Assessing social condition

Defining social capital

International developments in reporting are placing more importance on social relationships.

The integrated reporting framework makes the point that the value a business creates for its shareholders ‘is interrelated with the value the organisation creates for stakeholders and society at large through a wide range of activities, interactions and relationships.’ The integrated reporting framework identifies a number of different types of capital: financial, manufactured, intellectual, human, natural, and…social and relationship capital.

In ‘good times’, a financial service company’s social capital could be up to 40 per cent of the company’s total value — about the same as financial capital. It is inherently sensible from the shareholders’ perspective for a business to build and maintain high-quality relationships, both internally and with external groups including customers, suppliers, partners, regulators, media, politicians and bureaucrats.  Of course, a business’s value to a social group is not the same as the value to shareholders. And the return the group expects on its social capital is not necessarily financial — rather it is in the quality and outcomes of the relationship with the business.

It is helpful to think about it this way: each relevant social group provides relationship (or social) capital, which creates value in the form of an intangible asset for the business (goodwill). The terms social capital and social goodwill are therefore referring to the same thing.

There is a pressing need to find ways to fundamentally improve the understanding and management of key relationships, and this could be done via a social condition report.

Loss of social capital

The response of markets to unfolding events at the banking royal commission demonstrated how social or relationship-related events can quickly destroy significant business value. It demonstrated the inherent volatility and fragility of social capital.

Loss of social capital can occur with little or no warning provided by current management indicators and reporting, which have proven to be backward‑looking and ineffective.

This is not surprising. Despite social capital being extremely important to the achievement of business objectives, a financial services organisation typically invests little (time and money) in understanding and measuring the state of its relationships and hence its social capital. In contrast, it will have major systems and large numbers of employees dedicated to measuring, understanding, managing and reporting on its financial capital and financial risks.

There is a pressing need to find ways to fundamentally improve the understanding and management of key relationships, and this could be done via a social condition report.

Recent events and the risk angle

A failure of risk management lies behind many of the current travails of the Australian financial services industry. In particular, the industry has not kept pace with changes in society’s standards and expectations and has struggled to either recognise this or deal with it.

It is common for assessments of the current level of a risk to be based on backward-looking measures — and this can give a poor indication of the actual risk profile. For example, cyber security risk might be rated ‘green’ based on a low frequency of cyber incidents, whereas the underlying risk may have increased significantly because of recent changes to the data management structure, and this will manifest as poor incident experience in future.

There should be much more focus on forward-looking indicators that monitor underlying risks rather than outcomes. This leads to the idea of ‘risk sensing’ — using indicators that identify underlying risks as they emerge and evolve, giving early warning of possible problems and the need for action. The analogy is the self-drive capabilities of some modern cars, which use an array of smart cameras, radar and ultrasonic sensors. The system is able to identify prospective risks (another vehicle on a collision path) and take management action (applying brakes, etc) to ensure the car continues safely.

Risks to relationships

Relationships can be damaged, diminished or diluted in many different ways. Sometimes it is because a relationship partner has been ignored or hasn’t been actively engaged in the relationship. This could result from careless or poor management, or more likely could be an outworking of an organisation’s ‘transactional’ mindset — resulting in systematic under-investment in relationships.

Sometimes relationship partners feel a lack of parity when they perceive outcomes as unfair, or when they feel disrespected. They may feel they don’t have the power to influence the situation.

Sometimes partners are frustrated by the company’s lack of ‘memory’ about previous interactions and history — and an apparent lack of loyalty and commitment.

Operational processes can be important to the quality of social relationships; a business’s poor systems and procedures, or errors, might be seen as inadequate or uncaring. It’s important that operational risks are understood and managed to avoid unnecessary damage to relationships. The organisation’s response to an operational event with adverse relational outcomes is particularly important to relationships.

The case for a social condition report

The inspiration for the social condition report was the financial condition report (FCR), required by APRA to be prepared by an insurer’s appointed actuary and provided to the board. The FCR has a prescribed minimum scope set out in APRA’s prudential standards. It’s a comprehensive report that assesses an organisation’s financial condition, including assessment of pricing, capital adequacy and capital management, investment strategy, and profitability. The FCR draws on work done throughout the year by various parties, as well as work specifically completed for the FCR.

The discipline and insights provided by a social condition report could prove very valuable to management and boards in identifying and addressing the root causes of poor behaviour and unacceptable customer outcomes.

Boards place considerable value on the FCR because of its comprehensive view of the financial dynamics and the insights that flow from this. The FCR plays a key role in the successful financial management of a complex industry.

The social condition report would take a conceptually similar approach. It would be a comprehensive report to the board about the quality and value of the relationships with key groups in society. The discipline and insights provided by a social condition report could prove very valuable to management and boards in identifying and addressing the root causes of poor behaviour and unacceptable customer outcomes.

Many organisations will currently be thinking about how to best respond to the royal commission and the APRA report into the CBA. No doubt the management and assessment of customer and other relationships will figure strongly in those deliberations. Many responses are likely to involve being more diligent, working harder, applying more resources, improving reporting etc — essentially, pedalling harder.

The authors are sceptical about the effectiveness and efficiency of such approaches. In this context, they summarise the benefits of the social condition report for management and boards and regulators as set out below. They also introduce ASIC as a party who, in the current environment, might find valuable insights in social condition reports. In this context, ASIC could be seen as representing the interests of customers and society more broadly.

What would a social condition report look like?

As a practical guide, the authors have created a mock social condition report for a hypothetical large bank GBC (General Banking Corporation).¹ The report:

• identifies key groups in society with whom GBC has relationships — these are: customers, employees, suppliers & partners, shareholders, the public, politicians and bureaucrats, regulators, and media
• assesses and measures the quality of the relationships with each key social group, and how they have changed since the previous report
• assesses the risks to those relationships, referring to the board’s risk appetite. As an example, one risk that’s discussed is ‘community tolerance risk’ — the risk that society’s tolerance for certain attitudes and behaviours changes quickly, catching the business unaware.
• reviews the approach taken to manage those relationships and risks.
• reviews social relationship incidents since the last report, and the company’s responses. The incidents for GBC included: the format and content of the regular communications to home loan customers were revised, and the changes caused some confusion and anger with branch employees and customers.
• reviews implementation of past social condition report recommendations, and the outcomes.
• makes new recommendations for action. The recommendations for the fictional GBC included.
  • (Employees) Understand the root causes of the broken link between senior and middle management
  • (Customers) Develop a program to identify customers who have had particularly poor experiences, and support them in a way that turns them into advocates.

Measuring the state of relationships

In order to manage the quality of relationships, and assess and manage the related risks, it is necessary to systematically measure the quality of relationships. (‘If you can’t measure it, you can’t manage it’.)

So how can this be done in a structured way that will be valuable to management and board? The authors note that there is a range of potential approaches, and draw on their own experience to suggest two specific methodologies.

• They use relational analytics to assess the quality of relationships. In this framework, the strength of a relationship is measured as ‘relational proximity’ (R) (maximum = 100 per cent). As relationship distance increases, the risk of relationship problems increases.
• They use signal analysis as an additional method for assessing the quality of relationships, as well as to inform the assessments made using relational analytics. Signal analysis uses artificial intelligence to assess the quality of relationships, using communications inside and external to the organisation.

They believe that these two methods are complementary and synergistic, and provide richer insights when used together. The proposals are much more comprehensive than some of the simple measures of customer satisfaction, such as NPS.

One of the key assessments in the mock GBC social condition report is the following table, which derives an overall ‘Social Goodwill Measure’ for GBC — a weighted average measure of the quality of relationships across all key groups. If all relationships were extremely strong and close, this measure would be close to 100. In practice, there is a range of limiting factors on relationship strength — including limited time to invest, limited history, misalignment of interests, hesitancy to share information, etc. Relational analytics practitioners regard proximities above 75 per cent to be generally indicative of effective relationships.

The social goodwill measure would be estimated yearly — to track changes over time, and to assess the impact of any interventions for the relationship groups.

Practical implications

The social condition report would not be based solely on original analysis. Much of it would rely on work carried out for a range of other purposes — market research for product insights, culture work by HR, feedback from auditors, risk assessment work etc. Part of the value of the social condition report would be in drawing it all together, with additional work, to give a comprehensive view of the quality and value of social relationships. It would analyse the associated risks, and make recommendations to improve the organisation’s social condition.

The authors have previously floated the introduction of a new senior role: the social risk officer, as a way to make sure that appropriate attention and expertise are brought to the management of social risks. GBC’s social risk officer is the author of the GBC social condition report.

However, the social condition report’s author could be from any one of a number of different disciplines. Ideally, the author would be numerate and have a good understanding of the business, its products, strategy, and risk management, and not least the importance of social and cultural issues. It would be highly desirable for an appropriately skilled person to have clear and sole responsibility for the social condition report, and to have a reporting line and direct access to the board.

Pros and cons

The case for the focus on social capital and relationships that a social condition report would bring is clear. It’s easy to see how a board would find such a report valuable — in particular, as it ties together all of the ‘relationship elements’ of the company’s operations.

Short of designating a social risk officer, who is best placed to write the social condition report? No one individual is likely to have the full set of skills needed — CROs, heads of HR and actuaries would all bring valuable perspectives and skills. A small group could successfully cooperate to put the report together — and this sort of cooperation could have other positive impacts, such as increased understanding across ‘silos’, identification of opportunities for fruitful collaboration.

Some organisations may fully embrace the idea of a social condition report in the short term. Others may wish to work towards a full report in smaller steps, for instance:

• existing reporting or governance materials could introduce commentary on the organisation’s relationships, their strategic significance, and any available indicators of their current strength
• the social condition report could be developed over a number of years — starting with a high-level report, and fleshing out one or two additional sections each year.

If relationship strength is to be measured — and this is highly recommended — there’ll need to be some thought given to the available methods and what would best suit the individual organisation.

Conclusion

This paper is a valuable read for governance professionals and directors who feel underprepared to deal with the social risks confronting them. It provides a framework, and methodologies, to gather deeper relationship insights and forward-looking indicators. Adopting the ideas could assist in protecting and building an organisation’s social capital, and therefore its total enterprise value. In the current environment, the approach may help organisations respond to issues raised by the banking royal commission, and prevent similar issues arising in future.