1.1.4 SBL Technical Articles

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SBL TECHNICAL ARTICLES IN WORD

Passing Strategic Professional exams
This article looks at what you can do to improve your chances of passing ACCA’s Strategic Professional exams.
Strategic Professional exams are a step up from the Applied Skills level and candidates require a different approach
to these exams in order to pass and move on towards becoming an ACCA member.
A useful resource is the articles about stepping up from the Applied Skills underlying papers. These are full of useful
guidance and are highly recommended reading if you are taking one of these exams.
At Strategic Professional, candidates are expected to have a good level of technical knowledge across the full range
of topic areas in the Study Guide. While technical knowledge is essential, on its own it will not be enough to obtain a
pass mark.
What is important is an understanding of the skills the examining team are testing. What they are looking for is the
application of the detailed knowledge and, how it is used in context.
Strategic Professional exams are at the higher end of learning skills, and require such skills as analysis, evaluation,
assessment, decision making, critical analysis and discussion. Repetition of textbook material or model answers to a
different question is highly unlikely to be awarded many marks. For the Strategic Business Leader exam, the
integrated case study, you will be required to demonstrate the professional skills that employers deem as most in
demand in the accountancy sector, such as analysis, scepticism, evaluation, commercial acumen, and
communication.
There are a number of things you can do, once you have completed your learning phase, to give yourself the best
chance of passing your Strategic Professional exams and we will look at these in turn.
Timed question practice
To allow yourself the best chance of passing the exam on the day, you should practice answering questions to the
time that you would have available in the exam. ACCA’s approved content providers have question and answer
banks with plenty of exam standard and style questions for you to practice with.
Once you have answered the question to time, it is important to look at your answer against the published answer –
are you making the same kind of points or do your calculations follow the correct approach?
Don’t be disheartened if your answer does not appear to be the same as the published answer. These are usually
comprehensive answers for learning purposes and are not intended to be representative of what can be achieved in
the time available. If you are able to understand where you went wrong, this is good learning for future questions.
Also remember that calculation mistakes are only penalised once under the own figure rule so if you make a mistake
at the start of a calculation you are still able to pick up the remaining marks.
Read the question requirements
Although many candidates may want to read the scenario first, it is beneficial to read the question requirements
before the scenario. This will ensure that when you read the scenario, it is with a clear idea of what you are looking
for.
Read the question very carefully – what is the requirement? This is absolutely crucial in the exam. A significant
number of students produce an answer to a different question than the one which has been asked. In an exam
situation, to ensure that you do not misunderstand the question you should adopt the following approach. Read the
question once and then read it again, trying to be as objective in your reading as possible and do not make the
question appear to be the one that you wanted to be asked.
Read the question scenario and plan your answer
Now that you are clear on the question requirements, you can read the question scenario, identifying key points
which relate to the question requirements.
Then make a quick plan of what you are going to write taking into account the mark allocation. Then, before actually
starting your answer, check that the plan and the question match up. It is almost impossible to misinterpret the
question when taking this approach.
Your answer plan will have identified key areas that you wish to address in your answer. It is a valuable skill to be
able to prioritise the problems/issues within the scenario and to show the marker that you are able to think
strategically. It will help you focus on key strategic issues in the scenario and mean you are likely to score higher
marks.
Time management
Your approach to planning your time in the exam is crucial for completing the exam and to ensure best use of the
time available.
Downloaded by Anil Kumar ([email protected])

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If you do not manage your time well, the penalty can be quite severe. It is often seen that there are candidates who
reach 46% with one or two requirements still to be answered, only to find that there is nothing left to mark. If you
manage your time badly your chances of passing are reduced – it is much tougher to get 50 marks if you only answer
90, 80, or 75 marks of the 100 available.
Explaining points in appropriate detail
When answering business scenarios candidates need the following skills:
 To identify key issues/defects from the question scenario
 The ability to use analysis to make inferences from the question and to delve deeper into the problems.
 To identify things noticeable by their absence. That is, things the organisation should be doing but is not
doing at present.
It is the ability to add value to the scenario in this way that scores marks in the exam – repetition of information from
the scenario or long introductions or descriptions score very little, if any, marks.
A common mistake is that candidates will write a lot about a single point on which they are very knowledgeable with
the following point being a single short sentence. The balance of time and content should be about the same for each
point made. Once the marker is satisfied that you have made the point, you will score the mark.
Once you have made the point, extra marks can be obtained from explaining the consequences from this point and
what needs to be done about it.
You can add these points into your answer through the use of phrases such as:
 this indicates…
 the impact of this is…
 to address this problem management need to…
Additionally markers can only give marks for what has actually been written and so it is important to ensure the
significance of the point and its main consequence has been fully explained. Even if you believe it is really obvious,
include an explanation of any consequences in your answer. You cannot be awarded a mark for something that you
haven’t included in the answer.
You may have reached this stage of your studies without needing to do some of the above tips. However, as stated
earlier, the Strategic Professional exams are a step up from the lower level and different skills are needed here and
these methods will significantly improve your chances of passing your exams.
Good luck with your Strategic Professional exams and your journey towards ACCA membership
The strategic planning process – part 1

The first of two articles that focus on applying your knowledge of management and strategy to a scenario situation.
Part 1 considers the complexities of strategic planning and how they can be broken down into three main areas.
 Introduction
 Strategic analysis
 Summary
Introduction
One of the main problems which Strategic Business Leader (SBL) candidates could face will be the application of
knowledge. Candidates might feel comfortable whilst preparing the topics.. The main skill that a student needs to
develop is an ability to apply the acquired knowledge in a scenario situation. The following provides an insight into
how to apply your knowledge effectively.
This first article deals with the strategic planning process. Many of the various texts on the market comprehensively
cover the key processes involved in strategic planning. These often involve comprehensive flow charts with many
subparts. Rather than explain these in detail, let us first distil the process into three main areas:
1. Strategic analysis
2. Strategic choice
3. Strategic implementation
Strategic analysis
Essentially a business will address the following questions:
 Where do we want to go?
 What constraints exist on our resources?
 What are the key threats from the external environment?
Where do we want to go?

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The answer to this question is influenced by many factors. Key influencers are often the owners (for example,
shareholders) who may have a particular expectation for the organisation. However, one also needs to take into
account other stakeholder influences, which could include the government, employees and the general underlying
culture of the organisation. These views are very often consolidated into a corporate vision or mission statement.
What constraints exist on our resources?
Resources needed would include finance, plant and machinery and human resources. However, to make it easy, I
would recommend that you simply think 6Ms. 6Ms is simply a mnemonic used to save time when thinking about the
various resource constraints. It can be summarised as:
 money
 machinery
 manpower
 markets
 materials
 make-up.
The typical questions, which you would ask against each of these resource constraints, would be as follows:
Money
 How much do we have?
 What is the current cost of our capital?
 Is the company excessively geared or are there any opportunities for raising additional finance?
Machinery
This would refer to machinery in the broadest sense of the word, and typical questions one might ask would include:
 How technically up to date is the machinery?
 Is there a danger of obsolescence?
 Has it been poorly maintained over the years?
Manpower
 How expensive is our workforce?
 How efficient are our employees?
 Is the business overstaffed?
 Is it understaffed?
 What is the labour turnover rate?
 What is the absence rate?
 Are there good structures to allow management succession?
Markets
There is a danger of overlapping with the external environment here, so try to keep to such questions as:
 Are the markets declining/growing?
 Where are new markets emerging?
 How strong are our brands in the current market?
Materials
 How expensive are our materials compared to our competitors?
 Do our suppliers have excessive control of materials?
 Do we have favourable access to materials?
 Are our raw materials becoming exhausted?
Make-up
 What type of structures do we have and are they likely to limit future growth?
 What is the culture of the organisation and will it stifle or fuel future developments?
We will explain later how we can apply these concepts to a case scenario.
What are the key threats from the external environment?
Once we have established constraints on our internal resources we need to assess the threat posed by the external
environment. The easiest way to assess the external environment is to use the following two frameworks:
1. Porter’s five forces.
2. PESTEL analysis.
Porter’s five forces
The American management writer Michael Porter describes the main external competitive threats to be summarised
by his five forces model. Essentially, this model determines the level of competition an organisation is facing by
assessing the extent to which the five forces are relevant. The five forces are summarised as follows:
1. The threat from new entrants.

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2. The bargaining power of buyers.

3. The bargaining power of suppliers.
4. The threat from substitute products.
5. The extent of competitive rivalry.
1. The threat from new entrants
This is a problem because if competitors can easily enter your business sector they will be able to put a ceiling on
your profits. Therefore, the greater the threat from new entrants entering the sector, the higher the levels of
competition. The ease which new entrants can enter the business segment is largely determined by the extent of the
barriers to entry.
The following summarises the main barriers to entry.
 Capital cost of entry. The higher the capital cost, the greater the deterrent to someone entering the business
and, therefore, the likelihood of competition being less than in industries where it is much cheaper to set up business.
 Economies of scale. This will apply if a substantial investment is needed to allow a new entrant to achieve
cost parity. Therefore, anyone entering the segment that cannot match the economies of scale will be at a substantial
cost disadvantage from the start.
 Differentiation. Differentiation is said to occur if consumers perceive a product or service to have
properties, which make it unique or distinct from its rivals. The differentiation can be in the appearance of the
product, its brand name or services attached to the product – for example, Concorde. Therefore, if new entrants are to
be successful in entering the market they will need to spend a lot of money on developing the image of the product –
hence, they are likely to be put off.
 Switching costs. This is the cost not incurred by a new company wishing to enter the market but by the
existing customers. If the buyer will incur expense by changing to a new supplier, they may not wish to change. For
example, when the compact disc was invented consumers had to incur a cost of a CD player, as the new compact
discs would not work on a conventional record player.
 Expected retaliation. If a competitor entering a market believes that the reaction of an existing firm will be
too great then they will not enter the market.
 Legislation. There might be patent protection for a product or the government might only license certain
companies to operate in certain segments – for example, Nuclear Power.
 Access to distribution channels. Existing relationships between manufacturers and the key distributors of
the products may make it difficult for anyone else to enter the market.
Therefore, in summary, when thinking about the barriers to entry go through the above list in your planning to see
which of them apply. Remember that it is unlikely that they all will apply, but the checklist should ensure that all
those that do apply would be picked up.
2. The bargaining power of buyers
Do the buyers of the product have the power to depress the supplier’s prices? If the answer to this question is yes, it
is likely that competition will increase. Buyers will have power when:
 they are concentrated and can exert pressure on the supplier
 the buyer has a choice of alternative sources of supply.
3. The bargaining power of suppliers
The extent of supplier bargaining power is very closely linked in with the issues of buyer power. The extent of the
power of the suppliers will be affected by:
 the concentration of suppliers: if only a few suppliers, the buyers will have less opportunity to shop around
 the degree to which products can be substituted by the various suppliers
 the level of importance attached to the buyer by the supplier. The switching costs of moving to another
supplier.
4. The threat from substitute products
If there are similar products that can be used as substitute then the demand for the product will increase or decrease
as it moves upwards or downwards in price relative to substitutes.
5. The extent of competitive rivalry
The most competitive markets will be affected by the previously discussed forces. However they will also be
affected by:
 the number of competitors and the degree of concentration
 the rate of growth of the industry
 the cost structures if high – fixed costs prices are often cut to generate volume
 the exit costs. If they are high, firms may be willing to accept low margins so as to stay in the industry.

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PESTEL factors
The other framework, which should be applied when surveying the external environment, is PESTEL factors:
 Political
 Economic
 Social
 Technological
 Environmental
 Legal.
Again, all of these factors will not necessarily apply but provide a useful checklist against which you can compare in
an exam situation. They are explained more fully below.
Political environment
The organisation must react to the attitude of the political party that is in power at the time. The government is the
nation’s largest supplier, employer, customer and investor and any change in government spending priorities can
have a significant impact on a business – for example, the defence industry.
Political influence will include legislation on trading, pricing, dividends, tax, employment, as well as health and
safety.
Economic environment
The current state of the economy can affect how a company performs. The rate of growth in the economy is a
measure of the overall change in demand for goods and services. Other economic influences include the following:
1. Taxation levels.
2. Inflation rate.
3. The balance of trade and exchange rates.
4. The level of unemployment.
5. Interest rates and availability of credit.
6. Government subsidies.
One should also look at international economic issues, which could include the following:
1. The extent of protectionist measures.
2. Comparative rates of growth, inflation, wages and taxation.
3. The freedom of capital movement.
4. Economic agreements.
5. Relative exchange rates.
The social environment
The organisation is also influenced by changes in the nature, habits and attitudes of society.
 Changing values and lifestyles.
 Changing values and beliefs.
 Changing patterns of work and leisure.
 Demographic changes.
 Changing mix in the ethnic and religious background of the population.
The technological influences
This is an area in which change takes place very rapidly and the organisations need to be constantly aware of what is
going on. Technological change can influence the following:
 Changes in production techniques.
 The type of products that are made and sold.
 How services are provided.
 How we identify markets.
Environmental
This concerns issues regarding factors that could impact on the ecological balance of the environment and could
include such issues as climate change and pollution
Legal environment
How an organisation does business:
 Law of contract, law on unfair selling practices, health and safety legislation.
 How an organisation treats its employees, employment laws.
 How an organisation gives information about its performance.
 Legislation on competitive behaviour.
 Environmental legislation.

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Therefore, when surveying the external environment think through Porter’s five forces and PESTEL factors and you
will have a fully comprehensive framework with which you can assess the case.
The example below relates to a P3 exam syllabus, which is also relevant to the new SBL syllabus
Championsoft is a specialist software house, which has developed and now markets a modular suite of financial
software packages under the product name of Champlan. In addition, the company provides a systems design
consultancy service to the financial services industry. The company was established in 1988 and the three founding
shareholders are also the three full-time working directors. Extracts from the financial results for the last three years
are given below. These show declining profitability although aggregate sales revenue has increased year on year.
Champlan sales Systes design services sales Operating profits

Year Champlan units sold
$ $ $
2010 2,050 922,500 650,000 162,000
2011 2,700 1,080,000 600,000 144,000
2012 3,600 1,260,000 550,000 107,500
Operating profit is before interest charges and taxation. The current interest rate on the medium term loan is 10% per
annum.
Medium term Share capital and

Fixed assets Current assets Current liabilities
Year loan reserves
$ $ $
$ $
2010 950,000 425,000 260,000 200,000 915,000
2011 1,000,000 525,000 375,000 200,000 950,000
2012 1,225,000 650,000 475,000 400,000 1,000,000
The current liabilities figure includes an overdraft with the bank of £300,000. This is also the agreed maximum. The
company owns its own premises and these comprise the majority of fixed assets. The premises have recently been
expanded to cope with the increased sales volume of the Champlan package. Although the consultancy workload of
the company has shown some decline in recent years, this has been due to pressure on the software staff to develop
more powerful versions of the Champlan package rather than a shortage of potential work. Championsoft is well
regarded in the system design services field and attracts good profit margins on the work carried out. It is estimated
that the operating profit to sales ratio on system design services is in the region of 15%.
Championsoft employs 18 people mainly as software specialists. There is little subcontract software development
undertaken. The managing director and majority shareholder with 40% of the voting capital is Simon Champion. He
was the prime mover behind the creation of Championsoft and has substantial experience in the financial services
industry. He sees his main role as ensuring the efficient day-to-day administration of the business. The software
technical aspects of the business are managed by the technical director, Dr John Chan, who holds 30% of the voting
share capital. He is responsible for research and development on the Champlan product range, customer technical
support on software products and systems design consultancy projects.

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Jill Mortimer, the third director, holds the final 30% of voting shares and is in charge of sales and marketing of both
software products and consultancy services. Her background is in the marketing of fast moving consumer products.
Championsoft see its Champlan product range as a market leader in terms of quality and functionality, although this
segment of the software market appears to be increasingly driven by price and product awareness. There is also a
recent marked tendency for hardware suppliers to bundle in the Champlan product as part of the hardware price of
their product. The main competitor to Champlan is the Pennsoft product range. Pennsoft is part of a large
international organisation, and its product range is very similar to Champlan if lacking in its level of functionality.
Pennsoft software is marketed at prices, which have always undercut Champlan. Jill Mortimer believes that Pennsoft
hold about two-thirds of the market, Champlan about one-quarter and the rest is split among a few other software
houses. There are few barriers to other software houses entering this market. Almost any quality software house is
able to produce a similar product for this market providing that they are willing to devote sufficient resources.
Jill Mortimer has a strong personality and her views have tended to dominate the recent direction of the business.
She believes that Championsoft must cut its prices and put more effort into winning sales. ‘Look at the way the
software market is developing. Every year there is a bigger market as new users get access to the hardware. Our extra
sales effort and a bigger sales force will easily be covered by additional unit sales. We must tackle Pennsoft head on
and capture some of their market share.’ Last year Championsoft spent £100,000 on advertising while Pennsoft spent
in the region of £500,000.
Simon Champion is not fully convinced. ‘Although our current advertising has generated lots of enquiries, very few
of these resulted in firm sales. In fact, the high level of spending on promotion is straining our cash flow.’ He was
thinking about the letter recently received from the bank which, while professing continuing support, pointed out that
Championsoft’s overdraft was rising year on year and that this must not be seen as a permanent source of finance.
The bank had concluded that it would like to see some medium-term projection about how the overdraft was to be
brought under control.
As usual John Chan took the opportunity to launch into his familiar attack on the marketing strategy or lack of
strategy as he was heard to remark to his software team: ‘We should move away from the package market and into
consultancy activities. These build on our reputation and software expertise.
‘The margins are good and we can sell on recommendation not expensive advertising campaigns. As it stands, my
team is being torn between development of Champlan and working on software projects. We cannot do both well, we
are in danger of losing clients and at the same time failing to keep the edge over Pennsoft.’
Simon Champion was at a loss how to respond. Something had to be done, but what?
Simon Champion has come to see you, as the company’s auditor, and has asked for your objective advice. He feels
that Championsoft needs a strategy but is not sure what it should be or how to go about preparing it. ‘Events move so
fast in our industry that plans are out of date before they can be implemented’ was a comment made at your meeting.
Requirements
(a) Identify any additional internal and external information, which you need before you could set about writing your
report and indicate how you would gather such information. (12 marks)
Suggested approach
As you can see, the question asked above in the case scenario clearly seeks for information of both an internal and
external nature together with how you would gather such information.
All answers in the exam should be roughly planned out and all you need to remember to score well in this part of the
question are the mnemonics to help you break down the internal and external factors.
So, to help get some structure for internal factors, think 6Ms and you think:
 Money
 Markets
 Machinery
 Materials
 Manpower
 Make-up
We then need to quickly think which of these 6Ms would be most relevant to the answer. I would expect your
thought process to go something like the following:
 Machinery? Is machinery relevant to Championsoft’s business as a specialist software house? How cost
effective is the current use of the machinery? You may comment on the fact that in order to remain competitive
ongoing investment in the latest equipment is likely to be relevant.
 Money? An analysis of profitability of individual products, how competitive is the interest on the medium-
term loan?
 Manpower? Cost/productivity/staff turnover of the current employees compared to the industry average.

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 Markets? The growth potential for financial software and the systems design consultancy market.
 Materials? In the case of Championsoft, materials do not seem to be so relevant so I would suggest no
comment is needed.
 Make–up? We would need to look at the current culture of the staff and assess whether it would be happy
if one side of the business was run down – for example, software development.
Therefore, we have shown how, by using the 6M’s approach in our plan, we can provide ourselves with more than
enough criteria on which to comment. We should now be confident in applying five forces and PESTEL in much the
same way – for example, questions regarding the five forces would include:
 What are the main barriers to entry for new entrants entering the software and design consultancy business
and how much of a deterrent are they?
 Do buyers have the power to ask Championsoft to reduce its prices? You may comment on the fact that it
has an alternative choice in Pennsoft and therefore may be able to get a more competitive price than if Pennsoft was
not there.
 Are there any other packages out in the market that could be used as a substitute for Championsoft’s
products?
 Questions of a PESTEL nature would be similar to those used above.
Armed with this information in your plan you should now be able to develop an answer that should fulfil the 12
marks allocated. Do not forget to answer the entire question, which required suggestions as to how you would gather
such information suggested. It must be stressed that all of the 6Ms, five forces and PESTEL need not necessarily be
used in your answer, but they should almost certainly be used in developing your answer plan.
P3 past exam-related example, which is also relevant to the SBL syllabus

Bowland Carpets Ltd
An example of a question that concentrates on a specific part of the above environmental analysis is given below.
Bowland Carpets Ltd is a major producer of carpets within the UK. The company was taken over by its present
parent company, Universal Carpet Inc, in 2012. Universal Carpet is a giant, vertically integrated carpet
manufacturing and retailing business, based within the US but with interests all over the world.
Bowland Carpets operates within the UK in various market segments, including the high value contract and
industrial carpeting area – hotels and office blocks, etc – and in the domestic (household) market. Within the latter
the choice is reasonably wide, ranging from luxury carpets down to the cheaper products. Industrial and contract
carpets contribute 25% of Bowland Carpets’ total annual turnover, which is currently £80m. During the late 1980s
the turnover of the company was growing at 8% per annum, but since 2011 sales have dropped by 5% per annum in
real terms. Bowland Carpets has traditionally been known as a producer of high quality carpets, but at competitive
prices. It has a powerful brand name, and it has been able to protect this by producing the cheaper, lower quality
products under a secondary brand name. It has also maintained a good relationship with the many carpet distributors
throughout the UK, particularly the mainstream retail organisations.
The recent decline in carpet sales, partly recession-induced, has worried the US parent company. It has recognised
that the increasing concentration within the European carpet-manufacturing sector has led to aggressive competition
within a low growth industry. It does not believe that overseas sales growth by Bowland Carpets is an attractive
proposition, as this would compete with other Universal Carpet companies. It does, however, consider that vertical
integration into retailing (as already practised within the US) is a serious option. This would give the UK company
increased control over its sales and reduce its exposure to competition. The president of the parent company has
asked Jeremy Smiles, managing director of Bowland Carpets, to address this issue and provide guidance to the US
board of directors. Funding does not appear to be a major issue at this time as the parent company has large cash
reserves on its balance sheet.
Requirements
Acting in the capacity of Jeremy Smiles you are required to outline the various issues, which might be of
significance for the management of the parent company. Your answer should cover the following:
(a) To what extent do the distinctive competencies of Bowland Carpets conform with the key success factors
required for the proposed strategy change? (10 marks)
(b) Suggest and discuss what might be the prime entry barriers prevalent in the carpet retailing sector. (7 marks)
(c) In an external environmental analysis concerning the proposed strategy shift, what are likely to be the key
external influences that could impact upon the Bowland Carpets decision? (8 marks)
(Total: 25 marks)
Suggested approach
If we are to concentrate on Part (b), you can see that it asks for the prime entry barriers in the carpet retailing sector.

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All that you need to do here is undertake a quick brainstorm of what we described earlier as barriers to entry and then
see whether any of them will apply to the carpet retailing sector.
So thinking back the main barriers to entry which we listed were:
 Capital cost of entry
 Economies of scale
 Differentiation
 Switching costs
 Expected retaliation
 Legislation
 Access to distribution channels
Most of the above could be a potential barrier in the carpet retailing sector, but in order to score high marks you need
to apply them in the context of carpet retailing rather than just list them.
 Capital cost of entry. How much investment would be required in a lease and stock?
 Economies of scale. Are there any current carpet retailers that have superior buying power and economies
of scale in distribution and marketing?
 Differentiation. Are there any retailers that have high levels of customer loyalty to their shop, which would
prevent them from buying carpets from anyone else?
 Switching costs. Switching costs are not relevant and one would become relevant if a householder were to
enter into a lifelong contractual agreement to buy all their carpets from one particular retailer, which is clearly
unlikely.
 Expected retaliation. If a retailer existed in the carpet retailing sector that was very aggressive to any
potential new competitor this could prove to be a potential barrier.
 Legislation. Are there any planning constraints or specific licences that are needed to operate in the carpet
retailing sector.
 Access to distribution channels. How easy will it be for a new entrant in the carpet retailing sector to find a
prime retailing site that is appropriate for the sale of carpets.
Therefore, using the framework in an applied way, we have been able to construct an answer that, if presented
appropriately, will be worth almost maximum marks. If you look at Part (c) you will see that the external analysis
frameworks fit in perfectly again – see if you can do it.
Summary
Hopefully now when we think about the strategic planning process we think about:
1. Strategic analysis.
2. Strategic choice.
3. Strategic implementation. This article has explained in detail the process of strategic analysis, which we
should all be able to break down into:
- Where do we want to go?
- What constraints exist on our resources? (6Ms)
- What are the key threats from the external environment? (five forces, PESTEL)
The next article will take a similar approach to the issues of strategic choice and implementation.
Adapted from an article originally written by Sean Purcell BA ACMA (a leading freelance lecturer for P3 and
lectures on the ACCA Study School and Train the Trainer Programme for P3 and SBL)
The strategic planning process – part 2

The second of two articles that focus on applying your knowledge of management and strategy to a scenario
situation.
 Introduction
 Strategic choice
 Strategic implementation
 Summary
Introduction
Part 1 considered the complexities of strategic planning and how they can be broken down into three main areas. Part
2 adopts a similar simplification approach to the issues of strategic choice and strategic implementation.
Strategic choice
Johnson and Scholes break down the issue of strategic choice into three distinct subheadings, which are:
 On what basis do we decide to compete?

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 Which direction should we choose?

 How are we going to achieve the chosen direction?
On what basis do we decide to compete?
A useful framework to use here is Porter’s generic strategies. Michael Porter stated that a firm that is wishing to
obtain competitive advantage over its rivals is faced with two choices:
Choice 1: Is the company seeking to compete by achieving lower costs than its rivals achieve and by charging similar
prices for the products and services that it offers, thereby achieving advantage via superior profitability? Or…
Is the company wishing to differentiate itself and the customer is prepared to pay a premium price for the added
value which the customer perceives in the product, and thereby enjoys greater margin than the undifferentiated
product.
Choice 2: What is the scope of the area in which the company wishes to obtain competitive advantage? Is it industry-
wide or is it restricted to a specific niche?
The answers to these two choices leave the organisation faced with three generic strategies, which are defined as:
1. cost leadership
2. differentiation
3. focus.
1. Cost leadership
Set out to be the lowest cost producer in an industry. By producing at the lowest possible cost the manufacturer can
compete on price with every other producer in the industry and earn the highest unit profits.
In order to achieve cost leadership some of the following need to be in place:
 Seek to set up production facilities for mass production as these will facilitate the economies of scale
advantages to be achieved.
 Invest in the latest technology – improved quality less labour needed.
 Seek to obtain favourable access to sources of raw materials.
 Look to develop product designs that facilitate automation.
 Minimise overhead costs by exploiting bargaining power.
 Concentrate on productivity objectives and constantly seek to improve efficiency and economy – for
example, ZBB, value chain analysis.
One should also be aware of the drawbacks of such a strategy, such as the need to continually keep up to date with
potential changes in technology or consumer tastes.
2. Differentiation
A firm differentiates itself from its competitors when it provides something unique that is valuable to buyers.
Differentiation occurs when the differentiated product is able to obtain a price premium in the market that is above
the cost incurred to create the differentiation.
As a consequence of differentiation being about uniqueness, it is not really possible to give an exhaustive list
detailing how a firm may differentiate itself. To truly differentiate yourself we must understand the product or
service offered and the customer to whom you are selling it.
Ways of achieving differentiation:
 Image differentiation
Marketing is used to feign differentiation where it otherwise does not exist – ie an image is created for the product.
This can also include cosmetic differences to a product that does not enhance its performance in any serious way –
for example, perfume – colour, size, packaging.
 Support differentiation
More substantial, but still has no effect on the product itself, is to differentiate on the basis of something that goes
alongside the product, some basis of support. This may have to do with selling – for example, 0% finance, 24-hour
delivery.
 Quality differentiation
This means the features of the product that make it better – not fundamentally different, but just better. The product
will perform with:
- greater initial reliability
- greater long-term durability
- superior performance.

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 Design differentiation
Differentiate on the basis of design and offer the customer something that is truly different as it breaks away from the
dominant design if there is one – for example, Apple’s iMac computer.
 Reward of a differentiation strategy

Consumers are likely to pay a higher price for the goods because of the added value created by the differentiation.
3. Focus
A focus strategy is based on fragmenting the market and focusing on particular market niche. The firm will not
market its products industry-wide but will concentrate on a particular type of buyer or geographical area.
Cost focus: This involves selecting a particular niche in the market and focusing on providing products for that niche.
By concentrating on a limited range of products or a small geographical area, the costs can be kept low.
Differentiation focus: Select a particular niche and concentrate on competing in that niche on the basis of
differentiation – for example, luxury goods.
This can be summarised in the following diagram:
An example of a focus strategy
We stated that the alternative directions available to a business could be described in general terms as follows:
1. Do nothing
2. Withdrawal
3. Market penetration
4. Product development
5. Market development
6. Diversification
Do nothing
This involves following the current strategy while events around change and can often prove to be a successful short-
term strategy. Basically, if an organisation is exposed to some form of competitive threat, its short-term objective is
to not react and, hence, get involved in what could be an expensive decision.
Sell out/withdraw from the market
This may be followed so as to maximise the return on a business that may be at the top of its cycle and, hence, will
be in line with the goal of maximisation of cash flows. Withdrawal from a business sector may be chosen to give the
business more focus – for example, Richard Branson’s decision to sell his original business Virgin Records to
concentrate on the airlines business.
Market penetration
This involves increasing the market share in the current market with the current product. Market share can be
enhanced by such techniques as improved quality, productivity or increased marketing activity.
Product development
This involves introducing a new product into the current market. The product change is often the result of changes
and modifications to an existing successful product – for example, Mars ice cream. This is an alternative to the
present product and builds on present knowledge and skills.

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Market development
In this case the organisation keeps its tried and tested products but aims to apply them to different market segments.
This strategy maintains the security of the present product while enabling extra revenue to be generated from new
segments – for example, McDonald’s and its geographic market development.
Diversification
This is the most risky of the product market strategies as it involves the introduction of a totally new product in a
new market. Diversification can either be related or unrelated.
Related diversification
This involves development of the product and market but still remaining within the broad confines of the industry.
There are three main types.
1. Backward. A development into the business that inputs into the present business – for example, move up
the supply chain into raw material inputs.
2. Forward. A development into activities concerned with a company’s outputs also called downstream
integration – for example, move down the supply chain into distribution activities.
3. Horizontal. Movement into activities that are competitive with existing activities – for example, to benefit
access to market or technology.
Unrelated diversification
This involves movement into industries that bear little relationship to the present one and is often the result of a
profit motive.
Ansoff represented the last four choices in his product/market matrix.
Ansoff's product market matrix

How?
The final problem that must be overcome is to decide how the chosen strategic option should be undertaken.
The options available are:
 internal development
 external development/acquisition
 joint development.
Internal development
Reasons
Often undertaken to maintain the present equilibrium within the company as it is much less disruptive than an
acquisition. Another reason may be that there is not sufficient finance available for an acquisition or that the
government may prevent acquisition/merger through legislation.
Acquisitions
 If there is sufficient finance available an acquisition will provide a very quick way of providing access to
new product/market areas and the new organisation will have economies of scale advantages.
Joint development
A formal agreement between two or more organisations to undertake a new venture together – for example, Airbus
(spreading of cost).
Methods of joint development
 Consortia. Two or more firms working together to share the costs and benefits of a business opportunity.
 Joint venture. A separate business entity whose shares are owned by two or more business entities.
 Strategic alliance. A long-term agreement to share knowledge, technology or business opportunities.

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 Franchising. The purchase of the right to exploit a business brand in return for a capital sum and a share of
profits or turnover. The franchiser also usually provides marketing and technical support to the purchaser of the
franchise.
 Licensing. The right to exploit an invention or resource in return for a share of proceeds. Differs from
franchise because there will be little central support.
To summarise, we can use Figure 1. Once all the alternative options have been generated we need to evaluate their
appropriateness before making a choice. A useful framework to apply when considering the appropriateness of an
option is:
 suitability
 feasibility
 acceptability
Suitability
Suitability identifies the extent to which the proposed strategy enhances the situation identified in the strategic
analysis. The following questions need to be addressed about the strategic options:
 Does it close the planning gap?
 Does it address threats and weaknesses?
 Does it build on identified strengths and exploit opportunities?
 Does it fit in with the organisation’s mission?
 Will the portfolio remain balanced?
Feasibility
The issue of feasibility evaluates whether the chosen strategy can be implemented successfully. The resources the
organisation has at its disposal will obviously determine this. To save time, simply think about the 6Ms.
Acceptability
The final issue to address is whether the selected strategy will meet the expectations of the key stakeholders in the
firm and typical issues to be looked at would include the level of risk and return resulting from the option.
Remember that in the exam it is unlikely that you are going to get a question that asks you to regurgitate the
information on strategic choice in the way in which I have just explained to you. Questions will normally touch on
some part of the process we have described and if you have an in-depth understanding of everything that we have
covered you will be able to construct much more comprehensive arguments in the exam. We will show this in a
previous exam question later.
Strategic implementation
The area of strategic implementation covers many areas from project management to structure. However, as with
strategic analysis and strategic choice, it is possible to simplify the issues in to a number of key sub-headings:
 Resource management.
 Organisational structure.
 Management of change.
Resource management
This will ensure that the 6Ms are working for you in the best way possible. Budgets and other performance
management tools are likely to be used here.
Organisational structure
This will deal with issues regarding the levels of centralisation and decentralisation, together with structural form and
style of management.
Management of change
The scope, speed and style of the changes need to be carefully reviewed in order to obtain full commitment to them.
A useful model of change to remember is Kurt Lewins’ three-step model, which involved:
 unfreeze
 change
 refreeze.
Unfreeze
For the change to take place the existing equilibrium must be broken down before a new one can be adopted.
Change
This is the second stage, mainly concerned with identifying what the new, desirable behaviour or norm should be,
communicating it and encouraging individuals and groups to ‘own’ the new attitude or behaviour. To be successful,
one should consider the adoption of the following management styles to improve the acceptance of the change:
 Participation with employees affected by the change, so that they feel more of a sense of ownership.

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 Education and communication of the new ways, so that they fully understand what is going on and are not
in a situation where they are afraid of the unknown and therefore show resistance.
 Negotiation may also be appropriate if there are large group stakeholders such as a trade union.
Refreeze
This is the final stage, implying consolidation or reinforcement of the new behaviour. Positive reinforcement (praise,
reward, etc) or negative reinforcement (sanctions applied to those who deviate from the new behaviour) may be used.
You should also look at the Change Kaleidoscope and Cultural Web.
Therefore to summarise what we have just said:
Strategic choice
 On what basis do we decide to compete? (Porter’s generic strategies.)
 Which direction should we choose? (Ansoff’s product market matrix, do nothing, withdraw.)
 How are we going to achieve the chosen direction? (Internal external joint venture.)
Strategic implementation
 Resource management (6Ms)
 Organisational structure (centralisation, decentralisation, specific structural form)
 Management of change (unfreeze, change, refreeze)
Let us see how we can expect to get questioned in this area in the exam.
Question 1
Sample ACCA exam
Jerome Gulsand is the owner and chief executive of a chain of 20 sports equipment shops, Sportak. These shops are
clustered in the south of the country. The company is privately owned by the family and the freeholds of these shops,
which the company owns and which are on prime retail sites, account for the majority of the assets of Sportak. The
company sells a wide range of sports equipment such as golf clubs, tennis, skiing equipment, soccer and other sports
equipment. Recently it has expanded its range to include certain types of designer sports clothing.
The company was founded by Jerome’s father a quarter of a century earlier when he opened his first small shop.
Over the next 25 years the company grew steadily. A major reason for this successful development lay with the
philosophy of Jerome’s father who delegated much of the decision-making to the individual shop managers. He
believed that this gave the local managers a higher degree of motivation. It also allowed them to respond to local
demand conditions as stock ordering was carried out by each shop and was not organised at the head office. The
managers were also permitted to develop local marketing activities, using sales promotions and publicity as they felt
appropriate.
These shop managers were remunerated partly by a basic salary and partly by a sales-related performance bonus,
which could be up to 40% of their basic salary. These methods of operation were satisfactory while the company was
operating in a steady growth environment. However, by late 2007 there was evidence that Sportak’s overall position
within the market was weakening. Sales had stabilised but, even more importantly, competition was growing from a
number of discount traders who were prepared to operate on low profit margins but with larger volumes. It was at
this time that Jerome took over the company from his father.
Jerome was impatient with the lack of growth. By nature he was an entrepreneur who sought growth. He was not
sure that the steady organic growth was appropriate to these conditions. His father’s policy had been to open a store
each year, funding this growth out of current earnings. Jerome saw that the market was becoming so competitive that
even small and specialist markets were proving to be vulnerable. He believed that only the big, nationwide retail
chains would survive and that the smaller sized groups would be taken over by the larger chains of sports goods
retailers who were more profitable and had greater capability to raise finance.
He decided that a ‘dash for growth’ was required if the company was to achieve the critical size to survive in the
market place. It had been suggested to him that the franchising of the Sportak brand name would be a reasonable and
relatively risk-free method of expansion. Growth, using other people’s money, has its advantages, but it did not
appeal to Jerome. He wanted a more ‘hands-on’ approach.
At about this time another chain of 15 sports shops became available for purchase. This group was in a distinctly
separate area of the country – about 150 miles from Sportak’s current area of operations. As the overall sports
equipment and sportswear market was still growing, the price being asked for this acquisition was rather high.
However, Jerome was convinced that this was too good an opportunity to miss. He believed that Sportak needed this
expansion so as to take advantage of the profitable sales still available in this sector. However, for an acquisition of

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this size, it was obvious that the growth could not be funded internally. Jerome assumed that he might use the
freeholds of the properties Sportak owned as securities for the finance the company needed to borrow. Before
approaching the bank Jerome discussed this issue with his accountant and offered the following ideas for his
proposed expansion.
In anticipating this proposed expansion and the need to manage an enlarged group, Jerome believes that it is time for
a strong and centralising leader. Recognising that the current system of product ordering is delegated to individual
store managers, he proposes to provide a centralised purchasing function based upon a warehouse owned and
controlled by Sportak. Individual shop managers will be permitted to decide upon their stock range, but they will
have to order from the central warehouse set up by Sportak.
Jerome has also decided to tackle the problem of marketing and, in particular, promotion. The decentralised approach
adopted by his father has not brought about the development of a well-known image and, therefore, the brand of
Sportak needs to be strengthened. Under Jerome’s plan it is proposed to allocate a substantial budget – 15% of sales
– to spend on press advertising and on public relations, and this level of commitment will continue for the
foreseeable future. Sports personalities will be paid to appear in all stores, which will have to be re-equipped. By a
competent use of merchandising it is hoped that these stores will increasingly be recognised as centres for
influencing the fashion of both sports equipment and clothing. The shop managers will also be encouraged to stock
more expensive lines of products where the margins will be higher and, in addition, they will be expected to hold
much more stock. A criticism of the stores when Jerome’s father was in charge was that they were often short of
stock. Most customers were unwilling to wait for the product to be ordered and they therefore bought from
competitors’ shops.
Jerome recognised that during this period of change Sportak might lose a number of its key shop managers. These
people have enjoyed substantial autonomy, and although they will still have some freedom on the stock range that
they offer, they might increasingly see their freedom to act as managers being eroded. In appreciating that these shop
managers provide much goodwill and their loss would be damaging to the company, Jerome is proposing to increase
their sales-related bonuses as an inducement to stay.
Jerome fully understands that the costs incurred in the proposed acquisition involve more than the purchase of the
new shops. Store modernisation programmes for all the shops, as well as upgrading stock with a wider and more
sophisticated range of products, will also require funding. Forecasts of immediate future sales appear to be attractive.
Jerome anticipates that sales per store will rise by about 8% over the next year. He believes that this growth in sales,
accompanied by his more aggressive approach to retailing, will enable his bold expansion plans for Sportak to be
achieved. Above all, Jerome wishes to see his company, Sportak, become a national company, no longer having to
operate as a regional retailer does.
In Table 1 is a summary of the figures that have been prepared by Jerome’s accountant for discussion. Part of the
data has been obtained from trade association statistics as well as government forecasts.
Requirements
(a) Jerome Gulsand’s father was a great believer in the decentralisation of both operations and decision making. To
what extent has this process harmed or benefited Sportak? Provide examples to justify your arguments. (10 marks)
(b) Evaluate the key features that you consider to be important and would expect to see in the business plan that
Jerome Gulsand would have to present to his bank to support his application for financial assistance. (15 marks)
(c) Acting in the position of Jerome Gulsand’s accountant, and using the financial data provided and the intentions
developed by Jerome, assess the viability of the strategy that has been proposed by him. (15 marks)
(d) Discuss whether a franchise operation would have been a better option for expansion than an acquisition. (10
marks)
Table 1

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2007 2008 2009 2010

Actual Budget Forecast Forecast
$m $m $m $m
Sales of revenue 30.00 29.50 58.80 57.96
Costs of sales 15.00 14.75 25.28 24.92
Gross margin 15.00 14.75 33.52 33.04
Expenses 12.00 12.50 29.50 29.75
Operating profit 3.00 2.25 4.02 3.29
Interest paid 0.00 0.00 2.50 2.50
Proft after interest 3.00 2.25 1.52 0.79
Fixed assets 15.00 15.00 34.00 34.00
Current assets 6.00 5.90 9.80 9.66
Current liabilities 3.75 3.69 7.35 7.25
Equity 24.75 24.59 26.15 25.91
Debt 0.00 0.00 25.00 25.00
Gross margin 50% 50% 57% 57%
Return of sales 10% 7.62% 6.83% 5.67%
Activity ratio 1.21 1.20 1.15 1.14

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2007 2008 2009 2010

Actual Budget Forecast Forecast
$m $m $m $m
Return on net assets 12.2 9.15 7.85 6.46
ROE 12.2 9.15 5.80 3.04
Industry sales 125 135 140 138

(2000 100)
Part (a) examines your knowledge of the implementation stage by asking a specific question on structure and
whether you believe decentralisation has had any detrimental effect on Sportak. If you were to brainstorm the main
issues regarding centralisation and decentralization, and then see which apply in the context of the case, a
comprehensive answer would be able to be obtained.
Part (b) would be best answered by mixing common sense with the key issues from strategic analysis, strategic
choice and strategic implementation. Common sense would tell you that the business plan should include an
overview of Sportak’s business. More detailed information should be provided on the organisation’s resources
(6Ms), together with an overview of the business environment in which it exists (use PESTEL and five forces for
inspiration). A clear description of the basis on which Sportak intended to compete should also be included (use
Porter’s generic strategies and Ansoff’s product market matrix for inspiration) together with the likely returns the
business is to make from the chosen strategy.
Part (c) requires you to apply the financial skills you have learned throughout your ACCA studies to give an
overview of how viable Jerome’s plans are.
Part (d) again would have been easily answered if you had approached your studies in the logical way suggested
earlier and it specifically dealt with the how? Part of the strategic choice stage. (Use the internal, external or joint
venture model for inspiration).
Summary
Hopefully you are now able to overview the strategic planning part of the syllabus in a more systematic and logical
way. All you need to remember is the key steps of strategic analysis, choice and implementation. This should then
set off another chain of words in your head, such as:
 strategic analysis (think 6Ms, think PESTEL and five forces and stakeholder constraints)
 strategic choice (on what basis do we decide to compete? Which direction should we choose? How are we
going to achieve the chosen direction?)
 strategic implementation (resource management, organisational structure, management of change)
All that is necessary now is to use the framework in an applied way relevant to the question asked.
Adapted from an article originally written by Sean Purcell BA ACMA (a leading freelance lecturer for P3 and
lecturer on the ACCA Study School and Train the Trainer Programme for P3 and SBL)
All about stakeholders – part 1

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This article introduces the idea of stakeholders and stakeholding. It starts with definitions of the relevant
terms, explains the nature of stakeholder ‘claims’, and then goes on to use the Mendelow framework to
explain how stakeholding is linked to influence. Finally, it covers the different ways in which stakeholders are
categorised and how they are distinguished from each other.
 Definitions and examples
 Stakeholder 'claims'
 Understanding the influence of each stakeholder (Mendelow)
 How to categorise stakeholders
Definitions and examples
The subject of stakeholders features in section B4 of the Strategic Business Leader (SBL) syllabus. It is central to
any understanding of the subject of business and organisational ethics. The purpose of this – and the next – article is
to bring all aspects of the subject together so that students new to the field can gain an understanding of what the
subject means and how it is constructed as far as ethics is concerned.
Any definition of a stakeholder must take into account the stakeholder–organisation relationship. The best definition
of this is by Freeman, who in 1984 defined a stakeholder as: ‘Any group or individual who can affect or [be] affected
by the achievement of an organisation’s objectives’. This definition shows the important bi-directionality of
stakeholders – that they can be both affected by – and can affect – an organisation. Of course, some stakeholders will
be in both camps.
When we think of stakeholders, it is possible to list many examples, but the ones that usually come to mind are
shareholders, management, employees, trade unions, customers, suppliers, and communities. However, larger and
more complex organisations can have many more stakeholders than these. Compare, for example, the different
complexities of a small organisation, such as a corner shop or street trader, with a large international organisation
such as a major university or ACCA. The first important aspect of stakeholder theory is, therefore, to recognise that
stakeholders exist and that the complexity and range of stakeholders relevant to an organisation will depend on that
organisation’s size and activities.
Stakeholder 'claims'
The reason why stakeholders are important in both business ethics and in strategic analysis is because of the notion
of stakeholder ‘claims’. A stakeholder does not simply exist (as far as the organisation is concerned) but makes
demands of it. This is where understanding stakeholding can become more complicated.
Essentially, stakeholders ‘want something’ from an organisation. Some want stakeholders to influence what the
organisation does (those stakeholders who want to affect) and others are, or potentially could be, concerned with the
way they are affected by the organisation and may want to increase, decrease, or change the way the activities of the
organisation affect them. One of the problems with identifying stakeholder claims, however, is that some
stakeholders may not even know that they have a claim against an organisation, or may know they have a claim but
are unaware of what it is. This brings us to the issue of direct and indirect stakeholder claims.
Direct stakeholder claims are made by those with their own ‘voice’. These claims are usually unambiguous, and are
often made directly between the stakeholder and the organisation. Stakeholders making direct claims will typically
include trade unions, shareholders, employees, customers, suppliers and, in some instances, local communities.
Indirect claims are made by those stakeholders unable to make the claim directly because they are, for some reason,
inarticulate or ‘voiceless’. Although this means they are unable to express their claim direct to the organisation, it is
important to realise that this does not invalidate their claim. Typical reasons for this lack of expression include the
stakeholder being (apparently) powerless (eg an individual customer of a very large organisation), not existing yet
(eg future generations), having no voice (eg the natural environment), or being remote from the organisation (eg
producer groups in distant countries). This raises the problem of interpretation. The claim of an indirect stakeholder
must be interpreted by someone else in order to be expressed, and it is this interpretation that makes indirect
representation problematic. How do you interpret, for example, the needs of the environment or future generations?
What would they say to an organisation that affects them if they could speak? To what extent, for example, are
environmental pressure groups reliable interpreters of the needs (claims) of the natural environment? To what extent
are terrorists reliable interpreters of the claims of the causes and communities they purport to represent? This lack of

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clarity on the reliability of spokespersons for these stakeholders makes it very difficult to operationalise (to include
in a decision-making process) their claims.
Understanding the influence of each stakeholder (Mendelow)

In strategic analysis, the Mendelow framework is often used to attempt to understand the influence that each
stakeholder has over an organisation’s objectives and/or strategy. The idea is to establish which stakeholders have
the most influence by estimating each stakeholder’s individual power over – and interest in – the organisation’s
affairs. The stakeholders with the highest combination of power and interest are likely to be those with the most
actual influence over objectives. Power is the stakeholder’s ability to influence objectives (how much they can),
while interest is the stakeholder’s willingness (how much they care).
Influence = Power x Interest
There are issues with this approach, however. Although it is a useful basic framework for understanding which
stakeholders are likely to be the most influential, it is very hard to find ways of effectively measuring each
stakeholder’s power and interest. The ‘map’ generated by the analysis of power and interest (on which stakeholders
are plotted accordingly) is not static; changing events can mean that stakeholders can move around the map with
consequent changes to the list of the most influential stakeholders in an organisation.
The organisation’s strategy for relating to each stakeholder is determined by the part of the map the stakeholder is in.
Those with neither interest nor power (top left) can, according to the framework, be largely ignored, although this
does not take into account any moral or ethical considerations. It is simply the stance to take if strategic positioning
is the most important objective. Those in the bottom right are the high-interest and high-power stakeholders, and are,
by that very fact, the stakeholders with the highest influence. The question here is how many competing stakeholders
reside in that quadrant of the map. If there is only one (eg management) then there is unlikely to be any conflict in a
given decision-making situation. If there are several and they disagree on the way forward, there are likely to be
difficulties in decision making and ambiguity over strategic direction.
Stakeholders with high interest (ie they care a lot) but low power can increase their overall influence by forming
coalitions with other stakeholders in order to exert a greater pressure and thereby make themselves more powerful.
By moving downwards on the map, because their power has increased by the formation of a coalition, their overall
influence is increased. The management strategy for dealing with these stakeholders is to ‘keep informed’.
Finally, those in the bottom left of the map are those with high power but low interest. All these stakeholders need to
do to become influential is to re-awaken their interest. This will move them across to the right and into the high
influence sector, and so the management strategy for these stakeholders is to ‘keep satisfied’.
Figure 1 -
The Mendelow Framework
How to categorise stakeholders
The Freeman definition is something of a ‘catch all’ and many writers in the field have found it helpful to develop
other ways of distinguishing one type of stakeholder in an organisation from another.
Internal and external stakeholders

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Perhaps the easiest and most straightforward distinction is between stakeholders inside the organisation and those
outside. Internal stakeholders will typically include employees and management, whereas external stakeholders will
include customers, competitors, suppliers, and so on. Some stakeholders will be more difficult to categorise, such as
trade unions that may have elements of both internal and external membership.
Narrow and wide stakeholders (Evans and Freeman)
Narrow stakeholders are those that are the most affected by the organisation’s policies and will usually include
shareholders, management, employees, suppliers, and customers who are dependent upon the organisation’s output.
Wider stakeholders are those less affected and may typically include government, less-dependent customers, the
wider community (as opposed to the local community) and other peripheral groups. The Evans and Freeman model
may lead some to conclude that an organisation has a higher degree of responsibility and accountability to its
narrower stakeholders.
Primary and secondary stakeholders (Clarkson)
According to Clarkson: ‘A primary stakeholder group is one without whose continuing participation the corporation
cannot survive as a going concern’. Hence, whereas Evans and Freeman view stakeholders as being (or not being)
influenced by an organisation, Clarkson sees the important distinction as being between those that do influence an
organisation and those that do not. Secondary stakeholders are those that the organisation does not directly depend
upon for its immediate survival.
Active and passive stakeholders (Mahoney)
Mahoney (1994) divided stakeholders into those who are active and those who are passive. Active stakeholders are
those who seek to participate in the organisation’s activities. These stakeholders may or may not be a part of the
organisation’s formal structure. Management and employees obviously fall into this active category, but so may
some parties from outside an organisation, such as regulators (in the case of, say, UK privatised utilities) and
environmental pressure groups.
Passive stakeholders, in contrast, are those who do not normally seek to participate in an organisation’s policy
making. This is not to say that passive stakeholders are any less interested or less powerful, but they do not seek to
take an active part in the organisation’s strategy. Passive stakeholders will normally include most shareholders,
government, and local communities.
Voluntary and involuntary stakeholders
This distinction describes those stakeholders who engage with the organisation voluntarily and those who become
stakeholders involuntarily. Voluntary stakeholders will include, for example, employees with transferable skills (who
could work elsewhere), most customers, suppliers, and shareholders. Some stakeholders, however, do not choose to
be stakeholders but are so nevertheless. Involuntary stakeholders include those affected by the activities of large
organisations, local communities and ‘neighbours’, the natural environment, future generations, and most
competitors.
Legitimate and illegitimate stakeholders

This is one of the more difficult categorisations to make, as a stakeholder’s legitimacy depends on your viewpoint
(one person’s ‘terrorist’, for example, is another’s ‘freedom fighter’). While those with an active economic
relationship with an organisation will almost always be considered legitimate, others that make claims without such a
link, or that have no mandate to make a claim, will be considered illegitimate by some. This means that there is no
possible case for taking their views into account when making decisions.
While terrorists will usually be considered illegitimate, there is more debate on the legitimacy of the claims of lobby
groups, campaigning organisations, and non-governmental/charitable organisations.
Recognised and unrecognised (by the organisation) stakeholders

The categorisation by recognition follows on from the debate over legitimacy. If an organisation considers a
stakeholder’s claim to be illegitimate, it is likely that its claim will not be recognised. This means the stakeholder’s
claim will not be taken into account when the organisation makes decisions.
Known about and unknown stakeholders

Finally, some stakeholders are known about by the organisation in question and others are not. This means, of
course, that it is very difficult to recognise whether the claims of unknown stakeholders (eg nameless sea creatures,
undiscovered species, communities in close proximity to overseas suppliers, etc) are considered legitimate or not.
Some say that it is a moral duty for organisations to seek out all possible stakeholders before a decision is taken and

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this can sometimes result in the adoption of minimum impact policies.
For example, even though the exact identity of a nameless sea creature is not known, it might still be logical to
assume that low emissions can normally be better for such creatures than high emissions.
Adapted from an article originally written by a member of the P1 examining team
All about stakeholders – part 2

The second of a two-part article focuses on stakeholders and stakeholding by looking at a number of different
stakeholder groups.
 Who's who: the stakeholder/stockholder debate
 Instrumental and normative motivations of stakeholder theory
 Seven positions along the continuum: Gray, Owen and Adams
 Conclusion
Who's who: the stakeholder/stockholder debate
The stakeholder/stockholder (or stakeholder/ shareholder) debate is at the heart of the ethical consideration of
stakeholders and is central to the discussion as it separates people into political and ethical ‘camps’. The term
‘stockholder’ rather than ‘shareholder’ was used more in American literature that discussed these issues and has been
the more commonly used term to describe the belief that shareholders are the only stakeholder with a legitimate
claim to influence.
Essentially, proponents of the stockholder theory argue that because organisations are ‘owned’ by their principals,
the agents (directors) have a moral and legal duty to only take account of principals’ claims when setting objectives
and making decisions. Hence, for a joint stock business such as a public company, it may be assumed that because
principals (shareholders) seek to maximise their returns, the sole duty of agents is to act in such a way as to achieve
that.
Stakeholder theorists, in contrast, argue that because a business organisation is a citizen of society, enjoying its
protection, support and benefits, it has a duty to recognise a plurality of claims in the same way that an individual
might act as a ‘responsible citizen’. In effect, this means recognising claims in addition to those of shareholders
when reaching decisions and deciding on strategies.
Instrumental and normative motivations of stakeholder theory

Another debate, from an ethical perspective, is why organisations do or do not take account of stakeholder concerns
in their decision making, strategy formulation, and implementation. A parallel can be drawn between the ways in
which organisations view their stakeholders and the ways in which individual people consider (or do not consider)
the views of others. Some people are concerned about others’ opinions, while other people seem to have little or no
regard for others’ concerns. Furthermore, the reasons why individuals care about others’ concerns will also vary.
In attempting to address this issue, Donaldson and Preston described two contrasting motivations: the instrumental
and the normative.
The instrumental view of stakeholders
The instrumental view of stakeholder relations is that organisations take stakeholder opinions into account only
insofar as they are consistent with other, more important, economic objectives (eg profit maximisation, gaining
market share, compliance with a corporate governance standard). Accordingly, it may be that a business
acknowledges stakeholders only because acquiescence to stakeholder opinion is the best way of achieving other
business objectives. If the loyalty or commitment of an important primary or active stakeholder group is threatened,
it is likely that the organisation will recognise the group’s claim because not to do so would threaten to reduce its
economic performance and profitability. It is therefore said that stakeholders are used instrumentally in the pursuit of
other objectives.
The normative view of stakeholders
The normative view of stakeholder theory differs from the instrumental view because it describes not what is, but
what should be. The most commonly cited moral framework used in describing ‘that which should be’ is derived
from the philosophy of the German ethical thinker Immanuel Kant (1724–1804). Kant’s moral philosophy centred
around the notion of civil duties which, he argued, were important in maintaining and increasing overall good in
society. Kantian ethics are, in part, based upon the notion that we each have a moral duty to each other in respect of
taking account of each others’ concerns and opinions. Not to do so will result in the atrophy of social cohesion and
will ultimately lead to everybody being worse off morally and possibly economically.

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Extending this argument to stakeholder theory, the normative view argues that organisations should accommodate
stakeholder concerns not because of what the organisation can instrumentally ‘get out of it’ for its own profit, but
because by doing so the organisation observes its moral duty to each stakeholder. The normative view sees
stakeholders as ends in themselves and not just instrumental to the achievement of other ends.
Seven positions along the continuum: Gray, Owen and Adams

Let’s return to the idea that the internal audit department is carrying out the delegated work of the audit committee.
This is a fruitful area to explore because it explains some of the characteristics of effective (and ineffective) IA. The
audit committee is made up of independent non-executive directors (NEDs). This isn’t the place to explore the
concept of independence in detail, but independence is central to an effective IA department. The work of IA
becomes meaningless if it is compromised by management influence. Achieving independence is difficult, and made
more so because internal auditors are usually employees of the company.
The stakeholder/stockholder debate can be represented as a continuum, with the two extremes representing the ‘pure’
versions of each argument. But as with all continuum constructs, ‘real life’ exists at a number of points along the
continuum itself. It is the ambiguity of describing the different positions on the continuum that makes Gray, Owen
and Adams’s ‘seven positions on social responsibility’ so useful.
Pristine capitalists
At the extreme stockholder end is the pristine capitalist position. The value underpinning this position is shareholder
wealth maximisation, and implicit within it is the view that anything that reduces potential shareholder wealth is
effectively theft from shareholders. Because shareholders have risked their own money to invest in a business, and it
is they who are the legal owners, only they have any right to determine the objectives and strategies of the business.
Agents (directors) that take actions, perhaps in the name of social responsibility, that may reduce the value of the
return to shareholders, are acting without mandate and destroying value for shareholders.
Expedients
The expedient position shares the same underlying value as that of the pristine capitalist (that of maximising
shareholder wealth), but recognises that some social responsibility expenditure may be necessary in order to better
strategically position an organisation so as to maximise profits. Accordingly, a company might adopt an
environmental policy or give money to charity if it believes that by so doing, it will create a favourable image that
will help in its overall strategic positioning.
Social contract position
The notion of social contract has its roots in political theory. Democratic governments are said to govern in a social
contract with the governed. This means that a democratic government must govern broadly in line with the
expectations, norms and acceptations of the society it governs and, in exchange, society agrees to comply with the
laws and regulations passed by the government. Failure by either side to comply with these terms will result in the
social contract being broken. For businesses, the situation is a little more complex because unlike democratic
governments, they are not subject to the democratic process.
The social contract position argues that businesses enjoy a licence to operate and that this licence is granted by
society as long as the business acts in such a way as to be deserving of that licence. Accordingly, businesses need to
be aware of the norms (including ethical norms) in society so that they can continually adapt to them. If an
organisation acts in a way that society finds unacceptable, the licence to operate can be withdrawn by society, as was
the case with Arthur Andersen after the collapse of Enron.
Social ecologists
Social ecologists go a stage further than the social contractarians in recognising that (regardless of the views of
society), business has a social and environmental footprint and therefore bears some responsibility in minimising the
footprint it creates. An organisation might adopt socially and/or environmentally responsible policies not because it
has to in order to be aligned with the norms of society (as the social contractarians would say) but because it feels it
has a responsibility to do so.
Socialists
In the context of this argument, socialists are those that see the actions of business as those of a capitalist class
subjugating, manipulating, and even oppressing other classes of people. Business is a concentrator of wealth in
society (not a redistributor) and so the task of business, social, and environmental responsibility is very large – much
more so than merely adopting token policies (as socialists would see them) that still maintain the supremacy of the
capitalist classes. Business should be conducted in a very different way – one that recognises and redresses the
imbalances in society and provides benefits to stakeholders well beyond the owners of capital.

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Radical feminists
Like the socialists, radical feminists (not to be confused with militants, but rather with a school of philosophy) also
seek a significant re adjustment in the ownership and structure of society. They argue that society and business are
based on values that are usually considered masculine in nature such as aggression, power, assertiveness, hierarchy,
domination, and competitiveness. It is these emphases, they argue, that have got society and environment in the
‘mess’ that some people say they are in. It would be better, they argue, if society and business were based instead on
values such as connectedness, equality, dialogue, compassion, fairness, and mercy (traditionally seen as feminine
characteristics). This would clearly represent a major challenge to the way business is done all over the world and
hence would require a complete change in business and social culture. This theory relates to Hofstede’s ‘cultural
dimensions’ introduced in the Paper F1 syllabus.
Deep ecologists
Finally, the deep ecologists (or deep greens) are the most extreme position of coherence on the continuum. Strongly
believing that humans have no more intrinsic right to exist than any other species, they argue that just because
humans are able to control and subjugate social and environmental systems does not mean that they should. The
world’s ecosystems of flora and fauna, the delicate balances of species and systems are so valuable and fragile that it
is immoral for these to be damaged simply (as they would see it) for the purpose of human economic growth.
There is (they argue) something so wrong with existing economic systems that they cannot be repaired as they are
based on completely perverted values. A full recognition of each stakeholders’ claim would not allow business to
continue as it currently does and this is in alignment with the overall objectives of the deep ecologists or deep greens.
The audit committee is one of the vital parts of the committee structure of sound corporate governance. Its role in
overseeing IA is important because it is the audit committee that ensures that the IA function actually supports the
strategic objectives of the company (and doesn’t act purely on its own initiative). In addition, though, it is likely that
the audit committee – at the strategic level – will not only provide the IA function with the authority it needs to
scrutinise the internal controls, but also to ensure that its work is actually supporting and providing the compliance
needs of the company. It is part of ensuring the hierarchical congruence or consistency necessary in sound
governance and strategic management.
Members of the IA function may encounter ethical threats (such as familiarity, self review, independence threats, and
so on). An accountant working as an internal auditor, for example, may be unwilling to criticise the CFO if he
believes the CFO has an influence on his future prospects with the company. Someone coming into IA from an
operational position could also be exposed to a self-review threat. Even where external contractors are used to carry
out the IA function, they are acting on behalf of management. To avoid this, and other ethical threats, internal audit
work is one of the jobs expressly forbidden to external auditors under the terms of the Sarbanes–Oxley Act in the
US, indicating just how valuable a characteristic independence is for all auditors (other codes have similar
provisions).
There are some inherent limitations in what an IA department can achieve. Although corporate scandals sometimes
arise from failings in operational level controls, there are also examples where the problem is a failure of strategic
level controls, either arising from management override of controls (as at Enron) or through poor strategic level
decisions (as at some of the banks that required state support in the 2008 banking crisis). Even in companies where
excellent procedures are put in place to assess operational level controls, it is hard to imagine how IA can fully
monitor strategic controls. It would be very hard to design a corporate governance structure in which even the most
independent IA department had a mechanism to do much more than check that procedures have been followed at
board level. The board ultimately has to be responsible for the proper working of strategic level controls. This is also
illustrative of the way IA fits in to overall corporate governance. The corporate governance big picture has to be
addressed if IA is going to be effective. A domineering CEO cannot be countered by the existence of an IA
department. Indeed, interference in the work of internal audit would indicate broader corporate governance problems.
Conclusion
The issue of stakeholders lies at the heart of most discussions of ethics, and, accordingly, is very important for the
Strategic Business Leader (SBL) exam. Being able to identify the stakeholders mentioned in a case scenario, and
describing their individual claims upon an organisation, is likely to be an important skill for SBL candidates to
develop.
In addition, being able to identify the ethical viewpoints of people in a case scenario, perhaps with regard to
stakeholder/ stockholder perspectives, or using Gray, Owen and Adams’s positions, is also important. The various
ways of categorising stakeholders is helpful for any stakeholder analysis but a general appreciation that business
decisions are affected by and can affect many people and groups both inside and outside of the business itself, is

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fundamental to an understanding of the importance of stakeholders.
Big data
This article defines what exactly ‘big data’ is, how it can be used to inform and implement business strategy and
examples of how it is being used by different industries today.
 Introduction
 Volume
 Variety
 Velocity
 Other examples of the use of big data
 Dangers of big data
Introduction
Big data is part of the Strategic Business Leader (SBL) syllabus:
D2. Discuss how big data can be used to inform and implement business strategy.
There are many definitions of the term ‘big data’ but most suggest something like the following:
'Extremely large collections of data (data sets) that may be analysed to reveal patterns, trends, and associations,
especially relating to human behaviour and interactions.'
In addition, many definitions also state that the data sets are so large that conventional methods of storing and
processing the data will not work.
In 2001 Doug Laney, an analyst with Gartner (a large US IT consultancy company) stated that big data has the
following characteristics, known as the 3Vs:
 Volume
 Variety
 Velocity
These characteristics, and sometimes additional ones, have been generally adopted as the essential qualities of big
data.
The
3Vs: characteristics of big data
The commonest fourth 'V' that is sometimes added is:
Veracity – is the data true and can its accuracy be relied upon?
Volume
The volume of big data held by large companies such as Walmart (supermarkets), Apple and EBay is measured in
multiple petabytes. What is a petabyte? It’s 10 15 bytes (characters) of information. A typical disc on a personal
computer (PC) holds 109 bytes (a gigabyte), so the big data depositories of these companies hold at least the data that
could typically be held on 1 million PCs, perhaps even 10 to 20 million PCs.
These numbers probably mean little even when converted into equivalent PCs. It is more instructive to list some of
the types of data that large companies will typically store.
Retailers
Via loyalty cards being swiped at checkouts: details of all purchases you make, when, where, how you pay, use of
coupons.

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Via websites: every product you have every looked at, every page you have visited, every product you have ever
bought.
Social media (such as Facebook and Twitter)
Friends and contacts, postings made, your location when postings are made, photographs (that can be scanned for
identification), any other data you might choose to reveal to the universe.
Mobile phone companies
Numbers you ring, texts you send (which can be automatically scanned for key words), every location your phone
has ever been whilst switched on (to an accuracy of a few metres), your browsing habits. Voice mails.
Internet providers and browser providers
Every site and every page you visit. Information about all downloads and all emails (again these are routinely
scanned to provide insights into your interests). Search terms which you enter.
Banking systems
Every receipt, payment, credit card information (amount, date, retailer, location), location of ATM machines used.
Variety
Some of the variety of information can be seen from the examples listed above. In particular, the following types of
information are held:
 Browsing activities: sites, pages visited, membership of sites, downloads, searches
 Financial transactions
 Interests
 Buying habits
 Reaction to advertisements on the internet or to advertising emails
 Geographical information
 Information about social and business contacts
 Text
 Numerical information
 Graphical information (such as photographs)
 Oral information (such as voice mails)
 Technical information, such as jet engine vibration and temperature analysis
This data can be both structured and unstructured:
Structured data: this data is stored within defined fields (numerical, text, date etc) often with defined lengths,
within a defined record, in a file of similar records. Structured data requires a model of the types and format of
business data that will be recorded and how the data will be stored, processed and accessed. This is called a data
model. Designing the model defines and limits the data which can be collected and stored, and the processing that
can be performed on it.
An example of structured data is found in banking systems, which record the receipts and payments from your
current account: date, amount, receipt/payment, short explanations such as payee or source of the money.
Structured data is easily accessible by well-established database structured query languages.

Unstructured data: refers to information that does not have a pre-defined data-model. It comes in all shapes and
sizes and it is this variety and irregularity which makes it difficult to store in a way that will allow it to be analysed,
searched or otherwise used. An often quoted statistic is that 80% of business data is unstructured, residing it in word
processor documents, spreadsheets, powerpoint files, audio, video, social media interactions and map data.
Here is an example of unstructured data and an example of its use in a retail environment:
You enter a large store and have your mobile phone with you. That allows your movement round the store to be
tracked. The store might or might not know who you are (depending on whether it knows your mobile phone
number). The store can record what departments you visit, and how long you spend in each. Security cameras in the
ceiling match up your image with the phone, so now they know what you look like and would be able to recognise
you on future visits. You pass near a particular product and previous records show that you had looked at that
product before, so a text message can be sent perhaps reminding you about it, or advertising a 10% price reduction.
Perhaps the store has a marketing campaign that states that it will never be undersold, so when you pass near
products you might be making a price comparison and the store has to check prices on other stores websites and

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message you with a new price. If you buy the product then the store might have further marketing opportunities for
related products and consumables and this data has to be recorded also. You pay with an affinity credit card (a card
with associations with another organisations such as a charity or an airline), so now the store has some insight into
your interests. Perhaps you buy several products and the store will want to discover if these items are generally
bought together.
So just walking round a store can generate a vast quantity of data which will be very different in size and nature for
every individual.
Velocity
Information must be provided quickly enough to be of use in decision making. For example, in the above store
scenario, there would be little use in obtaining the price-comparison information and texting customers once they had
left the store. If facial recognition is going to be used by shops and hotels, it has to be more or less instant so that
guests can be welcomed by name.
You will understand that the volume and variety conspire against velocity and, so, methods have to be found to
process huge quantities of non-uniform, awkward data in real-time.
Software for big data
Without getting too technical on this issue, a library of software known as Apache Hadoop is specifically designed
to allow for the distributed processing of large data sets (ie big data) across clusters of computers using simple
programming models. (Clusters of computers are needed to hold the vast volume of information.) Hadoop IT is
designed to scale up from single servers to thousands of machines, each offering local computation and storage.
The processing of big data is generally known as big data analytics and includes:
 Data mining: analysing data to identify patterns and establish relationships such as associations (where
several events are connected), sequences (where one event leads to another) and correlations.
 Predictive analytics: a type of data mining which aims to predict future events. For example, the chance of
someone being persuaded to upgrade a flight.
 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: as above but with audio.
 Statistical analytics: used to identify trends, correlations and changes in behaviour.
Google provides website owners with Google Analytics that will track many features of website traffic. For example,
the website OpenTuition.com provides free ACCA study resources. Google analytics reports statistics such as the
following:
Geograp
hical distribution of users

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Type
of browser used
Age
of user
The final table is instructive. OpenTuition.com does not ask for users’ ages, so this data has been pieced together
from other information available to Google. It has been able to do this for only about 58% of users.
The analytical findings can lead to:
 better marketing
 better customer service and relationship management
 increased customer loyalty
 increased competitive strength
 increased operational efficiency

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 the discovery of new sources of revenue.
Other examples of the use of big data

Netflix: this company began as a DVD mailing service and developed algorithms to help it to predict viewers’
preferences and habits. Now it delivers films over the internet and can easily collect information about when movies
are watched, how often films might be stopped and restarted, where they might be abandoned, and how users rate
films. This allows Netflix to predict which films will be popular with which customers. It is also being used by
Netflix to produce its own TV series, with much greater assurance that these will be hits.
Amazon: the world’s leading e-retailer collects huge amounts of information about customers’ preferences and
habits which allow it to market very accurately to each customer. For example, it routinely makes recommendations
to customers based on books or DVDs previously purchased.
Airlines: they know where you’ve flown, preferred seats, cabin class, when you fly, how often you search for a
flight before booking, how susceptible you are to price reductions, probably which airline you might book with
instead, whether you are returning with them but didn’t fly out with them, whether car hire was purchased last time,
what class of hotel you might book through their site, which routes are growing in popularity, seasonality of routes.
They also know the profitability of each customer so that, for example, if a flight is cancelled they can help the most
valuable customers first.
This information allows airlines to design new routes and timings, match routes to planes and also to make
individualised offers to each potential passenger.
Disease epidemic identification: in 2009, Google was able to track the spread of influenza across the USA faster
than the government’s Center for Disease Control and Prevention. How? They monitored users entering terms like
‘Flu symptoms’, ‘Flu remedies’, High temperature’. This connection was uncovered by web analytics looking at
popular search terms then finding a correlation with other information confirming influenza infections. Of course,
you have to be careful drawing conclusions about correlations: the association between the use of search terms and
the outbreak of flu might be driven by news articles on the spread of the epidemic rather than the epidemic itself.
Target: Target is the second largest discount retailer in the USA. There is an often quoted story about their ability to
predict when a customer is pregnant – frequently before the customer has informed her family. By looking at about
25 products it is claimed that they can create a pregnancy predictor. For example, early pregnancy often causes
morning sickness so consumers would perhaps change to blander food and less perfumed shower gel. Why would
Target be interested in knowing whether a consumer is pregnant? Well that person will require different products
during the pregnancy then in a few months the baby will have its own product needs: nappies, baby shampoo and
clothes. Early identification of pregnancy can allow Target to establish the shopping habits of the mother and
perhaps even the preferences of the child.
Dangers of big data
Despite the examples of the use of big data in commerce, particularly for marketing and customer relationship
management, there are some potential dangers and drawbacks.
Cost: It is expensive to establish the hardware and analytical software needed, though these costs are continually
falling.
Regulation: Some countries and cultures worry about the amount of information that is being collected and have
passed laws governing its collection, storage and use. Breaking a law can have serious reputational and punitive
consequences.
Loss and theft of data: Apart from the consequences arising from regulatory breaches as mentioned above,
companies might find themselves open to civil legal action if data were stolen and individuals suffered as a
consequence.
Incorrect data (veracity): If the data held is incorrect or out of date incorrect conclusions are likely. Even if the data
is correct, some correlations might be spurious leading to false positive results.
Employee monitoring: data collection methods allow employees to be monitored in detail every second of the day.
Some companies place sensors in name badges so that employee movements and interactions at work can be
monitored. The badged monitor to whom each employee talks and in what tone of voice. Stress levels can be
measured from voice analysis also. Obviously, this information could be used to reduce stress levels and to facilitate
better interactions but you will easily see how it could easily be used to put employees under severe pressure.

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Adapted from an article originally written by Ken Garrett (a freelance lecturer and writer)
Corporate governance from the inside out

This article explains that effective corporate governance has both internal and external drivers.
 Introduction
 Agency theory
 The stewardship concept
 The separation of ownership and control
 The legal and professional framework
 Corporate governance
 Principles or rules-based codes of corporate governance
 Corporate governance and cultural values
 Conclusion
Introduction
Although directors and managers of companies may have little influence over the external regulatory framework,
they can and must play their part in ensuring effective internal governance and compliance from deep within their
own organisations.
This should extend beyond external financial reporting and corporate governance structures into more operational
areas of business management. By promoting deep-rooted corporate governance ideals within their own
organisations, a culture of stakeholder focus and individual and corporate responsibility, for the common good, can
flourish.
This article first briefly introduces agency theory and the agency problem, which recognises that the interests of the
shareholders and of the board of directors may sometimes conflict and how issues relating to this problem brought
about the need for corporate governance codes in the first place. It then examines the traditional stewardship concept
that underlies conventional corporate governance within an external financial reporting framework.
The article then compares ‘rules’ versus ‘principles’ based codes and the implementation of governance within
organisations. It argues that a broader and longer-term view of agency theory, such as applies to a wider group of
stakeholders can engender a better team spirit that will help promote a culture of pro-stakeholder behaviour and
positive attitudes at all levels of the organisation. The important links between corporate governance and corporate
culture and values are also highlighted.
Agency theory
Under the narrowest of perspectives the principal objective of a company has traditionally been to maximise profits
and thereby add to the wealth of its shareholders. However, the degree to which the pursuit of profit and wealth
dominates depends upon the society's view of ‘agency theory’. The questions to ask are; who discharges
responsibility; who is accountable and what particular structure of relationships and potential conflicts exist between
‘principals’ and their ‘agents’.
In business the stakeholder is known as the ‘principal’ and the officers of the company or the directors are known as
the ‘agents’. The extent to which boards of directors act in the interests of shareholders and in the pursuit of fiduciary
interests such as wealth maximisation is determined by which of the seven perspectives is taken on corporate social
responsibility; Gray, Owen and Adams (1996).
The stewardship concept

Generally it is accepted that the rights of shareholders and other stakeholders connected with the company should be
protected and promoted by ‘stewards’ of these stakeholders and their interests, Argenti (1997) and Campbell (1997).
In theory, agents should be held responsible and accountable for balancing the conflicting interests of a whole range
of stakeholders of the company.
The traditional ‘pristine capitalist’ view of ‘stewardship’ implies that the rights of the shareholders and the pursuit of
their wealth are of paramount importance (Sternberg 1998). However, the banking crisis and spectacular corporate
failures such as Enron and World Com would indicate that even the narrower interests of owners can often be
neglected or ignored, along with those of a much wider group of stakeholders, including the general public.
The separation of ownership and control

The introduction of the limited company as a legal entity was a great advance from the private solely owned business
or the partnership in that it greatly increased the supply of long-term funds to industry and commerce, and
contributed to the creation of far more wealth within the global economy. The concepts of shareholdings and limited
liability encouraged many more people of moderate means to invest their disposable income in businesses and at

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much lower risk than would hitherto have been possible within unincorporated organisations. With many more
investors, many of whom have little or no business acumen, came the need to divorce ownership and control for
practical purposes, and to introduce a ‘court’ or board of directors, as the ‘agents’ of this disparate group. This is the
basis of what became the public limited company, a separation of ownership and control. This is a normal
arrangement these days and it is hardly ever questioned.
‘The trade of a joint stock company is always managed by a court of directors. This court, indeed, is frequently
subject, in many respects, to the control of a general court of proprietors. But the greater part of those proprietors
seldom pretend to understand anything of the business of a company…’
Adam Smith (1776), p408
The separation of ownership and control, and the disparity and inexperience of shareholders in business and financial
matters, as Adam Smith recognised, would be problematic unless some system of external governance was imposed
to safeguard the interests of these owners. The separation of ownership and control, and the potential divergence of
the interests of owners and managers, is the main reason why there is a need for a system of corporate governance.
Adam Smith also recognised the problem of the separation of control and ownership interests within companies:
‘….The directors of such companies, however, being the managers rather of other peoples money rather than their
own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the
partners in a private copartnery frequently watch over their own…. Negligence and profusion, therefore, must
always prevail, more or less, in the management of the affairs of such a company’
Adam Smith (1776), p408
Clearly it was recognised as long ago as 1776 that the ‘agency’ model within the corporate context would not
naturally work to the advantage of the principals without some intervention.
The legal and professional framework

Successive Companies Acts throughout the world from 1844 in the UK, have laid down increasingly complex layers
of legislation about the constitution, the format, the minimum disclosure requirements, about the use of reserves, the
maintenance of capital, and the general protection of creditors. In addition there has been a legal requirement for an
‘independent’ external audit of the financial disclosures of a company’s affairs on a periodic basis to be carried out
by competent and qualified professionals.
One of the major responsibilities of company directors is to ensure that the financial reports of companies are
relevant and faithfully represent the affairs of the company and that stakeholders can make rational decisions based
on the qualitative characteristics of the reports that are published (they are a ‘true and fair’ representation of the state
of the company’s finances at a given point in time). Auditing is mainly concerned with the faithful representation
aspect of financial information.
Companies in most countries are by law required to have their accounts audited at the end of every financial period.
A major aspect of most external corporate governance codes is about ensuring that the role of the auditor is effective
and the relationship between the auditors and directors has integrity and is independent and objective. The issues to
consider here are who should appoint the auditors, how long should the same firm of auditors be used repeatedly, and
should firms of auditors, or even their subsidiaries or associates be providing consulting services to their clients?
Corporate governance
Corporate governance can be seen as having internal and external sources, where external corporate governance
consists of mandatory and voluntary codes, reports and frameworks such as company law, stock market listing rules
and accounting and auditing standards. Internal corporate governance is how such external governance is complied
with and embedded within the culture and values of the organisation and how sound governance is implemented and
works in practice.
The corporate governance framework can play its part in providing a structure for governing the behaviour of
companies and their officers, but external rules, regulations, and codes of practice are not effective unless a climate
of compliance within organisations is promoted to support such structures and mechanisms at all levels through such
mechanisms as corporate and ethical codes of behaviour and values. There also needs to be a deeper culture
embedded within companies, recognising the responsibilities and duties of management with regard to the legitimate
rights of their stakeholders and shareholders.
Effective corporate governance is about promoting this climate of transparency, scepticism and objectivity; by
creating systems, procedures, and internal structures, aimed at complying with external requirements, but also pre-
empting and dissuading anti-stakeholder behaviour from deep within the organisation. Internal corporate governance
(or the corporate culture) should therefore be instrumental in reducing the ‘expectations gap’ between the interests

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and motivations of the ‘agent’ and those of the ‘principal’; thereby addressing the agency problem at all levels within
the organisation.
Principles or rules-based codes of corporate governance

Corporate governance structures can be voluntarily complied with and any departures from best practice can be
explained in the notes to the accounts. The main benefit of this ‘principles based’ approach is that full compliance is
often difficult for companies in specific situations or in special circumstances. ‘Rules-based’ compliance is a ‘one
size fits all’ (box ticking) approach where full compliance is required by law and where departures can entail legal
sanctions. This approach, such as adopted in the USA, is felt to be more effective because it doesn’t rely as heavily
on the integrity of the boards of directors to interpret and comply or explain openly and objectively.
Corporate governance is based on voluntary control in many countries, such as in the UK and is often a requirement
for stock exchange listing. It is based on the adoption of specific board sub-committees and structures with clear
recommendations relating to sound internal financial and operational controls and the promotion of high quality
financial information to strengthen the accountability of boards of directors to their shareholders.
The Cadbury Code, (1992) was designed to concentrate on the essential internal control mechanisms to support this
need for greater transparency and accountability to shareholders, which at the time was felt to be deficient. This
voluntary report highlighted the ways in which companies could better underpin a company’s legal and regulatory
obligations to its shareholders through accountability and control, viewing the role of the non-executive director
(NED) as being critical from an independence perspective.
The recommendations of the Cadbury Report emphasised higher standards of corporate governance through
improvements in the quality of financial reporting. This aspect has also been supported by accounting standards
bodies nationally and internationally, striving to provide more consistency, relevance, and understandability within
the process of accounting for financial transactions and for reporting income, assets and liabilities. The Cadbury
report (1992) and others, were eventually enforced as listing rules on many stock exchanges.
The Cadbury Report recommended that external auditing should be more independent and closely monitored through
the introduction of audit committees composed of a minimum number of non-executive directors (NEDs). However,
where corporate governance was to have most impact was through the introduction of robust internal control
mechanisms and a system of internal audit where the design and control of processes and continuous monitoring of
transactions and decision-making can help safeguard assets and prevent and detect anti-stakeholder behaviour within
the organisation. The concept of internal control was to be based on promoting continuous vigilance by management
in preventing financial loss through fraud, error, inefficiency or incompetence.
There are many corporate governance codes, published around the world focusing on such matters as the role of the
boards of directors and on how they are constituted. These include various recommendations on the procedures to
appoint directors, the qualifications of directors, the proportion and independence and effectiveness of non-executive
directors (Higgs 2003) and their diversity (Tyson 2003), and on the need for additional and independent board
committees such as audit (Smith 2008), nomination, risk and remuneration committees. Indeed many corporate
scandals (pre-Enron) tended to revolve around inappropriate or unjustified pay increases or bonuses for executives,
seemingly regardless of performance, leading to so called ‘fat cat’ scandals. Both the Greenbury Report (1995), and
the Hampel Report (1998), have focused their attention on directors' remuneration, rather than upon broader and
more significant financial, performance or governance issues, because it was seen as being such a problem.
The main recommendations of the above committees were subsequently incorporated by the Turnbull Committee
into the original Combined Code of the Committee on Corporate Governance in 1999, but this code also emphasised
the broader responsibility of companies with respect to safeguarding shareholders’ interests.
‘The board should maintain a sound system of internal control to safeguard shareholders' investment and the
company's assets’
Principle D.2 – Combined Code May 1999
The combined code has been revised since 1999, and in 2010 it included several new recommendations. Eventually
various versions of the UK Corporate Governance Code were published (FRC, 2014). These various iterations of the
combined codes include the requirement for the company chairman to be re-elected annually and to encourage
greater diversity (specifically gender diversity) of the board. The revised code also requires more emphasis on the
board of directors’ performance in the larger companies being independently reviewed on a regular basis. It requires
disclosure of the business model and responsibilities relating to risk; such as how much risk the company can accept
and how much it will need to avoid, reduce or transfer. These new requirements link well with new proposals for a
broader corporate reporting framework relating to integrated reporting <IR> (IIRC, 2013).

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The revised combined code also makes new recommendations about the need to align remuneration of directors to
longer-term performance metrics and having a closer interface between non-executive directors and the executive
directors. The changes also include the chairman’s responsibility relating to identifying the training and development
needs of directors and around more effective external communications with shareholders, including institutional
investors.
More effective company law, listing rules, regulations, accounting and auditing standards and corporate governance
codes have clearly provided a better structure and basis for the governance of companies' behaviour in relation to the
original agency problem. Whether these governance structures are principles or rules-based, the essential agency
problem still seems to remain, as highlighted by continuing evidence of director failings and further corporate
failures.
Reliance on voluntary codes, professional standards, and even on legislation may not provide an adequate safeguard
against governance failure unless boards of directors, on behalf of stakeholders, set a clear ‘tone from the top’ and
actively create a culture of transparency, honesty, and integrity within their organisations at all levels.
Corporate governance and cultural values

For corporate governance to be effective and for the interests of stakeholders to be properly safeguarded, a climate
should be created where those working for the stakeholders and on behalf of them, are conscious of the ultimate
economic, social and ethical consequences of their decisions and behaviour (at whatever level).
Directors should therefore promulgate and inculcate within their organisations a climate of responsibility,
accountability, and transparency. This can be achieved by the use of formal structures such as audit and remuneration
committees, by appointing effective and independent non-executive directors, and by tightening up on auditing
regulations, but it is mainly achieved by having a sustainable, longer-term and broader perspective and by
encouraging all to act ethically.
Companies can encourage such behaviour by designing appropriate corporate codes of ethics and behaviour within
organisations, supported by a system of cultural values which are themselves linked to individual performance
appraisal and professional development.
For example, promoting consonance between the aims of primary stakeholders and those of other stakeholders can
create a team spirit where all perceive they are working for a common purpose or goal. This common purpose can
also be reinforced by having a clear corporate mission and setting strategic aims and objectives which are coherent
and sustainable and which can be broken down into meaningful and measurable departmental and team objectives
that all within the organisation can buy into and relate to.
This kind of climate is promoted by such instruments as:
 equitable productivity and bonus schemes
 transparent recruitment and promotion policies
 good staff welfare and reward systems
 effective environmental policies, and
 good customer relations.
All of these are based on an overriding quality culture, where effectiveness and efficiency are promoted and every
aspect of the organisations activities are considered to be important at all levels, where people of all levels are valued
and respected and where the impact of all decisions on the interests of stakeholders is always recognised and
anticipated.
Good governance therefore must, by implication, extend beyond basic compliance with external reporting and
auditing requirements, to such areas as internal control, performance measurement and management, budgetary
control systems, quality management, staff recruitment, training and development, and to reward and promotion
systems within a business organisation.
Conclusion
A business that embraces the underlying principles as well as ‘being seen’ to be compliant with corporate
governance codes is better placed to protect the interests of its stakeholders, including the public interest, from a
more sustainable and longer-term perspective.
This wider view of agency theory is in stark contrast to the narrower ‘stewardship’ perspective, but whichever
perspective is taken, corporate governance and all it entails is an essential framework within which the rights,
responsibilities, and rewards available to the principals and their agents is best balanced.

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The development of an informal corporate culture and of ethical values to underpin and support formal corporate
governance structures is essential. This approach reduces the risk of negative behaviours such as, wastefulness,
inefficiency, idleness, greed, fraud, deception, bribery or theft occurring or being tolerated.
Such a business culture can sustainably meet and balance the needs of shareholders, lenders, employees, suppliers,
customers, and the general public, recognising their respective interests as being entirely compatible over the longer
term.
This balance can only be realistically achieved if effective acceptance of corporate social responsibility, rather than
compliance with governance structures alone, becomes part of the ‘mindset’ of all those working in business
organisations; so that accountability and responsibility to all stakeholders is delivered from the inside out.
COSO's enterprise risk management framework

This article examines the guidance published by the Committee of Sponsoring Organisations (COSO).
 COSO
 The ERM model
 Internal environment
 Objective setting
 Event identification
 Risk assessment
 Risk response
 Control activities
 Information and communication
 Monitoring
COSO
The Committee of Sponsoring Organisations (COSO) was established in the mid-1980s, initially to sponsor research
into the causes of fraudulent financial reporting. Its current mission is to: ‘provide thought leadership through the
development of comprehensive frameworks and guidance on enterprise risk management, internal control and fraud
deterrence designed to improve organisational performance and governance and to reduce the extent of fraud in
organisations.’
Although COSO’s guidance is non-mandatory, it has been influential because it provides frameworks against which
risk management and internal control systems can be assessed and improved. Corporate scandals, arising in
companies where risk management and internal control were deficient, and attempts to regulate corporate behaviour
as a result of these scandals have resulted in an environment where guidance on best practice in risk management and
internal control has been particularly welcome.
The ERM model

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The ERM model

COSO’s enterprise risk management (ERM) model has become a widely-accepted framework for organisations to
use. Although it has attracted criticisms, the framework has been established as a model that can be used in different
environments worldwide.
COSO’s guidance illustrated the ERM model in the form of a cube. COSO intended the cube to illustrate the links
between objectives that are shown on the top and the eight components shown on the front, which represent what is
needed to achieve the objectives. The third dimension represents the organisation’s units, which portrays the
model’s ability to focus on parts of the organisation as well as the whole.
This article highlights a number of issues under each of the eight components listed on the front of the cube that
organisations have had to tackle – issues which can be featured in exam questions for the Strategic Business Leader
(SBL) exam, relating to sections B1 and F1 of the syllabus.
Internal environment
The internal environment establishes the tone of the organisation, influencing risk appetite, attitudes towards risk
management and ethical values.
Ultimately, the company’s tone is set by the board. An unbalanced board, lacking appropriate technical knowledge
and experience, diversity and strong, independent voices is unlikely to set the right tone. The work directors do in
board committees can also make a significant contribution to tone, with the operation of the audit and risk
committees being particularly important.
However, the virtuous example set by board members may be undermined by a failure of management in divisions or
business units. Mechanisms to control line management may not be sufficient or may not be operated correctly. Line
managers may not be aware of their responsibilities or may fail to exercise them properly. For example, they may
tolerate staff ignoring controls or emphasise achievement of results over responsible handling of risks.
One criticism of the ERM model has been that it starts at the wrong place. It begins with the internal and not the
external environment. Critics claim that it does not reflect sufficiently the impact of the competitive environment,
regulation and external stakeholders on risk appetite and management and culture.
Objective setting
The board should set objectives that support the organisation’s mission and which are consistent with its risk
appetite.
If the board is to set objectives effectively, it needs to be aware of the risks arising if different objectives are pursued.
Entrepreneurial risks are risks that arise from carrying out business activities, such as the risks arising from a major
business investment or competitor activities.
The board also needs to consider risk appetite and take a high-level view of how much risk it is willing to accept.
Risk tolerance – the acceptable variation around individual objectives – should be aligned with risk appetite.
One thing the board should consider is how certain aspects of the control systems can be used for strategic purposes.
For example, a code of ethics can be used as an important part of the organisation’s positioning as socially
responsible. However, the business framework chosen can be used to obscure illegal or unethical objectives. For

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example, the problems at Enron were obscured by a complex structure and a business model that was difficult to
understand.
Event identification
The organisation must identify internal and external events that affect the achievement of its objectives.
The COSO guidance draws a distinction between events having a negative impact that represent risks and events
having a positive impact that are opportunities, which should feed back to strategy setting.
Some organisations may lack a process for event identification in important areas. There may be a culture of no-one
expecting anything to go wrong.
The distinction between strategic and operational risks is also important here. Organisations must pay attention both
to occurrences that could disrupt operations and also dangers to the achievement of strategic objectives. An
excessive focus on internal factors, for which the model has been criticised, could result in a concentration on
operational risks and a failure to analyse strategic dangers sufficiently.
Businesses must also have processes in place to identify the risks arising from one-off events and more gradual
trends that could result in changes in risk. Often one-off events with significant risk consequences can be fairly easy
to identify – for example, a major business acquisition. The ERM has been criticised for discussing risks primarily in
terms of events, particularly sudden events with major consequences. Critics claim that the guidance insufficiently
emphasises slow changes that can give rise to important risks – for example, changes in internal culture or market
sentiment.
Organisations should carry out analysis to identify potential events, but it will also be important to identify and
respond to signs of danger as soon as they arise. For example, quick responses to product failure may be vital in
ensuring that lost sales and threats to reputation are minimised.
Risk assessment
The likelihood and impact of risks are assessed, as a basis for determining how to manage them.
As well as mapping the likelihood and impact of individual risks, managers also need to consider how individual
risks interrelate. The COSO guidance stresses the importance of employing a combination of qualitative and
quantitative risk assessment methodologies. As well as assessing inherent risk levels, the organisation should also
assess residual risks left after risk management actions have been taken.
The ERM model has, though, been criticised for encouraging an over-simplified approach to risk assessment. It’s
claimed that it encourages an approach that views the materialisation of risk as a single outcome. This outcome could
be an expected outcome or it could be a worst-case result. Many risks will have a range of possible outcomes if they
materialise – for example, extreme weather – and risk assessment needs to consider this range.
Risk response
Management selects appropriate actions to align risks with risk tolerance and risk appetite.
This stage can be seen in terms of the four main responses – reduce, accept, transfer or avoid. However risks may
end up being treated in isolation without considering the picture for the organisation as a whole. Portfolio
management and diversification will be best implemented at the organisational level and the COSO guidance stresses
the importance of taking a portfolio view of risk.
The risk responses chosen must be realistic, taking into account the costs of responding as well as the impact on risk.
An organisation’s environment will affect its risk responses. Highly regulated organisations, for example, will have
more complex risk responses and controls than less regulated organisations. The ALARP principle – as low as
reasonably practicable – has become important here, particularly in sectors where health or safety risks are
potentially serious, but are unavoidable.
Part of the risk response stage will be designing a sound system of internal controls. COSO guidance suggests that a
mix of controls will be appropriate, including prevention and detection and manual and automated controls.
Control activities
Policies and procedures should operate to ensure that risk responses are effective.
Once designed, the controls in place need to operate properly. COSO has supplemented the ERM model by guidance
in ‘Internal Control – Integrated Framework’. The latest draft of this framework was published in December 2011. It
stresses that control activities are a means to an end and are effected by people. The guidance states: ‘It is not merely
about policy manuals, systems and forms but people at every level of an organisation that impact on internal control.’

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Because the human element is so important, it follows that many of the reasons why controls fail is because of
problems with how managers and staff utilise controls. These include failing to operate controls because they are not
taken seriously, mistakes, collusion between staff or management telling staff to over-ride controls. The COSO
guidance therefore stresses the importance of segregation of duties, to reduce the possibility of a single person being
able to act fraudulently and to increase the possibility of errors being found.
The guidance also stresses the need for controls to be performed across all levels of the organisation, at different
stages within business processes and over the technology environment.
Information and communication

Information systems should ensure that data is identified, captured and communicated in a format and timeframe that
enables managers and staff to carry out their responsibilities.
The information provided to management needs to be relevant and of appropriate quality. It also must cover all the
objectives shown on the top of the cube.
There needs to be communication with staff. Communication of risk areas that are relevant to what staff do is an
important means of strengthening the internal environment by embedding risk awareness in staff’s thinking.
As with other controls, a failure to take provision of information and communication seriously can have adverse
consequences. For example, management may not insist on a business unit providing the required information if that
business unit appears to be performing well. Also, if there is a system of reporting by exception, what is important
enough to be reported will be left to the judgment of operational managers who may be disinclined to report
problems. Senior management may not learn about potential problems in time.
Monitoring
The management system should be monitored and modified if necessary.
Guidance on monitoring has developed significantly since the initial COSO guidance. At board level, the Turnbull
guidance on the scope of regular and annual review of risk management has been very important.
COSO supplemented its ERM guidance with specific guidance on monitoring internal controls in 2009, based on the
principle that unmonitored controls tend to deteriorate over time. The guidance echoes the Turnbull guidance in
drawing a distinction between regular review (ongoing monitoring) and periodic review (separate evaluation).
However weaknesses are identified, the guidance stresses the importance of feedback and action. Weaknesses should
be reported, assessed and their root causes corrected.
Key players in the separate evaluation are the audit committee and internal audit department. Whether separate
monitoring can be carried out effectively without an internal audit department should be a key question considered
when deciding whether to establish an internal audit function. Once an organisation goes beyond a certain level of
size and complexity, it becomes difficult to believe that an internal audit function will not be required.
The ERM model has provided a foundation for organisations to manage risks more effectively. However, managers
need an awareness of the limitations of risk management and where the process could fail. Paper P1 questions have
concentrated on organisations that have had serious shortcomings, as there is usually not enough to discuss about an
organisation that is perfect!
Culture and configuration

This article focuses on two areas of the SBL syllabus on preparing and evaluating a cultural web of an organisation,
and the importance of organisational structure and configuration.
 Knowledge brought forward from the Accounting in Business (AB) exam
 Specific Strategic Business Leader matters
 Interaction of configuration and cultures
 Application of culture and organisational configuration to scenarios
 Conclusion
Knowledge brought forward from the Accounting in Business (AB) exam
In the ACCA Qualification, organisational culture and structure first arise in the Accountant in Business (AB) exam.
Organisational culture was described by Handy as ‘the way we do things round here’. Most of us are very sensitive
to organisational culture and tread warily when joining a new school, college or employer: we want to see ‘how they
do things round there’.

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With regard to organisational culture, the work of three academics is mentioned:

(1) Handy’s four cultural stereotypes. These are:
 Power culture. Here, power is concentrated in the hands of one person, ‘the boss’. This culture is often
found in small, family businesses, particularly where the name of the business is the same as the name of the boss.
Fast – but perhaps arbitrary – decisions can be made. As businesses grow, it becomes more difficult for one person to
wield absolute power simply because of the demands on their time and ability. However, it is sometimes seen in
large organisations, but then it is usually taken as a danger sign, and many of the corporate governance rules are
there specifically to spread power and reduce risks. For example, splitting the roles of chief executive and chairman,
holding regular board meetings to encourage collective responsibility, and balancing executive and non-executive
directors.
 Role culture. This is characterised by a traditional organisational structure in which jobs are arranged by
function and seniority, and each employee has a distinct role and job specification. This culture can be efficient in a
stable environment in which employees are expected to do the same tasks year-in year-out, but can lead to
inflexibility and can slow down response to change as employees defend their roles and rewards.
 Task culture. Here, the emphasis is on getting the job done. Flexibility is encouraged and it is more
important to serve customers and clients well than to defend one’s role. This culture is much more responsive to
environmental and competitive developments.
 Person culture. In the person culture the employee is following a personal ambition in the context of the
organisation, and interacts with the organisation as little as possible. In this culture the individual is the central point.
The organisation is seen as serving the individuals within it. Barristers’ chambers, architects’ partnerships and small
consultancy firms often have this person orientation. The organisation structure is as minimal as possible; the
individuals are clustered together, a small galaxy of individual stars.
(2) Schein’s determinants of organisational culture. These are:

 Artifacts. These are the influences on culture that can be seen. For example, how employees dress, the
layout of the office, the way in which people behave.
 Espoused values. These are the strategies, goals and objectives of the organisation. For example, an
emphasis on low cost or an emphasis on excellent service.
 Basic assumptions and values. These are the taken-for granted beliefs. They can be called a ‘paradigm’,
which is a set of assumptions held in common.
(3) Hofstede’s international perspectives on culture. Hofstede recognised that people in different countries often have
different outlooks and that these will influence organisational culture. The influences are:
 Power distance. Cultures that favour low power distance expect power relations to be relatively
consultative or democratic. In high power distance countries, the less powerful accept power relations that are more
autocratic.
 Individualism v collectivism. Individualistic societies place stress on personal achievements. In
collectivist societies, individuals act predominantly as members of a group or team.
 Uncertainty avoidance. People in cultures with high uncertainty avoidance tend to be more cautious and
proceed by careful planning. Low uncertainty avoidance cultures feel relatively comfortable making unstructured
situations and dealing with changing and novel environments.
 Long-term orientation v short-term orientation. Long-term oriented cultures attach importance to the
future and place emphasis on persistence, flexibility and a willingness to change. Short-term oriented cultures
emphasise tradition and meeting social expectations.
 Masculinity v femininity. Masculine cultures include competitiveness and assertiveness; feminine
cultures place greater emphasis on relationships and consensus.
With regard to organisational structure and configuration, the AB Study Guide mentions:
Entrepreneurial, functional, departmental, divisional and matrix structures

 An entrepreneurial structure is one in which the owner (the entrepreneur) dominates. An entrepreneurial
structure tends to be found in new businesses, where the entrepreneur is still a hands-on manager. A power culture
and an entrepreneurial structure will normally go hand-in-hand.
 A functional (and departmental) structure is a conventional structure with different departments for
accounting, sales and marketing, research and development, and so on. This structure can be efficient and can lead to
economies of scale, but as departments increase in size and power, they can begin to look after their own interests

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more than the organisation’s. Then a functional organisation has taken on the characteristics of a role culture: intense
interest in role rather than getting the job done.
 As businesses grow, there is often a degree of diversification as new products and new markets are
developed. It then often makes sense to set up separate divisions for each market and product group as this allows
specialisation. So, the European Division will know about pricing, competitors, customer preferences in Europe, and
the North American division will develop expertise for that market.
 A matrix structure is very common in project-led organisations as it allows multi-skilled teams to be set up
for each project. However, it will mean that an employee is responsible to two superiors, and this was anathema to
classical management theory. For example, the person shown below is responsible to the Project B manager and to
the quality control manager. It is easy to imagine a situation where the project manager puts pressure on the
employee to cut out some tests because the project is slipping and, at the same time, the quality control manager
would put pressure on the employee to carry out full testing. The wrong way for the employee to choose what to do
is to comply with the wishes of the manager who shouts louder; anyhow, it is unfair to expect the most junior
member of the trio to make the decision. However, the matrix structure could empower the employee to point out to
the two managers that there is a conflict and that they, as managers and as more experienced employees, should get
together to resolve the problem.
A matrix structure
1. Tall and flat organisations
The difference between tall-narrow

and wide-flat organisations
Tall-narrow organisations are characterised by having many management layers, with each manager looking after
only a few subordinates. Wide-flat configurations have relatively few layers, but each manager has many
subordinates. In the 1990s and 2000s, many organisations made a determined effort to move from tall-narrow to
wide-flat. This process is known as ‘delayering’ or ‘flattening’ the organisation.
The drivers behind this structural change are:
 Cost. There was increasing price competition from products made in developing countries, and it was
recognised that costs could be saved by getting rid of many of the middle management layers.
 Slow, poor communication. The tall-narrow structure fragments the organisation and imposes many
layers between the bottom and the top of the organisation. If Person A in the diagram above needs to communicate
with the chief executive officer at the top, in a strictly run organisation, the message might have to pass through
many layers of managers, leaving scope for delay, misunderstanding and distortion. If Person A needs to
communicate with Person B, once again many managers might be involved. In stable environments, people at the
bottom of organisations rarely needed to communicate with the top. However, nowadays, new recruits are likely to
have valuable information that top management needs to know. For example, the use of social media such as
Facebook in marketing and stakeholder communication.

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 Inflexibility. Many layers of management imply many grades of pay and benefits and, if the organisation
needed to change to respond to environmental developments, the large number of managers can be obstructive so as
to defend their positions.
Moving to a flat-narrow configuration can address these problems. Note that the tall-narrow structure is likely to
exhibit a role culture, whereas the wide-flat structure is more likely to have a task culture. The movement to wide-
flat can also provide job enrichment because if a manager has more people to look after, less time can be given to
each, and employees are therefore almost inevitably given more responsibility.
(2) Centralisation and de-centralisation
Centralisation means that most decision making is retained at the top of an organisation, and this implies a power
culture. Decentralisation means that decision making is passed down through the group, and this brings the following
advantages:
 Top management has more time to concentrate on the most important decisions.
 Decisions are made by technical experts, are made more quickly, and are made with an awareness of local
conditions. The best person to decide about advertising in Brazil is almost certainly someone with a marketing
background resident in Brazil, rather than a chief executive from an accounting background based in London.
 Motivation of staff. Giving decision-making responsibility is an excellent example of job enrichment.
On the downside, there is an increased chance of dysfunctional decision-making, where one division or department
makes a decision that hurts the group overall. To reduce the chance of this, management needs to keep a coordinating
role.
Specific Strategic Business Leader matters

1. The cultural web
This is usually depicted as follows:
The cultural web

In essence, this is a list of the factors that influence culture. It is a more detailed list than Schein’s artifacts, espoused
values, and basic assumptions and values. An approximate correlation between the two approaches is:
Cultural web Schein
Symbols and titles For example, how people dress and how they are Artifacts
addressed
Power relations For example, autocratic or participative Artifacts
Organisational structure For example, tall-narrow or wide-flat Artifacts

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Cultural web Schein
Control systems For example, highly centralised or decentralised Artifacts
Rituals and routines For example, a regular start-of-week meeting Espoused values
Myths and stories For example, a story about when the organisation Espoused values
won an important client
Organisation assumption For example, that the organisation exists to fulful Basic assumptions and
(paradigm) charitable objectives values
View this table as an image

The cultural web is a very useful way of analysing organisational culture and could have been used to great effect in
all of the questions mentioned at the start of this article.
2. Mintzberg’s organisational configurations
Mintzberg suggested that an organisation consisted of five elements:
 The strategic apex – the board and top management.
 The middle line – middle managers responsible for carrying out the decisions of the strategic apex; the
chain of command down through the organisation.
 The operating core – the workers.
 Support staff – departments such as accounting, personnel and IT.
 The technocracy – the people responsible for devising and enforcing standards and procedures such as the
personnel manual, the internal control system, the quality control system, health and safety rules.
The size and importance of these elements depends on the type of organisation being described, and diagrams can be
drawn to illustrate this, but the diagrams are not needed for the exam. The characteristics of three of Mintzberg’s
organisational stereotypes are as follows:
 The simple structure. This consists only off the strategic apex and the operating core: it is the boss and
the workers and equates to Handy’s power culture and to entrepreneurial organisations. Indeed, the simple structure
is often known as the entrepreneurial structure.
 Machine bureaucracy. This refers to the structure that is common in mass-manufacturing industries. The
middle line is lengthy, implying tall-narrow, with many management layers. The technocracy is large because in
manufacturing companies, making large numbers of identical items, it is essential that production, quality, safety
training and finance are carefully and repeatedly regulated.
 The professional bureaucracy. The professional bureaucracy. This refers to the structure that is typically
found in firms of lawyers or accountants. The middle line is relatively short, implying wide-flat, with good
communication between the top and bottom of the organisation. The technostructure is small because, although
documentation can be standardised, each job is unique and is therefore not capable of standardisation. Because each
job is unique, the partners (strategic apex) have to discuss directly the problems and findings of the accounting or
legal staff who were closely involved with the work (the operating core). The professional form of organisation
appears wherever the work of the organisation is dominated by skilled workers who use procedures that are difficult
to learn, yet are well defined. Schools, universities and hospitals are prime examples.
Interaction of configuration and cultures

It is important to realise that cultures and configurations go hand-in-hand. Indeed, Mintzberg has said that
‘configurations are not just cultures, nor even just power systems. They are cultures.’
For example, a tall-narrow hierarchical structure will usually imply a role culture and a machine bureaucracy with
great emphasis on control, symbols, titles, and strict power relations. As mentioned earlier, this can work well in

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stable environments, where the paradigm will often be based round efficiency and cost leadership. It is also needed
in high-risk environments where careful supervision of subordinates is needed.
In contrast, a wide-flat structure will more often imply a task culture and a professional bureaucracy, with little
emphasis on symbols of hierarchy, more participative decision making, and fewer stultifying controls. Here, the
paradigm is more likely to be based around customer service, responsiveness, differentiation and innovation.
Application of culture and organisational configuration to scenarios

Culture and organisational configuration could be examined in the following contexts:
(1) Culture clashes
A good example of this can be illustrated where there is a power culture that a new employee tried (unsuccessfully)
to change to a role culture. Another example can be where a new director attempted to change both structure and
culture to the fury of established personnel.
A recent real-life example is seen in the Hewlett-Packard (HP) takeover of Autonomy. HP is predominantly a
hardware company and employed about 350,000 people worldwide. Autonomy was a relatively young,
entrepreneurial software company based in Cambridge, UK, and had about 3,700 employees. HP took over
Autonomy in 2011 for $12bn and all of Autonomy’s top level executives had left within about nine months; about
25% Autonomy’s staff also left, claiming that the bureaucracy they encountered at HP was more than they could
bear. ‘We kept a running tally of the number of HP staff to Autonomy staff on conference calls. The record was 52 to
1,’ said a former employee (Financial Times, 24 May 2012). Given that one of the main reasons for the acquisition of
Autonomy was to acquire software skills and brainpower, losing a large proportion of staff is probably not a good
result for HP.
A clash of cultures is likely to continue to appear in future questions. It allows the examining team to examine
aspects of culture and configuration in context without suggesting that one culture is better than another.
(2) Inappropriate cultures and configurations
For example, if an organisation wanted to change its generic strategy from cost leadership to differentiation, almost
certainly both culture and configuration will have to change. A similar issue can be illustrated, where the work
routines effectively excluded female staff and customers were treated as lazy and incompetent. The survival of some
organisations is threatened by clinging to a culture that is no longer appropriate, either within the industry sector or
within society as a whole. Culture and configuration have to be changed to allow survival – however hard that is on
individuals currently employed in the company.
(3) Different stages of an organisation’s lifecycle
Also there may be situations illustrating how a business’s culture and structure changed throughout its lifecycle, and
how it should be managed. The company may have started in an entrepreneurial/power culture with a charismatic
leader who recruited like-minded employees. Formal controls could have been non-existent and the company was
fun to work in. Later it could become listed and inevitably have to adopt much more of a role culture; controls will
become tighter and public scrutiny will affect rituals, symbols and the organisational paradigm. Neither the founder
nor existing staff may enjoy the new situation. Finally, the founder could buy back the company and tries to turn the
clock back to earlier, happier days, but the staff then employed may dislike those changes.
(4) Change management
If a culture or organisation structure has to be changed, then the problem of change management arises. How can we
encourage employees and other stakeholders to willingly embrace the change – or at least not to oppose it actively?
Communication, education and participation in the change process are usually advised.
Conclusion
Culture and configuration will be examined in the SBL exam, particularly with reference to the cultural web and
Mintzberg’s configuration stereotypes. Candidates must ensure that they can apply theories and principles to the case
study scenario. Mismatch of cultures and configurations is likely to be a recurring theme.
Adapted from an article originally written by Ken Garrett (a freelance author and lecturer)
Diversifying the board – a step towards better governance

The responsibilities of the board of directors have been on the corporate agenda for years. Acting as the agents of
shareholders, directors are expected collectively to devise operational and financial strategies for the organisation
and to monitor the effectiveness of the company’s practices.
 Introduction
 Definition of board diversity
 Benefits of board diversity

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 Costs of diversifying the board

 Regulatory initiatives of board diversity
 Conclusion
Introduction
The board of directors forms one of the pillars of a robust corporate governance framework. This is evidenced by the
Organisation for Economic Co-operation and Development (OECD) Principles of Corporate Governance stating that:
'the corporate governance framework should ensure the strategic guidance of the company, the effective monitoring
of management by the board, and the board’s accountability to the company and the shareholders'.
This, in turn, links to the fundamental concepts of corporate governance – namely, judgment, responsibility and
accountability.
Recent academic literature suggests that one of the ways to enhance corporate governance, arguably, is to diversify
the board. In the Strategic Business Leader (SBL) Study Guide, section B5e requires students to (i) explain the
meaning of 'diversity' and (ii) critically evaluate issues of diversity on the board of directors.
This article attempts to elaborate on this topic by first introducing the concept of board diversity and how it may
benefit the organisation, which is followed by a discussion on the possible costs of board diversity.
The article will then conclude with a comment on the current regulatory initiatives of board diversity.
Definition of board diversity

Over the years, regulators have placed great emphasis on addressing different matters relating to the board of
directors. Two prominent examples were: (i) stressing on the roles of non-executive directors as well as the
importance of independence of the board in the Higgs Review in 2003; and (ii) emphasising the significance of
balancing skills and experience of the board members as in the Walker Review in 2010. Until recently, there has
been an urge for diversifying the board. Intuitively, diversity means having a range of many people that are different
from each other.
There is, however, no uniform definition of board diversity. Traditionally speaking, one can consider factors like age,
race, gender, educational background and professional qualifications of the directors to make the board less
homogenous. Some may interpret board diversity by taking into account such less tangible factors as life experience
and personal attitudes.
In short, board diversity aims to cultivate a broad spectrum of demographic attributes and characteristics in the
boardroom. A simple and common measure to promote heterogeneity in the boardroom – commonly known as
gender diversity – is to include female representation on the board.
Benefits of board diversity

Diversifying the board is said broadly to have the following benefits:
 More effective decision making.
 Better utilisation of the talent pool.
 Enhancement of corporate reputation and investor relations by establishing the company as a responsible
corporate citizen.
1. More effective decision making

It is believed that a diverse board is able to make decisions more effectively by reducing the risk of 'groupthink',
paying more attention to managing and controlling risks as well as having a better understanding of the company’s
consumers. These benefits are further elaborated below.
Directors are responsible, as mentioned previously, for devising strategies through critical analysis and effective
problem solving. One of the pitfalls behind the decision-making process in the boardroom is 'groupthink', which is
described as a psychological behaviour of minimising conflicts and reaching a consensus decision without critically
evaluating alternative ideas in a cohesive in-group environment.
Combining contributions of a group of people with different skills, backgrounds and experiences is assumed to be
able to approach problems from a greater range of perspectives, to raise challenging questions and to debate more
vigorously within top management groups. Such a multiple-perspective analysis of problems can change the
boardroom dynamics and is more likely to be of higher quality than decisions made under a 'groupthink'
environment.
Diversified board members are more likely to possess different personal characteristics, which lead to dissimilar

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leadership, thinking, emotional styles and even risk preferences and behaviours. Not only may this foster creativity in
delivering solutions to problems, but also provide a more comprehensive oversight to the operations of the
organisation through a further enhancement of the company’s sensitivity to a wider ranger of possible risks such as
reputation and compliance risks. This may then support a greater supervision on the boards in its performance
evaluation and in the decision-making process.
Further, companies are competing in a global environment nowadays. In order to achieve organisational goals and
objectives, directors need to understand diverse stakeholders’ claims – in particular the needs of customers – well. A
balanced board will have more representatives of users and customers of its products in the boardroom to make
informed judgment. This may be especially important for consumer-facing industries to have female directors and
for multinational companies to include foreign nationals on the board.
Dissimilar backgrounds, experience and social networks in the boardroom may therefore improve their
understanding of the stakeholders, provide diverse connections with the external environment and help address
stakeholders’ claims in a more responsive manner.
2. Better utilisation of talent pool

Stakeholders are demanding more from directors, in particular from non-executive directors (NEDs). Having NEDs
on the board has already been a common requirement across countries. NEDs are, however, often criticised for
having insufficient devotion of time and effort in understanding the business and representing stakeholders to
scrutinise executive directors in making appropriate decisions.
One of the problems of searching for suitable directors lies on the limited number of candidates – there is especially
a tendency to search for board members with typical characteristics, such as male directors. If directors expand the
pool of potential candidates by considering more diversified attributes, like women and ethnic minorities to be
included in the boardroom, it will alleviate the problem of 'director shortage' and therefore better utilise the talent
pool. It is therefore vital for companies to initiate tapping into the under-utilised pool of talent through board
diversity.
3. Enhancement of reputation and investor relations by establishing the company as a responsible corporate
citizen
Having a heterogeneous board can enhance corporate reputation through signalling positively to the internal and
external stakeholders that the organisation emphasises diverse constituencies and does not discriminate against
minorities in climbing the corporate ladder. This may somehow indicate an equal opportunity of employment and the
management’s eagerness in positioning the organisation as a socially responsible citizen.
It is also argued that board diversity reflects the diversity of the society and community served by the organisation.
This reflection strengthens the social contract between a business and its stakeholders, which, in turn, improves its
strategic fit that the business has with its environment. As a result, it is suggested that a diverse board can help a
company build its reputation as a responsible corporate citizen that understands its community and deserves its trust.
Further, more institutional investors have taken into account board diversity as a factor for investment evaluation due
to the reasons that: (i) a number of academic research papers indicated the positive correlation between firm value
and board diversity; and (ii) institutional investors are placing greater emphasis on corporate social responsibility.
Board diversity can, therefore, to a certain extent, improve its investor relations.
Costs of diversifying the board

Diversifying the board is not without costs. Though a board is inherently subject to conflict as it is formed by
individuals collectively, having a diverse board may potentially increase friction between members, especially when
new directors with different backgrounds are stereotyped by existing members as atypical. This may split the board
into subgroups, which reduces group cohesiveness and impairs trust among members, leading to reluctance to share
information within the board.
Another danger of board diversity is sometimes referred to as tokenism. Theoretically, as mentioned in the previous
section, the minorities in the boardroom are said to contribute to value creation of the organisation by their unique
skills and experiences; however, in practice, they may feel that their presence is only to make up the numbers

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required by the external stakeholders. They may then tend to undervalue their own skills, achievements and
experiences, which demeans their potential contribution to the organisation.
Further, the board may potentially ignore the underlying important attributes of successful directors as a sacrifice to
meet the requirement of board diversity. The board needs to pay special attention to these costs when implementing
measures to diversify the board.
Regulatory initiatives of board diversity

Board diversity can be promoted by a number of methods. Measures currently adopted by different regulatory bodies
are generally classified into the following approaches: (i) through imposing quotas on the board; and (ii) enhancing
disclosures using the 'comply or explain' approach.
Imposing quotas refers to mandatory requirement in appointing a minimum number of directors with different
attributes on the board. This legislation enactment mainly deals with gender diversity to tackle the relative
underrepresentation of women in the boardroom. For example, since 2008, each listed company in Norway has had
to ensure that women fill at least 40% of directorship positions. Spain and France are implementing similar
mandatory requirements for gender diversity. This approach increases the number of women on the board at a faster
rate and forces companies to follow the legislation.
Another measure to enhance board diversity is through transparency and disclosure. Companies, under corporate
governance codes, are required to disclose their diversity policy in appointing directors so that investors and
stakeholders can make proper evaluation. Those who fail to implement such measures have to explain their non-
compliance in the corporate governance report or equivalent. The Corporate Governance Code (2010) of the United
Kingdom, for example, stipulates that companies are required to: (i) incorporate diversity as a consideration in
making board appointments; and (ii) disclose in their annual reports describing the board’s policy on diversity, as
well as its progress in achieving the objectives of that policy. Australia and Hong Kong are promoting diversity using
a similar 'comply or explain' approach. Supporters of this approach believe that board appointments should be made
on the basis of business needs, skills and ability instead of legislative requirements, which may sometimes be
considered excessive in the market.
Conclusion
Board diversity is justified as a key to better corporate governance. The following extract from academic literature
by Conger and Lawler (2001) serves as a good summary of board diversity:
'The best boards are composed of individuals with different skills, knowledge, information, power, and time to
contribute. Given the diversity of expertise, information, and availability that is needed to understand and govern
today’s complex businesses, it is unrealistic to expect an individual director to be knowledgeable and informed about
all phases of business. It is also unrealistic to expect individual directors to be available at all times and to influence
all decisions. Thus, in staffing most boards, it is best to think of individuals contributing different pieces to the total
picture that it takes to create an effective board.'
In implementing policies on board diversity, both the company’s chairman and the nomination committee play a
significant role.
The chairman, being the leader of the board, has to facilitate new members joining the team and to encourage open
discussions and exchanges of information during formal and informal meetings. To create such a well-functioning
team, the chairman further needs to commit and support mentoring, networking and adequate training to board
members.
The nomination committee should give consideration to diversity and establish a formal recruitment policy
concerning the diversity of board members with reference to the competencies required for the board, its business
nature as well as its strategies. The committee members have to carefully analyse what the board lacks in skills and
expertise and advertise board positions periodically. They are strongly encouraged not to seek candidates merely
through personal contacts and networks in order to carry out a formal and transparent nomination process.
The most important ingredient to the success of board diversity, however, would most probably be the board

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members’ changing their mindset to welcome a more heterogeneous board, as well as to place greater trust in one
another and work together more effectively.
References
 The Tyson Report on the Recruitment and Development of Non-Executive Directors, June 2003
 Green Paper – The EU Corporate Governance Framework, 2011
 Women on Boards by Lord Davies, February 2011
Adapted from an article originally written for P1 by Eric YW Leung FCCA, lecturer, CUHK Business School,
The Chinese University of Hong Kong
E-commerce
This article looks at business-to-business and business-to-consumer e-commerce and benefits for business, as well as
the social and employment costs involved.
 Introduction
 Business-to-consumer (B2C)
 Benefits for business
 The self-serve economy
 Social and employment costs of e-commerce
 E-commerce – a glossary of terms
Introduction
E-commerce is now synonymous with the internet. Users – private or corporate – can communicate with web-based
online stores using a web browser such as Microsoft Explorer or Netscape Communicator. An internet store provides
all the facilities a customer needs, including a product catalogue, a virtual shopping basket, and a secure credit card
payment system.
In theory, the internet has no geographical, political or temporal boundaries. It has a common infrastructure available
to all. The universal availability of access to the internet, while not radically changing logical processes, has created
new opportunities and removed some of the physical limitations of traditional methods of conducting business.
Those studying the Accounting in Business (AB) exam may be interested in the social and employment
consequences of e-commerce. For Strategic Business Leader candidates, e-commerce is now a weapon of
competitive strategy, offering the possibility of new products and services, more efficient ways of performing
traditional business processes, and new distribution channels.
Business-to-business (B2B)
E-commerce
E-commerce can be simply defined as conducting business transactions over electronic networks by way of linked
computer systems. When the concept was originally introduced, it was envisaged that it would mainly involve
business organisations linking their computer systems to conduct business with each other more speedily, efficiently
and economically.
B2B e-commerce is well-established and is still a fast-growing area. Examples include companies linking to their
suppliers to facilitate Just-In-Time (JIT) stock control. To enable this to happen, participating companies have had to
agree on interface and application standards. Many office equipment and consumable suppliers can now take orders
online and provide direct delivery to business customers.
One of the key drivers associated with B2B e-commerce is the overhaul of inefficient trading processes. Companies
can link directly to suppliers, check availability of products, and then place orders and track shipments without delay
or human assistance. In an increasingly competitive world, the best businesses are using new technologies to clarify
customer demand, target marketing efforts more precisely, tighten business processes, and investigate new methods
of distribution.
Business-to-consumer (B2C)
E-commerce
The volume of B2B e-commerce has been overtaken in the last five years by the growth of consumer e-commerce
applications as the general public (B2C) increasingly conduct business over networks with commercial and public
sector organisations. The catalyst for B2C e-commerce has been the growth in the number of people who have access
to both a home computer and the internet. Most e-commerce applications are now internet-based, trading goods and
services. Other terms used to refer to this practice include e-business, e-tailing and e-trading.
Business activities

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Commerce refers to the activities in which an organisation or individual engages in order to complete a transaction.
Most stages in the lifecycle of a product or service can be conducted in an e-commerce environment. For example, a
book retailer might undertake the following e-commerce activities:
 market research
 advertising
 providing product information
 contacting customers
 taking orders
 tracking shipping
 receiving and processing payments
 ordering stock from publishers.
The list of activities or logical processes does not differ significantly from the list of business activities that the
organisation has always carried out. The difference is that the company can conduct its retail business by using
computers and telecommunications technologies instead of, or in addition to, operating stores.
Benefits for business

Some of the organisational benefits of doing business over the internet include the following:
 Business can be conducted 24-hours-a-day, seven-days-a-week.
 Products can be supplied to anyone, anywhere in the world (as long as there is an economic and reliable
distribution channel).
 Suppliers can respond quickly to customer requirements.
 Suppliers can build a one-to-one relationship with customers. Through search tools and customer profiles,
information can be tailored to customer requirements on demand. Direct communication results in improved pre and
post-sales support.
 Customers can access up-to-date information – expensive printed catalogues and service guides can be
replaced by a single electronic product database (which must be kept up to date at all times).
 Email distribution is cheaper than direct mail, and providing the information on a website is cheaper still if
users can be encouraged to access it for themselves.
 The overheads of maintaining a physical retail outlet are reduced.
 Routine business operations can be automated, saving time and money – the supply chain is shortened so
delivery times and costs are reduced.
 Staff costs can be reduced – standard enquiries and sales can be handled automatically via software,
leaving staff with time to handle the difficult or higher added-value transactions.
 Entirely new services can be developed – for example, software and music can be delivered
instantaneously and cheaply via the internet.
The self-serve economy

Email and websites are as easily, and readily, accessible as telephones and faxes. As a result, consumers are
becoming more confident in the use of electronic media to conduct all kinds of transactions, from transferring money
between bank accounts, to reserving film or theatre tickets, to ordering books online. The willingness of consumers
to help themselves, and to make new technologies part of their daily lives, bypassing the shop assistant and customer
service representative, is the principal characteristic of the self-serve economy. Self-serve characteristics, valued and
required from an e-commerce service include availability, reliability, choice, speed, and convenience. A well-run and
efficient e-commerce operation will deliver the following benefits to consumers.
 24-hour shopping, seven-days-a-week.

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 Global choice and access to a wider range of goods and services than in any local retail store or shopping
centre.
 Lower prices – because of reduced operating costs and wider competition.
 Ease of use when identifying and browsing the choices available.
 Rapid response to orders – not as fast as retail off-the-shelf, but few retail chains provide their complete
product offering at every outlet, and frequently products have to be ordered.
 For products that can be delivered electronically, such as software, video, newspapers and music, supply is
instantaneous without any delay caused by intermediaries.
Social and employment costs of e-commerce

Although the benefits of e-commerce are significant, they do not come without the risk of some longer-term social
costs.
 If substantial numbers of residents of small communities choose to shop on the internet, local stores may
not be able to compete and may have to close. For those who do not have, or do not wish to have access to the
internet, such closures could lead to social deprivation.
 Many aspects of electronic shopping are automated and fewer staff are needed to process orders, leading to
a possible rise in unemployment in certain economic sectors.
 E-commerce businesses have access to global markets but they are also subject to global competition. This
means that costs and working practices need to remain flexible to cope with changing consumer demands and
competitor activity. Suppliers can choose to operate from offshore low-cost bases. This has a particular impact on
high wage/high social cost economies which may find that jobs are exported to lower cost economies.
 Flexibility to operate offshore and to buy internationally means that it is very difficult for national
governments to police the legality of operations and to ensure the quality and safety of some products supplied (eg
medicines).
 Ensuring the reliability, security and integrity of data and operations can be a problem – electronic hacking
is often one step ahead of the security industry.
E-commerce – a glossary of terms

Internet development
E-commerce would not have developed so rapidly without the global network of computers which we now call the
internet. In the 1960s, the US government developed the connectivity standards to network computers for defence
research purposes. The agency responsible for managing and developing the network, and linking together
universities and defence research establishments, was called the Advanced Research Project Agency (ARPA). The
ARPANET became the internet. At the core of its design philosophy was flexibility and resilience – enabling new
computers to be easily linked and, in the event of any catastrophe destroying one or more computers, for the
remainder of the network to be able to continue to function.
Over the following 30 years, the US National Science Federation (NSF) played a guiding role in developing the
network. The developing internet was mainly used as a communications tool in the scientific and academic
communities for electronically transferring and exchanging research materials. In 1989, the NSF opened the internet
to commercial network traffic. Then, in 1992, Tim Berners Lee, working at the European Laboratory for Particle
Physics, created the world wide web (www).
While we tend to use the terms internet and world wide web interchangeably, the internet describes the entire system
of networked computers and the World Wide Web describes the method used to access information contained on
computers connected to the internet. The availability of a common internet infrastructure – of computers, networks
and protocols – and the development of an easy to use Graphical User Interface (GUI) have been the catalysts for the
growth of e-commerce. It has created an open community – easy to join and easy to use.
Hyperlink
This is the highlighted text on a web page. You can click on a hyperlink and be routed to another web page, either on
the same website or to a different website anywhere in the world. Hyperlinks are designed and set up to enable
consumers to easily navigate and find information and purchase products.
Intranet

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This term refers to a closed community of users, often within an organisation. intranets are designed to be used for
internal business purposes only. It uses the same standards and protocols as the internet, but with increased password
and security protection. Intranet websites can look just like the internet websites, but normally a firewall surrounds
the intranet to prevent access by unauthorised users. A firewall examines all requests and messages entering and
exiting the intranet and blocks any not conforming to specified criteria.
Extranet
An extranet is an extension of an organisation's intranet. The difference is that an extranet is accessible to selected
people or groups outside the organisation. Many B2B transactions are made over extranets. An individual can enter
an organisation's public website on the internet, obtain a password authorisation and then be routed to the
organisation's extranet to conduct transactions and obtain information not available to the public. Extranets are
frequently used to connect an organisation's corporate intranet with the intranets of the organisation's suppliers,
distributors and corporate customers.
Web browsers
Internet users (private or corporate) communicate through their web browsers (such as Microsoft Explorer or
Netscape Communicator) with websites. The web browser is a software utility program with a Graphical User
Interface which helps users navigate through the web. It takes a request and then transmits and receives information
from other users or information providers. Using a browser, the user does not need to know the format and location
of the information required. They can jump from site to site by clicking on hypertext links.
Navigation aids
Website developers create navigation aids to enable customers to navigate their way around a website. A navigation
aid can be hyperlink text, buttons, and tables of contents or graphical symbols such as icons or pictures. Navigation
aids are designed to allow users to visit a website and conduct their transactions instinctively, quickly and easily,
moving between pages and re-tracing steps as necessary.
Website search tools
An online store can use a search tool to help customers quickly find products. Techniques include simple features
such as drop-down lists, where customers click a downward pointing arrow to display a list of products or
specifications from which they may choose. Another technique is inviting the entry of key words which trigger a site
search. The challenge for the designer is to pre-identify as many alternative (or even misspelt) versions of potential
key words as possible. Most website search tools use indexing robots – software which electronically visits a site,
follows all links contained therein, and automatically indexes the contents.
Databases
Online businesses need to access, store, retrieve, amend, and generate data in a wide variety of formats. A database is
defined as a collection of information that is organised so that the required information can be quickly retrieved,
amended if necessary, and then the electronic image updated. There are a number of proprietary database
management systems that can provide the necessary functionality – and operate in a real time processing
environment, with high volumes – while maintaining security and availability.
Form design
An e-commerce enabled website must include mechanisms for customers to enter information such as their name,
address, and credit card number. This information is then stored in a database. Website developers create forms for
customers to complete. Most electronic forms comprise text boxes combined with drop-down lists to simplify tasks
for the customer and to avoid transcription errors where possible.
Shopping carts and checkouts
Many online stores use the image of a shopping cart (or trolley) to characterise the online shopping process. The
shopping cart is now considered a standard component of all online stores. A shopping cart records the ongoing
results of the ordering process, generated from a database, and is effectively the interface between the customer and
the database. In the browser, these results appear on a web page that is updated every time a customer adds an item
to the cart. Shopping carts are usually set up so that the customer can view all details of the ongoing transaction on
request, at any time. When all transactions are complete, the customer is invited to go to the checkout to complete the
purchasing process.
The checkout is usually located on a secure server that protects customer payment information during its
transmission. For small businesses, standard software modules can be bought in for the shopping cart and checkout
processes. In such cases the payment process is routed to a secure server managed by a specialist company, eg
PayPal.
Although a small number of products and services can be distributed electronically, most products need to be
physically delivered. Once a commitment to purchase has been made, ensuring that distribution is controlled, speed
and visibility are critical success factors for the online store. Most online stores offer a variety of shipping methods

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with different timescales and prices. Some online stores will choose shippers who have 'track and trace' monitoring
procedures available online. Customers are provided with the identity of the shipping agent and a reference for their
package. They can then track its progress.
Ethical decision making

Many business decisions have ethical elements to them. This is because of the impacts of those decisions, and the
fact that outcomes are likely to affect stakeholders in different ways and will express different ethical values.
 Introduction
 The American Accounting Association (AAA) model
 Tucker's 5-question model
 Using these models – in summary
Introduction
In this article, two of the main decision-making frameworks from the SBL Study Guide are examined. In particular,
this article clearly explains the two frameworks mentioned in Study Guide Section A3 – namely the American
Accounting Association (AAA) model, and Tucker’s 5-question model. In each case, we start with an explanation of
the model before showing how it might be used in a case situation.
The American Accounting Association (AAA) model
The American Accounting Association (AAA) model comes from a report for the AAA written by Langenderfer and
Rockness in 1990. In the report, they suggest a logical, seven-step process for decision making, which takes ethical
issues into account.
The model begins, at Step 1, by establishing the facts of the case. While perhaps obvious, this step means that when
the decision-making process starts, there is no ambiguity about what is under consideration. Step 2 is to identify the
ethical issues in the case. This involves examining the facts of the case and asking what ethical issues are at stake.
The third step is an identification of the norms, principles, and values related to the case. This involves placing the
decision in its social, ethical, and, in some cases, professional behaviour context. In this last context, professional
codes of ethics or the social expectations of the profession are taken to be the norms, principles, and values. For
example, if stock market rules are involved in the decision, then these will be a relevant factor to consider in this
step.
In the fourth step, each alternative course of action is identified. This involves stating each one, without
consideration of the norms, principles, and values identified in Step 3, in order to ensure that each outcome is
considered, however appropriate or inappropriate that outcome might be.
Then, in Step 5, the norms, principles, and values identified in Step 3 are overlaid on to the options identified in Step
4. When this is done, it should be possible to see which options accord with the norms and which do not. In Step 6,
the consequences of the outcomes are considered. Again, the purpose of the model is to make the implications of
each outcome unambiguous so that the final decision is made in full knowledge and recognition of each one. Finally,
in Step 7, the decision is taken.
Scenario for the AAA model

An auditor uncovers an irregular cash payment and receives an unsatisfactory explanation for it from the client’s
finance director. He suspects the cash payment is a bribe paid to someone but can’t prove it. The client then offers to
pay the auditor a large amount of money if he pretends not to have noticed the payment. The amount of money
offered by the client is large enough to make a significant difference to the auditor’s wealth. Should the auditor take
the money?
Step 1: What are the facts of the case?

The facts are that the auditor has uncovered what he believes to be a bribe and has, in turn, been offered a bribe to
ignore or overlook it.
Step 2: What are the ethical issues in the case?

The ethical issue is whether or not an auditor should accept a bribe. In accepting the bribe he would be acting
illegally and would also be negligent of his professional duties.
Step 3: What are the norms, principles, and values related to the case?

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The norms, principles, and values are that auditors are assumed (by shareholders and others active in capital markets)
to have impeccable integrity and to assure that the company is providing a ‘true and fair view’ of its financial
situation at the time of the audit. Auditors are entrusted with the task of assuring a company’s financial accounts and
anything that prevents this or interferes with an auditor’s objectivity is a failure of the auditor’s duty to shareholders.
Step 4: What are the alternative courses of action?

Option 1 is to accept the bribe and ignore the irregular cash payment. Option 2 is to refuse the bribe and take
appropriate actions accordingly.
Step 5: What is the best course of action that is consistent with the norms, principles, and values identified in
Step 3?
The course of action consistent with the norms, principles, and values in Step 3 is to refuse the bribe. The auditor
would report the initial irregular payment and then also probably report the client for offering the second bribe.
Step 6: What are the consequences of each possible course of action?

Under Option 1, the auditor would accept the bribe. He would enjoy the increase in wealth and presumably an
increase in his standard of living but he would expose himself to the risk of being in both professional and legal
trouble if his acceptance of the bribe was ever uncovered. He would have to ‘live with himself’ knowing that he had
taken a bribe and would be in debt to the client, knowing that the client could expose him at any time.
Under Option 2, the auditor would refuse the bribe. This would be likely to have a number of unfortunate
consequences for the client and possibly for the future of the client–auditor relationship. It would, however, maintain
and enhance the reputation and social standing of auditors, maintain public confidence in audit, and serve the best
interests of the shareholders.
Step 7: What is the decision?

The ethical decision is Option 2. The auditor should refuse the bribe.
Tucker's 5-question model

This model is conceptually slightly different from the AAA model but is nevertheless a powerful tool for
determining the most ethical outcome in a given situation. It might be the case that not all of Tucker’s criteria are
relevant to every ethical decision. If it were used when considering the AAA model scenario above, for example,
there is no indication of the environmental relevance of the auditor’s decision. In addition, the reference to
profitability means that this model is often more useful for examining corporate rather than professional or individual
situations.
Applying Tucker’s model requires a little more thought than when using the AAA model in some situations,
however. This is because three of the five questions (profitable, fair, and right) can only be answered by referring to
other things. So when the model asks, ‘is it profitable?’, it is reasonable to ask, ‘compared to what?’ ‘Similarly,
whether an option is ‘fair’ depends on whose perspective is being adopted. This might involve a consideration of the
stakeholders involved in the decision and the effects on them. Whether an option is ‘right’ depends on the ethical
position adopted. A deontological perspective may well arrive at a different answer than a teleological perspective,
for example. In order to see how Tucker’s model might work in practice, we will consider two decision scenarios,
one fairly clear cut and one that is a little more complicated.
Tucker: Scenario 1
Big Company is planning to build a new factory in a developing country. Analysis shows that the new factory
investment will be more profitable than alternatives because of the cheaper labour and land costs. The government of
the developing country has helped the company with its legal compliance, which is now fully complete, and the local
population is anxiously waiting for the jobs which will, in turn, bring much needed economic growth to the
developing country. The factory is to be built on reclaimed ‘brownfield’ land and will produce a lower unit rate of
environmental emissions than a previous technology.
Is it profitable?
Yes. The investment will enable the company to make a superior return than the alternatives. The case explains that
these are ‘because of the cheaper labour and land costs’.

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Is it legal?
Yes. The government of the developing country, presumably very keen to attract the investment, has helped the
company with its legal issues.
Is it fair?
As far as we can tell, yes. The only stakeholder mentioned in the scenario is the workforce of the developing country
who, we are told, is ‘anxiously waiting’ for the jobs. The scenario does not mention any stakeholders adversely
affected by the investment.
Is it right?
Yes. The scenario explains that the factory will help the developing country with ‘much needed economic growth’,
and no counter - arguments are given.
Is it sustainable or environmentally sound?

Yes. The scenario specifically mentions an environmental advantage from the investment. So in this especially
simplified case, the decision is clear as it passes each decision criteria in the 5-question model. In more complex
situations, it is likely to be a much more finely balanced decision.
Tucker: Scenario 2
Some more information has emerged about Big Company’s new factory in the developing country. The ‘brownfield’
land that the factory is to be built on has been forcefully requisitioned from a community (the ‘Poor Community’)
considered as ‘second class citizens’ by the government of the developing country. The Poor Community occupied
the land as a slum and now has nowhere to live.
Is it profitable? Yes.
The same arguments apply as before.
Is it legal?
It appears that the government of the developing country has no effective laws to prevent the forced displacement of
the Poor Community and may be complicit in the forced removal. While the investment may not be technically
illegal, it appears that the legal structures in the host country are not particularly robust and are capable of what
amounts to the oppression of the Poor Community.
Is it fair?
While the issue of the much needed employment remains important, it must be borne in mind that the jobs are
provided at the cost of the Poor Community’s homes. This apparent unfairness to the Poor Community is a relevant
factor in this question. The answer to ‘is it fair?’ will depend on the decision maker’s views of the conflicting rights
of the parties involved.
Is it right?
The new information invites the decision maker to make an ethical assessment of the rights of the Poor Community
against the economic benefits of the investment. Other information might be sought to help to make this assessment
including, for example, the legality of the Poor Community’s occupation of the site, and options for rehousing them
once construction on the site has begun.
Is it sustainable or environmentally sound?

Yes. The same arguments apply as before.
Using these models – in summary

In the exam, candidates may be asked to assess or evaluate a situation such as one of the above scenarios in order to
evaluate and may decide to use one of these models as an effective way of justifying their decision. Although some
marks will be available for remembering the questions in the model used, the majority of marks will be assigned for
its application. If the situation is relatively complex, exam answers should reflect that complexity, showing, for
example, the arguments for and against a given question in the model and also showing this in the final decision. In
most situations, the models can be used as a basis for identifying the factors that need to be addressed. In only the

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most clear-cut cases, or when the case provides a minimum of information, will the decision be straightforward.
In summary, these two models can be used to ensure that ethical considerations are included when making important
leadership type decisions.
Both models contain distinct steps or questions that encourage the decision maker to recognise the ethical issues in a
decision. The AAA model invites the decision maker to explicitly outline their norms, principles, and values, while
Tucker’s model allows for discussion and debate over conflicting claims (eg between different beliefs of what is
‘fair’ and ‘right’). Both are potentially useful to senior decision makers and hence their inclusion as an important part
of the SBL Study Guide.
Independence as a concept in corporate governance

This article explores the theory of independence, and discusses why it’s vital in many contexts relating to corporate
governance and professional behaviour.
 Introduction
 Degrees of independence
 Independence and non-executive directors
 Measures to increase NED independence
Introduction
The concept of independence occurs at several points in the Strategic Business Leader (SBL) Study Guide. It is listed
as one of the key underpinnings of corporate governance in Section B5, it is a crucial quality possessed by both
internal and external auditors (Sections F2), and it is included in Section A3 as an ethical quality.
In corporate governance, independence is therefore important in a number of contexts. It is vital that external
auditors are independent of their clients, that internal auditors are independent of the colleagues they are auditing,
and that non-executive directors have a degree of independence from their executive colleagues on a board. But what
do we mean by ‘independence’ as a concept?
Independence is a quality that can be possessed by individuals and is an essential component of professionalism and
professional behaviour. It refers to the avoidance of being unduly influenced by a vested interest and to being free
from any constraints that would prevent a correct course of action being taken. It is an ability to ‘stand apart’ from
inappropriate influences and to be free of managerial capture, to be able to make the correct and uncontaminated
decision on a given issue.
If, for example, an auditor is a longstanding friend of a client, the auditor may not be sufficiently independent of the
client. Given that it is an auditor’s job to act on behalf of shareholders and not the client, the friendship with the
client may compromise the auditor’s ability to effectively represent the interests of the shareholders. The auditor may
not be as thorough as he ought to be, or he may be influenced to give the benefit of a doubt to the client when he
should not be doing so.
The same could apply to non-executive directors (NEDs). In some countries, NEDs are referred to as independent
directors to emphasise this very point. NEDs are appointed by shareholders in order to represent their interests on
company boards. The primary fiduciary duty that NEDs owe is, therefore, to the company’s shareholders. This
means that they mustn’t allow themselves to be captured or unduly influenced by the vested interests of other
members of the company such as executive directors, trade unions or middle management.
Degrees of independence
A common problem in many organisational situations is ensuring independence where it could represent an ethical
threat if absent. In real-life situations, friendships and networks build up over many years in which relationships exist
at a number of different levels of intensity. Audit engagement partners can get to know clients very well over many
years, for example, and serving together on boards can cement friendships between NEDs and executive members of
a board.
Clearly then, there are varying degrees of independence. I find the use of continua helpful when describing a variable
such as this. A continuum is a theoretical construct describing two extremes and a range of possible states between
the two extremes. In the case of the continuum in Figure 1, the left-hand extreme describes the ‘total independence’
extreme. At this point, the parties in the relationship have no connection with each other, may not know the identity
of each other and, therefore, have no reason at all to act other than with total dispassionate independence. On the
other extreme on the right-hand side – the ‘zero independence’ end – the two parties are so intimate with each other
they are incapable of making a decision without considering the effect of that decision on the other party.

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Figure 1
Of course, in real-life situations, the actual degree of independence is likely to be somewhere between the two
extremes, but it is clearly desirable in most situations that the real position should be as near to the left of the
continuum as possible. Any of the five main ethical threats can undermine or reduce a person’s independence (self-
interest, self-review, familiarity, advocacy, intimidation).
In some situations, company law or corporate governance codes make provisions to reduce threats to independence.
It is often required, for example, to rotate engagement partners every so many years in an audit situation.
Independence is also very important for NEDs, however, and it is to this that I now turn.
Independence and non-executive directors
So looking in a bit more detail at the roles of NEDs in particular, what are the specific benefits of NED
independence? We have already discussed the fact that the primary fiduciary duty of a NED is to the company’s
shareholders. In order to increase NED independence, some shareholders prefer to bring new NEDs in from outside
the industry in which the company competes. This is because a number of independence-threatening informal
networks can build up within an industry over the years as staff move between competitor companies and as they
collaborate in industry ‘umbrella’ bodies from time to time.
There is a debate about the pros and cons of appointing NEDs that have some industry experience compared to
appointing NEDs from outside the industry in which the company in question competes. Previous industry
involvement brings with it a higher technical knowledge of issues in that industry (which might be important), a
network of contacts and an awareness of what the strategic issues are within the industry. While these might be of
some benefit to a NED’s contribution, the prior industry involvement might also reduce the NED’s ability to be
objective and uncontaminated by previously held views: in other words, they can make the NED less independent.
Accordingly, it is sometimes easier to demonstrate independence when NEDs are appointed from outside the
industry. In addition to the benefits of the ‘new broom’ effect of bringing a fresh pair of eyes to a given problem, a
lack of previous material business relationships will usually mean that a NED will not have any previous alliances or
prejudices that will affect his or her independence.
In practice, many companies employ a mix of NEDs, and it is often this blend of talents and areas of expertise that is
what makes a non-executive board effective. Technical input can be given by some NEDs, while wider political or
regulatory insights might be provided by others. In large and highly visible companies, NEDs able to bring a social
or political perspective to board deliberations can be strategically important. They may have retired senior
government ministers or former chairmen of other large companies on their boards to give these insights. The fact
that such people usually have no previous material business relationship with the company is seen as important in
ensuring that they are materially independent.
Measures to increase NED independence
In order to enhance the independence of non-executive directors, a number of provisions are made in company law
and in corporate governance codes. The nature of these provisions and their enforceability in law also varies with
jurisdiction.
First, it is usually the case that NEDs should have – and have had – no business, financial or other connections with
the company during the past few years (again, the period varies by country). This means that, for example, the NED
should not have been a shareholder, an auditor, an employee, a supplier or a significant customer.
Second, cross-directorships are usually banned. This is when an executive director of Company A serves as a NED
in Company B and, at the same time, an executive director of Company B serves as a NED at Company A. Such a
relationship is considered to make the two boards too intimately involved with each other and potentially reduces the
quality of the scrutiny that the two NEDs involved in the cross-directorship can bring.
Third, restrictions or total bans on share options for NEDs are often imposed. These are intended to help ensure that
NEDs are able to stand slightly apart from the executive board and offer advice and scrutiny that are unhampered by
vested interests such as short-termism on the company’s share price.
Fourth, NED contracts sometimes allow them to seek confidential external advice (perhaps legal advice) on matters
on which they are unhappy, uncomfortable or uncertain. This should be at the company’s expense and helps the NED
to gain outside, objective advice on the issue he or she is concerned about. Finally, NEDs are usually time-limited
appointments (typically three years) and the number of terms that a NED can serve is also often limited, perhaps to
two consecutive terms.

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In conclusion, then, independence is an essential quality in a number of situations in corporate governance and in
professional behaviour. Independence is sometimes enhanced and underpinned by regulation and legislation, but
over and above that, it is expected of every professional person and of every professional accountant.
Internal audit
Internal audit – the control of controls – can feature as a key part of the corporate governance framework of an
organisation, and can be viewed as a high level control in response to risk or by considering the detailed work
required of internal audit.
 Introduction
 Decision to have an internal audit department
 Reporting to the audit committee
 Day-to-day internal audit
Introduction
Thinking about the internal audit (IA) function as the control of controls is useful for making sense of the way in
which the topic appears in Strategic Business Leader (SBL). IA features in the SBL Study Guide in the section on
internal control and review – specifically internal control, audit and compliance in corporate governance.
Think about how the topic of control arises when SBL covers the board of directors. It is best practice that ‘the board
should maintain sound risk management and internal control systems’ and ‘should establish formal and transparent
arrangements for considering how they should apply the corporate reporting and risk management and internal
control principles’ (UK Corporate Governance Code). The detailed provisions of the code then specify that there
should be an audit committee that ‘review[s] the company’s internal control and risk management systems’ and
‘should monitor and review the effectiveness of the internal audit activities’. It goes on to say that ‘where there is no
internal audit function, the audit committee should consider annually whether there is a need for an internal audit
function and make a recommendation to the board, and the reasons for the absence of such a function should be
explained in the relevant section of the annual report’.
The internal audit function

Decision to have an internal audit department
At each stage of the process the board faces a number of decisions: setting the firm’s risk appetite, assessing risks,
and then choosing which risks to accept, transfer, reduce or avoid. If a risk reduction response is adopted, the board
must then design an appropriate set of controls, possibly including establishing an internal audit function. In most
jurisdictions, especially where corporate governance is principles-based, IA departments are not required by statute
or regulation, but are considered best practice. However, as soon as the task of reviewing the company’s internal
control and risk management system reaches even a reasonably low level of complexity, the audit committee will
find that they need to delegate this work. This is clearly a sensitive task, as it involves investigating and discovering
how effective strategic and operational controls have been. It requires a skilled team of internal auditors, who can act

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independently and who will report back objectively to the audit committee. As you can imagine, it would be unusual
for a company of any size (not just a listed company) to be able to dispense with the services of an IA department,
which is why an explanation is required when there are no internal auditors.
One obvious issue to consider is what other factors apart from size would indicate that an IA department might be
required. It is not hard to come up with some of the relevant factors by reflecting that a company needs a control
when risk needs reducing. So factors giving rise to increased risk, such as complex or highly regulated transactions,
might suggest the need for the IA control to be deployed. You would, therefore, expect banks to have IA departments
since some of the transactions they handle are complex (accounting for financial instruments) and they operate in a
regulated industry.
In some regulated industries it is mandatory to have an internal audit department, but even where this is not the case
there may be close scrutiny of the company by the regulatory authority, which can apply significant sanctions such as
the removal of operating licences. When a compliance failing (including timely reporting to the regulator) might
mean that the company cannot operate at all, the case for an internal audit department becomes overwhelming.
Companies in regulated industries may also need the information from internal audit to use in their reports and
submissions to regulators and, so, reliable and accurate IA information is also needed to ensure the adequacy of this
reporting.
The UK’s influential Turnbull report provides some other suggestions for the factors that ought to be considered
when considering the establishment of an IA function. Some of them are things that might indicate risks. For
example, one factor – number of employees – might indicate risks directly (a large volume of payroll transactions to
process) but, more significantly, it indicates size and complexity, so perhaps widespread locations with complex
reporting lines and less shared culture (of risk awareness, or of integrity). Specific problems with internal controls
and an increase in unacceptable events are two other factors that might also be indicative of deeper issues within the
organisation. As well as an immediate problem that needs investigating, both suggest failings in the board-
implemented process of risk assessment and risk response, which – had it been done more effectively – might have
implied the need for an IA department.
Arising out of uncertainty, risk is fundamental to change. Any significant changes faced by the business will
therefore inevitably create risk, and the organisation should consider its need for internal audit. The changes
highlighted in the Turnbull report are changes in key risks and changes in the internal organisational structure.
Table 1: The Turnbull criteria to assess the need for internal audit
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
Reporting to the audit committee

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Let’s return to the idea that the internal audit department is carrying out the delegated work of the audit committee.
This is a fruitful area to explore because it explains some of the characteristics of effective (and ineffective) IA. The
audit committee is made up of independent non-executive directors (NEDs). This isn’t the place to explore the
concept of independence in detail, but independence is central to an effective IA department. The work of IA
becomes meaningless if it is compromised by management influence. Achieving independence is difficult, and made
more so because internal auditors are usually employees of the company.
The audit committee is one of the vital parts of the committee structure of sound corporate governance. Its role in
overseeing IA is important because it is the audit committee that ensures that the IA function actually supports the
strategic objectives of the company (and doesn’t act purely on its own initiative). In addition, though, it is likely that
the audit committee – at the strategic level – will not only provide the IA function with the authority it needs to
scrutinise the internal controls, but also to ensure that its work is actually supporting and providing the compliance
needs of the company. It is part of ensuring the hierarchical congruence or consistency necessary in sound
governance and strategic management.
Members of the IA function may encounter ethical threats (such as familiarity, self-review, independence threats,
and so on). An accountant working as an internal auditor, for example, may be unwilling to criticise the CFO if he
believes the CFO has an influence on his future prospects with the company. Someone coming into IA from an
operational position could also be exposed to a self-review threat. Even where external contractors are used to carry
out the IA function, they are acting on behalf of management. To avoid this, and other ethical threats, internal audit
work is one of the jobs expressly forbidden to external auditors under the terms of the Sarbanes–Oxley Act in the
US, indicating just how valuable a characteristic independence is for all auditors (other codes have similar
provisions).
There are some inherent limitations in what an IA department can achieve. Although corporate scandals sometimes
arise from failings in operational level controls, there are also examples where the problem is a failure of strategic
level controls, either arising from management override of controls (as at Enron) or through poor strategic level
decisions (as at some of the banks that required state support in the 2008 banking crisis). Even in companies where
excellent procedures are put in place to assess operational level controls, it is hard to imagine how IA can fully
monitor strategic controls. It would be very hard to design a corporate governance structure in which even the most
independent IA department had a mechanism to do much more than check that procedures have been followed at
board level. The board ultimately has to be responsible for the proper working of strategic level controls. This is also
illustrative of the way IA fits in to overall corporate governance. The corporate governance big picture has to be
addressed if IA is going to be effective. A domineering CEO cannot be countered by the existence of an IA
department. Indeed, interference in the work of internal audit would indicate broader corporate governance problems.
Day-to-day internal audit
In the Audit and Assurance (AA) exam, you will have studied the types of work carried out by internal auditors:
 value for money audits
 information technology audits
 best value audits
 financial audits
 operational audits.
One of the key differences between internal and external audit is that the scope of internal audit work in an
unregulated industry is determined by the company (specifically by the audit committee) while the scope of the
external auditors’ work is determined by the fact that they are undertaking a statutory audit, a legal requirement. IA
will mean something different in each organisation. In one company, the ‘internal audit’ department might only carry
out quality control checks, while in another it is a sophisticated team of specialists with different expertise that reflect
the risks faced by that organization, including the regulatory requirements placed upon it.
Whether the IA department is carrying out a review of the process of designing systems, or a review of the operation
of controls within those systems, will depend on the current concerns of the organisation. In an exam it would be
wise to tailor the suggestions made for IA to the concerns hinted at in the scenario. For example, in a highly
regulated business where compliance failures are a significant risk, monitoring compliance might be a key task
assigned to IA. If safeguarding assets is a key concern you could discuss how IA might be involved in a review of
the safeguarding of assets. You may have noted that the last two suggestions both relate to the Turnbull statements
about a sound system of internal controls. Any of those could be related to the work of internal audit – for example,
IA might need to review the implementation of corporate objectives.
SBL also covers issues of sustainability, environmental and social responsibility. IA is a resource that could be
deployed to monitor how effective a company’s corporate social responsibility (CSR) policies are. This could mean
monitoring how well the policies have been implemented or it could mean IA monitoring how well CSR policies and

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wider corporate objectives are aligned with each other. Schemes like the European Union’s Eco-Management and
Audit Scheme (EMAS) provide an example of an instance where specific monitoring of targets (by IA) is an
externally imposed requirement on a company. ISO 14000, another environmental standard, also explicitly requires
internal audits and reports to management.
To sum up, internal audit is the control of controls. It can feature in SBL as a key part of the corporate governance
framework of an organisation, and it can be viewed through the lens of risk management as a high level control in
response to risk or by considering the detailed work required of IA. Finally, as a key component of the control
system, it is important to maintain the integrity of internal audit and, from this perspective, issues of professional
ethics and characteristics such as independence come into play.
Adapted from an article originally written for P1 by Amanda Williams (a tutor and subject specialist at BPP
Professional Education)
Job design
This article focuses on section H2 of the Strategic Business Leader (SBL) study guide.
 Introduction
 Scientific management
 The human relations school
 Theories of motivation
 Job design theory
 Job design in practice
 Japanese work practices
 Re-engineering
 Post-industrial job design
 Ethical issues of job design
Introduction
H: PEOPLE
Strategy and people: job design
(a) Assess the contribution of four different approaches to job design (scientific management, job enrichment,
Japanese management and re-engineering).
(b) Explain the human resource implications of knowledge work and post-industrial job design.
(c) Discuss the tensions and potential ethical issues related to job design.
Scientific management
Job design can be thought of as starting with the work of Frederick Taylor (1856–1915) who devised ‘scientific
management’ in the early 20th century. It will seem odd to you now, but before Taylor’s ideas, management played
little part in determining how workers could best achieve their tasks. Management would, of course, make sure that
workers came to work and would even set production targets, but it was largely left up to each worker to get on with
it. This omission in the management function probably arose because until the middle of the 1800s many jobs and
professions were more like crafts where the craftsmen were assumed to know best. However, with growing
industrialisation craft industries gave way to large manufacturing companies, but until Taylor, management was
reluctant to interfere with the detail of work practices.
Taylor believed that it was a duty of management to discover the best way of accomplishing tasks and then to
instruct their workforce in these methods. Management’s discoveries were to be based on scientific methods such as
trying out different approaches and measuring the results, for example, by timing operations and analysing their
component parts. As a result of these investigations, workers should become more productive – and boost their
earnings.
Often management’s scientific experiments concluded that maximum productivity was achieved by breaking down
processes into small steps and then requiring each worker to repeatedly carry out one step only. When this approach
was combined with Henry Ford’s invention of the production line (where workers had little control over the speed at
which they had to work) the jobs were repetitive, low skilled, pressurised, and neither satisfying nor motivating. It
was certainly difficult to take a pride in the finished product and quality often suffered. However, the de-skilling of
jobs provided employers with more power over their workforce. In a woodwork business instead of employing
skilled carpenters to make entire chairs it is easier and cheaper to have one employee who only cuts lengths of wood,
another employee who only drills holes and so on. Each of these employees is low-skilled, easily replaced and cheap.
The human relations school

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In the late 1920s and the 1930s Elton Mayo supervised a series of experiments at Western Electric's Hawthorne
factory. These became known as the ‘Hawthorne experiments’. Although there is considerable criticism of the
methodologies and conclusions drawn from the Hawthorne experiments, two of their widely believed discoveries
were:
 The power of peer pressure (groups norms)
 Motivation (and performance) can be improved by establishing better working relationships and social
interactions.
Peer pressure and group norms can be used to increase the performance of a worker who is in a team because of the
disapproval of other team members if the employee lets the team down.
Motivation improvements from better working relations and interactions, for example taking an interest in
employees, recognising achievement and soliciting suggestions, implies that the job specialisation production line
automaton approach might not be the most successful approach.
Theories of motivation
There are many theories of motivation, but three of the earliest, dating from the 1950s, are:
 Maslow’s hierarchy of needs
 Herzberg’s hygiene factor theory
 McGregor’s Theory X and Theory Y
Without getting into too much detail, Maslow claimed we have higher order needs, such as social needs, ego needs
and self-actualisation needs. If the work environment can supply these then employees will be motivated.
Herzberg suggested that after basic (hygiene) factors had been put in place, motivation at work was achieved through
motivating factors such as challenge, responsibility, recognition and a feeling of advancement through learning new
skills.
McGregor suggested that not everyone wants the same things from work. Theory X people like certainty and
direction whereas Theory Y people prefer more challenge, risk and freedom. Managers should act accordingly,
matching their approach to what their employees will respond to.
Job design theory

The theories of Maslow and Herzberg have a resonance with the human relations school started by Mayo. All
suggest that there is more to successful work practices than simply requiring people to unthinkingly repeat simple
tasks: challenge, variety, initiative, recognition and team-work are all seen as valuable contributors to motivation and
productivity. Undoubtedly there will be some situations where traditional production lines, in which each person
does only a repetitive simple task, will minimise the marginal cost of production. However, those calculations would
not take into account:
 The costs of recruitment and training caused by high staff turnover that is likely to result if employees
dislike their jobs.
 The costs of staff shortages.
 Poor quality because employees do not identify with what they are producing.
 Disengagement of employees from trying to improve production methods.
In the 1960s and 1970s these considerations gave rise to the job redesign movement which attempted to improve jobs
(and employee performance) by deliberately designing ‘better’ jobs. A useful way considers a job’s design elements
are the job characteristic model (Hackman and Oldman, 1980) where five core job characteristics were identified:
 Skill variety: Does the job require various activities that in turn require workers to develop a variety of
skills and talents?
 Task identity: Does the job allow the employees to identify with the work in hand (the finished item or
service)?
 Task significance: Does the job impact other people’s lives, either society in general, the firm or a sub-
group within the firm?
 Autonomy (responsibility): Does the job provide the employee with significant freedom, independence,
and discretion in scheduling the work and in determining the procedures to be used in carrying it out?
 Feedback (knowledge of the results of work): Is the employee provided with feedback about
effectiveness and performance?
The first three, above, contribute to the meaningfulness of the work or job.
Hackman and Oldman suggested that these characteristics should produce the following outcomes:
 High intrinsic motivation, leading to high productivity
 High job performance (quality)

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 High employee satisfaction

 Low absenteeism
 Low employee turnover.
Job design in practice

The practice of deliberate improvement in a job’s characteristics can be called ‘job enrichment’ of which there are
three types: job enlargement, job rotation and (with rather confusing terminology) a method known as job
enrichment.
Job enlargement means allowing an employee to take on more tasks, but still at the same level. So if you were
working on a car assembly line, instead of merely fitting the front wheels, you are now asked to fit the front and rear
wheels and the bumpers (fenders). The job cycle time is increased (you would spend longer on each car), there is
some more variety and therefore less boredom. Note however, that all of these tasks are at the same level: basic,
repetitive assembly tasks.
Job rotation moves employees round, perhaps on a daily basis, from one simple task to another. So, one day the car
worker might be on wheels and bumpers, the next day the worker might be fitting the front and rear windows. The
third day would be a different set of tasks. Again this introduces the employee to some additional skills (though all at
the same level) reduces boredom and is perhaps beginning to give more insight into task identity: building a car.
Job enrichment is a vertical change because it gives an employee some responsibility, discretion and authority that
would previously been exercised by supervisors and managers. So now the car worker might be expected to perform
some quality control checks as the car is being worked on, or might be responsible for reporting production
problems. Not only does this increase task significance but it adds to autonomy. Feedback can also become more
comprehensive.
In 1974 the Volvo car company built a new plant at Kalmar in Sweden which was based on teams of workers
responsible for entire sub-units of car assembly, such as the wiring system. Encouraged by these results, the
company built a much larger plant at Uddevalle where each team was responsible for entire car construction.
Employees were happy, quality was improved, but productivity was reduced because this approach took about twice
as long to build a car as it would in a conventional production line. Neither factory lasted for long; the final irony
was that Volvo was sold to Ford (still with its conventional production lines) in 2000.
However, the Volvo experiment in fully autonomous group working should not be seen as evidence that all forms of
group working and job enrichment are undesirable. As explained below, Japanese work practices make use of these
techniques.
Japanese work practices

Japanese work practices are important because of the great success of Japanese mass production that began in the
late 1970s. There are several key components:
Flexibility: frequently seen in the concept of cellular manufacturing in which a team of workers is responsible for
the production of complete items. The employees are in semi-autonomous, multi-skilled teams and instead of the
production machinery being arranged linearly, it will often be in ‘U’ shape to allow workers to be involved in variety
of tasks. Fairly obviously, these arrangements promote better job-design in terms of Hackman’s and Oldman’s core
job characteristics. The group of employees working in a cell are semi-autonomous so that they can be flexible in
their approach – provided targets for quality and quantities are met.
Quality control: quality is promoted by identification with the final product, peer pressure and the concept of
Kaizen in which continuous small improvements are sought. Quality control circles (QCC) are an important aspect of
the Japanese approach as workers meet regularly (for example, at the start of each day) and discuss work-related
problems such as quality, productivity and safety. Recommendations for changes can be referred to more senior
managers. QCCs can greatly enrich jobs by providing outlets for higher skills, variety, task significance and
feedback.
Minimum waste: flowing naturally from quality control and flexibility but also promoted by technologies such as
just-in-time inventory management.
Re-engineering
Automation, rationalisation and business process re-engineering (BPR) will all have an effect on job content and so
job design should be taken into account during these processes. All have the potential to make employees’ jobs either
better or worse. For example:

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Automation could remove low skilled drudgery from a job, leaving the employee more time to concentrate on more
interesting and demanding tasks. Alternatively, automation could remove the need for employees to exercise skill
and talent and could simply turn them into machine minders.
Similarly, job rationalisation might result in employees being forced to work in a traditional production line where
they have no influence on the rate that work has to be done. Or, by freeing employees from frustrating bottlenecks in
the flow of material or information, rationalisation could provide employees with much greater flexibility.
BPR is the most radical type of change a business can attempt. It can be defined as:
'The fundamental rethinking and radical redesign of business processes to achieve dramatic improvements in critical
contemporary measures of performance such as cost, quality, service and speed' (Hammer and Champy, 1993)
This is far beyond what could be called process improvement and process redesign. One of the most famous
examples of BPR was in the accounts payable department of Ford Motor Company. That had been run on traditional
lines: order, wait for goods received note, wait for invoice and then check that the prices and calculations are correct;
The goods were ordered and received, the invoice posted and then paid. An enormous amount of employee time was
taken up with the dull process of matching documents, comparing amounts and reperforming calculations.
Ford then told their suppliers not to send invoices. Ford knew what they had ordered at what price and whether or not
the goods had been received. After the goods were received Ford would send payment without the need for an
invoice. Suddenly prices and invoices didn’t have to be checked nor compared to goods received notes. Hammer
reported that Ford managed to reduce its staff in accounts payable by around 75%. Presumably the employees who
were left had most of their time taken up by the more interesting tasks of dealing with problems rather than repetitive
clerical work.
Post-industrial job design

Knowledge work can be distinguished from ‘ordinary work’ by its information content, its non-routine nature and its
requirement for problem-solving. Knowledge work requires knowledge workers to carry it out and these employees
will be highly trained to acquire the relevant knowledge, keep it up-to-date and to use it.
Within an organisation, the knowledge that is of value to it is likely to be widely disseminated and not confined to
top management. Different employees will have different knowledge specialities which will have to be combined
from time-to-time to address customer needs. Mass production is less likely in these organisations than is providing
bespoke products and services. Even if mass production were used, each product would have a short life and would
soon be superseded by a new, better one.
Success for these organisations depends on:
 Flexibility to provide new products and services.
 Exploiting knowledge quickly before it goes out of date.
 Being open to new knowledge and ideas.
 Grabbing opportunities as they arise.
The job design for the knowledge workers in these organisations must embrace these essentials. Therefore post-
industrial job design would be expected show:
 Wide flat organisation structures. This is essential to shorten the distance knowledge has to flow between
the bottom and top of the organisation. A shorter distance means faster and more accurate flows.
 An openness by managers to learn from new and junior employees. For example, a new, young employee
is likely to know more about the importance of social media in marketing than the manager who has been with the
company for 20 years.
 The quick formation of temporary teams to address new, perhaps fleeting, opportunities.
 Multi-skilled employees to provide the flexibility to form the required teams.
 Autonomy for teams to solve problems so that solutions are delivered to customers.
 Task identity so that employees fully understand the unique task that they have been assigned to.
 Feedback. Knowledge workers are hungry for feedback from managers, colleagues and customers because
performance cannot be measured by, for example, units produced.
Ethical issues of job design

Finally, this article briefly mentions some ethical issues that can arise from job design:
 Although the article has championed how employees appreciate more challenge, autonomy and variety,
these qualities also give rise to more risks for employees: they might make a wrong decision. McGregor’s Theory X
and Theory Y mentioned above recognised that not everyone wants more freedom. Some people want a relatively
quiet undemanding job that they can go home and forget about. For these employees, job enrichment is likely to be
unwelcome.

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 Some aspects of redesign bring with them additional employee monitoring. For example, in call centres,
employees will be expected to judge the mood of a customer and to use their judgement in how to deal with that
customer. But call centres record details of conversations, how long each conversation lasts, and they often allow
customers to rate the employee.
 It is important to take equal pay for equal work, equal opportunities and safe working into account. Multi-
skilled teams are all very well provided each team member is properly trained so that they can carry out the required
variety of tasks efficiently and safely.
 Bullying can become an issue. Teams of employees are given tasks such as completing a certain number of
units in a day. They might be competing against other groups to win an award. In such an environment members of
the team who are perceived as ‘weak links’ could be subjected to severe bullying and ridicule. Their colleagues
might hope that this will force them to leave so that a better team member can be employed.
 Some writers view BPR as a fraud on employees. BPR is often driven or justified by the need to alter the
business radically so as to recognise that, above all, customers must be given what they demand. Unless workers are
prepared to change their work patterns (that is, adopt new job designs) then they get what’s coming to them:
redundancy. BPR can therefore be used as a cloak to disguise other company objectives.
Organising transactions
Is transaction cost theory just simply a different lens through which agency theory may be observed and analysed?
Are both theories trying to tackle the same problem: how do we persuade company management to pursue
shareholders’ interests and company/shareholder profit maximisation rather than self-interest?
 Introduction
 Bounded rationality and opportunism
Introduction
Transaction costs occur whenever a good or service is transferred from a provider to a user.
If the finance director (FD) of a listed company is tasked with lowering the transaction cost of the finance department
in order to increase investment returns and deliver the most economically viable transaction solution to the
shareholders, what will the FD need to consider?
The FD will need to decide the appropriate governance structure, whether to internalise transactions and keep all of
the roles undertaken in the department in-house, or whether to outsource and buy in some of the roles from the
external market. When transactions occur within an organisation the transaction costs can include managing and
monitoring the employees within the department and procuring inputs and capital equipment. The transaction cost of
buying the finance services provision from an external provider can include the cost of supplier searching,
negotiation, performance management and dispute resolution. Thus, the organisation of transactions or 'governance
structure' can affect transaction cost.
There are two assumptions underlying the choice between market and internalising. They are bounded rationality and
opportunism.
Bounded rationality and opportunism

Bounded rationality refers to the fact that the FD will have limited capacity to understand business situations which
limits the factors considered in the decision. Equate this to running your own business and using the services of an
accountant who you pay fees to on an ad hoc basis for sorting out your VAT and tax. It is likely you have been using
the services of the same accountant for a substantial period of time. You continue with the relationship knowing you
will get a satisfactory service. You do not know that it is the best or optimal solution as you do not try other
accountancy options. Why do you not try anywhere else? That is because of performance uncertainty. You cannot
guarantee the quality of any other accountant and would put yourself at risk if you made a decision to purchase the
services of an accountant you are not familiar with or have not heard about.
Opportunism refers to the possibility that the FD or the service provider will act in their own self-interest. That is,
some people may not be entirely honest and truthful about their intentions some of the time, or they may attempt to
make use of unexpected circumstances that gives them the chance to make the most from another party in a
transaction. This creates mistrust between parties. In a world of opportunism, individuals cannot be assumed to keep
their promises to fulfil their obligations and to respect the interests of their trading partners unless safeguards are in
place. Equate this to obtaining information that your accountant is experiencing personal financial difficulties and
cannot afford to lose any customers so you negotiate a reduction in the amount of fees you pay. You are making the
most of the unexpected circumstances that your accountant is in and with no contract in place your accountant has no
safeguard.

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Transaction cost theory can be further impacted by three variables:

 Frequency – how often a transaction is made
 Uncertainty – from bounded rationality, opportunism and the difficulty of predicting the future
 Asset specificity – whether the product/service can be put to alternative uses
Frequency refers to the occurrence of the economic transaction. The FD is not likely to have strong justification for
having 'in-house' provisions of a good or service that is rarely used. In principle, if some of the services of the
finance department are used infrequently, and the services are not unique to the company, then it is likely that the
market will offer scale and scope benefits, making outsourcing the favoured option. If you needed the services of
your accountant every day, then it may be beneficial for you to employ an accountant on a full-time basis. Unless the
accounting services are used frequently, then it can offer little advantage over the market where the accountant’s core
competence is in the service required and, due to the service cost being spread across many customers, the service
can be offered at a price that compares to the permanent structure of employing an accountant full time solely for
your benefit.
Uncertainty causes problems because of bounded rationality and the danger of opportunism and the difficulty to
predict possible events that may occur during the course of a transaction. Transactions that require a commitment
over time have more uncertainty built in. The FD might be uncertain about whether the outsourced partner might go
out of business or try to renegotiate the contract at some future time during the life of the contract. The FD will need
to safeguard the contract to protect the company – this is likely to raise the costs of contract and performance
management. You are unlikely to sign a long-term contract with your accountant as you might move location in the
future making it too difficult to continue to use the services. In the absence of a contract with your accountant, it is
also easy for you to walk away if the service delivery falls. If the service delivery falls for the FD this would be
evaluated against the terms of the outsourcing contract and consideration would need to be given to using other
suppliers or continuing with the same supplier.
Asset specificity relates to the specialisation of the asset. As assets become more specialised, they become less
transferable to another provider or to the market. Economies of scale then become more easily organised internally.
A central premise of transaction cost theory is that transaction cost increases when those who transact make greater
asset-specific investments. The services required by the FD are likely to be required by many other companies
making a market solution contract less complex and financially feasible. The skills of your accountant are required
by many people who own their own business, so the cost of delivery is spread over many transactions allowing for
you to obtain the service at a lower cost than the full-time employment of an accountant.
Clearly, it appears to be in the interest of the FD to internalise transactions as much as possible. The main reason for
this is that internalisation removes the risks and uncertainties about future prices and quality. It allows the FD to
remove the risk of dealing with suppliers and mistrust between parties. The FD will organise transactions to suit his
or her own best interest and this activity needs to be controlled.
For many types of transactions, markets are the preferred governance structure because the supplier can provide
incentives, the supplier reaps the full benefits or bears the full costs of its own activities, and thus has a strong
incentive to maximise value of net production costs. The external supplier can also provide other benefits, such as
improved performance because of greater specialisation in their area of expertise.
The corporate governance problem of transaction cost theory is the effective and efficient accomplishment of
transactions by companies. Efficient governance structures depend on the characteristics of the transaction. Company
management need to pursue the most economically viable solution and not their own interest.
Adapted from an article written by a member of the P1 examining team
Performance appraisal
Performance appraisal requires good interpretation and a good understanding of what the information means in the
context of the question.
 Introduction

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 Specific problems
 Use the scenario
 Know the basics
 Profitability
 Liquidity
 Conclusion
Introduction
Performance appraisal is an important aspect of the Financial Reporting (FR) exam and of interest to Strategic
Business Leader candidates. At this level you are not only required to prepare financial statements but understand the
information underpinning the results.
You will often be required to make use of ratios to aid interpretation of the financial statements for the current year
and to compare them to the results of a prior period, another entity, or against industry averages.
Increasingly, candidate exam performance is demonstrating a lack of commercial awareness and knowledge that
barely stretches past the 'rote learned' phase. Candidates regularly state facts such as 'gross profit margin has
increased' or, 'payables days have gone down' but this offers no interpretation of the reason behind the change in
ratio. As a result markers find it difficult to award sufficient marks to candidates to achieve a pass.
This article is designed to aid candidates in understanding what is expected to create a solid answer to a performance
appraisal question.
Specific problems
When marking this style of question there are some common weaknesses that are identified, some of which are
highlighted below:
 limited knowledge of ratio calculations
 appraisal not linked to scenario
 poor understanding of the topic
 limited understanding of what accounting information represents
 lack of commercial awareness
 discursive elements often not attempted
 inability to come to a conclusion
 poor handwriting (often illegible in some instances)
 poor English.
Use the scenario

The majority of questions that feature in Question 3 have an accompanying scenario to the question requirement. A
weak answer will make no attempt to refer to this information in the appraisal and, therefore, will often score few
marks. It is important that you carefully consider this information and incorporate it into your appraisal because it
has been provided for a reason. Do not simply list all the possibilities of why a ratio may have changed; link the
reason to the scenario that you have been provided with.
Example
The question scenario may provide you with a set of financial statements and some further information such as
details of non-current assets (potentially including a revaluation, a major acquisition or disposal) or measures
undertaken during the year in an attempt to improve performance. When constructing your answer you must consider
the effect that information such as this would have on the company results.
A major asset disposal would most likely have a significant impact on a company's financial statements in that it
would result in a profit or loss on disposal being taken to the statement of profit or loss and a cash injection being
received. It is worth noting that while the current year results will be affected by this, it is a one-off adjustment and
bears little resemblance to future periods. When calculating ratios the disposal will improve asset turnover as the
asset base becomes smaller over which revenue is spread and will, therefore, also improve return on capital
employed. The operating margin is likely to be affected also as the profit or loss on disposal will be included when
calculating this.
It is often worth calculating some of the results again (eg ROCE or operating profit margin) as part of your
interpretation without the one?off disposal information, as arguably this will help make the information more
comparable to the results that do not include such disposals (if time is limited a comment about the disposal's effect
will be sufficient).

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From a liquidity point of view the cash received on disposal of the asset will have aided cash flow during the year -
ask yourself what would have happened if the company had not received this cash - ie are they already operating on
an overdraft? If so, the cash flow position would be far worse without the disposal cash.
If a revaluation of non-current assets has taken place during the year the capital employed base will grow – this will
have the impact of reducing both the asset turnover and return on capital employed ratios without any real change in
operating capacity or profitability.
A major asset purchase again would cause both asset turnover and return on capital employed to deteriorate as the
capital employed base would grow. It may appear that as a result of the acquisition the company has become less
efficient at generating revenue and profit but this may not always be the case.
If, for example, the purchase took place during the latter half of the year, the new asset will not have contributed to a
full year's profit and it may be that in future periods the business will begin to see a better return as a result of the
investment. When analysing the performance and position of the company, if management have implemented
measures during the year to improve performance it is worth considering whether or not these measures have
actually been effective. If, for example, a company chose to give rebates to customers for orders above a set quantity
level - this would have the impact of improving revenue at the sacrifice of gross profit margin.
Know the basics

Ratios can generally be broken down into several key areas: profitability, liquidity, gearing and investment. As a
candidate taking the FR exam you need to know the formulae for the relevant ratios and also what movements in
these ratios could possibly mean. Provided below is a brief overview of the key ratios and what movements could
indicate – further clarification and understanding can be found through your study text and then by practising past
questions (due to the limited space of this article, investment ratios will not be discussed but this does not make them
any less important).
Profitability
Return on capital employed (ROCE)
Profit before interest and tax
Shareholders' equity + debt
This ratio is generally considered to be the primary profitability ratio as it shows how well a business has generated
profit from its long?term financing. An increase in ROCE is generally considered to be an improvement.
Movements in return on capital employed are best interpreted by examining profit margins and asset turnover in
more detail (often referred to as the secondary ratios) as ROCE is made up of these component parts. For example,
an improvement in ROCE could be due to an improvement in margins or more efficient use of assets.
Asset turnover
Revenue
Total assets - current liabilities
Asset turnover shows how efficiently management have utilised assets to generate revenue. When looking at the
components of the ratio a change will be linked to either a movement in revenue, a movement in net assets, or both.
There are many factors that could both improve and deteriorate asset turnover. For example, a significant increase in
sales revenue would contribute to an increase in asset turnover or, if the business enters into a sale and operating
lease agreement, then the asset base would become smaller, thus improving the result.
Profit margins
Gross or Operating profit
Revenue
The gross profit margin looks at the performance of the business at the direct trading level. Typically variations in
this ratio are as a result of changes in the selling price/sales volume or changes in cost of sales. For example, cost of
sales may include inventory write downs that may have occurred during the period due to damage or obsolescence,
exchange rate fluctuations or import duties.
The operating profit margin (or net profit margin) is generally calculated by comparing the profit before interest and
tax of a business to revenue, but, beware in the exam as sometimes the examiner specifically requests the calculation
to include profit before tax.
Analysing the operating profit margin enables you to determine how well the business has managed to control its
indirect costs during the period. In the exam when interpreting operating profit margin it is advisable to link the
result back to the gross profit margin. For example, if gross profit margin deteriorated in the year then it would be
expected that operating margin would also fall.

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However, if this is not the case, or the fall is not so severe, it may be due to good indirect cost control or perhaps
there could be a one-off profit on disposal distorting the operating profit figure.
Liquidity
Current ratio
Current assets
Current liabilities
The current ratio considers how well a business can cover the current liabilities with its current assets. It is a common
belief that the ideal for this ratio is between 1.5 and 2 to 1 so that a business may comfortably cover its current
liabilities should they fall due.
However this ideal will vary from industry to industry. For example, a business in the service industry would have
little or no inventory and therefore could have a current ratio of less than 1. This does not necessarily mean that it has
liquidity problems so it is better to compare the result to previous years or industry averages.
Quick ratio (sometimes referred to as acid test ratio)
Current assets - inventory
Current liabilities
The quick ratio excludes inventory as it takes longer to turn into cash and therefore places emphasis on the business's
'quick assets' and whether or not these are sufficient to cover the current liabilities. Here the ideal ratio is thought to
be 1:1 but as with the current ratio, this will vary depending on the industry in which the business operates.
When assessing both the current and the quick ratios, look at the information provided within the question to
consider whether or not the company is overdrawn at the year-end. The overdraft is an additional factor indicating
potential liquidity problems and this form of finance is both expensive (higher rates of interest) and risky (repayable
on demand).
Receivables collection period (in days)
Receivables x 365
Credit sales
It is preferable to have a short credit period for receivables as this will aid a business's cash flow. However, some
businesses base their strategy on long credit periods. For example, a business that sells sofas might offer a long credit
period to achieve higher sales and be more competitive than similar entities offering shorter credit periods.
If the receivables days are shorter compared to the prior period it could indicate better credit control or potential
settlement discounts being offered to collect cash more quickly whereas an increase in credit periods could indicate a
deterioration in credit control or potential bad debts.
Payables collection period (in days)
Payables x 365
Credit purchases*
*(or cost of sales if not available)
An increase in payables days could indicate that a business is having cash flow difficulties and is therefore delaying
payments using suppliers as a free source of finance. It is important that a business pays within the agreed credit
period to avoid conflict with suppliers. If the payables days are reducing this indicates suppliers are being paid more
quickly. This could be due to credit terms being tightened or taking advantage of early settlement discounts being
offered.
Inventory days
Closing (or average) inventory x 365
Cost of sales
Generally the lower the number of days that inventory is held the better as holding inventory for long periods of time
constrains cash flow and increases the risk associated with holding the inventory. The longer inventory is held the
greater the risk that it could be subject to theft, damage or obsolescence. However, a business should always ensure
that there is sufficient inventory to meet the demand of its customers.
Gearing
Debt or Debt
Equity Debt + equity
The gearing ratio is of particular importance to a business as it indicates how risky a business is perceived to be
based on its level of borrowing. As borrowing increases so does the risk as the business is now liable to not only
repay the debt but meet any interest commitments under it. In addition, to raise further debt finance could potentially
be more difficult and more expensive.

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If a company has a high level of gearing it does not necessarily mean that it will face difficulties as a result of this.
For example, if the business has a high level of security in the form of tangible non-current assets and can
comfortably cover its interest payments (interest cover = profit before interest and tax compared to interest) a high
level of gearing should not give an investor cause for concern.
Conclusion
In the exam make sure all calculations required are attempted so that you can offer possible reasons for any change
in the discussion part of the question.
There is no absolute correct answer to a performance appraisal question. What sets a good answer apart from a poor
one is the discussion of possible reasons for why (specifically in the given scenario) changes in the ratios may have
occurred.
Adapted from an article originally written by Bobbie Retallack (a Kaplan Publishing's content specialist for
the FR exam)
Performance indicators
This article explains and illustrates key performance indicators and critical success factors.
 Introduction
 Objectives
 Critical success factors
 Performance indicators and key performance indicators
 Performance measures – a practical framework
 Use of performance indicators in the SBL and APM syllabi
Introduction
Both Strategic Business Leader (SBL) and Advanced Performance Management (APM) require candidates to be able
to establish key performance indicators and critical success factors. For example, Question 1 of December 2013
APM illustrates this.
A surprising number of candidates do not feel comfortable with these terms, and this article is aimed at explaining
and illustrating these concepts. In particular it will explain what is meant by:
 Performance
 Objectives
 Critical success factors
 Performance indicators
 Key performance indicators.
Performance
This can be defined as:
‘A task or operation seen in terms of how successfully it is performed’ (www.oxforddictionaries.com).
Organisations differ greatly in which aspects of their behaviour and results constitute good performance. For
example their aim could be to make profits, to increase the share price, to cure patients in a hospital, or to clear
household rubbish. The concept of ‘performance’ is very relevant to both SBL and APM. SBL looks at how
organisations can make decisions that improve their strategic performance and APM is focused on how organisations
evaluate their performance.
The primary required tasks are often found in the organisation’s mission statement as it is there that the
organisation’s purpose should be defined. These are called ‘primary required tasks’ because although the primary
task of a profit-seeking business is to make profits, this rests on other subsidiary tasks such as good design, low cost
per unit, quality, flexibility, successful marketing and so on. Many of these are non-financial achievements.
Some aspects of performance are ‘nice to have’ but others will be critical success factors. For example, the standard
of an airline’s meals and entertainment systems will rank after punctuality, reliability and safety, all of which are
likely to be critical to the airline’s success.
Objectives
Objectives are simply targets that an organisation sets out to achieve. They are elements of the mission that have
been quantified and are the basis for deciding appropriate performance measures and indicators. There is little point
measuring something if you do not know whether the result is satisfactory and cannot decide if performance needs to

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change. Organisations will create a hierarchy of objectives which will include corporate objectives which affect the
organisation as a whole and unit objectives which will affect individual business units within the organisation. Even
here objectives will be categorised as primary and secondary, for example an organisation might set itself a primary
objective of growth in profits but will then need to develop strategies to ensure this primary objective is achieved.
This is where secondary objectives are needed, for example to improve product quality or to make more efficient use
of resources.
Objectives often follow the SMART rule. They should be:
Specific: there is little point in setting an objective for a company to improve its inventory. What does that mean? It
could mean that stock-outs should be less frequent, or average stock holdings should be lower, or the inventory will
be held in better conditions to reduce wastage.
Measurable: if you can’t measure something you will be at a loss as to how to control it. Some aspects of
performance might be difficult to measure, but efforts must be made. Customer satisfaction is important to most
businesses and indications could be obtained by arranging customer surveys, repeat business and so on.
Achievable/agreed/accepted: objectives are achieved by people and those people must accept and agree that the
objectives are achievable and important.
Relevant: relevant to the organisation and the person to whom the objectives are given. It is important that people
understand how achieving an objective will help organisational success. If this connection isn’t clear, employees will
begin to feel that the objective is simply a cynical exercise of management power. The person to whom the objective
is given must also feel that they can affect its achievement.
Time-limited: all objectives have to be achieved within a specified time period otherwise procrastination will rule.
Critical success factors

A critical success factor (CSF) can be defined as:
‘An area where an organisation must perform well if it is to succeed.’
Alternatively, Johnson, Scholes & Whittington defined CSFs as:
'Those product features that are particularly valued by a group of customers, and, therefore, where the organisation
must excel to outperform the competition.’
This definition is more complex than the first, but it is more useful because it makes the organisation look towards its
customers (or users) and recognises that their opinion of excellence is more important and reliable than internally
generated opinions. If an organisation doesn’t deliver what its customers, clients, patients, citizens or students value,
it is failing.
Performance indicators and key performance indicators

Performance indicators (or performance measures) are methods used to assess performance. For example:
In profit-seeking organisations:
 Profit
 Earnings per share
 Return on capital employed
In not-for-profit organisations:
 Exam grades (a school)
 Waiting times for hospital admission (a health service)
 Condition of roads (a local government highways department)
Particularly in profit-seeking organisations, the prime financial performance indicators allow performance to be
measured but they say little about how that performance has been achieved. So, high profits will depend on a
combination of good sales volumes, adequate prices and sufficiently low costs. If high profits can only be achieved
by a satisfactory combination of volume, price and cost, then those factors should be measured also and will need to
be compared to standards and budgets.

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Similar effects are found in not-for-profit organisations. For example, in a school, a CSF might be that a pupil leaves
with good standards of literacy. But that might depend on pupil-teacher ratios, pupils’ attendance and the experience
of the teachers. If these factors contribute to good performance, they need to be measured and monitored.
Just as CSFs are more important than other aspects of performance, not all performance indicators are created equal.
The performance indicators that measure the most important aspects of performance are the key performance
indicators (KPIs). To a large extent, KPIs measure how well CSFs are achieved; other performance indicators
measure how well other aspects of performance are achieved
There are a number of potential pitfalls in the design of performance indicators and measurement systems:
 Not enough performance measures are set
Often, directors and employees will be judged on the results of performance measures. It has been said that
‘Whatever gets measured gets done’ and employees will tend to concentrate on achieving the required performance
where it is measured. The corollary is that ‘Whatever doesn't get measured doesn't get done’ and the danger is that
employees will ignore areas of behaviour and performance which are not assessed.
 Too many performance indicators

This occurs especially where performance measures are not ranked by importance and none have been identified as
KPIs. Performance indicators have to be measured, calculated and reported to management, and discrepancies must
be explained or excuses invented. Too many measures can divert time from more important tasks and there is a
danger that employees concentrate on the easier but more trivial measures than on the more difficult but vital targets.
 The wrong performance measures

An example of this would be applying strict cost measures in an organisation where luxury products and services are
sold (a differentiation strategy). This is likely to detract from the organisation’s strategic success.
 Too tight/too loose performance measures

Performance indicators that are too difficult to attain can lead to a loss of employee motivation and promote
dysfunctional behaviours such as gaming and the misrepresentation of data. Performance measures that are too loose
can pull down performance. Benchmarking can help to avoid this. Internal benchmarking generally sets measures
based on previous period’s measures or set measures with respect to other branches or divisions. However these
internal benchmarks can lead to complacency as many organisations have to compete with others and benchmarks
should be aligned to competitors’ performance.
 ‘Hit and run’ performance indicators

This means that a performance indicator is set and then it is assumed that things will look after themselves.
Performance indicators need a management framework they are to be at all effective.
Performance measures – a practical framework

Expanding on the last point, above, to establish a performance measurement system, something like the following is
needed for each measure:
1. A meaningful title of the measure
2. What is its purpose and how does that purpose relate to strategic success?
3. What other performance measures might be affected by this one, how are they affected and how are
conflicts to be resolved?
4. Who will be held responsible for it?
5. What is the source data, who is responsible for its supply, how is it measured and how is the measure
calculated?
6. What investigations and explanations are required and who is responsible?
7. What target is set and how has that target been determined?
8. How often should the target be updated?
9. How often is the measure reported on?
10. Reporting and action?
For example, consider a passenger train company called TTTE:
1. Title of performance Punctuality (the percentage of trains arriving at their destination on time)

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measure
2. Purpose of TTTE’s strategic objective is to provide comfortable, reliable and punctual services
performance measure to passengers. TTTE competes with other train companies, cars, buses and airlines.
Punctuality is seen as a key competitive lever and therefore must be measured
3. Other performance Safety – safety checks and speed limits will take priority over punctuality
measures affected Cleanliness – it might be necessary to occasionally reduce cleaning to keep to the
timetable
Energy consumption running a train faster than normal (though within speed limits)
will cause higher fuel consumption but punctuality takes precedence
4. Who is held Operations director

responsible?
5. Source data, The duty manager at each station is responsible for logging the arrivals time of each
measurement and train. A five-minute margin is allowed ie a train is logged ‘on time’ if it is no later
calculation of the than 5 minutes after the advertised time. Beyond five minutes the actual time by
measure. which the train is late is logged. Results will be calculated in percentage bands: on
time, up to 15 minutes late, >15–30 minutes late, >30 minutes – one hour late, >one
hour late, and so on
6. Investigations and While logging late arrivals, station duty managers should also note the cause where
explanations possible. The operations director must collate this information using statistical
analysis which highlights persistent problems such as particular times of the day,
routes or days of the week
7. Target and how it is The target is dictated by the railway timetable. The timetable should be reviewed
determined twice a year to look for ways of reducing journey times to keep TTTE competitive
with improvements in competing transport
8. Update of target The banding and any tolerances will be updated annually
9. How often should Weekly

the measure be reported
10. Reporting and The operations director will report performance on a monthly basis to the board
action together with plans for service improvement
Use of performance indicators in the SBL and APM syllabi

Performance indicators are relevant to the following models and theories:

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Mission statements: these define the important aspects of performance that sum up the purpose of the organisation.
See the article ‘Reports for performance management’ (see 'Related links').
Stakeholder analysis: recognises that different stakeholders have different views on what constitutes good
performance. Sometimes what stakeholders want is different to what the mission statement suggests as the purpose
of the organisation. This can be a particular problem when the stakeholders are key-players.
Generic strategies: the main generic strategies to achieve competitive advantage are cost leadership and
differentiation. If a company’s success depends on being a cost leader (a CSF) then it must carefully monitor all its
costs to achieve the leadership position. The company will therefore make use of performance indicators relating to
cost and efficiency. If a company that has chosen differentiation as its path to success then it must ensure that it is
offering enhanced products and services and must establish measures of these.
Value chain: a value chain sets out an organisation’s activities and enquires as to how the organisation can make
profits: where is value added? For example, value might be added by promising fantastic quality. If so, that would be
a CSF and a key performance indicator would the rate occurrence of bad units.
Boston consulting group grid: this model uses relative market share and market growth to suggest what should be
done with products or subsidiaries. In SBL if a company identifies a product as a ‘problem child’ BCG says that the
appropriate action for the company is either to divest itself of that product or to invest to grow the product towards a
‘star’ position on the grid. This requires money to be spent on promotion, product enhancement, especially attractive
pricing and perhaps investment in new, efficient equipment. In APM the model would be used to establish how to
manage the performance of the products and what measures should be used depending on their position in the grid.
For example, good performance for a star would be measured by market share growth rather than profits. Return on
investment could be low until full use is made of the new equipment. Once a product reaches its ‘cash cow’ stage
performance measures will focus on revenues, costs and profits.
PESTEL and Porter’s five forces: both the macro-environment and competitive environment change continuously.
Organisations have to keep these under review and react to the changes so that performance is sustained or improved.
For example, if laws were introduced which stated that suppliers should be paid within a maximum of 60 days, then
a performance measure will be needed to encourage and monitor the attainment of this target.
Product life cycle: different performance measures are required at different stages of the life cycle. In the early days
of a product’s life, it is important to reach a successful growth trajectory and to stay ahead of would-be copycats. At
the maturity stage, where there is great competition and the market is no longer growing, performance will depend
on low costs per unit and maintaining market share to enjoy economies of scale.
Company structure: different structures inevitably affect both performance and its management. For example as
businesses become larger many choose a divisionalised structure to allow specialisation in different parts of the
business: manufacturing/selling, European market/Asian market/North American market, product type A/product
type B. Divisional performance measures, such as return on investment and residual income, then become relevant.
Information technology (IT): new technologies will influence performance and could help to more effectively
measure performance. However, remember that sophisticated new technology does not guarantee better performance
as costs can easily outweigh benefits. If IT is vital to a business then downtime and query response time become
relevant as might a measure of system usability.
Human resource management: what type of people should be recruited, and how are they to be motivated,
appraised and rewarded to maximise the chance of good organisational performance? Performance measures are
needed, for example, to monitor the effectiveness of training, job performance, job satisfaction, recruitment and
retention. In addition, considerable effort has to be given to considering how employees’ remuneration should be
linked to performance.
Fitzgerald and Moon building blocks
Section E(1) of the APM Study Guide mentions three specific approaches or models:
 Balanced scorecard
 Performance pyramid
 Fitzgerald’s and Moon’s building blocks
The balanced scorecard approach is probably the best known but all seek to ensure that the net is thrown wide when
designing performance measures for organisations so that factors such as quality, innovation, flexibility, stakeholder
performance, and delivery and cycle time are listed as being important aspects of performance. Whenever an aspect
of performance is important then a performance measure should be designed and used.
The Fitzgerald and Moon model is worth a specific mention here as it is the only model which explicitly links
performance measures to the individuals responsible for the performance.
The model first sets out the dimensions (split into results and determinants) where key performance indicators should
be established. You will see there is a mix of financial and non-financial, and both quantitative and qualitative:

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 Results
 Financial performance
 Competitive performance
 Determinants
 Quality
 Flexibility
 Resource utilisation
 Innovation
The model then suggests standards for KPIs:
 Ownership: refers to the idea that KPIs will be taken more seriously if staff have a say in setting targets.
Staff will be more committed and will better understand why that KPI is needed.
 Achievability: if KPIs are frequently and obviously not achievable then motivation is harmed. Why would
staff put in extra effort to try to achieve a target (and bonus) if they believe failure is inevitable.
 Fairness: everyone should be set similarly challenging objectives and it is essential that allowance should
be made for uncontrollable events. Managers should not be penalised for events that are completely outside
everyone’s control (for example, a natural disaster) or which is someone else’s fault.
The model then suggests how employee rewards should be set up to encourage employees to achieve the KPI
targets:
 Clarity: exactly how does performance translate into a reward?
 Motivation: the reward must be both desirable and must be perceived as achievable if it is to be
motivating.
 Controllable: achievement of the KPI giving rise to the reward should be something the manager can
influence and control.
Public sector governance

This topic is covered in section B6 of the Strategic Business Leader syllabus. The purpose of this article is to
introduce this topic and give some pointers as to what the important themes are in terms of teaching and learning.
 Introduction
 What is the 'public sector'?
 Agency in the public sector
 Forms of organisation
 Lobbying and lobby groups
 Stakeholders in the public sector
Introduction
Public sector governance is covered in the section B6 of the new SBL syllabus. In this article, and the second part,
these themes will be covered in the order that they appear in the Study Guide.
a) Describe, compare and contrast public sector, private sector, charitable status and non-governmental (NGO and
quasi-NGOs) forms of organisation, including purposes and objectives, performance, ownership and stakeholders
(including lobby groups).
What is the 'public sector'?

In what economists call a ‘mixed economy’, there is a range of organisations. Some are business organisations and
exist to make a profit; others are charitable or benevolent in their purpose, and another type is referred to as public
sector. Not to be confused with ‘public companies’ (which describe the public availability of their shares), these are
organisations that are, in some way, connected to, or deliver, public goods and services. This means that they help to,
in some way, deliver goods and services that cannot be, or should not be, provided by ‘for profit’ businesses.
In most cases, public sector organisations are operated, at least in part, by the state. A state, not to be confused with a
government, is a self-governing, autonomous region, often comprising a population with a common recent or ancient
history. A state has four essential ‘organs’ without which it cannot fully operate: the executive (or government), the
legislature, the judiciary and the secretariat (or administration). Because national constitutions vary, it is not possible
to give general examples of how these ‘work’.
In the UK, by way of example, however, the head of state is the reigning monarch and the head of government is a
different person (the prime minister). The head of government leads the executive, and the head of state is largely a
ceremonial position, but in other countries, he or she also has a role in government. The legislature formulates and
passes statute law, which the judiciary (the system of courts) interprets and enforces along with other non-statute

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laws called common laws. In a democracy, the legislature is largely elected and the judiciary is independent of
government so that, if necessary, the judiciary can bring a legal case against the government or members of it.
The state’s secretariat or administration is by far the largest of the four ‘organs’ and is responsible for carrying out
government policy and administering a large number of state functions. Again, the roles carried out by the secretariat
depend upon the country’s constitution but these typically include education, health, local authority provision, central
government, defence, foreign affairs, state pensions, tax collection and interior issues such as immigration, policing
and prisons. For the most part, organisations such as these are funded by revenues from the state (mainly taxes) and
they exist to deliver public services that cannot, or – in the opinion of the government – should not be provided by
the private sector (the name given to businesses funded by private capital).
In most developed countries and in many developing countries, the public sector is very large. In the most developed
countries, the state spends over 40% of the country’s domestic product and this figure is over 50% in some cases. In
the UK, for example, the public sector accounts for around a quarter of all jobs. Accordingly, then, the public sector
is very large and accounts for many different organisations delivering important services and employing, in many
cases, thousands or even millions of people.
Agency in the public sector

One of the key concepts in corporate governance in the private sector is agency. This means that the people who
manage a business do not own it, and in fact manage the business on behalf of their principals. It is said that
management has an agency relationship with the principals in that they have a fiduciary duty to help the principals
achieve the outcomes that they (the principals) seek. In a private or public incorporated business organisation, the
principals are shareholders and, in most cases, shareholders seek to maximise the long-term value of their shares.
This is usually achieved by profitable trading and having strategies in place to enable the company to compete
effectively in its competitive environment.
It is slightly different for public sector organisations. Those employed in the public sector work just as hard as those
in the private sector and have objectives that are just as clear (but are sometimes conflicting), but the principals are
different. Whereas private and public companies have shareholders, public sector organisations carry out their
important roles on behalf of those that fund the activity (mainly taxpayers) and those that use the services (perhaps
pupils in a school, patients in a hospital, etc). Funders (ie taxpayers) and service users are sometimes the same people
(for instance, taxpayers placing their children in state school) but sometimes they are not, and this can give rise to
disagreements on how much is spent and on what particular provisions. Part of the nature of political debate is about
how much state funding should be allocated to which public sector organisation and how the money should be spent.
In general, however, public sector organisations emphasise different types of objectives to the private sector.
Whereas private companies tend to seek to optimise their competitive positions, public sector organisations tend to
be concerned with social purposes and delivering their services efficiently, effectively and with good value for
money.
A common way of understanding the general objectives of public sector organisations is the three
Es: economy, efficiency and effectiveness.
 Economy represents value for money and delivering the required service on budget, on time and within
other resource constraints. It is common for public sector employees and their representatives to complain about
underfunding but they have to deliver value to the taxpayers, as well as those working in them and those using the
service.
 Efficiency is concerned with getting an acceptable return on the money and resources invested in a service.
Efficiency is defined as work output divided by work input and it is all about getting as much out as possible from
the amount put into a system. It follows that an efficient organisation delivers more for a given level of resource
input than an inefficient one.
 Effectiveness describes the extent to which the organisation delivers what it is intended to deliver.
Forms of organisation
The entry in the Study Guide contrasts ‘public sector, private sector, charitable status and non-governmental (NGO
and quasi-NGOs) forms of organisation’. The term ‘third sector' is sometimes used to refer to charitable and non-
governmental organisations. The public and private sector are the first and second sectors, though the order of these
– which is the first and which is the second – varies with who is writing. The third sector comprises organisations
that do not exist primarily to make a profit nor to deliver a service on behalf of the state. Rather, they exist primarily
to provide a set of benefits that cannot easily be provided by either profit-making businesses or the public sector.

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Organisations delivering international medical aid are a good example of non-governmental organisations (NGOs).
Well-known NGOs such as Medicins sans Frontiers (‘doctors without borders’ in English) are large and well-
structured organisations, delivering important medical aid in war zones and the like. Although supported by
businesses and governments in their aims and activities, such NGOs are often mainly privately funded (eg by
benevolent individuals) and do not operate under either a conventional business or public sector structure.
In such cases, NGOs and charities may have an executive and non-executive board, but these are subject to a higher
board of trustees whose role it is to ensure that the NGO or charity operates in line with its stated purpose or terms of
reference. In these cases, the agency relationship is between the NGO or charity, and its donors. When donors give to
NGOs or charities, it is important for them to be reassured that their donation will be responsibly used for its
intended purpose and the board of trustees help to ensure that this is what happens.
In some cases, NGOs can be funded by a government but remain semi-independent of the government in their
activities. It might be, for example, that a government is seeking to provide a certain service (eg regional support of
businesses) but wants to ensure, because of the importance of that service, that its delivery is free from – and seen to
be free from – any political interference. If a government wants to be free from the accusation, for example, that a
local business-support decision was based on political advantage for the governing party, it might give a publicly
funded organisation effective autonomy in its decision making, even though it is helping to implement government
policy.
These organisations are sometimes referred to as QuANGOs – quasi-autonomous non-governmental organisations.
QuANGOs are sometimes accused of being unaccountable for their decisions because they only weakly report to the
government (and the taxpayers) who fund their decisions. But that is partly the point of a QuANGO: it accounts to
many principals including local stakeholders, central government and national taxpayers. QuANGOs can be
politically awkward and, accordingly, their use in the public sector changes over time.
Public sector organisations themselves can take several forms. In each case, they are directly responsible for
delivering part of a government’s policy and are, in most countries, under the control of the government. This means
that they are under ‘political control’ in that people in government with a political agenda partly control their
objectives and activities. In many countries, politics divides along a ‘left-right’ split while, in others, political
divisions are more concerned with ethnicity, culture or religion. In some countries, for example, universities are
funded mainly by governments, while, in others, they are mainly private institutions. It is similar with healthcare and
schools – in some countries, these are under central government control and funding while, in others, they are
privately funded and citizens must pay for services directly or through insurance.
Lobbying and lobby groups

In a democratic society, one in which political priorities are publicly debated and governments change with the
collective will of voters, a range of external interests seek to influence public policy. In some cases, external interests
coalesce around a certain opinion and it seems appropriate, to some, to campaign to influence government policy in
favour of their particular vested interest. When organised specifically to attempt to influence government policy or
the drafting of legislation (statute law), such interests sometimes ‘lobby’ politicians to try to get them to vote in the
legislature in favour of their particular interest. These ‘lobby groups’ may attempt to influence in favour or against a
wide range of issues and, although their activities are legal, some argue that they are not always helpful because it is
thought by some that those that are the best funded will be the most likely to be heard. This can act against the public
interest and in favour of sectional interests and this is thought to not always be helpful to the democratic process.
Stakeholders in the public sector

SBL exams will examine the complexities of stakeholders for a private sector (ie business) as well as public sector
organisations as business leaders are required in all sectors. Public sector organisations have, in many cases, an even
more complex set of stakeholder relationships than some private sector businesses. Because most public sector
activities are funded through taxation, public sector bodies have a complicated model of how they add value. For a
private business, revenues all come from customers who have willingly engaged with the business and gained some
utility for themselves in the form of benefit from goods or services.
With a government, however, taxation is mandatory and may be paid against the wishes of the taxpayer. Citizens of a
country might disagree with the levels of taxation taken by a government, especially when a taxpayer sees most of
his or her tax being spent on causes or services that mainly benefit others (and not themselves) and with which they
may disagree.
Political theorists have long discussed the importance of a social contract between the government and the governed.
In this arrangement, those who pay for and those who use public services must all feel that they are being fairly

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treated and not being over-exploited nor badly served. Because there are so many claims to balance, then, the
stakeholder pressures on a government are often very difficult to understand.
Furthermore, the claims of some stakeholders are assessed differently by different people according to their
particular political stance. This means that some stakeholder claims are recognised by some but not by others, and
this can make for a very complex situation indeed when it comes to deciding which stakeholder claims to recognise
and which to reduce in weight or ignore. Some stakeholders have a very weak voice, while others have no effective
voice at all in order to express their claim. Part of the debate in politics is the extent to which these weaker
stakeholders are represented and how their assumed needs are met.
Strategic and operational risks

Examining the risks in terms of their potential impact and probability of occurrence.
 Introduction
 Strategic risks
 Operational risks
 Conclusion
Introduction
Risks are bound up with all aspects of business life, from deciding to launch a major new product to leaving
petty cash in an unlocked box. The SBL exam syllabus highlights risk management as an essential element of
business governance. The examiner has emphasised that being aware of all possible risks, and understanding
their potential impact – as well as the probability of their occurrence – are important safeguards for investors
and other stakeholders.
In order to provide a structure for risk analysis, and to help allocate responsibility for managing different types of
risk, risks need to be categorised appropriately. One method of risk classification is to reflect broad business
functions, grouping risks relating to production, information technology, finance, and so on. However, directors also
have to ensure that there is effective management of both the few risks that are fundamental to the organisation’s
continued existence and prosperity, and the many risks that impact on day-to-day activities, and have a shorter time
frame compared with longer-term strategic risks. These two types of risk can be categorised as strategic and
operational respectively. Having categorised risks, management can then analyse the probability that the risks will
materialise and the hazard (impact or consequences) if they do materialise.
Strategic risks
Strategic risks are those that arise from the fundamental decisions that directors take concerning an organisation’s
objectives. Essentially, strategic risks are the risks of failing to achieve these business objectives. A useful
subdivision of strategic risks is:
 Business risks – risks that derive from the decisions that the board takes about the products or services
that the organisation supplies. They include risks associated with developing and marketing those products or
services, economic risks affecting product sales and costs, and risks arising from changes in the technological
environment which impact on sales and production.
 Non-business risks – risks that do not derive from the products or services supplied. For example, risks
associated with the long-term sources of finance used. Strategic risk levels link in with how the whole organisation is
positioned in relation to its environment and are not affected solely by what the directors decide. Competitor actions
will affect risk levels in product markets, and technological developments may mean that production processes, or
products, quickly become out-of-date.
Responsibility for strategic risk management
Strategic risks are determined by board decisions about the objectives and direction of the organisation. Board
strategic planning and decision-making processes, therefore, must be thorough. The UK Cadbury report recommends
that directors establish a formal schedule of matters that are reserved for their decision. These should include
significant acquisitions and disposals of assets, investments, capital projects, and treasury policies.
To take strategic decisions effectively, boards need sufficient information about how the business is performing, and
about relevant aspects of the economic, commercial, and technological environments. To assess the variety of
strategic risks the organisation faces, the board needs to have a breadth of vision; hence governance reports
recommend that a board be balanced in skills, knowledge, and experience.
However, even if the board follows corporate governance best practice concerning the procedures for strategic

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decision making, this will not necessarily ensure that the directors make the correct decisions.
For example, the severe problems that the UK’s Northern Rock bank faced were not caused by a lack of formality.
Northern Rock’s approach to risk management conformed to banking regulations, but its strategy was based on the
assumption that it would continually be able to access the funds it required. In 2007, its funding was disrupted by the
global credit crunch resulting from problems in the US subprime mortgage market, and UK Government action was
required to rescue the bank.
The report Enterprise Governance – Getting the Balance Right, published by the Chartered Institute of Management
Accountants (CIMA) and the International Federation of Accountants (IFAC) highlighted choice and clarity of
strategy, and strategy execution, as key issues underlying strategic success and failure. Other issues identified in the
report were the ability to respond to abrupt changes or fast-moving conditions, and (the most significant issue in
strategy-related failure) the undertaking of unsuccessful mergers and acquisitions.
Managing strategic risks
Strategic risks are often risks that organisations may have to take in order (certainly) to expand, and even to continue
in the long term. For example, the risks connected with developing a new product may be very significant – the
technology may be uncertain, and the competition facing the organisation may severely limit sales. However, the
alternative strategy may be to persist with products in mature markets, the sales of which are static and ultimately
likely to decline.
An organisation may accept other strategic risks in the short term, but take action to reduce or eliminate those risks
over a longer timeframe.A good example of this sort of risk, would includefluctuations in the world supply of a key
raw material used by a company in its production. For instance, the problem can be global, the business may be
unable to avoid it, in the short term, by changing supplier. However, by redesigning its production processes over the
longer term, it could reduce or eliminate its reliance on the material.
Ultimately, some risks should be avoided and some business opportunities should not be accepted, either because the
possible impacts could be too great (threats to physical safety, for example) or because the probability of success
could be so low that the returns offered are insufficient to warrant taking the risk. Directors may make what are
known as ‘go errors’ when they unwisely pursue opportunities, risks materialise, and losses exceed returns.
However, directors also need to be aware of the potentially serious consequences of ‘stop errors’ – not taking
opportunities that should have been pursued. A competitor may take up these opportunities, and the profits made
could boost its business.
Operational risks
Although boards need to incorporate an awareness of strategic risks into their decision making, there is a danger that
they focus excessively on high-level strategy and neglect what is happening ‘on the ground’ in the organisation. If
production is being disrupted by machine failure, key staff are leaving because they are dissatisfied, and sales are
being lost because of poor product quality, then the business may end up in serious trouble before all the exciting
new plans can be implemented. All of these are operational risks – risks connected with the internal resources,
systems, processes, and employees of the organisation.
Some operational risks can have serious impacts if they are not avoided. A good example of an operational risk is the
failure to receive material sent by mail, as it was not sent by a secure method. This operational risk materialised for
the UK Government taxation authority, HM Revenue & Customs (HMRC). In October 2007, the personal details of
25 million people, stored on two CDs, were lost in the internal mail. The fallout from the loss of these CDs included
the resignation of HMRC chairman Paul Gray, due to the organisation’s ‘substantial operational failure’.
What happened concerning these CDs is an example of an operational risk that has a serious impact if it materialises
even once. Other operational risks may not have serious financial (or other) impacts if they only materialise once or
twice. However, if they are not dealt with effectively, over time – if they materialise frequently – they can result in
quite substantial losses. Again, a good example to illustrate the latter, would be a situation regarding a concern that
security measures at a factory might be insufficient to prevent burglaries. The impact of a single burglary might not
be very great; the consequences of regular burglaries might be more significant.
Responsibility for operational risk management

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Clearly, the board can’t manage all operational risks itself. However, it is responsible for ensuring that control
systems can deal appropriately with operational risks.
The board may establish a risk committee to monitor exposure, actions taken and risks that have materialised. The
risk committee is likely to assess operational risks in aggregate, over the whole organisation, and decide which risks
are most significant, and what steps should be taken to counter these. This may include setting priorities for control
systems and liaising with internal audit to ensure audit work covers these risks.
The risk committee may be supported by a risk management function, which is responsible for establishing a risk
management framework and policies, promoting risk management by information provision and training, and
reporting on risk levels.
A key part of line managers’ responsibilities is the management of the operational risks in their area. As well as
ensuring specific risks are dealt with effectively, managers will be concerned with their local working environment
and will deal with conditions that may cause risks to materialise. For example, they may need to assess whether
employees are working excessively long hours and are more likely to make mistakes as a result. They will also
supply information to senior managers to enable them to assess the risk position over the whole organisation.
Ultimately, employees will be responsible for taking steps to control operational risks. However, senior management
is responsible for ensuring that employees, collectively, have the knowledge, skills, and understanding required to
operate internal controls effectively.
Managing operational risks
It may be fairly obvious what the most significant strategic risks are and how important they are. But because of the
number and variety of operational risks, accurate operational risk analysis can be more difficult, and can require
evidence from a large number of different sources.
A key distinction, when defining different types of operational risk, is between low probability high impact risks and
high probability low impact risks. The management of risks with low probability but severe impact may well involve
insurance, for example a sporting venue insuring against the loss of revenue caused by an event being cancelled.
Alternatively, for other risks, the organisation may have a contingency plan in place, such as the availability of
alternative information technology facilities if a major systems failure occurs.
Any controls put in place to deal with low probability high consequence risks will normally be designed to prevent
the risks occurring. Preventative controls would be considered necessary such as necessary in order to minimise the
possibility of a poisonous chemical emission.
By contrast, risks that materialise frequently, but are unlikely to have a significant impact if they do, may be dealt
with by controls that detect or correct problems when they arise. These controls will often reduce risks rather than
eliminate them totally.
Conclusion
If risk management is to be effective and efficient, the board needs to understand the major risks that its strategies
involve, and the major problems that could occur with its operations. Risk and initiative cannot be separated from
business decision making; however, directors can ensure that a wide view is taken of risk management and thus limit
the trouble that risks can cause.
Adapted from an article written by Nick Weller (a technical author at BPP Learning Media)
The integrated report framework
In 2013, the International Integrated Reporting Council (IIRC) released a framework for integrated reporting. The
framework establishes principles and concepts that govern the overall content of an integrated report.
 Introduction
 Principle-based framework
 Relationship with stakeholders
Introduction
In 2013, the International Integrated Reporting Council (IIRC) released a framework for integrated reporting. This
followed a three-month global consultation and trials in 25 countries.

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The framework establishes principles and concepts that govern the overall content of an integrated report. An
integrated report sets out how the organisation’s strategy, governance, performance and prospects, which lead to the
creation of value. There is no benchmarking for the above matters and the report is aimed primarily at the private
sector but it could be adapted for public sector and not-for-profit organisations.
The primary purpose of an integrated report is to explain to providers of financial capital how an organisation creates
value over time. An integrated report benefits all stakeholders interested in a company’s ability to create value,
including employees, customers, suppliers, business partners, local communities, legislators, regulators and
policymakers, although it is not directly aimed at all stakeholders. Providers of financial capital can have a
significant effect on the capital allocation and attempting to aim the report at all stakeholders would be an impossible
task and would reduce the focus and increase the length of the report. This would be contrary to the objectives of the
report, which is value creation.
Historical financial statements are essential in corporate reporting, particularly for compliance purposes, but do not
provide meaningful information regarding business value. Users need a more forward-looking focus without the
necessity of companies providing their own forecasts and projections. Companies have recognised the benefits of
showing a fuller picture of company value and a more holistic view of the organisation.
The International Integrated Reporting Framework will encourage the preparation of a report that shows their
performance against strategy, explains the various capitals used and affected, and gives a longer-term view of the
organisation. The integrated report is creating the next generation of the annual report as it enables stakeholders to
make a more informed assessment of the organisation and its prospects.
Principle-based framework
The IIRC has set out a principle-based framework rather than specifying a detailed disclosure and measurement
standard. This enables each company to set out its own report rather than adopting a checklist approach. The culture
change should enable companies to communicate their value creation better than the often boilerplate disclosures
under IFRS. The report acts as a platform to explain what creates the underlying value in the business and how
management protects this value. This gives the report more business relevance rather than the compliance led
approach currently used.
Integrated reporting will not replace other forms of reporting but the vision is that preparers will pull together
relevant information already produced to explain the key drivers of their business’s value. Information will only be
included in the report where it is material to the stakeholder’s assessment of the business. There were concerns that
the term ‘materiality’ had a certain legal connotation, with the result that some entities may feel that they should
include regulatory information in the integrated report. However, the IIRC concluded that the term should continue
to be used in this context as it is well understood.
The integrated report aims to provide an insight into the company’s resources and relationships that are known as the
capitals and how the company interacts with the external environment and the capitals to create value. These capitals
can be financial, manufactured, intellectual, human, social and relationship, and natural capital, but companies need
not adopt these classifications. The purpose of this framework is to establish principles and content that governs the
report, and to explain the fundamental concepts that underpin them. The report should be concise, reliable and
complete, including all material matters, both positive and negative in a balanced way and without material error.
Integrated reporting is built around the following key components:
1. Organisational overview and the external environment under which it operates
2. Governance structure and how this supports its ability to create value
3. Business model
4. Risks and opportunities and how they are dealing with them and how they affect the company’s ability to
create value
5. Strategy and resource allocation
6. Performance and achievement of strategic objectives for the period and outcomes
7. Outlook and challenges facing the company and their implications
8. The basis of presentation needs to be determined, including what matters are to be included in the
integrated report and how the elements are quantified or evaluated.
The framework does not require discrete sections to be compiled in the report but there should be a high level review
to ensure that all relevant aspects are included. The linkage across the above content can create a key storyline and
can determine the major elements of the report such that the information relevant to each company would be
different.
Relationship with stakeholders

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An integrated report should provide insight into the nature and quality of the organisation’s relationships with its key
stakeholders, including how and to what extent the organisation understands, takes into account and responds to their
needs and interests. Further, the report should be consistent over time to enable comparison with other entities.
South African organisations have been acknowledged as among the leaders in this area of corporate reporting with
many listed companies and large state-owned companies having issued integrated reports. An integrated report may
be prepared in response to existing compliance requirements – for example, a management commentary. Where that
report is also prepared according to the framework, or even beyond the framework, it can be considered an integrated
report. An integrated report may be either a standalone report or be included as a distinguishable part of another
report or communication. For example, it can be included in the company’s financial statements.
The IIRC considered the nature of value and value creation. These terms can include the total of all the capitals, the
benefit captured by the company, the market value or cash flows of the organisation and the successful achievement
of the company’s objectives. However, the conclusion reached was that the framework should not define value from
any one particular perspective because value depends upon the individual company’s own perspective. It can be
shown through movement of capital and can be defined as value created for the company or for others. An integrated
report should not attempt to quantify value as assessments of value are left to those using the report.
Many respondents felt that there should be a requirement for a statement from those ‘charged with governance’
acknowledging their responsibility for the integrated report in order to ensure the reliability and credibility of the
integrated report. Additionally, it would increase the accountability for the content of the report.
The IIRC feels the inclusion of such a statement may result in additional liability concerns, such as inconsistency
with regulatory requirements in certain jurisdictions, and could lead to a higher level of legal liability. The IIRC also
felt that the above issues might result in a slower take-up of the report and decided that those ‘charged with
governance’ should, in time, be required to acknowledge their responsibility for the integrated report while, at the
same time, recognising that reports in which they were not involved would lack credibility.
There has been discussion about whether the framework constitutes suitable criteria for report preparation and for
assurance. The questions asked concerned measurement standards to be used for the information reported and how a
preparer can ascertain the completeness of the report.
There were concerns over the ability to assess future disclosures, and recommendations were made that specific
criteria should be used for measurement, the range of outcomes and the need for any confidence intervals be
disclosed. The preparation of an integrated report requires judgment but there is a requirement for the report to
describe its basis of preparation and presentation, including the significant frameworks and methods used to quantify
or evaluate material matters. Also included is the disclosure of a summary of how the company determined the
materiality limits and a description of the reporting boundaries.
The IIRC has stated that the prescription of specific KPIs and measurement methods is beyond the scope of a
principles-based framework. The framework contains information on the principle-based approach and indicates that
there is a need to include quantitative indicators whenever practicable and possible. Additionally, consistency of
measurement methods across different reports is of paramount importance. There is outline guidance on the selection
of suitable quantitative indicators.
A company should consider how to describe the disclosures without causing a significant loss of competitive
advantage. The entity will consider what advantage a competitor could actually gain from information in the
integrated report, and will balance this against the need for disclosure.
Companies struggle to communicate value through traditional reporting. The framework can prove an effective tool
for businesses looking to shift their reporting focus from annual financial performance to long-term shareholder
value creation. The framework will be attractive to companies who wish to develop their narrative reporting around
the business model to explain how the business has been developed.

1.1.4 SBL Technical Articles

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SBL TECHNICAL ARTICLES IN WORD

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The strategic planning process – part 1

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2. The bargaining power of buyers.

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Champlan sales Systes design services sales Operating profits

2010 2,050 922,500 650,000 162,000

2011 2,700 1,080,000 600,000 144,000

2012 3,600 1,260,000 550,000 107,500

Medium term Share capital and

2010 950,000 425,000 260,000 200,000 915,000

2011 1,000,000 525,000 375,000 200,000 950,000

2012 1,225,000 650,000 475,000 400,000 1,000,000

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P3 past exam-related example, which is also relevant to the SBL syllabus

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The strategic planning process – part 2

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 Which direction should we choose?

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 Reward of a differentiation strategy

This can be summarised in the following diagram:

An example of a focus strategy

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Ansoff's product market matrix

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2007 2008 2009 2010

Sales of revenue 30.00 29.50 58.80 57.96

Costs of sales 15.00 14.75 25.28 24.92

Gross margin 15.00 14.75 33.52 33.04

Expenses 12.00 12.50 29.50 29.75

Operating profit 3.00 2.25 4.02 3.29

Interest paid 0.00 0.00 2.50 2.50

Proft after interest 3.00 2.25 1.52 0.79

Fixed assets 15.00 15.00 34.00 34.00

Current assets 6.00 5.90 9.80 9.66

Current liabilities 3.75 3.69 7.35 7.25

Equity 24.75 24.59 26.15 25.91

Debt 0.00 0.00 25.00 25.00

Gross margin 50% 50% 57% 57%

Return of sales 10% 7.62% 6.83% 5.67%

Activity ratio 1.21 1.20 1.15 1.14

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2007 2008 2009 2010

Return on net assets 12.2 9.15 7.85 6.46

ROE 12.2 9.15 5.80 3.04

Industry sales 125 135 140 138

All about stakeholders – part 1

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Understanding the influence of each stakeholder (Mendelow)