In light of the ongoing debates as to the (lack of) independence and objectivity of financial auditors and the shock presented by Steinhoff end of last year, we debate if some could have been avoided by balancing strategic audits with financial audits, using two different independent advisors.
In 1995, the late Prof. Gordon Donaldson raised the fundamental issue at the heart of investors’ concern, which is still true today, namely, “the capacity of the board to intervene in the face of an unsuccessful or ailing business strategy or business model. Proposals to strengthen that ability are among the most important to consider but are also the most difficult to gain consensus on and to implement.” His proposal was the implementation of strategic audits.
While the King III report on Corporate Governance made the role of the board in strategy ownership and development clear, with the demise of many corporates in recent times, King IV (released in 2017) strengthened this by adding to the board’s role as follows:
- Steering the organisation and setting the strategy, whilst defining the way in which the specific governance areas are approached, addressed and implemented;
- Approving policy and ensuring planning giving effect to the approved strategy and direction;
- Overseeing and monitoring the performance of the organisation and the execution of the strategy by the Executive; and
- Ensuring accountability for organisational performance, by means of amongst others, ethical and transparent reporting and disclosure.
In combination King III and IV direct boards to take ownership and authority of corporates’ strategy and its execution for the sake of investors trust, thus implementing the proposal of Prof Donaldson two decades after his passionate article in Harvard Business Review.
Research also overwhelming continues to show that management teams fail at both strategy renewal and strategy implementation. In strategy development, incumbent large businesses are continuously caught sleeping when it comes to industry innovation and changes to how value is captured in markets – here the assumptions made in their strategy are just plain wrong. Implementation efforts, on the other hand, tend to fall short in aligning resources with objectives and in driving large scale change initiatives.
Defining the scope of a strategic audit and understanding what the audit aims to mitigate against specifically, is yet a matter of opinion.
A strategic audit does what the financial audit doesn’t, it tackles the long term sustainability of the business. Internal auditors also neglect this as they typically focus on procedures, processes and compliance. Putting the question of sustainability first is the difference of ticking the box of “license in place” during a financial audit and the question of “is the license sustainable going forward” during a strategy audit. We have had a case where the regulator was threatening to withdraw a license, yet this had never been raised in the financial or internal audit report going back a number of years.
Our research showed that professional opinions and offerings vary widely on what a strategic audit entails. Consulting and audit firms offer checklists which include completeness of plans, adequacy of strategy processes, strength of organizational commitment, applied strategic logic, and adequacy of action plans or resourcing. Some propose to leverage the strategic audit as a new strategy exercise, auditing the understanding of the external environment and internal alignment to external scenarios. In essence, the variations are due to whether the strategic audit is done by and for management, or as a board audit in the context of the boards’ governance responsibility towards its investors. Our wide research indicates that most consulting offerings tend to “sell” to management, which inevitably leads to a lack of independence and objectivity in its advice.
In our opinion the strategic audit at board level must be designed to achieve the following four outcomes
- surface the risks inherent in the business’ overarching goal and business model, as well as in the pursued strategy combined with its base assumptions on the dynamics of the competitive and industry environment;
- give serious consideration to alternative opportunities / strategies / business models that may achieve better results or the same goal more efficiently
- critically assess if sufficient resources (capabilities and capital) are aligned to the strategic pursuits; and
- audit the effectiveness and risks of the actions taken and propose to adjust these if the desired outcome is not progressing.
The above will allow the board to properly address risks, threats, and opportunities in order to meet investors’ expectations, stay relevant in customer markets, and guide the management of a sustainable organisation. It takes a different lens to the financial and internal audit and will bring to light inconsistencies between financial outcomes and value achieved from strategic pursuits.
Despite the strategic audit being proposed since the mid 90’s, very few organisations have implemented it, or at the least set up a strategy board committee to monitor progress against strategy on a more constant and meaningful basis. The following examines why this is so.
The nature of the board set up, meeting schedule and relationship to management has prevented a stronger role in strategic reviews thus far.
Board involvement in developing and executing business strategy has always been a sensitive issue. Although it is standard for executives to inform directors about their strategic pursuit and set up an annual board meeting dedicated to strategy, it has always been understood that the “ownership” of the strategy remains firmly in the hands of the CEO and the management team. Prof. Donaldson explains: “This is for good reason. In order to be effective, every organization requires not only a clear and unambiguous strategic plan but also the confidence that its top management has the authority and ability to carry it out. By nature, the typical board of directors is poorly designed and ill equipped to provide hands-on product and market leadership. The majority of its members usually lack the industry-specific experience, the company-specific knowledge, and, most important, the time necessary to turn broad strategic vision into operational reality.”
Let’s step into a board member’s shoes for a moment. On average, they give their undivided attention once a month for six or eight hours at a time, more dedicated members may spend three to five days a month. As such, they should not be expected to have the detailed command of the issues and market dynamics necessary to make persuasive proposals to counter those of management, or to micro-manage the operations on progress against strategy.
In addition, the typical board meeting is an unsuitable forum for raising somber concerns about a company’s strategic direction or progress. The drive for meeting efficiency and getting through the set agenda in the hours available once a quarter, holds detailed discussions at bay. Requests for comprehensive reports are seen as counter-productive and micro-management, and serious reservations about underlying strategic assumptions typically receive a hostile response by management and even other board members.
Further complications arise from the relationship between the board and management. The question of authority leads to the avoidance of rigorous debate on strategic progress, keeping tensions in check especially if the board meetings are attended by management.
Lastly, there is the issue of how to keep track of the many strategic initiatives or programmes, also considering multiple business units in numerous locations or geographies, several product areas and often serving more than one target market. How can one create an integrated picture of progress, risks, capabilities and linkages? There are additional challenges. Paraphrasing Prof Gary Hamel, “the world’s leading expert on business strategy” according to Forbes Magazine, it is clear that our 21st century leaders face daunting challenges way beyond those of the industrial age. They need to deal with fast changing markets and disruptive innovations, less patient investors, and employees challenging the basic tenets of bureaucracy. Strategies are designed to unleash entrepreneurship, removing barriers to innovation, raising engagement levels, accelerating growth, or improving the effectiveness of key management processes. Taking control of the myriad of strategic pursuits seems mind-boggling.
The strategic audit must now focus on these specific areas, the initiatives designed around them and the execution teams involved. This is the new part of the board’s role under King IV and where the matrix comes in, linking organizational units to the objectives. If formulated correctly, each of the objectives is likely to require multiple disciplines in the organisation, often found across the company’s functions. Follow your business model structure or value chain for this. In our example we use the traditional banking structure of front office, middle office and back office. The intersection between organizational unit and key objectives carry the priority programmes, initiatives and actions required to contribute towards the achievement of the objective. This is illustrated below:
The strategy committee now has a structured framework, based on the existing, board approved strategy, to audit the strategy and progress against it. It may now start to question and confirm:
- Overarching goal or “the business we are conducting” – the strategy committee needs to validate that the majority of income streams and profits are indeed coming from this business pursuit. If income growth is not coming from trading, either the goal is wrongly stated (e.g. it’s a financing business not a trading one) or this needs to be referred to the financial audit committee making sense of it through investigating income and profit streams. (This might have helped in the Steinhoff case.) Further we need to know if the business we are in is sustainable in the future, i.e. addressing an ongoing customer need.
- Are the objectives relevant and comprehensive to achieve the goal or do they need to change– i.e. is our broader strategy, and the underlying assumptions, right? What is the baseline and hence the gap we are trying to close? Do we obtain competitive advantage if we achieve the objectives? Has the strategy identified new potential opportunities to exploit? For example, opportunities for increased sales and profits, developing new products, or capturing new markets.
- Questioning the objectives further and assessing the gap to be addressed, it is also important to ask if the fundamental basics are in place or at risk to operate sustainably – e.g. the license issue previously mentioned or basic capabilities to be competitive.
- Do we have the right programmes in place to achieve these objectives, are they adequately resourced, and made a priority in the organisation? Is our budget explicitly linked to these? Do staff know about them, understand their importance and contribute pro-actively to their achievement?
- Are Executives KPIs explicitly linked to these,or are they rewarded no matter the methods or sources of profit growth? If so, this may detract them from pursuing the strategy and seeking easier or more opportunistic ways to success. The financial acrobatics performed in Steinhoff certainly seem to suggest this being the case.
- Do we have adequate reporting on key programmes and their specific outcomes? This should at least cover risks identified and mitigation steps, action sequencing and timing, executive responsible, cost metrics and monitoring of targeted impact (outcome metric, e.g. increasing market share).
- What actions have been taken by management to correct the course of key programmes that are slow in progressing, outside budget or not achieving the expected outcome?
- And finally, what actions or decisions does the Board need to take to ensure a positive outcome from the strategy?
These are the 8 fundamentally relevant, but arguably loaded, questions for a strategic audit and ongoing quarterly strategic reviews. It is not as onerous as many imagine if done with focus and structure, supported by software available today to make the monitoring efficient.
Seems too simplistic? Thinking about a myriad of other issues to address? Remember that other committees audit other aspects of governance such as the integrity of management (ethics and people committees), financial reliability (audit committee), operational risk, etc. The strategy board committee must stick to its mandate, namely to strengthen the capacity of the board to intervene in the face of an unsuccessful or ailing business strategy or business model, and to fulfil the King IV directive of defining, challenging, overseeing and monitoring the performance of the organisation and the execution of the strategy.
Could the “big mistakes” Steinhoff’s CEO Mark Jooste alluded to in his letter of apology post the still unfolding drama been avoided, if there had been more strategic oversight? Unlikely due to the many people colluding to make this extraordinary scheme work for so long, but possibly it would have raised eyebrows earlier with more power of the independent directors to intervene. Given their highly professional board, including representation of the King Committee in South Africa, it reminds us of the old nursery rhyme where “all the King’s horses and all the King’s men couldn’t put Humpty together again”.