Middle East Point of ViewFall 2014 - Deloitte · PDF filePast\Present - Future? Supply/Demand economics Hotels in 2020 Dubai Is there a lawyer in the house? The changing role of the

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Middle EastPublished by Deloitte & Touche (M.E.)and distributed tothought leadersacross the region.

Fall 2014 PointofView

In the MiddleEast since

Past\Present - Future?

Supply/Demand economicsHotels in 2020 Dubai

Is there a lawyer in the house?The changing role of the GC

An industry with line livesThe future of telecoms

We’re off to see the wizardOrganization Design

2 | Deloitte | A Middle East Point of View | Fall 2014

Fall 2014Middle East Point of ViewPublished by Deloitte & Touche (M.E.)

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Deloitte | A Middle East Point of View | Fall 2014 | 3

A word from theeditorial team

I am the first to admit that I am a bit of a worrywart.And who can blame me? As we watch the news withforeboding and open newspapers with trepidation, aswe worry about our children becoming social recluses infront of a media screen, who hasn’t wondered, withdisquietude, “what is this world coming to?”

“Today,” goes the saying, “is the tomorrow you worriedabout yesterday.” We worry about the future becausewe tend to fear what we do not know and are uneasyabout what we cannot understand (Phablet you said?).But fear can sometimes paralyze us and keep us fromreaching our future goals.

Witness the characters in the movie The Wizard of Oz(1939). As Mazen Afif points out in his article onOrganization Design, The Wizard of Od, following herjourney filled with turmoil, Dorothy Gale came backhome with renewed vision and goals. On her way, shehelps the lion find his courage, Scarecrow to get a brainand Tin-Man to obtain a heart. “Fear of change,” saysAfif, “often leads organizations and employees intochaos and they focus on their new roles in a way thatmay affect their productivity.” But this fear should notkeep organizations from tweaking or redesigning theirorganizational structure, he says.

Telecom operators in the GCC region also face anuncertain future if they do not take the necessaryactions. In his article on the subject, An industry withline lives, Omar Massaed points out that “Opportunityabounds for GCC operators to prepare for futurechallenges by adopting a comprehensive costmanagement plan, addressing incremental efficiencies,process reengineering, and value chain restructuring.Operators that do not implement wide-ranging plans tomanage their costs run the risk of steep declines inprofitability.”

Wide-ranging plans seem to be the ordre du jour in thisissue of Middle East Point of View. Abdul RahmanBatakji, in his article on the changing roles of GeneralCounsels (Is there a lawyer in the house?) recommends

implementing a wide-range Risk Intelligent culture tohelp companies cope with expansion across borders.“The foremost inevitable realities that businesses facetoday and that GCs have to deal with are the increasingregulatory demands and cross-border landscapes,” hesays. This expansion, he continues, is “no longerrestricted to large-scale multinationals, as even medium-sized businesses now have more capabilities to expandto new markets through different channels andintermediaries.”

Expansion across borders and collaboration withinternational players will grow in the region as localbusinesses seek to diversify and create employmentopportunities, according to Mark Taylor and PaulOsbourn (Stronger Together). “Joint ventures,” they say,“can be an efficient mechanism for participatingpartners to realize synergies when it comes to sharinglarge-scale investments, gaining access to technologies,entering new markets, or strengthening market positionin general.” But joint ventures are not without their risksand pitfalls, and seeing as they “are likely to be anessential driver of growth in the Middle East… adoptinga number of best practice principles can maximize thechance of a successful outcome.”

As successful outcomes go, the Wizard of Oz turned outto be nothing but a humbug, a regular middle-agedman. Dorothy Gale and her companions the lion,Scarecrow and Tin-Man had all found what they wanted within themselves and were all the better for it.

Sometimes the future only looks scary, but turns outopportune.

Other articles in this issue cover the hospitality market in 2020 Dubai, Finance Transformation, emerging publicsector regulatory services and project finance: andalthough they may not divine the future, they willcertainly help us understand it.

ME PoV editorial team


In this issue

Hotel economicsSupplying hotels in Dubai will be morechallenging than securing the demand Grant Salter and Martin Cooper

The wizard of OdMazen Afif

An industry with line livesTelecom operators in the GCC Omar Massaed

“Is there a lawyer in the house?”The shifting role of General CounselsAbdul Rahman Batakji

“Proceed with Caution”Better controls for a burgeoning development marketDavid Stark and Ben Hughes

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Table of contents

More than just a number Finance transformation in the Middle EastGabriel Mustafa

Stronger TogetherMark Taylor and Paul Osbourn

On the road(map) againBalancing the emerging regulatoryrequirements in the Middle East public sectorZiad Haddad

Behavioral traps and innovationWhat innovators can learn from investors’ failuresDr. Alexander Börsch and Nicolai Andersen


HoteleconomicsSupplying hotels in Dubai will bemore challenging than securingthe demand

Travel, Hospitality and Leisure


Ambitious growth targetsIn November 2013 the Department of Tourism andCommerce Marketing (DTCM) in Dubai announced theneed to raise the number of hotel rooms availablesignificantly in order to meet the growth in tourismenvisaged by 2020. The total room stock is set todouble by 2020 to around 160,000 rooms from thenumber of rooms available in the market at the end of2013. As part of its Tourism Vision 2020 the DTCM istargeting 20 million visitors by 2020, a substantial risefrom just over 11 million visitors in 2013. The doublingof the room stock from its current base of approximately68,000 hotel rooms and 14,000 hotel apartment roomswill present a host of challenges to the market. Mostindustry players have raised concerns over the ability ofthe market to absorb such a high rate of increase inroom supply. But it is not only the quantum of roomsthat is the issue as much as delivering this high numberin the targeted timeframe.

The demand side of the equationHistorical visitor growth in Dubai from 2003 to 2013was 7.5 percent a year on average. In order for Dubai toachieve the 2020 target of 20 million visitors, the rate ofgrowth required is almost 9 percent per year from 2014until 2020. Over the last three years the growth invisitors has exceeded the 9 percent target and thegrowth in 2013 over the 2012 number was almost 10.5 percent following two previous periods of growthin excess of 9 percent, proving that these high levels ofgrowth are indeed possible and may even be exceeded.The development of Dubai’s tourism infrastructure andthe ever-expanding route network of Emirates Airlinesare helping to add to the number of visitors to Dubai.The average length of stay at Dubai hotels has also risenmarkedly from 2.2 days in 2002 to 3.2 days in 2013whilst the length of stay at hotel apartments in Dubaihas risen even more from 3.1 days in 2002 to 5.3 daysin 2013, adding significantly to the demand for guestaccommodation. So assuming there are no dramaticmarket shocks, we estimate that the demand side of theequation is not a major concern.


The history of room supply growth in DubaiIn the period between 2007 and 2011 a total of 78 new hotels were added in one of the busiest and mostconcentrated development periods in Dubai’s recenthistory as shown in the chart below. At its peak thehighest number of hotels delivered in a single calendaryear was 26, in 2011. Much of the planning for thesehotels would have begun at least four years prior totheir delivery, given the typical hotel development cycle.

Hotel supply target for 2020If we focus on hotels only, the market needs to deliverapproximately 283 additional hotels between 2014 and2020 in order to meet the doubling of hotel room stock(an additional 68,000 rooms) based on the average sizeof hotels recently developed in Dubai. According to dataprovided by STR Global, there are 56 hotels underconstruction or in the final stages of planning in Dubaiacross all hotel grades. This means that approximately227 additional hotels are required to meet the supplytarget by 2020.

The delivery challengeA typical hotel development cycle runs between 36months and 48 months depending on the complexity ofthe project and the scale and standard of the hotel. Thismeans that if hotels are to be delivered to the marketprior to 2020, the majority of the planning needs to becompleted prior to 2017 for delivery by 2020. We havecompiled a simulation of how the supply of new hotelscould be delivered in order to meet the requisite roomsupply target. At the end of 2013 there were 331 hotels in Dubai. The chart below indicates our simulated growth in supply taking into account theknown/confirmed additional hotel supply (from STRGlobal data) and the required future supply growthtaking into account the typical hotel development cycle.

Hotels

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2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Supply gap to meet target

The supply of hotel rooms grew at a compound average growth rate (CAGR) of 4.9 percent between 2007 and 2014.


Travel, Hospitality and Leisure

The previous simulation shows that in order to meet thesupply of hotels by 2020, up to 60 hotels need to bedelivered to market in at least two consecutive calendaryears. (See chart below which shows our simulated roll-out of new hotels.)

Historically Dubai has managed to deliver an average of 14 hotels per year over the last 8 years up to amaximum of 26 hotels in a single calendar year. In orderto meet the target of doubling the hotel room stock by2020, this remarkable achievement needs to double toaround 60 per year for at least three years, which islikely to be quite challenging.

Building the supply is not the only challengeNot only is the physical delivery of the number ofadditional hotels in such a short timeframe going to bestretching the contractors’ ability to meet the target butthe impact of such high demand on constructionmaterials, labor and, more importantly, funding is likelyto drive overall development costs higher. Between2014 and 2020 the GCC region will witness significantlyhigher levels of construction activity. Qatar is preparingfor the FIFA 2022 World Cup, Dubai is gearing up forExpo 2020 and other general growth, and Saudi Arabiais forging ahead with numerous massive projectsthroughout the country. All of this demand is likely toimpact overall construction costs, and consequently theattractiveness of hotel developments in Dubai, whereyear-to-date construction material costs have risen byaround 5 percent between January and June 2014alone. The mid-market sector, which is very margin-conscious, will likely be impacted the most by this higherdevelopment cost regime, thus reducing the investorappeal for this very necessary sector of the market.

Location, location, locationIn virtually any real estate investment, the mantra“location, location, location” holds true. As Dubai hasmatured into a complex and varied hospitality andtourism market, location plays an ever increasing role inthe performance and value of real estate investments.With an additional 283 hotel sites needed between2014 and 2020, the selection of suitable land plots forhotel development will become critical. The highdemand for quality sites will drive land prices ever higherand in so doing, reduce investor returns. Mid-markethotels are again likely to feel the brunt of this hike inland pricing further reducing their appeal to prospectiveinvestors.

So what does this mean for the market?Fortunately the profitability levels at most quality hotelsin Dubai are such that there is capacity to absorb theescalation in development costs and still render healthyreturns. For many years investors in Dubai’s hotel sectorhave seen returns above other market norms. This“normalization” of the market will actually be a goodthing for the market in the long-term. Market-wideoccupancies are likely to be lower in the coming yearsand this will ultimately result in a lowering of room ratesmaking the destination of Dubai more attractive to awider audience and assist in achieving the targeted 20million visitors in 2020 and even higher beyond that.

by Grant Salter, director, Travel, Hospitality and LeisureAdvisory, Deloitte Corporate Finance Limited (Regulatedby the Dubai International Financial Center) and MartinCooper, director, Real Estate, Deloitte CorporateFinance Limited (Regulated by the Dubai InternationalFinancial Center)

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2014 2015 2016 2017 2018 2019 2020

For many years investors in Dubai’shotel sector have seen returns aboveother market norms. This‘normalization’ of the market willactually be a good thing for the market.



Expo 2020

Dorothy Gale lived on a farm and was swept awayto a magical land on a journey full of turmoil andupheaval. But Dorothy ultimately returned homewith a new vision, mission and goals. Fear ofchange often leads organizations and employeesinto chaos and they focus on their new roles in away that may affect their productivity. But,should the fear of change keep organizations fromtweaking or redesigning their organizationalstructure?

AuditOrganization design

The wizard of Od


The journey to “meet the wizard” lies in the will tounlock the real potential of the organization.Organizations need Organization Design (OD) just likethe characters in the seminal 1939 movie The Wizard of Oz needed courage, a brain, a heart, and a way back home.

The lion was looking for courage Organizations should realize that OD will affect theirstructure, hierarchies, objectives, culture, people,technology, processes and performance measures. Butthey should also realize that the upshot of that processis employees who are motivated and focused onachieving the goals of the organization.

How ambitious company leaders are and how far theyare willing to go depends on, firstly, determining thestrategic imperatives that lead, eventually, to a decisionof reorganization. Determining a future vision requirescourage in itself. Leadership has to decide which areasneed immediate intervention and which changes can bemade at a later stage. It is detrimental to a company to

define areas to change based on the promise ofimmediate returns while neglecting other areas tointerfere with when the time is right.

Scarecrow needed a brain Organization Design thinking is still a new process and is therefore not utilized efficiently, if at all, in manyorganizations. Whether organizations succeed or fail inimplementing OD depends on several factors: • Proper role definition and allocation ofauthority/decision rights in an effective way thatmaximizes organizational performance;

• Proper examination of the relationship betweenorganization structure and culture: culture developsaround the structure and oftentimes a change inculture requires a change in the firm’s structure; and

• Enhancement of the interactive resources i.e. themechanisms of communication and collaborationacross departments for greater responsiveness andefficiency.

The quality of Human Resource systems is a key successfactor because competing in the global market calls forsound Employee Value Proposition that in turn requiresreengineering the rewards scheme, the properdeployment and development of human resources and proper use of HR Information Systems.

Tin-Man wanted a heart Despite the major and positive strategic role that HRplays in an organization, there are still cases in whichemployee performance measures are not clear andpeople are still rewarded subjectively. Important HRfunctions as listed below that are the core of theorganization are missing despite their criticalcontribution to the wellbeing of the workforce: careerplanning is absent and employee advancementopportunities are scarce, leading to rising employeeturnover. Procedures, manuals and Job Descriptions are

Organizations should realize that ODwill affect their structure, hierarchies,objectives, culture, people, technology,processes and performance measures.But they should also realize that theupshot of that process is employeeswho are motivated and focused onachieving the goals of the organization.

not complete or not representative of reality leading toconfused roles and responsibilities. All these areindicators that the “heart” of the organization is notpumping properly: the organization is in danger and inreal need for OD intervention.

Building a client-focused organizational structurethrough the involvement of all stakeholders from projectincept to concept and onto implementation also plays amajor role in building a successful design backed by bestpractices and principles but primarily empowered bymotivated employees eager to successfully deliver theobjectives through a structure that they contributed indesigning.

Dorothy Gale wanted a way back home The key element of OD is ensuring that the organizationis appropriately designed to deliver optimal impact inboth the short- and long-term.

For organizations to move from the steady to the readystage, there are steps to be taken. These steps consist ofsetting the context for the design, assessing the currentmodel and designing the targeted model, identifyingmajor processes, defining measures and governance,implementing and evaluating design, and identifying thetools, blockers and challenges. Organizations shouldmake the most of their existing talent and capabilities:there is a need to agree on the related TalentManagement areas that need to be addressed to bringan integrated valuable solution.

Ultimately, the question to be asked is: are organizationsready for OD? Optimizing organization design is one ofthe most powerful yet underutilized approach availableto professionals and executives. Improved organizationdesign can lead to higher employee satisfaction,improved customer experience and better financialperformance.

No house is a home if it is not strong and solid. OD isnot simply a drawing with boxes and connecting lines. It requires a process that begins with a vision and the courage to face challenges and turn them intoopportunities, a strategy and a brain, which is the mostimportant aspect of OD, and a heart that ensuressecuring the best talent to appropriately achieve setgoals.

And the organization would finally find its way home.

by Mazen Afif, director, Consulting, Deloitte Middle East


Ultimately, the question to be asked is:are organizations ready for OD?Optimizing organization design is one of the most powerful yetunderutilized approach available toprofessionals and executives.

Organization design



Telecommunications

An industrywith line lives

After years of strong growth, Gulf CooperationCouncil (GCC) telecom operators have slowlyadapted to the new realities of their maturingmarkets. Rising oil prices contributed to sharpincreases in the level of gross domestic product(GDP) per capita, creating an attractive telecomsmarket. Between 2004 and 2007, GCC telecomrevenues grew 15 percent annually, with earningsmargins hovering around 47 percent. Fueled bygrowing profits and healthy cash flow, GCCoperators went on a buying spree across theMiddle East, Africa, and Asia, acquiring existingoperators or licenses to launch their own networks.

Telecom operators in the GCC survived thefinancial crisis and maturing markets by adjustingto the end of explosive growth. How ready arethey to adapt again to new industry trends?


Telecom operators worldwide face numerous obstaclesto their continued success such as stagnating growth,heightened competition, increasing investments in newtechnologies, and growing consumer sophistication. Asthese trends are still nascent in the region, GCC telecomoperators have thus far implemented tactical, short-terminitiatives to overcome these obstacles.

Opportunity abounds for GCC operators to prepare forfuture challenges by adopting a comprehensive costmanagement plan, addressing incremental efficiencies,process reengineering, and value chain restructuring.Operators that do not implement wide-ranging plans tomanage their costs run the risk of steep declines inprofitability.

Network costs are on the rise. An insatiable appetite formore data is forcing telecommunication companies toinvest heavily in next generation networks. At the sametime competition has gone global, creating enormous

price pressure in most markets. On the other hand, withdeclining revenues from traditional income sources suchas wire line and wireless voice, the pressure is on to lookfor new products and services, but many are struggling.

GCC operators are now turning their attention outwardagain–adapting to new industry dynamics and gettingahead of the latest trends in the global telecom industry.

Data, more data The Middle East has not been immune to the worldwideexplosion in data, driven by data-savvy consumers andthe deployment of a vast portfolio of mobileapplications. Statistics from YouTube, which accountsfor 24 percent of global mobile traffic, reveal that SaudiArabia has the world's most YouTube clicks per Internetuser (more than 90 million daily page views.) The MiddleEast ranks second after the United States in number ofdaily views, with 167 million video views per day. TheMiddle East and Africa are expected to have year-on-year data increases of 133 percent through 2014.

Technology To meet the rising demand for data, operators mustcontinually expand network capacity and roll out newtechnologies, such as fiber-optic networks and high-speed mobile broadband (4G), all while facing pressurefrom shareholders to limit capital expenditures andmaintain healthy cash flow and attractive returns.Several GCC telecom operators have made hugeinvestments in fiber networks and Internet Protocoltelevision (IPTV) platforms, although the financial returnsare not yet clear. Newer players are competing withembedded media ecosystems.

Aggressive OTT players The rise of new competitors, broadly dubbed over-the-top (OTT) players, has the potential to impact the globaltelecom industry. They offer attractive services via their

To meet the rising demand for data,operators must continually expandnetwork capacity and roll out newtechnologies, such as fiber-opticnetworks and high-speed mobilebroadband (4G), all while facingpressure from shareholders to limitcapital expenditures and maintainhealthy cash flow and attractive returns


Telecommunications

own platforms and ecosystems, including voice overInternet Protocol (VoIP), instant messaging (IM), andservices such as TV, video, and music. And whilesubscribers pay telecom operators for fast connections,most revenue comes from pay-per-usage andadvertisements. Operators benefit by chargingsubscribers for data consumption, but it is oftenrestricted by data packages that offer unlimited data. As a result, the battle between operators and OTTplayers has begun for voice revenues (especially high-margin mobile international traffic), Short Message Services (SMS), and media.

Consumer behavior Not so long ago, subscribers would make consciousdecisions about which telecom operator to join, if theyhad a choice at all. Low-value subscribers generallychose the best value-for-money option, and high-valuesubscribers chose the operator with the best networkand the most extensive portfolio of value-addedservices. Today's subscribers want the latestsmartphones, tablets, applications, and content, most of which is neither owned nor sold by an operator.

How to adapt with new trendsAlthough some of these services have been around for a few years, operators have to actively offer value added services (VAS) such as M-Health, M-Education,and M-Banking. They will need to offer high qualityvoice solutions to limit the impact of eroding revenuesand profitability from Voice-over-Internet Protocol (VoIP)players such as Skype.

To fight the decrease in SMS usage, operators need toconsider offering enhanced functionalities in the instantmessaging (IM) domain such as multi-userconversations, sharing of pictures, and status updates,by either partnering or entering alliances with otherplayers, or by offering their own platforms.

Operators will need to also invest more in machine-to-machine (M2M) communication, which is expected tobe a major growth market. The right partnerships tobundle connectivity with high value products (forexample e-readers, cameras, laptops, cars and Internetof Things (IoT)) is critical.

Lastly, operators will increasingly need to enter thenascent, fast-growing cloud services market, which isopening up opportunities in consumer and enterprisebusinesses. Because the cloud market is relatively new,this is the optimum time for telecom operators to beginto capitalize on the opportunity with the right valuepropositions, the right technology and go-to-marketpartnerships and investing in large data centers.

The mobile telecoms market in theregion continues to display signs ofgrowth. Driven by strong mobilehandset data growth, telecoms servicerevenue in the Middle East and NorthAfrica (MENA) region will grow at acompound annual growth rate (CAGR)of 2.9 percent during 2013-2018(mobile at 3.3 percent and fixed at 2.8 percent), to reach US$96 billion in 2018.


Growth of mobile in MENAThe mobile telecoms market in the region continues todisplay signs of growth. Driven by strong mobilehandset data growth, telecoms service revenue in theMiddle East and North Africa (MENA) region will grow ata compound annual growth rate (CAGR) of 2.9 percentduring 2013-2018 (mobile at 3.3 percent and fixed at2.8 percent), to reach US$96 billion in 2018.

The market will continue to be dominated by mobile.Mobile retail revenue will grow from US$50.4 billion in2013 to US$59.1 billion in 2018. Growth will be drivenby handset data spending, with smaller contributionscoming from non-handset mobile broadband andmobile voice. The fixed market will also continue togrow in all countries–from US$23.7 billion in 2013 toUS$27.3 billion in 2018, driven by fixed broadband andIPTV revenue, while fixed voice revenue will decline inmost countries.

At country level, five of the eight major markets that we model individually–Algeria, Morocco, Qatar, SaudiArabia and the UAE–show strong net growth intelecoms service revenue. The fastest growing of thesewill be the UAE, at just over 3 percent CAGR, closelyfollowed by Algeria and Saudi Arabia. In Kuwait,revenue will decline at a CAGR of -0.2 percent. Egyptwill only experience marginal growth because of political instability.

The focus in most markets is on reducing costs without impacting service quality. Thus key costoptimization strategies include networking outsourcing,organizational restructuring and rationalizing assetportfolios.

The power to surviveThe GCC telecoms industry continues to be a highlydynamic sector and GCC operators are faced withconsiderable challenges in 2014 and beyond. Operatorsthat act now will ensure they remain relevant andmaintain healthy growth and profit margins.

Operators, particularly those in GCC countries, need tobe prepared for the significant impact of over-the-top(OTT) messaging and eventually voice, as thepenetration of smartphones passes the 50 percent mark.Early movers in 4G deployment should aim to maximizethe initial opportunity for premium pricing for 4G, butinternational examples show that the 4G premium is notsustainable, so it is important to be realistic about thelength of time this can be maintained. Alternativestrategies to monetize mobile data are critical, as arestrategies to accelerate revenue development fromadjacent market partnerships and new business models.To cope with increasing network complexity, investment

The focus in most markets is onreducing costs without impactingservice quality. Thus key costoptimization strategies includenetworking outsourcing,organizational restructuring andrationalizing asset portfolios.


Telecommunications

requirements and the financial expectations ofshareholders, GCC operators will continue to improvetheir balance sheets by off-loading assets and adoptinga more asset-light model in line with developments inAsia, Europe, and North America. As a consequence,more managed services outsourcing deals of coreactivities such as network operations and maintenanceare expected, as is the selling of assets, such as towers,to specialized tower companies. Operators will benefitfrom the scale and expertise of these third parties andbe able to move from the traditional network andinfrastructure focus to critical topics such as pricing,retention, customer experience, and digitaldiversification.

by Omar Massaed, senior director, Audit, DeloitteMiddle East

Operators, particularly those in GCCcountries, need to be prepared for thesignificant impact of over-the-top(OTT) messaging and eventually voice,as the penetration of smartphonespasses the 50 percent mark

Over the last three decades, the role of the General Counsel(GC) in organizations has been gradually shifting from theold-school perspective of the policeman–called insporadically to fix a situation–to the essential addition to anyorganization aiming at sustaining its growth, reputation,stability and compliance.

“Is there a lawyerin the house?”The shifting role of General Counsels


Although from an old school perspective the limited anddefined role of the GC as rescuer may prevail, the GC’srole has been molded and folded over the years due to thechanging face of business and the inevitable challenges itpresents. So how do today’s business leaders perceive therole of GC; Is it that of protector or preacher; or both?

Defining the role of a GC has come a long way, yet maystill be faced with some equivocation. During the 1970sand 80s, hiring in-house lawyers was considered theoptimum solution for businesses to reduce increasing feesspent on external legal counselling. A similar trend wasnoticeable during and after the financial crisis of 2008when business leaders thought that having their own in-house legal counsel was by far a more convenient meansof tackling the organization’s risk-related issues andreducing costs for external legal fees. Inasmuch as theseare, and remain, valid considerations, the aforementionedcan no longer serve as the only drivers justifying therecruitment of the General Counsel.

The typical duties entrusted to GCs can range fromdrafting and reviewing legal contracts, handling clientnegotiations, standardizing internal processes, liaising,monitoring and preventing, to the extent possible,potential litigation against an organization. While carryingout his typical duties, the GC builds on his acumen ofknowledge and experience within the context of definedparameters such as the legal framework of specific

jurisdictions. While delivering their duties, GCs may also befaced with typical inherent challenges. Some practitionersmay avoid disclosing certain details to their GCs, thinkingprobably that maintaining this “safe distance” may avoidcompromising a long-awaited business deal; or trying toavoid a situation of being “lectured” on how to do theirown jobs. It is those very typical challenges where GCsneed to exert additional efforts to soothe and actproactively, in order to change a certain misperceptionabout his or her role. GCs need to reconsider their owntone and mindset in communicating and advocating their views.

The typical responsibilities of the GC listed above remainessential. The question is do these duties alone suffice inthe course of handling organization-wide predicaments,risky and devastating if neglected, and which may imposehuge challenges to businesses yearning for sustainabilityand growth?

Continually evolving challengesThe foremost inevitable realities that businesses face todayand that GCs have to deal with are the increasingregulatory demands and cross-border landscapes. The expansion of businesses across borders is now moreprevalent than it has been during the last three decades.Geographic expansion is no longer restricted to large-scalemultinationals, as even medium-sized businesses nowhave more capabilities to expand to new markets through


Legal


different channels and intermediaries. The pace ofdevelopment and growth of the business landscape ismore notable in the professional services industries. Thesebusinesses, as others, do not bind themselves togeography; yet one differentiator in their success is theirwillingness to understand and adapt to the cultural,business norms and ethics and the legal framework of thetargeted geographies, all of which could be markedlydifferent to those of their own countries of incorporation.Employment and nationalization laws, contract laws,principles of liability exposure and indemnification,performance warranties and professional indemnityinsurance, rules governing public bids and other areas areall examples of distinct bases of the wider risk arena thatprofessional service providers may face while operatingoutside of their jurisdictions.

In addition to what can be categorized as the “domesticnational laws or regulations” noted above, comes theoverarching supranational regulatory requirements andsanctions, which as a matter of reality have, and willcontinue to reshape the business world and to establish anew economic world order.

Whether the interference by governments is right orwrong as a principle does not change the realitybusinesses face today. The debate on the merits ofautonomous versus responsive law may continue to be along-lasting one; as each ideology has its own objectives,advantages and disadvantages for society at large. Aninteresting observation though on the regulator’sintervention over the past decades, and “ironically” ineconomies established on the “laissez faire, laissez passer”ideology, is that such interference by governments hassubstantiated a doctrine in the world today that businessesmay not be left “unleashed.” This can be bettercomprehended as a consequence of some malpracticesthat have led to devastating outcomes which impactedeconomies in the last thirty to forty years. Accordingly, the rationale behind the issuance of acts such as ForeignCorrupt Practices Act, Anti-Bribery laws, Anti MoneyLaundering, Sarbanes Oxley Act, Dodd Frank Act and a list of other laws and acts that tackle different aspects ofbusiness, regulated or non-regulated, is now morecomprehensible.

Compliance with sanction laws imposed by foreigngovernments or supranational bodies follows the sameargument; though the primary difference in the case ofsanctions is the political driver (in most scenarios) initiatingsuch sanctions.

Inasmuch as the argument on the enforceability of foreignrules and policies from a “sovereignty” perspective is valid,the reality also requires businesses to reconsider their viewson this aspect. Some “domestic” policies have beenstructured in a way that –in fact– enables their scope ofapplication to extend beyond domestic territory and reach,potentially, any market and imposing a minimum ofunavoidable restraints for doing business. Some clientshave no option but to be bound to a “forced marriage”with these set policies, regulations or sanctions, to anextent that it is up to the service provider to think carefully

The foremost inevitable realities thatbusinesses face today and that GCshave to deal with are the increasingregulatory demands and cross-borderlandscapes


whether it is worth shouldering these onerous obligationsor refrain from working with that client and lose a strategicbusiness account.

The way forward and the new role of GCsSo how should organizations and their GCs deal with suchcontinuously expanding parameters, such unequivocalestablished realities, in today’s business world? The answerlies in a change of mindset and approach, a shift in culturewhere the knowledge of risk is assumed by the wholeorganization and not by the GC alone.

Shifting to a Risk Intelligent culture within an organizationnow makes more sense than ever. It is becoming all themore evident for organizations to have a morehomogeneous level of risk-cognizant culture among thedifferent bodies and functions within these organizations.Awareness of risk-related matters must no longer beprivileged to legal departments and senior executives; but rather “Knowledge for all” is what needs to be aprioritized goal for business leaders and GCs. Enhancingthe level of awareness among departments, functions and teams should be carefully planned both by seniorexecutives and GCs; all in an organized, tactful and timelybasis so the purpose of such initiatives is made clear.Although the level of awareness may range depending onlevels and functions, it is to the organization’s own benefitto have well-informed leaders and teams on differentaspects; all prepared and ready to identify, adapt and takeaction when it comes to risk-related matters. Moreimportantly, the “tick-a-box” approach in understandingthe size and impact of the noted risks does not achieve thepurpose. While serving his or her organization, it is theGC’s role to exert that extra effort in liaising, coordinatingand educating his or her colleagues on risks in anunsophisticated and focused approach. The onus iscollective, but the result can be more rewarding.

by Abdul Rahman Batakji, legal advisor, DeloitteMiddle East

Some “domestic” policies have beenstructured in a way that –in fact–enables their scope of application toextend beyond domestic territory andreach, potentially, any market andimposing a minimum of unavoidablerestraints for doing business

Legal



“Proceed with Caution”Better controls for a burgeoningdevelopment market

Integrated Project Monitoring

During the previous Middle Eastern development boom,consumer confidence was high, investment was of astaggering scale and all aspects of economic lifeappeared to be on an upward trajectory. Reports oftickets, used simply to gain access to the offices of someof the major developers to purchase units, wereexchanging hands for hard currency, and lavish launchevents were held for virtually all new developmentprojects.

Forward to 2009/2010 and the picture is markedlydifferent. The world economy is in crisis, the debtmarket is in turmoil and real estate development is onlife support. The days of profligate spending, extravagant

lifestyles and speculative development were endedvirtually overnight. The causes of such failures are welldocumented, but ill-considered, highly leveraged andover-engineered developments were always likely to failin a market as dynamic as this.

The graph on the following page says it all. Between2009 and 2014, the number of cancelled developmentsin U.S. Dollar value alone is truly staggering, peaking atUS$3.5 billion in the summer of 2011. This statisticapplies only to the UAE but it could be extrapolatedacross the entire region and produce similarly startlingresults.


When a market that has become artificially inflated, asthe development market in this region was back in 2008,there really is only one inevitable direction, and that isdown. But the speed and depth of the decline here inthe Middle East was probably the most surprising thing.

Fast forward to 2013If we now look over the past 12-18 months, we canalready see that the development market is slowlyreturning to pre-2008/2009 levels. Press reports aboundrelating to unsustainable rental increases, stampedes atdevelopers’ offices when new schemes are launchedand the questionable levels of cash purchases that areinflating the market. According to MEED Projects, thereare US$2.5 trillion-worth of projects either planned orunderway as at April 2014.

Figure 2: Development activity across the GCC, February2013

The International Monetary Fund (IMF) has been activein expressing caution over the GCC’s latest developmentcycle, urging restraint and calling for greater control atpolicy level to curb debt to equity ratios, increased duediligence in respect to cash purchases and much greaterpowers for government to even out the peaks andtroughs of such a cycle. Moreover, the IMF has beenactively promoting the introduction of mechanisms toprevent “flipping” properties in the region and it iscertainly something that governments across the GCCare considering.

While this is commendable at a policy level, what isneeded is constraint at a systemic level by ensuring thereis sustainable growth across real estate and constructionindustries by implementing better controls andmechanisms across all sectors, through changingbehavioral patterns.

Consider, implement, monitorSo what are the appropriate control mechanisms thatneed to be put in place to avoid a system-wide crash asexperienced in 2008? Due diligence, cautious planningand careful monitoring are some of the controls thatspring to mind.

Historically, key lending and credit decisions have beenmade with misleading and/or incomplete information,typically prepared by construction specialists who lackthe financial and commercial expertise to translateproject specific information into a format suitable foruse at credit committees. Often, a detailed business casethat considers fully all of the risks and opportunities forthat particular investment would not be made, norwould it consider in finite detail the wider financialcontemplations outside of the raw construction costs.

When projects run into difficulties and lenders are askedto provide additional financial support, they oftenrequest both legal advice and an independent review of the financial position and forecast performance inorder to understand the severity of the situation. Thisinvolves an independent third party review ofconstruction progress and remaining costs to complete,in addition to a review of prevailing market conditions inorder to understand income projections, which are then

Figure 1: Project Values (US$ million) cancelled in the UAE from 2009 to present day

4,000

3,500

3,000

2,500

2,000

1,500

1,000

500

Source: MEED Projects

2009

-01

2009

-04

2009

-07

2009

-10

2010

-01

2010

-04

2010

-07

2010

-10

2011

-01

2011

-04

2011

-07

2011

-10

2012

-01

2012

-04

2012

-07

2012

-10

2013

-01

2013

-04

2013

-07

2013

-10

2014

-01

2014

-04

0

Mar

ket

spen

d (U

SD)

US$ 2.5Trillion

Source: MEED Projects


Integrated Project Monitoring

translated into revised financial forecasts. After this,much stricter financial controls are often put in placethrough to ultimate completion.

This could potentially be avoided by implementingtighter, integrated controls at the outset of projects. In order to reduce the risks attached to real estateproject financing, an integrated approach to monitoringshould be taken from initial feasibility assessmentthrough to ultimate completion, handover andoperation. This would typically include the full range of construction and financial technical skills andcommercial expertise required to understand andcontinuously monitor the financial performance ofprojects overall.

This typified “Integrated Project Monitoring” wouldincorporate an initial feasibility study to give anindicative, high-level assessment of project viability priorto any facilities being extended. This would be followedby a detailed construction program and risk review, andpreparation of the financial business model againstwhich ongoing performance will be monitored, andwould then be followed by detailed periodic monitoringof performance and analysis of variances against theoriginal business plan.

So while the real estate and construction markets maywell be returning to levels akin to those in 2007/2008,certainly in terms of releases of new developments,there does appear to be acknowledgment at policy levelto better control the surge in development that ispredicted to 2020 and beyond.

Although there has been alarm at the perceivedescalation in rental values in the residential sector, thereis some evidence to suggest that unit sales (as opposedto rental prices) are at least cooling. Indeed, there havebeen numerous articles recently written about thewaning of prices in the residential sales market, and thishas been supported by the recent announcement from

Moody’s, the ratings agency, to categorize one of theregion’s largest developers at B1 status (which is onestep below investment level.) While this is not viewed as a reflection of that particular developer, it is areaction to the potential over-supply that may inevitably impact sales prices.

This brings us full circle. By implementing a moreconsidered approach through Integrated ProjectMonitoring, the initial business plan will be far morerobust as there will be a greater level of financial andtechnical due diligence from the outset. Furthermore, byinitiating a regime of detailed and independentchecking, it will ultimately safeguard the investment by tracking progress against pre-determined metrics(financial, technical and time-related) using appropriateadvisors to provide this level of assurance.

by David Stark, managing director, ReorganizationServices, Deloitte Corporate Finance Limited (Regulatedby the Dubai International Financial Center) and BenHughes, director, Infrastructure and Capital Projects,Deloitte Corporate Finance Limited (Regulated by theDubai International Financial Center)

By implementing a more consideredapproach through Integrated ProjectMonitoring, the initial business planwill be far more robust as there will bea greater level of financial and technicaldue diligence from the outset

Initial feasibility studyDetailed business plan and

construction timetablePeriodic progress monitoring reports


More than just a number Finance transformation in theMiddle East

The finance industry, in the Middle East inparticular, is going through a majortransformation phase where Chief FinanceOfficers (CFOs) are constantly looking for waysto radically improve business performance.


Finance


What is Finance Transformation?Finance executives today must take a broader range ofresponsibilities than existed in their traditional role ascorporate accountant, including the effectiveness of the finance function, quality and consistency of theinformation and data, finance talent management,internal controls and corporate governance and businessperformance management. In a nutshell, the role of thecorporate executives is to ensure that they have effectivepeople, process and technology in place to be successfuland competitive in the market.

Finance Transformation enables CFOs and financeexecutives to radically improve business performance. By streamlining management information to improveoperational effectiveness and decision-making, theworld-class finance function can be a significant driverof shareholder value. It is important to remember thatFinance Transformation is not a one-size-fits-all solutionand it doesn’t always mean a massive overhaul of theFinance function. Successful transformation can beachieved by addressing shorter-term initiatives thatremain true to the longer-term vision of finance and theorganization as a whole.

Finance Transformation is an “umbrella” set of servicesto help CFOs and finance organizations improve thecapabilities in the various roles they play in order toeffectively generate and preserve value.

There are a number of challenges that should beconsidered by the CFO when defining a FinanceTransformation agenda. These challenges includeensuring that the accounting, risk and control processesare compliant and provide accurate, timely and usefulinformation. An important challenge faced by the CFO isstakeholder management and talent retention. Howdoes a CFO serve the needs of different stakeholdersand how does she attract, develop and retain the talentrequired to fulfill the Finance function’s mission?

It is important to remember thatFinance Transformation is not a one-size-fits-all solution and it doesn’talways mean a massive overhaul of the Finance function. Successfultransformation can be achieved byaddressing shorter-term initiatives thatremain true to the longer-term vision offinance and the organization as a whole.

The key challenges faced by the CFOs include:

Control challenges Efficiency challenges Performance challenges Execution challenges


The four faces of the CFO–a global perspectiveCFOs play a key role in managing external stakeholderexpectations to confirm alignment of investors’ andmanagement’s views on the value of the business. There are four key roles that the CFO and financeorganizations need to play: Strategist, Catalyst,Operator, and Steward (see chart.) This forms the basicframework in evaluating finance function capabilities.

It is vital for the CFO to understand the financefunction’s overall capability to effectively serve the fourkey roles and utilize the most effective operating modelto deliver these capabilities at benchmark cost to staycompetitive.

When is Finance Transformation required?A Finance function’s processes, talent, systems, policies,and organization are used as the enablers to delivervalue to the enterprise. Finance Transformation:• Focuses on addressing issues and opportunities withina finance function to improve efficiency andeffectiveness in order to more effectively collaboratewith the business, and to deliver value to thecompanies and shareholders they serve.

• Focuses on identifying opportunities for financefunctions to create value across core drivers such asstrategy and execution, governance, risk and capital,performance and decisions, and closing andtransaction processes.

As the Middle East market grows rapidly, the need for a Finance department that moves beyond numbercrunching to a more proactive role of streamliningbusiness processes to continually improve both qualityand effectiveness becomes more evident. But as theCFO dons the many hats required for a FinanceTransformation initiative, it is important for him tomaintain the key balance between serving the needs of the stakeholders and preserving value andcompetitiveness.

By Gabriel Mustafa, senior manager, Consulting,Deloitte Middle East

Catalyst

OperatorSteward

Strategist

Execution

Efficiency

Performance

Control

on

Effi

Perfo

l

Stimulate behaviors across the organization

to achieve strategic and financial objectives

Protect and preserve theassets of the organization

Balance capabilities, costs and service levels to fulfill the finance organization’s responsibilities

Provide financial leadership in determining strategic business direction and align financial strategies

Finance

function

Leading edge

Thresholdperformance

Drivers of FinanceTranformation

Drivers of Finance Tranformation

Major shift inbusiness or strategy

organization

Operational failure

Finance costreductioninitiatives

Major mergerand acquisition

Appointment of anew CFO or seniorfinance executive

Localized process or controlproblems, such as difficulty closing

the book in a timely manner

Financialrestatements,

delayed filings,material

weaknesses, or other financial reporting issues

New financial system

implementation or reimplementation

Finance


StrongerTogether

Joint Ventures

Joint ventures (JV) can be an efficient mechanism forparticipating partners to realize synergies when it comesto sharing large-scale investments, gaining access totechnologies, entering new markets, or strengtheningmarket position in general. However, creating a jointventure can be a complex process that is not withoutpitfalls and risks. Given that JV establishment is likelyto be an essential driver of growth in the Middle East,this article considers why this is a favored strategy andhow adopting a number of best practice principles canmaximize the chance of a successful outcome.



Why JV and why the Middle East?The overriding macroeconomic factor that will see localbusinesses collaborate increasingly with internationalplayers is the need to diversify and create additionalemployment opportunities. Historically, up to 80 percentof government revenue and export earnings have beenderived from the oil and gas industry. It is widelyacknowledged that GCC policymakers need to develop abalanced, diversified industrial base to reducedependence on hydrocarbons as reserves are depletedand alternative sources are developed. Additional andvaried employment opportunities are required for ayoung and growing domestic workforce. Consequently,alternative industries outside of the public sector andthe oil and gas industry will need to be developed. It istherefore highly likely that the private sector, andspecifically family businesses, will play a major part inthis trend given their pivotal role in the economy.Outside of government and the oil and gas industry,family-owned businesses are the predominant form ofcommercial entity within the Middle East. Someestimates suggest that 80 percent of non-oil GDP isaccounted for by privately owned business. However,this segment of the economy is still relatively young andmost businesses are still managed by first or second

generation family members. Many started as tradingbusinesses but now cover a broad spectrum ofcommercial activities. As these family groups in theregion seek new opportunities to grow and diversify, it islikely that joint ventures with international partners willcontinue to represent an important strategic tool. Inaddition to the macroeconomic factors outlined above,there are compelling reasons why this will be the case:

Growth is essential Many family offices are now in, or moving toward theirthird generation. Given that the average family size isfive children, there is an obvious requirement to growthe family business in order to preserve wealth andavoid significant dilution as more and more demands aremade of the group’s resources and investments. Someestimates calculate that annual compound growth(ACGR) needs to be close to 20 percent to avoiddilution.

Organic options are difficultEstablishing and growing domestic concepts is timeconsuming and difficult and will often be competingwith established imported international brands andconcepts. Additionally, local R&D (Research andDevelopment) capabilities are seldom as advanced asthose from long-established players in advancedeconomies.

Good acquisitions are hard to findWith commerce dominated by family groups having atendency to buy and hold assets for the long-term orpermanently, good fitting acquisition opportunities arerelatively rare and therefore often fiercely contested.

For a family group, a JV with an international partnerwill typically be motivated by access to IntellectualProperty (IP) and/or the transfer of technology orknowhow that is otherwise unavailable to them. Aproduct or marketing alliance whereby distribution orfranchise rights to products, brands or retail concepts

Some estimates suggest that 80 percentof non-oil GDP is accounted for byprivately owned business. However,this segment of the economy is stillrelatively young and most businessesare still managed by first or secondgeneration family members.


Joint Ventures

are granted to a local player allows international brandsto minimize the risk of entry to local markets that mightotherwise remain closed to them. Joint domesticmanufacturing may also be established developing localjobs and skills while cutting product manufacturing anddistribution costs. Family office groups are uniquelypositioned to develop international concepts andproducts within their home market given legislativerequirements for a local partner and their strong localnetworks and relationships.

JV Best Practice–what can be learned?There are costs and benefits to JV structures. Having aclear understanding of these will facilitate making aninformed choice.

JV pros• Opportunity to leverage the distinct strengths of bothpartner organizations.

• Cuts investment or funding costs versus developingcommercial opportunities in-house.

• Partner skill sets are complementary, making the valueof the JV greater than the sum of its parts, as well asproviding quick and low-cost access to expertise inareas of weakness.

• Reduces downside risk should the partnership notdeliver the expected returns.

• Increased power over the activities and principlesguiding the JV's operations and objectives comparedto a minority interest investment.

• Allows a deal to be done when funding mightotherwise preclude it, since partners can contributethings other than cash, such as assets, IP or know-how.

JV cons• No overall control. In the event of deadlock betweenthe partners there has to be a mechanism for decision-making, and by definition this will not always delivereach partner's preferred outcome.

• While different services will be provided to the JV byeach of the partners, there will be synergies that areunobtainable under this structure.

• While the local partner gets immediate and low-costaccess to established international brands, it will beinvesting in developing someone else’s brand equityand remains exposed to shocks to that brand outsideof the local market and their control.

• Rewards of success are shared with the JV partner.• Need for an exit plan to avoid value destructivedeadlock. In the event that the JV is terminated, eachpartner should be protected against the other to avoidusing the knowledge or market entry gained throughthe JV to set up in competition themselves.

• Being more complex arrangements to enter into, JVstend to require a more widely scoped and complexdue diligence process and carefully drafted Sales andPurchase Agreements (SPA) and other contractualterms.

For a family group, a JV with aninternational partner will typically bemotivated by access to IntellectualProperty (IP) and/or the transfer oftechnology or knowhow that isotherwise unavailable to them


There are, however, a number of common challenges that JV partners face. Mitigation strategies considered andagreed upfront will set the foundations for a solid working relationship.

Challenge Context Mitigation

Vision • The JV’s vision and objectives are critical • Early development and clear definition of the JV’s operating model, objectives andpriorities

Governance • Each partner (and the JV’s management team)will have different agendas, needs, ideas, andpriorities

• Establishing the constitution of the Board andthe governance structures upfront will create a framework for decision-making and issueresolution

Management • The absence of a clear controlling stakeholdercan create uncertainty around whoseobjectives performance is measured

• Appointing an effective and empoweredManagement team, responsible to the Board is critical for meeting objectives and driving value

• Clear allocation of roles and responsibilities

Partner sponsorship andrequirements

• The JV will be inefficient or fail without the fullcommitment of both partners

• Understanding and managing stakeholderobjectives and personalities is critical

• The commitment of responsible partnerexecutives will simplify communication anddecision-making

• Early and comprehensive definition of theareas and mechanisms for communicatingwith, and reporting to, the partners is critical

Change • A framework is required that enables changeand avoids costly stalemate

• Investing up-front in the JV’s guiding principleswill be time well spent. Tightly defined legalarrangements may drive uncommercialdecisions.

Synergy delivery

• Often JVs are established to deliver synergiesneither partner could achieve independently

• Delivery is therefore key to success

• Early identification of synergy areas and cleardelivery plans needed

• Robust progress reporting required to highlightissues and enable prompt corrective action

People management

• JVs are rarely transacted speedily as theydepend upon diverse stakeholder agreement

• A prolonged process may be distracting foremployees

• Retaining and motivating key talent andproviding certainty where possible requires aneffective communications program

Conflicts • Existing partner relationships may lead toconflicts within the JV

• Implementation of a clear framework fordispute resolution

Exit • A shared understanding and agreementsurrounding when and how the JV might endis an important component of establishment

• Early planning of exit scenarios recommended• Legal agreements are rarely effective atprotecting the parties from changingcircumstances


We believe successful Joint Ventures are characterizedby consistent themes:

Clarity of purpose• Ensure the JV’s rationale and objectives are set outclearly from the start for all parties.

• Communicate clearly to ensure broad buy-in acrossthe organization.

• Identify synergies and establish clear responsibility fortheir achievement.

• Agree how value will be derived and shared with theJV partners.

• Focus on a small number of critical initiatives.

Control• Implement robust planning, program managementand reporting processes to underpin the JV’sobjectives.

• Carefully consider the appointment and alignment ofthe JV’s leadership team.

• Allocate your best people to managing theimplementation of the JV.

• Make planning and reporting frameworks as practicalas possible.

• Tackle risks and issues quickly and take toughdecisions early.

• Track benefits rigorously and ensure only one set ofnumbers.

Managing people• People management and open, honest and timelycommunication are the main differences betweensuccess and failure.

• Recognize that major change creates uncertainty.• Plan for change at all levels across the organizationand ensure effective support and training areavailable.

• Realign objectives and rewards.

To conclude, the establishment of Joint Ventures willcontinue be an important driver of economic growthwithin the region. However, agreeing key issues up frontand forward planning for all scenarios will minimize therisk of disharmony between partners.

by Mark Taylor, director, Corporate Finance Advisory,Deloitte Corporate Finance Limited (Regulated by theDubai International Financial Center) and PaulOsbourn, director, Transaction Services, DeloitteCorporate Finance Limited (Regulated by the DubaiInternational Financial Center)

Family office groups are uniquelypositioned to develop internationalconcepts and products within their homemarket given legislative requirementsfor a local partner and their strong localnetworks and relationships

Joint Ventures


On theroad(map)againBalancing the emerging regulatory requirementsin the Middle East public sector


Governments in the Middle East seeking to play a more importanteconomic role on the global map have, over the last two decades,been looking to exert a more positive influence and building trustwithin their own citizens and other governments alike. As such,and in order to fulfil their strategic objectives, these governmentshave invested significantly in large transformation initiativeswithin the public sector, more specifically, in the modernization of Government through the development of next generationInformation and Communication Technologies (ICTs) for publicservices (or what is more commonly referred to as e-Government)which has revitalized public administration, overhauled publicmanagement, fostered inclusive leadership and moved civil servicetowards higher efficiency, transparency and accountability.

Public Sector

Finaldestination


Vital to the success of the modernization initiativeswithin the public sector in the Middle East has been theestablishment of the relevant regulations that controland govern the conduct of government entities andsimultaneously addresses the threat landscape as theynavigate through the implementation of theseprograms.

More recently, the Middle East has seen regulationintroduced in domains like cyber security, qualityassurance, service resiliency, environmental managementand work-related health and safety; when combinedwith some government entities’ desire to align withrelated internationally recognized best practices, such asthe frameworks issued by the International Organizationfor Standardization (ISO), difficult questions have arisensuch as:- With all these regulations have we created tremendousoverhead in the operations of these organizations?- And with this overhead, are governments seeing theexpected results?

The key challenge in adopting these regulatoryprograms has been the need for each entity to tailor andfind the right balance for resource allocation betweenthe regulatory requirements, best practices and its ownorganizational requirements. Entities that have failed to

do so have been mired with costly and distortedprograms, which have led to failures in complying withthe requirements in some cases and have escalated tothe level of jeopardizing the maturity level of businessoperation services in others.

Key challengesComplying and maintaining various regulatory and BestPractice requirements must be driven, managed andmonitored in a holistic approach and a coherentstrategy. Instead, in the case of many governmententities, a reactive rather than a proactive model is beingapplied, treating the implementation and maintenanceof these requirements as a “check box” or “to-do” taskand executed in a siloed approach, which has very oftenbeen affected by one of the following reasons:

• Increasing number of regulatory bodies The past few years have seen a remarkable increase in the number of new regulatory bodies, each onereleasing various regulatory programs to addressdifferent domains. These programs, while necessary to achieving the desired outcome for pan-governmentperformance, have resulted in excessive cost to thegovernment entities by failing to leverage the cross-regulatory synergies and duplicating in many cases the implementation and reporting efforts.

• Governance structure Not everyone is responsible for compliance. Surely,adequate implementation of regulatory requirementsis on everyone’s radar, but “ownership” and“accountability” have to be clearly defined andassigned to specific people. A reform of the publicsector entities’ structure did not follow theintroduction of the new regulatory programrequirements. A majority of the entities have struggledto align with the introduction of these programs andassigned the responsibility for implementing theregulatory requirements on an ad-hoc basis inaccordance with the existing organizational structure.

More recently, the Middle East hasseen regulation introduced in domainslike cyber security, quality assurance,service resiliency, environmentalmanagement and work-related healthand safety


Although efficient to a certain extent, assigning theimplementation and monitoring responsibilities to thefunctional operating units without proper planning,can bring its own headaches, such as prioritizing thedaily challenging operational activities over thecompliance requirements.

• Budgetary constraints Achieving government modernization initiatives in thepost-global financial crisis world is putting publicsector entities under immense pressure of doing morewith less as the number of regulatory requirementsincrease and the budgets get smaller. Cutting servicesor compromising the quality of these services is not afavorable option. The current siloed approach forcomplying with regulations is resulting in lowefficiency and high costs, leading to losing the trustand motivation necessary to implement the regulatoryprograms.

• The human factor Many entities within Middle Eastern governmentsbelieve that technology alone is sufficient to meetregulatory requirements. The reality is that theseemerging requirements necessitate the involvement oftalented people with the right specialization.Regrettably, there are very few specialized people,globally and regionally, in the fields of cyber security,quality assurance, services resiliency, environmentalmanagement and work-related health and safety.Currently, the knowledge and expertise in thesedomains is limited to self-studies or readings, trainingand practitioners’ experience or lessons learned.Additionally, governments and regulatory bodies haveyet to consider prepping the next generation for thesedomains by embedding and dedicating educationalprograms as part of their respective educationalcurricula.

• Culture and awareness Although several governments have initiated awardprograms to recognize excellent service performancein order to provide incentives and motivation to public

sector entities, it is getting even more common totreat regulatory requirements implementation by“ticking the box.” Regulatory bodies have notestablished an appropriate mechanism to demonstratehow to embed regulatory requirements in a businessmodel, providing real value to the services andenabling effective and efficient operation thatincreases the maturity of the entity. While it isreasonable to assume that the entities, as opposed tothe regulatory bodies, are responsible for creating acompliance culture framework that bridges the gapbetween the importance of adequate implementationand improvement of the public services performance,it is also true that as the number of requirements andentities grows, the need for centralizing andmandating the practices becomes more essential for standardized and focused implementations toward the main objective.

• Automation It is practically impossible for both, the entities and theregulatory bodies, to manually manage and monitorthe implementation status of regulatory requirements.A customized solution that enables and facilitates theimplementation and maintenance of regulatoryprograms has yet to be considered, leading to adegradation in the quality of the implementation andtherefore preventing the maturity and performanceincrease of the services.

Adequate compliance with regulationsand best practices requires acooperative and shared responsibilitybetween the government, regulatorybodies and the public sector entities

Public Sector


As regulations and best practices expand at a fast pacewith the fast changing threat landscape, forward-thinking leaders are concerned about theaforementioned challenges, more specifically, about thereactive, rather than proactive, approach in managingregulatory programs that may expose them to legal andreputational risk or afford them more costs thanbenefits.

Overcoming the problemAdequate compliance with regulations and bestpractices requires a cooperative and shared responsibilitybetween the government, regulatory bodies and thepublic sector entities. Overcoming the current challengesnecessitates a coordinated and integrated approachsupporting one vision, enabled by processes, people and technology.

Processes integrationIt is important for government entities to exploreopportunities for cross-regulatory synergies and alleviatethe significant operational overhead that has beenintroduced via regulatory requirements. Establishing acoordinating body with an overarching responsibility tomanage the integration between all the regulatorybodies could drive widespread benefits throughout thegovernment and its constituents. The coordinating body

offers significant support by developing and enforcingan Integrated Controls Framework1 (ICF) that streamlinesthe overlapping requirements and enables efficiency and effectiveness in designing, implementing andmaintaining applicable controls.

Additionally, the enforcement of the ICF necessitates theappropriate governance structure among the regulatorybodies as well as the entities. An executive role such as “Chief Compliance Officer” function should beembedded in the entities’ organizational charts, with the right seniority and authority to ensure successful,smooth and value add implementation of the IntegratedControls Framework.

PeopleHiring talented employees, training people and creatinga compliance culture should be on the top of theexecutive management’s priority list. It is not reasonableto assume that employees have the right expertise in the emerging domains such as those mentioned above(cyber security, quality assurance, services resiliency,environmental management and work-related healthand safety.)

Educational programs will positively contribute, not onlyto the government entities, but also to the society as awhole, which stands to gain from these programs onceeducational institutions take on the mandate to train the next generation of the workforce. That would alsoenable an improvement of the private sector, henceattracting stakeholders to increase their investmentswithin a community that supports their growth andexpands their operation.

TechnologyWith the increasing number and diversity of theregulatory requirements, it is challenging to manuallymanage the implementation and maintenance of theserequirements. Evidently, technology complements the

Hiring talented employees, trainingpeople and creating a complianceculture should be on the top of theexecutive management’s priority list


right people and processes in place to consistentlyimplement and monitor the ICF. Using technology willdrive greater integration and will allow a holistic real-time visibility of the compliance status, related risks andimpact on the affected organizations. This existingtechnology in the market known as Governance, Riskand Compliance (GRC) solution has powerful featuressuch as defining, implementing, maintaining,monitoring, analyzing, remediating and reportingaround the strategic and technical implementationstatus of the regulatory and best practices programs.

Besides GRC solutions, leveraging data analyticstechnology is another important tool to connect thedots and analyze the overarching entity’s level of impact on the governments’ strategic objectives.

Governments in the Middle East are determined andcommitted to improve the performance of their publicsector services to permit a top-notch lifestyle competingwith the most developed and growing economies. Greatefforts and milestones have been achieved towards thisgoal; nevertheless, increasing the maturity of theseservices imposes changes in the current operating modelthat consider the contemporary challenges faced by theentities and their executive management.

To be most effective, regulatory and Best Practicerequirements should be applied within the businesscontext, focusing on where their use would provide themost benefit to the entity. Executive management,middle management, regulatory representatives andcompliance officers should work together to make surethat the implementation of these practices lead toimproving the performance of the public sector in acost-effective and well-controlled manner.

by Ziad Haddad, senior manager, Enterprise RiskServices, Deloitte Middle East

Endnotes1. Integrated Controls Framework is the unique mapping of controlsdefined in two or more regulatory or best practices programs.

Governments in the Middle East aredetermined and committed to improvethe performance of their public sectorservices to permit a top-notch lifestylecompeting with the most developedand growing economies

Public Sector



There’s a well-documented disconnect between the decisions that people make about money and the assumptions that classical economists madeabout these choices. Generally, individuals are notrational creatures when making choices about how to invest their money. But less-than-ideal decisionsare not the sole province of investors. The biases andemotions that cloud our judgment about money andstymie well-intended investment plans are the sameforces that compromise the ways companies invest in innovation and organize innovation processes. As innovation climbs corporate agendas, theunderstanding of how it works and how it can be managed is struggling to keep pace.

Behavioral trapsand innovationWhat innovators can learnfrom investors’ failures

Deloitte Review


There are two main factors that make meaningfulinvestment in innovation harder to manage than othercorporate activities. First, innovation is fraught withuncertainties. It deals with the future, requiringassumptions about future market needs, market trends,dominating technologies, and many other factors. Theoutcomes of innovation projects are, therefore, highlyuncertain. Research suggests that 40 to 90 percent ofnew product developments eventually fail.1

Second, there is a tension between the short term and the long term. Innovation may be crucial for acompany’s long-term wellbeing, but it requiresinvestment in capacities and resources withoutimmediate cash flows. This makes innovation activitiesvulnerable to short-term pressures to allocate capital to more pressing matters, making rational decisions hardto come by. Faced with high levels of uncertainty andtangible near-term needs, most companies forego apromising investment in growth for the more presentconcerns of value preservation and cost savings.

Investors, of course, face the same challenges. Investingmoney involves decisions about how much to save; itinvolves estimates about a company’s future cash flowsas well as the future performance of whole economies;and it involves choices between asset classes andbetween thousands of securities. Furthermore, thesechoices require investors to define their appetite for riskbeforehand.

According to neo-classical economists, there is noreason to worry. Rational humans are up to the taskbecause in the world of economic models, individualsare assigned complete foresight and unlimited capacityfor processing information. A relatively new academicbranch, however, sees plenty of reasons to worry.Behavioral scientists in economics and finance combineeconomic theory with psychology to explore howpeople actually make their decisions and how theydeviate from the rational decision-making processesfound in the textbooks. Behavioral finance specificallylooks at investment decisions and how investors processinformation, and has illuminated all sorts ofpsychological biases that prevent people from makingoptimal investment decisions that are consistent withcapital market theory. In practical terms, this means that people lose money by following their instincts.

For these three shared characteristics–future orientation,uncertainty, and tensions between the long-term and the short-term decisions about how to pursueinnovation and decisions about investing have similarstructures and take place in comparable contexts.Therefore, the systematic biases pertaining toinvestment that are identified by the field of behavioral finance–and the solutions that have beendeveloped–can help inform decisions about innovation.The analogy between innovation and investmentsenables the transfer of behavioral insights to decisions

Four behavioral traps can impairinvestment decisions and haveparticular relevance for innovationdecisions: underinvestment, choosingby not choosing, focusing on the treesand ignoring the forest, and stickingwith the familiar


about management, thereby opening a new perspective on innovation. This lens brings new andunderappreciated questions and potential solutions tothe fore.

Behavioral finance has explored and documenteddozens of cognitive biases and deviations from rationaldecision making. For the present discussion, fourbehavioral traps can impair investment decisions andhave particular relevance for innovation decisions:underinvestment, choosing by not choosing, focusingon the trees and ignoring the forest, and sticking withthe familiar. This article will describe the investmenttraps and their psychological underpinnings, drawing onempirical research from behavioral finance. We will thenaddress the behavioral solutions that can be applied toinnovation decisions and processes.

Trap oneUnderinvesting Investors planning for retirement struggle with akey behavioral challenge. They have to save today andtherefore consume less, while the benefit–a comfortableretirement–lingers in the future. What is difficult aboutthis choice is that investors know, in principle, that itmakes sense to save for retirement, but they face veryconcrete temptations to enjoy the present even if it putstheir financial future at risk. Think of trips to sunnyislands or the new electronic gadget you need to have.How do people deal with this tension, and how do theydecide? Even individuals with the best of intentions tendto spend what they have, delaying retirement savings.

The empirical evidence is quite clear. Data on retirementsavings in the United States show two things. First, onlya minority of employees (slightly more than a third) joinsan employer pension plan, even if joining is–thanks toemployer contributions and tax advantages–a no-

brainer from a purely financial perspective. If peopleactually join a pension plan, they mostly stick with thedefault contribution rates, which are likely to be too lowto afford a comfortable standard of living in retirement.2

It is not a question of awareness or knowledge. Even ifpeople admit that their saving rate is too low, only afraction plans to increase it. And if they do plan toincrease it, only a fraction actually does.3 In short,people underinvest in their own futures, even when theyknow they aren’t saving as much as they should. Behindthat behavior is a powerful psychological tendencycalled loss aversion. People are much more sensitive tolosses than they are to gains. This holds true even ifboth are of the same magnitude. People hate losses

The empirical evidence is quite clear.Data on retirement savings in theUnited States show two things. First,only a minority of employees (slightlymore than a third) joins an employerpension plan...If people actually join apension plan, they mostly stick withthe default contribution rates, whichare likely to be too low to afford acomfortable standard of living inretirement.

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twice as much as they value gains, according to severalstudies. A reduction of current consumption is seen as aloss, so people try to avoid it. Loss aversion often resultsin inertia, which suggests that resting wallets tend tostay at rest, even when it’s contrary to an individual’sself-interest. The consequence is an effect familiar to allchange managers: the status quo bias. The status quohas a built-in advantage over other courses of action. Itis the reference point for judging developments, anddeviations from the status quo are felt to bring losses.Maintaining the status quo is a tempting option toprevent losses.

Behavioral solution: provide mechanisms thathelp individuals plan for the futureThe challenge of low saving rates can be counteractedby relying on automatic mechanisms that work withoutconscious intervention. An example from the field ofretirement savings is a program called Save MoreTomorrow, established by behavioral economists RichardThaler and Shlomo Benartzi.4 Employees pre-commit tohigher future contributions once they receive a pay rise.In this way, their current take-home income is notreduced, and the higher contributions in the future golargely unnoticed because the contributions grow at a

slower rate than their income. The power of thisprogram comes from the fact that employees need tomake the decision to save only once, and they makethat decision for the future, not the present. Thisautopilot solution takes advantage of the tendency toprocrastinate and maintain a status quo. The programaddresses loss aversion by allowing employees to savemore for retirement without compromising their currentincome.

Underinvesting can be a serious problem for innovationactivities, too. From an economic standpoint, there is astrong tendency to underinvest in innovation. Accordingto the founder of modern innovation theory, JosephSchumpeter, organizations will invest too little ininnovation because they will have a hard time keepingthe new knowledge secret and appropriating the returnsfrom those investments. Add to that the uncertainnature of innovation, the natural advantage of projectswith more secure cash flows, and the temptation to cutinnovation budgets in favor of projects that are morepressing in the short term. Even if companies depend oninnovation in the long term and acknowledge this, theystill run the risk of underinvesting in it.

Companies could use these mechanisms in ananalogous way if they face the danger of underinvestingin innovation. They can shield their innovation budgetsand commit to a certain level of R&D spending in thefuture, irrespective of the current business situation. Forexample, companies could commit to and communicatetheir R&D intensity (R&D expenses relative to sales) inorder to align the innovation budget with their long-term strategic growth goals. If disruptive innovation is arisk for companies, they could also set aside a separatebucket to fund radical innovation initiatives. Essentially,an innovation budget should be handled in a strategic

Companies could commit to andcommunicate their R&D intensity(R&D expenses relative to sales) in orderto align the innovation budget withtheir long-term strategic growth goals


way, rather than having to compete with short-termprojects. Recent empirical research of 1,200 companiesfrom 39 countries suggests that companies with R&Dspending significantly above the industry standard enjoyhigher market capitalizations.5 Capital markets seem tobe aware of the strategic value of R&D spending, soself-commitment might help manage expectations andstrategic priorities.

Trap twoChoosing by not choosingOne of the main challenges for investors is choiceoverload. The range of investment options is huge, andchoosing between so many options overwhelms mostpeople. Choice overload has two main effects onfinancial decision making. First, people tend to leantoward a default option. Second, if there is no defaultoption, they become indecisive. The first effect isevident in the Swedish pension system. In 2000,Sweden introduced a pension system in which citizenshad to invest a percentage of their public pensioncontributions into mutual funds, credited to theirindividual retirement accounts. The program offers 650mutual funds and one default fund, run by thegovernment. How did people deal with thisoverwhelming array of choices? More than 90 percentchose by default–that is, by not choosing–and wereautomatically enrolled into the government’s fund.6 Inother words, they took the path of least resistance.

In other situations with no default option, choiceoverload results in decision paralysis. Research suggeststhat more choice attracts more attention, but itparalyzes decision making. That is true for buyingdecisions when it comes to marmalade7 as well as forinvestment options. When the number of investment

options in company pension plans increases,participation decreases.8 So, choice overload leads toparalysis, and if there is a default option–an option thatautomatically applies if no active choice is taken–itquickly becomes the most popular option, as peoplefollow the path of least resistance.

Behavioral solution: designing appropriatedefault optionsThe design of a default option is critical for overcomingparalysis. Many studies show that the low participationrates in company pension plans can be increased bychanging the default option. Normally, employees haveto make an active and conscious choice to join apension plan: they have to tick a box if they wish to join.

So, choice overload leads to paralysis,and if there is a default option–anoption that automatically applies if no active choice is taken–it quicklybecomes the most popular option, as people follow the path of leastresistance

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Therefore, the default option is not to join. If, however,enrolling is the default option and employees have tomake an active choice to opt out, participation ratesincrease dramatically.9

Increasing a company’s innovation prowess is distinctlymore complex than changing the choice set of a one-time decision. Nevertheless, the analogy illustrates animportant point: while innovation itself cannot beautomated, innovation incentives and contexts canbecome institutionalized. This involves makinginnovation an integral part of workplace routines,internal and external stakeholder expectations, andcorporate culture. In other words, innovative behavior in a company must become the default option. Inbehavioral economics parlance, the reference pointneeds to be shifted.

Consider Red Bull, a producer of energy drinks. Foundedin the mid-1980s, Red Bull had within a short timeframebecome the leader in a strongly growing market thatthe company itself created. A big part of this rise restedon the institutionalization of permanent innovations inits marketing approach. Associating the brand with edgysports and relying on non-traditional marketing, Red Bullcreated unorthodox events such as the flugtag, or“flight day,” where homemade flying machines vie tostay in the air as long as possible; breakdancecompetitions; cliff diving events; and soapbox and airraces. The latest and possibly most spectacular was theStratos project, the world-record jump from the edge ofspace to the earth, which was watched by 8 millionYouTube users. The default option, in the case of RedBull’s marketing, was to create novel events andexperiences in a clearly defined area of focus. This raisesthe bar for future marketing activities, sets internal andexternal expectations, and establishes a clear referencepoint against which new projects must compete.

Trap threeFocusing on the trees and ignoring the forestInvesting is about portfolios. According to economictheory, investors should not worry about the singlesecurities in their portfolio; their only concern should be the bottom line–that is, the risk and the performanceof their overall portfolio, no matter whether somesecurities go up and others go down.

However, in the real world, that is not how stockinvestors usually handle their investments. More oftenthan not, they look at single securities and neglect thefact that they are part of a portfolio. What happens inthe investor’s mind is something called mentalaccounting. There is a mental account for everyinvestment, and the success of the investment is judgedagainst the initial price of each investment. Selling

What happens in the investor’s mind is something called mental accounting.There is a mental account for everyinvestment, and the success of theinvestment is judged against the initialprice of each investment. Selling stocksthat are performing well bringspleasure, and selling underperformingstocks brings mental suffering.


stocks that are performing well brings pleasure, andselling underperforming stocks brings mental suffering.Consequently, investors tend to realize gains too quicklyand have strong psychological barriers to losses. Theytend to hold on to loss-making stocks way too long,hoping they at least recover their investment. In otherwords, they do not consider the future earnings of theirinvestments, compare them with other investmentoptions, and buy and sell accordingly. Instead, they hold on to what they have.

There are several behavioral effects at work. Lossaversion, as the name implies, discriminates againstrealizing losses. A second and related culprit is theendowment effect. People value things more once theyown them. It doesn’t matter whether they own stocks,coffee mugs, or projects. Owning something means

wanting to keep it. A third effect has to do withreference points. People make their decisions usingarbitrary reference points–in the case of stocks, theinitial price. They judge developments relative to thisreference point and base their decisions on an irrelevantmental benchmark. Taken together, these tendenciescombine in a powerful way and discriminate againstholistic thinking.

Behavioral solution: shift toward a portfolio viewAn effective way to get around this investment trap is tomake a conscious and disciplined effort to shift theperspective away from mental accounting. For aninvestor, that might involve the need to zoom out andlook at a portfolio from 10,000 feet. In other words,avoid caring about individual securities, and look at theportfolio as a whole.

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This implies that risk measures and return expectationsshould be set at the portfolio level, and the most basicinvestment decision about asset allocation needs tofollow from this. After all, research shows that about 90 percent of investment fund performance over timehinges on high-level decisions about asset allocation.10

Many institutional investors set their return goals beforethey determine their asset allocation and considerwhether they can bear the resulting risks.

Mental accounting in investments corresponds to thesunk-cost fallacy in project and innovation investments.All too often, companies decide to throw good moneyafter bad, perhaps at the expense of more promisingprojects, hoping the project underway can at leastrecover its initial investment in what Nobel laureateDaniel Kahneman calls the escalation of commitment.11

Understanding innovation projects as a portfolio cancurb the tendency toward escalation of commitment.First, innovation and performance metrics should beapplied to an innovation portfolio as a whole, ratherthan governing individual projects. Given the inherentuncertainty of innovation, it is safe to expect that someprojects will fail, and others will succeed. The criticalgoal is to ensure that the overall innovation portfolioperforms well.

A second and related point is the structuring of theportfolio. Like investments, innovation projects havevarying levels of risk and potential returns. They can beradical (with high risk and return potential) orincremental (with low risk and return potential) as wellas several degrees in between. A conscious effort toclassify innovation projects according to their risk/returnprofile and manage the resulting portfolio according topre-defined goals shifts the focus away from individualprojects in favor of the portfolio level.

Similar to investors constructing a portfolio between thepoles of risky new technology firms and governmentbonds, innovation managers can construct a portfolioranging between high risk/high return and low risk/lowreturn and manage the portfolio and its risk budget. Thisemerging innovation portfolio should be aligned to acompany’s overall growth goals. Ambitious growthgoals may require a comparatively risky innovationportfolio with higher potential payoffs.

Trap fourSticking with the familiarPeople have a strong tendency to focus on what theyknow, and they tend to rely on information that is easilyavailable or recallable. Our gut feeling tells us to favorthe familiar over the unfamiliar. The unfamiliar might

According to economic theory,investors should not worry about thesingle securities in their portfolio; their only concern should be thebottom line–that is, the risk and theperformance of their overall portfolio,no matter whether some securities goup and others go down


carry new and unknown risks, and the familiar feelssecure. That also plays out on an emotional level: thereis a well-documented tendency for people to preferfamiliar things.

In the realm of investments, there are severalphenomena related to this tendency. The first is a grossover-reliance on employer stock for retirement investingpurposes. From a risk perspective, it may not be a goodidea to invest your money in your employer’s stock.After all, if the company goes bankrupt, you lose yourretirement savings along with your job and your income.But current data suggest that, even after the well-publicized cases of Enron or Lehman Brothers, morethan half of all employees in the United States who caninvest their retirement savings into their employer’sstock do so.12

The same tendency affects international investing. While the standard recommendation of capital markettheory is to diversify your portfolio as much as you can, investors massively overweight their own country.According to the IMF, the share of domestic equities in US portfolios in 2005 was 87 percent; for Germanportfolios, 72 percent.13 Given the shares in worldmarket capitalization (43 percent and 3 percent,respectively), the attraction to familiar territory isoverwhelming for investors. As a result, they are under-diversified, implying that they are exposed to too muchrisk for a given level of returns, or they forego returnsfor a given level of risk.14

Behavioral solution: cast your net widelyIn an investment context, the familiarity bias can becountered by overcoming the emotional affinity for thefamiliar by making a conscious decision to diversify a

portfolio as widely as possible in terms of geographies,asset classes, and securities within these asset classes.As this is difficult for private investors, the institutions offinancial advisers and the mutual fund industry emergedto deliver decision support and easy-to-use tools.

In the realm of innovation, the familiarity biascorresponds to the not-invented-here syndrome.Instincts suggest that the ideas generated internally are superior or more feasible than those coming fromexternal sources. Familiarity with the context and thebackground of new ideas is higher, and it is easier toconnect the dots.

The other consideration pertains to which sources feed an innovation portfolio and which ideas enter an innovation portfolio. To avoid the familiarity bias,innovators need to diversify their sources of ideation in the same way investors need to diversify theirinvestments.

In the realm of innovation, thefamiliarity bias corresponds to the not-invented-here syndrome. Instinctssuggest that the ideas generatedinternally are superior or more feasiblethan those coming from externalsources.

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Consider the case of Freudenberg, a Germanmanufacturing company with 37,000 employees and a presence in 57 countries. Freudenberg SealingTechnologies, the biggest part of the company,introduced a holistic innovation approach to expand its sources of ideation. The company developed asystematic trend-monitoring system grounded in itsrespective market segments. These trends are discussedwith clients to map them to client problems and needs,and to collect feedback at a very early phase ofinnovation. In the product development phase, carriedout in a dedicated and interdisciplinary innovationcenter, Freudenberg integrates external experts, mostlyfrom academia, to access new perspectives and lateralthinkers. The company maintains close relationshipswith universities, intensively cooperates with universitychairs and research projects, and regularly discussestrends that are important to the company in trendforums or during tech days with clients, experts, andindustry participants. This external ecosystem and theconstant external feedback in every phase of theinnovation process help the company to have diversifiedsources of ideation and to steer the innovation processin a market-oriented manner.

Good behaviorViewing innovation from a behavioral perspective can lead to more effective innovation processes andoutcomes. In this sense, a behavioral approach does not compete with other approaches to innovationmanagement. It is a framework to reflect on existingpractices, identify weak spots, and provide direction.Furthermore, it can foster an awareness of the biasesborn of our routines and our intuitions. The rise ofbehavioral finance demonstrates that taking cognitivebiases into account can help investors improve theperformance of their investments, and may be quiteilluminating with regard to improving the returns ontheir investments in innovation.

Viewing innovation from a behavioralperspective can lead to more effectiveinnovation processes and outcomes


Reprinted from Deloitte Review, issue #15: 2014

by Dr. Alexander Börsch is a director with Deloitte & Touche GmbH and head of research for Deloitte inGermany and Nicolai Andersen is a partner withDeloitte Consulting GmbH and the Innovation leader for Deloitte in Germany.

Endnotes1. George Castellion and Stephen K. Markham, “Perspective: New

product failure rates: Influence of argumentum ad populum andself-interest,” Journal of Product Innovation Management 30,no. 5 (2013.)

2. Brigitte C. Madrian and Dennis F. Shea, “The power ofsuggestion: Inertia in 401(k) participation and savingsbehaviour,” Quarterly Journal of Economics 116, no. 4 (2001):pp. 1,149–1,187.

3. John Beshears, James Choi, David Laibson, and Brigitte Madrian,“Helping employees help themselves,” Milken Institute Review,2006.

4. Richard Thaler and Shlomo Benartzi, “Save more tomorrow:Using behavioral economics to increase employee saving,”Journal of Political Economy 112/1 (2004.)

5. Deutsche Bank Research, Capital markets reward R&D, June2011, www.dbresearch.com.

6. Waldo Tapia and Juan Yermo, “Implications of behaviouraleconomics for mandatory individual account pension systems,”OECD working papers on insurance and private pensions, no. 11 (2007.)

7. In a series of experiments Sheena Iyengar from ColumbiaBusiness School has shown that more choice attracts moreattention, but fewer decisions. The researchers organized atasting of exotic jams in a grocery store, displaying either 6 or 24exotic jams. It turned out that more passersby approached thestand with more jams. However, only 3 percent of customerswho approached the stand with the extensive selection finallybought a jam, while 30 percent of the consumers who wereinterested in the limited selection finally bought a jam. For moredetails, see Sheena Iyengar and Mark Lepper, “Choice and its

consequences: On the costs and benefits of self-determination,”Self and Motivation: Emerging Psychological Perspectives, ed.Abraham Tesser, Diederik A. Stapel, and Joanne V. Wood(Washington, D.C.: American Psychological Association, 2002.)

8. Gary Mottola and Stephen Utkus, Can there be too much choicein a retirement savings plan?, Vanguard Center for RetirementResearch, June 2003.

9. James Choi, David Laibson, Brigitte Madrian, and AndrewMetrick, “Saving for retirement on the path of least resistance,”Harvard University working paper, July 2004.

10. Roger G. Ibbotson and Paul D. Kaplan, “Does asset allocationpolicy explain 40, 90, or 100 percent of performance?,” FinancialAnalysts Journal, 2000.

11. Daniel Kahneman and Amos Tversky, “Prospect theory: Ananalysis of decisions under risk,” Econometrica, 1979. EmployeeBenefit Research Institute, 401(k) plan asset allocation, accountbalances, and loan activity in 2012, EBRI

12. issue brief no. 394, December 2013.13. Hisham Foad, “Familiarity bias,” Behavioral Finance: Investors,

Corporations, and Markets, ed. Kent Baker and John Nofsinger(Wiley, 2010.)

14. There are several other explanations for the home bias ininternational investment, stressing institutional and informationalfactors as well as transaction costs. These include thesignificantly better ability to gain information about companiesor the overall state of the economy in the home country andcomplicated tax laws on dividends for foreign investments. See,for example, Hisham Foad, “Familiarity bias,” Behavioral Finance:Investors, Corporations, and Markets, ed. Kent Baker and JohnNofsinger (Wiley, 2010.)

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Deloitte provides audit, tax, consulting, and financial advisory services to public and private clients spanningmultiple industries. With a globally connected network of member firms in more than 150 countries,Deloitte brings world-class capabilities and high-quality service to clients, delivering the insights they needto address their most complex business challenges. Deloitte has in the region of 200,000 professionals, allcommitted to becoming the standard of excellence.

Deloitte's professionals are unified by a collaborative culture that fosters integrity, outstanding value to markets and clients, commitment to each other, and strength from cultural diversity. They enjoy anenvironment of continuous learning, challenging experiences, and enriching career opportunities. Deloitte'sprofessionals are dedicated to strengthening corporate responsibility, building public trust, and making apositive impact in their communities.

About Deloitte & Touche (M.E.)Deloitte & Touche (M.E.) is a member firm of Deloitte Touche Tohmatsu Limited (DTTL) and is the first Arabprofessional services firm established in the Middle East region with uninterrupted presence since 1926.

Deloitte is among the region’s leading professional services firms, providing audit, tax, consulting, andfinancial advisory services through 26 offices in 15 countries with around 3,000 partners, directors andstaff. It is a Tier 1 Tax advisor in the GCC region since 2010 (according to the International Tax ReviewWorld Tax Rankings). It has received numerous awards in the last few years which include Best Employer inthe Middle East, best consulting firm, and the Middle East Training & Development Excellence Award by theInstitute of Chartered Accountants in England and Wales (ICAEW).

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Middle East Point of ViewFall 2014 - Deloitte · PDF filePast\Present - Future? Supply/Demand economics Hotels in 2020 Dubai Is there a lawyer in the house? The changing role of the