Strategic Management

flexible work in emerging economies

Software developers and flexibility: Can they be trusted to work from home?

The Steinhoff Saga Management review - University of Stellenbosch Business School

January – June 2020

flexible work in emerging economies

Software developers and flexibility: Can they be trusted to work from home?

By Wim Conradie and Prof Mias de Klerk

  • AUG 2020
  • Tags Strategic management

17 minutes to read

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Working in a connected world
Technology makes it possible for knowledge workers like software developers to work from home and/or to work flexitime. For employees, this comes with benefits such as cost savings, convenience, a better work-life balance and less rigidity.

But employers are asking: Can we trust these employees do an honest day’s work? Will they hold themselves accountable for their outputs? Won’t we lose control over our employees?

The benefits of flexible work arrangements (FWAs) – such as flexitime (working flexible hours) and telecommuting (working from home) – have been confirmed by most researchers. However, research on the outcomes of FWAs is somewhat inconclusive and sometimes contradicting, both within and across developed and emerging economies. Also, most of the research on FWAs has been conducted in the developed economies of Western countries. What, then, should employers in an emerging economy like that of South Africa take into account when considering FWAs?

Looking at flexible work arrangements in emerging economies
Globally, the software development industry is known for its flexible work arrangements. Indeed, it has been shown that FWAs can lead to high performance and increased engagement.

Can employers in a country such as South African confidently offer workers like software developers more leeway when it comes to work arrangements? In this study, we took a closer look at the use and outcomes of two FWAs – flexible working hours and telecommuting – among software developers in South Africa.

… employers worldwide are increasingly adopting FWAs as a way to retain talented employees and enhance competitiveness

What does research on this topic say?

We started off by conducting a literature review to gain a better understanding of flexible work arrangements. This is what we found:

  • Employees are increasingly seeking FWAs: The internet and information and communication technology are making new work arrangements possible. Today’s workforce want more freedom of choice and more flexibly in terms of when and where they work. The drivers behind the growth in FWAs include employees’ need for better work-life balance, a drive to resolve family-work conflict, and a desire to reduce the time ‘wasted’ in commuting. Providing the experience of choice and flexibility at work engages employees psychologically. Therefore, employers worldwide are increasingly adopting FWAs as a way to retain talented employees and enhance competitiveness.
  • FWAs mostly yield positive benefits: Research indicates that both organisations and employees find flexible work arrangements attractive. Organisations value outcomes such as reduced turnover rates, lower absenteeism, increased loyalty and productivity, and more positive work attitudes. Similarly, employees value more balance between work and family demands, less workload stress and improved quality of work life. Yet, not all organisations are comfortable with such arrangements, and neither is it a solution for all workplace problems. Empirical results on the relationship between FWAs and well-being are somewhat inconclusive and sometimes contradicting. For instance, it was found that teleworking can promote isolation, lead to a perceived lack of organisational support, increase stress as work and home life become inseparable, and reduce well-being through increased workload.
  • Flexible work arrangements are not the same in all sociocultural contexts: Most research on FWAs has been conducted in Western countries. Yet, several studies have shown that the use and outcomes of FWAs can differ significantly across nations. Hence, there is a need to investigate the use and outcomes of FWAs in specific countries and economies.
  • Flexible work arrangements are valued in South Africa: It has been shown that skilled South African workers value the opportunity to make use of FWAs. Research has also shown that in South Africa, which has an emerging economy, FWAs are associated with increased loyalty, decreased stress, less time spent on commuting, and increased job satisfaction and work-life balance. FWAs in this country have been found to be particularly effective in emerging multinational companies. It therefore appears that FWAs would render positive outcomes for South African employees.
  • Software developers in South Africa will embrace FWAs: Some researchers have argued that service-oriented and private, high-tech organisations have more flexibility than manufacturing organisations, and are thus better able to accommodate FWAs. South Africa has a particular competitive advantage in the fast-growing software development market. However, its growth is inhibited by the lack of skills and shortage of software developers. Many software development firms are small and medium-sized private enterprises, typically lacking the resources to compete with larger firms on salaries. Offering benefits such as FWAs can therefore help to attract and retain employees with sought-after skills. Access to a fast and reliable internet connection is a prerequisite for effective telecommuting. This is not a problem in most developed economies but it can be in emerging economies. However, even in emerging economies, the IT environment is suited for telecommuting because these workers usually have better access to the internet than workers in other industries. Overall, it seems reasonable to expect that FWAs will be generally available to these employees and that they will gladly make use thereof.
  • Flexible work arrangements can strengthen employee engagement: The relationship between FWAs and employee engagement is of particular interest in South Africa where employee engagement tends to be one of the lowest globally. Engagement is seen as a strong predictor of positive work outcomes such as high performance and low turnover intentions, high morale, enhanced commitment and involvement, and increased job satisfaction, commitment and productivity. Psychologically, FWAs create an empowering sense of personal freedom and autonomy with regard to structuring one’s work and time, supported by an encouraging signal of being cared for by the organisation. Physiologically, FWAs allow workers to work from anywhere, and at times that suit their circumstances. With FWAs pervasive in the software development industry globally, and correlations between FWAs and engagement performance confirmed by research, it can be argued that South African software developers who make use of FWAs are likely to measure higher on engagement and performance outcomes than those who do not.

… profit margins of software development companies are sensitive to slight changes in the performance of software developers. This means that even small changes can have a direct impact on output.

How was this research conducted?

The study set out to test four hypotheses:

  1. FWAs are generally available to South African software developers, and they do make substantive use of FWAs.
  2. South African software developers perceive FWAs as beneficial (helpful and advantageous).
  3. South African software developers who make use of FWAs are more engaged than those who do not make use of it.
  4. South African software developers who make use of FWAs perform better than those who do not make use of it.

An anonymous web-based survey was used to find out how South African software developers perceive flexible work arrangements. A sample of 260 respondents provided information on the use of FWAs, whether they found these arrangements beneficial, and how FWAs correlated with their tenure, working hours, engagement and performance.

The respondents represented 86 companies, which were mostly SMEs. Most of the respondents were male (89%) and were 30 to 39 years old, followed by those younger than 30 years. Their tenure at their current employers was fairly short at 5.7 years, although this is much longer than the 1.9 for medium-sized and 1.5 years for small software development companies in the USA.

What did the study find?

  • The employees worked longer hours than the norm: The software developers in this sample tended to work longer than the 40-hour week norm in South Africa, with the mean being 45.3 hours a week. Although the mean value is higher than the norm, it is not unexpected, as it is common for highly skilled workers in South Africa to work extra time.
  • They have access to both flexitime and telecommuting: Most of the respondents (78.6%) indicated that they have access to both flexitime and telecommuting, and most of them (81.6%) actually made use of both options.
  • They saw FWA as beneficial: The respondents said FWAs were beneficial to themselves (or would be if they had access to it). Similarly, most respondents regarded FWAs as beneficial to companies (or would be if such arrangements were provided).
  • Those who used FWAs performed better than those who did not use FWAs: Most respondents indicated high perceptions of their performance reviews (those who used and did not use FWAs combined). The respondents who made use of FWAs reported significantly higher perceived performance than those who did not. This result provides support for hypothesis 3 – South African software developers who use FWAs are more engaged than those who do not make use of it, and hypothesis 4 – local software developers who make use of FWAs experience higher performance outcomes than those not using FWAs.

The link between FWAs, engagement and performance

The relationship between FWAs and engagement and performance was also assessed for respondents who made use of FWAs. The strongest relationship was between the use of FWAs and engagement, which confirms hypothesis 3. The second strongest relationship was between engagement and performance.

… employers do not have to be concerned that less control over employees who work from home or who work flexitime will lead to fewer hours of work.

Although the correlations were regarded as weak and of less practical value, even if statistically significant, one can argue that the correlation between performance and the use of FWAs may indeed have some practical value. The reason for this is that profit margins of software development companies are sensitive to slight changes in the performance of software developers. This means that even small changes can have a direct impact on output. Based on this reason, hypothesis 4 is supported, but with caution.

What does your organisation need to know about flexible work arrangements?

This study looked at how a group of software developers in South Africa experienced flexible work arrangements – specifically flexitime and telecommuting. It is possible that these outcomes can also be beneficial to companies in the same, and other, industries:

  • FWAs work for the local software development industry: The study found that software development companies in South Africa do offer FWAs to their employees and that their software developers make use of this. It was also found that FWAs contributed to improved engagement and performance, and that engagement is associated positively with performance – the same as in developed economies.
  • Companies can trust their software developers to work from home: This study did not find a statistically significant difference in the working hours of developers who made use of FWAs compared to those who worked at the office, although the former indicated more working hours per week on average. This says employers do not have to be concerned that less control over employees who work from home or who work flexitime will lead to fewer hours of work.
  • The combination of flexitime and telecommuting works better: The results showed that the correlations of FWAs with engagement and performance are stronger when telecommuting and flexible hours are used in combination. This confirms previous research that specific FWAs are less effective when used in isolation.

Flexible work arrangements can enable companies to recruit from a much larger talent pool.

  • Engagement is important: The study confirmed a positive link between FWAs and engagement. With employee engagement generally a strong predictor of performance and many other positive work outcomes, as was found by other research, even slight increases in developers’ engagement are important to competitive software developing entities.
  • It is worth trying out FWAs: FWAs can yield positive work outcomes, and should be encouraged where practical and appropriate. It was recommended that employers should at least consider implementing flexitime and telecommuting. This recommendation does not only apply to South African organisations in the software development industry, but perhaps also to other industries and other emerging economies as well.
  • Recruit from a bigger talent pool: Flexible work arrangements can enable companies to recruit from a much larger talent pool. Such arrangements can reduce the high costs associated with office space constraints and relocation.
  • Every bit helps: This study confirmed the importance of FWAs for software development firms in South Africa – a fast-growing sector that suffers from chronic skills shortages. In this industry, perhaps more so than in other industries, the output of developers directly affects products or services.

Workplace flexibility offers a way to address many workplace concerns and to improve individual and organisational functioning. The results confirmed that in South Africa’s emerging economy, outcomes of FWAs do not necessarily differ from those in more developed economies. This finding is important in the light of the critical shortage of software developers, and the high-pressure environment and competitive context in which they work.

The combination of flexitime and telecommuting works better than only flexitime or only telecommuting.

To conclude, the benefits of flexible work arrangements are significant, whereas the risk appears to be low. South African software development employers who are still considering FWAs can probably implement such arrangements with confidence and are likely to receive support from their staff.

  • This article is based on the South African Journal of Human Resource Management article titled ‘To flex or not to flex? Flexible work arrangements amongst software developers in an emerging economy’. It is written by Wilhelm Conradie and Prof Mias de Klerk. Find the original article here.
  • Wilhelm Conradie is an MBA alumnus of USB.
  • Prof Mias de Klerk is head of Research at USB. He is a professor in Leadership and Organisational Behaviour at USB, and Director of USB’s Centre for Responsible Leadership Studies (Africa).

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Management skills in the digital era

Management skills in the digital era

The Steinhoff Saga Management review - University of Stellenbosch Business School

January – June 2020

Management skills in the digital era

Management skills in the digital era

By Prof Martin Butler

  • AUG 2020
  • Tags Strategic management

21 minutes to read

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Leading when the context is changing

By the year 2025 machines will perform more traditional work tasks than humans according to the World Economic Forum’s Future of Jobs Report (WEF, 2018). This is in comparison to 71% of these tasks being performed by humans in 2018. However, the rapid evolution of machines and algorithms in the workplace could create 133 million new roles in place of 75 million that will be displaced. The development of the digital skills required to fill these new roles is well recognised..

Offerings to develop capabilities – ranging from digital literacy and programming to understanding blockchain, applying machine learning and leveraging artificial intelligence – are plentiful. These skills are in demand and will be required, but what about the management skills for the future? Do managers also need to study machine learning and digital strategy to prepare for the digital reality and virtual future? This leads me to reflect on the interesting debate that Don Tapscott and Michael Porter had nearly two decades ago about the impact of the internet on strategy.

Offerings to develop [digital] capabilities … are plentiful. These skills are in demand and will be required, but what about the management skills for the future?

Porter (2001) contended that in our endeavours to see how the internet is different, we forgot to see how it is the same as previous technologies that influenced strategy. The central premise of his argument was that the internet would change industry, like so many things before it, but that does not change the fundamentals of formulating strategic intent. Porter implored business leaders to use the traditional tools and methods but to incorporate the impact of the internet on the different dimensions to mitigate against threats and exploit new opportunities. He saw the internet as a powerful force shaping business as usual.

Tapscott (2001) had a very brave subtitle to his rebuttal, “Why Michael Porter is wrong about the internet”. Duelling with the strategic management guru of the 20th century in a Harvard management journal requires equal amounts of bravery and robustness in the argument. In his article about rethinking strategy in a networked world, Tapscott provided compelling evidence about how the business context was busy changing at the turn of the millennium. With a fundamentally different structure to the economy, his ideas centred on playing a game in which the rules were about to change. The internet was leading to business unusual in Tapscott’s opinion.

The world of strategic management has evolved … Although some of the fundamental principles embedded in the resource and market-based views are still useful … the new strategic management principles of dynamic capabilities and transient advantage are essential to formulate strategy in 2020.

Tapscott implored managers to recognise how the internet is altering the business context completely. In 2001 already, he firmly believed that the societal impact of the internet and the accompanying structural changes would change the business and consumer landscape fundamentally. Supplementing the traditional strategic management toolset with new techniques was a necessity, in his opinion.

Since the debate, 20 years have passed, and the horse has mostly bolted. Leaders appreciate that we operate in a network economy that does not align with the somewhat outdated market and resource views. The network transcends these traditional foundations of strategy. With the benefit of hindsight, there are well-known examples like Kodak and Toys R Us that simply could not compete with new digital and online business models. The same happened to local mainstays like Musica and Mr Video.

The internet also led to the birth, or in some cases re-birth, of e-commerce giants like Amazon, Google and Facebook and closer to home the multiple digital businesses like m-pesa in Kenya, and Media24, Takealot and Showmax in the Naspers stable. Add to this social media giants like Twitter and Facebook and the unicorns of the sharing economy like Uber and Airbnb, and it is evident that many of the largest corporates in our country, continent and globally either did not exist in 2001, or were fundamentally different organisations.

The world of strategic management has evolved with the new networked economy as well. Although some of the fundamental principles embedded in the resource and market-based views are still useful, the new strategic management principles of dynamic capabilities and transient advantage are essential to formulate strategy in the year 2020. The question is whether the same management skills that built the S&P500 in the previous millennium, or even the JSE100 over the past few decades, will be applicable when working in a virtual global company serving double-sided markets? Should we not look for the appropriate skills for managers as well?

I believe the same principles apply when looking at the collective management skill set for the digital era. The fundamentals that were important 50 years ago, are essential today and will probably be for decades to come. Like the world of strategic management, transient advantage and dynamic capabilities only make sense once the resource, market and capabilities views are understood and appreciated. Similarly, some new skills are essential or may increase in importance, but not necessarily at the expense of some of the time-proven and fundamental management skills.

It is the essence of leadership to ensure sustainable organisations that are context-resistant.

The fundamentals

The fundamental skills have always been important and required in order to succeed as a leader in any context, and will remain as such. It is the essence of leadership to ensure sustainable organisations that are context-resistant. The skills are equally important in a time of economic growth and a time of contracting markets, or when products and services need to be optimised, culled or added. These management skills are timeless.

  1. Creativity and an innovative mindset remain critical management capabilities. The well-known quote ‘Insanity is doing the same thing over and over again while expecting different results’ (at times attributed to Albert Einstein) applies equally to management. If we want a situation to change, we need to try something different. Where creativity refers new ideas, innovation is the successful application of these ideas, within a specific context.
  2. Emotional intelligence and social intelligence remain top of the pile for managers who have to manage teams. The ability to compromise pragmatically, based on the social context and all the different attributes of emotional intelligence, leads to more robust and trusting teams. Every systems thinker knows that the collective team is stronger than the sum of the parts only when the interactions between team members are optimal. This skill is key to creating more robust and trusting teams.
  3. Communication and persuasion are the abilities needed to effectively communicate ideas and persuade colleagues and stakeholders that it is in their collective best interest to follow a desired path of action. Employees value individuals who can explain not just what needs to be done, but also why specific actions are required. Being able to communicate and persuade across all levels and functional areas remains imperative.

Every systems thinker knows that the collective team is stronger than the sum of the parts only when the interactions between team members are optimal.

  1. Diversity management and cultural intelligence are powerful allies, with cultural intelligence often defined as the ability to manage diversity. This includes the ability to overcome explicit or unconscious bias, an understanding of culture and cultural differences, and the ability to adapt verbal and non-verbal behaviours. This skill decreases the risk of miscommunication and helps to lead diverse team members in a manner that conveys respect and builds trust.
  2. Critical thinking and decision-making are the skills needed to make sense of multiple levels of complexity, to use the tools and techniques required to see potential outcomes, and to make informed decisions. The ability to think critically allows for the execution of bold ideas, rather like Tapscott felt he could challenge Michael Porter because he had a solid argument based on his critical thinking. Good leaders make decisions. Poor leaders will get back to you tomorrow.
  3. Integrity encapsulates various skills. It includes being authentic and sincere. Managers with integrity maintain consistency in their work, know their limitations, are honest and accept responsibility for their mistakes. When you are creative and also brave enough to make those bold decisions, you will make mistakes. Owning up to one’s mistakes and being authentic in one’s remedial efforts is the mark of a true leader.

I believe that these six skills are the evergreen attributes of management behaviour that will stand the test of time, no matter how the context changes. However, managers will lead a workforce that is increasingly expected to develop digital skills to operate efficiently in a digitised environment. Some of the following capabilities, for instance virtual collaboration, have strong roots in these fundamental management skills.

Good leaders make decisions. Poor leaders will get back to you tomorrow.

The digital imperatives

Digital technologies are advancing real-time engagement with distributed teams and communities. Artificial Intelligence and Machine Learning platforms support various business processes, and open-source communities are sharing ideas and solving problems. Projects are recognised as the engines of creation and the routine work of monitoring discrete activities are becoming automated. The following skills are necessary to thrive in the current digitised organisations:

Analytical thinking ability is crucial as every single business process has become digitised and decision making has become data-driven.

  1. Analytical thinking ability is crucial as every single business process has become digitised and decision making has become data-driven. It is no longer acceptable to make business decisions without looking at the correct data appropriately contextualised. Many of the foundational aspects, such as validity and reliability, need to move from academic papers to the boardroom to ensure the rich sets of data accurately represent that which they should, and are used to make the best possible decisions.
  2. Computational thinking involves a host of capabilities, but in essence, modern managers have to understand the basic principles of the pervasive technologies that share our working space. This includes the elements of digital literacy, managing data digitally, and an appreciation of the complementary roles of technological speed and accuracy, and human brilliance and adaptability. It includes working in harmony with the multiple forms of artificial intelligence increasingly sharing our working space.
  3. Virtual collaboration is the new normal, and it is well recognised that high-functioning teams can accomplish more than any individual. Leaders can significantly lower the opportunity cost to collaborate internally and externally, and need to develop the skills and embrace the opportunity to ensure high-quality engagement.
  4. Flexible adaptability looks like a tautology, but it indicates the multiple layers of change in society and business that are highly fluid. Leaders need to embrace the reality of constant change and display a positive attitude and open-minded professionalism when dealing with a new customer, served by new processes, supported by new systems, in the face of new competition and regulatory and societal pressures brought about by hyper digitalisation.
  5. The ability to learn independently could be the least appreciated skill for the current digital work environment. My go-to question in job interviews is this: “What was the last [insert role-specific word] skill that you learned and how did you accomplished this?” I do not want to hear how the company sent you on a course; that is a disqualifier. Managers have to take responsibility for working out what they need to know and where to find that knowledge. This is an ongoing process in knowledge-based work because the knowledge base is continually changing.

In an era when automated algorithms decide how much we pay for insurance, where deliveries are made by driver-less vehicles, and when we have digital twins for any corporate asset or even customer, it is difficult to see into the future when we cannot yet make sense of the fast-moving ‘current’. Nevertheless, if there is anything that we can learn from the past couple of decades it is that there is a future that will be fundamentally different from the current reality and that will require new skills for leaders.

… modern managers have to understand … the complementary roles of technological speed and accuracy, and human brilliance and adaptability.

Future requirements

It is highly likely that the future will see flatter organisational structures. There is bound to be performance-based organisations focusing on the ability to contribute value, and less on the governing of processes and employees. Advanced artificial intelligence algorithms using gigantic sets if real-time data will select tactics, tailor offerings and monitor fulfilment without human intervention. With outputs increasingly controlled by intelligent machines and fewer human workers, the role of business leaders will be redefined.

The ability to understand extremely complex problems that do not have natural domains or boundaries but that are simply a slice of multiple interdependent systems could become one of the most sought-after management skills.

Many of the current management problems will be resolved before they occur, creating the impression that leadership somehow becomes irrelevant or obsolete. On the contrary, it makes the appropriate management actions more important than ever before. However, it will transform what managers have to do, how they need to work, and how they will lead their teams and organisations. In the absence of a new model of management, these are the skills that I believe should be valuable, without necessarily replacing any of the previous abilities. These skills are not new; it is just they will probably be in higher demand.

  1. Networking agility and active listening. As organisations flatten and virtualise, the focus of work will be horizontal and not within traditional business functions. Managers will need to organise temporary structures to seize emerging opportunities and squash fast-moving threats. Active listening will become a critical skill as insights to challenges will reside somewhere outside of the traditional work team and experts. Good decisions will require an extensive network in order to tap into the right resources at the right time.
  2. Cognitive flexibility. This is not multi-tasking, but there is a clear relationship. The rise of digital technologies means leaders need to be able to handle the plethora of opportunities and challenges that come with it. Instead of focusing on optimised processes, managers need to pay attention to the behavioural dynamics that shape organisational performance – why and how people act, their constraints and resource requirements and, most importantly, how to combine individual behaviours to create the collective behaviour underlying new definitions of performance.

Managers will need to organise temporary structures to seize emerging opportunities and squash fast-moving threats.

  1. Mixed-methods problem solving. Making sense of and solving management problems considerably more complex than what they are currently dealing with, managers will need to use multiple methods of analysis and synthesis. The ability to understand extremely complex problems that do not have natural domains or boundaries but that are a slice of multiple interdependent systems could become one of the most sought-after management skills. It will require the ability to make sense of vast amounts of data, using machine learning to narrow down options, making systems diagrams to present influences and interviewing stakeholders to get qualitative data. I do not believe we will employ any future leaders without asking them to perform an analysis of and make recommendations about a complicated and messy management challenge.
  2. Empathyand recognising the contributions of people. This skill will move from valuable to critical in an increasingly virtual environment. In my lifetime, the meaning of the word work has changed from the place my father used to go to in the mornings and return from in the evenings to play with us, to the things we do at night in our laptops when the children are playing on tablet computers. Blurring the boundaries of work on both time, locality and what constitutes performance means considerable pressure from multiple perspectives on employees. The best leaders will have the ability to place themselves in the numerous different pairs of shoes of their team members and be empathetic to their lived realities.

Active listening will become a critical skill as insights to challenges will reside somewhere outside of the traditional work team and experts.

For many of us, the future organisations requiring these skills are somewhere over the horizon. Not every organisation will adopt technology at the pace of an organisation born digital; nor will all organisations be reshaped to the same extent. Most organisations will evolve at the speed of their industries, competitors and customers. In all of this fuzziness and excitement, leaders will still be leading. We need to develop the leadership competencies for the future.

What are the management skills that will be required to make a success of Elon Musk’s colony on Mars in 2035? I do not profess to know, but I do think it will be a healthy balance between the evergreen fundamentals, the digital imperatives and a splattering of the future requirements.

Footnote: The alternation between managers and leaders is intentional. I do not subscribe to the low-value debate about a clear distinction between leadership and management.

  • The article was written by Prof Martin Butler who lectures in Digital Enterprise Management and Technology Futures at USB. He is also head of Teaching and Learning at the business school.

References

Porter, M. E. (2001). Strategy and the Internet. Harvard Business Review. https://hbr.org/2001/03/strategy-and-the-internet

Rainie, L., & Anderson, J. (2017). The Future of Jobs and Jobs Training. Pew Research Center. https://www.pewresearch.org/internet/2017/05/03/the-future-of-jobs-and-jobs-training/

Tapscott, D. (2001). Rethinking strategy in a networked world (or why Michael Porter is wrong about the internet). Strategy & Business, 34-41. https://www.strategy-business.com/article/19911?pg=0

World Economic Forum (WEF). (2018). The Future of Jobs Report 2018. http://www3.weforum.org/docs/WEF_Future_of_Jobs_2018.pdf

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Responsible investment

Responsible investment: How can the investment decisions of institutional investors improve their stakeholder impact?

The Steinhoff Saga Management review - University of Stellenbosch Business School

January – June 2020

Responsible investment

Responsible investment: How can the investment decisions of institutional investors improve their stakeholder impact?

By Dr Colin Habberton

  • AUG 2020
  • Tags Finance

29 minutes to read

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Why is responsible investment important for South Africa?

In one way or another, all of us are beneficiaries of past investment. This highlights the responsibility of investors to optimise returns in a way that protects the progress and prosperity of both present and future generations. In boardrooms and universities across the globe, this has led to a growing discourse about responsible investment.

This puts the spotlight on those people making the investment decisions – institutional investors. These ‘professional’ investors, as agents of other people’s money, have come to dominate investment holdings globally. They are mandated to manage the majority of assets, which translates into considerable power to influence decision-making in the companies in which they invest.

Traditionally, the message to institutional investors was: “Maximise risk-adjusted returns as much as you can. Don’t worry too much about the environmental and social impact of the investments.” Now there is a new narrative.

The World Bank identifies South Africa as having one of the highest ratios of inequality of all countries in the world. The legacy of the country’s colonial history, coupled with the global repercussions of financial crises and company collapses, has raised questions about the roles and responsibilities of institutional investors.

All over the world, this has led to the approval of new laws and the adoption of codes of corporate governance by civil society and increasingly by the private and public sectors. For more than a decade, we have seen ‘responsible’ investment principles, policies and practices emerging globally that integrate environmental, social and governance (ESG) criteria in investment decision-making.

The legacy of the country’s colonial history, coupled with the global repercussions of financial crises and company collapses, has raised questions about the roles and responsibilities of institutional investors.

As early as the 1960s, research on corporate executives in the US showed that over 80% of them felt that acting in the interests of shareholders alone was unethical. This led to the rise of stakeholder management, corporate social responsibility and corporate governance founded on principles that enable decision-makers to adopt a ‘stewardship’-orientated mind set.

Despite progress in policy and practice, research has found that barriers to the growth of responsible investment in South Africa outweigh the drivers and enablers of this investment philosophy. What’s more, there appears to be lack of commitment among local institutional investors to really embrace responsible investment.

To better understand the connection between institutional investors and the impact of their investment decisions, we need to take a closer look at the factors influencing the decision-making processes of South African institutional investors towards responsible investment (RI) – which is exactly what this study set out to do.

After reviewing current research on the topic and conducting a pilot study, the researcher interviewed 25 senior decision-makers working in the field of institutional investments. This led to the design of a framework that offers an integrated view of the factors influencing investment decision-making towards responsible investment.

The overall aim was to provide a tool that would help to offer a stakeholder-driven view of the investment value chain in order to improve RI policy and practice. The framework recommends mutual accountability in the investment value chain to optimise stakeholder salience, improve accountability, guide engagement and promote participation in the investment decision-making process. Another aim of this tool was to help address the inertia and inconsistency in the entrenchment of RI philosophy, policy and practice among local institutional investors.

Understanding the institutional investment value chain

Institutional investors, as opposed to individual investors, are financial institutions that invest vast capital into financial instruments on behalf of other institutions or the aggregated funds (like pension funds) of individual investors.

Institutional investors are key drivers and enablers of the global financial system due to the volume of assets under their management. Through their concentration of ownership, they have the ability to exert both internal and external influence through their activities. What’s more, they have the potential to influence external decision-making on financial and non-financial performance. They do this among other things by providing market signals whenever they sell, hold and buy more stock in a company.

To understand the complexity of the factors influencing the decision-making process of institutional investors towards responsible investment, it helps to see the institutional investment process from a value chain perspective. This investment value chain includes:

  • Asset owners (AOs): This includes pension funds, provident funds, retirement funds, endowment funds, life insurance companies, banks, companies and non-profit organisations that invest pooled funds into various financial instruments.
  • Asset managers (AMs): Asset managers have the delegated responsibility to invest capital into financial instruments and to manage those assets. Asset managers are appointed by asset owners.
  • Professional service providers (PSPs): This includes asset consultants, research providers and investment advisors, accountants, lawyers and administrators.
  • Network supporters (NSs): This includes industry associations, trade unions, regulators, academic institutions, special-interest groups, the state apparatus and other civil society bodies that have influence over a process, practice or participants involved in the institutional investment value chain.

The relationships between the stakeholders in this value chain are non-linear. Instead, the relationships represent a virtuous value chain – with each factor influencing the flow of value and information among the stakeholders in the business system all the time.

The flow of value – not just monetary value – between a business, its customers, partners (i.e. suppliers, vendors and distribution channels), employees, investors and competitors leads to interdependent value creation between parties. These relationships are influenced by external factors such as market conditions, environmental and community considerations as well as the legal and ethical regulations and norms applied by government and society. Various studies have confirmed that this sharing of information and knowledge helps to strengthen chains of accountability and knowledge when it comes to investment decisions.

Institutional investors are key drivers and enablers of the global financial system due to the volume of assets under their management.

The call for more responsible investment

When making investment decisions, institutional investors have a duty of care towards the functioning economy as a whole as well as to the individual companies in their portfolios considering how integrated company activities are on the social and environmental risks prevalent in the economies in which they operate. This has led to a call for more responsible investment and the emergence of normative frameworks and global initiatives that encourage such investment practices, especially after the global financial crisis of 2008.

Today, various global frameworks and collective initiatives encourage investment practices that promote the inclusion of ESG and ethical considerations into decision-making processes and company reporting. Examples include the United Nations’ Global Compact (UNGC), the UN’s Principles for Responsible Investment (PRI), the Carbon Disclosure Project (CDP) and Integrated Reporting. In South Africa, we have the King Codes of Corporate Governance, the Code for Responsible Investing in South Africa (CRISA) and the PRI.

One initiative that has gained global traction is the Principles for Responsible Investment (PRI). This code was born out of the United Nations Environment Programme Finance Initiative (UNEP FI). Since inception in 2006 to April 2018, the PRI grew to over 1 961 signatories with collective assets under management of over USD81,7 trillion. The UNPRI claims that 94% of its signatories have a responsible investment policy in place, with 71% requiring ESG reporting from their investments. This finding suggests that the principles do serve a purpose. However, their importance does not necessarily encourage organisations to become signatories.

Since the introduction of these frameworks, support for RI has been growing all over the world. What’s more, ESG considerations are increasingly applied in the decision-making of institutional investors in South Africa. And yet, research shows that local institutional investors lack the commitment to fully embrace the principles of responsible investment.

What then needs to change in the institutional investment landscape in South Africa for responsible investment to flourish?

The impact of institutional investment decisions

Investors increasingly want to know where their capital will be invested without necessarily sacrificing financial returns.

Responsible investment (RI) is an investment philosophy that transcends financial boundaries to recognise the impact of environmental, social and governance (ESG) criteria on investments and decision-making. It focuses on long-term investment, a broad-based consideration of investment criteria, ESG criteria in particular, and expectations of returns beyond purely financial metrics.

From an investment perspective, the history of South Africa suggests that decisions made by investors have significant social and environmental impact on the people and places where their capital is invested. Through their mandates, institutional investors assume a contractual responsibility to generate returns for their clients who are the contributors of the capital about which investment decisions are made. Institutional investors therefore need to make decisions about the allocation of vast amounts of capital. This puts them in a powerful position.

Investors increasingly want to know where their capital will be invested without necessarily sacrificing financial returns.

What should these institutional investors take into account when they make investment decisions?

Investment decision-making is a complex process

This study was undertaken to answer a question: What aspects of  South African institutional investors’ decision-making process need to change for responsible investing to become the philosophy that guides their investment decisions?

In essence, the study wanted to better understand the connections between stakeholders in the investment value chain and, in turn, assess the effectiveness of RI principles and practice to achieve their promise.

Investors use various theories and tools to help them with decision making. These models largely employ quantitative methods to guide choices towards investments and instruments to achieve risk-adjusted returns for investors. Yet, the systemic nature of the relationships between decision-making, institutional investors and responsible investment is complex and unpredictable.

To complicate matters, transparency regarding the institutional investment decision-making process is affected by shareholder activism and investor literacy:

  • Shareholder activism: Shareholder activists are institutional and individual investors who use their equity stake in a company to hold managers accountable for their actions. In South Africa, shareholder activism is on the increase although there is still much inertia and apathy when it comes to companies taking action.
  • Individual investor literacy: Various initiatives are currently addressing the systemic challenge of financial literacy among institutional investors.

Who has power in the system?

The prevalence and influence of power dynamics in the decision-making process needs to be acknowledged. This includes the following:

  • The stakeholder’s voice: The more power a stakeholder has in the value chain, the more salience that stakeholder has in the eyes of a firm against which it has a claim. In the context of institutional investment, such a firm could be an asset owner, asset manager, service provider or investee company. This shifting agency is known as the institutional investor’s ‘voice’ which is used to negotiate its priorities and interests within the stakeholder system. The institutionalisation of responsible investment – fuelled by the urgency to respond to ESG risks, accountability and the need for active ownership – is an example of how a stakeholder group can shift its agency, develop authority and create change. For example, Regulation 28 of the Pension Fund Act requires all pension fund trustees to ensure that pension fund assets are managed in line with ESG principles.
  • The size of the stakeholder: Some of the largest institutional investors in the world and in South Africa (i.e. Government Employees Pension Fund – GEPF) are public sector institutions. Although some influential investors, such as the GEPF, are actively encouraging responsible investment, there appears to be a lack of commitment in this regard, even among PRI and CRISA signatories.
  • Non-decisions: The power that institutional investors may have to influence a decision or outcome is not necessarily observed in their explicit participation in the decision-making process. They may also obstruct decision-making through their ‘non-decisions’. This subversive form of power also needs to be considered when evaluating the behaviour and motivation of the stakeholders involved in institutional investment decisions.
  • Hard power and soft power: “Hard power” in decision-making refers to the use or threat of force to achieve an outcome, while “soft power” refers to the use of features like culture, value and policies that influence the behaviour of others without coercion. “Smart power” refers to the ability to draw on both approaches.
  • Groupthink: The invisible power of groupthink needs to be taken into account, as this can lead to the ‘herding’ of decision-makers towards conventional decision-making processes.
  • Incentives: Incentive systems have the power to reinforce behaviour. Investment incentives are often driven by short-term horizons, despite the underlying premise of RI seeking sustainable returns in the long-term.

In South Africa, shareholder activism is on the increase although there is still much inertia and apathy when it comes to taking action.

A conceptual framework for investment decisions that incorporate responsible investing

One of the outcomes of this study is a framework that takes into account all the stakeholder groups, as well as the ethical and analytical factors that can influence decision-makers or contribute to the investment decision-making process, integrating ESG criteria.

First, a pilot study was undertaken, followed by the main study which included interviews with 25 senior decision-makers in the field of institutional investment. The outcome of this is the framework represented below.

Habberton Map

In practice, the conceptual framework proposes that ESG integration into the decision-making process connects market participants in the investment value chain, the respective behavioural dimensions of investors and the companies in which they invest, and the factors that drive the inputs and outputs of each dimension. The mapping of the factors across ESG domains and horizons suggests an interconnected, interdependent relational system. As an output, the mapping process offers a novel conceptual framework that could be used a diagnostic tool to assist institutional and individual investment decision-makers seeking to implement a stakeholder-orientated, more ‘responsible’ approach to their investments.

What else did the study find?

There was evidence of progress in the application of responsible investment principles and practice when comparing the perspectives of the interviewees from the pilot and main studies. This is what the study found:

The influence of power dynamics in the decision-making process needs to be acknowledged.

RI is not a fund or a signature, it’s an investment philosophy. There was little improvement in the number of South African PRI signatories over the study period. Although this statistic might indicate that RI is losing ground, feedback from participants suggest the opposite. The main study’s participants showed far more acceptance of the concept of ESG and its integration into investment decision-making. Even asset owners who did not know that much about PRI and CRISA agreed that ESG factors should be considered in investment decisions.

Reputation, not just performance, influences investor practice. During both the pilot and main phases of the research, there were complaints about certain PRI signatories’ non-compliance with reporting requirements. The researcher also noted that the interviewees, in their personal and professional capacity, ascribed a significant amount of value to their reputation. The preservation of reputation therefore provides an important motivator to influence invest decisions towards RI.

Professional investors are unaware of their governance liabilities. Financial service providers in South Africa are regulated in their individual and institutional capacities through legislation such as the Financial Advisory and Intermediary Services Act (FAIS), consumer protection laws and market conduct requirements as Treat Customers Fairly. Listed companies are expected to apply corporate governance frameworks to their operations. Failure to comply could lead to penalties, criminal and/or civil charges, imprisonment and/or the removal of licences to operate. Surprisingly, participants in the main study showed a limited understanding of the risks and liabilities associated with their responsibilities as investment decision-makers.

Trustees of pension funds appear to support short-termism. Asset owners in both the pilot and main studies had a clear understanding of their fiduciary roles and responsibilities but they were not very aware of RI principles and practice. Their main concern was the financial performance of their funds as they delegated the performance requirements of the funds to asset managers mediated through mandates and professional service providers like asset consultants. The performance of their funds was assessed quarterly, with only a three-year investment horizon applied to most asset managers’ performance measures. Asset owners interviewed in this study relied on peer benchmarks to compare performance, using the threat of switching their business to alternative asset managers should certain performance expectations not be met. Considering that asset owners oversee contributors and beneficiaries over generational thresholds, it was interesting to note that none of them applied long-term planning scenarios beyond a 10-year time horizon. This apparent lack of generational thinking supports their short-term approach to investment.

Public sector activity suggests ‘lender-of-last-resort’ role. In contrast to the role understood by private sector institutional investors, public sector participants in both the pilot and main studies seemed to assume responsibilities beyond the interests of their contributors and beneficiaries in the fulfilment of political, social and macroeconomic interests. Examples were shared of interventions and engagements with investee companies to stabilise markets, save jobs and promote the policies of the government. Interviewees recognised that, due to their size, they have the power to influence investment systems and therefore they aimed to act responsibly. During the study period they have taken action to avert the closure of assets, playing the role of lender of last resort. Due to their alignment with national government and the requirement for government officials to act as trustees and board members, there is an inherent conflict. In the pursuit of national interests, public sector asset owners and asset managers may deploy the savings of individuals seeking long-term protection of their personal retirement capital for objectives partly determined by the state. It is unknown to what extent contributors are informed about these purposes and associated risks. Should there be full disclosure there is a possibility that government employees may raise the power and urgency of the contributors’ ‘voice’. They can even become ‘dangerous’ in their demands for access to or influence over the decision-making process.

Institutional investors … may also obstruct decision-making through ‘non-decisions’.

It is a question of time. In all the participant discussions on the factors influencing the investment decision-making process toward RI, time was a common denominator. Time was a factor in investment decisions, disclosure, communication and cost. Time was associated with the scheduling, frequency and length of meetings for all constituents involved in the investment decision-making process. Time was mentioned as a key determinant for assessing investment and investor performance. Time was a fundamental input into the calculation of fund liability in actuarial models. Time defined the thresholds of the materialisation of financial and ESG risk impacting both current and future generations. Time therefore needs to be integrated in all dimensions of the framework.

Stakeholder interests through the value chain are not aligned. Private sector asset managers and professional service providers were all profit-driven organisations, employing expensive professionals supported by costly infrastructure to deliver services to clients. Private and public-sector asset managers were fee-conscious custodians of contributor capital, governed by trustees who accepted the liability of their position, while typically receiving no additional remuneration for their services. Asset owners seek returns from their assets to meet liabilities of a legal entity that is, by definition, a not-for-profit organisation. Asset owners accepted the fiduciary duty for the funds over which they preside, but were the least familiar with the complexity of investment decision-making and responsible investment. Professional service providers and asset managers accepted the responsibility for most of the investment decision-making process for a fee but were unaware of the contingent liabilities attached to the services they provide the public. This highlights the need for ongoing training in this regard.

The future of responsible investing in South Africa

This study explored the factors influencing the institutional investor decision-making process towards responsible investment in South Africa. In particular, the research focused on understanding the connections, or lack thereof, between the decision-makers responsible for allocating the capital and the impact of those decisions on the stakeholders in the investment value chain.

Of concern is the small percentage of institutional investors who are signatories of the PRI relative to the number of stakeholders in the South African institutional investment community. Participant feedback suggested that the value proposition offered by the PRI to local institutional investors, versus the cost, does not appeal to smaller institutions. What is even more worrying is evidence of limited commitment from PRI and CRISA supporters. Shareholder activism in South Africa, until recently, has been relatively muted. With the all the scandals and controversies around executive remuneration, governance failures and other ESG risks, public shareholder engagement will in all likelihood grow in future.

The integration of ESG considerations demand that decision-makers accept complexity. Institutional investors are ultimately responsible to mediate between the interests of the profit-driven companies for which they work, while optimising the savings funds dutifully provided by other stakeholders who place their assets under their care.

Responsible investment provides institutional investors with an opportunity to play a transformative role in addressing some of the challenges that South Africa is facing. Through the integration of the PRI and CRISA, with a stakeholder stewardship-oriented approach, institutional investment decision-makers can indeed provide voice and access to the decision-making process for marginalised stakeholders. This more inclusive approach creates greater accountability in the investment system and encourages stakeholder participation.

Based on the study’s findings, the researcher made various recommendations to stakeholders in ecosystem of institutional investors. Here are some of these recommendations:

Incentive systems have the power to reinforce behaviour. Investment incentives are often driven by short-term horizons, despite the underlying premise of RI seeking sustainable returns over longer-term horizons.

Recommendations to asset owners

  • Improve the engagement of asset owners with assets, contributors and beneficiaries: Evidence suggests a disconnection between local asset owners and other stakeholders in the investment value chain. Improving asset owner engagement with the directors and management of investee companies in the commercial dimension, and contributors and beneficiaries in the contractual dimension, will help to address this disconnection. In light of the societal impact of pension funds on investment and provision for future generations, it is recommended that the costs of trustee training be recovered from the state via the financial regulator.
  • Review the governance structures of pension funds: Asset owner governing bodies or boards of directors should review the structures of pension fund governance to ensure alignment with King IV recommendations. This would likely affect the way in which the individuals are selected to serve on such boards. Participant feedback confirmed that there is a lack of additional remuneration for attending to trustee duties. In addition, the lack of parity between employer and employee representatives could be intentionally overlooked. Similarly, information asymmetry between the contributors and institutional investors may be orchestrated by both employers and skilled employee representatives to protect one set of interests over another. To support independent decision-making, it is recommended that an independent, skilled and non-executive chairperson be appointed to mediate the interests of the trustees. It is also proposed that additional professional trustees be recruited where there may be a lack of parity in terms of financial literacy, or a lack of independence due to employer or employee interests. In addition, financial and administrative literacy should be significantly improved for inclusive decision-making.
  • Delegate fewer duties and manage conflicts of interest: The enormous responsibilities that asset owners delegate to asset managers and professional service providers is a concern as it can disempower the governing body and raise the potential for conflicts of interest. In principle, asset consultants might fulfil this role, but a clear separation between the interests of professional service providers, asset managers and asset owners is recommended. As the interviewees pointed out, asset managers and professional service providers play many roles in the investment system, serving many masters.
  • Shift the decision-making horizon: The researcher found that funds usually have a longer investment horizon (20 years or more) than institutional investors (typically between five and 10 years). The researcher recommends that asset owners implement investment decision-making processes that consider long-term scenarios. The following should also be considered: future generations, multiple time horizons, saving, ongoing financial literacy education, and stakeholder participation in the investment decision-making process. Also, mandates could be shared with contributors and beneficiaries to enhance decision-making transparency.

RI is not a fund or a signature, it’s an investment philosophy.

  • Build the reputation of asset managers: The study participants said the success of asset managers depends on their ability to maintain their reputation and deliver returns. Reputation in this context is underpinned by professional service, acquiring and retaining clients, and consistent investment performance.
    • Turn RI practice into opportunities for growth for asset managers: The researcher believes that responsible investment brings additional layers of service to asset managers’ value proposition, which can enhance their reputation. However, some institutional investors see this as unnecessary and an additional cost. Firstly, responsible investment and integrated reporting are increasingly being required by industry bodies. Secondly, the reconfiguration of asset manager evaluation criteria towards more RI-orientated metrics might shift how asset owners and professional service providers ascribe value to and remunerate asset managers. From a reputation perspective, asset managers could assume wider responsibility and start to educate their clients about the potential financial implications, as well as ESG impacts, of their choices. The researcher recommends that institutional investors actively engage with the PRI community and leverage the value it offers to signatories.
    • Restructure the remuneration of asset managers: Asset managers’ remuneration should not be linked to investment performance alone; a fee-for-service based approach is also suggested. By adopting responsible investment as an embedded philosophy, asset managers assume responsibility for active ownership, communication, ESG risk identification, monitoring and reporting services that could build their revenue pipeline away from cost structures based on assets under management. This approach could protect clients’ interests and enhance the reputation of asset managers and service providers.
    • Mandate compliance: The PRI’s increased power as a stakeholder could be leveraged through research and case studies confirming the value of RI. The benefits for asset owners to recognise asset managers and professional service providers for incorporating the philosophy of responsible investment into mandates could be highlighted through such case studies.

Reputation, not just performance, influences investor practice.

Stepping up efforts to integrate responsible investment

Institutional investors, in concert with the state, play a pivotal role in the global financial system. As the custodians of other people’s money, they are responsible for delivering on the long-term financial objectives and needs of the contributors and beneficiaries of those investments. In addition, they carry a fiduciary duty toward current and future generations.

Repeated examples show that sustainable, risk-adjusted returns are a function of collective stakeholder alignment throughout the investment value chain. The traction of frameworks – such as those proposed by King IV, PRI and CRISA – suggests greater responsibility is being taken. However, personal conviction by individual decision-makers is required to promote these principles with peers.

In South Africa and elsewhere the word, the prevailing level of income and wealth inequality between nations, institutions and individuals are wicked problems manifested through volatile financial, political and social movements. The demands for trade, employment and wage increases seemingly stand in tension with the competing needs for prioritising the environment, increased automation and maximising returns for shareholders. The balance between self-interest and collective progress is precarious.

Responsible investment can indeed become a dominant investment philosophy. This calls for commitment from the individual investment decision-makers and their institutions. It also calls for proactive communication, education and engagement by all the participants in the investment decision-making process.

  • Dr Colin Habberton is a PhD alumnus of the University of Stellenbosch Business School. The title of his PhD dissertation is: Connecting capital: The factors influencing the decision-making process of institutional investors towards responsible investing. Find his thesis here: http://scholar.sun.ac.za/handle/10019.1/105695
  • The supervisors for his PhD dissertation were Prof Suzette Viviers and Dr Lara Skelly.

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Independent record labels on the Cape Flats How new technology can lead to new business models

Independent record labels on the Cape Flats: How new technology can lead to new business models

The Steinhoff Saga Management review - University of Stellenbosch Business School

July – December 2019

Independent record labels on the Cape Flats: How new technology can lead to new business models

Independent record labels on the Cape Flats How new technology can lead to new business models

By Arthur Price

  • DEC 2019
  • Tags Strategic Management

19 minutes to read

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What was this study about?

The Cape Flats, a disadvantaged area of Cape Town, offers a rich cultural heritage. Here, independent record labels help to create awareness through music genres such as hip-hop, R&B, house, kwaito, soul and jazz. But how did technology change the way in which these independent record labels operate? Can technology help these producers to become more sustainable?

Until now, research on digital disruption in the music industry mostly came from the developed world. However, it is also important to gain an understanding of how industry professionals can leverage technology in a localised context.

This calls for a better understanding of how digitalisation affects the design and shape of business models, and how the industry, market forces and innovation shape opportunities to monetise music through the use of digital technologies.

About digital disruption in the music industry

First we had the gramophone and radio. Then came vinyl records, audiocassettes and CDs, followed by the internet, ICT and social media. This has changed the way in which recorded music is distributed and consumed. But it was the development of the MP3 music format, better storage technology and increased broadband internet speeds that really drove the digital disruption of the music industry. Digital interfaces for music production was developed, which eradicated revenue streams monopolised by large record companies. This enabled music professionals to self-produce and publish music far more cost-effectively.

Digital interfaces for music production … enabled music professionals to self-produce and publish music far more cost-effectively.

Next, online music services, music downloading and music streaming led to new platforms for artists to distribute their music and for consumers to find this music.

This changed when music aggregation sites became central hubs for individuals to access music and when music labels created music that could not be sold on major digital distribution hubs because they did not have an agreement with a professional distributor.

The rise in social media has led to online service companies putting more effort into gathering customers than making money from them. Social media gives business owners with a direct route to market and increases consumer-to-consumer promotion.

In addition, crowdfunding has become popular in the music industry due to the success of fan involvement in the creative side of music production. Crowdfunding can indeed provide a revenue stream to help artists and independent record labels to overcome financial limitations associated with music production.

About business models and value chains for the music industry

A business model is a strategic management tool that improves a company’s competitiveness in an industry’s value chain. It can help a company to structure its business for operational efficiency. Four elements are essential for the development of a good business model: A value proposition, supply chain, customer interface and financial model.

The traditional value chain in the music industry went from composing tunes, song writing, live performances, publishing, recording, reproduction and distribution to retailing. But now, fewer people are buying physical music products. This allows music to be classified as information, which calls for a new value chain.

The rise in social media has led to online service companies putting more effort into gathering customers than making money from them.

A virtual value chain is created when value-adding steps are performed through and with information. With the increase of digital technologies in the core of products, services and operations, business models need to change accordingly. This means we need to ask what such a business model should take into account, how networked interdependencies can influence the design of such a business model, and how technology can facilitate two-way links between stakeholders.

A review of the existing literature on this topic says the music industry value chain should be seen as a network. The creation of a musical concept, digitisation and collaboration serves as a value-creation loop. Value is captured by ensuring a personalised delivery and experience for consumers. Expenditure during the value-creation process includes tangible and digital product development, aggregator fees and royalties to rights holders. Revenue is generated, among others, via digital downloads, streaming revenue and crowdfunding.

But what about smaller record labels?

This study wanted to develop a business model and value chain for independent record labels with digitisation as a core competency in order to improve business sustainability. The argument was that if there is a better understanding of the variation in business models and virtual value chain perceptions among independent record labels on the Cape Flats, then surely this will provide much-needed insight into sustainable economic development in a geographical space that would benefit from favourable growth? What’s more, this growth may even help to off-set youth unemployment.

To find out, semi-structured interviews were conducted with eight participants who collectively had over 100 years of experience as independent music professionals. Thematic analysis was used to identify repeating themes, which enabled the researcher to propose a better business model.

What did the study find?

Four themes surfaced from the participant interviews: musical concepts are shared visions, virtual organising is important, digital distribution is important for value creation, and crowdfunding is not necessary for success. Each of these themes were developed to gain a better understanding the respondents’ views.

When delving deeper into why the strong emphasis on the musical concept, most participants referred to the criticality of a shared vision between all parties for an independent record label to remain consistent …

Theme 1: Musical concepts are shared visions

Theme 1 refers to a shared vision between owner and artist, which is critical for musical concepts to be developed. Musical concepts are more than establishing a theme for a project; it is a prerequisite for strategic musical narratives that create label identity and improve business sustainability.

The interviews with the independent record label producers started with a discussion around musical concepts. It probed the creative process when artists and the label decided to embark on a project, and how the parties involved choose to interact with each other. Various participants mentioned that the musical concept is important for independent record label producers. In most cases, it related to what job they want the music to perform and whether they were planning to distribute the project commercially. In many cases, single releases and experimental projects are designed to be given away for free.

When delving deeper into why the strong emphasis on the musical concept, most participants referred to the criticality of a shared vision between all parties for an independent record label to remain consistent and sustainable over the long term. According to them, incongruence in this “shared vision” can lead to creative instability and even derail projects.

Theme 2: Virtual organising

This theme reaffirms the importance of virtual organising through digital technologies when performing the tasks of creating musical concepts, music production and customer interaction. The interaction of these elements integrates the asset configuration and customer interaction sections of the theoretical business model. This theme explains the key technologies together with the respondents’ rationale for using tools such as WhatsApp, Google Drive and WeTransfer.

Yes, software allows them to record in real time with everyone being in different places, but then they need to deal with bandwidth, speed and reliability …

Virtualness as a strategy facilitates interaction via digital technologies between customers and stakeholders that are geographically dispersed. To assess the relative importance of virtual organising within the local context it is essential to explore the driving forces behind the chosen channel and platform for virtual interaction across the supply chain. These interactions are discussed from the perspective of musical concepts, music production and customer interaction:

  • Musical concepts: In terms of virtual organising, all the participants referred to digital tools such as social media platforms, iTunes, Google Play and Spotify. However, affordability and access to the internet are also shaping their interactions. This means that file size, download platforms and interaction platforms were considered as important for a successful digital strategy. Most participants said they use WhatsApp groups to interact with stakeholders, finalise concepts and coordinate schedules. Even though sophisticated platforms designed for cloud-based interaction offer a lot of functionality, the affordability of data and challenges like sign-up procedures can hamper their use.
  • Music production: The importance of owning one’s own recording studio was emphasised. This circumvents the challenges associated with using digital audio interfaces. Yes, software allows them to record in real time with everyone being in different places, but then they need to deal with bandwidth, speed and reliability, which is why these independent record producers preferred to record the final product together at the same time.
  • Customer interaction through social media: One participant mentioned that the use of social media makes it easy to interact with his customers and to enable his record label to have a presence on various digital platforms. However, he added, one must also nurture followers on a personal level (through “personal communication” and “physical presence”) and never overestimate brand strength merely based on social media reactions of support. Another participant stressed the importance of quality content and a solid work ethic to gain a tangible followership (“which calls for a lot of hard work”). They agreed that social media interaction is critical for maintaining the public image of the artist or independent record label, but does not necessarily create revenue streams. They said that social media, Facebook in particular, can be used as a reference point for potential bookings from corporates and event managers when determining the influence and likeability of an artist.

Theme 3: Digital distribution is for value creation

All the participants viewed digital distribution via major distributors such as iTunes, Google Play and Spotify as a key factor for business success. For them, digital distribution via these platforms is not about revenue generation. Instead, it is a way to improve brand equity which is needed to unlock revenue generation through business-to-business interaction. Their primary revenue come from live performances. As one participant said, “These are just like little things that give you legitimacy but makes no money…”

Digital distribution via major distributors is therefore a component of the value-creation process and not their main revenue stream.

Theme 4: Crowdfunding is non-essential for success

Most of the respondents considered crowdfunding a non-essential activity despite agreeing that it could add value to their business. This opinion was largely driven by the enormous effort required to ensure a successful crowdfunding campaign. For these independent record label producers, sustainable fund generation mostly happened a personal manner within business networks. As one participant explained: “I believe as an artist you first need to be able to invest in yourself.” The participant believed that these entrepreneurs should be willing to invest in their businesses and that the loss of money will result in critical lessons learnt. Another participant believed that crowdfunding only “works if you have a compelling story”. Furthermore, crowdfunding is a technical process, which does not guarantee returns or success of the campaign. Based on the participants’ feedback, it was clear that crowdfunding is a contentious subject that has not yet reached maturity.

What is the take-out from this?

Key findings from the in-depth interviews with the eight independent record label producers from the Cape Flats included the following:

  • Have a shared vision: The independent producers said that musical concepts need to be expanded to factor in the vision of the independent record label. What’s more, the artist and the business owner should agree on this vision. This will help to ensure that musical concepts become strategic musical narratives that ultimately translate into label identity. It is recommended that the initial business model incorporates shared vision as a prerequisite for a strong label identity.
  • Use WhatsApp groups for virtual organising: All the participants referred to the use of WhatsApp groups for communication with business partners and customers. Exclusive content distribution and direct interaction with customers via WhatsApp can create a cost-effective and vibrant online community, which provides a direct route to customer interaction. It is recommended that the initial business model incorporates WhatsApp groups for efficient virtual communication.
  • See digital distribution and social media interaction as a system: Virtual organising for digital distribution and social media interaction with customers serves as a key driver to grow brand equity when followers increase. This leads to an enhanced value proposition, which drives revenue generation. However, primary revenue is generated from live shows. Digital distribution is not crucial for revenue creation. Instead, it forms part of a complex system that incorporates social media interaction, increased downloads and investment in brand identity to build optimal brand equity. Digital distribution via major distributors is therefore a component of the value-creation process and not their main revenue stream.

Previously, corporate clients were neglected as a source of revenue. However, it is now possible for independent record labels to attract revenue from event managers and corporate clients if their brand equity justifies the investment.

  • Ignore crowdfunding for now: Globally, independent music artists have benefitted from crowdfunding. However, most of the participants were hesitant about the potential return of crowdfunding. For the participants, the probability of a successful crowdfunding campaign is not high as they have limited resources while crowdfunding calls for a huge investment of resources. So, crowdfunding is currently not considered a key activity for them.
  • Distinguish between corporates and consumers: Independent record label producers should segment customers into corporates and consumers. Previously, corporate clients were neglected as a source of revenue. However, it is now possible for independent record labels to attract revenue from event managers and corporate clients if their brand equity justifies the investment. This will, of course, also depend on the successful use of digital as a core competency.
  • Manage the customer value proposition: A key expansion from the prior business model is that customer interaction is actually a value-creation system. Social media success requires a mix of online platforms such as Facebook and Twitter, but value optimisation takes place through communication of strategic musical narratives via WhatsApp groups. Integrating strategic musical narratives with digital distribution and social media interaction as a system is critical for managing the customer value proposition across the various customer segments.

Suggested changes to the business model for independent record label producers

What insights can be incorporated into the business model for smaller producers?  Firstly, start with a shared vision to ensure alignment between all parties. Secondly, incorporate WhatsApp groups for efficient virtual communication. In addition, focus on live shows for revenue generation (with a strong focus on corporate clients), and on digital distribution and social media interaction to build brand equity. Most importantly, see customer interaction as a value-creation system.

… personalised delivery and experience management for the consumer segment is now seen as part of the value-creation process.

Suggested changes to the value chain for independent record label producers

The independent producers did not regard digital distribution as a key source of revenue because the earning potential via digital distribution was too low. However, they do realise that it is important to build brand equity. Live performances – whether self-managed, contracted through event managers or corporate clientele – were important as these generated revenue. This triggered key changes to the theoretical value chain. Firstly, personalised delivery and experience management for the consumer segment is now seen as part of the value-creation process. Secondly, successful value creation is necessary to build the brand equity required to capture optimal value, which includes the ability to tap into corporate revenue streams.

The future of music on the Cape Flats is digital

Smaller, independent record labels – such as those on the Cape Flats – can unlock new revenue streams and improve business sustainability if they enhance their digital competencies in the areas that help to build their brand equity. What’s more, digital technologies can help them to save costs and leverage advantages when competing against firms with similar service offerings.

    • This article is based on the research assignment of Arthur Price – an MBA alumnus of USB. The title of his research assignment was: Business models of independent record labels on the Cape Flats to stimulate business sustainability.
    • His study leader was Prof Marius Ungerer, who teaches strategic management, leadership and change management on programmes such as the MBA, the MPhil in Management Coaching, and the PGDip in Leadership Development at USB. Prof Ungerer is an annual Visiting Professor at the NUCB Graduate School, International MBA Program, Nagoya, Japan, and a visiting faculty member of the University of Johannesburg.

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