Magazine article

The influence that boards of directors have on company performance is particularly important in an unpredictable operating environment – think Brexit – in which economic growth is stagnant. There are divergent views among directors about whether a change of strategy is required given the low-growth environment.

But there is agreement that high-performing boards and businesses are those that pay close attention to setting strategy and monitoring and tweaking it over time.

One business that has found this balance is Newcastle Permanent Building Society, which produced a return 4.6 per cent higher than average in the banking sector in the previous financial year.

Chair Michael Slater says directors have an opportunity to set the right strategy to influence performance in a low-growth environment. “Strategic plans are directly related to optimal performance as they translate to short, medium and long-term planning.

“They incorporate targeted outcomes and key performance indicators at the strategic and operational level. This allows everybody to understand their roles, responsibilities and accountabilities,” he says.

Slater says the strategic plan must take into account the business’s risk management strategy and framework, so corporate outcomes are realistic to risk. “The board’s role is to monitor performance in terms of achieving the outcomes they’ve agreed to in the strategic plan.”

It’s an approach that is paying off. The banking sector as a whole returned 6.9 per cent last financial year, while Newcastle Permanent achieved 11.5 per cent growth, which Slater says was achieved by strict adherence to the strategic plan.

It’s also a particularly significant result given how competitive and fast moving the banking sector is. “We have to have competitive products by design and by channel delivery. Younger customers require online interactivity. They want to be able to transact on the run, in real time, and they want to have access to a range of products, and we have to deliver this,” he explains.

This requires substantial annual investment in capital and development of IT systems to drive product functionality, and sophistication of product delivery through mobile channels, all in a cost-effective way. Slater says the business understands that if it can’t deliver this it won’t be able to maintain performance.

A corollary of this is that the business has focused on organic rather than acquisitive growth. “We have not indulged in acquisitions because based on our experience, both in this industry sector and others, developing a cost benefit case that supports acquisitions is extremely hard,” he says.

Slater says benefits tend to be overvalued and under-actualised. “Unless we can clearly demonstrate there is an incremental benefit to existing members in acquiring another organisation, we cannot justify asking them to take a reduction in consolidated revenue in terms of shareholders’ funds to support acquisition-derived benefits to other members.” He says the volatile operating environment has informed this approach, but it hasn’t required a fundamental change to the business’s approach.

“But we have provision to accommodate any substantial changes that occur in the economic environment.

“Back in 2007 and 2008 we did effect changes. We looked at our business model and the CEO and I agreed it was not appropriate at that time given what was happening. There was a near run on the banks and the government of the day remediated that by extending its sovereign guarantee for deposits.”

So the business revised its business model and strategic plan. It reviewed some investment strategies and operating costs and deferred expenditure that wasn’t critical.

“We did change our strategic plan because there was a substantial and threatening change in the environment. Since then, there has not been a need to do that,” says Slater. Newcastle Permanent’s strategic plan is re-written every 12 months, with a set timetable for that process. The review includes a reconsideration of three-year projections, which are moderated depending on the current environment. Medium-term, 18-month projections can also be reconsidered at this time. The board also does quarterly reviews of the strategic plan’s underlying assumptions.

“Your strategic plan should drive the operational structure, operating plan and budgets. That means setting up cost and revenue targets, and establishing new areas in terms of capital investment for new product development to attract additional revenue. Across the organisation there is a mindset and understanding that we have to be increasingly competitive each period to be successful,” Slater says.

The “new normal”

Rather than accepting the thesis that the economy is in a low-growth environment only for the short term, John Reynolds, a director of Brisbane’s Mater Misericordiae Health, says the “new normal” operating environment is now one of disruption, uncertainty and less vigorous growth.

At the Mater, the board is responsible for the safety, quality and clinical governance of the organisation as well as the overall corporate, marketing and financial strategy. It is provided with a comprehensive range of performance measures, typically related to the hospital’s obligations to meet or surpass the National Safety and Quality Health Service Standards.

“In these challenging times, our task at the board table, along with the executive, is to stop admiring the problem and fix it together with a sense of confidence and practicality. We have an aspirational vision of where we want to take the Mater to by 2020.

“We’re setting targets that are compatible with the best-in-the-world benchmarks. We’ve used current challenges as an opportunity for renewal. We have developed a range of new performance standards across the organisation to define quality, service and cost. We have cascaded our objectives throughout the whole organisation to get genuine commitment,” he says.

Driving costs and productivity is fundamental, and these two elements do not operate in isolation. Despite current challenges the board is driving revenue, customer focus, business development and outstanding service.

Reynolds believes the board is the differentiator when it comes to company performance given the current operating environment.

“We’ve had to move to focus on performance. We have to put forward big ideas. We have to take a more creative and hands-on, problem-solving approach. We have to demand relentless focus on accountability in this new era. We need to be visible and accessible. We need to create a sense of aspiration and creativity to all around us. It’s our privilege to lead in these challenging times.”

Clarity of purpose

James Beck, managing director of Effective Governance, agrees that driving performance at the moment is about clarity of strategy, and clearly communicating it across all levels of the organisation.

“It’s no good for boards to come up with a strategy in conjunction with management and then just assume that it’s been disseminated throughout the organisation. Make it very clear what the organisation has to do, and how it’s going to achieve that. That requires a very close integration of the board and the executive team.”

This also involves developing KPIs that are tightly linked to strategy. “An organisation may have a number of measures it’s trying to achieve over a five-year window. But only a handful are relevant in the first year. They’re the ones the CEO and executive team should focus on. Many organisations give their CEOs dozens of KPIs. You can’t measure this volume of KPIs. So look at five salient ones. It’s about being laser-focused on what you’re there to achieve in the next 12 months.”

Effective Governance has analysed the governance maturity levels of companies in relation to performance over a number of years. Preliminary research suggests that what is key is the board’s role in monitoring progress towards achieving its strategic goals and reporting progress against strategic goals, as well as the board’s role in developing strategy. They’re the three key areas that drive performance from a strategy perspective.

The link between KPIs and strategy plays a role, as does the right management team and developing appropriate behaviours throughout the business. Beck says rather than making wholesale changes to strategy as a result of the operating environment, many boards are making constant assessments about what’s happening in the economic and political environment that could impact their businesses.

However, he says a business’s growth outlook will often depend on the sector it is in. “If you are already on a growth trajectory then you could expect that growth to possibly slow. If you’re a very mature organisation, then extracting value or performance will be hard, especially in a sustainable manner. That doesn’t mean you should be retrenching people and cutting costs. It’s more about how you can really add value.”

Beck says this is no easy task and the years of easy growth are over. “But that doesn’t mean you can’t improve performance.”

Target focus

John Peberdy GAICD, chair of Victorian Managed Insurance Authority, is another director who agrees setting targets that are appropriate for the current environment is critical. “The annual business plan provides an organisation with the opportunity to tweak their corporate plan’s long-term goals to reflect the year ahead. In many cases, increased income may not be the most appropriate goal in a low growth environment. Profitability can be maintained by adopting a lower growth strategy with a clear focus on not sacrificing margin,” he explains.

According to Peberdy, KPIs driving incentive programs are moving away from solely focusing on financial objectives. “Most leaders and managers will also have non-financial targets to ensure the organisation is growing. This ensures there is a focus on personal and organisational growth in terms of capability and sustainability.”

He says setting goals that are inappropriate in a low growth environment can be soul destroying for those responsible for performance and will lead to a reduction of engagement. “It is important for the board to set shareholder expectations to ensure disappointment is managed and poor decisions based on unreal expectations do not become entrenched.”

Of course, strategy and targets are just one aspect of a board’s role. Sue O’Connor FAICD, chair of Yarra Valley Water and a director of Mercer Superannuation, says boards should be focused on multiple factors.

These include the external environment and the potential for growth. Boards need to be looking at how to optimise existing performance, improving productivity, growing market share and new opportunities to pursue growth.

Shareholder expectations about growth, returns and risk must also be a focus. “You need to be aligned with your shareholders. If there’s misalignment, that’s a problem,” she notes.

O’Connor says when it comes to driving performance, it’s essential to have a full understanding of the market, customers and opportunities in existing and emerging markets. “The board must assess how well you can execute to be able to go after those opportunities, looking at whether the business has the right balance between pursuing existing markets and short-term returns, and building the business for tomorrow.”

She uses Goulburn Valley Water, a board on which she was previously a director, as an example. “By taking an innovative approach to improving efficiency, it was able to reduce debt by 30 per cent over a two-year period.”

In terms of the future, O’Connor says boards are questioning how much growth is possible in new and emerging markets. “There has to be an assessment of shareholder expectations and whether that changes the strategy. In many cases, the answer is yes, but not for all boards.”

She says boards are actively looking at ways to pursue growth, and agrees KPIs are a very active discussion both by boards and regulators. “Incentives must be matched to executive-to-shareholder returns, considering the balance between short-term and long-term gain.”

If a board decides it wants to set a growth goal that is higher than the underlying market, O’Connor believes the board needs to assess its own capabilities.

“In this environment, boards need to have high levels of commercial expertise, resilience and the ability to operate and deliver in more fluid and uncertain markets,” she says.

While outperformance is certainly possible, even when markets are as challenging as they are at the moment, it is much tougher now than in the past for many businesses to achieve the stretch targets that were such a feature before the financial crisis of 2007-2008.

Better boards recognise this, and are still pursuing growth strategies, whilst at the same time managing shareholder expectations to ensure the market is not disappointed.