company like
Amul to operate in it.

Tutorial note: This was a highly summarized example of a PESTEL analysis. In the real exam, you will
be expected to explain why each point is favourable or unfavourable.

Research Activity: Perform a PESTEL analysis of any Pharma company operating in India.

Porter’s five forces:

These forces directly affect the operations of an organisation. In the porters five forces model, we
again try to analyse the strength of each force and decide whether it is good or bad for us.

Factors to consider when trying to analyse the forces:

1) Bargaining power of customers:

Often customers want to buy a good quality product at a lower price, and companies are
trying to sell at a higher price to achieve higher margins. Who eventually gets their demand
fulfilled will depend on the following factors:
 Strategy and Business environment 46

• Significance of the customer for the organisation

• Number of buyers as compared to the number of sellers
• Switching costs
• Level of differentiation or uniqueness
• Access to perfect information
• Customers bargaining skills

2) Bargaining power of suppliers:

Organisations want to buy good quality material at lower prices, and suppliers want to
supply low quality material at higher prices. The following factors decide which party gets
their demands fulfilled.
• Significance of the supplier to the organisation
• Number of suppliers as compared to buyers
• Importance of the product to the ultimate customer
• Extent of uniqueness
• Access to perfect information

3) Threat of substitutes:
Having substitutes for a product reduces the sales volume and hence the margin of the
company. The following factors determine whether the threat is high or low.
• Extent of suitability
• Switching cost of the substitute
• Price and performance of substitutes

4) Threat of new-entrants:
The existing market share of any organisation is reduced when new entrants appear in the
market. This creates a threat of reduction in profits. This threat can be measured by looking
at the barriers to entry, such as:
• Level of capital investment required
• Protected industries (such as nuclear energy etc.)
• Customer loyalty
• Economies of scale

5) Competition/rivalry:
Competition has an indirect correlation with profits. Higher the competition, lower are the
profits. The current competition can be measured by looking at the following factors:
• Relative size competitors
• Barriers to exit
• Market growth rate
• Lifecycle stage of industry
 Strategy and Business environment 47

Illustration:

Analysis of micro-economic environment of Nike:

1) Threat of new entrants:

• Very high capital investment is required.
• Nike enjoys a very high degree of brand recognition and customer loyalty.
• Rise in e-commerce industry resulting in new entrants selling cheaper products.
• Overall the threat of new entrants is low due to strong brand positioning.

2) Threat of substitute products:

• It is very difficult to find a substitute for athletic footwear and apparel; hence
the demand for such products is bound to increase.
• However, a major threat is posed by counterfeit products who sell shoes with
names such as Mike.
• This may result in decreasing sales for Nike’s products, further resulting in falling
margins.
• But, still overall the threat of substitutes remains low.

3) Bargaining power of customers:

• Nike mainly caters to retail customers, and as they are diversified, their
bargaining power is low.
• The switching costs are low, and hence customers can choose to buy
competitors products. Hence, it becomes necessary to maintain the quality of
the products.
• Nike does have some wholesale customers, such as big e-commerce chains.
These have some bargaining power over the company.
• Overall, the bargaining power of customers is neutral.

4) Bargaining power of suppliers:

• Nike products are manufactured by third-parties who are based outside of the
U.S.
• The production mainly takes place in countries such as Vietnam, Indonesia and
China. These third-parties are diversified and do not account for a significant
level of production as individuals.
• Hence, the bargaining power of suppliers is low.

5) Competition:
• Nike faces severe competition from the likes of Adidas and Puma.
• The switching cost between the different brands remains low; however, brand
loyalty is what binds the customers.
• Overall the force of competition remains high, which reduces profit margins.
 Strategy and Business environment 48

Research activity: Perform an analysis of the micro-economic environment of Parle-g

National competitive advantage:

Some Nations, due to their socio-political and environmental factors, offer a competitive advantage
to some industries which other countries cannot offer. E.g. China’s availability of cheap labour and
access to raw material gives it a competitive advantage in the manufacturing industry. No other
country can afford to produce a similar product at such lower prices, and hence China has a
competitive advantage in that industry.

National competitive advantage can be measured by using the Porters diamond model. This model
captures the essential factors for the success of a particular industry. Our job will mainly include to
analyse these factors and understand whether a particular industry would thrive there.

Porters Diamond:

Determinants of national competitive advantage:

1) Factor conditions:
These are the factors of production necessary to do business, such as labour, land,
machinery, infrastructure, technical expertise, raw materials etc.
E.g. China has the availability of raw materials and cheap labour required for manufacturing
industries.
2) Demand condition:
This is the availability of demand for the product which the organisation plans to sell in the
intended country.
 Strategy and Business environment 49

E.g. China’s huge population itself is a great source of demand for manufactured goods.
3) Related and supporting industries:
Along with the industry which we are considering, we also need to consider whether there
are related and supporting industries which will fuel the growth of the industry.
E.g. Infrastructure industry will support the manufacturing of steel and iron products.
4) Firm strategy, structure and rivalry:
Here we will consider factors such as the ownership pattern( public or private ownership),
level of competition ( monopoly or healthy competition etc.).

Research activity: Analyse why the automobile industry thrives in Germany and why the fashion
industry is so prominent in Italy.

Stakeholder mapping

a) Discuss and critically assess the concept of stakeholder power and interest using the Mendelows
model and apply this to strategy and governance.

Mendelows matrix can be used for stakeholder mapping.

As you can see above in the Mendelows matrix, we use two factors to determine stakeholder
importance which are interest and power.

Stakeholder Influence = Interest x Power

Stakeholders can be classified as follows:

1) Key Players
Stakeholders who have high power and high interest are known as key players. Management really
needs to keep those people happy. They have the power, and they have the willingness to do
something about it if they are upset. These stakeholders can stop any strategy in its tracks.
 Strategy and Business environment 50

2) Keep Satisfied
Some stakeholders have high power, but they are unlikely to take action even if management does
something which they dislike. They may be unwilling to take action because of professional or ethical
reasons.

For example, medical staff in hospitals are very unlikely to take industrial action. Management
doesn’t have to be quite as careful with these people as with the key players. However, they have to
be kept satisfied; otherwise they could be provoked to take action and turn into key players.

3) Keep informed:
People with low power but high interest have to be kept informed. They can’t do much about it
themselves, but they might be able to influence key players to take action on their behalf.

4) Minimal effort:
These stakeholders have low power and low interest. Management can almost ignore these people.
After all, what are they going to do if they don’t like what’s happening?

We need to understand that once we classify all our stakeholders into the various quadrants, they
may not be static forever. Changing conditions may change a stakeholders influence and will lead to
a change in position.

Porters value chain:

 Strategy and Business environment 51

Porters value chain tries to break down an organisations activities into primary and activities and
support activities. This helps in breaking down the various processes of an organisation and
understanding what all things are done by the organisation.

You must have already studied this model previously in your ACCA studies, but in SBL, we need to
check where we need to compare what we do and what our competitors do and how we can add
value to each component of the chain.

We need to understand that providing a more valuable product indirectly adds to shareholders value
as we can charge higher profits and earn higher profits.

Some common ways to add value to our products are: Integrating the entire value chain by using
technology to reduce costs, improving the features of the product to make it more user-friendly and
making it more reliable by using R&D and efficient after sales service, promoting the product by
using correct channels of marketing to exploit a specific segment.

Value Networks

b) Assess the implications of strategic drift.

c) Evaluate the external key drivers of change likely to affect the structure of a sector or market.
e) Assess scenarios reflecting different assumptions about the future environment of an
organisation

Value networks recognize 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, logistics companies.

Ultimately, customer satisfaction and value added depend on all parties working well together
 Strategy and Business environment 52

A value network joins an organization's value chain to those of its suppliers and customers. It
recognizes that a company is dependent on its suppliers and its distributors to ensure that products
are made and are bought by the final consumers. What is ultimately offered to consumers is the end
result of all parts of the value network, and if the value is to be added successfully, all parts of the
network should contribute.

Strategic drift:

Strategic drift occurs when the external environment changes rapidly, and the organisations
strategies are not able to cope up with the change.

As you can see in the above diagram at the first phase, the gap between the organisations strategy
and the external environment is not much as the organisation continues to make small and
incremental changes to match its environment. However, as we move further, the incremental
change is not enough to be in line with the environment, and hence this creates a strategic drift. If
this is not controlled, the organisations are at risk of becoming irrelevant in the market, and then
they have either of the two choices to make some very big change or to wind up.

E.g. Kodak was one of the market leaders in the analog camera segment for over a century. But in
early 2000’s as the world was under a technological boom, many small companies developed digital
camera technology. This trend was ignored by Kodak and it did not innovate to catch-up with the
changing environment. This led to a fall in sales and profitability. Eventually, Kodak had to declare
bankruptcy in 2012.

Research activity: Find out the reasons behind the fall of Nokia and analyse it in terms of strategic
drift.
 Strategy and Business environment 53

Drivers of change:

These are the reasons why the environment of a company changes

• Developments of disruptive technologies.

• Increase in developing economies.
• Globalization.
• Changes in demographics of countries.
• Increasing automation and development of Artificial Intelligence.
• Increasing awareness towards sustainable development.
• Emergence of insourcing markets

Scenario planning:

Scenario planning is all about developing a future plan of how an organisation wants to become in
response to the changing external environment.

Example:

In the near future, electric cars are going to be more prominent, and hence every car manufacturer
is aiming to transform almost all of its production from fuel-based vehicles to electric vehicles.
Jaguar company which is owned by Tata motors, aims to go all electric by 2025 to support its mission
of go green.

3 b) Analyse customers and markets, including market segmentation.

e) Evaluate the opportunities and threats posed by the competitive environment of an organisation.

Customer analysis:

Customer analysis is a process of examining current and potential customers, which can be divided
into segments having similar characteristics. These segments can then be targeted by deriving
specific marketing strategies. (This will be covered in more detail in the coming chapters)

Market segmentation:

This is the process of breaking down the market into smaller segments which have similar
characteristics and then choosing the market which the organisation wants to target.

E.g. the tourism market can be divided into business, leisure and medical tourism etc. Accordingly, a
tourism agency can target a particular segment in this market.
 Strategy and Business environment 54

Opportunities and threats posed by competitive environment:

The favourable conditions which arise due to the changes in the entity’s environment are the
opportunities it can exploit. E.g. Opening of new economies, the discovery of a new trade route,
competitors going out of business etc.

Similarly, the unfavourable conditions will pose a threat to the entity. E.g. new restrictions placed on
a product or service, changes in customer taste and preference etc.

It is important to understand new opportunities and threats posed by the changing environment in
order to strategically exploit opportunities and reduce threats. It should be noted that internal
deficiencies shouldn’t be treated as threats. Opportunities and threats are always external to the
organisation.

Apply Your Knowledge (AYK)-1

Introduction

Network Management Systems (NMS) is a privately-owned high technology company established in

1997 by computer engineer Ray Edwards. It is situated in the country of Elsidor, a prosperous
developed nation with a stable well-established political system. Successive governments in Elsidor
have promoted technology by providing grants and tax incentives. Tax credits are also provided to
offset company investment in research and development. The government, like many governments
worldwide, have invested heavily in a national telecommunications infrastructure. However, in 2010
the country suffered an economic downturn that led many companies to postpone technological
investment.

By 2010 NMS employed 75 full-time employees in a new, purpose-built factory and office unit. These
employees were a mixture of technically qualified engineers working in research and development
(R&D), factory staff manufacturing and assembling products and a small sales and service support
team.

Product areas

In 2010, NMS had three distinct product/service areas – data communication components, network
management systems and, finally, technical support.

NMS sells data communication components to original equipment manufacturers (OEMs), who use
these components in their hardware. Both the OEMs and their customers are predominantly large
international companies. NMS has established a good reputation for the quality and performance of
its components, which are competitively priced. However, NMS has less than 1% of the domestic
marketplace and faces competition from over twenty significant suppliers, most of who also
compete internationally. Furthermore, one of the company’s OEM customers accounts for 40% of its
sales in this area. The international market for data communication components had increased from
$33billion in 2001 to $81billion in 2010. Forecasts for 2011 and beyond predict growth from
increased sales to currently installed networks rather than from the installation of new networks.
The maturity of the technology means that product lifecycles are becoming shorter. Success comes
from producing high volumes of reliable components at relatively low prices. NMS produces
components in a relatively prosperous country where there is significant legislation defining
 Strategy and Business environment 55

maximum work hours and minimum wage rates. All new components have to be approved by an
appropriate government approval body in each country that NMS supplies. This approval process is
both costly and time consuming.

The second product area is network management systems. NMS originally supplied fault detection
systems to a small number of large end-users such as banks, public utility providers and global
manufacturers. NMS recognised the unique requirements of each customer, and so it customised its
product to meet specific needs and requirements. They pioneered a modular design which allowed
customers to adapt standard system modules to fit their exact networking requirements. The
success of their product led to it being awarded a prestigious government technology award for
“technological innovation in data communications”. This further enhanced the company’s reputation
and enabled it to become a successful niche player in a relatively low volume market with gross
margins in excess of 40%. They only have two or three competitors in this specialist market. Unlike
component manufacture, there is no requirement to seek government approval for new network
products.

Finally, the complexity of NMS products means that technical support is a third key business area. It
has an excellent reputation for this support. However, it is increasingly difficult and costly to
maintain the required level of support because the company does not have a geographically
distributed network of support engineers. All technical support is provided from its headquarters.
This contrasts with the national and international support services of their large competitors.

Current issues

NMS currently manufacture 40% of the components used in its products. The rest of the
components, including semiconductors and microprocessors, are bought in from a few selected
global suppliers. Serious production problems have resulted from periodic component shortages,
creating significant delays in manufacturing, assembly and customer deliveries. NMS is still a
relatively immature organisation. There are small functional departments for sales and marketing,
technical research and development, manufacturing and procurement. Ray still personally
undertakes all staff recruitment and staff development. He is finding the recruitment of high calibre
staff a problem, with NMS’ small size and geographical location making it difficult to attract the key
personnel necessary for future growth.

Required:

(a) Evaluate the macro-environment of NMS.

(b) Analyse the industry or marketplace environment that NMS is competing in.
 Strategy and Business environment 56

Levels of strategy:

1) Corporate
2) Business
3) Functional

JSW model:

Strategic analysis, Strategic choice & strategic implementation

Analysis of macro-environment: PESTEL model

P: Political
E: Economic
S: Social
T: Technological
E: Ecological
L: Legal
Analysis of micro-environment: Porters-five forces
1) Bargaining power of suppliers
2) Bargaining power of customers
3) Threat of substitutes
4) Threat of new entrants
5) Competition
Analysis of national competitive advantage: Porters diamond

1) Factor conditions
2) Demand conditions
3) Related industries
4) Firm strategy, structure, ownership

Answers to Apply Your Knowledge

The suggested answers presented below give more detail than would be expected from a candidate
under examination conditions. The answers are intended to provide guidance on the approach
required from candidates and on the range and depth of knowledge, which could be written by an
excellent candidate.
 Strategy and Business environment 57

AYK 1

a) The PESTEL framework may be used to explore the macro-environmental influences that might
affect an organisation. (Candidates will be given credit for defining the main macro-economic
influences that affect NMS, rather than the strict classification of these in the PESTEL
framework.)

Political

The political environment in which organisations operate is very significant. Political parties may
encourage or discourage economic activity through taxation policies and legislative programmes.

NMS is based in a stable, prosperous country, where successive governments have valued and
encouraged technology. Tax incentives and grants are given to companies that invest in technology
and in research and development.

Tax credits are also provided to companies that invest in research and development. These
incentives are open to NMS, its domestic competitors and its domestic customers. The government
has also promoted the use of technology through a well-publicised awards scheme. NMS is a recent
beneficiary of such an award – for “technological innovation in data communications”.

The scenario suggests that the government itself is a major investor in communications technology.
This technology has to be delivered through equipment that meets certain standards of reliability
and compatibility. The government has put an approval process in place to ensure such standards.
Such a process should ensure that technically inferior goods do not make it into the market place.

The current political environment wishes to protect its citizens who are employees by enacting
legislation concerning employment hours, conditions and rewards.

Economic:

The stage or phase of the economic or business cycle clearly affects customer buying decisions. The
case study suggests that 2010 saw a downturn in the domestic economy which resulted in a
reduction of customer commitment to long-term investment. Customers may postpone their buying
decisions, although if innovative products bring cost and communication advantages, then they will
eventually have to invest in them.

Despite worsening economic conditions, labour costs remain high in Elsidor, and the company may
have to reconsider their commitment to manufacturing in the country.

Socio-cultural:

It appears that electronic communication and information exchange will continue to increase with
implications for companies supplying products and systems to meet these growing needs. All
evidence suggests that the social use of services on such networks will increase. Hence, although
demand appears to be currently dropping off, new social uses for telecommunication networks
might spark off a new wave of investment.
 Strategy and Business environment 58

Technological:

Technology is a significant factor in shaping the life cycles of existing products and the introduction
of new ones. The technology sector is extremely innovative, with new and improved technologies
constantly emerging. NMS must scan the external environment for such technologies and identify
how they might affect the future of their current products. NMS must also consider how such
emergent technologies might be used in their own products. The forecast that increased sales will
come from currently installed networks rather than from the installation of new networks is also
relevant here.

Environmental issues:

Green issues have an increasing impact on organisations, particularly in prosperous developed

countries. The reduction of emissions and improvement of re-cycling are likely to be reflected in
socio-cultural trends and enshrined in legislation. The cost of waste disposal is also increasing. All
these issues combine to increase the costs of manufacture and affect the competitiveness of the
company in its market place.

Legal:

NMS operates in a country where there are laws defining employer responsibilities and employee
rights. It is likely that such regulation will continue, and NMS, like all companies working in Elsidor,
have to evaluate the benefits and costs of working within such constraints.

Some organisations seek to gain a competitive advantage by moving to countries where regulation is
more lax and hence avoid the compliance costs incurred by their competitors. The case study
scenario suggests that NMS has significant international competitors. It is likely that some of these
will be based in countries where employment and other legislation are less onerous.

Summary: In the context of the case study scenario, it is political, legal and economic factors that
significantly affect NMS. However, as a technology company with significant investment in research
and development, NMS must continue to scan the technological environment to identify trends that
could undermine, enhance or replace their products.

b) Michael Porter provides, through his five forces framework, a useful way of analysing the
competitive environment of NMS. Analysis suggests that the following key factors are shaping this
environment. Other appropriate models and frameworks could be used, and appropriate credit
would be given.

Bargaining power of buyers

NMS is competing in two discrete market places. In the data communications component market,
where it has less than 1% of the market share, it is, at best, a supplier of marginal significance. The
customers are OEMs, large industrial buyers who are likely to demand a testing combination of low
prices, high quality and reliability. They are unlikely to tolerate the late delivery of orders. It appears
that alternative sources of supply are readily available and that switching costs are relatively low.
This combination of circumstances suggests that OEMs have significant bargaining power in this
market place. This is particularly true for the OEM who currently accounts for 40% of NMS’ current
sales.
 Strategy and Business environment 59

In the second market place, where network management systems are supplied to large end users,
the buyers appear to have less bargaining power. NMS is catering for each customer’s specific needs,
and so each solution is, to some degree, a bespoke solution. This makes it much harder for buyers to
compare products and prices of potential suppliers, unlike in the commodity like data
communication component market. Alternative sources of supply are much more difficult to find as
there are only two or three companies in this specialist marketplace. Furthermore, the product
purchase is likely to represent a relatively small part of the buyer’s overall investment in information
and communication systems. Reduced bargaining power makes this product less price sensitive, and
so provides an opportunity to generate good margins. Large international customers are likely to be
cautious about moving to new suppliers.

The bargaining power of suppliers:

It seems unlikely that NMS will be able to exert much influence on its suppliers. They are purchasing
semiconductors and microprocessors from major global companies, who probably have well-known
and powerful brands. NMS, as a small company, will not have the power to exert buyer pressure on
its suppliers, either in terms of price or delivery. Current problems associated with the delivery of
components are having a significant impact on the company’s ability to meet customer deadlines
and expectations. Clearly, an audit needs to be made of supplier performance and the opportunity,
or otherwise, for NMS to concentrate on suppliers able to deliver on time. However, for a small
company like NMS, the supplier appears to be in an excellent bargaining position.

If labour is seen as a supplier, then evidence again suggests that NMS is in a relatively weak position.
The scenario notes the difficulty of finding high calibre staff with NMS’s “small size and location
making it difficult to attract the key personnel necessary for future growth”.

Threats from new entrants:

NMS is operating in an industry where the costs of entry are significant because it is capital and
knowledge intensive. NMS has shown that there is a place for smaller innovative companies able to
identify and exploit specialist market niches. Economies of scale compel new entrants to enter at
significant output levels or suffer a cost disadvantage. The products are complex, and there is likely
to be a significant learning curve with costs only falling as volume builds up over time.

The need for government approval of new data communications components creates an approval
process that is both lengthy and expensive, and so creates a significant barrier to new entrants. New
entrants may be discouraged by the uncertainty surrounding the industry in terms of technology,
user acceptance and the R&D investment necessary to create components and systems compatible
with OEM’s equipment and end user systems. Furthermore, the need to offer comprehensive
aftersales support, although a problem for NMS, does also create a significant barrier to new
entrants. Finally, the exit costs and barriers to exit in the shape of industry-specific knowledge, skills
and assets reduce the attractiveness of the marketplace to new entrants.

Threats from substitutes:

High technology industries are, by their very nature, prone to new technologies emerging that
threaten and then eventually replace the established technology. Hence it is very important that
companies in such industries constantly scan the external environment to identify and anticipate
such threats. There is evidence that large, successful, high technology companies are particularly
vulnerable to ignoring the challenge from disruptive new technologies. However, the small size of
the NMS may give it a competitive advantage in its ability to respond quickly and flexibly to change.
 Strategy and Business environment 60

Rivalry amongst competitors:

Very different levels of competition are being experienced in the two market places NMS is
operating in. Unfortunately, the financial data given does not separate out the revenue and costs for
each market place. However, it is clear that the high-volume, low-margin component business offers
intense competition with buyers who are able to use their size to extract favourable prices. NMS has
less than 1% of the home market, and there are over twenty competing suppliers, some of whom
have a significant international presence, with a dedicated, geographically distributed support team.
The ability of NMs to generate better market share and volumes through product innovation in this
market seems highly unlikely. Competitive rivalry is high when there are many competing firms and
the costs of leaving the industry are high.

The intensity of rivalry in the network management systems market is significantly less because
there are only two or three competitors in this specialist market. NMS is dealing with a small number
of large end users, designing products specific to their needs. In Porter’s terms, NMS are adopting a
focused differentiation strategy. In these low-volume, high-margin markets, the emphasis has to be
on increasing the volume side of the business, but at the same time making sure that they have the
resources to handle new customers
 Strategy and Business environment 61

PO3 – STRATEGY AND INNOVATION

Description

You contribute to the wider business strategy of your organisation through your personal and team
objectives. You identify innovative ways to improve organizational performance – which may include
making or recommending business process changes and improvements.

Elements

a. Research and be familiar with your employer’s business, the sector it operates within and
the wider business environment.
b. Listen to and learn from colleagues and experts. Anticipate challenges, show openness and
contribute to new ideas and opportunities.
c. Plan, identify and monitor your personal targets and standards of delivery so that they meet
the wider departmental and strategic objectives of your organisation.
d. Think systematically, critically and innovatively using technological capabilities, where
appropriate, when you’re solving business problems.
e. Develop financial acumen and commercial [Link] will allow you to adopt and apply
innovative methods and technologies to identify business problems and evaluate strategic
options and manage solutions.

Example activities

• Using market data analytics tools to research competitor and customer activities.
• Attending courses or conferences and accessing online training that will help you with your
work.
• Highlighting business problems or system issues.
• Planning or managing a project.
• Proposing innovative and practical ideas.
• Discussing general business matters with your colleagues.
• Thinking creatively and speaking openly about business issues and how to solve them.
• Using online resources to develop commercial awareness and keep up with emerging
technologies.
• This could include using social and business media to develop your business networks.
• Highlighting issues at work which cause ineffectiveness or inefficiencies and recommending
solutions.
• Improving organisational systems/tools to drive innovation, process, system and
technological change.

Obtaining information from other departments to evaluate performance or suggest business

improvements.
 Strategy and Business environment 62

PO13 – PLAN AND CONTROL PERFORMANCE

Description

You plan business activities and control performance, making recommendations for improvement.

Elements

a. Contribute to setting objectives to plan and control business activities.

b. Coordinate, prepare and use budgets, selecting suitable models.
c. Regularly review your progress against plans.
d. Use appropriate techniques to assess and to evaluate overall performance against plans.
e. Advise on business performance and recommend improvements.

PO21 – BUSINESS ADVISORY

Description

Develop clear insight into both internal and external clients’ business issues and provide expert advice,
specific to that client, which will add value to the business or organisational function. You support
clients’ objectives and plans to improve, innovate and grow; identify efficiencies and respond to
changing business conditions, helping them to continuously improve.

Elements

a. Identify and use appropriate financial and non-financial information to build a

comprehensive understanding of a client’s business and the business environment in which
they operate.
b. Identify ways for clients to use business partnering to make better connections and develop
successful, relationships, based on achieving best practice and creating additional value.
c. Identify the objectives of the advisory engagement to develop plans to investigate,
implement and support effective change to meet those engagement objectives.
d. Prepare and present plans in an understandable way, which allows the client to evaluate and
act on the business advice.
e. Advise on the appropriate actions to enable the implementation of the chosen solutions.
 Internal capabilities and strategic choices 63

3. Internal capabilities and strategic choices

3.1 Internal resources and capabilities:

a) Identify and evaluate an organisation's strategic capability, threshold resources, threshold

competencies, unique resources and core competencies.
b) Discuss the capabilities required to sustain competitive advantage.

We can try and understand threshold resources and competencies through the following table:

RESOURCES COMPETENCIES
THRESHOLD These are the minimum resources a Threshold competencies include
firm requires to exist. E.g. A the basic processes and activities
restaurant requires chef’s, dining performed by a firm.
tables, waiters etc. E.g. every telecom company is
expected to provide a calling
service.

UNIQUE/CORE Unique resources are particular to an Core competencies are, again,

individual business and are hard to activities which make the firm
replicate. stand out. E.g. Airtel claims to
E.g. when a restaurant has a star chef. provide fasted 4G network in
India.

Strategic capabilities:

The unique resources and the core competencies together give a firm strategic capabilities which it
can use to gain a competitive advantage. These capabilities are hard to replicate by competing firms
and hence are valued by the customers.

Strategic capabilities create value for a company. Creating value in simple terms is what makes the
customer pay extra rupees for. E.g. The branding, camera and security adds value to an i-phone, and
hence people are ready to pay extra money for it.

Research activity: Find out the strategic capabilities of Mcdonald’s.

Critical success factors:

These are the areas where a business must perform well if it wants to achieve its objectives. In the
context of strategy CSF are the features in any product or service which are valued by the
customer.

E.g. From a food processing company, customers expect new and innovative products, health
benefits and lower costs. These become the CSF’s for any company entering the food processing
industry.
 Internal capabilities and strategic choices 64

The difference between strategic capabilities and CSF is that capabilities reflect what the firm has,
and CSF’s reflect what a firm should have.

c) Discuss the contribution of organisational knowledge to the strategic capability of an

organisation.
d) Identify and evaluate the strengths and weaknesses of an organisation and formulate an
appropriate SWOT analysis.

Importance of knowledge as a strategic capability

Data – raw facts

E.g. Detailed entries in sales ledger accounts

Information – data with a meaning

E.g. Sales ledger totals, aged listing

Knowledge – information in someone’s mind

Tacit & Explicit knowledge

E.g. Key contacts within an organization, orders likely to be placed by the customer

Knowledge can be defined as ‘the collective experience accumulated through systems, routines and
activities of sharing across the organization.’

Organisational knowledge can become a very important strategic capability. If an organisation has
good know-how of its customers, suppliers, creditors etc. this can give it a great competitive
advantage.

Much of the knowledge which an organisation needs is in the minds of its employees, which is called
implicit knowledge. There is a growing importance of managing this information with the help of
Knowledge Management Systems. These systems try to extract implicit knowledge, store it and then
use it for organisational success.
 Internal capabilities and strategic choices 65

SWOT analysis

In a SWOT analysis, we do the analysis of the organisations strengths, weaknesses, opportunities and
threats.

It is important to note that strengths and weaknesses are internal to the organisation, whereas
opportunities and threats are external to the organisation.

Example: SWOT analysis of Tesla in India

Strengths:

It has a good know-how of producing electric vehicles. It is an internationally recognised brand. Has
a good portfolio of cars to suit different needs?

Weakness:

No prior experience of selling in India. Not many service centres in India.

Opportunities:

Many people are turning towards eco-friendly cars. Improving the standard of living making it easier
to purchase Tesla cars. Subsidies provided by the government on the purchase of Electric
Vehicles(EV).

Threats:

Threat from competitors offering a similar EV at a lower price. Increase in customers buying from
indigenous companies

Research activity: Do a similar analysis of Citroen company

 Internal capabilities and strategic choices 66

Strategic choices

After we have performed a strategic analysis of the business environment and internal capabilities,
we will now look to analyse the different strategic options available to us which suit our organisation
the best. For analysing the correct options, we again have various models which we will look at in
turn. These will help us analyse the pros and cons of choosing a particular option.

a) Assess the suitability, feasibility and acceptability of different strategic options to an

organisation.
b) Assess the opportunities and potential problems of pursuing different organisation strategies of
product/market diversification from a national, multinational and global perspective.
c) Advise on how the 7 ‘P’s, including price-based strategies, differentiation and lock-in can help an
organisation sustain its competitive advantage.

Suitability, Feasibility & Acceptability (SFA) Framework

This is a framework which can be used while evaluating a strategic choice. E.g. A company wants
to open a new store in the home country.
It can also be used to evaluate acquisition decisions. E.g. when a company wants to buy another
company situated in the same or another country.
We will now look at each of the elements in detail
Suitability
This is where we decide whether the proposed choice is suitable for the organisation by
evaluating whether it is in line with the organisations goal and mission and whether it helps in
solving the current problems faced by the company.
This elements will cover the opportunities and threats which the decision inherits if it’s an
acquisition decision, we will need to discuss the factors of the home country and target country.
Simply we need to check whether taking this decision will be good for the business in the current
scenario. Hence, the focus is more on external factors.

Feasibility:
Here we need to evaluate whether the firm has the necessary resources and competencies to
undertake the proposed strategy and implement it.
We can broadly think of three major resources, which are Human, financial and IT & brand.
Under Human resources, we will check whether we have prior experience of implementing such a
strategy, whether we have experience of working in the intended country of operations etc.
Under Financial resources, we need to check whether we have the necessary funds to implement
the strategy. Whether we can borrow funds given our current gearing ratio etc.
Under Brand and IT, we can see whether we have the necessary infrastructure to implement the
strategy and how our brand name will get affected by it.

Acceptability:
Under acceptability, we want to analyse whether the decision will be acceptable by the
shareholders of the company. As we have seen in previous studies that shareholders are happy
when there is wealth addition, we need to see how the strategy pays of returns. We can do this by
analysing the NPV or forecasts profits.
There will be other factors as well which the shareholders will consider before accepting, such as
risk and drift from proposed goals.
 Internal capabilities and strategic choices 67

Finally, we will also need to do a review of the cultural differences the strategy may pose.

EXAM TIP – WHENEVER THE QUESTION ASKS YOU ABOUT SELECTION OF ANY STRATEGY – USE
THE SFA MODEL.

Ansoff’s growth matrix:

When companies want to grow, they have various choices available to them, which are as follows:

1) Market penetration:
This option focuses on increasing sales of existing products in an existing/current market.
Here we want to increase our market share. This strategy is considered to be low risk as we
have better knowledge of our product and its market. Market penetration strategy can be
followed by:
i) Reduction in sales price.
ii) Increase in marketing and promotional offers.
iii) Buying out a competitor in the same market.

Example: Jio sim introduced itself at a very low price to gain more of market share. This was
a market penetration strategy. It has continuously used this strategy even for other products
like Jio Fibre etc. which focus on acquiring customers by providing services at very low rates.

2) Market development:
In this strategy, the firm tries to enter new markets to sell its existing products to new
customers. New markets may mean new geographical regions or new customer segments
etc. This is considered to be a riskier strategy than market penetration as we do not have
enough experience of working in the new market.

This strategy can be executed by:

 Internal capabilities and strategic choices 68

I. Entering into new regional/domestic markets

II. Entering into foreign markets
III. Selling to a different customer segment

E.g. Under Armour entering India is a part of its market development strategy where it is
trying to sell the same product to a different market.

3) Product development:
This strategy involves developing of new products to sell in the existing markets. This is done
by adding new products to the existing range through the use of R&D.
This strategy is mainly implemented by companies to solve the existing problems. Again, it
can be considered a riskier option than market penetration as we are uncertain about how
the market will react to the new product.

E.g. Introduction of a new e-moped bike called Chetak by Bajaj can be considered as a
product development strategy where it is trying to offer an environmentally friendly product
to the same market.

4) Diversification:
Diversification involves entering into new markets with a new product. This is the riskiest
option as we don’t have enough knowledge regarding both the product and the market.
Diversification can be of two types:
i) Related diversification: There are some similarities between the existing business
and the new product/ market.
E.g. H.P. starting to sell printers is considered as a related diversification strategy.
ii) Unrelated diversification: There are no similarities between the existing business
and the new product/market.
E.g. When Coca-Cola, a beverage company, purchased Columbia Pictures, a movie
studio, it was considered as an unrelated diversification.

Conglomerate diversification:

Conglomerate diversification refers to an unrelated type of diversification. This is when companies

try to increase their portfolio of products. This diversifies the risk of the company and provides
stable returns for the shareholders.
 Internal capabilities and strategic choices 69

E.g. ITC, which is actually a cigarette company, has diversified itself into packaged food (Sunfeast,
Bingo etc.), personal care (Vivel, Engage etc.) and stationery (Classmate).

Horizontal Diversification:

Horizontal diversification means expanding into a related business. For example, an airline taking
over a chain of hotels. Because the businesses are related, there is a real chance that the combined
business will achieve efficiencies, for example, through cost savings or better marketing. You can see
how the airline and the hotels could cooperate by offering accommodation when people go to the
airline booking system.

Backward and forward vertical integration:

Backward and forward of vertical integration are forms of related diversification. Backward vertical
integration means taking over or setting up with a supplier. Forward vertical integration means
taking over or setting up a distributor or customer. Obviously, the operations are related, and there
appear to be great attractions in vertical integration. It’s very easy for a firm to say it itself, I make a
profit, my suppliers also make a profit, and I want their profit, and therefore we will take them over.
However, like many elements of strategy, the real situation can be more complicated.

ADVANTAGES DISADVANTAGES

Diversification may lead to higher profits. Lack of experience may lead to failure.
It helps in spreading of total risk as the portfolio Diversification is a risky strategy compared to
increases others.
Related diversification may lead to the May lead to a lack of concentration on the
achievement of synergies original business

Research activity: Find out your own real life examples for each of the above strategies.

7 P’s of Marketing:

When operating in any business environment, firms have to take some key decisions regarding their
products and services. When a new product is launched, we need to decide some important factors,
which are summarized in the form of 7P’s. Out of which, the first four relate to products, and the
next three can be added for services. These factors (7P’s) are as follows:

1) Product:
Product should be able to satisfy the needs of our customers. It should also be able to stand
out from the competition and hence it should be given a brand name, be of appropriate
quality and have attractive packaging.
2) Price:
Pricing involves the various pricing strategies which can be used for products such as:
 Internal capabilities and strategic choices 70

Price skimming: Where the product is initially sold for a very high price.
Penetration pricing: Where products are sold at a very cheap price initially to gain market
share.
3) Promotion:
This involves how a product will be advertised to potential consumers. The promotion mix
contains four elements: Personal selling, sales promotions, public relations and advertising.
4) Place:
By place, we mean the channel through which the products will be sold in the market, e.g.
online or retail etc. This decision is influenced by the type of product and what the end
consumer would like.

Additional 3 P’s
5) Processes:
This will involve how things are done while providing a service. Speed and efficiency are key
drivers for proving quality service. E.g. the speed at which you get served at a restaurant.
6) People:
In the service industry customer facing employees play a big role for organisational success.
They are in direct contact with the consumer and hence should be well trained. E.g. Air-
hostess is greeting people at the entrance of a flight.
7) Physical evidence:
As services are intangible, it becomes necessary to provide some physical evidence as a
symbol of the service provided. E.g. physical tickets to a cricket match.

To summarise while launching a new products or service we need to take decisions regarding the
above factors which will help us in differentiating ourselves from the competition and giving us a
competitive advantage. These decisions must focus on what the customer wants and how a
particular thing will add value to the product or service.

d) Apply the Boston Consulting Group (BCG) and public sector matrix portfolio models to assist the
organisation in managing their organisational portfolios.
e) Recommend generic development directions using the Ansoff matrix.
f) Assess how internal development, or business combinations, strategic alliances and partnering
can be used to achieve business growth

Portfolio analysis

Now when we are already an established business and if we need to take decisions regarding already
existing products, we need to do a portfolio analysis. This analysis will include evaluation and
classification of each of the current products and then accordingly proposing appropriate strategies
for the same. The analysis can also be of the various subsidiaries of a parent company.

Instead of doing such an analysis in a haphazard manner, there are models already developed which
help us in appropriately analysing models and frameworks.
 Internal capabilities and strategic choices 71

For analysing private sector entities, we can use the Boston Consulting Group (BCG) Matrix, and for
the public sector, we can use the Public sector portfolio matrix.

BCG matrix:

This is used to analyse the current position of subsidiaries or products and to then decide what
course of action needs to be taken.

Analysis:

As you can see above, all the products of a business can be classified into four broad categories. We
will look at each of the categories in detail with the example of Apple’s product portfolio.

Before that, we need to understand some key terms.

Market growth: This is the rate at which the total demand for a type of product increases. A market
growth of 10% or more is considered to be high

Relative market share: This shows a firms market share relative to the largest or (if we are the
largest) the next largest market participant. A market share of more than 1 is considered to be high.

1) Star:
• As the name suggests, this is the star product of the company. The reason a product is
placed in a star is because the market (demand) growth for that product is high, and the
company owns a relatively high market share.
• This shows that the product has the potential to grow in future and make money for the
company.
• E.g. Apples i-phone is a star for the company as the market for mobile phones is on the
rise, and Apple owns a relatively high market share in the mobile segment.

2) Cash cows:
 Internal capabilities and strategic choices 72

• Cash cows, as the name suggest, generate cash for the company. They are in a saturated
market, which means the market growth rate is low, and they hold a high market share.
• Due to this position, they are able to generate high returns in terms of cash and do not
require much investment.
• E.g. I-pad’s. This is because the market for tablets is well saturated, and Apple has a very
high market share. This means that Apple can earn enough cash by holding its position in
the market.

3) Question Marks:
• These are also sometimes referred to as problem child. These are the products which have
a growing market, but the company has not been able to achieve a high market share.
• This shows that the product holds the potential to be a star one day but needs to achieve
a higher market share.
• E.g. Macbook. The total market for laptops is growing by a high rate, but Apple has not
been able to establish a strong foot-hold in the market.

4) Dog:
• This is the least productive product for a company. It is in a saturates market which
means that future prospects of the demand growing are low. Also, the firm does not
have a high market share to generate enough cash.
• Most of the times, these products are because of emotional attachment to them.
• E.g. I-pod. The overall market for I-pod like products decreased immensely after the
introduction of apps like Spotify. The market share of i-pods is also not enough to
generate cash for the company.

Strategies:

After doing the analysis part, we now need to decide what we need to do with the products
identified. The strategies for them can be as follows:

1) Star- Invest
Stars are the future of the business, and hence the firm needs to maintain the market share
in the growing market. To do so, it needs investment, and hence we can use the cash
generated from the cash cow and from the star itself.
Our aim will be to hold the star, and as the market saturates, we will be able to turn our star
into a cash cow.

2) Cash cow- Hold

This is the main source of cash for the firm, and hence the firm would like to hold on to this
and exploit it as far as possible.
To do this, we need to only invest as much as is needed to keep the product needed.

3) Question marks- Invest/divest

As we discussed earlier, question marks have the capacity to become future stars but to gain
a majority market share, it will require a huge amount of funds. These funds can be sourced
from cash cows.
However, the firm needs to decide whether the question mark has the capacity to become a
star and whether the market will keep growing.
 Internal capabilities and strategic choices 73

Accordingly, we will decide whether to invest further or to divest. If the firm does not do
anything, the question mark eventually turns into a dog.

4) Dog- Divest*
The most obvious strategy which comes to our mind when we think about a dog is to divest,
but again we have a catch in here. Dogs can sometimes be closely related to the success of
the star products. E.g. because there is a discount on the dog, customers come into the store
and eventually end up purchasing the star.
These relations should be considered before making a decision to divest or continue.

Research activity: Perform a BCG matrix analysis of the portfolio of ITC.

A similar matrix can be drawn for public sector units with different axis. It is as follows:

The analysis remains somewhat the same as we saw for the private sector in the BCG matrix.

The difference between the private and public sector is that the objective of public sector units is
not to make profits but to deliver service for the benefit of the society.

Apply your Knowledge (AYK 1)

Domestic Appliances Ltd (DAL) commenced trading in 1955, when it started to manufacture semi-
automatic washing machines. From 1965, DAL expanded its product portfolio. Core products now
include fully automatic washing machines, dishwashers, and cookers. The market in domestic
appliances is extremely competitive. DAL’s principal competitor is the Jarvis Electrical Group (JEG),
which has achieved the position of the market leader in many similar areas of the market. Other
information is as follows:
 Internal capabilities and strategic choices 74

1. JEG is the market leader in dishwashers, having 48% of the market. DAL has only 30% of the
market. Environmentalist pressure groups concerned about water consumption have caused a
significant diminution in the size of the market for dishwashers. However, the market remains
profitable, and this is expected to continue.

2. DAL continues to manufacture washing machines using a process which uses new materials for
each unit. Legislation now requires that 35% of all materials used comprise recycled materials,
which means that DAL will no longer be able to sell its washing machines in certain markets.

3. Both DAL and JEG have invested very heavily in the manufacture of steam ovens. DAL has 12% of
the new market, while JEG has an 18% share of the new market.

4. DAL has recently produced a new washing machine, the Celeribus, which washes three times
faster than any other machine on the market. Market awareness of this machine is growing. The
development costs of the Celeribus were significant. At present, the company is making heavy
losses on the production of this product.

Required:

Analyse the product portfolio of DAL using the Boston Consulting Group matrix.

Porter’s generic strategies:

These are the general strategies which organisations adopt in order to gain a competitive advantage
and to decide the scope of its business.

Sources at competitive advantage:

1) Cost leadership:
Here firms try to compete by being the lowest cost producer in the industry. This way,
the firm gains a competitive advantage by competing on the basis of cost.
 Internal capabilities and strategic choices 75

E.g. McDonalds

2) Differentiation:
Here firms try to provide unique products with unique features. The uniqueness forms
the competitive advantage for the firm.
E.g. Apple

3) Cost focus:
This is similar to cost leadership, but here the firm tries to focus on only one type of
product.
E.g. Rorito pens

4) Differentiation focus:
This is similar to differentiation, but again the firm tries to differentiate with a focus on a
single product.
E.g. Rolls Royce

An organisation needs to select the appropriate general strategy after evaluating its
internal resources and capabilities.

Organic and Inorganic methods of growth

When an organisation wants to expand itself, it has various options to choose from.

When an organisation grows from internal development, i.e. by building and expanding everything
from scratch with their own efforts, it is called as organic growth.

When an organisation grows by acquiring, merging or partnering with another firm, it is known as
inorganic growth.

Organic growth:

It is also called as internal development. Here we have to use our own resources to grow.

There are plenty of advantages of growing internally, such as:

• Lower requirement of funds.

• No cultural mismatch with any other organisation.
• Can stay firm with the original strategy of the firm.
• Risk is low due to better knowledge of own organisation as compared to buying an unknown
firm.

However, along with advantages, there will be disadvantages as follows:

• Such growth happens at a very slow rate as everything has to be done from scratch.
• It takes time to reap the benefits of investing in internal growth strategies, and hence new
investments cannot be expected to perform immediately.
 Internal capabilities and strategic choices 76

E.g. Apple believes in the philosophy of organic growth and has grown internally as compared to its
rival Microsoft who has acquired more than 45 companies

Inorganic growth:

1) Acquisitions and mergers:

When a company acquires a controlling interest in another company, it is called an
acquisition.
E.g. acquisition of Flipkart by Walmart.

When two separate firms come together to form a single company, it is called a merger.

E.g. the merger of Vodafone and Idea into a new company called Vi.

Advantages:
• Acquisition and merger is a faster way to grow as compared to the organic model.
• This strategy is mainly used to enter into foreign countries of which the company
being acquired will have more knowledge.
• As the firm being acquired will be selling the same product acquiring it increases the
market share by reducing competition.

Disadvantages:

• Although the growth is fast a lot of money has to be paid to acquire and hence it’s
the more expensive option.
• Every acquisition has the inherent risk of failure to mismatch of culture and strategy.
• It's not always possible to find companies readily available to be taken over.

ORGANIC GROWTH MERGER & ACQUISITION

SPEED Slow Fast
CAPITAL Less required Greater requirement
RISK Substantial Higher
COST Cheapest Goodwill
DISTRIBUTION No distribution Highly Distributive
New opportunities are (may last up to 1 year)
available as the business
expands

Joint ventures:

• When two companies come together and form a separate new company, it is called
a Joint Venture.
• E.g. Tata Sons and Singapore airlines came together to form Vistara airlines, a
completely different entity
• JV’s are always created to exploit the synergies of both the companies.
• However, there are chances that JV’s may also fail due to the similar risks faced like
M&A’s.

Strategic alliance:
 Internal capabilities and strategic choices 77

• When two or more firms come together and operate as one without forming a
separate entity or merging, it is called a strategic alliance.
• E.g. Starbucks India is a strategic alliance between Tata and Starbucks.
• It was created to exploit common opportunities. According to the alliance, Starbucks
has to buy a fixed amount of coffee from Tata coffee, and this transfer happens at a
cheaper price than normal. Hence it created a win-win situation for both.
• However, some alliances may not be equally beneficial for both parties. These also
have the same disadvantages and risks like M&A’s
 Internal capabilities and strategic choices 78

Strategic Capability= Unique resources + Core competencies.

SFA: To analyse Suitability, Feasibility and Acceptability.

Ansoff’s growth matrix

Market penetration: Same product, same market

Market development: Same product, new market

Product development: New product, same market

Diversification: New product, new market

7P’s of marketing: Product, place, promotion, price, process, people, physical evidence

BCG matrix

Star: High growth, high share

Cash cow: Low market growth, high market share

Question mark: High market growth, low market share

Dog: Low market growth, low market share

Porters generic strategy:

1. Cost leadership

2. Differentiation

3. Cost focus

4. Differentiation focus

Growth strategies:

Organic growth: Internal development.

Inorganic growth: Mergers, acquisitions, strategic alliance, joint venture etc.

 Internal capabilities and strategic choices 79

Answers to Apply Your Knowledge

‘AYK 1

The steam oven appears to be a star at the moment since it has a relatively large market share in
what is a high growth market. The Celeribus is a problem child as it has generated losses to date, and
has a relatively low market share in a high-growth market. The challenge facing the management of
DAL is to convert the product into a star. The dishwashers are cash cows as even though the rate of
market growth is low, DAL has a relatively high market share. Cash generated can be used not only
to further develop stars but also to problem children where it is deemed appropriate. The washing
machines will soon become dogs as they are no longer able to be sold in certain markets.’
 Agency, governance and board of directors 80

4. Agency, governance and board of directors

4.1 Agency

a) Discuss the nature of the principal-agent relationship in the context of governance.

b) Analyse the issues connected with the separation of ownership and control over organisation
activity.

Introduction to Agency Theory:

Assume you are an entrepreneur having your own start-up. You own your entire firm and strive hard
to grow it at make it a profitable business. As you are the owner and manager of the business, you
will take decisions which are in the best interest of the firm as this would also reward you as an
owner.

Now imagine a scenario in any listed company, e.g. ITC. The shares of ITC, which represent a certain
amount of ownership in the business, are held by a large number of shareholders. It is not possible
for these shareholders to come together and run the business, and hence they elect Directors to
manage the business on behalf of them.

Now there is separation between the owner(shareholders) and the manager (Director) of ITC. The
shareholders are the principal’s and the directors are the agents.

In a similar way, in Not for profit organisations, the fund providers are the principal’s and the
trustees or the directors of the NPO are the agents.

This relationship between the principal and the agent is known as agency theory.

Issues regarding agency:

In the first scenario stated above, we saw that the owner and manager of business was the same
and he took decisions which were in the best interest of the firm, which also benefitted him.

In the second scenario, the shareholders(principal) and directors(agents) are different. Hence, it is
not always the case that these agents will take decisions which are the best decision of the company
and the shareholders. This conflict of interest is caused due to the differing objectives of both the
parties.

Although it is the fiduciary duty of the agent to act ethically and legally in the best interest of the
shareholders, the following problems may arise.

Problems with Agency theory:

1) Conflict of interest: Directors may put their own interests ahead of shareholders. E.g. Having
high remunerations for themselves.

2) Dishonesty and lack of integrity: E.g. Directors may commit fraud.

3) Ethical violation: E.g. Using unethical ways to earn profit.

4) Lack of transparency: E.g. preparing false financial reports.

 Agency, governance and board of directors 81

Agency cost:

Agency cost is mainly the cost incurred by the principal’s to monitor the activities of the agent. These
costs may be in monetary terms or by time and effort used for monitoring.
E.g. 1) Costs for appointing auditors.
2) Costs of attending Annual General Meetings(AGM).
3) Costs of meeting with financial analysts to analyse the company’s financial health.
4) Remuneration for directors etc.
Residual loss:
When director’s spend over and above their budgeted remuneration, e.g. for luxury cars to
commute etc. it indirectly is taken from the shareholders pocket, and hence it is called a residual loss
for the shareholder. This is also a type of agency cost.

4.2 Governance scope and approaches

a) Analyse and discuss the role and influence of institutional investors in governance systems and
structures.
b) Compare rules versus principles-based approaches to governance and when they may be
appropriate.
c) Discuss different models of organisational ownership that influence different governance
regimes (family firms versus joint stock company-based models) and how they work in practice.
d) Apply general principles of the International Corporate Governance Network (ICGN)’s Global
Governance Principles to organisations’ corporate governance.

Introduction to Corporate Governance:

Corporate governance, in simple words, is the way in which companies are directed and controlled.
The purpose of having a term such as corporate governance emerges due to the separation of
ownership and management.

The objective of corporate governance is to increase accountability towards shareholders and

improve corporate performance.

We can further try to expand its objective based on the type of organisation. Private sector
organisation’s objective behind having good corporate governance will be to increase shareholder
wealth, whereas the objective of a public sector organisation will be to provide value for money
services.

The need for having good corporate governance has grown recently due to the large number of
corporate scandals taking place. These scandals resulted in share-holders losing their confidence in
the company and the capital market system as a whole which affects the entire economy.
 Agency, governance and board of directors 82

Example: Satyam Scam

In 2009 the chairman of Satyam confessed that he had manipulated the financial reports of the
company of Rs 14,162 crores. He had used several ways to do so. This sent shockwaves in the capital
markets.

The share price of Satyam, which was at a high of Rs 544, tumbled to Rs 11.50 within a matter of
days. This resulted in many people losing their money as well as their confidence in the stock
markets.

The global corporate community was said to be shocked and scandalised. This scam was possible
due to the weak corporate governance of the company.

Characteristics of good governance

• Accountability: The directors(agents) should be accountable to shareholders(principals).

• Independence: The directors should not have any conflict of interest, which will limit their
independence.
• Transparency: Directors should provide accurate reports to shareholders with all material
information.
• Responsibility: Directors are responsible for ensuring compliance with laws and regulations
and have a clear understanding of their roles.
• Fairness: Directors should treat all stakeholders fairly
• Social responsibility: Considering moral and ethical issues while taking decisions.
• Probity: Being integral and honest and not concealing any wrongdoings.

Impact of Institutional Investors:

Who are institutional investors?

When you purchase shares in a company as an individual, you are termed as a retail investor, and
when a large organisation with more money invests in a company, they are called institutional
investors.

Insurance companies, mutual fund houses, pension funds etc are common examples of institutional
investors. As we know that they have more money to invests, they will have a significant
shareholding in the company and hence will be able to exert more influence than a normal retail
investor.

As the institutions which investors are looking to make a good return on their investment, they show
shareholder activism by:

• Actively participating in general meetings and exercising their voting rights.

• Participating in key decision making.
• Keeping a record of board composition, non-executive directors and committees.
• Reviewing policies related to remuneration and risks etc.
 Agency, governance and board of directors 83

Problems regarding institutional investors:

• These institutions (e.g. mutual funds) collect money from many small members and create a
large pool of funds. Then they invests these funds in companies to get a significant
shareholding. Hence, the actual owners are the many small members, but they do not get
the right to communicate directly with the company.
• Institutional investors (suppose an insurance company) like to have a steady flow of returns
coming back regularly. Hence, they are more focused on short term profits.
• As these types of investors can exert greater power over the company, it may happen that
the demands of other minority shareholders may get ignored.
• As these institutions have a dominance, they can frequently intervene in the operations of
the company. Some of the situations where they may intervene are given below.

Intervention by institutional investors:

They can interfere in the following circumstances:

• When the board is acting unethically or has weak non-executive directors.

• The company is not complying with the laws and regulations.
• A fall in performance and annual returns.
• Director’s enjoying above average remuneration.
• The company is planning to make an acquisition or disposal.
• When the company is facing strategic drift.

Rules v Principles based approach to governance:

Introduction:

RULES BASED APPROACH PRINCIPLE BASED APPROACH

• In a rules-based approach, an entity is • These approaches are based on
expected to abide by the law at all frameworks which provide guiding
times without any exception. principles on how good corporate
• Any failure to comply is treated as a governance looks like.
legal offence, and the company faces • This approach applies the comply or
prosecution and punishment. explain the principle, where an entity
• This type of approach is adopted in will need to give a valid reason for non-
USA, where the companies have to compliance.
abide by the Sarbanes Oxley Act. • This type of approach is seen in the
United Kingdom in the form of UK
Corporate Governance code

Advantages:

RULES BASED APPROACH PRINCIPLE BASED APPROACH

• As rules are given clearly, there is no • It is more flexible and can be adopted
subjectivity involved. according to the organisation.
 Agency, governance and board of directors 84

• Investors with less knowledge can also • Wider applicability as it is principle

understand the regulations. based.
• Rules are the same for all industries, • Cost of complying is relatively lower.
which prevents discrimination • Extent of compliance can be chosen.
• Any non-compliance is not ignored.

Disadvantages

RULES BASED APPROACH PRINCIPLE BASED APPROACH

• Cost of compliance is higher. • A lot of subjectivity is involved.
• Every issue cannot be addressed by • Cannot be understood by everyone.
rules. • No consistency across industries.
• No scope for flexibility.

Research activity: Identify which type of CG approach is adopted in the top 5 economies of the
world. Find out the major frauds which took place due to which the Sarbanes Oxley Act was
introduced.

General principles of corporate governance:

Organisation for Economic Cooperation and Development (OECD) and International Corporate
Governance Network (ICGN) have published general corporate governance codes which can be used
by organisations all over the world.

OECD Principles:

• Ensure the basis for an effective corporate governance framework to promote transparent and
efficient markets, be consistent with the rule of law

• The rights of the SH and key ownership functions

• Equitable treatment of SH including minority and foreign SH

• Recognize the rights of stakeholders established by law or through mutual agreements

• Timely and accurate disclosure is made on all material matters

• Responsibilities of the board

ICGN Principles:

ICGN believes that for companies to compete effectively, high standards of corporate governance,
including effective dialogue between companies and shareholders, is important. It also believes
that it is beneficial for the public to encourage shareholders to participate in their governance.

• Corporate objectives – generate sustainable shareholder value over the long term.
 Agency, governance and board of directors 85

• Corporate Boards – Deals with many aspects: responsibilities, time, composition and
structure, the role of the chair appointment.
• Corporate culture – Integrity, codes of ethics, bribery, corruption, whistle-blowing.
• Risk Management – Dynamic management process, disclosure to shareholders
• Remuneration of Senior management – proper alignment with value creation
• Audit – robust internal and external auditing
• Disclosure and transparency – aims, challenges, failures
• Shareholder rights – eg. Director accountable
• Shareholder responsibility – particularly institution

UK Corporate governance code:

The UK corporate governance principles can be used to assess the corporate governance problems in
any company. You can use the following points to do so:

• Leadership
– Every company should be headed by an effective board which is collectively
responsible for the long- term success of the company.
– There should be a clear division … between the running of the board and the
executive responsibility for the running of the company’s business. No one individual
should have unfettered powers of decision. This means that the roles of CEO and
Chairman should not be performed by one person as that concentrates too much
power in that person.
– The chairman is responsible for the leadership of the board
– Non-executive directors (NEDs) must be appointed to the board, and they should
constructively challenge and help develop proposals on strategy.

• Effectiveness
– The board should have an appropriate balance of skills, experience, independence
and knowledge. In large companies, NEDS should be at least 50% of the board; in
small companies, there should be at least 2 NEDS.
– New directors should be appointed by a Nomination Committee to ensure a formal,
rigorous and transparent procedure for their appointment. The Nomination
Committee consists of NEDs. This provision is to prevent directors from appointing
their friends and colleagues to the board and ensures that the best people for the
job are considered and appointed.
– All directors should be able to allocate sufficient time to company business.
– There should be induction on joining the board and a program to update and refresh
directors’ skills and knowledge.
– The board should be supplied in a timely manner with the necessary information.
– The board should undertake a formal and rigorous annual evaluation of its own
performance and that of its committees and individual directors.
– All directors should be submitted for re-election at regular intervals

• Accountability
 Agency, governance and board of directors 86

– The board should present a balanced and understandable assessment of the

company’s position and prospects.
– The board is responsible for determining the … significant risks …and should
maintain sound risk management and internal control systems.
– The board should establish formal and transparent arrangements for applying the
corporate reporting, risk management and internal control principles and for
maintaining an appropriate relationship with the company’s auditor.
– This means that an Audit Committee (NEDs again) should be established to liaise
with both internal and external auditors. Before audit committees, the finance
director liaised with auditors, but this was not satisfactory because the finance
director was often the person responsible for accounting problems. Therefore
auditors were often reporting problems to the person who caused them. The
directors are responsible for establishing an internal control system and must review
the need for an internal audit.
• Remuneration
– Levels of remuneration should be sufficient to attract, retain and motivate directors
of sufficient quality… but avoid paying more than is necessary.
– A significant proportion of executive directors’ remuneration should be structured
so as to link rewards to corporate and individual performance. In other words, profit
related pay is encouraged. Directors should not receive high pay irrespective of
company performance.
– There should be a formal and transparent procedure for developing policy on
executive remuneration and for fixing the remuneration packages of individual
directors. No director should be involved in deciding his or her own remuneration.
This means that a Remuneration Committee (NEDs) should be formed to fix
directors’ remuneration.

• Relations with Shareholders

– There should be a dialogue with shareholders based on the mutual understanding of
objectives. The board as a whole has responsibility for ensuring that a satisfactory
dialogue with shareholders takes place.

The board should use the AGM to communicate with investors and to encourage their
participation

4.3 Board of directors (BoD)

a) Assess the duties of directors and functions of the board (including setting a responsible ‘tone’
from the top and being accountable for the performance and impacts of the organisation.
b) Evaluate the cases for and against unitary and two-tier board structures.
c) Describe and assess the purposes, roles, responsibilities and performance of Non-Executive
Directors (NEDs).

The directors of a company collectively are known as the board of directors. The board occupies the
highest level of management in any company. They are held responsible for running the company on
behalf of the shareholders.
 Agency, governance and board of directors 87

The key duties of the BoD according to the UK Corporate Governance code can be summarised as
follows:

• To provide the company with entrepreneurial leadership.

• Represent companies views and its accountability towards the public.
• Prepare a formal schedule of matters for board discussion.
• Set the purpose and mission of the company
• Determine the values and standards by which the company will abide by.
• Appoint the CEO, Chairman and other directors.
• Ensure appropriate internal controls exist to assess and manage risk.
• Have necessary resources in place for achievement of the company’s objective.
• To understand and meet the obligation of the company towards its shareholders and
other stakeholders.
• Establish the necessary board committees.
• Assess and report its performance to the shareholders.

Along with these duties, the board also needs to set a ‘Tone from the Top’. In simple words, this
means that they need to set a good example of themselves for their subordinates to follow. E.g. if
the top managers act in an ethical manner, their subordinates will also follow them and act
accordingly and vice-versa.

As the board is the responsible party for running the company, it also has to take responsibility of its
performance and be accountable for it. The board cannot blame their subordinates or any other
part for poor performance. Along with this, they are also responsible for any wrongdoing happening
in the company.

Structures of the Board:

The board structure can be of two types:

1) Unitary and
2) Two-tier

Unitary boards:

This is the normal structure of a board where there is a single board comprising of Executive and
Non-Executive directors.

The executive directors are responsible for the day-to-day management of the company, and the
non-executive directors are responsible for advising the board and protecting the rights of the
shareholders.

Advantages Disadvantages
All major decisions taken in one forum Less independence & separation of duties
Faster decisions as only one vote needed May lack a clear division of responsibilities
Close ED/NEDs relations More difficult to incorporate representatives of
other stakeholders
Effective communication & information flow

Two-tier boards:
 Agency, governance and board of directors 88

The two tiers are:

1) Lower tier: Operating board

This board generally includes executive directors and is headed by the CEO.
The main function of this board is to manage the day-to-day business of the company.

2) Upper tier: Supervisory board

This board includes representatives of various stakeholder’s, environmental groups etc and
is headed by the chairman. Although these are non-executive directors, they are not
considered as independent as they have some financial and non-financial interest attached
with the company.

These are responsible for:

Appointing and supervising members of the lower tier.
Providing strategic oversight to the organisation.

Advantages of two-tier boards Disadvantages of two-tier boards

• Clear separation of roles • Poor information flows
• The supervisory board can include a • Confusion over power and roles
wide range of stakeholders, e.g., • Slower decisions and potential
workers’ representatives stalemates
• Greater independence of discussion
and decision making

Example:

In Germany, a two-board system is prescribed to the companies listed on the stock exchange. E.g.
The famous automobile manufacturer BMW has two boards.

The reason cited for having two boards is that in countries like Germany, stakeholders such as banks
work closely with the company and are interested in what decisions are taken by the executive
board. Hence to prevent managerial opportunism, two boards are prescribed.

Non-executive directors:

Commonly known as NED’s these directors, as their name suggests, do not take part in day-to-day
activities of the company. Instead, they assume a more of a supervisory role on the board. They try
to protect the rights of shareholders and other stakeholders.

NED’s try to ensure that the executive directors don’t act in an unethical manner and take decisions
in their favour at the expense of the shareholder’s interests.

It is important to note that NED’s should be independent from the company. This means that they
should not have any financial or non-financial interest in the company. This ensures that they act in
the best interest of the shareholders.

Roles of NED’s:
 Agency, governance and board of directors 89

1) Bring external experience to the table and help in formulation of strategy.

2) Scrutinize the performance of executive directors
3) Ensure appropriate internal controls are in place to control and mitigate risk.
4) Participate in formation of committees relating to risk, nomination, remuneration and audit.

Advantages Disadvantages
• Increases shareholder confidence. • Difficult to identify appropriate and
• Increases expertise and experience of independent directors.
the board. • May face resistance from executive
• Reduces the risk of malpractices taking directors.
place. • May not be able to influence the board
• Provides managers and employees with if low in number.
an independent platform to express • May not devote enough time and effort
their concerns and problems. towards the organisation.

Composition of the board

We know that there are executive and non-executive directors on the board, but there is more to it
when we consider the composition of the board.

The board should ideally consist of a chairman and a CEO.

The board should have enough members and enough knowledge, skills and expertise to run the
company.

Ideally, there should be an equal number of executive and non-executive directors on the board to
ensure that the NED’s have enough power and independence of the board is maintained.

Role of Chairman and CEO

Chairman:

• Chairman is the person responsible for running the board. He is a NED.

• He needs to act as a link between the shareholders and the company and communicate with
them.
• He is also responsible for protecting the rights of shareholders and increases shareholders
wealth.

CEO:

• CEO is the person responsible for running the board.

• His main job is to propose strategies, implement decisions and monitor day to day activities
of the company.
• He also needs to efficiently use company’s resources to achieve the aim of the company,
manage risks and provide the shareholders with accurate and timely reports.

Splitting the role of CEO and Chairman:

 Agency, governance and board of directors 90

According to corporate governance principles, the position of CEO and Chairman should ideally be
held by two different people. The person running the board and the person running the company
should not be the same person.

This ensures that accountability is maintained, and no single person gets complete power over the
board. Having complete power gives a person the rights to implement any decision he wants
without being considerate about the shareholders expectations.

Example:

WeWork

We Work is an American real estate company. It was considered to be the next unicorn. It was
backed by renowned financers such as Soft Bank and was being valued at $47 billion at its peak. The
then CEO of the company Adam Neuman was considered to be the next Steve Jobs, ready to
revolutionise the real estate industry.

The problem with We Work lied in its corporate governance. Adam Neuman had complete control
over the company and the board. He had taken out loans from the company at negligible interest
rates. His influence was so high that he sold the company’s logo to the company for nearly $6 million
dollars. Sounds absurd, doesn’t it?

When all this was discovered, the valuations of the company fell to $9 billion dollars from $47 billion
and had to sign a bail-out deal. This bail out deal meant that Softbank would acquire the company,
and Neuman had to resign.

This is why the role of CEO and Chairman should be split, and corporate governance principles
should be followed.

Advantages and disadvantages of splitting the role

Advantages Disadvantages
• Increase in shareholder confidence as • Separation may give rise to groupism as
chairman is a NED two leaders may be created.
• Improved governance • There is a possibility that there will be a
• Split of power leading to better clash between Chairman and CEO.
decision making. • Chairman may purposely disagree with
• Other directors can contact the all decisions just to show power.
chairman regarding any problems with • Chairman is a NED and hence may not
the CEO. have appropriate knowledge of the
• CEO can concentrate on running the business.
business instead of spending time to
manage board and communicate with
shareholders.
 Agency, governance and board of directors 91

d) Describe and assess the importance of induction, performance appraisal and the continuing
professional development of directors on boards of directors.
e) Explain the meanings of ‘diversity’ and critically evaluate issues of diversity on boards of
directors.
f) Assess the importance, roles purposes and accountabilities of the main board committees within
an effective governance
g) Describe and assess the general principles of remunerating directors and how to modify
directors’ behaviour to align with stakeholder interests: .
h) Explain and analyse the regulatory, strategic and labour market issues associated with
determining directors’ remuneration.

Induction of Directors:

Induction refers to the process of orientation and familiarisation of new directors with the company.
It’s the Chairman’s responsibility to ensure that new directors receive formal induction.

Things covered under induction:

• Introduction to the company and its strategies and business plans.

• Introduction to role and responsibilities of a director
• Codes of conduct and professional values all employees need to follow.
• Information regarding directors, major shareholders, stakeholders etc.

Importance of induction:

Helps new directors to get comfortable in their role and understand their duties and responsibilities.

Directors can immediately start contributing after understanding the business of the company.

Helps directors to establish relationships with other directors, chairman, CEO etc.

Continuous Professional Development (CPD)

CPD is a systematic way to maintain and improve the knowledge and skills necessarily required to
carry out their duties and advance in their professional career. Again it’s the Chairman’s
responsibility to ensure that all directors undertake regular CPD.

CPD can be done by:

• Completing professional courses and certifications.

• Reading relevant books.
• Attending internal or external training etc.

After becoming ACCA members, we too need to complete a certain amount of CPD hours every year
as a part of our membership.

CPD is particularly useful to employees an directors to learn about emerging trends in their
particular field. For e.g. a finance director can get to know about emerging trends in the field of
finance such as cryptocurrencies, NFT’s, blockchain etc. This knowledge will help him/her to provide
competent service to the employer as well as gain knowledge at the same time.
 Agency, governance and board of directors 92

Performance Appraisal of the board

As normal employees, even the board of directors has to undergo a performance appraisal process.
The performance of the board is evaluated against their ability to achieve the goals set by the
organisation.

The goals can be as follows:

• Maximisation of shareholder wealth.

• Achieving a certain growth rate ( e.g. 5% increase in profits, revenue etc.)
• Compliance with regulations (amount of fees and penalties paid)

These were just a few measures against which a boards performance can be assessed against. The
directors are then paid bonuses etc. according to their performance.

Diversity in the board:

Diversity refers to having a variety of people on the board as directors. This diversity is based on age,
gender, professional background, experience, ethnicity etc.

You may have read in the news or by reports published by companies and professional bodies such
as ACCA on diversity and inclusion. This is a growing theme in the business world. Stating that a
company has a diverse board such as ‘50% of our directors are females’ creates a good impression
and enhances the company’s reputation.

Advantages Disadvantages
• Directors can be chosen from a wider • Views of diversified members may get
pool of talent. ignored.
• Broader range of resources and • May lead to groupism in the board.
knowledge. • Motivation to contribute will be low in
• Representation of various communities diversified members.
on the board.
• Enhances company’s reputation

Board committees:

These committees are formed by the board members to deal with specific areas of business.
Formation of board committees increases shareholders confidence. The committees can give more
time to specific issues, and the rest of the board can focus on strategic and business matters.

The key board committees are as follows:

1) Nominations committee: It is concerned with recommending appointments of new

directors. The committee should consist of majority of NED’s.
Its key roles are as follows:
• Decide the right size, balance and diversity of the board.
• Ensure the board has relevant knowledge, skills and expertise.
• Identify and attract appropriate and competent directors.
• Carry out induction training and CPD.
 Agency, governance and board of directors 93

2) Remuneration committee: This committee mainly recommends the remuneration policy for
the directors. All the directors in this committee should be NED’s(100% NED’s) to ensure
that the committee remains independent.
While deciding the package, care must be taken that the package is enough to attract, retain
and motivate directors and is somewhat linked to their performance.
Its key roles are:
• Determine appropriate salary for the executive directors.
• Demonstrate that remuneration is set objectively.
• Ensure that remuneration is linked to performance.
• Ensure remuneration policy is accurately disclosed in the annual report.

Remuneration of executive directors:

I. While deciding the remuneration of directors, companies should determine how much
are they ready to pay as compared to competitors.
II. Then the company needs to decide the remuneration level by job description. E.g. by
how much contribution is expected from the director. It should be based in such a way
that it encourages directors to contribute more.
III. Then finally, the company will need to decide how much of the remuneration should be
paid as basic fixed salary, variable pay and in the form of share options etc.
The variable component should be enough to motivate the employees but not too much
as they might take excessive risks to achieve a bonus.
Companies very often pay their directors in the form of share options which help them
in retaining the directors for long periods. This makes them more committed towards
the company as they too become shareholders(potential) of the company.
E.g. when Sundar Pichai became the CEO of Alphabet, he was awarded stock options
worth $240 million. This encourages the CEO or director to stay with the company for
long periods.

Remuneration of non-executive directors (NED’s)

• As NED’s are independent from the company, they are preferably not paid a variable
pay. This ensures that they are in a better position to manage risks.
• Instead, the remuneration consists of a basic salary and some extra pay based on their
contribution(e.g. hours committed to meetings etc.)

3) Risk committee:
This committee is responsible for overseeing the risk management process at an
organisation and ensuring that appropriate internal controls are in place.
Risk committee comprises of a majority of NED’s. Executive directors having specific risk
management expertise can help this committee.

Roles of risk committee are as follows:

• Advise the board on risk appetite of the company and set ALARP levels.
• Identify risks and recommend strategies to manage them.
• Ensure internal controls are present and effective.
• Communicating to shareholders any significant change in the company’s risk profile.
• Implementing formal risk management framework.
 Agency, governance and board of directors 94

4) Audit committee:

This committee tries to ensure that accurate reports are created, internal audit function is
effective and external auditors remain independent. The audit function tries to act as a link
between external auditors and the company.
This committee is only comprised of NED’s.

Role of audit committee is as follows:

• Ensuring that accurate reports are created, and integrity in financial reporting is
maintained.
• Appropriate accounting policies are used, and internal controls relating to financial
reporting are in place.
• Independence and objectivity of internal audit function is maintained.
• Recommend to appoint or remove an external auditor
• Provide whistle blowing arrangements.

We will look at the audit committee in more detail further in the syllabus.

“Apply Your Knowledge 1 (AYK 1)

New Ideas Company (NIC) was launched early this year as a result of a scientific breakthrough at a
university. The company was located in a relatively small regional city, some distance from the main
centres of population. Because the initial capital needed was large, the scientists behind the
company decided to float the company on the stock exchange, and the take up of shares was very
good. This meant that the initial capital needs were fully funded. The business itself was highly
technical, with many shareholders only weakly understanding the science behind the company.
Upon reading the share prospectus, some analysts believed that NIC was a relatively risky business
and that it could fail within two years unless a very good management team, including suitable non-
executive directors (ideally locally based), was in place.

None of the scientists involved in NIC had any experience of business before and had to learn about
the roles of a board and how to effectively run a company. Dr Ranjana Foo, the lead scientist who
made the scientific discovery, was thought to be the logical person to become chief executive, but
she herself questioned her suitability for the role. She said she was happiest working alone and in
the quiet environment of her laboratory and was not inclined to invest valuable time learning about
running a business as she was not good at relating to a wide range of people.

Colleagues said of Ranjana that, being a good scientist, she was excellent at detail but sometimes
struggled to see the bigger picture on a project. Always popular, however, Ranjana liked to think that
all of her colleagues liked her, and she tended to avoid confrontation and conflict wherever possible.

One potential director of NIC was an experienced local businessman, Dr Idris. Upon being
approached about the position, he said that he may have a conflict of interest because he was a
major shareholder in one of the potential suppliers of the capital equipment which NIC would be
purchasing.
 Agency, governance and board of directors 95

Required:

(a) Assess Ranjana Foo’s suitability to become a chief executive officer (CEO) of New Ideas
Company (NIC). Your answer should include an explanation of the roles and personal qualities
of a CEO.
(b) Explain the benefits, specifically to NIC, of the appointment of ‘suitable non-executive
directors’ and discuss the difficulties which the company may encounter in non-executive
recruitment.
(c) Explain ‘conflict of interest’ and briefly discuss how a major shareholding in a potential
supplier could be a conflict of interest to Dr Idris were he to become a director of NIC.”

AYK 2

Lum Co is a family business that has been wholly-owned and controlled by the Lum family since
1920. The current chief executive, Mr Gustav Lum, is the great grandson of the company’s founder
and has himself been in post as CEO since 1998. Because the Lum family wanted to maintain a high
degree of control, they operated a two-tier board structure: four members of the Lum family
comprised the supervisory board, and the other eight non-family directors comprised the operating
board.

Despite being quite a large company with 5,000 employees, Lum Co never had any non-executive
directors because they were not required in privately-owned companies in the country in which Lum
Co was situated.

The four members of the Lum family valued the control of the supervisory board to ensure that the
full Lum family’s wishes (being the only shareholders) were carried out. This also enabled decisions
to be made quickly, without the need to take everything before a meeting of the full board.

Starting in 2008, the two tiers of the board met in joint sessions to discuss a flotation (issuing public
shares on the stock market) of 80% of the company. The issue of the family losing control was raised
by the CEO’s brother, Mr Crispin Lum. He said that if the company became listed, the Lum family
would lose the freedom to manage the company as they wished, including supporting their own
long-held values and beliefs. These values, he said, were managing for the long term and adopting a
paternalistic management style. Other directors said that the new listing rules that would apply to
the board, including compliance with the stock market’s corporate governance codes of practice,
would be expensive and difficult to introduce.

The flotation went ahead in 2011. In order to comply with the new listing rules, Lum Co took on a
number of non-executive directors (NEDs) and formed a unitary board. A number of problems arose
around this time, with NEDs feeling frustrated at the culture and management style in Lum Co,
whilst the Lum family members found it difficult to make the transition to managing a public
company with a unitary board. Gustav Lum said that it was very different from managing the
company when it was privately owned by the Lum family. The human resources manager said that
an effective induction programme for NEDs and some relevant continuing professional development
(CPD) for existing executives might help to address the problems.

Required:
 Agency, governance and board of directors 96

(a) Compare the typical governance arrangements between a family business and a listed
company, and assess Crispin’s view that the Lum family will ‘lose the freedom to manage the
company as they wish’ after the flotation.

(b) Assess the benefits of introducing an induction programme for the new NEDs and requiring
continual professional development (CPD) for the existing executives at Lum Co after its flotation.

(c) Distinguish between unitary and two-tier boards, and discuss the difficulties that the Lum
family might encounter when introducing a unitary board.

Answers to Apply Your Knowledge:

AYK1

a) Roles and qualities of chief executive officer (CEO)

The main roles of the chief executive of a listed company such as New Ideas Company (NIC) are first
to propose and develop strategies capable of making an acceptable return to shareholders. This
involves the CEO having highly developed strategic thinking skills and being able to consider a wide
range of potential outcomes and implications when making strategic plans for the business. It is also
necessary to ensure that strategies are resourced, and so an understanding of investment and the
raising of capital is important.

Second, the CEO implements the decisions of the board. This means that the various divisions and/or
departments in the organisation must work out the strategies agreed, and the CEO must configure
and co-ordinate the business to achieve these. This role requires a strong understanding of the
business and an ability to relate to colleagues at a high level in a number of specialised areas. Highly
developed communication skills are important in this, and the ability to understand the technical
and business aspects of the company are both very important.

Third, the CEO must analyse the performance of all parts of the business in terms of each one’s
contribution to strategy and its fit with the rest of the organisational structure. Because successful
strategies require all parts of the business, at all levels, to contribute fully, the CEO must have the
analytical and processing skills to be able to achieve this. This partly involves analysis of ‘hard’
numerical data such as variances against budget, etc. and also ‘softer’ qualitative skills such as the
ability to assess the human skills and abilities in colleagues and subordinates.

Fourth, the CEO plays the leading role in ensuring that appropriate systems are in place for internal
controls and the management of risk. The robustness of the organisation’s internal systems and
their ability to work effectively towards the achievement of strategic goals means that effective
internal controls need to be in place, possibly including internal audits. Likewise, full and detailed
knowledge of the risks faced by the business, especially strategic risks, is essential. These roles
require the CEO to have multi-conceptual skills and be able to consider a wide range of internal and
external issues at the same time. He or she must be able to delegate technical responsibility for
these tasks whilst having the knowledge and force of personality to be able to make rapid changes
when necessary to respond to new challenges and opportunities as they arise.

Dr Ranjana Foo’s suitability

 Agency, governance and board of directors 97

By her own admission, Dr Ranjana Foo is probably ill-suited to the role of CEO of NIC. As the scientist
who made the discovery in the first place, she is clearly very able in her own technical field, but this
does not necessarily qualify her for the role of CEO. As the scientist who developed the technical
product upon which NIC is based, Ranjana clearly has an excellent understanding of the technical
aspects of the business. Her limitations are likely to be in analysing the performance of other parts
of the business.

As one who prefers to work alone, she would be uncomfortable in large meetings such as board
meetings where she would be required to interact with people most of the time. Her preference for
a ‘quiet environment’ would not be met in the CEO role, where she will need to manage other
directors and negotiate with others.

In her colleagues’ view, she is good at detailed work but sometimes struggles to see the bigger
picture. This would suggest that her strategic thinking skills are underdeveloped, and this would
make it difficult for her to conceive strategic objectives for NIC and put plans in place for their
implementation.

Finally, as one who prefers to avoid confrontation and conflict, she may be unable to effectively
assert her own will and purpose on colleagues who may not fully agree with her on occasions. This is
not to say, of course, that conflict is desirable or necessary, but it is sometimes necessary to over-
rule one or more colleagues in the interests of the greater strategic good.

(b) Benefits of non-executive director (NED) recruitment at New Ideas Company

As a start-up business, NIC faces a number of challenges. The first is the lack of business expertise
among the scientists, and particularly with Dr Foo herself. Dr Foo, obviously a committed scientist, is
unwilling to invest the time necessary to learn about running a business, so they will be heavily
reliant on the expertise and skills of others in developing the scientific breakthrough into a
commercial success.

Because the business is considered risky by analysts, the presence of experienced non-executives is
important in increasing the board’s accountability to the shareholders. With appropriate experience,
NEDs can advise on specific issues with start-up businesses, including working capital management
and issues capable of affecting cash flow in early trading.

The third benefit of having a suitably-experienced NED presence on the board is to demonstrate
compliance with corporate governance listing rules. This would have the effect of reassuring
shareholders, and the analysts providing information to shareholders, on specific types of
businesses. It is important, and especially in the early years of a company’s life, to have the
confidence of markets. An adequate and fully compliant non-executive presence on the board will
help achieve this.

Difficulties in NED recruitment

Despite the increase in non-executive board memberships in many parts of the world, it should not
be forgotten that NEDs have a relatively little financial incentive for board membership compared to
their better-remunerated executive colleagues. In the case of recruiting non-executives to the board
of NIC, the case refers to three specific difficulties which could apply in many regions and not just
the one in which NIC is located in.

The case mentions that NIC, and the university it grew out of, were located in a small city away from
the main centres of population. The isolation of some regions makes the chances of locally recruiting
 Agency, governance and board of directors 98

an experienced and effective non-executive team very difficult. There is usually very little
occupational or geographical mobility (‘churn’) in such regions, with relatively few suitable people
being available. There would also be less chance that those available to be non-executives would be
sufficiently independent of each other (i.e. they are likely to already know each other quite well
through local networks and social organisations).

The highly technical nature of the company’s operations is another potential difficulty. Given that
the company is a highly technical business, it is likely that relatively few people will fully understand
the nature of its work and the technical issues behind it. One of the main purposes of a NED is to
represent the shareholders’ interests on the board, and it therefore is necessary for them to have a
good understanding of how value is added. In scrutinising the internal controls, risks and the
effectiveness of the operations, NEDs need to understand the sources and implications of internal
strengths and weaknesses, and also external opportunities and threats. A failure to understand the
company’s main activities would be likely to deter many potential NED applicants.

The analysts’ view, upon reading the company share prospectus, was that, as with many start-up
businesses, it was risky. Some predicted that the business could fail within two years. Uncertainty
over a business’s future would be a disincentive for some potential NEDs to commit to joining a
board. Some would believe that being associated with a company failure would be bad for their own
business reputations, and therefore they may be reluctant to join the board as a NED. In the same
way, because it is a business which could fail early, the time required to adequately guide and advise
NIC may be substantial and more than many would be able or willing to provide. With so much
resting upon the successful adaptation of a scientific breakthrough into commercial success, and
with a new company start-up developing its own culture and structure, the management
commitment required by NEDs is likely to be initially high.

c)A conflict of interest arises when a person’s ability to act with independence and impartiality is
hindered by a countervailing interest held in a cause which could be the beneficiary of decisions
made. In the case of directors in a business, any countervailing interest which prevents a director
from acting solely in the interests of the shareholders of the business can be considered a conflict of
interest: he or she must act in the interest of shareholders but may also stand to gain or lose
personally by decisions made in his or her capacity as director.

In the case of Dr Idris, his shareholding in the equipment supplier may reduce his impartiality when it
comes to the choice of supplier to NIC. As a director of NIC, he would be duty-bound to always seek
out the best value-for-money for all capital purchases in order to return the highest value to the NIC
shareholders. In this role, he should have no interest in any of the potential suppliers, which may
steer him, in principle, towards or away from any particular supplier.

As a major shareholder in the potential supplier, however, he may stand to gain personally were the
supplier to be awarded the supply contract by NIC. A large contract would generate cash flows and
potential profits to the equipment supplier, increase its visibility and make it more likely to receive
future supply contracts. This could increase the value of Dr Idris’s shareholding in the equipment
supplier, and hence he may have an incentive to recommend the award of the supply contract to the
supplier even although that may not be in the best interests of the shareholders of NIC. There may
be an alternative supplier which would represent better value to NIC and its shareholders.”
 Agency, governance and board of directors 99

AYK 2

(a) Family business and a listed company.

Compare family and listed

There are a number of differences between the governance arrangements for a privately-owned
family business like Lum Co and a public company which Lum Co became after its flotation.

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.

For example, public companies must comply with regulations that apply to their stockmarket listing
(listing rules). Whilst not a legal constraint in a principles-based jurisdiction, listing rules require
listed companies to meet a certain standard of behaviour and to meet specific conditions. These
sometimes include using a unitary board structure and thus, in the case, would require a change in
the governance arrangements at Lum Co.

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.

Assess Crispin’s view

It is likely that the flotation will bring about a change in the management culture and style in Lum
Co. Flotations often cause the loss of the family or entrepreneurial culture, and this contains both
favourable and unfavourable aspects. Whether the company loses the freedom to manage as they
wish will depend upon a number of factors.

Firstly, whether Gustav Lum’s ‘wishes’ (such as the values and beliefs) are known and trusted by the
shareholders. The need for returns to meet shareholder expectations each year often places cost
pressures on boards, and this, in turn, sometimes challenges a paternalistic management style (such
as at Lum Co) which some investors see as self-indulgent and costly.

Second, the company will become subject to listing rules such as the governance code, and, because
of its higher visibility on the stock market, a range of other societal expectations may be placed upon
the company. This will have an effect on all aspects of the company’s internal systems and norms,
including its prior management style. Because of these things, the family will no longer be able to
choose how to act in a number of ways, which supports Crispin’s view.
 Agency, governance and board of directors 100

Third, the board of Lum Co will be subject to influence from institutional investors. They will demand
an effective investor relations department, information on a number of issues throughout the year,
briefings on final year and interim results and sound explanations whenever performance or
behaviour is below expectation. This places the management of Lum Co in a very different
environment to when it was privately owned.

Fourth, the board will be under pressure to produce profits against targets each year, which may
militate against the company’s previous long-term and sustainable commercial approach. If, for
example, the long-term approach may have meant taking less profit from a particular operation in
one year to leave liquidity or cash in place for a future period, this may become more difficult for a
listed company, which can sometimes be under pressure to achieve short-term financial targets such
as a dividend payment.

(b) Induction and CPD

Induction for the new NEDs

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. In the case of the
problems with NEDs at Lum, an effective induction programme will enable the new NEDs to gain
familiarisation with the norms and culture of Lum. This might be more important for Lum, being at
the flotation stage and having a deep-seated family culture.

They will be able to gain an understanding of the nature of the company and its business model.
This will, as with the culture and norms, be especially relevant for a company like Lum emerging
from a long period as a private company with little need to explain its business model to outside
parties.

Induction will help NEDs in building a link with people in Lum Co and other directors. The building of
good quality interpersonal links is important in NEDs working effectively. This applies to their
relationships with other executive and non-executive directors and also with relevant people in the
company itself. This is especially important in NEDs populating the board committees. Induction will
enable the new NEDs to gain an understanding of key stakeholders and relationships, including
those with auditors, regulators, key competitors and suppliers. In order to understand the business
model operated by Lum Co, NEDs need to understand its external relationships and how these
support the company’s operation.

CPD for the existing executives

The purpose of any programme of CPD is to update skills and knowledge as relevant to the
professional situation. This will typically involve content on regulation and law, best practice, new
developments, etc. Directors should undergo CPD regularly to keep these areas up to date and to
ensure they do not ‘fall behind’ on key skills.

In the case of the changes at Lum Co, another specific benefit of CPD will be learning about working
with NEDs and the new board procedures that apply to listed companies. For Lum Co this involved
creating a new unitary board, employing NEDs and generally taking a more consultative approach to
decision-making.
 Agency, governance and board of directors 101

They would also benefit from learning about compliance requirements as a listed company. Legal
and regulatory frameworks differ between private and public companies. The listing rules that will
be imposed by the stock exchange may be seen as an imposition, especially the need to comply with
the corporate governance code. This is likely to necessitate a lot of internal change in governance
and reporting behaviour, and the CPD will help to provide the directors with this support.

After the flotation, the board of Lum Co gained a number of shareholders other than the Lum family.
This would have created a new governance environment, and so learning about coping with the
expectations of shareholders would also be a benefit of the CPD. This would include, for example,
learning about investor relations, dealing with shareholders at an AGM and similar.

(c) Unitary and two-tier boards.

Distinguish between In a unitary board, all directors, including all executive and non-executive
directors, are members. All directors are of equal ‘rank’ in terms of their ability to influence strategy,
and they also all share the collective responsibility in terms of legal and regulatory liability. There is
no distinction in constitution or law between strategic oversight and operational management.

In a two-tier board, responsibilities are split between a supervisory or oversight board (chaired by
the company chairman) and an operational board (usually chaired by the chief executive). The
supervisory board decides on strategic issues, and the operational board becomes responsible for
executing the strategy determined by the supervisory board. Responsibilities between the boards
are clearly demarcated, with the supervisory board responsible for many legal and regulatory
compliance issues (such as financial reporting). Directors on the lower tier (operational board) do
not have the same levels of responsibility or power as those on the supervisory board.

Difficulties for the Lum family

The first difficulty for the Lum family is the loss of the tight control they enjoyed prior to the
flotation. In a unitary board, all strategic decisions need to be taken by a full board, including the
NEDs. It is precisely to prevent small groups of powerful executives from making decisions on their
own that the counterweight of the non-executive board was introduced. This may lead to frustration
in the Lum family members, which may affect the objectivity of some decisions.

The company will lose the capacity for fast decision-making in the family supervisory board because
of the need to involve everybody. Large boards generally meet regularly but on fixed dates. NEDs
and other executive directors are likely to seek explanations for decisions taken outside the main
board discussions and can act against any members, including family members, as the Lum family
only controls 20% of the shares.

The change in culture brought about by the governance changes are difficult for the family to
manage, and the movement to a unitary board is likely to add to the difficulty of this adjustment.
The need to consult widely (on a larger board) and to seek consensus are likely to be significant
changes for the Lum family. For those used to the family way of managing the company, these
changes are likely to be difficult to deal with.
 Agency, governance and board of directors 102

PO4 – GOVERNANCE, RISK AND CONTROL

Description

You contribute to effective governance in your area. You evaluate, monitor and implement risk
management procedures, complying with the spirit and the letter of policies, laws and regulations.

Elements

a. Provide and present information at the appropriate time to comply with organisational
requirements and external regulation.
b. Operate according to the governance standards, policies and controls of your organisation.
You also review your work and your colleagues’ work to make sure it complies.
c. Evaluate and identify areas of risk including data and cyber security risks – assessing the
probability of fraud, error, security breaches and other hazards in your area of responsibility,
and the impact they would have.
d. Assess the risk of failures in the internal controls and procedures in your area of responsibility.
e. Consult with stakeholders and specialists, communicating with them to solve problems and
reach conclusions.

Example activities

• Collating data on risks, including cyber security risks and assessing their likelihood and
potential impact using appropriate technology.
• When you identify risks, bringing them to the attention of your line manager.
• Complying with authorisation limits and other internal controls.
• Complying with money laundering legislation or regulation – and reporting any suspicious
activities.
• Briefing a team on a new policy, procedure or methodology.
• Creating and/or updating policies and/ or process documentation/procedures.
• Training staff on recent compliance issues.
• Reviewing policies, processes or procedures following audit reviews and revise them
accordingly.
Contributing to or organising a survey or focus group to obtain opinions and feedback from
colleagues, clients or customers.
 Stakeholder analysis, reporting to stakeholders, Public sector governance 103

5. Stakeholder analysis, reporting to stakeholders, Public sector governance

5.1 Stakeholder analysis and social responsibility

b) Evaluate the stakeholders’ roles, claims and interests in an organisation and how they may
conflict.
c) Explain social responsibility and viewing the organisation as a ‘corporate citizen’ in the context of
governance and sustainability.

Introduction:

Stakeholders, in simple words, are people who have financial or non-financial interest attached with
the organisation and are affected by the activities of the organisation.

Shareholders are one of the many stakeholders an organisation has.

Stakeholders can be classified as internal and external.

Internal stakeholders: These stakeholders are within the business, such as employees, managers
and shareholders etc.

External stakeholders: These are not involved in directly running the business but are affected by
the organisations decisions. E.g. customers, suppliers, banks, governments and society as a whole.

Stakeholder claims:

Stakeholder claims are the demands stakeholders have from a company. These claims can be of two
types:

Direct claim: These claims are made directly by the stakeholder to the organisation. E.g. Employees
asking for better working conditions is a direct claim.

Indirect claim: These claims are made by those who are unable to directly express their claims as
they do not have a voice. E.g. the claim of the natural environment to protect itself is an indirect
claim.

It should be noted that having an indirect claim does invalidate the claim.

It is an important part of the SBL syllabus to identify who can be the potential stakeholders of a
business and what their claims are.

Research activity: Make a list of the possible stakeholders and their respective claims for a company
like Adidas.

Conflict between claims:

As we saw above that, an organisation will be having many stakeholders and hence many claims as
well. Every stakeholder is trying to maximise his/her benefit from the organisation, and hence claims
are often in conflict with each other.
 Stakeholder analysis, reporting to stakeholders, Public sector governance 104

E.g. Shareholders expect employees to work for longer hours and increase profits. However, on the
other hand, employees want better pay and working conditions which will reduce profits. This
creates a conflict for the organisation.

Solution to such conflicts:

When the organisation needs to decide which stakeholders claim should get priority over the other,
they need to first understand the significance of each stakeholder. This can be done by
systematically mapping stakeholders and then applying appropriate strategies, which were covered
in chapter 2.

Corporate social responsibility

Along with the main aim of maximising shareholder wealth, companies also need to consider their
impact on social and environmental aspects. CSR is an obligation of an organisation towards
considering the interests of customers, employees, general public and ecology and not just of
shareholders.

By implementing CSR strategies along with general business, companies can achieve both social and
corporate value.

In simple words, CSR is what a company does to care for the society as a whole rather than just
building wealth for their shareholders.

Example:

Mahindra and Mahindra (M&M) has established Mahindra Education trust and Mahindra foundation
for achieving its CSR goal of providing education programs to economically and socially
disadvantaged communities. It’s CSR programs mainly cover the provision of scholarship and grants,
livelihood training, health care etc. for remote areas.

As you can observe, M&M is actually an automobile manufacturer but for the purpose of CSR, it is
going beyond its natural business activities and helping the community.
 Stakeholder analysis, reporting to stakeholders, Public sector governance 105

Approach towards CSR:

1) CSR Strategy:
This approach suggests that organisations should have formal policies in place for
implementing CSR strategy. This will help organisations select and focus on a particular
activity from a pool of CSR activities which can be undertaken.

2) Strategic CSR:
This approach suggests that instead of doing CSR as a separate activity, it should be
incorporated in firms core operations.
E.g. Tech companies providing learning opportunities to young graduates via internships and
scholarships to work in their own company.

Arguments

For CSR Against CSR

• Builds a good reputation for the • CSR activities require money, and
company. hence they reduce profits.
• Compensates the society for the • It should be the Governments job to
hardship caused by companies. care for the society, and as companies
• Acts as a way to give value back to the pay taxes to the Government, they
society, which provides companies with should not be required to do anything
resources. else.

Corporate Citizenship:

It is defined as "A company's role in, or responsibilities towards society."

We all know that a company is an artificial person. Hence, like a normal person, a company should
also be responsible for the well-being of its environment.

Corporate citizenship is about companies going beyond their ethical and legal obligations and doing
something positive for their stakeholders.

It is achieved by activities which enable interaction between the company and its stakeholders. It is
gaining popularity as corporates have the power to a good way and bridge the gap of government
failure.

Example: Companies have started working towards achieving zero emission, although it is not
required by the law. This act is done as a symbol of corporate citizenship.
 Stakeholder analysis, reporting to stakeholders, Public sector governance 106

Apply Your Knowledge (AYK1)

Rosey and Atkins (R&A) is one of the largest institutional investors in the country. Its investment
strategy has traditionally been to own a minor shareholding in each of the top 200 companies on the
stock exchange. The R&A shareholding is typically between 2% and 10% of each company, and it
manages funds for over two million clients (people and businesses who buy into share funds
managed by R&A).

Established over 200 years ago, R&A has always believed itself to be socially responsible. As part of
its CSR strategy, R&A recently purchased 100% of the shares in a national housebuilder, Natcon,
which it owned as a direct holding and did not include in its managed funds. Natcon, in turn, owned
a large amount of land suitable for future low cost housing development. The R&A website reported
that the reason for this purchase was to address the board’s concerns over a shortage of affordable
housing in the country, which R&A felt they could help to address by having outright ownership of
Natcon. R&A reported that there was a large social need for affordable homes, and it hoped to
create many hundreds of new low cost homes each year.

Natcon wanted to build a large estate of new homes in the town of Housteads, and the local
government authority granted the required building permission. But the nearby University of
Housteads strongly opposed it because it believed the new houses would ruin what was considered
to be a panoramic view from the university campus, which helped it to recruit staff and students to
the university. Both the Housteads local government authority and the University of Housteads had
money from reserves invested as clients (i.e. fund investors) with R&A, but with the university
having a substantially smaller investment in the fund than the local government authority. The local
government authority also owned shares in R&A, meaning that it was both an investor in funds and
a shareholder in R&A.

Required

a) Explain the difference between ‘corporate social responsibility (CSR) strategy’ and ‘strategic
CSR’, and construct the argument that the purchase of Natcon (the house builder) is an
example of strategic CSR.
b) Explain how stakeholder claims are sometimes in conflict and, using a suitable stakeholder
analysis framework, assess the competing claims of the local government authority and the
University of Housteads in the proposed housing development
 Stakeholder analysis, reporting to stakeholders, Public sector governance 107

5.2 Reporting to Stakeholders

a) Discuss the factors that determine organisational policies on reporting to stakeholders, including
stakeholder power and interests.
b) Assess the role and value of integrated reporting and evaluate the issues concerning accounting
for sustainability.
c) Advise on the guiding principles, the typical content elements and the six capitals of an
integrated report, and discuss the usefulness of this information to stakeholders...
d) Describe and assess the social and environmental impacts that economic activity can have (in
terms of social and environmental ‘footprints’ and environmental reporting).
e) Describe the main features of internal management systems for underpinning environmental
and sustainability accounting, including EMAS and ISO 14000.
f) Examine how the audit of integrated reports can provide adequate assurance of the relevance
and reliability of organisation reports to stakeholders.

Introduction:

Stakeholders need a variety of information to take decisions regarding the concerned company. This
information is provided by companies in various forms of disclosures. They can be categorised as:

1) Mandatory disclosures: This includes all the information which is required to be disclosed as
per the law. E.g Audited financial reports etc.
2) Voluntary disclosures: This will include all the information which the company wishes to
disclose and is not required by the law. E.g. Forecasts and future plans etc.

The annual reports published by the company are mainly addressed to the shareholders, but other
stakeholders can also derive relevant information from it. The Annual General Meeting is considered
as the only major channel through which shareholders can communicate with the directors.

Problems associated with annual reports:

Consider you are an investor who has recently started investing, and you are looking for potential
companies to invest your money. The main source of information will be available through the
company’s annual report only.

The problem here is that the annual report only gives a historical view of the company (i.e. profit for
the year, revenue growth etc.), whereas you as an investor want to know more about what the
company does, who are its competitors, what are the future plans of the company, how is the
company performing on the social and environmental front.

Traditional reports failed to provide such information, which lead to the development of Integrated
reporting.

Integrated Reporting:

Integrated reporting is a principles based framework developed by the International Integrated

reporting Council (IIRC) in 2013. The main aim of an integrated report was to remove the drawbacks
of traditional reports.
 Stakeholder analysis, reporting to stakeholders, Public sector governance 108

An Integrated report:

• Is a concise communication of an organisation’s strategy, governance and performance.

• Helps in demonstrating the links between an organizations financial performance and its
wider social, environmental and economic context.
• Shows how organisations create value over the short, medium and long term.

The main aims of an Integrated report are to:

• Enable more effective decision-making at the board level.

• Improve the information available to investors.

• Encourage more integrated thinking and business practices.

As mentioned above, Integrated reporting is a principles based framework, and hence it is not
mandatory to produce integrated reports. As it is principle based every company can create a report
which best suits its business and has the relevant contents of the report.

Integrated reporting does not replace other forms of reporting. The disclosures which are legally
binding have to be made either separately in isolation or as a part of the integrated report. IR’s
vision is that the makers of the report collate relevant information which is already produced to
explain the key drivers of business value.

IR should also provide insight into the quality of relationships an organisation has with its key
stakeholders. This will include how and to what extent the organisation understands and responds
to the needs of these stakeholders. Another important element about IR is that it should be
consistent over time to enable comparison with itself and other entities.

Contents of Integrated Report:

• Organizational overview and the external environment. What does the organization do,
and what is the environment in which it operates?

• Opportunities and risks. What are the key opportunities and risks, and how do they affect
the organisation’s ability to create long-term value?

• Strategy and resource allocation. Where is the organization headed, and how will it get
there?

• Business model. What is the business model (how does it make money), and is this resilient?

• Future outlook. What are the challenges and uncertainties that are likely, and how could
these impact on strategy?

• Performance. How is this measured, and how has the organization performed?

• Governance. What is the governance structure? Is it effective and fair to stakeholders?

• Basis of preparation. How have items been measured, and on what basis are they included
in the integrated report?
 Stakeholder analysis, reporting to stakeholders, Public sector governance 109

An integrated report tries to explain the value creation process of the company. For this, it tries to
explain how an organisation uses its capitals to generate expected output within the business
environment.

Six capitals of IR (Highly examinable)

• Financial

Financial capital is the pool of funds available to an organization. Not only is it the cash it
has, but also potential borrowings or other sources of funds.

• Manufactured – Non Current assets

Manufactured capital is human-created, production-oriented equipment and tools.

• Intellectual:

Intellectual capital is of key importance to an organization's future earning potential. It is

linked with investment in R&D, innovation, human resources and external relationships,
which can determine the organization's competitive advantage. Also included here are
brand and reputation.

• Human

The knowledge, skills and experience of the company’s employees and managers as they
are relevant to the operations of the business. It includes competencies, tacit and implicit
knowledge and attitudes.

• Social and relationship

 Stakeholder analysis, reporting to stakeholders, Public sector governance 110

This is the collection of resources created by the relationships between an organization and
all its stakeholders, such as customers, suppliers and government. A common feature of
social and relationship capital is the trust upon which it is built

• Natural Capital

Natural capital includes resources, such as metal, water, minerals and oil, which can be
used to provide a return. Also included is the capacity of the world’s carbon sinks — i.e., the
air, forests and oceans — to neutralise or absorb the waste generated by economic activity

Difference between traditional reports (Financial statements) and Integrated reports

Traditional Reports Integrated reports

• Convey financial performance of a • Convey the overall business
company performance
• Only considers financial capital • Considers the role of six capitals
• Focus is on short term results • Focus is on long-term value
• Provides historic information creation
• Minimal consideration given to • Provides historic as well as
environmental and social factors futuristic information.
• Provides sufficient information
regarding social and environmental
performance

The characteristics of IR mentioned in above table can also be considered as the advantages
of using IR

Research Activity: Read the latest Integrated Report of ACCA

Sustainability

Sustainability refers to meeting the needs of the present without compromising the ability of future
generation to meet their own needs. For e.g. we cannot use up all the natural resources like crude
oil to meet our demand right now as it will hamper the ability of future generations.

The activities of a company leave three types of footprints which need to be measured.

Economic footprint: It refers to the economic performance of the company.

Social footprint: It refers to the impact of the company’s social policies on the world. E.g. policies
regarding the company’s employees, partners, sub-contractors etc.
 Stakeholder analysis, reporting to stakeholders, Public sector governance 111

Environmental footprint: It is the impact a company has on the environment in terms of the natural
resources it uses and any harm it causes by pollution etc.

It is believed that for a company to prosper, it needs to have a synergy between the three types of
footprints. This means that you cannot do great in one part thing by sacrificing the other.

Accounting for Sustainability:

The two main methods for accounting of sustainability are as follows:

1) EFCA (Environment Full Cost Accounting): This aims to calculate the full cost of companies,
including economic, environmental and social costs. It also includes costs incurred outside
the company, which may be non-financial as well e.g. cost of environmental damage.
2) Triple bottom line: This method is encouraged by the Global Reporting Initiative(GRI). It
aims to include social and environmental performance along with financial performance. It is
also called as 3 P’s (Profit, People, Planet) method of reporting. The three areas can have the
following measures.
Financial: ROCE, profitability, dividend payout etc.
Social: CSR, diversity, lesser discrimination etc.
Environment: Carbon footprint, use of resources such as water etc.

Environmental reporting:

Environment reporting is supported by various management systems, which include:

1) EMAS
2) ISO 14000

EMAS (Environmental Management and Audit Scheme)

It is a management instrument developed by the European commission to evaluate the report and
improve their environmental performance. It can be used by any organisation.

Under this system, organisations are required to regularly produce reports regarding their
environmental performance.

ISO 14000

It is a series of international standards on environmental management. The series provides:

• Guidance on the development of environmental management systems.

• General principles and specific guidance on environmental auditing.
• Guidance for qualification criteria for environmental auditors.
• Guidance on audit program review and assessment material.
• Guidance on performance targets
• Coverage of life-cycle issues.
 Stakeholder analysis, reporting to stakeholders, Public sector governance 112

Apply Your Knowledge (AYK) 2

Recent changes to environmental regulations have shifted the onus of responsibility onto companies
to prove that their actions did not cause environmental harm, rather than requiring the regulators to
prove where the fault lies. The board of Oskal Petroleum decided to review its strategic position and
how this regulatory change could impact on Oskal Petroleum. The directors concluded that the new
regulations potentially exposed their business to considerable costs if they were required to deal
with the aftermath of spillage of any environmentally hazardous substance, such as oil. These costs
would be above and beyond any fines or compensation orders which might flow from a related
prosecution.

A major spillage from a competitor’s oil rig off the African coast several years ago is still under
investigation, and so far, it has resulted in hundreds of millions in related costs, which damaged the
business significantly and caused a large and sustained drop in the share price.

Oskal Petroleum, although based in Europe, is a global business with onshore and offshore oil fields
in four continents. It has always enjoyed good relations with the host governments in those
countries where it has operations, but recently several governments have adopted a more
interventionist approach to domestic environmental policy in the aftermath of the African oil
disaster. Consequently, the finance director strongly advised the board to set aside an amount of
cash equal to 10% of profits to mitigate against the impact of any costs which might arise if an Oskal
oil field suffered a major spillage. The finance director’s proposal was approved alongside the
decision to undertake a formal environmental risk assessment of all Oskal operational assets
throughout the world, particularly in those countries where governments were taking a keen
interest in influencing the environmental and social policies of businesses.

In a further attempt to pacify its active stakeholders and show shareholders that they were taking
environmental risks seriously, the board decided to fully adopt the integrated reporting framework.
It planned to include the findings from the environmental risk assessment in the next annual report.

Required:

Explain the concept of integrated reporting, and explore how an integrated report covering the six
capitals provides insights for the shareholders and other stakeholders of Oskal Petroleum.

5.3 Public sector governance

a) Discuss public sector, private sector, charitable status and non-governmental (NGO and quasi-
NGOs) forms of organisation, including agency relationships, stakeholders’ aims and objectives and
performance criteria.
b) Assess and evaluate the strategic objectives, leadership and governance arrangements specific
to public sector organisations as contrasted with the private sector.
c) Explain democratic control, political influence and policy implementation in public sector
organisations.
d) Discuss obligations of the public sector organisations to meet the economy, effectiveness,
efficiency(3 ‘E’s) criteria and promote public value.
 Stakeholder analysis, reporting to stakeholders, Public sector governance 113

Up till now, we have studied governance from a private sector point of view in which we normally
assume the aim of companies to be the maximisation of shareholders wealth. However, now we will
study governance from a public sector point of view where the main aim is not to increase wealth
but to provide value for money services to the public.

First, let us start by understanding the difference between public, private and charitable
organisations.

Private Public Charity/NGO

Aim Profit maximisation Provision of VFM services Social wellbeing

Principal Shareholders Public(tax payers) Donors

Agent Director Government officers Trustees
Governance Board of directors Ministries/Committees, Board of trustees
structures Directors

Sources of finance Debt and equity Tax collection, Government Donations

spending

Performance Profitability, TSR (total Value for money criteria Achievement of social
measures shareholder return) objectives.

Difficulties in Public sector governance:

1) Principal-agent relationship:
Unlike the private sector, the principal agent relationship is not direct in the public sector.
The tax payers remain the principals, but they are not in direct contact with the agents
providing those services. The agents providing those services, such as directors of a public
company, are also known as sub-agents.

2) Multiple objectives:
Public sector organisations are not for profit, and hence they need to cater to a variety of
objectives. E.g. government railways have to provide a cheap mode of travel and a high level
of passenger security at the same time.

3) Performance measurements:
The above problem of multiple objectives further creates another problem of performance
measurement. It is difficult to find measures for each activity an organisations perform. E.g.
Is having a low number of crime cases reported a sign of inefficiency of the local police
department or a sign of they being able to achieve their objectives.

4) Financial constraints and no motivation for profit:

Unlike the private sector, public companies cannot raise funds directly from the public. Their
funding is internally controlled by the government. Plus, there is no motivation for the
directors to increase revenue and profits as they are going to get paid anyways.
 Stakeholder analysis, reporting to stakeholders, Public sector governance 114

5) Political influence and lack of competition:

Public sector organisations have a high level of political influence. They are most sensitive to
changes in Government policies etc. It also enjoys some privileges from the Government
and hence does not have direct competition but this further results in a lack of
benchmarking performance and inefficient service.

Value For Money (VFM) framework

This is also known as the three E’s framework. It is used for measuring the quality of service provided
by the public sector organisations.

Economy - Attaining the appropriate quantity and quality of inputs at the lowest cost. Even at lower
costs, the organisation cannot compromise on quality.
E.g. Cost of procuring books for a public school.

Efficiency - Maximizing the output for a given input. Again the quality of the service should be
upheld.
E.g. Number of students taught by a single teacher (student teacher ratio)

Effectiveness - Determining how well the organization has achieved its desired objectives.
E.g. Number of students passing the relevant exam.
 Stakeholder analysis, reporting to stakeholders, Public sector governance 115

Stakeholder types: Internal and external

Stakeholder claims: Direct and Indirect

Solution for conflicts between claims – Stakeholder mapping

CSR- Corporate Social Responsibility- Giving back to the society

Corporate citizenship- Duty of a company towards the society

Integrated report

Contents:

• Organizational overview and the external environment

• Opportunities and risks
• Strategy and resource allocation
• Business model
• Future outlook
• Performance
• Governance
• Basis of preparation

Capitals:

1) Financial
2) Manufactured
3) Intellectual
4) Human
5) Social and relationship
6) Natural capital

Environmental accounting methods:

1) Environmental Management and Audit Scheme(EMAS)

2) ISO 14000

Sustainability accounting:

1) Environment Full Cost Accounting (EFCA)

2) Triple bottom line (Profit, People, Planet)

Public Sector problems

• Agent-principal relationship
• Multiple objectives
• Performance measurement problems
• Government interference and limited funding
• No motive for profit and no competition
 Stakeholder analysis, reporting to stakeholders, Public sector governance 116

AYK answers

AYK 1

a) Distinguish between CSR strategy and strategic CSR

To have a strategy for CSR is to have a set of policies which guide and underpin CSR activities. 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.

When CSR is undertaken to maximise its effects on the long-term economic benefit of the business,
it can be described as strategic CSR. When CSR activities are strategic, they generally support the
main business areas of the business. 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.

Argument that the purchase of the house builder is strategic CSR

The purchase of the house builder is described in the case as a departure from R&A’s longstanding
strategy of investing in listed companies as part of its holding of passive funds. In arguing that it is
nevertheless strategic and therefore in the long-term economic interests of the R&A shareholders,
several points can be made.

The case scenario describes a ‘shortage’ of low cost housing, and whenever demand exceeds supply,
prices rise. This has the capacity to make the prices chargeable for the new properties higher than
might be expected, and the large reserves of land (land bank) are also likely to increase in value over
time if demand continues to exceed supply. So although it may be described as a CSR measure by
R&A, it is likely that substantial returns may be made on the investment at the same time. Because it
serves both ends (CSR and the strategic good), it could be argued to be a good example of strategic
CSR.

As with other CSR initiatives, the development of affordable homes may make some reputational
capital for R&A, especially as it frames its purchase in terms of meeting a social need. If the housing
developments are conveyed to the public as R&A exercising its social responsibility, it may increase
the company’s profile generally and also enhance the favourable perception by which R&A is
viewed. These joint effects may make it more likely that people will invest in R&A either as
shareholders or clients, thereby ensuring the company makes an economic return on its CSR.

Because R&A is an investment company which purchases shares but does not control the companies
it invests in, the outright purchase of a company represents a diversification of its business activities.
It could be argued that such a diversification represents a strengthening of the robustness of R&A’s
business as it means that risk and return become more widely spread
 Stakeholder analysis, reporting to stakeholders, Public sector governance 117

b)

Stakeholder claims are the outcomes sought in a given situation by a specific stakeholder. If a
stakeholder has a voice (such as a university, a local government authority, a trade union, etc.), then
the claim can be articulated clearly in terms of which outcome is being sought. If it does not have a
voice (such as future generations), then its claim is less certain, and the best outcome is not always
clear. Stakeholder claims are often in conflict. This means that two stakeholders want different
outcomes in a certain situation. The university, in the case, does not want new housing to be built
whilst R&A and the local government authority are both in favour of the development. This is an
example of stakeholder claims in conflict because both preferences cannot be accommodated; one
must ‘win’ over the other.

In any stakeholder situation, including those which are in conflict, the influence can be ascertained
by the Mendelow matrix. This is one way of mapping the influence of stakeholders. Identified
stakeholders are assessed according to their relative power and interest. Those stakeholders with
the highest combination of these variables are those with the most influence over outcomes.

The local government authority has higher structural power than the university because of its ability
to grant or withhold planning consent. This is a statutory power devolved to local government
authorities from the central government, although it is usually required that local consultation be
entered into before final approval is granted. It also has limited power as a shareholder of R&A and
possibly some influence as an investor in R&A’s funds. As an external stakeholder being an authority
interested in the construction of low cost housing and both a client and a shareholder of R&A, there
are considerable conflict issues. It has a social obligation to see the development approved as this
will allow lower cost housing to be built where most needed. The local government authority’s
interest in the activities of R&A therefore derives from two sources: its interest in providing low cost
housing and its concern for the profitability of the R&A company in which it holds shares.

The university has less power over the planning decision because it has no statutory power, is not a
shareholder in R&A directly and has a lesser investment in R&A’s funds than the local authority as an
R&A client. It is likely that the views of such an important local institution would be taken into
account, however, because a successful university is important in the development of Housteads as
a town. The local government authority must balance the claims of a number of stakeholders when
taking decisions of this type, including the economic interests of R&A. The interest of the university
is over the spoiled view from one of its buildings (sometimes referred to as a visual amenity). The
university is of the opinion that the new houses will reduce the view over countryside currently
enjoyed. The weight given to the value of the view over and against the social value of the new
housing development to the local government authority and the local community is an ethical
matter and one which, in this case, seems to have been decided in favour of the development.
 Stakeholder analysis, reporting to stakeholders, Public sector governance 118

AYK 2

Integrated reporting

Integrated reporting<IR> is a more concise communication of an organisation’s strategy, governance

and performance. It demonstrates the links between the organisation’s financial performance and
its wider social, environmental and economic context. Additionally, it illustrates how organisations
create value from their activities over the short, medium and long term. The main purpose of <IR> is
to enable more effective board level decision making, improve the quality of information available to
investors, and encourage more integrated thinking and business practices.

The use of <IR> at Oskal will encourage the preparation of a report which shows its performance
against strategy, explains the various ‘capitals’ used and affected, and gives a longer term view of
the organisation and enable its stakeholders, like host governments, to make a more informed
assessment of the organisation and its prospects.

<IR> capitals

All organisations depend on various forms of capital for their success. These ‘capitals’ store value
which eventually becomes the inputs to the company’s business model. The capitals will increase,
decrease or transform through the various activities undertaken by the organisation. Therefore it is
important that a company like Oskal is able to measure and monitor the use of its capitals, which can
be incorporated into its annual report.

These capitals are classified under the following six headings under<IR>:

Financial capital is the pool of funds available to a company, including both debt and equity finance.
The focus is on the source of funds rather than its application which results in the acquisition of
manufactured or other forms of capital. Oskal must be able to source sufficient financial resources to
deliver its strategy and achieve its objectives, so by providing such information to its investors, it will
inspire greater confidence.

Manufactured capital is seen as human-created, production-oriented equipment and tools, with a

distinction drawn between inventory and plant and equipment. These are the tangible assets which
are employed by the company to create value. In Oskal, this would include the very expensive
drilling and extraction equipment.

Intellectual capital is a key element in the company’s future earning potential, with a tight link and
contingency between investment in R&D, innovation, human resources and external relationships,
which can ultimately determine the company’s sustainable competitive advantage. The intrinsic
value in Oskal lies within its many oil reserves, and it is essential that an accurate valuation appears
on its statement of financial position, as any significant error could affect its share price. Oil
companies usually have a considerable stock of intellectual capital and have large R&D budgets.

Human capital is the individual capabilities, knowledge, skills and experience of the company’s
employees and managers, as they are relevant to the task at hand. Oskal is operating in a
knowledge-based industry and is highly dependent on the ingenuity of its employees to create and
maintain its business value. Therefore reporting information on human capital will give very valuable
insight for the users of annual reports.
 Stakeholder analysis, reporting to stakeholders, Public sector governance 119

Social and relationship capital in a business context include community acceptance, government
relations and customer loyalty. It is only by building relationships that a company can retain its social
licence to operate. This is particularly pertinent for Oskal, which must maintain a licence to operate
in each country, which is granted by the host governments. So investing in developing a sound
business relationship with government authorities will ultimately help it to continue in business.

Natural capital includes naturally occurring resources, such as oil, which can be used by businesses
to provide a return. The extraction of oil is the core business of Oskal, so providing detail about the
levels of extraction compared to previous periods and by area will give stakeholders very useful
insight into the operation of the company. Oil companies also need to report on their
‘environmental footprint’ and the impact they have on the wider natural capital, such as on the
quality of water, causing damage to land and the sub-terrain, or to the atmosphere.
 Stakeholder analysis, reporting to stakeholders, Public sector governance 120

PO2 – STAKEHOLDER RELATIONSHIP MANAGEMENT

Description

You manage stakeholder expectations and needs, developing and maintaining productive business
relationships. You listen to and engage stakeholders effectively and communicate the right
information to them when they need it.

Elements

a. Display sensitivity, empathy and cultural awareness in all your communications. This allows
you to establish trust and credibility with a range of stakeholders and gain their confidence.
b. Use a range of mediums and make appropriate use of digital technology to communicate
clearly, concisely and persuasively in formal and informal situations.
c. Gain commitment from stakeholders by consulting and influencing them to solve problems,
meet objectives and maximise mutually beneficial opportunities.
d. Develop and build effective and ethical professional relationships and networks using face to
face and digital technology.
e. Deal calmly and efficiently with conflicting priorities, deadlines or opinions – both internally
and externally – by listening and negotiating.
Example activities

• Communicating in a way that suits the audience or audiences, using the right tone, style and
medium, including data visualisation techniques. This could include communicating with
clients from different cultures.
• Developing relationships in meetings that lead to positive outcomes.
• Discussing work problems with colleagues or clients to improve and maintain relationships.
• Planning for and engaging positively with the appraisal process.
• Using media and technology to contribute to business related discussions – for example,
contributing to intranet community conversations, hosting virtual meetings or making online
presentations.
• Presenting internally or externally.
• Participating effectively in interviews.
• Drafting reports effectively.
• Dealing well with conflicting deadlines or requirements.
• Acting responsibly and with maturity when there are disagreements.
• Addressing service level complaints.
• Engaging productively with internal and external stakeholders including business partners.
• Discussing expectations of your work with your supervisor.
• Working within your supervisor’s requirements and giving them regular progress updates.
• Networking at conferences, internally or by joining business-related groups.
 Risk 121

6. Risk

6.1 Identification, assessment and measurement of risk

a) Discuss the relationship between organisational strategy and risk management strategy.
c) Identify and evaluate the key risks, including environmental and climate related risks and their
impact on organisations and projects.
d) Distinguish between strategic and operational risks.

Introduction to risk:

Very often, we use the terms risk and uncertainty interchangeably, but there is a major difference
between them. Risk is a possibility of having varied outcomes which can be quantified using
probabilities. Uncertainty is the possibility of having variable outcomes which cannot be quantified.

Commonly the word risk is used to suggest the happening of an unfavourable outcome. However,
this is not the case every time as there also can be an upside. One way of categorising risks:

Pure/downside risk: Possibility of a loss with no chance of again. E.g. fire destroying a factory.

Upside risk: Possibility of a project doing better than we expected.

Speculative risk: Possibility of having both favourable and unfavourable outcomes. E.g. Entering a
new market. Here there is the possibility of demand being low or high.

Conformance and performance

Should companies take risks? Now that we know that risks can also bring us upsides, we need to
understand that just preventing risk is not enough. Conformance can only prevent us from downside
risk. In order to make more profits, we need to take risks as they give us a competitive advantage.

There is a need to balance out how much we need to prevent and how much we need to accept in
order to grow as well as protect ourselves at the same time.
 Risk 122

Classification of risks

Risks can be broadly classified into strategic and operational risks.

1) Strategic risks:
• Strategic risks affect the overall mission of the company
• These arise from long term effects such as those relating to the nature and type of business,
changes in competitive and legal environments, poor long-term decisions being made.
• These risks should be assessed at the highest level of management, which is the Board of
Directors.
• Models such as SWOT and PEST can be used to identify strategic risks.

Example: Kodak faced a strategic risk of going out of business due to a lack of innovation. This
happened as the company did not show any interest in serving the changing trend of using a digital
camera over an analogue camera.

In the current scenario, there are many scenarios of strategic risks such as:

• The risk faced by normal television is because of OTT apps like Netflix.
• The risk of ecommerce wiping out retail stores etc.

2) Operational risk:
• This is the risk of losses resulting from inadequate or failed internal processes, people and
systems, or external events.
• Operational risks affect the day to day activities of the company. These may lead to potential
losses in business operations.
• These can be managed by having appropriate internal controls.
• Example: human error, fraud, Non-compliance with regulations, loss of key people etc.

Other types of risks:

Reporting Risk The risk of errors in reporting

Compliance Risk Non-compliance with applicable laws and
regulations
Environmental The release of dangerous chemicals into the
local river.
Economic Interest rates are being increased so that
consumer demand is suppressed.
Competitor A competitor launches a fantastic product.
Product You launch a poor product
Commodity The supply and price of raw materials change
adversely.
Political, cultural and legal Your product, for example, cigarettes,
becoming illegal or unpopular
Financial (currency, interest rate, market risk, You are exporting, and the buyer’s currency
reporting) weakens before you are paid.
Investment A subsidiary is bought, but it turns out that it
isn’t as good as you thought it would be.
IT Hacking and release of customer details
 Risk 123

Property Fire, flood

Health and safety risks Injury to employees and fines by regulators.
Trading risks Irrecoverable debts.
Resource risks Increasing difficulty recruiting the right people
Organizational risks The organization is too moribund and too slow
to respond to developments in the market.
Inadequate system risks Management information is inaccurate and
out-of-date.
Fraud risks Theft of cash or inventory.
Probity risks (unethical behaviour) An employee acts unethically, and the
company’s reputation is damaged.
Reputational risks Products get a name for being unreliable, so the
company’s reputation is damaged.
Knowledge management Techniques and know-how aren’t captured and
recorded so that when employees move-on
they leave little behind

e) Assess attitudes towards risk and risk appetite and how this can affect risk policy..
f) Discuss the dynamic nature of risk and the ways in which risk varies in relation to the size, structure,
industry, sector and development of an organisation
g) Assess the severity and probability of risk events using suitable models..
i) Explain and evaluate the concepts of related and correlated risk factors..

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

Risk appetite refers to the amount of risk an organisation is willing to take.

As we saw earlier that in order to make profits, we need to undertake risks. It is generally assumed
that high risks provide higher returns and low risks provide lower returns. Hence, the amount of risks
an organisation is willing to undertake will rely on how much return is expected by its shareholders.

There is no rule of thumb relating to how much risk a company should undertake. Risk appetites
differ from company to company. They are mainly determined by two factors.

1) Stakeholders ATTITUDE towards risk: Director’s / shareholder’s views of the level of risk
they think is desirable
2) Risk capacity: which is the amount of risk that the organization can afford to bear.

So, this brings us to another question. What are risk attitudes?

 Risk 124

Risk attitude is the inherent perception of a person or an organisation towards risk. Accordingly, we
can derive two distinct attitudes towards risk.

Risk seeker: Risk seekers are people who wish to generate high returns by undertaking a high level
of risk.

Risk averse: These people want to play it safe and are ready to accept lower returns for a lower level
of risk.

Example: Risk appetite of shareholders

Institutional:

If a company’s shareholding is owned by an institutional shareholder such as an insurance company

who needs a low but fixed amount of returns every year. The risk appetite will be low as they will try
to generate a constant, low but fixed return.

On the other hand, if the investor is a venture capitalist firm, they would like to generate very high
returns, and the risk appetite will be very high.

Retail investors

Now let us consider that you are investing in the stock market. If you have a high-risk appetite and
are a risk seeker, you will like to invest in new emerging companies who are not so well-known but
are growing very quickly. There is a risk of the company not being able to sustain itself, but you will
be ready to undertake that risk in order to gain higher returns.

Whereas if you are a risk averse person and wants to generate a fixed form of income, you will look
to invest in big and well established companies who are not growing at a high rate but have the
ability to give constant returns.

Relation between risks

Some risks increase or decrease due to a change in some other risks. These risks are said to be
correlated to each other. The correlations can be as follows:

Positive correlation:
When risks are positively correlated, they move in the same direction, i.e. when one risk increases,
the other too increases and vice versa.
E.g. Environmental and reputational risks are often correlated to each other as the risk of an
environmental disaster increases the risk of a company’s reputation taking a hit.

Negative correlation:
When risks are negatively correlated, they move in the opposite direction, i.e. when one risk
increases, the other one decreases and vice versa.
E.g. When more money is spent on reducing environmental risk, the environmental risk does reduce,
but the financial risk increases.

Sector specific risks

These are the risks which are faced specifically by companies operating in a particular environment.
Example: Oil extraction industry faces the inherent risk of environmental accidents and loss of
 Risk 125

reputation. This is because even a single mishap such as leakage of oil causes great environmental
damage as well as loss of reputation. Liquor industry faces reputational risks as people are more
aware of the ill effects of drinking.

a) Explain and assess the role of a risk manager

b) Evaluate a risk register and use heat maps when identifying or monitoring risk.
c) Evaluate the concept of embedding risk in an organisation’s culture and values.
d) Explain and analyse the concepts of spreading and diversifying risk and when this would be
appropriate.
e) Explain and assess the importance of risk transfer, avoidance, reduction and acceptance (TARA).
f) Explain and assess the benefits of incurring or accepting some risk as part of competitively
managing an organisation, referring to the ‘as low as reasonably practical (ALARP) principle..

Role of Risk manager:

Risk manager is a person responsible for the entire risk management process. The manager has to
report to the Risk Committee, and his main duties include.

• Determining an organisations risk management policies, systems and controls

• Analysing a firm’s risk appetite and ALARP levels and reporting them to the Risk Committee.
• Identifying new risks and updating the risk registers
• Implementation of risk management strategies and frameworks
• Embedding risk management in an organisations culture
• Compliance with risk management regulations
• Risk reporting

Embedding risk in organisation culture

The knowledge and importance of risk management should not be only limited for the Board of
Directors and top-level management. Instead, it should be embedded in the organisations culture so
that each and every person in the organisation is involved in the risk management process.

Following ways can be used to embed risk in an organisation:

– Creating a risk focused environment.

– Having a risk committee.
– Implementation of internal controls.
– Providing appropriate training to new and existing employees.
– Making risk management a part of the job description.
– Having a risk audit from time to time.

The process of risk management

 Risk 126

Risk identification- List of potential risk

Risk assessment- Prioritised risk list

Risk planning- Risk avoidance and contingency

plans

Risk monitoring- Risk audit

1) Risk identification- Here, risks are identified by the company and classified according to their
type.
2) Risk assessment- Risks are evaluated according to the likelihood of occurrence and impact, and
a list of prioritized risks is created which needs immediate attention.
3) Risk planning: Appropriate risk management policies are determined according to the type,
likelihood, impact etc.
4) Risk monitoring: Risks are monitored on a regular basis to identify changing or new risks. These
risks are again identified and classified. This makes the risk management process continuous and
repetitive.

Risk Management Cycle:

The above process can also be represented in the form of cycles, which is as follows:
 Risk 127

Identification of risks

In this stage, organisations are concerned about identifying the various risks faced by them. They do
it by the following ways:

1) By using models such as:

- SWOT analysis
- PESTEL analysis
2) By using risk questionnaires for staff throughout the organisation. As these people are closer
to operations, they have a better knowledge of operational risks.
3) Performing brainstorming sessions at the board level and with senior management.
4) Analysing internal events like loss of key personnel and external events like new regulations
etc. Checking for leading event indicators such as the risk of non-payment of customer
increasing due to his insolvency.
5) By using the expertise of external risk consultants.

Risk assessment:

Once we are done with the identification of risks in the next phase, we need to measure the impact
of those risks.

Likelihood/probability of a risk occurring and the consequence of that risk are the two main factors
which make a risk important. Using this, we can create a map for analysing risk, which is as follows:

Techniques for analysing risk:

There are many tools which can be used to quantify the impact of risks on the organisation, which
are as follows:

Scenario planning: In scenario planning, we try to construct a number of future scenarios which can
have an impact on the business of an organisation.
 Risk 128

Example: Wimbledon was able to insure itself against the pandemic due to scenario planning. They
analysed that if a pandemic like situation occurs in future, they will lose out on their entire revenue.
For this, they purchased a pandemic insurance. This was considered to be a too prudent measure
before the pandemic but was much appreciated once the tournament got cancelled due to the
Covid-19 pandemic.

Sensitivity analysis: In sensitivity analysis, the values of different factors which could affect an
outcome are changed to assess how sensitive the outcome is to changes in those variables.

E.g. With such analysis, we can measure by how much a variable like revenue needs to change
before our (forecasted) profits become zero.

Decision trees: These are 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.

Example:

Dynamism of risks:

Some risks reduce over time, and others increase, depending upon changes in the business
environment that organizations exist in. This change in risk happens due to the dynamic nature of
the risk.
 Risk 129

Example: For banks, the risk of customers defaulting on their loans was low before the recession
took place in 2008 as they had enough income. However, after the recession, people lost jobs, and
hence the risk of default increased automatically.

This makes the risk assessment process a continuous cycle, as we saw in the diagram above. We
cannot measure a risk ‘once and for all’. They need to be constantly analysed, and their impact
predicted in order to choose the correct response to those risks.

Risk Management/Planning: (Highly examinable)

The TARA framework can be used to manage risks. The framework is given below and builds on the
same two variables used in risk mapping:

Transfer risk:

When the impact of the risk is high, but the probability of the risk happening is low, we transfer the
risk. Risk can be transferred by the following ways:

1) Purchasing an insurance on the risky operation.

2) Outsourcing production to a third party.
3) Creating a Joint Venture to transfer a portion of risk to the other party

Avoid risk:

When both the impact and probability of a risk are high, we try to avoid the risk by not engaging in
the activity. Example: If we think that entering a specific market is very risky, we can decide not to
enter the market altogether.
 Risk 130

However, avoiding an operation is a very extreme step and should be suggested in an extreme
operation. In the exam, you cannot suggest a company to avoid an activity to reduce risk as that
activity may be a core business operation. Example: There is a risk of people dying on mining sites.
To reduce that risk, you cannot suggest the company to avoid mining activities as this would mean
shutting down the company.

Reducing risk:

When the likelihood of a risk happening is high, but the impact of the risk is low, we try to reduce
the impact of the risk. We can reduce risk in the following ways:

1) By implementing better internal controls

2) Reducing the volume of activity

By implementing better controls, our expenditure increases, but the risk is reduced. This is very
commonly done in many companies. For e.g. the risk of employees stealing products from a
company can be reduced by placing CCTV cameras. Etc

By reducing the volume, we sacrifice the expected return to indirectly reduce risk. Again, this can be
considered as an extreme measure and should be used only when significant reduction in risk is
possible by undertaking it.

Accepting risk:

When the probability of the risk happening and the potential impact both are low, we tend to just
accept the risk and do nothing.

Some companies 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.

Example: The risk of adverse weather conditions changing may have a low probability and a low
impact, and hence a company may choose to accept such risks.

The above matrix has been examined a number of time. Ensure that you understand the
rationale behind each of the options.

Diversification of risk:

Diversification which was earlier covered in the syllabus, can also be used for reducing risk.
Diversification is adjusting activities done by a business in such a way that it reduces the risk posed
by a single risky activity. Diversification can be achieved by:
 Risk 131

1) Investing in different types of businesses

2) Investing in different types of geographical locations
3) Using financial management techniques such as hedging
4) Sharing risk by entering into partnerships and Joint ventures

ALARP principle: As Low As Reasonably Possible

We normally assume that the relation between the level of risk of an activity and the acceptability of
an activity are inversely related, i.e. when the risk of an activity decreases, the acceptability
increases.

But, we also know that higher risks give a higher return. Hence, in order to generate returns, it
would be illogical to say that we should never take on projects with a risk.

The ALARP principle simply suggests that if a certain activity is considered to be a high risk, we
should not try to mitigate it altogether. Instead, we should try to bring down the risk to a reasonably
acceptable level.

E.g. On a construction site, there is an inherent risk that employees may suffer from physical
damage. This risk cannot be completely avoided as it is a part of the core business. Instead, we can
provide facilities such as safety gear like helmets and shoes etc., we can provide them with
appropriate training regarding safety measures. This will reduce the risk to an acceptable level, and
then we can carry out the project.
As you saw in the above example, to reduce risk, we may need to incur the cost. Hence, we are
making a trade-off between costs and likelihood and impact of risks.

Monitoring risk:

Risk management does not stop at the implementation of appropriate action we also need to
continuously monitor the risk to check for any change or addition of new risks. It is the responsibility
of the risk committee to monitor risk. Risk audits can be carried to monitor risk, which will include:

- Risk identification
- Risk assessment
- Risk of controls over risk
- Report

Risk register

Risk register is a document used for risk management, and it acts as a repository for all identified
risks. It contains the following elements:

• Description of the risk

• Date identified

• Its estimated likelihood of occurrence before mitigation

• Its likely impact before mitigation

• Pre-mitigation rating

• The risk owner (who is responsible for dealing with the risk
 Risk 132

• Detailed response strategy to the risk (TARA)

• Its estimated likelihood of occurrence after mitigation

• Its likely impact before mitigation after mitigation

• Post mitigation rating

• Date by when the response should be implemented

• Date response implemented

• Signed off by risk owner

Risk reports:

Listed companies are required to create and publish a formal risk report as a part of its annual
reports. This report mainly includes an executive summary of all the risks faced by a company and an
in-depth discussion on why a particular risk has been included.

b) Apply the enterprise risk management (ERM) approach to risk management and for establishing
risk management systems.

Enterprise risk management

We know that in order to generate returns, we need to undertake risks. These risks will be related to
almost all functions/departments of a business. Earlier, these risks would have been assessed by the
respective departmental managers, but now as businesses are getting more integrated, there is a
reason to look at these risks from an entire entity point of view.

Under ERM, management is able to assess risk on an enterprise wide basis by having a high-level
view.

“The goal of the ERM framework is to provide companies with key principles and concepts, a
common language, and clear direction and guidance regarding the management of enterprise
risks. This ERM framework incorporates adequate financial internal controls as a component of
enterprise risk management. “

The framework is as follows:

 Risk 133

The COSO ERM framework reflects the relationships between:

• The four objectives of a business (strategic, operations, reporting and compliance) which reflect
the responsibility of different executives across the entity and address different needs.

• The four organizational levels (subsidiary, business unit, division and entity) which emphasize
the importance of managing risks across the enterprise as a whole.

• The eight components that must function effectively for risk management to be successful. They
are as follows:

1. Control environment: This is essentially the general tone from the top which the company
adopts towards risk management, and so provides the basis for how risk is viewed and
addressed. Originating from the top of the organisation, the control environment is embedded
in the company’s culture and defines its risk appetite.

2. Objective setting: The Company’s risk appetite must be aligned to its business strategy, which
is achieved by the setting of suitable risk-adjusted objectives. The objectives must be agreed
before management is able to identify any potential events which may affect their achievement.

3. Event identification: These are the internal and external events, sometimes triggered by
uncontrollable sources, which can ultimately affect the company’s ability to achieve its
objectives. Some of the events may present the business with positive opportunities, whereas
other present risks.

4. Risk assessment: Risks are analysed, considering likelihood and impact, as a basis for
determining how they should be managed. Since likelihood can be measured in terms of
probabilities and impact in terms of its financial consequences, it is possible to quantify the risk
assessed and then prioritise relative importance to the operations.

5. Risk response: Although not an automated process, management can then select an
appropriate response to the individual risks assessed. Responses include avoiding the risk
altogether, reducing it to an acceptable level, transferring it to a third party or accepting the risk
if it falls within the pre-determined appetite.
 Risk 134

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 a periodic update to reflect the changing operational environment,
regulatory framework and the specific risks faced.

You do not require to learn each and every element. Just an understanding of what is ERM
and why does it exist is enough

Summarized principles of the framework:

• Consideration of risk management in the context of business strategy

• Risk management is everyone’s responsibility, with the tone set from the top
• The creation of a risk aware culture
• A comprehensive and holistic approach to risk management
• Consideration of a broad range of risks (strategic, financial, operational and compliance)
• A focused risk management strategy, led by the board (embedding risk within an organization's
culture

AYK1

RMBE is licensed to operate a high-speed rail network directly linking several cities in the large
country of Vinland. The government of Vinland heavily subsidises the rail network as it believes it to
be a critical infrastructure for the economic prosperity of this vast country. In return for the state
finance, the government has set RMBE challenging performance targets, the results of which it is
required to publish monthly, as well as explaining any significant variances to the transport ministry.

The board of RMBE acknowledges that severe delays or cancellations, even if caused by problems
outside the company’s direct control, present it with a risk to its reputation with the travelling public
and loss of financial subsidies from the government, which allow it to charge its customers
attractive, low prices. Therefore, RMBE proactively manages risk to ensure that customers receive
the services they expect and demand by employing an enterprise risk management (ERM)
framework. ERM aligns RMBE’s corporate objectives with its key performance indicators and targets,
clearly implying that it takes the management of risk very seriously. Indeed, the culture of putting
the customer’s needs first is embedded into everything RMBE does.
 Risk 135

Recently, a weather-related train accident in an outlying area resulted in fatalities, casualties and
major operational disruption on the RMBE rail network. The actions taken by managers at all levels
of RMBE were highly commended, as it was recognised that their prompt and effective responses to
this serious situation significantly reduced the number of deaths and injuries sustained. The
coordination of emergency services meant that help was on the scene quickly.

The conclusions drawn from the findings of an independent accident investigation report accepted
that although risks in operating a rail service could not be entirely eliminated, they should always be
reduced to as low as reasonably practicable (ALARP).

Required:

a) Describe how risk awareness could be embedded in RMBE’s culture and values.
b) Discuss the risks which RMBE is exposed to, and explain how the ALARP principle in risk
assessment relates to impact and probability.
c) Assess how RMBE uses risk management techniques to mitigate various types of business and
financial risks which it faces

g) Apply the concept of assurance mapping to modern risk management using the 'four lines of
defence'.

Assurance mapping is a technique which helps us in understanding the different layers of assurance
activities which can help in the management of risks. These levels of assurance can be described as
‘lines of defence’. These are as follows:

First Line:

The way risks are managed and controlled day-to-day. Assurance comes directly from those
responsible for delivering specific objectives or processes. It may lack independence, but its value is
that it comes from those who know the business, culture and day-to-day challenges.

Second Line:

The way the organisation oversees the control framework so that it operates effectively. The
assurance provided is separate from those responsible for delivery but not independent of the
management chain, such as risk and compliance functions.

Third line:

Objective and independence assurance, e.g. internal audit, providing reasonable (not absolute)
assurance of the overall effectiveness of governance, risk management and controls. The level and
depth of assurance provided will depend on the size and focus of the internal audit function and
management’s appetite for internal audit assurance.

Fourth line:

Assurance from external independent bodies such as the external independent bodies such as the
external auditors and other external bodies.

External bodies may not have the existing familiarity with the organisation that an internal audit
function has, but they can bring a new and valuable perspective.
 Risk 136

Additionally, their outsider status is clearly visible to third parties, so they can not only be
independent but be seen to be independent.

Strategic risk: Affects overall mission of the company

Operational risk: Affects day to day business of the company

Steps of risk management:

1) Risk identification
2) Risk assessment
3) Risk management
4) Risk monitoring

Risk responses: (TARA)

1) Transfer
2) Avoid
3) Reduce
4) Accept

ALARP: As Low As Reasonably Possible

Correlations:

Positive: Risks move in the same direction

Negative: Risks move in opposite directon

 Risk 137

AYK Answers

AYK1

(a) There are a number of ways in which risk awareness could be embedded into RMBE’s culture
and values, which are particularly important for a company operating in the rail industry.

Control environment

The strength of RMBE’s control environment will significantly influence the ability of senior
management to instil a more risk aware culture throughout this rail company. However, in order to
embed risk awareness in the collective mind set at RMBE, the senior management team will need to
clearly communicate the risk philosophy of the company as well as what is expected of all its
employees. The publication of enterprise risk management (ERM) policies and procedures, together
with statements of compliance, will help to make risk an integral aspect of RMBE’s standard railway
operating practices and its business culture.

Top level commitment

For the directors of RMBE, risk should be a prime consideration when developing a business
strategy. Shareholder value is largely driven by taking risks in pursuance of future growth
opportunities, so care should be taken during the planning process to identify those risks which may
prevent the achievement of corporate objectives and take appropriate mitigating action. One
positive initiative which would clearly indicate a top level commitment to greater risk awareness at
RMBE would be to establish a board level risk committee to provide the necessary leadership and
direction for the company. The risk committee would have the knowledge and authority to address
rail industry specific risks.

Risk register

At an operational level, the risk is an inherent feature of the core business activities of RMBE as a
railway company, and it thus cannot be totally avoided. Employees must be aware that some
operating processes are at higher risk than others and be constantly vigilant about them. A risk
register which lists and prioritises the main risks which the company faces can help employees
decide which risks need the 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 RMBE.

Human resource management

Culture has been described as the way we do things around here, so if greater risk awareness is to
become a key feature of the RMBE culture, it needs to be inculcated into all aspects of human
resource management, including:

(i) Individual job descriptions which should be drawn up with a greater emphasis on the duty of
all employees to recognise and act on risks which may arise in their area of operations,
particularly health and safety risk.
(ii) Induction programmes for new employees to include detail of RMBE’s ERM initiatives so
that risk becomes ingrained in employee behaviours from the outset.
(iii) Regular training workshops for existing staff to reinforce the key elements of the risk
management philosophy and ERM processes, particularly pertinent to running a rail
business.
 Risk 138

(iv) 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 railway employees.

(b) The risks currently facing RMBE include:

Health and safety risk

This is the potential source of harm or adverse health effect on a person or persons directly
impacted by the operation of the organisation. This is particularly relevant to a business like RMBE,
where its passengers are transported at high speed along a railway network linking cities throughout
Vinland. The inherent risks of rail travel in remote areas significantly increases the danger to safety
to which RMBE’s passengers and employees are exposed.

Political risk

This refers to both the stability of a government and the degree that it chooses to intervene in
business activities. There is no suggestion that the Vinland government is likely to change in the
foreseeable future. However, its recognition that the railway system is a key economic resource for
the country by offering financial subsidies means that RMBE is highly dependent on it as a major
stakeholder in its business. Failure to achieve the challenging performance targets set by the Vinland
transport ministry could result in the risk of a significant reduction in income for RMBE, and all that
entails for its core operations.

Regulatory risk

Such risks arise from those specific regulations which directly impact on the operation of an
organisation. RMBE holds a licence to deliver a safe and reliable railway service to the paying public
of Vinland. The recent unfortunate accident and the findings of the consequential independent
report may result in additional safety regulations, which could impact on the systems, operations,
resources and investment plans for RMBE.

Reputation risk

This is the potential harm to an organisation’s reliance an organisation has on its brand, image and
standing with the public at large. The fatalities and casualties which occurred from the tragic
accident may result in negative publicity and adverse public attitudes towards RMBE. If passengers
believe that the RMBE service is unsafe, they may opt for alternative forms of transport, and this
would, in turn, harm the company’s financial and competitive position.

Technology risk

This arises from those possible changes in the technology essential to support ongoing business
operations. The accident investigation report may recommend that RMBE invests in new safety
equipment, rolling stock or even track to avoid a recurrence. Apart from the additional cost which
would be incurred, the introduction of this new technology could negatively impact on the
operational performance of RMBE in the short term. This could then affect the level of subsidy it
receives as well as the reliability of its reputation with passengers.

Market risk

Represents the risk of potential losses on capital markets from the change in value or volatility of
share price. The market risk at RMBE is influenced by: (i) Operational performance and its ability to
 Risk 139

meet the pre-determined performance financial targets. (ii) Sourcing the necessary finance from
capital markets to meet its investment plans. (iii) Maintaining sufficient liquidity for the day-to day
running of the business. (iv) Obtaining the required resource inputs to deliver a reliable and safe rail
service to its customers.

Financial risk

This is a general term which describes a company’s reduction in revenue streams and profits, or
even the risk of incurring a loss. As a railway service company, RMBE is heavily reliant on fare paying
passengers as its primary source of finance, so any reduction in passenger numbers is likely to
impact heavily on its financial performance, particularly as it is likely to have a high proportion of
fixed operating costs. Compounding this with the risk of losing state subsidies for under-
performance makes RMBE very sensitive to financial risk.

The ALARP principle

The primary focus at RMBE will be to reduce risk to a tolerable level rather than eliminate it because,
in market-based systems, managed risk-taking is fundamental to success and profit generation. As a
general principle, the higher the level of risk, measured in terms of its impact and probability, the
less acceptable it will be to the company.

For a rail business like RMBE, certain aspects of its core activities could be viewed as potentially
hazardous and even dangerous, exemplified by the recent weather-related accident on a remote
part of the rail network, which resulted in casualties. It is clear that such risks cannot be completely
avoided but that they can be reduced to an acceptable level by investment in infrastructure, safety
systems and support services. In effect, the level of acceptable risk becomes a trade-off between the
assessment of the likelihood and impact of the risk materialising and the cost to RMBE of taking
action to mitigate it, such as a decision not to run rail services during short periods of extreme
weather.
National legislation in Vinland and safety regulations governing the operation of railways will
stipulate the minimum acceptable standards with which RMBE must comply. The role of the board
of RMBE is to decide what level of risk is as low as reasonably practicable (ALARP) for it to operate
within the law and at a safe level expected by its passengers and regulators.

The residual risk which remains after the necessary action has been taken needs to be subject to
constant review. This is because of the dynamic nature of the environment in which RMBE operates,
where risks can change both in terms of their severity and the probability of them arising, so
management may need to regularly refine and update operational practices. Indeed, it is possible
that the level of residual risk may no longer be deemed as low as reasonably practicable, so
alternative internal control actions will be required. An example could be when extreme weather
conditions occur more frequently, so extra measures are necessary to protect the rail track allowing
services to continue to run.

(c) RMBE can use techniques to mitigate the various risks it faces as follows:

Training sessions

Compulsory awareness training for all operational staff will help them to identify health and safety
risks before they become a potential hazard. Regular and structured planned maintenance of trains,
track and signalling equipment will reduce the likelihood of accidents and injury. Standard operating
procedures should be designed and implemented with the safety of RMBE’s passengers and staff at
their core.
 Risk 140

Enterprise risk management (ERM)

RMBE employs an ERM framework to align the corporate objectives which arise from its strategic
plans with its key performance indicators and agreed on pre-determined targets. This approach
should mitigate a number of risks identified, including political risk and market risk. The setting of
targets orientates the business culture towards maintaining high levels of operational performance,
but in a risk managed environment.

Marketing

The marketing orientation advocated by the stated policy of ‘putting the customer’s needs first’
suggests that RMBE is aware of the critical importance of its paying customers in all of its business
operations. Such an awareness will help to mitigate the reputation risk of the company as well as a
significant element of its financial risk. The dependence on government subsidies to keep passenger
fares at a competitive level has its own inherent risks but indicates the commitment of RMBE to
offer its customers value for money.

Performance information

The publishing of RMBE’s actual performance against its pre-agreed targets every month focuses
management attention on the necessity to maintain consistently high standards. This approach
could reduce technology risk since there would be a need to regularly upgrade systems and invest in
new technology simply to achieve the required standard. The additional requirement to explain any
significant variances against the target to the transport ministry is an added motivation to the board
of RMBE to manage business performance effectively.

Contingency planning

RMBE’s management was highly commended for the speedy and effective action taken in response
to the recent serious incident, as it significantly reduced the number of fatalities and injuries
sustained. The scenario implies that by employing its internal control systems, RMBE was able to
coordinate emergency services in a remote part of the country. This report would have helped to
mitigate RMBE’s reputation risk with the general public and reduce the risk of regulatory action by
the authorities.
 Risk 141

PO11 – IDENTIFY AND MANAGE FINANCIAL RISK

Description
You identify, measure, and advise on the financial risks to the organisation.

Elements
a. Identify key sources of financial risk to the organisation and how they might arise.
b. Assess the likelihood and impact of financial risks to specific business activities.
c. Assess whether to transfer, avoid, reduce or accept financial risk.
d. Advise on using instruments or techniques to manage financial risk.
e. Monitor financial risks, reviewing their status and advising on how they should be managed.
 Technology and data analytics 142

7. Technology and data analytics

7.1 Cloud, mobile and smart technology

a) Discuss from a strategic perspective the need to explore opportunities for adopting new
technologies such as cloud, mobile and smart technology within an organisation.
b) Discuss key benefits and risks of the cloud. Mobile and smart technology.
c) Assess and advise on using the cloud as an alternative to owned hardware and software
technology to support organisation information system needs.

With the changing business environment, IT is emerging as a major tool for gaining competitive
advantage. IT is helping organisations gain greater efficiency, reduce costs and explore new
opportunities. In this section, we will discover various new forms of technology transforming the
business space.

Cloud technology:

Cloud technology, also known as cloud computing, is the practice of using a network of remote
servers hosted on the internet to store, manage, and process data rather than a local server or a
personal computer.

Example

Netflix has around 200 million customers. These customers will have varied subscription plans,
viewing history, likes and dislikes. This will amount to a huge amount of data. If Netflix decides to
buy hard-drives to store all this data, it will cost millions and millions of dollars.

Instead, what it does is takes a subscription of cloud computing from Amazon Web Services (AWS).
Now AWS is a company who is specialized in providing cloud services. So now, all the data of
Netflix’s users will be stored on the servers of AWS. From here, Netflix can access and process data
and carry out data analytics on it. This leads to a significant level of cost saving.

Another advantage for Netflix is that it can increase or decrease the number of servers it wants to
hire as per the need of information storage. You can compare this model to the one of Uber and Ola,
where instead of owning a vehicle, you hire one as per your need. This concept, when applied in
terms of software, is known as SaaS (Software as a Service)

In an exam scenario, you may be asked to advise a firm on how it can save on data storage costs
by using cloud computing and what other merits and demerits it will bring.

Advantages Disadvantages
• Savings of IT operational costs. • Increased reliance on the cloud service
• Avoidance of heavy capital investment. provider.
• Ability to access data from anywhere. • Over-reliance on internet connectivity.
Data cannot be accessed offline.
 Technology and data analytics 143

• Higher amount of data storage • Risk of cyber-attack on cloud provider.

available. • May not comply with regulatory
• High level of security. requirements.

SMART technologies:

The word SMART can be broken down as: “self-monitoring, analysis and reporting technology. Any
technology which can provide cognitive awareness to objects that were considered as inanimate in
the past is SMART tech. E.g. artificial intelligence, machine learning and big data analysis.

These technologies have become essential in today’s world for companies to gain a competitive
advantage by increasing the number of markets, market segments, efficiency in operations and
improved marketing. We will review each of these technologies in detail further in this chapter.

7.2 Big data and data analytics

a) Discuss how information technology and data analysis can effectively be used to inform and
implement organisation strategy.
b) Describe big data and discuss the opportunities and threats big data presents to organisations.
c) Identify and analyse relevant data for strategic decisions about new product developments,
marketing and pricing.

Let us first start by understanding some key terms regarding IT and data:

Data - Raw facts which do not carry any specific meaning.

E.g. Detailed entries in sales ledger accounts

Information- Group of data which together carries a logical meaning.

E.g. Sales ledger totals and aged listing.

Knowledge – Information in someone’s mind.

E.g. Key contacts within an organization, orders likely to be placed by the customer.

Knowledge management:

It is the process of

• Uncovering or discovering knowledge

• Recording it

• Distributing it to those who may require it

• Levering it, thus making the knowledge acquired for one purpose useful for another purpose
(e.g. USA market to Europe Market)
 Technology and data analytics 144

• Ensuring that the knowledge is updated and remains current.

Big Data:

Big data is defined as,”extremely large collections of data (data sets) that may be analyzed to reveal
patterns, trends, and associations, especially relating to human behavior and interactions.”

In simple words, Big Data is a large amount of data collected by companies which can be used to
identify patterns and trends, which then can be used in business to gain a competitive advantage.
This data can be in a structured (e.g. forms) or unstructured (e.g. feedback in words) form. Data has
potential value, which means that the collection of data is only valuable if we can do further analysis
on it to derive information which can be used in business. Hence, data can be compared to raw
material which is used in manufacturing which needs to be processed in order to be useful. The
processing part is also known as data analytics, where analysts find out useful information from
huge chunks of data. This information is the final product.

Example: Use of Big Data in real life

Let us consider the use of Big Data in a simple business scenario. Suppose you own a supermarket
chain which sells all kinds of retail products such as milk, shampoo, oil etc. Your performance has
been moderate, but the business hasn’t seen any significant growth in terms of revenue. Therefore,
you are looking out for ways to improve your performance.

You realize that the positioning of the products can be vital in order to improve your sales. So, you
start thinking about which products should be placed together. You already have an information
system which collects data relating to all orders placed by customers while checking out.

Now you can choose to store this large amount of information and analyse it to gain some
understanding about which products are bought together so that they can be kept next to each
other. After doing a ‘basket-analysis’, you find out that bread, butter, milk and eggs are frequently
bought together, so now you can keep such products next to each other so that buyers can access
them easily and hence bring in more revenue.

This was a simplified use of Big Data.

Similarly, media companies like YouTube use a large amount of data to build their algorithms which
shows us the most relevant video one after the other. This results in we spending more time on their
website and they earning more by showing us advertisements.

Characteristic of Big Data: 3 V’s

3 V’s in detail

Volume

The amount of data matters greatly, and the more that can be accessed, the better. Most of this
may have no value, but no one will know until they try and structure it and use it. This data can
 Technology and data analytics 145

come from a wide range of sources but could include social media data, hits on a website, or results
from surveys or approval ratings given by consumers.

For some organisations, the sheer amount of this data will be difficult to manage unless the
organisation has the right capabilities, including adequate storage and processing capacity. The main
thing about the volume of big data is the additional reliability it gives the data analyst. As any
statistician knows, the more data you have, the more reliable your analysis becomes and the more
confident you can be about using the results you obtain to inform decision-making.

Velocity

Velocity is the rate at which data is received and used. In the modern world, transactions are
conducted and recorded in real time. As people increasingly shop with debit and credit cards and
use their phone apps, these transactions are updated immediately.

Stores themselves know exactly how much inventory they have and the sales they are generating on
a transaction by transaction basis, and because customers transact with them electronically, they
also know a lot more about their customers and their buying patterns. The banks too, immediately
know that funds have gone out of customers‘and into their suppliers’ accounts in real time.

Variety

Variety refers to the many types and sources of data which are available. Traditional data types were
more structured. With the rise of big data, data comes in new unstructured types. This also comes in
a variety of forms. These include numerical data, text, audio, pictures and videos.

All these require additional processing to transform them into meaningful and useful information
which can be used to support decision-making, but being able to access them and use them provides
richer information for the business leader, which can make the information obtained from the data
analysis more relevant and significant than larger amounts of data from more structured sources.
 Technology and data analytics 146

Examples of 3 v’s

Data analytics tools used for analysing big data.

Data analytics is the real valued addition process in the use of big data. This is the stage where the
extraction of useful patterns, trends etc. takes place. Following are the ways of analysing data:

• Data mining: Analyzing data to identify patterns and establish relationships such as associations
(where several events are connected), sequences (where one event leads to another) and
correlations.

• Descriptive analytics: Descriptive analytics is the analysis of data to observe what has been and is
currently happening. Examples of this could be to analyse data by product, by outlet and by
customer.

• Predictive analytics: It involves using techniques to allow the business leader to evaluate strategies
and to anticipate strategic outcomes depending on which scenarios play out. An example of this is
where weather conditions such as hours of sunshine, amount of rain and temperature levels can
affect sales of certain items, such as barbecues or cold drinks.

• Prescriptive analysis: It is concerned with optimisation, such as maximising sales, minimising costs
or maximising profit. Prescriptive analytics draws upon techniques which are commonly available in
spreadsheets such as ‘Goal Seek’ and, in particular, ‘Solver’

• Text analytics: scanning text such as emails and word processing documents to extract useful
information. It could simply be looking for key-words that indicate an interest in a product or place.

• Voice analytics: Similar to text analytics but with audio

• Statistical analytics: used to identify trends, correlations and changes in behavior.

Opportunities of Big data:

 Technology and data analytics 147

• Companies can get a deeper insight into data which is only possible due to the bigger
sample size of data.
• Customer relationships can be improved by keeping a record of previous purchases, tastes
and preferences etc.
• Companies can draw out targeted marketing strategies which will attract a particular
segment.
• Better knowledge of which pricing strategies to be used.
• Gives organisation a competitive edge due to a better overall understanding of the business
environment and stakeholders.
• A new source of revenue is developed as companies can sell Big Data further.

Threats of Big data:

• As we saw earlier that Big data is huge and varied, which also contains private information of
customers. This creates a data security threat as it may be subject to attacks.
• Big data cannot be processed on normal computers and hence requires a high initial
investment.
• To store and process, such a huge amount of data requires developed software and storage.
Although companies can use the cloud to store data, it may not be able to afford the high
operational costs.
• Some local jurisdictions may not allow the collection and storage of private information of
customers. Non-compliance with this may lead to fines and penalties.

Research activity: Find out companies who are using Big Data and how does it create value for them

In the SBL exam you may be asked to advise a company who is not using Big Data about its
benefits and risks. You may also be asked to comment on the correct and ethical use of data.

7.3 Machine learning, AI and robotics

a) Explain the potential benefits of using artificial intelligence (AI), robotics and other forms of
machine learning to support strategic decisions and the pursuit of corporate objectives.
b) Assess the risk, control and ethical implications of using (AI), robotics and other forms of
machine learning.

Currently, there are many misconceptions about the terms AI, Machine Learning (ML) and robotics.
So, first of all, let’s start by understanding the real meaning of these terms. Initially, we will discuss
about AI and machine learning together and then about robotics.
 Technology and data analytics 148

AI and ML are commonly used interchangeably, but these two terms have different meanings even
though they are related to each other.

Artificial Intelligence is a broad term used to refer to a technology which enables machines to
simulate human behaviour. E.g. Applications such as Siri and Alexa who can mimic a person.

Machine learning is a subfield of AI which enables machines to learn from past data or experience
without being explicitly programmed. E.g. Google search algorithms which show you the correct
results for the words you type in.

From this, we can establish that ML is a subset of AI.

Uses of AI and ML in businesses (Uses of ML are also the uses of AI)

1) Fraud detection
Many banks and financial institutions provide data regarding past fraudulent transactions from
which the machine learns and then can predict whether a transaction is fraudulent or not.

2) Customer support
Almost all big corporations use ‘chat’ functionality for providing customer support. Usually, its
an AI software on the other side which talks to use by understanding our language from the
words we type in it.

3) Cyber security
We as humans have a limit as to how much we can keep re-programming our security software’s
but AI, on the other hand, keeps continuously updating itself with new tricks and patterns used
by hackers and hence is able to build a more robust cyber security system.

4) Predict behaviour
As we saw, machines can continuously learn from past data, they can predict our behaviour by
showing us relevant marketing adverts in which we will be interested, and there’s a high chance
we may click on them.
 Technology and data analytics 149

5) Increase operational efficiency

AI can help in increasing operational efficiency by reducing outages or breakdowns in
production. It can do so by accurately predicting when a machine needs replacement. It uses
past data to make such predictions.

These were the broad uses of AI and ML when used in business scenarios. In the exam, you don’t
need to know the exact technicalities of AI and ML. However, the examiner will expect from you a
general understanding of what these terms mean and how can they benefit the organisation.

Research activity: Analyse other uses of AI and ML and state real life companies which are using the
same.

Robotics

Robots are not always of the type which we see in movies like ROBOT or Ra One. Those kinds of
robots are a part of ‘strong AI’. In our context, robots would simply mean machines who are
programmed in a way to perform repetitive tasks. They are used to automate any process, and
hence it is termed as RPA (Robotic Process Automation).

RPA is drastically different from AI and ML as here, the robot/machine cannot think by itself. Instead,
it is programmed and follows a fixed set of rules.

E.g. When you enter any well-established bank to update your physical passbook, you will be guided
to a kiosk which will automatically print and update your passbook once it is entered. This kiosk is a
programmed robot which is set up to carry out the repetitive task of printing people passbook. As
this reduces the need for human labour and automates the process, it is an example of RPA.

Benefits of RPA:

– Better efficiency in operations.

– Reduction in human errors.
– Robots can work 24/7.
– Human labour can focus on complex tasks rather than repetitive tasks.
– Cost savings in the long term

Research activity: Make a list of how other industries are using robotics in their businesses

7.4 E- business: value chain

a) Discuss and evaluate the main organisation and market models for delivering e-business.
b) Assess and advise on the potential application of information technology to support e- business.
c) Explore the characteristics of the media of e-marketing using the 6 ’I’s of Interactivity,
Intelligence, Individualisation, Integration, Industry structure and Independence of location.
d) Assess the importance of on-line branding in e-marketing and compare it with traditional
branding.
 Technology and data analytics 150

e) Explore different methods of acquiring and managing suppliers and customers through exploiting
e-business technologies.

E-business refers to the activity of doing business over the internet. E-commerce is the buying and
selling of goods over the internet. Hence, we can say that e-commerce is a subset of e-business.

There are various stages of having E-business which are as follow

Web • In this stage a firm only has a simple web page.

presence This page may be active or passive

E-commerce • Firms start selling goods and services electronically.

• At this stage the buying and selling

Integrated function is integrated with the
e-commerce information systems of the
company

• All business processes

E business are done over the
internet

Types of E-commerce:

There are primarily 3 broad types of e-commerce which are as follows:

1) Business to business (B2B):

This includes all the transactions done over the internet between different businesses. E.g.
When a construction company hires the services of a transport company from a platform like
Just Dial, it is a B2B construction.

2) Business to Consumer (B2C):

This will include the most regular transaction, which includes a business selling to a customer
over the internet. E.g. When we buy any product over amazon, it is a B2C type of transaction.

3) Consumer to consumer (C2C):

 Technology and data analytics 151

These will include the transactions carried out amongst customers. This will involve the sale of
second-hand goods. E.g. selling goods to other customers over platforms such as OLX is a C2C
type of transaction.

Advantages of E-Business:

• Lower costs due to savings in overheads such as rent etc.

• Better availability of customer and product information.
• Increase in revenue as firms can sell all over the internet.
• Improved level of marketing.
• Better customer support.
• High level of flexibility as there are no physical barriers.

Limitations of E-business:

• High set up and maintenance cost.

• Some customers may have phobia relating to the use of the internet.
• Data security risks.
• Some firms do not have the necessary technical capability and resources.
• Over dependency on technology.
• Legal risk due to differing legislation.

Infrastructure to support business information system:

• Local area network (LAN): Here, the network extends over only a relatively small area, such as
an office, a university campus or a hospital.

• Wide area networks (WAN): Here, the network can extend between several cities and countries.
Each office would have its LAN, but that connects to LANs in other offices and countries using
commercial, public communications systems

• Extranets are when your network can link to another organization's network, for example, a
supplier’s network, to trigger deliveries

• Networks may be wired, wi-fi, 3G, 4G

 Technology and data analytics 152

E-marketing:

E-marketing is the process of advertising and selling goods and services over the internet. Even
though the basic principles of marketing remain the same, there are some differences. These can be
described by using the following 6 I’s model.

It is also called as 6 I’s of E-business

The I’s E-marketing Traditional marketing

Intelligence E-marketing tools can be used to gather With traditional advertising, businesses
much more information about a potential have no indication of how many people
customer’s interests by recording click were interested in the advert or at
patterns, for example, and determining at what point they stopped watching or
what point a customer loses interest. This reading the marketing material.
helps to inform future product decisions as
a result.

Individualisation This refers to the ability to aim marketing Traditional marketing cannot be
directly at different individuals. The use of targeted individually, only at specific
customised home pages or responsive groups of people through – for
advertising allows for this through example, the programme choice (TV
technology and ensures the marketing is advertising) or publication choice
more relevant to each, and therefore more
likely to be successful. This can also be
linked to the intelligence gathered through
e-marketing.

Integration Marketing can be linked to other activities – Separate steps have to be taken with
for example, ‘click here to buy’ or ‘see traditional marketing in order to
 Technology and data analytics 153

upgrade options’. It can also allow the convert it into a sale – for example,
integration between companies – for make a phone call, go into a shop.
example, book discounted services with
partner organisation

Interactivity E-marketing is ‘pull’ marketing in which the Traditional marketing is ‘push’

recipient of the marketing can participate in marketing, with the message being
it – for example, by chatting with a bot, or broadcast to the potential customer
clicking on different links or entering search rather than being sought by them. The
terms. This interactivity can lead to greater aim is to try and ‘sell’ rather than
intelligence. provide a solution to a customer’s
specific requirements.

Independence of E-marketing can cover broad geographical Whilst traditional marketing can cover
location boundaries and could actually allow for wide geographical areas, this may still
delivery of some products or services – for need access to local sales forces.
example, online training courses, but Additionally, it will be expensive to
companies still need to consider whether reach broader markets using traditional
their product is suitable for boundaryless marketing as different methods of
marketing – for example, a large physical advertising may be needed to reach
product with expensive shipping may not different markets.
lend itself to this.

Industry E-marketing can lead to changes in an Traditional marketing supports

structure industry, allowing for disintermediation and traditional industry structure.
the growth of consumer-to-consumer
business models.

Advantages of E-marketing:

• Can be done from anywhere

• Cheaper than traditional marketing
• Targeted advertisement campaigns can be run
• Interactive campaigns can be used to collect data
• Operational efficiency increases
• New markets can be accessed

The limitations of E business also apply to E-marketing.

E-branding

A brand refers to the uniqueness of a product which differs it from its competitors, just like
traditional branding, e-branding is of utmost importance in order to attract customers.

Branding creates value for a company as customers are ready to pay more for a branded product
even though there may not be any significant differences in it as compared to an unrecognised
 Technology and data analytics 154

product. E.g. a white t-shirt with a Nike logo will be purchased at a higher price than without the
logo even if cloth quality remains the same.

Online branding is gaining importance due to the excessive use of social media by millennials and
Gen Z, who are the targeted customers of these brands. The six I’s discussed above can be used to
build a brand.

In the exam only stating which I means what won’t gain you any marks. You should also be
able to demonstrate how 6 I’s can create value for a business and increase its profits.

Technical article: Principles and application of e-marketing.

Customer Relationship Management (CRM):

CRM refers to the process of building long-term relationships with customers. This process can be
carried out by using technology. CRM aims to:

1) Acquire new customers: This is done by running advertisement campaigns, getting new
registrations, providing coupons on inviting new customers.

2) Retaining existing customers: This is done by keeping track of services in progress, giving loyalty
points, enabling auto-payments, giving discounts on multiple purchases etc.

Usually, companies use a CRM software to keep track of all the customer data so that appropriate
and attractive services can be provided. This helps in giving marketing campaigns a personalised
touch. E.g. Receiving promotional offers addressed to your first name, like an extra 15% discount
only for Vijay etc., when you call Tata Sky support from your registered number, they already know
your name and account number, which saves time and effort and is valued by the customer.

A good CRM application is able to:

1) Maintain customer information and order history.

2) Send personalised promotions from various mediums.
3) Integrate with the ERP systems.
4) Protect the data of customers
5) Attract and retain customers

E-procurement

E-procurement is the process of ordering purchases through the internet. It has many benefits as
compared to traditional procurement.
 Technology and data analytics 155

E.g. It can be easily integrated with the ERP software of the company. This would enable orders
being sent automatically to the supplier as inventory levels decrease, reducing the risk for stock
outs.

Other benefits are:

– Saves travelling cost of purchasing department to travel to the supplier for ordering.
– Cheaper materials can be obtained as purchases can be done from any supplier in the world.
– Just in Time system of ordering can be adopted, which reduces inventory costs.

Effect on supply chain

Technology has the potential to integrate the entire value chain of a business. This means right from
procurement of raw materials to delivery of products to customer everything can be connected to
each other through tech and networks.

This enables faster transfer of information and services. As we discussed above, there will be no
need for a person to raise a purchase invoice and deliver it to the customer and then receive the
delivery of goods. With IT, we can shorten this process and make it more efficient by cutting down
errors. This is done by e-procurement.

Along with this, we can also maintain healthy relationships with our customers and provide them
with top notch and personalised services. This also creates a sense of belonging towards the
company.

We will also be able to improve the overall efficiency of the business by reducing waste and better
allocation of resources.

7.5 IT systems security and control

a) Discuss from a strategic perspective the continuing need for effective information systems
control within an organisation.
b) Assess and advise on the adequacy of information technology and systems security controls for
an organisation.
c) Evaluate and recommend ways to promote cyber security.
d) Evaluate, and if necessary, recommend improvements or changes to controls over the safeguard
of information technology assets, to ensure the organisation’s ability to meet business objectives.

As businesses get increasingly dependent on the use of IT, the need for good data security increases
as well.

The following are the major reasons for having good cyber security in an organisation.

1) Increases value of data:

The volume and value of data available has increased exponentially. ACCA reports that '90% of
the [40 trillions GB of] data in the world has been created since 2016'.
 Technology and data analytics 156

Advances in machine learning and artificial intelligence allow patterns to be analysed that
revolutionise the way organisations interact with their stakeholders. This trend caused The
Economist to report in 2017 that 'the world’s most valuable resource is no longer oil, but data.'

2) A lack of awareness of vulnerability of personal data:

In 2010, reports emerged of Mark Zuckerberg having described Facebook users as 'dumb' for
being so ready to part with their personal data.

At the time, there was no public awareness of how this data might be used but, in 2018, it
emerged that Cambridge Analytica had harvested the personal data of 50 million Facebook users
as part of a strategy to target and influence voters in democratic elections.

3) The inevitability of software bugs:

Software is now so complex that it is beyond the scope of any human to identify every possible
weakness. For example, the software used in the average new car contains over 100 million lines
of code, leaving the potential for flaws or 'back doors' to exist that could be exploited.

Ten steps to promote cyber security

1. Set up your risk management regime

As part of good corporate governance, organisations should already have an effective risk
management policy in place. However, the technical complexity of cyber security creates a specific
risk that directors fail to engage with the issue, even though it is a critical risk for any organisation. It
is therefore crucial that any general risk management regime refers explicitly to cyber security risk.
The subsequent steps give examples of specific matters the board should consider.

2. Network security

In the same way that an organisation’s offices are kept physically secure, the perimeter of its
network needs to be kept secure in order to prevent unauthorised access.

3. User education and awareness

A network is only as secure as its weakest link, so it’s crucial that all those authorised to access an
organisation’s network understand how they might be exploited by a hacker.

4. Malware prevention

Malware is a generic term that covers all forms of malicious software, including viruses, spyware and
ransomware. Organisations and individuals can protect against malware by subscribing to software
that screens for such infections. With new malware threats emerging all the time, it’s crucial that
anti-malware software is kept fully up-to-date – many reputable providers provide daily updates.
 Technology and data analytics 157

5. Removable media controls

The ability to transfer media via removable media creates a key weakness that hackers can exploit. A
2019 report from Dtex Systems reported that 74% of staff surveyed were able to circumvent security
controls to use unsanctioned portable applications such as USB sticks.

Organisations clearly need to be more robust in regulating the use of such media.

6. Secure configuration

In the same way that removable media needs to be controlled, hardware added to an organisation’s
network needs to be configured in a way that restricts unauthorised use. An obvious example here
would be a standard configuration for any laptop connected to the company network.

7. Managing user privileges

The separation of duties is a widely used control, but the 2019 Dtex report discovered that 95% of
users actively attempted to circumvent corporate security policies. Much of this would not have
been malicious (how many people have allowed someone else to log on using their password so that
they can do their job?). Nevertheless, it creates a culture that dramatically undermines basic
controls.

8. Incident response

Cyber security attacks are inevitable. When they happen, an organisation needs to have a robust
response that minimises the immediate threat (e.g. off-site back-ups). However, what happens after
an attack has been neutralised is equally important – the organisation needs to learn from the
incident in order to minimise the risk of it recurring.

9. Monitoring

An organisation that spots an unsuccessful cyber-attack will be able to implement additional

measures that target potentially sensitive areas. For example, some organisations send fake phishing
emails to staff – messages that could result in unauthorised users gaining access to sensitive
information. Staff that fall for the trick can be targeted for additional training.

10. Home and mobile working

The increase in remote working requires organisations to permit network access from different
geographical locations. Effective controls in this field include the use of a Virtual Private Network
(VPN), which should only be accessed using appropriately configured devices (see 6 above).

IT controls

IT controls can be broadly segregated into three broad categories:

– General controls
– Application controls
– Physical access controls
 Technology and data analytics 158

1) General controls:
These controls cover the overall IT environment and include general policies and procedures.
These are applicable to all the IT systems in the organisation. Examples of general controls are:
– Firewalls and anti-virus software
– Backups and disaster recovery plans (covered in detail below)
– Passwords- Logical access control
– Segregation of duties

2) Application controls:
These apply to a specific software. These controls are put in place to ensure that transactions
are accurately entered, completed and authorised. Examples of application controls are:
– Completeness check
– Format check
– Sequence check
– Batch totals
– Authorisation

3) Physical access controls:

These controls are put in place to prevent any unauthorised person from accessing the IT
system. Another objective is to prevent IT assets from environmental hazards and terrorist
attacks etc.
Examples of such controls are:
– CCTV cameras
– Biometric access doors
– Security guards
– Smoke detectors
– Safeguarding of all confidential information

Apply Your Knowledge (AYK)

Introduction

TMP (The Management Press) is a specialist business publisher; commissioning, printing and
distributing books on financial and business management. It is based in a small town in Arcadia, a
high-cost economy, where their printing works were established fifty years ago. 60% of the
company’s sales are made through bookshops in Arcadia. In these bookshops, TMP’s books are
displayed in a custom-built display case specifically designed for TMP. 30% of TMP’s sales are
through mail order generated by full-page display advertisements in magazines and journals. Most
of these sales are to customers based outside Arcadia. The final 10% of sales are made through a
newly established website which offers a restricted range of books. These books are typically very
specialised and are rarely featured in display advertising or stocked by general bookshops. The books
available on the website are selected to avoid conflict with established supply channels. Most of the
online sales are to customers based in Arcadia. High selling prices and high distribution costs
makeTMP’s books expensive to buy outside Arcadia.
 Technology and data analytics 159

Business changes

In the last decade, costs have increased as the raw materials (particularly timber) used in book
production have become dearer. Paper is extremely expensive in Arcadia, and the trees used to
produce it are becoming scarcer. Online book sellers have also emerged who are able to discount
prices by exploiting economies of scale and eliminating bookshop costs. In Arcadia, it is estimated
that three bookshops go out of business every week. Furthermore, the influential journal
‘Management Focus’, one of the journals where TMP advertised their books, also recently ceased
production. TMP itself has suffered three years of declining sales and profits. Expenditure on
marketing has been reduced significantly in this period, and further reductions in the marketing
budget are likely because of the weak financial position of the company. Overall, there is increasing
pressure on the company to increase profit margins and sales.

Despite the poor financial results, the directors of TMP are keen to maintain the established supply
channels. One of them, the son of the founder of the company, has stated that ‘bookshops need all
the help they can get and management journals are the heart of our industry’. However, the
marketing director is keen for the company to re-visit its business model. He increasingly believes
that TMP’s conventional approach to book production, distribution and marketing is not sustainable.
He wishes to re-examine certain elements of the marketing mix in the context of the opportunities
offered by e-business.

A young marketing graduate has been appointed by the marketing director to develop and maintain
the website. However, further development of the website has not been sanctioned by the Board.
Other directors have given two main reasons for blocking the further development of this site.
Firstly, they believe that the company does not have sufficient expertise to continue developing and
maintaining its own website. It is solely dependent on the marketing graduate. Secondly, they feel
that the website will compete with the established supply channels which they are keen to preserve.

However, the marketing director is convinced that investing in e-business is essential for the survival
of TMP. ‘We need to consider what unique opportunities it offers for pricing the product, promoting
the product, placing the product and providing physical evidence of the quality of the product.
Finally, we might even re-define the product itself’. He feels if the company fails to grasp these
opportunities, then one of its competitors will, and ‘that will be the end of us’.

Required:

(a) Determine the main drivers for the adoption of e-business at TMP and identify potential
barriers to its adoption.
(b) Evaluate how e-business might help TMP exploit each of the five elements of the marketing
mix (price, product, promotion, place and physical evidence) identified by the marketing
director.
 Technology and data analytics 160

Cloud computing is storage of data in a virtual/remote servers instead of physical storage.

BIG DATA

-Volume

-Velocity

-Variety

Machine learning is where machines can learn from past data and experiences.

AI is the ability of machines to portray the cognitive skills of a human being.

RPA (Robotic Process Automation) is the process of using robots to do simple and repetitive tasks

The major need for cyber security arises due to the increasing value of data.

Controls over IT systems are categorised as:

- Physical controls
- General controls
- Application controls
 Technology and data analytics 161

Answers to Apply Your Knowledge:

AYK 1

a) The main drivers for the adoption of e-business at TMP are:

– Cost reduction, specifically raw material costs (the cost of paper) and distribution costs to
bookshops.

– Improved profit margin, perhaps achieved by removing the bookshop as an intermediary.

– Increased revenue, increasing sales (as well as profit margins) is an important objective.

– The desire to keep up-to-date (exemplified by the marketing director) and hence to avoid losing
market share to businesses prepared to embrace e-business.

– Increased ecological concern about the use of timber for paper manufacture. The trees used to
provide the timber are becoming increasingly scarce.

– People, in the shape of the marketing director and the graduate recruited to develop the website.

The main barriers to the adoption of e-business at TMP are:

– Concerns about the cost of developing the website, particularly when revenue and profits are
decreasing. Marketing expenditure has been reduced, and this is likely to continue. – Concerns that
it will destroy the relationship with bookshops and those sales will decrease overall as a result.
Destroying existing channels is often a major barrier to change.

– Lack of technical ability within the company to develop and maintain the website and the impact
this may have on its long-term viability.

– Concern about fraud and piracy. This may be within the context of the financial transactions of e-
commerce. It may also reflect concerns about the pirating of books, leading to either cheap printed
versions being produced and sold in local markets or to illegitimate copies being sold and distributed
on the web.

– Other directors could be perceived as a barrier to the adoption of e-business.

b) Product

At present, TMP offers conventional physical books. E-business may provide opportunities for either
replacing or augmenting this product. For example:

– Replacing the book with an electronic alternative that customers can read directly from the screen,
view through an e-book reader or print off at their own cost. This may allow the range of products to
be increased, introducing books that would be uneconomic to produce conventionally.

– Augmenting the product by providing supplementary services and features. For example, many
text books now have an associated website that includes further case studies, exercises, solutions,
simulations etc. This may be particularly applicable to management texts where readers often
require further information. Using e-business to change the nature of the product should help
reinforce two of the drivers identified in the first part of this question. It should help reduce raw
material costs as well as helping the company meet environmental targets. Augmenting the product
should help deliver a better quality product to customers.
 Technology and data analytics 162

E-business also offers opportunities for extending the product range, perhaps offering (through
intermediaries) management training, financial advice and other related services.

Price

At present, TMP largely sells through bookshops, and so the TMP price has to reflect a profit margin
for the bookshop. If TMP exploits e-business to develop a channel that eliminates bookshops, then it
should be able to simultaneously discount the price of the book and yet still improve their profit
margin. E-business may also be an opportunity to experiment with differential pricing. The scenario
notes that overseas sales are low because of the relatively high sales price of books. TMP may be
able to combine differential pricing (in local currencies) with electronic alternatives to find a product
that is saleable in these markets.

TMP has to be aware of any price-comparison websites and be prepared to monitor costs on these
sites and react accordingly. They also have to be aware of large established channels, such as
Amazon. Such sites will expect keen pricing, but will also pay commissions on books sold through the
site.

Finally, TMP might seek an alternative price strategy, based for example on subscribing to the site,
rather than selling books. A ‘book’ may become a continually updated web resource that customers
pay to use on either a one-off or continuing basis. There is no need for them to actually own the
book themselves. TMP therefore becomes a virtual library. Direct pricing to customers also provides
the opportunities for special offers, pre-publication prices and other deals. For example, special
discount prices on related books can be offered to customers who have placed an order for a specific
book.

Promotion

At present, promotion is restricted to a custom-built display case at bookshops and full-page display
advertisements in magazines and journals. Such promotion reflects a conventional ‘push’ approach
to marketing that focuses on the product rather than the customers. If the website records the
details of visitors, then the company can identify potential customers for its products and target
them in mail-shots and on-line suggestions. For example, customers who have bought certain titles
may have others suggested to them when they next visit the site. Many sites also make buying
suggestions based on the behaviour of other customers, for example displaying ‘other titles which
have been bought by customers who have bought this book’.

E-business will require the company to consider both its online and offline promotion. TMP may be
able to reduce its offline expenditure, cutting back on advertising. In its place, it might spend
elsewhere, particularly in making sure that it figures prominently in search engine listings. Links to
other sites should also be considered, allowing the promotion of TMP books on related sites. For
example, internet sites providing management advice, information and glossaries may have a link to
the TMP site. TMP pays commission to the site on sales made through such links. Banner advertising
might also be considered on such sites. A similar approach might be used with academic websites
where a TMP book is recommended reading for a course
 Technology and data analytics 163

Place

Bookshops have limited reach, although they do provide the facility for the potential buyer to handle
the book (see physical evidence). The display advertising has an unpredictable reach. Circulation
figures are usually provided by journals and magazines, but this does not give any information on
how many people actually read the advertisements in question. The scenario suggests that both
bookshops and journals appear to have declining reach, based on statistics about their closure. The
internet has a global reach. The relatively small percentage of books currently sold outside Arcadia is
attributed to the cost of those books. However, it may be that the rest of the world is simply
unfamiliar with TMP’s booklist, a shortcoming that will be addressed by the internet site.

In wider e-business terms, consideration of place will also lead to TMP considering whether it is
economic to continue printing in Arcadia, which is a high-cost economy. The printing works were
established 50 years ago, and it seems likely that cost-savings could be gained by printing and
distributing the books in lower labour cost economies.

Physical evidence

One of the problems in buying books is the ability to look inside those books before purchase. Often
titles are insufficient to make a purchasing decision. One of the advantages of the bookshop is that
the potential buyer can physically inspect the goods, looking at the content in detail to ensure that it
meets their needs. In contrast, physical evidence is not possible at all through display advertising in a
journal.

On the website, it would be possible to allow the potential buyer to view the contents of the book in
detail and (usually) one physical chapter. This so-called ‘look inside’ facility allows them to base their
buying decision on some (but not all) physical evidence. Further evidence can also be provided by
unsolicited recommendations and reviews from other customers. Feedback, comments and rating
systems are typical features on a website. These are rarely available through the bookshop. The
bookshop employees have rarely read all the books they sell and, if they have read the book, are
probably biased towards a sale. Sometimes, reviews have been placed in the book, often from a
previous printing or edition. However, these are only the ones sanctioned by the publisher.
Unsolicited references are one of the advantages of the website (as long as they are good!)

The problem of physical evidence can also be addressed by seeing the book as a website resource
rather than a physical entity. If the reader pays for access, then very little expenditure is likely on a
book that does not fulfil the reader’s requirements and expectations.
 Organisational control and audit 164

8. Organisational control and audit

8.1 Management and internal control systems

a) Evaluate the key components or features of effective internal control systems, such as those
included under the COSO framework.
b) Assess whether information flows to management are adequate for the purpose of managing
internal control and risk.
c) Evaluate the effectiveness and potential weaknesses of internal control systems.
d) Discuss and advise on the importance of internal sound control and compliance with legal and
regulatory requirements and the consequences to an organisation of poor control and non-
compliance.
e) Recommend new internal control systems or changes to the components of existing systems to
help prevent fraud, error, waste or harmful environmental impacts using appropriate metrics.

Internal controls are:

The whole system of controls, financial and otherwise, established by management in order to

– carry out the business of the enterprise in an orderly and efficient manner,

– ensure adherence to management policies,

– safeguard the assets,

– prevent and detect fraud and error

– secure the completeness and accuracy of the records and the timely preparation of financial
information.

Includes other controls such as quality, compliance controls etc.

In simpler terms, Internal controls are procedures put in place to reduce risk. We have previously
seen the features of an internal control system which are included in the COSO framework. Now we
will see what should be done for each of the five features to be effective.

1) Control environment:
– Promote integrity and ethical values
– Board of Directors should oversee the internal controls (Through Audit committee)
– Establishment of appropriate reporting lines, authorities, responsibilities.
– Attract and develop competent employees through training.
– Employees should be held responsible for their internal control responsibilities.

2) Risk assessment:
– Objectives should be clearly defined.
– Proper identification and classification of risks.
– Identification of changes in the external environment and consideration of fraud risk.
 Organisational control and audit 165

3) Control activities:
– Policies and procedures established to mitigate risks
– Policies are what is expected, and procedures are policies in action
– Development of general IT controls

4) Information and communication:

– High quality information should be generated
– Clear communication of internal control responsibilities
– Appropriate communication with external parties regarding internal control.

5) Monitoring activities:
– Continuous evaluation of the effectiveness of internal controls
– Timely communication of problems in internal controls to the BOD.

Limitations of Internal controls and possible reasons for failure

1. HUMAN / MANUAL INTERVENTION: Failures in human judgement when assessing a control or

fraud in measuring or reporting a control. Where a control relies upon human measurement, the
error is always a possibility either through lack of training, incompetence, willful 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: 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 be 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.
 Organisational control and audit 166

Control activities and procedures to reduce risk

• Segregation of duties: split up the stages of a transaction so that one person doesn’t carry
out every step. This helps to stop fraud and also means that several minds are involved in
ensuring the transaction is correct.

• Physical: lock cash and inventory away

• Authorization and approval

• Management and supervision

• Arithmetic and accounting: re-perform calculations, eg. BRS, inter-company reconciliation

etc.

• Personnel: recruitment and training of employees

Need for information flow to management relating to internal controls

The board is accountable for the management of risk; hence it is essential of them to know whether
appropriate controls are in place and whether they are effective.

The board then takes decisions relating to controls based on the information provided to it. A strong
set of internal controls will help in providing reliable information.

Further, the internal and external auditors use this information to carry out their tasks. The board
also needs to report to stakeholders regarding the internal controls in place. Hence, management
needs to have accurate information regarding internal controls.

8.2 Audit and compliance

a) Examine the need for an internal audit function in the light of regulatory and organisational
requirements.
b) Justify the importance of auditor independence in all client-auditor situations (including internal
audit) and the role of internal audit in compliance.
c) Justify the importance of having an effective internal audit committee overseeing the internal
audit function.
d) Assess the appropriate responses to auditors’ recommendations.

Internal audit function:

This is an independent function established within the organisation to provide assurance regarding
the effectiveness of internal control and financial reporting. Some jurisdictions may make it
compulsory to have an internal audit function, whereas it may also be regarded as good corporate
governance practice.

Having an internal audit function provides confidence to the stakeholders regarding the
effectiveness of internal controls.
 Organisational control and audit 167

Roles of internal audit department:

– Setting the tone for internal control environment

– Evaluating controls and advising managers at all levels
– Evaluation of risks
– Analysing operations and confirming the integrity of information
– Promotion of ethics
– Fraud investigation
– Other duties which may be prescribed by Audit Committee such as helping out the external
auditors

Companies decide whether there is a need for voluntarily set up internal audit function by
considering factors such as:

• Scale, diversity and complexity of the company’s operations

• Number of employees
• Cost-benefit considerations
• Changes in organisational structure
• Changes in key risks
• Problems with internal control systems
• Increased number of unexplained or unacceptable events
 Organisational control and audit 168

Internal auditors should be:

• Qualified
• Experienced
• Independent
• Professional

Types of assessments:

➢ Transactions audit: tracing transactions through the system, often from start to finish, to see if
they are treated correctly.

➢ Systems audit: an information technology, or information systems audit, is an examination of

the management controls within an Information technology (IT) infrastructure.

➢ Risk-based audits: an internal audit which is primarily focused on the inherent risk involved in
the activities or system and provide assurance that risk is being managed by the organization to
the defined risk appetite level.

➢ Accounting systems audit: ensuring, for example, that the proper accounting controls are being
applied consistently.

➢ Operational audits: a systematic review of effectiveness, efficiency and economy of operation.

For example, examining how customer complaints are dealt with.

➢ Value for money and best value. Usually associated with public or non-profit organizations. Its
purpose is to assess the effectiveness and efficiency of its use of public funds.

➢ Management audits: analysis and assessment of competencies, abilities and capabilities of a

company's management in order to evaluate their effectiveness, especially regarding the
strategic objectives and the implementation of the policies of the business.

➢ Social and environmental audits: looks at factors such as a company's record of charitable
giving, volunteer activity, energy use, recycling waste, diversity in recruitment, non-
discrimination in appointments, the standard of the work environment, workers’ remuneration

Independence of auditors:

Independence of auditors is of utmost importance as the stakeholders are reliant on the judgement
provided by them. If auditors have any financial or non-financial interest vested in the company, this
will hamper their judgement and influence their decisions.

Independence of internal auditors is all the more questionable as they are working for the employer.
They may not be able to perform their tasks properly as they will be too familiar to the staff, may not
report all problems due to fear of upsetting top level management.

Due to these concerns, companies often outsource their internal audit function. This increases the
independence of the internal auditors.
 Organisational control and audit 169

Difference between internal and external audit

INTERNAL AUDIT EXTERNAL AUDIT

Reports to Management – must have a Shareholders
clear route to the board
through day-to-day reporting
to the audit committee.
Appointed by Management Shareholder
Power from Management Statute – allows external
auditors to insist on seeing all
documents and to be given full
explanations.
Employed by Company (unless outsourced) External firm
Coverage All categories of risk and Financial Statements: true and
investigation fair view
Responsibility for improving A major function of internal Will report to management on
the organization audit internal weakness

7.3 Internal control and management reporting

a) Justify the need for reports on internal controls to shareholders.

b) Discuss the typical contents of a report on internal control and audit, including environmental
and sustainability audit.
c) Assess how internal controls underpin and provide information for reliable financial and
sustainable reporting.

Board of directors are required to annually report to the shareholders on the effectiveness of the
internal controls placed by the company. This reporting is important due to the following reasons:

• It increases shareholder confidence as they are updated

• Directors work more responsibly towards good internal control procedures as they have to
report.
• This increases the overall confidence of other stakeholders as well increasing the
creditability of the company.

Contents of a report on internal controls:

• Declaration by directors acknowledging their responsibility of maintaining effective control

systems
• Summary of the process applied to measure the effectiveness
• Overview of the entire system.
• Summary of how the board ensures that internal controls are effective
• Material control weaknesses in the system
• Action is taken to address the weakness.
 Organisational control and audit 170

“AYK 1

After a period of expansion into several overseas markets and some structural decentralisation, Loho
Company was considering its internal audit and internal control needs. Although privately owned
and therefore not subject to listing rules, Loho’s auditors had often suggested that a formal internal
audit function would be beneficial.

The launch of several new products and a rapid increase in exports had raised a number of problems
at Loho. These included problems in meeting order deadlines, whilst a number of operational
constraints had meant that some orders had been delivered to customers late. The increase in
overseas business had also, according to Sonja Tan, the financial director, increased the overall risk
profile of the business. Credit risk had risen substantially, as had a range of risks associated with
exporting and overseas investment. In addition to growth from 150 to 600 employees in its home
country, Loho also had recruited a further 200 people overseas in order to facilitate business in
those countries.

As part of her continuing professional development (CPD), Sonja Tan, the finance director who was
also a professional accountant, had been to a seminar on improving internal controls (IC). She
believed that at this point in its growth, Loho could benefit from tighter internal controls. Speaking
about this to the board on her return from the seminar, she reminded her colleagues that sound
internal controls could only provide ‘reasonable assurance’ and that any IC system had inherent
limitations and could never be totally effective whatever changes were made to improve them. This
came as a surprise to some board members who assumed, because internal controls were often very
expensive, that they should be guaranteed to be fully effective.

Required:

(a) Construct the case for establishing an internal audit function at Loho Company.
(b) Explain the reasons why many internal controls can never be guaranteed to be fully effective
and discuss why ICs being ‘very expensive’ are no guarantee of their effectiveness.”
 Organisational control and audit 171

Five elements of internal controls:

1) Control environment
2) Risk assessment
3) Control activities
4) Information and communication
5) Monitoring

Control procedures:

1) Segregation of duties

2) Physical

3) Authorization and approval

4) Management and supervision

5) Organization

6) Arithmetic and accounting

7) Personnel: recruitment and training of employees

Internal auditors report to the management via the audit committee

External auditors report to shareholders

 Organisational control and audit 172

Answers to Apply Your Knowledge:

AYK1

“a)Establishing an internal audit function at Loho Company

Some corporate governance reports set out a number of criteria for a company considering setting
up an internal audit function. The Turnbull Report, from the UK, for example, lists seven criteria: the
scale and complexity of operations; the number of employees; cost-benefit considerations; changes
in the organisational structure; changes in key risks, problems with internal control systems; and an
increase in the number of unexplained or unacceptable events.

In the case of Loho, the case for establishing an internal audit function has grown in recent years
because of five of these criteria. The successful expansion of Loho in recent years has given rise to
some problems associated with growth and greater complexity of operations. The case mentions
new products and new markets overseas. These, being the two major areas of uncertainty on the
classic Ansoff matrix, represent a significant increase in the complexity of the company’s operations,
and the company is manifestly having issues coping with this change. Effective internal audit systems
can scrutinise and report on each part of the organisation and ensure that the complexity of each
component is understood and controlled.

The growth and increased complexity has also seen an increase in the number of employees from
150 to 600 in its home country and the addition of 200 overseas positions. The configuration and co-
ordination of this increased number presents Loho with a considerable challenge if they are all to be
usefully employed to maximise each person’s contribution. This includes oversight of decentralised
activities, especially in overseas offices, and potentially managing the cultural and language issues
sometimes occasioned by the employment of overseas nationals.

The case mentions that the company has become more decentralised as a result of its growth. It is
common for growing businesses to increasingly delegate authority to divisions and departments as
they grow or to regional offices if the growth is geographical in nature. The loss of concentration of
power at the centre sometimes raises issues with control and co-ordination of the decentralised
parts, and so an internal audit can help to ensure compliance of those parts with company norms
and procedures. These decentralised centres must also be configured so they ‘fit’ with the rest of
the organisation and co-ordinated with the overall strategy, and an internal audit can help achieve
this.

One of the results of the increase in internationalisation is a change in some of the risks. Exporting
and conducting business in more than one country increases the number of risks, and the case
mentions credit risk in particular, which is the risk of failing to be paid on time (or at all) by
customers. This can severely affect working capital management and so can, in the worst case,
threaten the survival of the business if it is unable to meet current working capital liabilities, such as
the payment of suppliers. In some countries or in some sectors where cultural factors may mean
that credit risk is a material risk, an internal audit department could enforce credit controls and
ensure that mitigation systems are in place to manage those risks. It could also perform regular
‘stress test’ exercises to ensure that credit controls are effective and fit for purpose.
 Organisational control and audit 173

The final argument for establishing an internal audit function is an increased number of
unacceptable events at Loho. It would appear from the case that the growth of the company has
brought about a number of deficiencies in the operations department which have led to the
company failing to adequately meet orders through late deliveries. This level of operational
performance will threaten the long-term relationships with customers and could rapidly lead to a
loss of trust in Loho among its buyers. An effective internal control function could analyse the causes
of these events and help to reduce their impact or find ways in which the company’s vulnerability to
such events can be reduced.

b) Why the effectiveness of internal controls (IC) cannot be guaranteed

It is generally understood that however robust and expensive an internal control is, it can sometimes
be ineffective. There are a number of possible reasons for this, with the most common being as
follows:

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.

Human factors can undermine or circumvent the effectiveness of many internal controls. In this
regard, the most common is human error, which may or may not be accompanied by intentional
fraud. It is sometimes believed, by an individual, that personal gain could be achieved were a given
control not in place, and this can result in that person intentionally circumventing the control.

Likewise, controls can be ineffective if employees collude to achieve that circumvention. If a group in
a workplace believes a control to act against members’ personal interests, they can act together to
reduce its effectiveness. This may, of course, result in a sanction if discovered.

The fourth reason why ICs are sometimes ineffective is the occurrence of non-routine events when
control is designed for relatively routine behaviour. These might include events from any of the PEST
influences, for example, which might render the control ineffective, possibly by ‘overwhelming’ the
control or presenting it with a situation for which it was not designed. Linked to the previous point is
the occurrence of unforeseen or unforeseeable events.

Management or employees may exercise poor judgement or miscalculation, which means that
control will become ineffective. A brake on a machine tool or a vehicle is only effective, for example,
as long as the machine is responsibly and safely used. An excessive speed or the use of a wrong
material in a machine tool, for example, would negate the value of the brake, even though the brake
is effective in its own right.
 Organisational control and audit 174

Relationship to cost

There are several reasons why cost alone is a poor guide as to the effectiveness of internal controls.

First, it is the design of the control rather than the cost, which is the primary driver of effectiveness.
A wrongly or inappropriately designed control, regardless of cost, will be less than fully effective. It is
for this reason that a great deal of technical detail is applied to the design of controls, especially
those concerning financial risk. There need not be any direct relationship between design and cost. A
highly effective control can, at the same time, be very simple and inexpensive.

Second, a control can be over-specified, meaning that the control is more robust, and usually
therefore more expensive, than it needs to be. Cost-effectiveness is a key criterion to the adoption
of any control, and control costing disproportionately more than the loss which could be incurred by
its failure is seen to be poor value for money.

Third, almost any control can be corrupted, circumvented or ignored in line with the limitations
outlined in the first section of this answer. With sufficient determination, an employee or service
user can act against a control. Similarly, a technical failure (such as loss of power or a computer
failure) can render even the most well-designed control less effective.”
 Organisational control and audit 175

PO12 – EVALUATE MANAGEMENT ACCOUNTING SYSTEMS

Description

You apply different management accounting techniques using appropriate technologies in different
business contexts to effectively manage and use resources.

Elements

a. Evaluate management accounting techniques and approaches in an organisation.

b. Apply appropriate costing techniques to products and services.
c. Assess and advise on the effectiveness of an organisation’s management accounting and ICT
systems.
d. Contribute to developing and improving management accounting systems and internal
reporting recognising the impact of emerging technologies.
e. Monitor new developments in management accounting and consider their potential impact
on performance and systems.

PO20 – REVIEW AND REPORT ON THE FINDINGS OF AN AUDIT OR ASSURANCE ENGAGEMENT

Description
You complete an audit, preparing the formal documentation and reporting any control deficiencies
to management. You report back to managers in a formal audit report.

Elements

a. Review the performance of an audit; making sure that the evidence is accurate, complete
and sufficient.
b. Contribute to identifying and resolving audit or assurance issues and make sure there are no
outstanding queries.
c. Discuss the findings and implications of an audit or assurance engagement with
management and governance teams.
d. Draft written representations and report significant control deficiencies to management and
governance teams.
e. Prepare audit reports in accordance with relevant standards, regulations and legislation.
 Finance in planning and analysis 176

9. Finance in planning and analysis

9.1 Finance transformation

a) Discuss how advances in technology is transforming the finance sector and the role and structure
of the finance function within organisations.
b) Evaluate alternative structures for the finance function using business partnering, outsourcing
and shared or global business services.

Traditionally the role of the finance function was very limited and mainly focused of collections,
payments and financial reporting. Due to advancements in technology, these basic tasks have got
automated, and since then, the role of finance function has broadened. It is expected that the
finance function should help strategic level management by being futuristic, proactive and try to add
increase shareholders wealth.

This has opened up new horizons for finance professionals, and their job now focuses on:

1) Supporting in analysing, implementing and monitoring of strategies

2) Creating long term forecasts and scenario planning
3) Maintaining an optimum capital structure
4) Making businesses cost-efficient
5) Managing financial risks

These areas are over and above the legal compliance, accounting and reporting, which the finance
function has always focused on.

Evolving structures of the finance function:

Earlier finance was like any other department, which had to be there in all of the business units of a
company. But, lately the trend has changed. New structures of the finance function are developing
due to developments in IT. These are as follows:

Outsourcing:

Tasks such as bookkeeping, payroll, collections and payment processing are considered to be non-
core. These activities do not add much value and are simple and hence can be outsourced to third
parties.

Companies can hence save money and effort of hiring employees for performing such tasks.
Outsourcing is becoming very common these days as companies from Europe and the USA are
outsourcing their accounting and finance functions to Afro-Asian countries. This results in significant
cost savings due to the availability of qualified and inexpensive labour in such countries.

Shared service model:

 Finance in planning and analysis 177

Earlier, when an MNC like Samsung expanded into different countries, it was essential for them to
have a designated finance function in each of their business units. But now, as information can travel
in real time through the internet, such companies can have a centralised function for finance.

This will be located mostly in the head office but will serve all the business units. This shared service
centre of finance will charge each of the departments a particular fee.

Business partnering:

Finance business partners are accountants who work closely with a particular business unit creating
a real and active partnership with both operations and management. Their role is to provide 'real
time' support and analysis, to be a trusted adviser and to add value that will assist in decision
making.

Critical to their success is an ability to communicate their message, to understand their audience and
deliver the information in a clear and user friendly manner. It is this mix of analytical, commercial
and communication skills which are at the heart of successful finance business partnering.

9.2 Financial analysis and decision- making techniques

a) Determine the overall investment requirements of the organisation.

b) Assess the suitability, feasibility and acceptability of alternative sources of short and long term
finance, including initial coin offerings (ICO), available to the organisation to support strategy and
operations.
c) Review and justify decisions to select or abandon competing investments or projects applying
suitable investment appraisal techniques.
d) Justify strategic and operational decisions taking into account risk and uncertainty.
e) Assess the broad financial reporting and tax implications of taking alternative strategic or
investment decisions.
f) Assess organisation performance and position using appropriate performance management
techniques, key performance indicators (KPIs) and ratios.

Organisations need funds in order to grow. It is not possible to grow only on the basis of retained
earnings, and hence companies have to look outside their organisations to raise finance.

Any organisations funding strategy will depend upon a number of factors such as:

• The amount of finance required

• The time period for which it is required
• The creditability of the company
• Current gearing levels
• The riskiness of the company’s projects etc

The main sources of funding are mainly debt and equity. Following factors can be considered while
choosing between them.

1) Debt:
• Cost of debt is cheaper than the cost of equity
• Obligation to pay a fixed interest
• Increases gearing level of company and hence financial risk increases too.
 Finance in planning and analysis 178

• Amount of loan and interest rates available will depend on creditability and availability of
collaterals.

2) Equity:
• Cost of equity is more than the cost of debt
• No obligation to a fixed dividend
• Decreases gearing and financial risk
• Raising finance through equity will lead to dilution of existing shares and will lead to external
influence in the company.

Initial coin offerings:

Cryptocurrencies can also be used to raise finance for a company. Suppose you have a good business
idea and you want to raise finance through the public but due to stringent laws of the stock
exchange you cannot file for an Initial Public offer (IPO). So, instead you apply for an ICO.

In an ICO, you provide your own tokens to supporters (other word for investors) who pay you money
in exchange. These tokens initially don’t have any value, but if the company does well, their value
increases and then they can be exchanged for money or other cryptocurrencies. Again, like
cryptocurrencies, ICO’s are unregulated.

Benefits and threats of using ICO to raise finance.

BENEFITS THREATS
• Capital can be raised quickly than • As funds are received quickly, and upfront
conventional sources. founders may not work hard enough for
the success of the company.
• Cheaper way to raise finance due to a lack
of intermediaries. • Lack of transparency and oversight as
corporate governance principles do not
• Simple process and few barriers to entry. apply.

• Can attract global investors. • Risk of fake schemes

• Immediately liquid investment

Investment appraisal techniques:

NPV (Net Present Value)

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)
 Finance in planning and analysis 179

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)

If a project gives a positive NPV, it suggests that the project is adding value to the company and
increasing shareholder wealth. Hence, the decision rule is to accept a project if the NPV is positive.

It gives returns in absolute terms, and hence we cannot compare projects of different sizes using
NPV.

Internal rate of return:

IRR is a discount rate at which the NPV of a company turns zero. IRR is used to compare projects in
terms of the rate of return.

Or simply you can use the IRR formula in excel (=IRR (cash flows, guess))

The decision rule of IRR is that a company should accept any project which has a higher IRR than the
cost of capital. This suggests that the company is earning more than it is spending.

NPV and IRR are the top most techniques for investment appraisal. When a situation arises when
two projects are competing against each other and have a similar NPV and IRR, we can use the
following techniques:

Payback period:

It is the time in which the initial outlay of capital is expected to be recovered from the cash inflows.
𝑰𝒏𝒊𝒕𝒊𝒂𝒍 𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕
Payback period = 𝑪𝒂𝒔𝒉 𝒊𝒏𝒇𝒍𝒐𝒘 𝒑𝒆𝒓 𝒑𝒆𝒓𝒊𝒐𝒅

Project having a shorter payback period will be preferred over a project having a longer payback
period.

Discounted payback:
𝑷𝑽 𝒐𝒇 𝑰𝒏𝒊𝒕𝒊𝒂𝒍 𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕
Discounted payback period= 𝑷𝑽 𝒐𝒇 𝑪𝒂𝒔𝒉 𝒊𝒏𝒇𝒍𝒐𝒘 𝒑𝒆𝒓 𝒑𝒆𝒓𝒊𝒐𝒅
 Finance in planning and analysis 180

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 the Some information is available based on past
expected 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:

1) Expected values:

Expected value represents the average outcome that would be achieved if a decision were to be
repeated many [Link] method is used by a ‘Risk neutral’ decision maker

Expected value is calculated by multiplying the value of each possible outcome by the probability
and then adding all the results together.

EV=∑px

p= probability of the outcome

x= the possible outcome

2) Sensitivity analysis:

Sensitivity analysis tries to calculate the sensitivity of the outcome to the change in the variables
used to calculate it.
It does so by calculating the % change required in variable before the profit turns into a loss.

The lower the %, the higher the sensitivity of the variable. E.g., if only 1% of the change in sales
price will turn a profit into a loss then, the outcome is highly sensitive to the variable (Sales
price).
In this way, by using sensitivity analysis, the critical variables are determined.
In most cases sensitivity = Profit/Variable*100

3) Simulation:
Simulation is a modelling technique. In a simulation, computers are used to simulate real life
scenarios. The models help in predicting the range of outcomes possible from a given decision.
Simulation allows more than one variable to change, and hence a varied number of outcomes
can be obtained.

Due to technology, the cost of obtaining this information is decreasing, and the benefits derived
from it are large. After a certain point, models can become very complex due to many variables.
It is often used in capital investment appraisal.
 Finance in planning and analysis 181

4) 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.

Example:

We choose the option which maximises our expected value. In the above tree, we would choose
Project A.

Ratio analysis:

Ratio analysis is used to evaluate various aspects of a company’s operating and financial
performance, such as its efficiency, liquidity, profitability and solvency.

Following are some of the important ratios:

A) Profitability ratios:

These ratios help us in determining how profitable an organisation is. We can then compare these
figures with our competitors or previous years.

1) Gross profit margin:

𝐆𝐫𝐨𝐬𝐬 𝐩𝐫𝐨𝐟𝐢𝐭
𝐆𝐫𝐨𝐬𝐬 𝐩𝐫𝐨𝐟𝐢𝐭 𝐦𝐚𝐫𝐠𝐢𝐧 = 𝐱 𝟏𝟎𝟎
𝐑𝐞𝐯𝐞𝐧𝐮𝐞
• Gross profit margin reflects the performance of the company’s products and how well are the
production costs kept under control.

• A falling GP margin suggests that either the selling price of products is decreasing or the cost of
sales is increasing and vice versa.

• This ratio can be improved by selling products with a higher margin, using tools such as target
costing to control the cost of sales of the product etc.
 Finance in planning and analysis 182

2) Net profit margin:

𝐍𝐞𝐭 𝐩𝐫𝐨𝐟𝐢𝐭
𝐍𝐞𝐭 𝐩𝐫𝐨𝐟𝐢𝐭 𝐦𝐚𝐫𝐠𝐢𝐧 = 𝐱 𝟏𝟎𝟎
𝐑𝐞𝐯𝐞𝐧𝐮𝐞
• This shows overall profit as a percentage of sales, and it depends on how well the non-
production costs are kept under control.

• A falling ratio suggests that non-operating costs are increasing and vice versa.

• This ratio can be improved by having better control over non-operating costs such as
administration costs, distribution costs etc.

3) Return on capital employed:

𝐏𝐫𝐨𝐟𝐢𝐭 𝐛𝐞𝐟𝐨𝐫𝐞
𝐑𝐞𝐭𝐮𝐫𝐧 𝐨𝐧 𝐜𝐚𝐩𝐢𝐭𝐚𝐥 𝐞𝐦𝐩𝐥𝐨𝐲𝐞𝐝 = 𝐢𝐧𝐭𝐞𝐫𝐞𝐬𝐭 𝐚𝐧𝐝 𝐭𝐚𝐱 𝐱 𝟏𝟎𝟎
𝐂𝐚𝐩𝐢𝐭𝐚𝐥 𝐞𝐦𝐩𝐥𝐨𝐲𝐞𝐝

Profit before interest and tax= Operating profit

Capital employed= Shares + reserves + long-term liabilities

OR

Capital employed= Total assets – Current liabilities

• This calculates the return generated as a percentage of capital employed. This ratio is often used
to make comparisons with competitors.

• This ratio measures how much the company earns per $ invested.

A decline in ROCE can be caused by:

• A fall in profit margin

• Reducing asset turnover

• Decline in both ratios

4) Asset turnover ratio:

𝐒𝐚𝐥𝐞𝐬
𝐂𝐚𝐩𝐢𝐭𝐚𝐥 𝐞𝐦𝐩𝐥𝐨𝐲𝐞𝐝

• This ratio tells us the how much revenue was generated in relation to capital employed. This tells
us how much turnover is generated from each $1 invested.

• This ratio can be improved by selling underutilized non-current assets, recognizing impairments
and improving working capital management by, for e.g., reducing inventory level and having a
better credit control system in place.
 Finance in planning and analysis 183

B) Liquidity ratios

These ratios help us understand whether the entity has the ability to pay off its current liabilities as
they become due e.g., payables, interest payments etc.

It is important to know the liquidity status of a company because if it’s not able to pay off its
liabilities, it can go into liquidation that is, it can no longer be considered as a going concern.

1) Current Ratio:
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐀𝐬𝐬𝐞𝐭𝐬
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬
It measures the organisation’s ability to meet its current liabilities as they fall due.

A ratio of more than 1 is desirable that is, its current assets are more than its current liabilities.

A ratio of less than 1 means its current liabilities exceed its current assets, and hence it could mean
that it is suffering from liquidity problems, but it also depends on the nature of the business.

2) Quick ratio/ Acid test ratio:

𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐀𝐬𝐬𝐞𝐭𝐬 − 𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐢𝐞𝐬
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬
As it is said that inventory is not easily convertible into cash, it should be ignored. Hence, we make
use of another ratio which is similar to the current ratio, but it excludes inventory from current
assets.

If the ratio is more than 1, the company can meet its short-term liabilities with the help of its liquid
assets, however, if it’s less than 1 It indicates that there aren’t enough liquid assets to pay off the
current liabilities when they fall due. Although, we need to do further analysis of the same to judge
its liquidity.

Both these ratios can be improved by improving the working capital management.

The following ratios are important from a working capital management point of view.

3) Receivables collection period:

𝐃𝐞𝐛𝐭𝐨𝐫𝐬
𝐱 𝟑𝟔𝟓
𝐒𝐚𝐥𝐞𝐬
This measures the time taken by the debtors to pay off their debt. An increase in the period suggests
that the efficiency of the credit control process is deteriorating.

4) Payables payment period:

𝐂𝐫𝐞𝐝𝐢𝐭𝐨𝐫𝐬
𝐱 𝟑𝟔𝟓 𝐝𝐚𝐲𝐬
𝐏𝐮𝐫𝐜𝐡𝐚𝐬𝐞𝐬
 Finance in planning and analysis 184

This measures the length of the credit period taken from suppliers on an average. An increase in this
ratio could mean that we are obtaining favorable payment terms from suppliers or we are struggling
to pay off our debts.

5) Inventory holding period

𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲
𝐱 𝟑𝟔𝟓 𝐝𝐚𝐲𝐬
𝐂𝐨𝐬𝐭 𝐨𝐟 𝐬𝐚𝐥𝐞𝐬

The holding period of inventory suggests the average number of days the inventory items are held
for. The ratio may increase may increase due to:

1) Increase in inventory storage due to increasing demand

2) Increase in cash tied up in inventory due to obsolete inventory

D) Risk

These ratios are used to measure the financial risk of the company.

1) Financial gearing
𝐃𝐞𝐛𝐭
𝐱 𝟏𝟎𝟎
𝐄𝐪𝐮𝐢𝐭𝐲
OR
𝐃𝐞𝐛𝐭
𝐱 𝟏𝟎𝟎
𝐃𝐞𝐛𝐭 + 𝐄𝐪𝐮𝐢𝐭𝐲

• This ratio tries to explain the level of risk by comparing the level of debt to equity.

• Gearing ratio needs to be compared to the industry level to check whether our gearing is
within acceptable levels.

• Generally, higher gearing suggests higher risk.

• This ratio can be decreased by using equity to raise finance rather than debt.

2) Interest cover: number of times

𝐏𝐫𝐨𝐟𝐢𝐭 𝐛𝐞𝐟𝐨𝐫𝐞 𝐢𝐧𝐭𝐞𝐫𝐞𝐬𝐭 𝐚𝐧𝐝 𝐭𝐚𝐱
𝐈𝐧𝐭𝐞𝐫𝐞𝐬𝐭 𝐩𝐚𝐢𝐝

• This ratio tells us the number of times we can pay our current interest payments through our
profit.

• The higher the number, the less risky an organisation is.

3) Dividend cover: number of times

 Finance in planning and analysis 185

𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐚𝐟𝐭𝐞𝐫 𝐭𝐚𝐱 𝐚𝐧𝐝 𝐩𝐫𝐞𝐟𝐞𝐫𝐞𝐧𝐜𝐞 𝐝𝐢𝐯𝐢𝐝𝐞𝐧𝐝

𝐎𝐫𝐝𝐢𝐧𝐚𝐫𝐲 𝐝𝐢𝐯𝐢𝐝𝐞𝐧𝐝

• This ratio tells us how many times the dividend can be paid out of the profit that is, how
much profit is available to the shareholders.

4) Operating gearing:
𝐅𝐢𝐱𝐞𝐝 𝐜𝐨𝐬𝐭𝐬
𝐓𝐨𝐭𝐚𝐥 𝐜𝐨𝐬𝐭𝐬
• This is the measure of the company’s fixed cost as compared to total costs.

• The risk increases with an increase in the fixed costs. This is because even a small change in
revenue can make a lot of difference on the profits of a company as the majority of costs are
fixed.

• Organizations in service industries generally have high operating gearing as majority of the costs
are fixed.

7.3 Cost and management accounting

a) Discuss from a strategic perspective, the continuing need for effective cost management and
control systems within organisations.
b) Evaluate methods of forecasting, budgeting, standard costing and variance analysis in support of
strategic planning and decision making.
c) Evaluate strategic options using marginal and relevant costing techniques.

Budgeting and financial forecasting:

Budget is a plan for where a business wants to go, and a forecast is an indication of where it is
actually going.

Types of budgets:

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 assumes everything will
happen as per plan.

2) Flexible Budget: A flexible budget is a budget for more than one level of expected activity. The
flexible budget is more sophisticated and useful than a fixed/static budget which remains at one
amount regardless of the volume of activity. However, the 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.
 Finance in planning and analysis 186

4) Incremental budget: 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 the environment is relatively stable.

5) Zero-based budget: 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.

6) 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.

Forecasting techniques:

Quantitative techniques:

1) Linear regression analysis:

The centre of regression is the relationship between two variables called the dependent and
independent variables. 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?

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.i.e. daily closing stock prices, weekly interest rates, national income
etc.

Time series analysis aims to understand patterns evolving over time and use these patterns to
predict future behaviour (i.e. quarterly sales)

Qualitative techniques:

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 revaluate their responses to the first questionnaire. This
process continues until the researchers have a narrow shortlist of opinions about forecasts
 Finance in planning and analysis 187

3) Sales Force Polling:

Some companies believe that salespersons have close contact with the consumers and could provide
significant insights regarding customer behaviour. In this method of forecasting, the estimates are
derived based on the average of sales force polling.

4) Consumer Surveys:

Businesses often conduct market surveys of consumers. The data is collected via telephonic
conversations, personal interviews or survey questionnaires, and extensive statistical analysis is
conducted to generate forecasts.

5) Scenario Writing:

In this method, the forecaster generates different outcomes based on diverse starting criteria. The
management team decides on the most likely outcome from the numerous scenarios presented.

6) Reference Class Forecasting:

Reference class forecasting or comparison class forecasting is a method of predicting the future by
looking at similar past situations and their outcomes.

Standard costing and variances:

A standard cost is basically a planned ‘target’ cost of a product or a service, or how much should the
cost have been. These are set beforehand during the planning process and represents how much the
cost should be. But in reality, the cost will slightly differ.

This difference is called as a variance.

A profitable or a positive variance is known as a favorable variance. If we ended up spending less

than we budgeted, it will be known as a favorable movement and hence a favorable variance.

A costly or a negative variance is known as an adverse variance. If we ended up spending more than
we budgeted, it will be known as an adverse movement and hence an adverse variance.

Performance evaluation using variances:

To evaluate performance and improve it, we can follow a step-by-step process.

1) Identify the cause of the variance

2) Find the person responsible

3) Decide whether the standard set was achievable

4) Consider non-financial factors

5) Take steps to improve future performance

 Finance in planning and analysis 188

Variance analysis act as a tool to control the variability of performance. This encourages managers to
stick to the budgets as far as possible. This challenge increases motivation as they have a target to
aim for.

Using costing techniques in project evaluation:

Marginal costing

Variable cost increases as units increase, meaning it’s an additional cost that we incur. Total variable
cost of production includes direct material, direct labour, direct expenses and variable production
overheads.

Absorption costing values inventory at full production cost, marginal costing values inventory at
marginal or variable production cost.

Before we dig deeper, we need to understand the concept of contribution.

Contribution

As we understood, marginal cost takes into account all variable costs, but not fixed costs. Obviously,
what remains can’t be termed as profit. Profit is calculated after all costs are deducted. Hence, the
term contribution.

Contribution = Sales price – all variable costs (production & non-production)

Simply put, the contribution is the amount that the product will contribute towards the recovery of
fixed costs.

It is a principal management tool in decision making as it draws management's attention on

additional contributions from a decision. The more the contribution, the more the profit as in
theory, fixed costs remain the same at whatever level of production.

Relevant costing:

In any business situation, before making a decision, we want to know the possible outcomes which
may arise from it. For calculating these outcomes, we consider the cash flows which are going to
arise. The cash flows which are directly affected by a decision are considered to be the relevant
ones.

Characteristics of relevant costs:

1) Future: Only future costs and revenues are considered to be relevant. Historical costs which
have already been incurred are not relevant.

2) Incremental: This means that relevant costs are those which will be incurred over and above the
current costs if the decision is taken. The costs, which are already incurred even without making
the decision, are irrelevant.

3) Cash flows: Relevant costs are always in the form of cash flows. Non-cash expenditures such as
depreciation are ignored.

Opportunity costs are also relevant costs.

 Finance in planning and analysis 189

It can be used in a decision such as:

• Make or buy decisions

• Accepting or declining special contracts
• Closure or continuation decisions
• Effective use of scarce resources.

Major sources of finance:

• Debt financing
• Equity financing

Investment appraisal techniques:

• NPV
• IRR
• Payback
• Discounted payback

Risk and uncertainty measurement techniques:

• Expected value
• Sensitivity analysis
• Simulation
• Decision trees

Budgeting techniques:

• Incremental
• Zero based
• Rolling

Forecasting techniques:

Quantitative:

• Regression analysis
• Time series analysis

Qualitative:

• Executive opinions
• Delphi technique
• Sales force polling
• Consumer surveys
• Scenario writing
• Reference class forecasting
 Finance in planning and analysis 190

PO9 – EVALUATE INVESTMENT AND FINANCING DECISIONS

Description

You advise on alternative sources of finance. And you evaluate and review the financial viability of
investment decisions.

Elements

a. Advise on the appropriateness and cost of different sources of finance.

b. Identify and raise an appropriate source of finance for a specific business need.
c. Review the financial and strategic consequences of undertaking a particular investment
decision.
d. Select investment or merger and acquisition opportunities using appropriate appraisal
techniques.

Evaluate projects, financial securities and instruments – and advise on their costs and benefits to the
organisation.

PO22 – DATA ANALYSIS AND DECISION SUPPORT

Description

You use commercial acumen to articulate business questions to resolve problems, exploit
opportunities and identify and manipulate relevant data requirements; deeply analysing data by
applying appropriate techniques. You draw clear conclusions and present your findings to enable
relevant stakeholders to make sound business decisions.

Elements

a. Identify any relevant financial and non-financial data and use it to provide insights to answer
important business questions and provide solutions for your organisation.
b. Use appropriate analytical tools to process, manipulate and analyse data. These tools could
include spreadsheet applications or more technical statistical analysis software.
c. Apply modelling techniques to deliver specific types of analysis, which may include: scenario
analysis, forecasting, optimisation problems or cost-benefit analysis.
d. Use data and resulting information ethically and responsibly, analysing and interpreting data
sceptically to draw appropriate conclusions and make recommendations to support effective
decision-making.
e. Communicate the recommendations to relevant stakeholders in a way they can easily visualise
and understand, to exploit business opportunities, manage risk and evaluate performance.
 Enabling success and fintech 191

10. Enabling success and fintech

10.1 Enabling success: organising

a) Advise on how an organisation structure and internal relationships can be re-organised to deliver
a selected strategy.
b) Advise on the implications of collaborative working and partnering, such as franchising,
organisation process outsourcing, shared services and global business services.

Organisational structures: How an organisation is set up will play an important role in an

organisations success. In the SBL exam, you may be asked to analyse the current structure of the
company and discuss the advantages and disadvantages of the structure in relation to the firms
strategy.

1) Functional structures:

ADVANTAGES DISADVANTAGES
• It facilitates specialisation by bringing • It can be inflexible, particularly in a period
together those with the knowledge and of rapid change, and in economic systems
skills necessary to carry out each function, where it is difficult or costly to recruit or
and therefore should create economies of dismiss employees
scale • It encourages demarcation lines to be
• It enables the organisation to operate created, which may make employees
through clear lines of authority and well- reluctant to carry out tasks that they
defined responsibilities, with all employees consider not to be their responsibility
knowing to whom they report and for whom • As organisations become larger, there
they are responsible may be coordination problems as the
• It prevents duplication of effort, thereby number of functions increases
reducing inefficiencies • As information tends to flow through
• It accommodates specialists. formal organisational lines, larger
organisations may
encounter communication problems
 Enabling success and fintech 192

• Some argue that the functional model is

too inward looking, focusing on processes
instead of considering deliverables
defined by customer needs.

The functional structure is common to many organisations, but different concepts can be deployed
within it. For example:

• The organisation can be tall or flat: tall organisations have many levels (a long scalar chain),
while flat organisations have fewer levels

• The organisation may have many employees reporting to each manager, few employees
reporting to each manager, or a combination of these: this so-called span of control will depend
on many factors, including the nature of the work, variety of tasks performed, capabilities of
employees and risk factors

• Some organisations concentrate authority at the top of the management hierarchy, with key
decisions taken by senior executives, while others empower subordinates, with greater
discretion permitted further down the management chain: this relates to the concept
of centralisation and decentralisation.
 Enabling success and fintech 193

Matrix structures

ADVANTAGES DISADVANTAGES
• By involving individuals formally in teams • The matrix structure sacrifices the
allocated to specific projects, the notion that every employee should be
organisation can capitalise on the responsible to one manager, and this
knowledge, skills and experience they can can result in conflicting demands on
offer the employee in terms of what work
• Communication lines are shortened in that should be done, how time should be
project managers can deal with staff apportioned and how work should be
assigned to them carried out
• Bureaucracy should be reduced • The different managers to whom the
• Employees’ jobs are enriched, and this may individual reports may have very
improve motivation different styles, which may create
• More ambitious individuals can exploit conflict, or even confusion as to the
opportunities made available to them and best or correct approach
more readily pursue advancement • The matrix structure creates additional
• Cooperation between departments can be time management pressures, which
increased, and the disadvantages of work may have an effect on costs
being demarcated by ‘silos’ can be reduced • If the matrix is not designed or
• The matrix approach may make employees implemented systematically, it can
more responsive to change and more create organisational inefficiencies,
willing to welcome change. such as slower decision taking.

Boundaryless organisations:

As the name suggests, these organisations do not have a fixed boundary. They can have the
following structures:

1) Hollow(network) structures:
• In a hollow structure, firms rely heavily on outsourcing. All the core activities are retained in-
house, and the non-core activities are outsourced.
 Enabling success and fintech 194

• Example: Nike outsources its production activity and keeps activities such as designing, branding
in-house.

2) Modular organisation:
• A modular organisation extends the hollow concept by breaking down production processes into
modules. Production is outsourced, but each external organisation is responsible for only one
element of the process.
• For example, in producing the Dreamliner aircraft, Boeing enters into contracts with many
suppliers, each of which is responsible for one component or assembly. The outputs of these
suppliers can then be integrated.- other examples- automobile industry – maruti Honda etc.

3) Virtual Organisation:
• A virtual organisation is one which operates primarily through electronic communications, taking
advantage of the efficiencies made possible by information technology. It removes many of the
features of the working environment that were once taken for granted, such as bringing
managers and staff together at a defined location.
• People work together remotely, with little or no dependence on physical premises. Instead,
communications take place through media such as emails, e-conferencing, extranet and
intranet.
• Amazon is often cited as the first major virtual business in this respect.

ADVANTAGES DISADVANTAGES
• Costs can be greatly reduced, as there is less • There is heavy reliance on information
dependence on premises. This can result in technology, so if things go wrong, this can
significant reductions in overheads, such as have a catastrophic effect. Problems can arise
electricity, water, mortgage or rent, and from lack of connectivity, hardware and
service staff. software failures, malware and security
breaches.
• The adoption of e-business solutions can
create efficiencies, such as automated re- • Those who lack basic IT skills, or are
ordering and seamless transaction unprepared to use information technology
processing. In fact, while the virtual equipment, have no prospect of doing
organisation is a relatively new business business with virtual organisations or working
concept, many of the technologies deployed for them.
have been available for many years. For
example, electronic data interchange (EDI) • In some cultures, there remains a preference
was first developed in the 1960s. for the ‘personal touch’, so virtual
organisations may find it difficult to achieve a
• Jobs with the organisation may be more foothold.
attractive, as the need for daily commuting is
removed. This can be particularly appealing • Some of those who work for virtual
to those with family commitments at certain organisations feel isolated as direct human
times of day and those who would be interaction on a face-to-face basis is minimal.
deterred from working due to the cost of Feeling personally connected to a work group
transport and car parking. can be motivational, and this effect is lost
when members of teams do not meet on a
• The virtual organisation has a modern image regular basis.”
which may appeal to several stakeholder
 Enabling success and fintech 195

groups, including customers, suppliers and

distributors. Increasingly, this approach to
business aligns with the expectations of such
groups.

Working models for organisations:

Outsourcing:

Outsourcing is when a company contracts-out a part of its business to a third party. Mainly non-core
functions are outsourced to third parties.

E.g. US and UK companies tend to outsource their accounting function to countries like India.

ADVANTAGES DISADVANTAGES
• Cost savings • Loss of control and confidentiality
• Firms can concentrate on core business • Quality aspects
• Professional services and economies of • It results in redundancies and hence
scale of the third party. reputational loss
• Organisational flexibility • Difficulty in finding an appropriate
outsourcing partner

Shared services:

It refers to the centralisation of support functions at one location, usually at the head office. E.g.
Rather than having an IT team at each shop, Big Bazaar may have a centralised support function at
the head office.

The shared service is treated as a separate business unit, and it charges the other division for the
provision of its services.

ADVANTAGES DISADVANTAGES
• Cost savings • May make processes diplomatic
• Standardisation of services • May face resistance from individual
• Concentration of talent at one place business units.
• Changes can be implemented quickly • Centralised department may not have
knowledge of local regulations.

10.2 Enabling success: disruptive technologies

a) Identify and assess the potential impact of disruptive technologies such as Fintech, including
cryptocurrencies and blockchain.
b) Assess the impact of a new product, process, and service developments and innovation in
supporting organisation strategy.
 Enabling success and fintech 196

Disruptive technologies refer to those innovations which lead to disruption of the present business
model in an industry and the creation of new markets. Existing market leaders get displaced, and
new smaller companies emerge.

Example: Disruption of DVD rental business by Netflix, disruption of hotel industry by Air bnb etc.

In the financial world, an innovative product which is disrupting the industry is fintech.

Fintech:

Fintech, or financial technology, is the term used to describe any technology that delivers financial
services through software, such as online banking, mobile payment apps or even cryptocurrency.

Fintech is used to help individuals and businesses manage their finances by using specialised
software and algorithms.

Examples of fintech are: Digital banks, payment wallets, UPI apps, internet banking, digital lending
and insurance etc.

You can now invest in stocks, pay your electricity bill, buy gold, apply for a loan and buy an insurance
plan from just a single app like Phone Pe. This serves as a better and more efficient way of managing
money and reduces the tedious work of physically visiting shops and doing these activities.

Fintech apps can use big data and provide us with micro-loans which would not be possible with
traditional banks. Peer-to-peer lending can also be done by using fintech.

Following are the advantages which Fintech provides:

• Reduce cost and improve the quality of financial services.

• Reduces the burden of legacy operations, IT systems etc.
• Ability to generate accurate credit scores by using tools like big data and machine learning.
• World class compliance and security
• Greater speed of processing transactions
• Better transparency.

Exam tip: In a given scenario a company may be incurring very high costs for managing finances or
making losses due to non-payment of dues by customer. Here, you are expected to advise the
In a given
company scenario
on the a company
benefits may
fintech can be incurring
provide very high costs for managing finances or
if implemented.
making losses due to non-payment of dues by customer. Here, you are expected to advise
the company on the benefits fintech can provide if implemented.

Cryptocurrencies:

One of the most well-known applications of fintech is the development and use of cryptocurrencies.
In simple words, cryptocurrency is a digital asset. It somewhat works similar to traditional currency
but does not have a physical form. It only exists in the form of a digital code.
 Enabling success and fintech 197

In a cryptocurrency system, the holder of the cryptocurrency, i.e. holders of the code, have the right
to exchange the currency for other cryptocurrencies or exchange them for buying goods and
services.

How do cryptocurrencies work?

Our Indian Rupee (INR) operates through the central bank, which is RBI. The RBI holds all the records
of the currency centrally, transactions in INR are carried out and authorised by the bank clearing
system, and RBI takes ultimate responsibility of that currency.

However, in the cryptocurrency system, there is no central bank, no central records and no central
authority. Instead, it is operated by using a distributed ledger system.

A distributed ledger system is a database which is held on every computer of the cryptocurrency
network. When a transaction takes place between two members of the network, it is authorised by a
consensus mechanism carried out by the network, and then it gets recorded on every single
computer connected to the network.

Benefits and limitations of cryptocurrencies

BENEFITS LIMITATIONS
• Reduced currency risk. • Lack of accountability

• Avoidance of bank or regulator • Lack of central authority

transaction fees.
• Investors may lose their funds if the
• Easier business transactions with a password is lost.
wider range of domestic and
international users • Risk of tax evasion as transactions takes
place outside the formal banking
• Cryptocurrencies could also potentially system.
offer a more stable currency to
locations with unstable local • Due to the high level of confidentiality,
currencies.” illicit activities such as money
laundering and illegal drug transactions
may take place.

Despite the limitations of cryptocurrencies, their use is increasing at a fast pace. However, people
have started using cryptocurrencies as an investment and not for transaction purposes. This is
mainly due to the increase in value cryptocurrency has seen in recent years.

Blockchain:

The blockchain concept has been attributed to Satoshi Nakamoto, which is a pseudonym for the
person or persons who developed the technology in 2008.

Simply blockchain is an immutable digital ledger that can record managed transactions and tracks
assets over a decentralised network. Pretty much any item of value can be traded, transferred and
 Enabling success and fintech 198

tracked using a blockchain, which reduces both inherent risks and costs for all concerned. The assets
could be tangible, such as property, or intangible, like an identity.

In practical terms, a blockchain stores information across a network of distributed computers, with
no one person owning the system, but anyone can use it and help to operate it. As a result, it is
incredibly difficult for any single person to edit a block, corrupt the information or take down the
blockchain.

Unlike business systems, where it is the norm for one central database to be the secure repository of
all business data and information with a central processor, blockchain technology requires that all
blocks of data are stored on every single computer in the blockchain. The security that this builds
into a blockchain system is enabled through the peer-to-peer network configuration, with the
resultant block data storage managed autonomously and in a decentralised way.

The blockchain architecture allows all participants the ability to share a block that is synchronised
through peer-to-peer replication each time a transaction occurs. This approach means that each
participant in the network acts as both a contributor of and a subscriber to all of the information
contained within it. Each participant is able to receive or send transactions to others by adding
blocks, and the data is automatically synchronized across the whole blockchain as it’s transferred.

Key features of block chain

• Single source: the shared blockchain ledger provides participants with one place to determine
the completion of a transaction or the ownership of an asset.

• Consensus: for any single blockchain transaction to be valid, all participants must agree on its
validity.

• Origin: all participants know where any asset originates from and how its ownership may have
changed over time.

• Integrity: No participant can meddle with a transaction after it has been recorded to the
blockchain ledger. Indeed, should a transaction be recorded incorrectly or in error, a further
transaction must be added to the blockchain to contra the entry, with both transactions visible
to all participants.

Exam tip:An SBL examination might require a candidate to analyse a situation where an
An SBL examination might require a candidate to analyse a situation where an organisation of some
organisation of some kind may have had its information systems or databases infiltrated or
kind may have had its information systems or databases infiltrated or hacked, or there may be a
hacked, or there may be a situation where customers or clients complain that their records are
situation where customers or clients complain that their records are not visible to them and the
not visible to them and the company may experience reputational damage for not being
company may experience reputational damage for not being sufficiently transparent with its
sufficiently transparent with its stakeholders. All or part of the solution might be to recommend
stakeholders. All or part of the solution might be to recommend the implementation of blockchain
the implementation of blockchain with justifications.
with justifications.
 Enabling success and fintech 199

Research activity: Analyse and discuss how fintech, cryptocurrency and blockchain can affect
financial reporting and audits.

10.3 Enabling success: talent management

a) Discuss how talent management can contribute to supporting organisation strategy.

b) Assess the value of the four view (POPIT – people, organisation, processes and information
technology) model to the successful implementation of the organisation

In any organisation, employees play a big role in the achievement of organisational success. In fact,
employees are at the core of any organisation, and hence their attitude towards work determines
whether organisational goals will be achieved.

Hence, it becomes of utmost importance to manage the workforce(talent). In simple words, talent
management is the anticipation of the required human capital for an entity and the planning to
meet those needs.

It is not only concerned with hiring and firing of employees but also includes engaging, training and
developing the work force to build a pool of talented employees.

The process of talent management follows the following cycle:

The process of talent management begins with an understanding of organisational goals and
strategy. Accordingly, we can plan the kind and amount of workforce required.
 Enabling success and fintech 200

Talent acquisition is the process of hiring people. Here we need to ensure that along with basic
qualifications, prospective employees should also resonate with the goals of the organisation
and strive to achieve strategic goals.

Onboarding of employees is to help employees adjust to the working conditions and culture.
Development of employees involves upskilling them and keeping them abreast of current
developments.

Performance management and succession planning helps employees in understanding what

they need to do in order to move ahead in their professional career.

This process of talent management reaps the following benefits for the organisations:

1) Attraction and retention of talented employees

2) Continuous professional development of employees
3) Motivated employees
4) Better performance
5) Achievement of organisational goals.

POPIT Model: People Organisation Processes Information Technology

Traditionally when a project implementation or strategic change was analysed, only the obvious
processes were considered, which led to failures in managing change and implementation.

POPIT model provides us with the ability to ensure that all internal aspects are considered while
implementing a project. It provides a holistic approach to manage change and implement
projects where we are able to find out where problems may arise.

For successful implementation, all the four aspects should work in unison
 Enabling success and fintech 201

1. Organization - Consider the organizational capabilities and structure and ensure that these
are suitable.
2. Processes - How are the core business processes carried out? Analyze the value chain and
understand the processes (activities) and their linkages.
3. People - Roles, job descriptions, competencies, motivation, rewards, culture.
4. Information technology –secure, faster, cheaper, extendable - IT architecture, IT
capabilities, controls, software and information provision

10.4 Enabling success: performance excellence

a) Apply the Baldrige model for world class organisations to achieve and maintain business
performance excellence.
b) Assess and advise on how an organisation can be empowered to reach its strategic goals,
improve its results and be more competitive, focusing on its critical success factors (CSF).

Baldrige model for world class organisations:

Baldrige model is used as a tool to analyse organisations from a holistic perspective. It analyses
seven aspects of managing organisational performance, which help in creating and adding value to
increase competitiveness.

As a strategic business leader, you can use the Baldrige model to think about organisational
competitiveness, performance management and creation of value.
 Enabling success and fintech 202

The Baldrige model suggests that strategic business leaders should focus on the above aspects in
combination, to ensure effective management of business performance to create excellence and
improve competitiveness across the organisation.

Managing performance using Baldrige model:

At the top, the model starts with an organisation profile which involves understanding the
organisation itself, its environment and current strategic position. We can use models such as SWOT
and PESTEL for understanding the current organisational profile

If we observe the figure given above more closely, as far as its main elements are concerned, the
model starts with leadership because effective leadership is the cornerstone of excellent
performance and competitiveness. Although not specifically mentioned in the model, strong and
effective leadership should be supported by robust governance.

Looking at the Organisation Profile section of the model (across the top), leaders must first be able
to understand the business environment and the strengths and weaknesses of their organisations
and their current strategic position to identify and select alternative strategic options.

For a proper evaluation of the strategic options, business leaders must take into account risk factors
but must clearly understand and focus on building strong and productive relationships with
customers as the immediate source and creators of value.

For any strategy to be implemented successfully, which may involve change (some of it potentially
disruptive), business leaders must primarily focus on its customers, but also on the workforce and on
the effective management of operations (and processes) carried out by that workforce, to ensure
that strategy is implemented successfully and to deliver the desired results.

As shown at the right-hand side of the model, the results obtained from implementing corporate
strategy must be monitored and measured through the use of analysis and data and knowledge
management (box 4) to ensure that performance excellence and increased competitiveness has
been achieved.

If results indicate underperformance or lack of competitiveness, then the next step is to address why
this is and examine the key elements of the model to try and create improvements to performance
and competitiveness.
 Enabling success and fintech 203

Apply your knowledge 1

ABC – Product and geographical structure

ABC Company is a drug and vaccine manufacturer with two manufacturing plants based in two
different countries, Country Y and Country Z. It has designed a vaccine to immunise people against a
new virus. It sells its vaccine at a price which gives it a very small gross margin and has had pre-
orders from two governments with which it has signed formal contracts for the delivery of specified
quantities of vaccine at different times and at fixed prices. The government of Country Y placed its
order first for an earlier consignment, but Country Z had subsequently placed a larger order for a
later consignment, which they were promised would be fulfilled when due. The government of
country Y received most of its vaccine supply from the plant situated in Country Y but was also
getting additional supplies from the bigger plant in country Z.

Contractual, Production and Operational problems

After mass production had begun, ABC Company began having problems at its major production
facility in Country Z with the supply of glass vials (small bottles) into which the vaccine is dispensed
during production, as well as experiencing technical problems with the production process. There
was also significant workforce absenteeism due to sickness from the virus, which the vaccine is
intended to prevent. As a result, ABC Company was unable to fulfil its larger order to the
government of Country Z from that plant alone.

Potential legal action by customers

The company is now been threatened with legal action by the government of country Z for the non-
fulfilment of its order. ABC Company argued it was unable to deliver the vaccine because of its
problems at its plant in Country Z and because the factory in Country Y was still fulfilling the
remaining amount of the prior orders placed by the government of that country.

Financial implications
ABC Company now faces a contingent liability to pay considerable damages to the government of
Country Z and is also losing money because the planned volumes being produced across both its
plants are not being achieved to fully cover development and other fixed costs.

Required

You are a management consultant with business expertise, commissioned by the board of ABC
Company to advise them on their current situation.

Write a report to the board of directors of ABC Company to analyse ABC Company’s current position
and recommend approaches the company could adopt to help improve its competitiveness and
deliver performance excellence.”
 Enabling success and fintech 204

Performance management:

Performance can be defined as ‘A task or operation seen in terms of how successfully it is

performed.’

Performance management is the process of improving current performance. So how do we improve

performance?

You must have heard the term, “what gets measured gets done”. It simply means that to improve on
anything, we should know where we stand. And this process of knowing where we are is called as
performance measurement. To measure performance, we need the help of CSF’s and KPI’s.

Critical Success Factors (CSF)

A CSF is an area where an organisation must perform well for it to be successful.

E.g. A tuition provider needs to achieve high pass rates of its students for it to be successful. Hence,
student pass rates are a CSF for the tuition provider.

Accordingly, a business can have CSF for achieving financial results, increasing competitiveness etc.
Achievement of these CSF’s can be tracked by KPI’s. Hence, an organisation can perform better by
focusing on CSF’s.

Answers to Apply Your Knowledge:

AYK 1

Title: Report to ABC Company on the current situation and recommendations for action

To: Board of Directors

From: A. Consultant

(i) Introduction
The current situation ABC Company faces is critical in a number of ways:

• Potential legal liability

• Dissatisfied and important customers

• Low margins and profitability issues

• Supply issues

• Operational/process problems with production

• Staff shortages

In section 2 of my report, I will analyse the current situation and the key areas of performance which
need to be addressed, and I will include my recommendations under each heading.

Issues to address:

(ii) Organisational profile

ABC Company is facing several strategic and operational problems. It has set pre-contracted prices
 Enabling success and fintech 205

which are too low, meaning that the shortfall in production capability has led to lower volumes
being produced than were required to cover fixed costs. Furthermore, ABC Company relies on two
main customers for the sale of its entire output of the product, and one of these is extremely
dissatisfied and is threatening to sue the company. Finally, there are immediate in-bound product
supply problems, workforce and operational issues to address.

iii) Leadership
The leadership of ABC Company needs to address these issues urgently and act proactively to
understand its current position and how to improve it. It must do that by prioritising which issues it
must deal with based on importance and urgency. Clearly, the leadership should focus first and
foremost on both its customers and their needs and also address their supply, workforce and
operational issues, to deliver better results.

iv) Strategy
To resolve the issues facing ABC Company, alternative strategies will need to be considered, such as
how to manage the customers as the immediate issue and how to improve production capacity by
addressing the supply, workforce and operational/process problems. For the medium term, the
company needs to review its business model, such as their reliance on only two main customers and
on its overall vaccine pricing policy.

v) Customers
The company must engage positively and actively with its two main customers to ensure that it can
eventually deliver on its contractual arrangements to both governments, but first, it must establish
exactly what its contractual obligations are and any flexibility there may be for any variations in the
contract. Depending on any flexibility within the contracts, ABC Company must reassure both
customers that it can deliver on its contractual arrangements within an acceptable timeframe.

In the short-term, there may be a need to import some of the output from the plant sited in Country
Y or to reduce exports from its factory in Country Z to Country Y. These proposals must be subject to
meeting acceptable delivery times for the completion of the prior orders with Country Y and also
fulfil their overall contractual obligations to Country Z.

vi) Workforce
There seems to be a workforce shortage problem at the plant in Country Z, and this needs to be
resolved. The absenteeism is due to sickness caused by the virus which the vaccine produced is
intended to prevent. An immediate concern would be to re-deploy additional staff, possibly from the
other plant in Country Y, or to increase domestic recruitment for the plant in Country Z. Another
possible solution would be to vaccinate all staff working at both plants to help prevent further
spreading of the virus within the working environment. There may be scope to re-organise processes
and retrain staff to improve output and/or reduce the number of staff required to operate the plant.

vii) Operations
There appears to be a specific operational issue with the supply of glass vials into which the vaccine
is dispensed before packing. This needs to be investigated, and a solution found. It may be an option
to seek alternative suppliers or use a different material such as a suitable type of plastic, which
might also save costs.

It is not clear from my discussions with you, but there also seem to be other technical, operational
and process problems which need investigating, which may not only be causing the production
 Enabling success and fintech 206

problems but may increase the cost base. If properly investigated and resolved, this may mean that
production output can be increased, and unit cost savings achieved to help increase profit margins.

viii) Measurement, analysis and knowledge management

In addressing all of the above critical areas of performance, ABC Company needs to use effective
knowledge management to measure and analyse its performance (results), particularly in the
operational areas. It must measure and analyse its costs and carry out a break-even and cost-
volume-profit analysis to establish minimum volumes it needs to sell to cover its costs and to meet
its output targets, both from a workforce and operational perspective.

ix) Conclusions
ABC Company is facing a critical situation which it must address urgently. The most urgent is to
effectively negotiate and manage the expectations of its major customers, particularly of Country Z,
which is threatening legal action, identifying any flexibility offered within the contract terms.
Secondly, it needs to address its vaccine supply problems by re-scheduling its deliveries of vaccine
from both plants, working to increase its workforce availability and deal with the supply issues
affecting the bottling of the product. There are other immediate operational/process issues to
resolve, but in the longer term, ABC Company must look at its overall pricing model, its cost
structure and how to reduce its dependence on only two major customers by seeking other
contracts, possibly on better terms.
 Change and project management 207

11. Change and project management

11.1 Managing strategic change

a) Evaluate the effectiveness of current organisational processes.[3)

b) Evaluate different types of strategic change and assess their implications.
c) Establish an appropriate scope and focus for organisation process change using Harmon’s
process-strategy matrix.
d) Establish possible redesign options for improving the current processes of an organisation.
e) Assess the feasibility of possible redesign options.
f) Recommend an organisation process redesign methodology for an organisation.
g) Manage change in the organisation using models such as Lewin’s three stage model.
h) Assess implications of change in an organisation using Balogun and Hope Hailey’s contextual
features.

Strategic change

Strategic change refers to a major change in the way a company operates. This change may be
necessary due to changes in the business environment, a review of strategic capability wherein an
organisation discovers new competencies or when a decision to implement a new strategy is chosen.
As business leaders, you must be able to analyse and manage strategic change in a business.

Types of change:

To analyse the types of change, Balogun’s and Hope-Hailey’ types of change model can be used.

Here it is important to note that adaptation and evolution carry low risk as the change takes place
over time and people and systems get time to adapt. On the other hand, revolution and
reconstruction are more risky as the speed of change is high. In an SBL exam, you may be asked to
analyse which type of change is occurring. The above model can be used to structure your answer in
a better way.
 Change and project management 208

Process redesign:

In process redesigning, we think about how our current processes can be improved and made more
effective.

Due to the rising competition, organisations face immense pressure to deliver innovative products
throughout the year. E.g. Xiaomi, which is a low-cost mobile phone manufacturer, has to come up
with at least 4-5 new models of mobile phones as per the changing customer preferences. If its
current processes are inefficient, it won’t be able to meet customer expectations and would lose its
competitive edge. Hence, todays organisations need to deliver quality products to customers at a
faster rate which are done at right the first time.

Process redesigning are done with the following strategic impacts in mind:

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.

When we discuss about process improvement, we generally think about automation and job losses.
This is not necessarily the case every time.
 Change and project management 209

Harmon Process-Strategy matrix

This matrix tells us which processes can be outsourced and which should not be outsources based on
the strategic importance of the process and its level of complexity.

As you can observe in the above diagram, the processes which have high strategic importance are
not outsourced. This is because businesses cannot share their most valuable secrets with third
parties. Hence if the process is strategically important and less complex, we should automate it, and
if it's highly complex, we should try to improve on it.

If the strategic importance is low and complexity is low as well, we can easily automate the process
or use minimum resources for it to run efficiently. Whereas if the process is complex and of low
strategic importance, we can easily outsource it.
 Change and project management 210

Process redesign options:

1. Re-engineering – This pattern relates to a fundamental rethinking starting from a zero base and
building up the process from scratch. The object is to obtain major fundamental improvements
in the process.

2. Simplification – Here, it’s recognized that as time passes, most processes gather elements of
duplication and redundancy. Although the process may be well thought out at the start, it can
grow in a rather disorganized way so that considerable inefficiencies can be created.

3. Value added analysis – remove non-value added activities. A value adding activity is one for
which the customer is willing to pay, one which physically changes the output in some way, for
example, a manufacturing or chemical process. The activity has to be performed correctly on the
first attempt: there is no value-added and having to rework products.

4. Gaps and disconnects – Check flows of information and products between departments. Poor
communication between the various functions in the business is liable to result in non-value
added activity

Classification of business process changes:

1) Automation:

This can be regarded as taking place at an operationalLevel. Existing processes are automated,
and they are therefore made somewhat more efficient, perhaps more reliable, faster, and more
cost-effective. For example, a supermarket system keeps track of inventory volumes as items are
scanned at checkout. An order is then sent to suppliers when inventory falls below the reorder
level.

2) Rationalization:

This is sometimes called process redesign. This is at a more tactical level and can involve, for
example, removing bottlenecks. An example of a potential bottleneck could be seen in a
supermarket environment where frequent reordering of inventories is required.

A bottleneck could simply be the time it takes for suppliers to produce and send out new orders.
This will restrict the speed at which inventory can be replenished.

One way of removing the bottleneck and rationalizing the process is for the supplier to monitor
stock at the supermarket and to automatically start the dispatch process when it can be seen that
the stock is approaching the reorder level.

3) Business process engineering:

At the highest strategic level, business process reengineering is encountered. This looks at much
more radical changes taking place within the organization. It’s sometimes said that moving to
just-in-time inventory is business process re-engineering. Radical changes to production and
ordering are required so that the organization no longer has to rely on inventories.
 Change and project management 211

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.

Feasibility of re-design options:

Financial feasibility: Cost benefit analysis of the process change can be done.

Technical feasibility: We will need to determine whether innovation will be needed or existing
technology with some developments is enough to carry out the change.

Social feasibility: This will be concerned with the impact on employee motivation as there will be a
change in work patterns and staff redundancies.

Environmental feasibility: Environmental footprints will be needed to be considered.

Process redesign methodology:

When we are making process changes, they should not be carried out in a haphazard or ad-hoc
manner. Instead, they should be carefully planned. The following table explains the stages in the
process change cycle.

1. Planning a process redesign effort • Identify goals

• Define scope
• Identify personnel
• Develop plan and schedule
2. Analysis of an existing process • Document existing process
• Identify gaps and problems
• Devise a plan for redesign
3. Design of a new or improved process • Identify alternatives
• Choose the best alternative to redesign
process to achieve goals
 Change and project management 212

4. Development of resources for an • Make production process efficient

improved process. • Redesign jobs and work environment
• Hire new employees if necessary
5. Managing implementation • Train employees
• Integrate and test the new process
6. Review • Review whether the redesign has been
successful
• Modify the process as needed.

Lewin’s three-stage model

Lewin proposed that in order to manage change, organisations need to go through three stages.

Unfreeze Change Refreeze

Unfreeze:

In this stage, it is the managers responsibility to convince the employees why there is a need for
change. This is done by motivating them for change by making them understand the present
situation. Ways of unfreezing include.

• Identifying and exploiting existing areas of stress or dissatisfaction.

• Removing individuals from routines, social relationships, so that old behaviour 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:

This stage is mainly concerned with what the new norm should be. This will include.

• Exploring and identifying new patterns of behaviour or norms.

• Communication of these norms to employees.
• Setting up new appraisal schemes and reporting relationships.
• Introducing a new style of management.

Refreeze:

This stage involves the setting of new policies and standards so that employees embrace the
changes. This ensures people don’t fall back on old ways of doing things. Refreezing is done by:

• Introducing larger rewards for people who embrace change completely

• Publicising good behaviour by giving awards. E.g. Employee of the month.
 Change and project management 213

Balogun’s and Hope-Hailey’s contextual features of change

A single correct way of managing does not exist. The success rate of managing change depends on a
number of factors. Hence, Balogun and Hope-Hailey build a framework which will consider the
various factor involved and will help in determining whether the change will be managed
successfully.

Here we will need to analyse whether each factor is in favour or against the successful
implementation of change. E.g. if employee readiness towards change is low, it is unfavourable etc.
 Change and project management 214

11.2 Leading and managing projects

a) Determine the distinguishing features of projects and the constraints they operate in.
b) Discuss the implications of the triple constraint of scope, time and cost.
c) Prepare a business case document and project initiation document.
d) Analyse, assess and classify the costs and benefits of a project investment.
e) Establish the role and responsibilities of the project manager and the project sponsor.
f) Assess the importance of developing a project plan and its key elements.
g) Monitor and control project risks, and slippages recommending improvements.
h) Discuss the benefits of a post-implementation and a post-project review.

When it comes to the actual implementation of strategy, it cannot be implemented as a big single
task. Instead, it needs to be broken down into segments. These are known as projects. Realisation of
a strategic plan therefore depends upon carrying out many such small projects. Hence, project
management is a crucial activity for achieving strategic goals.

A project is an activity that differs from business as usual as it:

• Is unique
• Is temporary and has a start and an end date
• Brings about change
• Has known elements, which carry risk

Projects operate under the following three constraints:

1) Scope: Scope is the desired result from the project. The scope is linked to the expected
quality of the result.
2) Time: A project has a specified deadline before it needs to be completed.
3) Cost: A project has to be completed within a specified budget.

All these constraints are interrelated. E.g. in order to deliver a high-quality product, more cost would
be required, and more time would be spent. Trying to finish the project earlier may result in lower
quality and higher employee costs (overtime etc.).
 Change and project management 215

Stages of a project:

Initiation

Risk assessment

Business case

Project plan

Execution

Monitoring and controlling

Closing: Delivery
 Change and project management 216

Project initiation:

At this stage, we analyse whether or not to undertake the project.

This process is important as not all projects can be undertaken due to various reasons. Before the
start of the project, there should be thorough screening to avoid wastage of resources.

Some projects may not be undertaken as the risk element in them is too high, or they have social
and environmental issues. Some projects may get rejected due to unjustifiable costs.

The initiation process thus looks at the business case of the project, feasibility and risks of the
project. The SAF framework, which was covered earlier in the syllabus, can be used to select
projects.

Before initiating the project, its objectives and constraints are determined, project manager is
selected, and sponsors are identified.

Business case document:

This helps in explaining why the project is needed, what will the project achieve, and how will it
proceed.

Contents of a business case is as follows:

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 the org structure, for example)

4. Key risks and actions to mitigate them

5. Feasibility of the project

6. Recommendations

Cost and Benefit analysis:

It is a comparative assessment of the costs which are expected to be incurred and the benefits
anticipated from the project.

Benefits arising from a project may be monetary (reduced costs, increased revenue), or they may be
non-monetary (staff motivation etc.).

The costs would include the total life cycle cost of the project and will also include the opportunity
cost of undertaking the project.

Once the necessary costs and benefits are determined, we can further appraise the projects by using
techniques such as Net present value, IRR and payback period etc.
 Change and project management 217

Feasibility of the project:

In this part of the business case, we discuss about the:

1) Social feasibility
2) Environmental feasibility
3) Time feasibility
4) Technological feasibility

Project risk:

The following framework can be used to assess the extent of the project risk

To manage the project risk, we can use the TARA framework of risk management:

1) Transfer

2) Avoid

3) Reduce or

4) Accept
 Change and project management 218

Project initiation document:

The project management document is as follows:

FORMAT: PROJECT INITIATION DOCUMENT

1. Scope and objectives
2. Cost benefit analysis
3. Project sponsor
4. Project manager
5. Project team
6. Key stakeholders
7. Duration
8. Risks
9. Constraint
10. Governance/ monitoring

Project manager:

The project manager plays a major role in the success or failure of a project. He/she must be able to
demonstrate leadership ability, technical knowledge and project management skills. His major
responsibilities are as follows:

1) Ensuring the Project Initiation document is complete and comprehensive.

2) Leading the project team
3) Communicating with stakeholders
4) Communicating with sponsors
5) Understanding and solving technical project issues
6) Delegation of tasks
7) Technical competence to manage project
8) Ability to deliver a quality product in a limited time with limited resources.

Project sponsor:

The project sponsor is generally a senior member of the management team. He is the person who
has most to gain and most to lose, depending on the success and failure of the project. His main job
is to direct the project and let the manager manage it.

His other responsibilities are:

1) Choosing the right projects

2) Sponsoring and monitoring the project
3) Acting as a supporter and coach
4) Take decisions regarding factors outside the scope of the project
5) Make necessary resources available for the project
 Change and project management 219

Project plan:

Generally, a project plan will consist of the following:

➢ 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 uncertainties
➢ Plans for project communications
➢ Plans for ensuring project quality

Project slippage:

Project slippage is when a project is running behind schedule.

In such a situation, the project manager has the following choices:

– 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.

Project completion:

After all the tasks of a project are done. These last steps should be done:

• Get approvals of the final results.

• Close all project accounts
• Help team member’s move on to their next assignments

Post project review:

This is done at the end of the project to discuss the achievements of the team and lessons which can
be applied in the next stage.

This allows the project team to move on to other projects. This review is of the conduct of the
project team and not of the product delivered.
 Change and project management 220

Post implementation review:

This review is of the product delivered by the project. This allows the actual users of the product an
opportunity to use and experience the product or service and to feedback their observations into a
formal review.

The postimplementation review will focus on the product’s fitness for purpose. The review will not
only discuss strategies for fixing or addressing identified faults, but it will also make
recommendations on how to avoid these faults in the future. In this instance, these lessons learned
are fed back into the product production process.

Businesses use PIR for analysing whether the investment in the project was worthwhile.

AYK 1

Branch rationalisation project

Four years ago, Lowlands Bank acquired Doe Bank, one of its smaller rivals. Both had relatively large
local branch bank networks, and the newly merged bank (now called LDB) found that it now had
duplicated branches in many towns. One year after the takeover was finalised, LDB set up a project
to review the branch bank network and carry out a rationalisation that aimed to cut the number of
branches by at least 20% and branch employment costs by at least 10%. It was agreed that the
project should be completed in two years. There were to be no compulsory staff redundancies. All
branch employment savings would have to be realised through voluntary redundancy and natural
wastage.

LDB appointed its operations director, Len Peters as the sponsor of the project. The designated
project manager was Glenys Hopkins, an experienced project manager who had worked for
Lowlands Bank for over fifteen years. The project team consisted of six employees who formerly
worked for Lowlands Bank and six employees who formerly worked for Doe Bank. They were
seconded full-time to the project.

Project issues and conclusion

During the project, there were two major issues. The first concerned the precise terms of the
voluntary redundancy arrangements. The terms of the offer were quickly specified by Len Peters.
The second issue arose one year into the project, and it concerned the amount of time it took to
dispose of unwanted branches. The original project estimates had underestimated how long it would
take to sell property the bank owned or to re-assign or terminate the leases for branches it rented.
The project board overseeing the project agreed to the project manager’s submission that the
estimates had been too optimistic, and they extended the project deadline for a further six months.

The project team completed the required changes one week before the rearranged deadline. Glenys
Hopkins was able to confirm that the branch network had been cut by 23%. Six months later, in a
benefits realisation review, she was also able to confirm that branch employment costs had been
reduced by 12%. At a post-project review, the project support office of the bank confirmed that they
had changed their project estimating assumptions to reflect the experience of the project team
 Change and project management 221

Potential process initiatives

LDB is now ready to undertake three process initiatives in the Information Technology area. The IT
departments and systems of the two banks are still separate. The three process initiatives under
consideration are:

1. The integration of the two bespoke payroll systems currently operated by the two banks into one
consolidated payroll system. This will save the costs of updating and maintaining two separate
systems.

2. The updating of all personal desktop computer hardware and software to reflect contemporary
technologies and the subsequent maintenance of that hardware. This will allow the desktop to be
standardised and bring staff efficiency savings.

3. The bank has recently identified the need for a private personal banking service for wealthy
customers. Processes, systems and software have to be developed to support this new service. High
net worth customers have been identified by the bank as an important growth area.

The bank will consider three solution options for each initiative. These are outsourcing or software
package solution or bespoke development.

Required:

(a) The branch rationalisation was a successful project. Identify and analyse the elements of good
project management that helped make the branch rationalisation project successful.

(b) The bank has identified three further desirable process initiatives (see above).

(i) Explain, using Harmon’s process-strategy matrix, how the complexity and strategic importance
of process initiatives can be classified.

(ii) Recommend and justify a solution option for each of the three process initiatives.
 Change and project management 222

Answers to Apply Your Knowledge:

AYK 1

a)The elements of good project management that helped make the branch rationalisation project
successful might include:

1. A sponsor (Len Peters) was appointed to own the project. A sponsor is required to make
important and decisive decisions about project scope, conduct and approach. In the case study
scenario, the precise terms of the voluntary redundancy arrangements were quickly specified.
Without a sponsor, projects tend to drift and stall when important decisions have to be made.

2. The objectives of the project were clearly defined. The target was to cut the number of branch
banks by at least 20% and branch employment costs by at least 10%. Quantification makes these
specific objectives measurable. It should be clear at the end of the project if the project has
successfully met its objectives. Projects that have general objectives, such as ‘improve management
information, are less focused and more difficult to evaluate.

3. Constraints were specified at the outset of the project. For example, a time constraint was defined
(two years), and an operational constraint (no compulsory staff redundancies) agreed. This latter
restriction meant that the project team was clear at the onset about the scope of the changes they
could implement. If constraints are not defined in advance, then project teams might suggest
inappropriate solutions.

4. An experienced full-time project manager was appointed. The project team was also made up of
full-time staff seconded to the project. This meant that they could focus completely on the project
and not be distracted by their usual jobs. Part time secondments to projects rarely work because the
team members still have to undertake elements of their day job, and the urgency of these often
takes precedence over project work.

5. Potential slippage in the project and its cause was identified and dealt with relatively early in the
project’s life. This meant that early re-scheduling could be carried out and an extension to the
deadline agreed. It helps the management of expectations and helps avoid unexpected last-minute
changes in scope.

6. The project team formally conducted benefits realisation, reporting on the actual performance of
the project. This confirmed that the original objectives had been met. A formal post-project meeting
was also held to review lessons learnt on the project. This led to a change in estimating assumptions
which had lead to the original optimistic values. Lessons are learnt on many projects which are not
fed back into the project management system. Consequently, another team commits the same
mistake or operates under the same false assumption.

(b) (i) LDB could assess the priority of the three initiatives on the process-strategy matrix suggested
by Paul Harmon. The matrix has two axes. The vertical axis is concerned with process complexity and
dynamics.

Low strategic importance, low process complexity and dynamics

This quadrant contains relatively straightforward stable processes which add little business value.
They are processes that must be done in the company but add nothing to the company’s value
proposition. These processes need to be automated in the most efficient way possible. They are
often called ‘commodity processes’ and are suitable for standard software package solutions and/or
outsourcing to organisations that specialise in that area.
 Change and project management 223

Low strategic importance, high process complexity and dynamics

This quadrant is for relatively complex processes that need to be done but do not add significant
value to the company’s products or services. They are not at the heart of the company’s core
competencies. Harmon suggests that these should be outsourced to organisations which have them
as their core business.

High strategic importance, low process complexity and dynamics

These processes lie in the lower right quadrant of the model. They tend to be relatively
straightforward processes which, nevertheless, have a significant role on the organisation’s
activities. They are central to what the business does. The aim is to automate these, if possible, to
gain cost reduction and improve quality and efficiency.

High strategic importance, high process complexity and dynamics

Finally, in the top right hand quadrant are high value, complex processes which often include human
judgement and expertise and are often very difficult to automate. Harmon suggests that these might
be the focus of major process redesign initiatives focusing on business process improvement
through the improved performance of the people undertaking those processes.

(ii) In the context of LDB, the following is suggested. Clearly, these are value judgements, and a
credit will be given for coherently argued answers which do not match the examiner’s conclusions.

• The integration of the two bespoke payroll systems currently operated by the two banks into
one consolidated payroll system. Payroll has to be produced but does not add significant value
to the end-customer. It is unlikely that the recipients of the system (the bank staff) will notice
any difference if a new system is implemented. The bank is considering re-developing this
process because of the high cost of updating and maintaining two separate systems. This
appears to be of low strategic importance. From the case study, it is not clear how complex the
payroll requirements are or how difficult it will be to transfer data from the current systems to a
new solution.
• The most obvious approach is to suggest that a standardised software package is bought and
data transferred to this solution. It appears sensible to undertake this work using the in-house IT
departments who will be familiar with the current systems and so should be able to undertake
accurate data mapping and successful data transfer to the new system. However, if this is
difficult and time-consuming, there might be some benefit in outsourcing the solution and data
transfer problems to a specialist software provider, allowing internal IT to concentrate on more
strategic applications.
• The updating of all personal computer hardware and software to reflect contemporary
technologies and the subsequent maintenance of that hardware. The bank is perhaps looking for
efficiency savings through the standardisation of the desktop. Again, this does not appear to
directly give value to the bank’s customers. Consequently, this also appears to be of low
strategic importance. However, it could be of relatively high complexity, particularly when
considering the maintenance of hardware. There seems a clear case for outsourcing this process
to a specialist technology company who can bring all hardware and software up to date and then
maintain it at that level.
• The development of processes, systems and software to support private banking. This appears
to be of high strategic importance and high complexity. It delivers services to end-customers
 Change and project management 224

who the bank has identified as a source of business growth. Elements of human judgement and
interaction will be required when providing this service. The fulfilment of personal requirements
for the wealthy customer will bring variety, risk and reward. The development of processes,
systems and software to support private banking should have high priority and should be
developed in-house. The success of such an operation should deliver handsome profits to LDB.
This may mean that, given resources are finite, the development of the new payroll system
should be outsourced to a specialist in that functional area.
 “
“

Weekday Weekend Sel

f-Paced
 Mumbai

l
ear
ningpar
tner-

Mumbai Del
hi

APPLI
ED SKI
LLSLEVEL
602,EcoSpaceI TPark,OldNagardasRoad, Audi
t&Assur
ance(AA)
_______________
MograVi l
lage,Nat
warNagar ,Andher
iEast
,
Mumbai ,Maharashtr
a,400069
STUDYNOTES
r
eachus@zel
leducat
ion.
com
www.
zel
leducat
ion.
com
Sept
'22t
oJune'23
+919004935888