Organizational Strategy,

Business Models and Risk

Management
by Dr. Martua E. Tambunan, SE., Ak., MSi., CA
(Dosen Tetap MM UKI)
 Agenda

1.  Organizational Strategy

2.  Business Models

3.  Risk Management

OECD and Survey from NACD

OECD states that one of the primary responsibilities of the

board is to “ensure the strategic guidance of the company.”
The Higgs Report recommends that directors “constructively
challenge and contribute to the development of strategy.”

NACD indicates that directors themselves consider strategic

planning and over- sight to be their most important
responsibility—more than financial oversight, CEO
succession planning, compensation, and shareholder
relations.
Strategy development and oversight

1.  Defining the corporate strategy.

2.  Developing and testing a business model that verifies how
the strategy translates into shareholder or stakeholder
value.
3.  Identifying key indicators to measure corporate
performance.
4.  Identifying and developing processes to mitigate risks to
the strategy and business model.
Organizational strategy

•  Developing the corporate strategy begins with

identifying the organization’s overarching.
mission and specific objectives.
•  It answers questions such as :
“Why are we in business?” and
“What do we hope to achieve?”
The corporate strategy

The corporate strategy is how a company

expects to create long-term value for shareholders
and stakeholders, within the confines of the
corporate mission.
Multiple aspects of corporate strategy

•  Scope
•  Markets
•  Advantage
•  Resources
•  Environment
•  Stakeholders
Considerations in Developing the Strategy

•  Many describe the strategy-development

process as though it is always produced
through a formal, linear, and logical exercise.
•  The reality in most firms is quite different.
•  Many companies develop a strategy through a
nonlinear or iterative process. For example,
they might develop a pilot program and then
improve or refine the strategy based on the
results.
Strategy Implementation Process – a linear approach

•  Establish the overarching objective of the firm

•  Determine the outcomes that are necessary to
achieve the total shareholder return (TSR) target
•  Assess the viability of specific strategies to
achieve the company’s economic targets
•  Assign targets (both financial and nonfinancial)
that will enable the company to measure the
success of its strategy over time.
A causal business model

•  To satisfy itself that company goals are

achievable, the board needs to review a causal
business model of the organization.
•  A causal business model links specific financial
and nonfinancial measures in a logical chain to
delineate how the corporate strategy translates
into the accomplishment of stated goals.
The purpose of business model

•  It specifies how management expects to create

long-term value.
•  It lays out a concrete plan (value propositions)
that the board can test and evaluate when
approving the corporate strategy.
•  From a governance perspective, the business
model is an important tool that the board can rely
on to fulfill its oversight function.
The function of business model

•  It provides the basis for measuring management

performance and awarding compensation.
•  To perform this function adequately, directors
must have the requisite industry knowledge and
business background to carefully examine the
model and use informed judgment.
Considerations in Developing the Business Model

•  Instead of dedicating the time necessary to do a

thorough job, management might take shortcuts
(rely on general “best practice”).
•  Relevant data might be difficult to obtain.
•  Managers might resist the concept of a formal
business model, particularly if it requires that they
fundamentally change how they do business.
Example 1 : Fast-food chain and employee turnover

Problem :
•  The company was not growing fast enough,
based on peer-group comparisons and discussion
with sell-side and buy-side analysts.
•  In these sessions, executives outlined what they
believed to be a simple causal model of how the
company made money.
Consensus Business Model – Fast Food Chain
Assumption of the key driver

•  The group built this model based on an assumption that

customer satisfaction was a key driver of operating
performance.
•  Satisfied customers made repeat visits, which increased
purchase frequency and, therefore, sales.
•  Dissatisfied customers did not come back.
•  Company executives thought they had previously verified
this relationship through statistical analysis although the
supporting analysis and report could not be found and
were not made available to this cross-functional group.
Hypotheses what factors contribute to customer
satisfaction
•  The group hypothesized that employee performance played a
critical role.
•  Their reasoning was as follows:
Employees have substantial influence over the in-store
experience. They prepare the food, interact with
customers, and maintain the cleanliness and efficiency
of each location. Without diligent employee effort, customer
satisfaction would likely decline.
•  The underlying premise—that employees contributed to
customer satisfaction—was not explored through formal data
analysis, and the group did not interview customers (based on
professional intuition).
Results from the hypotheses

•  Employee turnover became a primary measure by which

decisions were made.
•  To support a reduction in turnover, the company began to
implement an expensive human resource program that
included retention bonus awards for all restaurant
employees.
•  The results were not what they had expected.
Findings

•  They discovered that groups of stores with the same over-

all employee turnover rates exhibited very different
financial performance.
•  These findings contradicted the premise of their causal
model.
•  Drilling into the data, the executives learned that the true
driver of store performance was not general turnover, but
turnover among store managers.
•  Based on these findings, senior management shifted its
priority from reducing the turnover of all store employees to
reducing the turnover of store managers.
Example 2 : Financial Services Firm and Investment Advisor
Retention
•  A large financial services organization had a goal of being
a “world leader in financial advisory and brokerage
services to retail investors.”
•  From prior statistical analyses, executives and the board
knew that customer retention and assets under
management were key success indicators that directly
impacted economic results.
Relationship between customer satisfaction and asset investment
level
Further statistical analysis

•  To better understand the factors that contributed to a

customer’s satisfaction with an investment advisor. They
found several : the advisor’s trustworthiness,
responsiveness, and knowledge.
•  However, one factor in particular was the most important:
advisor turnover.
•  Customers wanted to deal with the same advisor over
time, and when they were shuttled around from one
advisor to the next, they became dissatisfied—even if the
new advisor scored high on the personal attributes
mentioned earlier.
Updated business model – financial services firm

•  Management used this knowledge to explore the factors

that contributed to advisor turnover.
•  Statistical analysis revealed that they were (in decreasing
order) compensation level, work environment, challenging
career opportunities, quality of branch management, and
work/life balance.
•  The board’s review of corporate performance included not
only the traditional metrics of profitability and assets under
management (AUM), but also the newly devised metrics of
customer satisfaction, advisor satisfaction, and advisor
turnover.
Statistical analysis of factors contributing to customer
satisfaction
Key Performance Indicators (KPIs)

•  An important output from the business model is that it

serves as the basis for identifying key performance
measures that the board can later use to evaluate
management performance and award bonuses.
•  KPI, include both financial and nonfinancial metrics that
validly reflect current and future corporate performance.
Financial and nonfinancial KPIs

•  Financial KPIs include measures such as total shareholder

return; revenue growth; earnings per share; earnings before
interest, taxes, depreciation, and amortization (EBITDA);
return on capital; economic value added (EVA); and free
cash flow.
•  Nonfinancial KPIs include measures such as customer
satisfaction, employee satisfaction, defects and rework, on-
time delivery, worker safety, environmental safety, and
research and development (R&D) pipeline productivity.
Specifics of KPIs

•  Others are used by a more limited set of companies—

because of the specificity of their line of business—and
include both financial and nonfinancial measures, such as
sales per square foot (retailing), R&D productivity (science
and technology), and factory downtime (manufacturing).
•  Whatever KPIs a company selects, it is important that they
be closely tied to the company business model.
Measures to Determine Corporate Performance (1)
Measures to Determine Corporate Performance (2)
Key factors to consider the KPIs

•  Sensitivity
•  Precision
•  Verifiability
•  Objectivity
•  Dimension
•  Interpretation
•  Cost
Research evidence supports the importance of these efforts.
•  Ittner and Larcker (2003) found that companies that develop a causal business model
based on KPIs exhibit significantly higher returns on assets and returns on equity during
five-year periods than those that do not.
•  Gates (1999) found that companies with a formal set of strategic performance measures
tend to exhibit superior stock price returns compared to companies.
Non financial KPI and non financial measures

•  Nonfinancial KPIs can be a leading indicator of subsequent

financial performance.
•  Ittner and Larcker (1997b) found that customer satisfaction
was a leading indicator of future financial performance in a
sample of banking and telecommunications companies.
•  Banker, Potter, and Schroeder (1993) demonstrated a
similar relationship between customer satisfaction and
future financial results in the hospitality industry.
•  Nagar and Rajan (2001) demonstrated a correlation
between manufacturing quality measures and future rev-
enue growth in manufacturing firms.
The problem non financial measurements

•  The evidence points to a shockingly large disconnect

between the information that is important for understanding
value creation and the information that is actually being
supplied to the board.
•  More surprisingly, board members did not appear to have
an explanation for why they were not receiving this
information.
•  The most frequently cited reason was that the company has
“undeveloped tools for analyzing such measures”.
The importance of metrics vs the quality of their measurement
Risk and Risk Management

•  The concept of risk in terms of its relationship to the

corporate strategy and business model.
•  The meaning of risk management.
•  The role the board plays in both understanding
organizational risk and implementing the policies and
procedures
Risk management cycle
Risk and Risk Tolerance
•  The risk facing an organization represents the likelihood and
severity of loss from unexpected or uncontrollable outcomes.
•  This includes both the typical losses that occur during the
course of business and losses from extremely unlikely and
unpredictable events (so-called black swans, or outliers).
•  Each company must decide how much risk it is willing to
assume through its choice of strategy. It is not possible to
pursue a risk-free strategy, nor is risk management about
removing all risk from the firm.
•  In making this decision, each company must determine its
own tolerance for risk (risk tolerance).
The decision of risk tolerance
•  This decision should involve the active participation of the
board of directors.
•  If the board (as representatives of shareholders) is willing
to accept greater uncertainty and variability in future cash
flows in exchange for potentially higher economic returns,
then a risky strategy might be appropriate.
•  The company must strike its own balance between
aggressiveness and conservativeness.
•  This balance can be achieved only when the riskiness of
the corporate strategy and business model is properly
understood.
Risk to the Business Model
•  Operational risk—This reflects how exposed the company
is to disruptions in its operations.
•  Financial risk—This reflects how much the company
relies on external financing (including the capital markets
and private lenders) to support its ongoing operations.
•  Reputational risk—This reflects how much the company
protects the value of its intangible assets, including
corporate reputation.
•  Compliance risk—This reflects how much the company
complies with laws and regulations that otherwise would
damage the firm.
Risk Mitigation
•  The company should generally seek to mitigate risk to the
extent that it is cost-effective to do so.
•  Risks that the company is not willing to accept should be
hedged or otherwise transferred to a third party through
insurance or derivative contracts.
•  Other risks are desirable to retain and might be associated
with the firm’s competitive advantages, including labor
talent, manufacturing processes, brands, patents, and
intellectual property.
•  Good corporate governance requires that risks retained by
the company be properly disclosed to shareholders.
Risk Management
•  Risk management is the process by which a company
evaluates and reduces its risk exposure.
•  This includes actions, policies, and procedures that
management implements to reduce the likelihood and
severity of adverse outcomes and to increase the
likelihood and benefits of positive outcomes.
•  To accomplish this, the organization must define and
develop a risk culture.
Risk Culture

•  A risk culture involves setting the tone for risk tolerance in

the organization and ensuring that risk consideration is a
key part of all decisions.
•  Survey data suggests that strong leadership, clear
parameters surrounding corporate risk taking, and access
to information about potential risks are necessary for this to
occur.
The Process of Risk Management

•  The Committee of Sponsoring Organizations (COSO)

recommends that risk management be incorporated into
strategy planning, operational review, internal reporting,
and compliance.
•  Risk should be considered at the enterprise, division, and
business unit levels.
•  COSO outlines its recommendations in an eight-step
framework
Eight-step framework for risk management
1.  Internal environment—Establish the organization’s philosophy toward risk
management and risk culture.
2.  Objective setting—Evaluate the company’s strategy and set organizational
goals based on the risk tolerance of management and the board.
3.  Event identification—Examine the risks associated with each potential
business opportunity.
4.  Risk assessment—Determine the likelihood and the severity of each risk.
5.  Risk response—Identify the organizational actions taken to prevent or deal
with each risk.
6.  Control Activities—Establish policies and procedures to ensure that risk
responses are carried out as planned.
7.  Information and communication—Create an information system to capture
and report on the organization’s risk-management process.
8.  Monitoring—Review data from the information system and take actions as
appropriate.
Oversight of Risk Management
1.  The board is responsible for determining the risk profile of the
company. This includes considering macroeconomic, industry-
related, and firm- specific risk.
2.  The board is responsible for evaluating the company’s strategy
and business model, to determine whether they are appropriate,
given the firm’s appetite for risk.
3.  The board is responsible for ensuring that the company is
committed to operating at an appropriate risk level on an
ongoing basis.
4.  The board should determine that management has developed
the necessary internal controls to ensure that risk-management
procedures remain effective.
Assessing Board Performance on Risk Management

•  A 2007 study conducted by the Conference Board found

that most companies have not integrated risk management
into strategic planning and general operations.
•  A survey by PricewaterhouseCoopers LLP found that only
20 percent of chief executive officers understand their
responsibilities to manage risk.
•  A study by McKinsey and Directorship magazine found that
the board of directors generally gives nonfinancial risk only
“anecdotal treatment”.
Thank you!