He growing insignificance of the annual report



The month of June is an important month for investors. I am an investor myself, holding a portfolio of about 20 odd companies spread across diverse industries. I look forward to the month of June eagerly every year, for it is during this month that most companies dispatch their annual reports to their investors. The annual report contains details of the company’s performance during the financial year, which typically ends on the last day of March for most Companies. Hence it is quite natural for investors to be excited at the prospect of reading about all the happenings in their invested company in the past one year and to get critical insights about its prospects for the future. The annual report is supposed to be just that report. Yet if truth be told, nothing could be further to the contrary. Most, if not all, investors whom I know including myself give the annual report just a cursory glance before consigning it to the realms of the recycle bin. The contents of the annual report is not trash by any stretch of the imagination, yet the utter lack of usefulness of its content for investors year in and year out just defies common sense. Let’s look at the contents of a typical annual report to try and understand the reason behind this anomaly.

 

The first chapter of any annual report is an introductory statement by the Chairman of the company. The sole purpose of this statement is to create a feeling of warmth and generate goodwill amongst investors. Point taken, yet investors are better comforted by the warmth of wads of notes willowing in their wallets and the assurance of a repeat performance every year. Mere words and motherhood statements that find their way many a time into this section are a drag on investor patience. Hence the Chairman’s statement can be safely skipped without much risk.

 

Next follows the auditor’s certificate. Considering the fact that auditors are obligated by their profession to follow a boilerplate template while issuing this certificate, this section can be safely skipped as well.

 

Of late, many companies include a report on Corporate Governance which typically appears at this point in the annual report. In the name of Corporate Governance this report provides attendance records of the directors of the company at board meetings. In effect, investors are informed how many meetings are attended by directors but their contribution at such meetings is conveniently given the pass over. Hence this section is also worthy of skipping.

 

At this point, we reach the two sections which form the meat of any annual report – the financial statements and the management discussion and analysis. The financial statements and the associated explanations of the numbers that appear in numerous foot notes are about the most useful piece of information that one can find in an annual report. However, in this day of electronic updates, this data is already available on multiple financial web portals weeks before the annual report reaches the investor’s hands in physical form. This leaves the discussion and analysis section from our point and view. There is no defined format for this section. The quality and quantity of information revealed in this section varies with industry, company, management outlook and many other factors. If the company is interested in highlighting the drivers of the company’s performance, it should normally be found in this section. Many companies do try and give as much information as possible in this section about the drivers of their growth, now and into the future. Many others hold back in the fear of revealing sensitive company information. Still others are clueless about the reasons for their growth or lack thereof and end up making general risk free statements in this section.

 

 

Of the approximately 20 annual reports that I receive and read every year, I find a great difference in the thickness of these reports. I have read annual reports ranging from 15 pages to more than 150 pages. I have also observed that some companies follow the annual reporting process to the letter disclosing only as much as is legally required while a handful others try to go above and beyond the letter and try to comply with the spirit of annual reporting which is what investors are really interested in. The true spirit of annual reporting requires companies to not only analyze their past performance but also give a fair assessment of its future prospects based on the state of core competencies of the company and external economic conditions. Alas, this remains a distant dream as of now. Yet it can be done easily by including a section the Intellectual Capital of the company. A well designed Intellectual Capital Report that tracks the intangible assets and growth drivers of the company year on year is a good tool for informing investors about the inherent strengths of the Company. It will only take a few leaders to start disclosure of their intangible assets in this manner for the remainder to follow. The alternative is for the government to step in and introduce regulation requiring compulsorily disclosure of such information.

 

Packaging – Relational Capital in action

Of the three components of Intellectual Capital - Human, Structural and Relational – it is most difficult perhaps to understand the contribution and value of Relational Capital in real life. I decided therefore to focus this week on the one industry that contributes immensely, entirely and solely to the Relational Capital of its Customers. I am referring here to the multi-billion dollar packaging industry dominated by players such as Tetra Pak, Alcan Packaging, Crown Holdings, Alcoa, Amcor, Rexam, etc. 

 

The importance of packaging is critical to the successful selling of any product, especially in the Retail sector. New product launches especially benefit from an attractively designed package that clearly engraves the value of the product in the minds of the consumer. Initial sales of such products are driven by the attractiveness of the package (and also the price) while repeat sales depend on other product attributes such as quality, durability, reliability, satisfaction, etc. Next time you visit your local grocery store or a nearby shopping mall, try and find new product launches and then take a probing look at the packaging around the product. Compare that package to that of existing products in the same category and you will soon realize what I am talking about.

 

Packaging is an art, although over the years savvy marketing professionals have detailed it down to a science. Many a time, the package has nothing inherently to do with the product per se, but is designed solely to convey a positive impression and familiarity on the mind of the buyer. For e.g. have you ever wondered why products targeted for kids invariably have cartoon characters depicted on the package? I am quite sure that Mickey, Mini and Goofy have sold more toys, school supplies and snack items than Walt Disney could have ever imagined in his wildest dreams! Yet there is rationale behind this approach. Since the product package is a very tangible item, marketers leverage the physical properties of the package in order to draw the attention of buyers. These include color, shape, size and convenience among other things. Many different rules have evolved in this regard based on the conditioning of the human psyche. For instance, black implies luxury, brown conveys an earthy feel, green projects nature and freshness, sky blue implies purity, etc. The size of the package is determined by consumption patterns – this explains why cola cans have a capacity of 355 ml, a very odd number. The shape of the package is often dictated by optimum storage criteria – this is the reason why even cylindrical or spherical packages like cans and playing balls are aggregated together in rectangular shaped boxes. Finally, the package is often designed to enhance consumer convenience for e.g. fruit drinks packed in tetra-packs have a straw attached to the package and creamy cheese and yogurt packs come with a handy plastic spoon attached to the top.

 

Lest you get the impression that packaging is relevant only for the retail sector, let me dispel that notion by telling you that nothing could be further from the truth. Packaging is highly important not only to other products but in fact also to services. Consider a software product such as Windows, the Operating System that runs most personal computers on this planet. Microsoft, the maker of Windows, has a virtual monopoly in this category, yet Microsoft invests heavily into improving the User Interface of Windows and releases a newer version of the product every three years or so. The User Interface is the packaging of Windows – it is how you see the product and how you use it and get used to it. Improving it is the only way by which Microsoft can attract you to upgrade your operating system to a newer version every three years and thereby generate new sales on essentially the same product! If Microsoft did not improve the User Interface of Windows, you would have no need to upgrading your operating system, would you? Moving on to services now – let’s take the example of Banking. All banks essentially do the same thing – borrow money at the lowest possible rates, lend it at the highest possible rates and make money on the spread. All banking services therefore fulfill either the borrowing need or the lending need of the bank. Looked at this way, banking is really a commodity service isn’t it? Yet have you noticed how some savvy banks package their services differently. In their bid to attract you (the customer), they pamper you with special privileges such as free debit cards, no annual fee credit cards, gifts at the time of account opening, cash delivered to your home, etc. not to mention exclusive privileges such as private banking and wealth management that are offered only to the choicest few. Similarly airlines, that essentially offer the commodity service of transporting you from point A to point B, ensure your loyalty and your business by packing their service with a loyalty program into which you are enrolled free of cost!

 

There is no doubt about the huge value that the packaging industry creates. Yet it is a surrogate industry – the tangible packages that the industry develops fulfill the intangible needs of the product manufacturers. The product manufacturer focuses on developing the best quality product at the lowest possible cost whereas the packaging supplier focuses on developing and delivering the packaging concept for the product. This is a great example of how product manufacturers leverage the Relational Capital of their package solution suppliers. The deep relationship between two enables them to work jointly together on the best package for the product. Packaging solution providers are so glued-in on their Customers and their target markets that they themselves invest heavily into developing newer packaging materials such as recyclable and biodegradable materials that are in demand by end consumers. In the process they generate a steady quantum of value add for their Customers which looked at from the perspective of the product manufacturers is really nothing but Relational Capital.


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