Navigating the short- and long-term trade-offs

Short-term pain, long-term gain is a common refrain over recent years as economic headwinds have blown hard. As these headwinds ease (albeit with a lingering sense of fragility), and the mood shifts to optimism and opportunism, it is worth remembering that the opposite – short-term gain, long-term pain – is also true.

As highlighted in the summer Boardroom, ‘Return on capital’ “is about being smart with capital in all its forms – financial, human and natural resources”. With complexity and uncertainty a prominent feature in our operating reality, and the implications of exceeding our planetary boundaries more widely understood, the need for a broader, longer term and more integrated view of ‘capital’ is re-emerging.

Integrated capitals, the ‘non-financial’ myth and an Aotearoa lens

The concept and value of businesses accounting for a broader set of capitals – beyond simply financial – is not new. From the six capitals foundation of the landmark Integrated Reporting Framework to their more recent expression in the Capitals Coalition’s integrated decision-making framework, the benefits of a more integrated capitals perspective have been well traversed.

However, as the fragility of our economic dependence on natural resources – particularly in Aotearoa New Zealand – and the strategic importance of more inclusive decision-making in a more judicious and fragmented world become more evident, the imperative for business to take a broad capitals view has become even stronger.

While the case for, and opportunity of, change is clear, the broad uptake of these integrated capital frameworks remains somewhat stymied by the classification of the constituent capitals as either ‘financial’ or ‘non-financial’. This classification not only reinforces our bias towards the financial, but also overlooks the reality that each of these capitals has a financial context and would better be considered as ‘pre-financial’.

Whether we are considering environmental impacts, staff disengagement or shifting consumer trends, financial impacts inevitably materialise in the absence of robust accounting and management. The reverse is also true – particularly in a world that is requiring greater flexibility, adaptability and innovation – wherein those managing and proactively investing in broader capitals can better leverage new market opportunities and sustainable value creation.

The end of 2024 saw a further evolution of the integrated capitals concept, one with a distinct Aotearoa flavour. In response to “increasing demands for information beyond that provided by conventional financial reporting frameworks”, the External Reporting Board (XRB) released a draft of He Tauira, a voluntary ‘non-financial’ reporting framework. What is particularly interesting is the shift from a discrete ‘capitals’ conversation to a more integrated narrative founded on a conceptual ‘wharenui’ whose constituent elements cannot exist without each other.

From tūāpapa (identity and purpose) and tāhuhu (aspiration and vision) though to five supporting pou: tuarongo (institutional knowledge), hononga (ecosystem of connections), mokopuna (intergenerational impact), tāhu (strategic focus), and te tumu (interaction with the external world), He Tauira provides a framework for organisations to “consider how they articulate their long-term intergenerational impact, through a distinctive lens examining their operations and their broader relationships with the external world”.

Where to from here?

While focused on the necessary evolution of corporate reporting, frameworks such as Integrated Reporting and He Tauira are also an important reminder of the need for decision-makers navigating the realities of our operating environments to employ broader, more integrated thinking. It is important to reflect on where limited capital can best be deployed, to what level and in which forms. To do this well, several factors need to remain top of mind:

• The realities of our core assumptions. Chapter Zero’s Transition Planning Guide reminds us that the distinguishing point between a good and bad strategy is the quality of the assumptions upon which it is built. The guide also notes the ‘usual realm’ of corporate strategy are market assumptions, while other foundational assumptions, such as access to raw materials, reliable and safe global trade are often forgotten or minimised. It is important to ensure these foundational assumptions – which often sit in the domain of ‘pre-financial’ capitals – are sufficiently understood and accommodated.
• The norms and structures of the past may not be suitable for the present, let alone the future. Many of us have been interrogating and applying climate scenarios as part of the NZ climate disclosure regime. These scenarios paint radically different pictures of our present and future world and require us to question the sufficiency of all aspects of our businesses – from capital structures to operating models. The changing nature of insurance in the face of escalating extreme weather events is one arena where businesses are needing to grapple with the nature of capital allocation to accommodate the shifting insurance appetite. The UK’s Institute and Faculty of Actuaries has said these climate scenarios often “. . . exclude many of the most severe risks that are expected and do not recognise there is a risk of ruin. They are precisely wrong, rather than being roughly right.”
• Setting adaptative strategies is key but knowing when to shift is paramount. The volatility we are facing will continue to be an ongoing feature of our world. Strategies that can flex and change will be key to enduring value creation. Creating successful adaptive strategies is not just about identifying a range of potential future pathways and understanding their capital requirements, it is also about establishing triggers that can tell us when to switch paths. Historically, we have seen metrics and indicators showing us how close we are to achieving an outcome. It is increasingly important we set metrics and indicators that allow us to understand whether the world – and our core assumptions – are shifting as we had imagined.

• Time horizons have shifted. Short-term returns are no longer (if they ever were) immune from extreme weather events, geopolitical conflict and technological breakthroughs. The ability to deliver a return even in the short term is contingent on an organisation’s resilience. This requires a solid understanding of the broad capitals – financial and pre-financial – that an organisation is reliant on to operate. It also requires organisations to nurture and grow their stocks of these capitals so they can draw down on them in times of need.