Business enterprises are for-profit organisations. Their objective is to enhance the value of the business. Value of a business depends on how sustainable is the business model. Valuers forecast free cash flow (FCF) for an explicit time horizon (say 10 years) and assume that the business will reach the stable state at the end of that period. Business value is the total of the present value (PV) of the FCF stream that the business is expected to generate during the explicit time horizon and the terminal value. The underlying assumption in estimating the terminal value is that the business will survive to perpetuity, albeit with a low constant growth rate. If, the valuer perceives that that the business model is not sustainable, he/she relaxes the general assumption and estimates a lower value.
Sustainability of a business model depends on the availability, quality and affordability of capitals, internal and external. Business uses and impacts capitals through its operations and products. Thus, it impacts future availability and quality of capitals and consequently, their affordability. In order to test the sustainability of business model, understanding its outcome is essential. Outcome is the net value created by the business, taking into account value added to some capitals, value reduced of some capitals and transformation of one form of capital into another form of capital. If operation of a business results in negative outcome on a continuous basis, the business model is not sustainable. For example, if a business fails to conserve a natural capital that it uses extensively, availability and quality of the same in future will reduce significantly making its business model unsustainable. However, in case of natural capitals, initiatives by an individual or a group or an enterprise are not adequate. Availability and quality of natural capital depends on planetary limits. Therefore, it should be the collective efforts of all those who use natural capital to ensure its availability and quality in future.
In some cases, businesses have to collectively augment the availability of a particular type of capital to ensure sustainability of their business models. An example is human capital. Business enterprises make efforts to ensure that skilled and healthy manpower will be available in future. Therefore, most CSR projects focus on issues related to health care, education and capacity building. Sustainability of business model depends significantly on the social and relationship capital. Enterprises often fail to understand that failure to manage social and relationship capital exposes them to huge reputation risk. They focus on strengthening relationships with those stakeholder groups that enjoy strong bargaining power. They do not address the legitimate expectations and concerns of those with relatively low bargaining power. Examples are the recent tragedy with garment workers in Bangladesh and the 13-year long agitation against Coca-Cola in Plachimada, in Kerala's Palakkad district. The tragedy and the agitation have exposed the approach of some multinationals, who boast for their "responsible business" practices, towards marginalised sections of the society.
Steady increase in bargaining power of the marginalised sections of the society through the intervention of institutions (e.g. courts of law, government and civil society) makes the business models of many business enterprises unsustainable. For example, recent Supreme Court guidelines on iron ore mining at Bellary in Karnataka will definitely increase the cost of iron ore production. Mining companies will have to adopt sophisticated technology to minimise negative externalities. Moreover, in order to manage relationships with the local community, companies might have to bear the cost of health management of community members, who are affected adversely due to mining activities. Increased cost of production will adversely affect the enterprises' competitiveness in an industry that is intensely competitive and facing competition from substitute materials. A business enterprise that focuses on outcome forecast these situations much in advance.
Integrated reporting induces businesses to understand the outcome of their business model and identify risks flowing from it. But should businesses do more than what is required by law? The answer is yes. Legal compliance does not necessarily eliminate risks. Visionary companies develop mechanisms to understand undercurrents in society and in the expectations and concerns of stakeholders. They do not wait for enactment of a law to address those expectations and concerns. Waiting for enactment of laws can only increase the cost of changing the business model, if that is at all possible, and might cause huge damage to social and relationship capital. Therefore, such businesses try to address legitimate expectations and concerns of stakeholders as soon as possible.
Let us welcome the underlying principles of integrated reporting.
Affiliations: Professor and Head, School of Corporate Governance and Public Policy, Indian Institute of Corporate Affairs; Advisor (Advanced Studies), Institute of Cost Accountants of India; Chairman, Riverside Management Academy
E-mail: asish.bhattacharyya@gmail.com
E-mail: asish.bhattacharyya@gmail.com
