2-Budgets - How to Manage Without Them

7/25/2019 2-Budgets - How to Manage Without Them

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30 April 1999

In the first

article w e argued that

bu dgetary control w as

the hidden barrier to

success in the inform ationage. B ut building a con vincing case

for dism an tling budgeting system s is

not the m ajor ch allengethis

concerns the replacem ent of bu dgets

w ith alternative steering

m echan ism s. W hat are they and how

do they form the basis of a n ew

m anagem ent m odel? B udgeting is, of

course, m uch m ore than a financial

process. It is the glue that connects

the entire m an agem ent system

together from strategy and plan ning

through resource and cost

m anagem ent to m easurem ent andrew ards. W hile there is m uch detail

to b e understood, w e w ill focus on

three broad issuesthe plan ning

process, cost m anagem ent, and

m easurem ent and control.

The planning processO ne of the principal failings of the

budgeting p rocess is that it is based

on the n egotiation of a set of fixed

finan cial num bers. These tend to be

arbitrary and, m ore often than not,

they relate to previou s perform an cerather than shareholder exp ectation s

or com petitive m easures. H ow ever, in

the age of instan t inform ation ,

w hichever m easure is

usedfrom shareholder

value to custom er

satisfactionit is relative

success that m atters. B eating lastyears perform ance by 20% m eans

nothing if you r com petitors have

done even better. B ut, by definition,

com petitive targets can on ly be

estim atedthey cann ot be know n in

ad vance. R elative targets can be

internal (e.g. bran ch to b ran ch), or

external (e.g. business to business).

A nd they should preferably use

In the second of two

articles, Jeremy Hope

and Robin Fraser

explain how a numberof companies have

abandoned budgeting

and adopted a new

management model

Rela t ive measur es ar e more

effec t ive than s t r e tch tar get sbecause they ar e a lways

cur ren t an d keep moving the

mean upwards ; we jus t

commun icate to people the

mean an d a r an k ing t ha t sh ows

which bran ches ar e above and

which ar e be low. The s ys tem

works on it s own. Senior

man agement dont need to

push people , they jus t advise.D r Jan W allan der, vision ary architect of the

H andelsbanken m anagem ent m odel

Management accounting

Budgets: how tom anage w ithout

them


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April 1999 31


m easures that define the key

perform an ce indicators that drive

com petitive success w ithin a

particular business unit. A t

H an delsbanken, leagu e tab les of like

branches and regions app ear every

m on th, m aintaining a strong focus on

perform ance and harnessing the

pow er of peer pressure. W hile at firstthis m igh t appear to b e divisive, this

com petitive n etw ork also op erates

w ithin a b road ly based rew ards

system thus giving strong bran ches

am ple incentive to support those that

are not perform ing so w ell. T hus,

kn ow ledge and best practices are

qu ickly shared. H an delsban ken

m an agers believe that any specific

target is not w orth the p aper its

w ritten on .

In the em erging m odel the

plan ning process is no lon gercon strained by the annual cycle. In

som e businesses the ap propriate

cycle m igh t be quarterly, in others,

m on thly. It largely d epends on the

pace of chan ge an d the planning

horizons appropriate to a particular

firm or industry. Perhaps the key

elem en t is the u se of rolling forecasts

around w hich n ew grow th and

im provem ent strategies and action

plan s are tested an d co-ordinated

across the b usiness. A t Volvo Cars,

strategy and forecasts are review ed

an d u pd ated several tim es a yearw ith fou r distinct cycles apparen t.

E ach m onth flashforecasts look

on e quarter ah ead; quarterly rolling

forecasts look one year ahead ; on e

year rolling forecasts look fou r years

ah ead, an d an an nual strategic

plan ning p rocess looks 10 years

ah ead. O ne forecast dovetails into

an other like cogs in a w heel.

A ccording to O le Johannesson , V P

Finan ce, m an agers build

com petence in sketching the future

and w ithin that future lie theop portunities an d threats that

tradition al budget-driven processes

fail to see until its too late. These

forecasts form the core inform ation

for the m on thly m eetings, the

developm ent program s, and the

strategy review s.

Cost managementCon trolling costs through budgets

m ay give the im pression of tight

m an agem ent but the reality is that itprevents m anagers from asking the

really interesting questions that

m igh t lead not just to cost con trol but

to cost reduction . W hich m arkets,

segm ents, and custom ers are

profitable after ch arging all the costs

they consum e? W hich processes and

activities ad d value and how can this

value be increased? H ow can w e

m an age a process differently so that

it is faster and is accom plished at a

low er cost? N on e of these question s

are even asked never m ind answ eredby the bu dgeting approach.

In the new m odel, the cost

m anagem ent focus m oves from costs

to value. Som etim es this can sim ply

be qu estion ing w hy particular

activities are d on e. B ut a m ore

system atic ap proach is offered by

activity based m an agem ent. E ach

activity shou ld be m ad e to p ass a

valuetest, that is, w hether or not it

adds value to p roducts, custom ers, or

other strategic business need s.

Starting w ith last years costs as the

basis of cost m an agem ent is thew rong app roach. Cost estim ates

should be a function of the resources

required to m eet the agreed plan an d

on ly by looking at resources through

a value-addedlens can m an agers

really see w hat is an d isnt required .

A t B orealis, m an agers use anad vanced activity accou nting system

an d rolling m oving averages to

provide a clear picture of cost drivers

an d trend s. T he costs of central

service function s such as finan ce,

legal, hum an resources an d strategic

plan ning are sub ject to n o m ore than

trend an alysis and step-chan ge

control should this be thou gh t

desirable. For 1998 the d efau lt rule

for cen tral services costs w as zero

increase. B jarte B ogsnes, V P for

Corporate C on trol, believes that one

of the m ost insidiou s aspects of thetraditional budgeting process is that

it sets not just a ceiling but a floor for

costs. This m en tality is at its sharp est

w ithin central service d epartm ents or

purecost cen tres. B y rem oving this

floor the w ay is open to m ake sign ifi-

cant inroad s into these costs, m an y of

w hich have trad ition ally been fiercely

protected b y som e of the m ost

pow erful peop le in the organ isation .

This is an im portan t insigh t into the

chan ge of m entality that can ap ply if

the budgeting system is rem oved.Indeed it turns the typical question

how do w e m aintain control of

cen tral costs?into som ething of a

non -event. In the new m odel the

an sw er m ust be that w e dont just

w ant to controlthese costs, w e

w an t to reduce them , an d the key to

achieving this is to eradicate the

(an nual) budgeting m en tality.

Measurement and controlThe traditional m easurem ent

em ph asis is on p ast events and to

control current perform ance againstthe predeterm ined b udget. M easures

are usually derived from capital

efficiency and earnings ratios and

supported by a plethora of finan cial

detail by departm en t, division, etc.

All cen t r a l cos t s a r e cha rged t o t he r eg ions a nd b r a nches . I f they do not fee l they get good value for the i r money, they wi l l

no t demand our s e r v i ces . Sven G revelius, Finance VP, H an delsban ken

Meas ur es ar e der ived f rom s t ra tegy by ident i fy ing key

pe r form ance d r i ve r s . They a r e a l so r e l a t i ve t o ex t e rna l and / o r

in ter na l compet i tors a nd ar e more effect ive i f they ar e

discuss ed and agreed a t opera t ing uni t or t eam level . The fewer

the mea sur es th e be t ter (you only need a few cru cia l KPIs t ote l l man agers what s r ea l ly ha ppening) .


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32 April 1999

M easures usually com pare actual

perform an ce w ith the (fixed) budgetednum bers on a m onthly basis. A s no

one w ants to see an adverse variance

(it often leads to difficult

explanations), gam ingis rife. There

is a clear em phasis on finan cial

control w ith senior m anagers being

ab le to drill dow nthrou gh detailed

sets of nu m bers. B ut w ith so m any

reports and num bers appearing each

m onth it is often difficult to see w ith

an y clarity w hat is really h ap pening.

In particular, financial m easures fail to

record the chan ges in the value of

intellectual assets that now accountfor 50% -90% of the m arket value of

m any leading com pan ies.

Th e new m easurem ent em phasis

sw itches from past events to future

outcom es. T here is, for exam ple, a

strong link b etw een current m easures

an d rolling forecasts. The gap

betw een current trend s and targets

w ill have a bearing on an y action s

that need m ight be taken . M easures

are derived from strategy by

identifying key perform an ce drivers.

They are also relative to externalan d/or internal com petitors an d are

m ore effective if they are discussed

an d agreed at op erating u nit or team

level. The few er the m easures the

better (you on ly n eed a few crucial

K PIs to tell m an agers w hats really

hap pening). B y using visual reports

and m oving averages and focusing by

exception on key issues, m an agers

can h andle a far broader range of

bu siness units and issues an d provide

real feedback an d learning. K PIs

linked to action plan s enab le

m anagers to exam ine root causes ofdifferences. A good scorecard

reporting system w ill include b oth

leading and lagging indicators thus

giving m anagers an early w arning

that results are off-track.

H andelsbanken m easures its

progress on three sim ple m easures:

return on capital em ployed, incom e-

to-cost ratio, and profit per

em ployee. E very em ployee

un derstands these m easures w hich

are used to create internal

com petition betw een b ranches and a

sense of com m on purpose across theban k. Furtherm ore, em ployees know

that by follow ing the progress of

these m easures they can m onitor

how their ow n com pen sation w ill be

im proved each year. Con tribution s

are m ade to the em ployee profit

sharing fun d dep end ing on the

banks perform ance relative to its

external com petitors.

Future developments andnext stepsO f course this tran sform ation doesnt

hap pen overnigh t. It is a gradual

process of con fidence building as

m an agers, w ary of previou s false

prom ises, w ait and see if this really is

a chan ge w orth the effort. H ow ever,

w e m ight note that not on e of over 50

senior and m iddle m anagers w e

interview ed w ould w ish to return to

the bud geting system .

Th e BB R T h as developed a

diagn ostic that an y com pany can use

to position its existing practices and

identify an y gaps. B ut im plem entingthe new m odel w ill be n either easy

nor quick. It w ill require an holistic

approach and an evolutionary

process that w ill take a num ber of

years. W hat w e now need, in som e

detail, is a better understanding of

the m ain com pon ents of the m odel,

an overall fram ew ork for integrating

them , an d an effective approach to

im plem entation. W e also need

gu idelines for p lan ning and selling-in

the chan ges, introducing the n ew

steering m echan ism s and

dism antling the bu dgeting system .These are the m ain aim s and focus of

the B B RT program m e in 1999. It w ill

produce deliverables that m em bers

w ill be able to u se in their ow n

com pan ies. It w ill enable them to b y-

pass years of poten tial trial an d error

as they m ove tow ards a m anagem ent

m odel w ithout bu dgets and develop

their ow n perform ance m anagem ent

system s as sources of real

com petitive advan tage.

To obtain a free copy of a Beyond

BudgetingW hite Pap er pleasecontact Peter Bun ce at CA M -I Inc on

Tel: +4 4 (0)1202 67 07 17 or Fax: +4 4

(0)12 02 68 06 98 or e-m ail:

Peter@ cam -i.dem on .co.uk

Jeremy Hope (e-m ail: lh23@ dial.pipex.com ) is co-author ofTransformin g the

Bottom Lineand Competing in the Thir d

Wave, both pub lished b y H arvard B usiness

Sch ool Press.Robin Fraser (e-m ail:R obinF raser@ Com puserve.com ) is a

m anagem ent consultant, form erly a partner

in Pricew aterhou seCoopers.

Documents

2-Budgets - How to Manage Without Them