This is part two of a three-part series on integrated reporting. In the first article, we tracked trends and improvements that we have seen over the first six years since the introduction of integrated reporting in South Africa. In this article, we will look at developments in the business model and the capitals while we will examine the potential for misleading reporting in the final article
An integrated report should answer the question: What is the organisation’s business model? So says the International Integrated Reporting Framework (<IR> Framework).
The business model is the system of transforming the inputs (capitals) into outputs and outcomes. Prior to the introduction of integrated reporting, few organisations described their business models in a coherent and understandable way. Since the emergence of integrated reporting, these descriptions (often enhanced by diagrams) have become much more informative and useful. Through a clever business model description, an organisation can show stakeholders how it creates value and differentiates itself in the marketplace. Similarly, by providing information about the use and replenishment of capitals, organisations can demonstrate their preparedness to implement strategy in the short, medium and long term.
Important elements of the business model are the capitals which feature as inputs and outcomes. Early economists, including Adam Smith defined three economic inputs, land, labour and capital. Since those early days, the understanding of capitals employed in organisations has evolved greatly.
The <IR> Framework uses these advances and describes six forms of capital that are used or affected by an organisation in conducting its activities. It describes the capitals as: ‘Stocks of value on which all organizations depend for their success as inputs to their organisational model, and which are increased, decreased or transformed through the organization’s business activities and outputs.’
It lists the capitals as:
- Social and relationship
Today most organisations listed on the Johannesburg Stock Exchange describe their business model using the guidance provided in the <IR> Framework. Many use diagrams and pictures to enhance the understandability of the model.
The <IR> Framework does not require organisations to adopt the terminology used in the six capitals model. Indeed, several organisations including Pick n Pay, Standard Bank and Woolworths use their own terminology very successfully. In some cases, organisations cross-reference relevant sections of their reports to the six capitals.
As can be expected, different organisations have employed different approaches to present their business models. Some are very complicated and difficult to follow while others are simple and easy to understand. Often it depends on the nature of the industry and size of the organisation, but organisations are finding ever-more creative ways of presenting their business models.
In my opinion, one of the best illustrations can be found in the 2016 Tsogo Sun integrated report. It provides a two-page spread showing inputs, processes, outputs and outcomes connected to elements of the operating environment and external environment. Each of the components is referenced to pages where additional information can be found.
The 2016 Oceana Group integrated report presents a very effective diagram of its business model which is well cross-referenced to the various sections of the report. Truworths also provides an excellent picture of its business model in its 2016 integrated report. It includes a discussion of capital trade-offs and a description of its business activities and how they integrate to create value. Redefine in its 2016 integrated report includes a handy schedule showing how it acquires, develops, manages and disposes of capitals.
These business models set out a very useful basis from which to assess performance and understand how the organisation intends to create value in the future.
Each year we see visible improvements in the quality of business model presentation and in the discussion of relevant capitals. Some organisations are now showing the trade-off between capitals that takes place in the business process. A simple example would be expending financial capital on an employee training programme. Thus, reducing financial capital and enhancing human capital.
SASOL provides an interesting discussion of its capital trade-offs in its section dealing with strategic business context. Trade-offs – which happen in every organisation – can be very complex. Nedbank dedicates a separate page to the important trade-offs that the board must consider in its strategy. Hopefully more organisations will follow this trend in future. It is important, however, that these descriptions should not become too complicated, because that would defeat the purpose.
In looking at the areas of integrated reporting that have improved the most over the past five or six years, I believe information about business models and the capitals has probably made the greatest progress. It is clear that many organisations (including those mentioned above) take their reporting very seriously and that these boards and management have a good understanding of their businesses. This is not always the case as some organisations seem to have a confused picture of their business model and capitals integrate.
I said earlier that some companies have used their own terminology in presenting their reports. This is fine and in some cases better than adopting the generic terminology, because it shows that the concepts are understood and used throughout the organisation. If organisations simply use the generic descriptions used in the Framework without breaking them down into the components, it can signal to the reader that the leadership hasn’t really understood the capitals relevant to their organisation and how they integrate with the business processes and with each other. This is a pity because these leadership teams may not fully understand their businesses and how these issues impact performance. Hopefully more organisations will grow to understand these benefits as time passes.
Author: Graham Terry BCom (UCT), CA(SA), IIRC Ambassador; consultant on integrated thinking and reporting