Sustainable value creation through cost efficiency
Wednesday, 26 June 2013 00:05
By Shabiya Ali Ahlam
Focusing on the theme ’Sustainable Value Creation through Cost Efficiency’, the CMA Annual Conference for 2013 that was held last week in Colombo addressed the importance of proper cost and management accounting in both the public and private sector.
Featuring 15 eminent speakers from India, Pakistan, Bangladesh, Malaysia, Nepal, and Sri Lanka, the conference highlighted that correct methods of costing and pricing will help develop the efficiency and performance of the industrial and services sector.
Cost management in sustainability performance
Development is the only way forward, stressed Comtec Management Consultants Executive Director Manivannan R. Rajan.
Pointing out that most studies have showed that majority of the governments have failed or have not lived up to the expectations, Rajan said: “We talk about the triple bottom line where we focus on environment, and social aspects, now governance is added on to it. This brings into sustainability all dimensions that can be thought of, and that’s what makes it important.”
While businesses need to identify innovative strategies and practices that can turn threats into opportunities and contribute to a more sustainable world when creating sustainable value, he noted that cost management focuses primarily on resource consumption and minimisation, and efficiency of utilisation and operations.
Stating that the life cycle assessments are imperative as it aims at quantifying environmental impacts across all relevant environmental concerns at all relevant life cycle stages, Rajan noted: “The concept of ‘cradle to grave’ is being enlarged to ‘cradle to rebirth’ through recycle and reuse.”
With sustainable-cost, natural capital inventory accounting, and input-output analysis being identified as three different methods of sustainable reporting previously, he pointed that now there are also methods such as full cost accounting, where the total costs resulting from an organisation’s economic activities, including social and environmental costs are considered, triple bottom line of people, planet, and profit, Global Reporting Initiative (GRI), and carbon and water foot-print accounting.
“The role of cost accounting in areas such as valuing natural capital, life cycle cost assessment, determining transaction costs, and conducting cost-benefit analysis, is crucial.”
How management accountants can support investor needs of ESG
With investors becoming increasingly aware of the potential risk and value impact on their investments from macro Environmental, Social, and Governance (ESG) trends, Institute of Chartered Accountants of Pakistan Vice President Yacoob Suttar said that from natural resource scarcity to changing governance standards, from global workforce management to evolving regulatory landscape, ESG factors can impact the long-term risk and return profile of investment portfolios.
Pointing out that profits should not be looked at in isolation, Suttar said that socially responsible investments seek to consider both financial return and social good. He added that investors must be aware that ESG factors are also drivers of return on investments and investors can influence change in management’s working strategy.
So how management accountants can help? Suttar opined that the starting point should be the institutes helping to develop ESG savvy management accountants.
Moreover, management accountants should be in the financial system reporting team where they should collect data dispersed through the organisation, and must develop crisp, clear, disclosures which are easily understood by investors. According to him, management accountants must also conduct good research and analysis, and convince investors as to why they should look for ESG factors.
“They should be the bridge between investors, management, and stakeholders, and lobby for the inclusion of ESG in corporate governance codes, he said, while stating that management accountants can make life of investors easier by preparing meaningful ESG disclosures, and interpreting these for investment decision making, provide industry and sector wise comparison, and most importantly convince investors that returns of a sustainable company are higher in the long run.
Integrated and sustainable reporting
Justifying the need for Integrated Reporting (IR), International Federation of Accountants Professional Accountants in Business Advisory Group Chairperson A. N. Raman said that such reporting will be driven by enhanced communication between businesses and investors, leading to allocation of financial capital to businesses that can demonstrate the ability to create value in the short, medium and long term. “Integrated reporting helps investors’ to better understand the nature of businesses they invest in, whereas they will also be able to identify the means to make longer-term investments with reduced risk,” said Raman.
He added that while from a macro perspective the need for IR stems from the need for financial stability and sustainability, IR will also result in greater transparency which helps build resilience in markets.
In more practical terms, Raman said: “Currently the reporting content does not reflect a business’ value and strategic plans, but reflects past performance which means investors do not have the information they need to get a clear picture of value creation over time. IR shifts the focus towards strategy and future orientation and thus helps correct imbalance of the current methods of reporting.”
With other factors such as relationships, intellectual and human capital, making an increasing proportion of a company’s value, Raman opined that corporate reporting needs to evolve in order to reflect this change.
“IR enables the clear and concise communication of value creation, allowing investors to evaluate how all relevant factors that a business uses and affects are incorporated,” asserted Raman.
“Sustainable cost competitiveness is a war against short-termism,” asserted Brandix Casual Wear CEO Dhananjaya Rajapaksha.
As it aims to identify the key success factors that sustain competitive advantage over time, he said that a company could realise competitiveness via leveraging either, cost competitiveness or differentiation. “This leads to saying that cost competitiveness is winning sales at a price that generates a sufficient level of return both for stakeholders and for the investment needs of the business,” stated Rajapaksha.
With raw material accounting for 33% of the cost structure in the apparel industry, whereas the remaining 67% are overheads, Rajapaksha said that there is room for improvements in sourcing capabilities in terms of proximity and flexibility. “We need to have overhead cost control and increase labour productivity to improve source competitiveness,” he stated.
Pointing out that the pursuit of lower cost destination continues amidst the insignificant proportion of labour and raw material cost, “this hour calls for a revamped focus and new ideologies on sustainable cost competitiveness, across the entire value chain,” Rajapaksha emphasised.
The apparel value chain being an integrated one with suppliers and retailers operating in a synchronised manner, Rajapaksha said: “sustainable cost competitiveness would focus upon the end consumer of the product, aiming at delivering business benefit to the customer where the objective would be to deliver tangible value to the consumer by improving the overall efficiency of the value chain.”
Tea plantations industry
While Sustainable Cost Management (SCM) is where an industry has to maintain its cost competiveness, not only in the short term but in the long term with an integrated approach to manage its costs to ensure its long term economic, environmental and social sustainability, Hayleys Plantations Services Director Dilantha Seneviratne said: “The Sri Lankan tea industry has demonstrated that the role SCM has played as one of the key elements in its existence over a century. However it is yet to remain the best known brand of Sri Lanka Ceylon Tea.”
Stressing the fact that although Ceylon Tea is exported to approximately 139 countries, its global competiveness is not price driven, Seneviratne said that country’s tea is increasingly under pressure for price competitiveness from global brands in their pursuit to reduce blend costs.
With challenges such as labour shortage, high cost of production, ageing tea bushes, low field productivity, and maintaining Sri Lanka’s reputation as a high quality producer/exporter, is being faced by the tea industry, Seneviratne said that the way forward would be to increase the national yield to 2500/Kg/ha, reduce cost of production by adapting either contract farming, or the contract plucking with the existing employee/employer model, reduce the carbon footprint and go green.
Also presenting strategies other than cost leadership for the industry, he said that product differentiation, diversity, land use diversification, value addition, and niche marketing could help the industry achieve SCM.
Identifying the four drivers of cost efficiency and value creation at Holcim as, effective planning process, operational cost management, process excellence and Holcim Leadership Journey global initiative, Holcim Lanka CEO Philippe Richart highlighted that the pillars of value creation and cost drivers for the organisation are management commitment, people engagement, continuous investment on automation, tools, new technologies, and consistent focus on product quality and R&D.
“Holcim analyses the possible business risks and profitability of occurrence, and this forms the basis of our planning,” said Richart.
He shared that Holcim has identified avenues to generate advantage and sustainable saving potential as it aims to reduce its energy costs by 10% or US$ 200 million annually by 2015. In addition to this, it has introduced a new standard for energy management excellence which covers operations as well as sourcing.
Having conceptualised the EARN project (Energy Activation across Regional Network), it looks at measures for transparency, best practice sharing through regional communities of excellence, developing capabilities and capacities, creating academy and equip them to drive energy projects, cultural change, and creating competitive advantage.
“EARN is not a technical project alone, it is a transformation initiative to help achieve efficiency and competitiveness,” noted Richart.
Strategic risk management in achieving sustainable growth
“As a management committee, you will want to concern yourself most with identifying and managing major risks,” asserted Aduika & Associates Senior Partner Rajakumar S. Adukia.
He stated that major risks are those which have high likelihood of occurrence, and if they do occur, a severe impact on operational performance, achievement of aims and objectives, changing ways of management committee members would be witnessed.
To prioritise and understand risk, he professed that the first step in strategic risk management is to identify risks that will have the biggest impact and are most likely to occur. “Prioritise your strategic risks according to those two criteria and commit to monitoring and further studying those at the top of the list,” Adukia said and added that the committee should include assigning responsibility to an appropriate person or team and ensure that they meet monthly or at least quarterly and should provide regular updates to senior leadership.
Furthermore, he stressed that the assigned person or team should also be tasked with driving critical activities related to strategic risk mitigation or preparation. “This is where traditional performance improvement tools come into play. Do not make strategic risk another silo within the organisation, rather, integrate these activities with those already taking place around strategy implementation, quality, and performance improvement,” Adukia noted.
While the mentioned help manage and track strategic risk initiatives, he said that risk status should be added to the organisation’s balanced scorecard. Aduika opined that such steps will help ensure the organisation to be aware of the risks and will help senior leadership to address these items on a monthly basis.
Hedging as risk management strategy
Speaking on hedging as a risk management strategy in the petroleum industry, Lanka IOC Senior Vice President Finance Saurav Mitra shared the regulatory framework for the hedging of oil prices by domestic companies in Sri Lanka.
He stated that while oil importers are allowed to enter into derivative transaction to hedge their exposures arising from underlying transaction, derivative transactions can be entered only with commercial banks in Sri Lanka who are appointed to act as authorised foreign exchange dealers. “For this purpose, once can make use of swaps, options or combination of options, whereas the underlying transaction and hedging transaction needs to be in one of the special currencies which include USD,” Mitra said, pointing out that ISDA agreement is mandatory between parties.
Moving on to important considerations and systems controls, Mitra observed that a prudent risk management strategy is essential. In addition, there has to be systemic reconciliation of internal transactions and positions, and periodic reporting to the board, whereas management and regulatory agencies should also take place.
Are sustainable strategies extra costs?
Presenting sustainability guidelines, IndSearch Associate Dean Dr. Nachiket M. Vechalekar said that all business should aim to conduct and govern with ethics, transparency, and accountability, along with providing goods and service that are safe while to contributing to sustainability throughout their life cycle. “When promoting the wellbeing of employees, all organisations should respect the interest of and be responsible to all stakeholders,” stressed Vechalekar.
Focusing on the cost of sustainability, he pointed that one of the principle of cost management is that additional expenditure may be required for achieving long term benefits and cost reduction, and to implement sustainability strategies, additional investment may be required. “It is important to understand that it is an investment and not a cost, which means that future returns can be expected,” emphasised Vechalekar.
He elaborated that benefits arising from such investments will be substantially more than the initial investment but pointed that investments must be made prudently and the results should justify the investments.
“Sustainability strategies are not at extra cost but they are investments for future benefits in the form of sustainability itself. However, there should be proper governance in order to implement these strategies effectively,” he said.
Mergers and acquisitions: Strategy for sustainable growth
Recalling Malaysia’s strategies for sustainable growth, Kenanga Investment Bank Senior Vice President Kenny F. K. Yong shared that the country’s Mergers and Acquisitions (M&A) in the 1970s was driven by post independence foreign policy and domestic economic restructuring agenda.
While Malaysia achieved independence in 1957, the 1960-1970 period was fuelled with nationalistic pride according to Yong.
The country having created strong state owned asset management institutes, Yong said: “M&A was a key tool and it acted as a catalyst in the market to drive economic reform. M&As helped reorganise land ownership from colonial masters to Malaysians.”
With the example of Sime Darby, which Yong stated is a representative case study of a Government spearheaded M&A driven by national policy but with value creation propositions, he shared the success of the initiative in the country. “The equity market in Malaysia in the ’1980s was characterised by an over-exuberant optimism with stock prices scaling new heights over any M&A news. Some of the largest diversified conglomerates in Malaysia today are products of the M&A and equity frenzy during the 1980’s,” Yong said.
He elaborated that the development of the private debt securities market provided help for corporate acquirers and facilitated even larger M&A deals in the 1990s.
“Emerging markets undertake M&A for reasons other than business optimisation and this then creates temporary dislocations in the market structure. Markets will always find equilibrium but there will be pain and it is timely intervention via forced M&A that will help alleviate the pain,” stated Yong.
Pix by Daminda Harsha Perera and Upul Abayasekara