CAM-I Beyond Budgeting Round Table Beyond Budgeting White Paper Jeremy Hope and Robin Fraser May 2001

“Used with permission by CAM-I. CAM-I is an industry-led collaborative research consortium producing the “best-of-the industry” solutions, techniques, methods and tools for over 30 years. It is internationally recognized for Cost, Process and Performance Management.”

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Beyond Budgeting

Dear reader This paper is the outcome of research by the Beyond Budgeting Round Table (BBRT). Its primary quest was to contrast the management practices used in the ‘industrial age’ with those that are now required for the ‘information age’. The result is what we call the “BBRT model”. Why was the project about "beyond budgeting"? If you were to choose one word that was representative of industrial age management, then we reckon ‘budget’ would be hard to beat. It conjures up a physical world dominated by mass production, huge sales forces, and fleets of delivery vehicles, in which organizations were neatly divided into products groups, functions, divisions, and departments. People were defined by their position on the organization chart and layers of supervisors controlled armies of blue-collar workers. It was a world of order and efficiency with clearly defined markets filled with known competitors, physical supply chains, and predictable customers. And it was a world in which accountants could model cause-and-effect relationships between volumes, costs, and profits – confident in the outcome of their forecasts. For most companies today, however, this world is a fading memory. Increasing levels of uncertainty and more demanding customers have changed the business landscape, and in this environment the budgeting model is a real handicap. But many of its practices remain doggedly familiar. For example, most managers still dance to the tune of fixed plans and annual budgets, just as they did 30 years ago. This process of engaging huge numbers of people in a protracted cycle of detailed planning, and then making them march to the drumbeat of the budget, seems to us not just a waste of time, but also an insult to their intelligence. Yet almost every organization does it. It was our belief that this was the hidden barrier to change that persuaded us to form a partnership with international research organization, CAM-1, and establish the BBRT. Since its inception in January 1998, 55 (mostly large European) companies have participated in the BBRT. Though its origins are in the UK, the BBRT now has members from many countries including the UK, Belgium, Holland, France, Germany, Norway, Sweden, Switzerland, South Africa and the USA. All member companies joined the BBRT because they recognized that the budgeting model was increasingly out of kilter with their competitive environment. Despite these concerns, however, few were convinced at the outset that there was a viable solution. Our task was to provide this solution. We did this by first identifying those companies that had abandoned the budgeting model, visiting them, and through case reports and presentations, reporting back to BBRT members. Then, by extracting best practices, we gradually pieced together a coherent set of common principles that formed the framework of what has since become known as the BBRT model. It has taken a few years for many BBRT members to move from being curious observers to committed implementers. They needed to be convinced by the evidence. We believe that our step-by-step approach to producing a set of principles, then a diagnostic, and finally an implementation guide, provided this evidence and has given them the confidence to proceed. We focused our research on three questions: How are leading companies, that have abandoned, radically changed, or significantly de-emphasized their centralized planning and budgeting processes, now fulfilling their well-established purposes? Is there a coherent new management model emerging that will enable companies to introduce more effective

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management processes and steering mechanisms? And what lessons have been learned by those that have adopted the new model? So far, we have written 17 case reports, of which only 14 have been released (the others have been constrained for privacy reasons). In each case we have sought a range of opinions. Indeed, our objective for each case visit was to see a number of managers representing different functional areas and managerial levels within the firm thus providing us with a diverse range of opinion about the effectiveness of their management processes. For example, at Handelsbanken we met with the honorary chairman (Dr Jan Wallander), the chief executive, the finance director, the group controller, a regional manager, a senior branch manager, a junior branch manager, the IT manager, and a manager from their regional team in Norway. The latter was of particular interest because a few years earlier he had been a manager with a bank operating with budgets, prior to becoming part of Handelsbanken through acquisition. Meeting Dr Jan Wallander was an important milestone along the BBRT journey. His philosophy, values, and principles underpin the BBRT model. If Dr Deming was the founding father of the quality movement, then Dr Wallander is the founding father of ‘beyond budgeting’. His experience over 40 years (he practiced his ideas for ten years before he joined Handelsbanken) provides strong evidence that the model is not some faddish idea that will sparkle today and fizzle tomorrow. Besides producing case reports and a “guide” to the BBRT model, we have also prepared an in-company diagnostic that enables a senior management team to elicit a wide range of views about their management processes today, and where their key people at all organizational levels think they should be in the future. This diagnostic has also formed the basis of a global benchmarking survey that we believe will provide a rich source of knowledge about how firms are moving away from the budgeting model, and whether or not those that have moved have experienced better financial results. The early indications from over 200 companies show that there is a statistically significant correlation between the BBRT model and competitive success. Perhaps more surprisingly, the strongest correlation is with the devolution factors rather than performance management systems. You can take part in this survey (and see how the BBRT principles apply in your organization) by visiting its web-site at www.project.bbrt.org. The BBRT is now acknowledged to be a thought leader on the subject of devolved and adaptive organizations. We hope this paper will stir your interest in this fascinating subject and enable you to support our efforts to develop a new management model more in tune with today’s competitive needs. Jeremy Hope and Robin Fraser

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Table of Contents Introduction 5 The traditional performance management model 6 The changing environment 7 The barriers to change 7 Attempts to breach the budgeting barriers 8 The BBRT model 9 The barrier breakers 10 Achieving sustained success through the BBRT model 13 The role of tools and techniques 16 Implementing the new model 17 Conclusions 18 References 19 Acknowledgements 20

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Introduction Too many aspiring twenty-first century corporations are being handicapped by management processes designed and developed for early twentieth century environments. Firms are now competing in an age of discontinuous change. Fast response, imaginative strategies, and customized solutions are just a few of the key capabilities now required to outwit rivals and attract the fleeting loyalties of fickle customers. These are not the right conditions for laying down fixed plans and doggedly sticking to them. To succeed in the information age means that organizations need to respond faster to changing events, attract the best people, continuously innovate, pursue excellence in their operations, become more intimate with customers, and satisfy shareholders by achieving consistently better results than competitors. This cannot be done without embracing a new management model. It will devolve accountability to front line people and it will have adaptive performance management processes. This is what we call the “BBRT model”. This paper makes the case for the BBRT model. The flow of the argument and some of the implementation issues are set out below.

• The traditional performance management model was first developed in the 1920’s to help financial managers control costs in such large organizations as Dupont, General Motors, ICI and Siemens, and for the next 30-40 years it did the job reasonably well.

• The changing environment. Firms now compete in an age of discontinuous change, unpredictable competition, and fickle customers, and thus few companies can plan ahead with any confidence. Yet most organizations remain locked into a traditional ‘plan-make-and-sell’ management model that involves a protracted annual budgeting process based on negotiated targets and resources, and that assumes that customers will buy what the company decides to make.

• The barriers to change. To respond to these changes, organizations need to find a new management approach that effectively empowers capable and committed people to use their intuition and knowledge to satisfy customers profitably. Yet the annual planning and budgeting process acts as a barrier to change (both mental and systemic)

• Attempts to breach the budgeting barriers. Many attempts have been tried over the years to overcome the problems of the budgeting model. Zero-base budgeting, activity-based budgeting, and more frequent budgeting are just a few of the techniques used, but all have failed to result in sustainable improvement.

• The BBRT model. The Beyond Budgeting Round Table has developed the “BBRT model” from studying the best practices of companies that have adopted new devolved and adaptive management processes.

• The barrier breakers. Starting in Scandinavia, a number of companies have now broken through the budgeting barriers and adopted the BBRT model.

• Achieving sustained success through the BBRT model. It is evident that most BBRT companies achieve better performance than their rivals. This is also confirmed by our surveys that show a strong correlation between the BBRT model and competitive success.

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• The role of tools and techniques. Enterprise-wide management information systems, the balanced scorecard, shareholder value models, activity-based management, rolling forecasts, and benchmarking, are just some of the modern tools and techniques that have a role to play in the successful implementation of the BBRT model. However, in every case, there is a right and a wrong way to use them.

• Implementation of the BBRT model. While the implementation process is as much about doing less work and thus freeing time for more productive management processes, it is still a major change process and must be handled carefully.

The traditional performance management model The traditional performance model was designed to execute a ‘producer-led’ approach to business. The multidivisional organization (or “M-form”) coped with increasing complexity by placing the activities of each distinct product line, region, or technology into a separately managed compartment (e.g. a business unit or division) and subjecting all these compartments to the financial discipline of a strong corporate staff. The underlying thread was control. The mission statement agreed by senior executives was translated into the strategic plan by the planners and handed down the hierarchy to operational managers who prepared their plans and budgets (see figure 1). Once these were agreed, all that was demanded was adherence to the plan. Head office did not like surprises. Control reports were constantly fed back up the line and, should they show that performance was veering off-track, new directives would be issued. The traditional model, more often than not, represents a ‘fixed performance contract’ (either explicit or implied) between one organizational level and another. It is the pressure created to meet this contract (usually underpinned by large bonuses) that can lead to a range of unethical practices known as ‘gaming the numbers’ as managers hire part-time staff, provide high-risk finance to customers, and fill distribution channels with ‘sale-or-return’ products. The budgeting model

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Figure 1 A fixed performance contract

Mission statement

Strategic plan

Annual Budget

“Keeping on track”

Control (Versus Budget)

Incentives (Versus Budget)

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The changing environment The traditional model worked well when market conditions were stable, competitors were known and their actions predictable, relatively few people took decisions, prices reflected internal costs, strategy and products lifecycles were lengthy, customers had limited choice, and the priority of shareholders was good stewardship. But these conditions no longer apply. Today’s competitive climate is far more uncertain, many people are required to take decisions, the pace of innovation is increasing, costs reflect market pressures, customers are fickle, and shareholders more demanding. To compete more effectively in the information economy, firms must break free from the incremental planning and budgeting mentality and involve all their people in building a new platform for sustainable improvement.

The barriers to change While most senior executives want their organizations to be more adaptive (and thus more devolved), few know how to turn management rhetoric into operating reality. While they talk about fast response, empowerment, innovation, operational excellence, customer focus, and shareholder value, their management processes (e.g. targets, plans, measures, and rewards) all too often remain stuck in a time warp of command and control. Fixed strategies prevent fast response; rigid organization structures switch-off managers who seek challenge and development; bureaucracies stifle innovation; entrenched functions undermine cross-functional processes; an emphasis on product targets works against customer loyalty programs; and short-term performance contracts fail to support long-term value creation. Nor do the millions spent every year on reengineering, team-building, enterprise-wide systems, customer relationship management, value-based management and balanced scorecards seem to overcome these problems. In fact, the vast majority of these initiatives fail for exactly the same reason – they support the rhetoric but get slaughtered by the reality as they invariably collide with the immovable forces of the short-term planning and budgeting system. The independent research evidence also suggests that the budgeting model is failing its users. For example:

• Few firms are satisfied with their budgeting processes. In a 1998 CFO magazine survey, 88 percent of the respondents stated that they were dissatisfied with budgeting¹. In another CFO survey, 66 percent believed that their planning process was influenced more by politics than by strategy.²

• Far too much time is spent on budgeting and too little time is spent on strategy. Research has shown that 78 percent of companies do not change their budgets within the fiscal cycle;3 60 percent of organizations don’t link strategy and budgeting;4 and 85 percent of management teams spend less than one hour per month discussing strategy.5

• Financial capital is now a small part of market value. Intangible assets now outweigh tangible assets by over six-to-one. What this means, according to accounting professor, Baruch Lev, is that the balance sheet number – which is what traditional accounting measures (and budgets control) – represents only 10 to 15 percent of the value of these companies. Lev suggests that even if the stock market is inflated, even if you chop 50 percent off the market capitalization, you’re still talking about a huge difference between

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value as perceived by those who pay for it day-to-day and value as the company accounts for it.6

• Budgeting is expensive and adds little value either to the firm or its users. A 1998

benchmarking study showed the cost of operating with the budgeting model: the average company invests more than 25,000 person days per billion dollars of revenue in the planning and performance measurement processes; the average time taken for developing a financial plan is 4.5 months; and companies require 21 days to complete a forecast on average7. A KPMG study showed that inefficient budgeting is eating up 20 to 30 percent of senior executives’ and financial managers’ time. This is confirmed by two large European companies, Volvo Cars and Borealis, that have calculated that over 20 percent of management time is taken up by the budget and reporting processes – a huge potential for savings in both time and cost.

Attempts to breach the budgeting barriers Criticizing the budgeting model is not difficult, nor is it new. Its weaknesses have been recognized for decades. Indeed they have been the subject of academic research and discussion for well over fifty years. Writers such as Mayo, McGregor, Maslow, and Herzberg have all argued in one form or another that superior performance is driven not by planning, controls and incentives, but by team working, self-esteem and personal development. And more recently, such writers as Johnson, Kaplan, Mintzberg, Schein, and Argyris have all argued that the budgeting model fails to support organizational change and empowerment. The days of the budgeting model are clearly numbered. So why has so little action been taken? Perhaps it is because planning and budgeting remains one of management’s cherished principles – something undesirable maybe, but essential to organizational life nevertheless. But more likely it is because managers have not yet discovered a better model, though many attempts at overcoming the weaknesses of budgeting have been tried. These include:

• Zero base budgeting (ZBB) – ZBB is an approach to budgeting that starts with a blank sheet of paper in regard to discretionary expenditure. It became popular in the 1970s and 80s and proved to be useful (usually one-off) exercise to review discretionary overheads. As these are a large and growing proportion of total costs in many firms, significant cost reductions and resource reallocations can often be achieved through ZBB. However, in practice, the process is so bureaucratic and time consuming that few companies use it more than once. Another problem is that ZBB is applied hierarchically by functional department, whereas the real opportunities for improvement are more likely to be found by reviewing costs by business process.

• Activity based budgeting (ABB) – ABB is activity-based costing in reverse. In other

words, it starts from estimating the demand for resources and works backwards to derive the activities and resources required to support that demand. ABB is undoubtedly a useful tool for helping managers identify and eliminate excess capacity. However, not unlike ZBB, it requires painstaking detail to apply it well and introduces undesirable rigidities around processes. While many companies have successfully used activity-based costing, few have extended the use of its principles into their budgeting processes.

• Faster, cheaper budgeting – Many progressive companies today are introducing rolling,

more frequent, and much streamlined planning and budgeting processes in an attempt to address the demands of a business environment that is rapidly changing. But this approach

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will not prove to be a long-term solution because, like ZBB and ABB, it does not address many of the fundamental weaknesses (e.g. poor strategic linkage) of the budgeting model. In fact it often creates more work (and cost) rather than less. As a Fortune Magazine article noted many years ago: “The value of an annualized budget depreciates fast. Simply revising it every few months may tighten the budgetary coils instead of releasing managers to act strategically”.8

• The balanced scorecard (BSC) – The BSC helps managers to focus more on the strategic planning process. Indeed by using the BSC to derive three-to-five-year plans, firms are able to overcome some of the weaknesses of the budgeting model. But all too often, the practical outcome of the BSC approach is a budgeting variant – that is a top-down target setting process that includes non-financial as well as financial measures and results in a fixed performance contract. Even in the best implementations of the BSC it is assumed that the first year of the strategic plan is held together by the budget. Nor is there any acknowledgement that much can go awry due to the behavioural dynamics driven by the budgeting process. However, by harnessing the power of the BSC within the framework of the BBRT model (by, for example, using it to support the devolution of strategy to front line managers), it can begin to reach its true potential. The BBRT model The BBRT model (named after the initial letters of the Beyond Budgeting Round Table) is designed to overcome these barriers and create a devolved and adaptive organization that gives local managers the self-confidence and freedom to think differently, to take fast decisions, and to feel comfortable about engaging in innovative projects with colleagues in multi-functional teams both across the company and outside the firm. Implementing the BBRT model, however, is not a simple matter of introducing new performance management processes. As figure 2 illustrates, there are twelve principles that will provide managers with a robust framework for implementing the new model. Principles 1 to 6 are concerned with creating a devolutionary framework. This involves both the design of the organization and the devolution of power and responsibility to people closer to the customer. Principles 7 to 12 are concerned with adaptive management processes. A key element is that goals, measures, and rewards are “disconnected”, that is, not tied together in a ‘fixed performance contract’.

1. Governance – Establish a framework for devolution by clarifying purpose, principles and values, don’t enforce central control through rules and procedures

2. Empowerment – Give people the freedom and capability to act, don’t control and constrain them

3. Accountability – Make people accountable for achieving competitive outcomes, not for meeting functional targets

4. Organization – Organize around a network of interdependent customer-oriented units, not a hierarchy of functions and departments

5. Coordination – Coordinate cross-company interactions through “market like” forces, not through central planning, budgeting and control

6. Leadership – Challenge and coach people, don’t command and control them

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The BBRT model 1.

Devolutionary framework

Adaptive management Figure 2 processes

7. Goal setting – Beat the competition, not the budget

8. Strategy process – Make strategy a continuous and inclusive process, not a top-down annual event

9. Anticipatory system – Use anticipatory systems to inform strategy, not make short-term corrections to ‘keep on track’

10. Resource utilization – Make resources available when required, don’t allocate them on the basis of annual budgets

11. Measurement and control – Provide fast, open information for multi-level control, not detail for micro-management

12. Motivation and rewards – Base rewards on company and unit-level competitive performance, not predetermined negotiated targets. The barrier breakers A number of companies have now broken through the budgeting barriers, though some are further down the path than others. Of the barrier breakers we have identified, fourteen have so far been the subject of visits and case studies by the Beyond Budgeting Round Table. Here are six examples:

• Svenska Handelsbanken – a Swedish universal bank that, since abandoning the budgeting model in the 1970s, has outperformed its Nordic rivals on just about every measure you can think of including return-on-equity, total shareholder return, earnings-per-share, cost-to-income ratio, and customer satisfaction. And it has done this consistently, year-in, year-out, for the past 30 years – a testament to the smooth performance sustainability of its radically devolved model. It is the most cost efficient bank in Europe and has recently been voted one of Europe’s best Internet banks.

• Borealis A/S – A Danish company that is at the leading edge of polymer research and development and is now Europe’s largest producer (sales of $2.5bn) and the fourth largest

1. Self governance framework 2. Empowered managers

3. Accountability for outcomes 4. Network organization

5. Market-like coordination 6. Supportive leadership

7. Relative targets 8. Adaptive strategies

9. Anticipatory systems 10. Resources on demand

11. Fast, distributed controls 12. Relative, team rewards

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worldwide. Since it implemented its devolved model (and abandoned budgeting) in 1995, Borealis has met its ambitious return-on-capital targets and reduced cost by 30% over 5 years.

• CarnaudMetalbox – an Anglo-French packaging company that under the leadership of Jean-Marie Descarpentries was transformed from a debt-laden company worth only $19m in 1982 to a market value of $3bn in 1989. By abandoning the budgeting model, adopting competitive (stretch) targets and a supporting rewards system, Descarpentries created a group of entrepreneurs who, during his period at the helm (1982-89), achieved a dramatic turnaround in the company’s value – described by Fortune Magazine as one of the best European corporate performances in the 1980s.

• Ahlsell – a Swedish wholesaler offering a complete range of heating, plumbing, refrigeration, and electrical products and services for installation contractors, municipalities and retailers. The budgeting model was abandoned in 1995 and a fast, open information system now provides the necessary controls for self-governance by local units. Ahlsell’s net sales in 1999 amounted to SEK 5,177 M ($550M), and it is now the sector’s most profitable company in heating and plumbing, and the second most profitable in electrical – a major turnaround from its position in the early 1990s.

• Bulmers – a British company with a clear leadership position (60% share) in the UK cider market. Following the adoption of a more devolved management approach in 1998 and adaptive management processes in late 1999, the early results have been impressive. The firm is growing revenue and profitability at a much higher rate than the industry average and there have been significant cost savings. In 2001 the company was ranked as one of the best firms to work for in Britain.

• The AES Corporation – a U.S. based global power company the despite being one of America’s “wonder” stocks of the 1990s (total shareholder return was top of the Fortune rankings in the Utility sector for 1999), AES places its values and principles above anything else, and has adopted a highly devolved management model. Other cases that have adopted some or all of the BBRT model include Swedish roller bearings company, SKF; UK retailer, Boots; Swedish car maker, Volvo; U.S. eye care company, Ciba Vision; and UK charity, Sight Savers International. A number of other firms have also made real progress. General Electric and BP-Amoco, for example, have adopted most of the BBRT philosophy and empowered front line managers to make strategic decisions within clear values and boundaries. In every BBRT case one or two people have had the courage to stand up and challenge conventional wisdom. Dr Jan Wallander at Handelsbanken is perhaps the outstanding candidate for chief barrier breaker. He is from that rarest of breeds (like another “JW”, Jack Welch) – a real visionary who could see that the way large organizations were being managed was fundamentally flawed. As a new generation of managers rose to the top versed less in physical than financial engineering, he could see that their focus on financial plans, budgets, and short-term results was disconnected from real people who did the work and dealt with the customer. A ‘spreadsheet culture’ became prevalent. He recognized that only by dismantling this culture together with its attendant bureaucracy and top-down controls, would front line managers be free from its ever-increasing burdens. Only then, he reasoned, would decisions be faster, fresh ideas come to the fore, costs be lowered, customers be satisfied, and finally that the financial results would take care of themselves. The bank’s shareholders have much to thank him for. They should also be thankful that

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Tore Browaldh (the bank’s Chairman at the time) had the courage and foresight to let Jan Wallander impose his radical ideas on their bank. Since taking charge 30 years ago, Dr Wallander has turned Handelsbanken into one of the world’s most successful banks. Take any measure you like including total shareholder return, earnings per share, profitability, customer satisfaction, and cost efficiency – Handelsbanken is in a league of its own – far surpassing its rivals in bad times as well as good. Since 1972, annual contributions to the group wide profit sharing fund have been based on achieving a greater than average return-on-capital than all its Nordic rivals, and it has never once missed this target. How did it achieve such a stunning and consistent performance? According to Dr Jan Wallander, the key was radical devolution supported by the dismantling of the budgeting model. Just think about it. This is a bank in which the branch employees are only three steps away from the chief executive. Branch staff know their customers and tailor solutions to meet their needs. There is no annual planning, budgeting or target setting process, and no financial incentives based on product sales or profits. The bank and its constituent parts are all continuously striving to improve their place in a series of performance league tables geared to key ratios such as return-on-equity, cost-to-income, and profit per employee. It is these league tables and their constituent measures, underpinned by intense peer pressure, that drive continuous improvement at all levels. Beating the competition rather than some negotiated budget goes to the heart of the Handelsbanken management model. The benefits are evident everywhere you look. Talented graduates want to join Handelsbanken more than any other financial services company not because it offers the highest salaries and benefits, but because young managers are expected to ‘run their own business’ within a radically decentralized structure. Employee turnover is extremely low reflecting high levels of satisfaction (redundancies are unknown). Costs are also the lowest in the industry (a cost-to-income ratio of 43% in 2000 compared with over 60% for most international banks). One reason is that costs are constantly challenged rather than protected by the budgeting system; another is that bad debts are exceptionally low, largely due to its policy of devolving credit responsibility to front line people. It is perhaps because branches ‘own’ their customers (no matter where transactions take place), make fast decisions, and provide customized solutions, that Handelsbanken has the lowest number of complaints in its sector and consistently tops the customer satisfaction charts in Sweden. Returns to shareholders have also been outstanding (25% compound total shareholder return over the last 18 years) given its position as a relatively small bank (at least in global terms) that has relied more on organic growth than acquisitions and mergers. Other Scandinavian companies eventually followed the lead set by Handelsbanken. IKEA, Volvo, Borealis, Fokus Bank and Ahlsell all listened to Jan Wallander and liked what they heard. Bjartes Bogsnes at Borealis, for example, questioned the need for months of planning and budgeting in a petrochemicals industry in which forecasting was no better than a lottery. But unlike others who might have had similar thoughts (but could see no way of defeating ingrained opinions), he took on the challenge and convinced his superiors that a new approach would bring significant benefits. He showed that these initiatives can be successfully driven by finance people, and dismissed the risks by saying that ‘people don’t forget how to do budgeting overnight’. After six years and a new CEO and CFO, it has not been necessary to reintroduce the budgeting system. Tjerge Svendsen at Fokus Bank and Gunnar Haglund at Ahlsell have also had the strength to challenge the status quo and introduce most of the BBRT principles.

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It was obvious from the outset that most of the pioneering work on developing the new model had been done in Scandinavia. Why Scandinavia? Perhaps it’s a closely-knit business community where imaginative ideas travel quickly. Perhaps it’s because companies are subject to high levels of uncertainty (many of them operate globally). Perhaps it’s because financial budgeting conflicts with the notion of intellectual capital – an idea that also had its genesis in Scandinavia. Or perhaps Scandinavian companies are fortunate in having a predominance of well-educated people with the self-confidence to accept the high-levels of responsibility demanded by the new model. Whatever the answer, we are sure it is not some peculiar cultural phenomenon. Much the same questions were asked about Japanese quality in the early 1980s and Scandinavian knowledge management in the early 1990s. Besides, we have seen evidence in many other countries of the new model working effectively. The beyond budgeting action, however, was not confined to Scandinavia. Leaders elsewhere were also challenging the traditional model. Dennis Bakke and Roger Sant at U.S. electric utility, AES Corporation, had similar convictions. They also believed in radical devolution and instilled its principles within the company from its inception. That it has prospered (defying its critics) in the white heat of the U.S. stock market is testament to their vision and to the staying power of their management beliefs. Meanwhile in France, another charismatic character, Jean-Marie Descarpentries, was applying similar principles, first at Carnaud Metal Box, and then at Groupe Bull – both basket cases before he took over. Again using what we now call BBRT principles, he transformed both organizations only to see much of his work undone after he left. Many new heroes are being created through the Beyond Budgeting Round Table. Lesley Jackson at Bulmers has been instrumental in abandoning the ‘managing through numbers’ culture that had infected the company for years. After several internal workshops it became quickly apparent that few operating people took any notice of the plans and budgets so carefully crafted over many months. The impact on the finance team was amazing. They vowed never to do another budget and were prepared to stand together against the board that, for a short time at least, were taken aback by their approach. Fortunately, the Ceo who had only recently joined the company was of a like mind and was prepared to support the initiative. Other barrier breakers include Mark Doyle at UK drinks company, UDV-Guinness, and Adrian Poffley at UK charity, Sight Savers International. Many other BBRT members are just beginning their journeys. Achieving sustained success through the BBRT model. There are many economic factors causing firms to rethink their strategies, structures and management processes. These include globalization, advanced technology and, of course, the Internet. We have selected six critical success factors that arise from the changing environment: fast response, best people, continuous innovation, operational excellence, customer intimacy, and shareholder value. The list is, of course, not exhaustive, For example, the ability to form partnerships and outsource processes will be key success factors for many firms. “E” business capabilities do not feature as these are built into every success factor. Managing knowledge is also a critical element of every success factor. But the common (and most critical) factor is that to achieve these success factors means that firms must migrate to a devolved and adaptive organization. The link between the BBRT model and each of the six success factors is explained below.

1. The BBRT model enables firms to respond faster and thus cope better with rising uncertainty. In the days when competitor actions were, by and large, predictable and suppliers held sway over customers, firms could plan, make and schedule their activities to

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optimize the efficiency of their internal processes. But in less than a few decades such practices have been rendered ineffective as uncertainty has risen, firms cannot predict where competitors will next spring from and what business concepts they will use, and customer choice has extended beyond the imagination of industrial age managers. Such discontinuous change is wreaking havoc with traditional notions of planning and budgeting. Firms must learn to respond faster to changing conditions. This means making strategy an adaptive process, placing local managers in charge of strategy, enabling them to monitor it continuously rather than once a year. And if new initiatives are needed, they must have fast access to resources. The attitude to change is also important. BBRT companies see change as an opportunity rather than a threat. They constantly probe for signs of impending change and pre-empt what competitors might do and what customers might need. They prepare rolling forecasts that support strategy reviews and investment decisions (being careful not to distort the forecasting process by allowing senior managers to influence the outcome). And they have up-to-the-minute information about customers, costs, profits, market changes, and a host of other relevant knowledge essential for rapid response and good decisions.

2. The BBRT model helps firms find and keep the best people. As a 1998 McKinsey report entitled “The War for Talent” points out, big companies are finding it difficult to attract and retain good people.9 The top three reasons why managers chose one firm over another were “values and culture” (58%), “freedom and autonomy” (56%) and “exciting challenge” (51%)10. Thus offering a challenging environment is crucial to engaging and keeping the right people, but the budgeting model with its overarching bureaucracy, head office memos and directives, and its detailed rules and procedures, is a barrier to creating such an environment. BBRT companies structure their businesses to cope with the needs of talented people. For example, they create as many small profit centres as possible thus providing opportunities for their key people to ‘run their own business’ and engage in the strategy and innovation processes. Leaders also have an important role to play. Instead of spending time on planning and controlling the business, leaders in BBRT companies spend time with their people. Whether it be visiting the front line troops, reinforcing the company’s values and principles, or challenging their ambitions and strategies, leaders in BBRT companies are always championing the merits of the model. They also ensure that people share in the fruits of success. With an emphasis on groups rather than individuals, they enforce the ‘one-team’ message so critical to effective sharing and team working.

3. The BBRT model supports continuous innovation. Product and strategy life cycles are shrinking rapidly as new product ideas are quickly copied and firms are increasingly prepared to cannibalize existing products so that they can be first to market with new ones. It is increasingly clear that firms can no longer plan and control their way to the future in incremental steps. They must innovate to survive. They must learn to think differently. This means releasing the drive and creativity of their people to develop imaginative strategies, new business models, and more relevant management practices. Bloated bureaucracies and budgetary controls are the enemies of insight and innovation. They stifle creativity through a rigid system of budgetary controls that reward good housekeeping but fail to acknowledge creativity or innovation. And they fail to provide the right management climate within which creative people can thrive. Beyond budgeting leaders think and act more as venture capitalists, encouraging new ideas and new businesses, and providing the necessary resources. Managers foster insight and innovation by sharing knowledge across networks. And they know that they will only get their people to ‘stretch’ performance if they gain their emotional commitment and this means working for some higher purpose than just for money.

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4. The BBRT model leads to operational excellence. For decades firms have been able to pass on their internal cost increases to their customers. But this is no longer the case as technology and global markets are being used by enterprising firms to offer radically different (and usually cheaper) ways of delivering customer value. The downward pressure on prices and margins has never been so intense and enduring. Flattening management layers and reengineering processes have typified the approaches that companies have taken to solving these problems but most of their efforts have ended in disappointment. The problem is that the hierarchy is not wired for low cost or speed; it is wired for control, and budgeting systems are its traffic lights. BBRT companies operate with lower costs. They align products, processes, projects, and cost structures with their strategy. They also avoid fixing their capacity too far in advance. They collaborate with partners (both internal and external) to share resources and manage the ebbs and flows of customer demand by using integrated information systems. But, perhaps more importantly, people in BBRT companies challenge costs. They don’t use the budget to protect costs or see them as an entitlement. As Sven Grevelius, EVP Finance at Swedish bank, Handelsbanken, notes, challenging costs is fundamental to the Handelsbanken philosophy.

Why do we have lower costs than other banks? It’s not so easy to be specific, but there are a number of issues that spring to mind. First, we have few people at head office controlling the business. Secondly, and related to the first point, people in the regions and branches are self-sufficient. They run their own part of the business without much help from above and because they are measured on their competitive results instead of some negotiated budget, they are much more concerned about costs. Even branch secretaries query expenses if they look out of line. The group profit sharing scheme has much to do with this attitude of weeding out unwarranted expenses and improving profits. Thirdly, we have lower credit losses. This is related to the second point. Because we give responsibility to many front line people they feel that they own their decisions and take more interest in basing them on good information. Fourthly, we don’t simply allocate central costs to regions and branches. We expose these services to the pressure of negotiation. If branches feel they don’t want certain services or that they are paying too much, they will let their feeling be known in no uncertain way. Finally, we use technology to reduce costs where possible. Our Internet banking services have been very successful, but we are careful to ensure that all Internet transactions end up at the branch that owns the customer. Devolving responsibility for results, turning cost centres into profit centres, squeezing central costs, using technology, and, most importantly, eradicating the budgeting ‘cost entitlement’ mentality, are just some of the actions we have taken to place costs under continuous pressure.

5. The BBRT model leads to finding and keeping the right customers. As we travel further

into the information age, customers are presented with more choice (often at the click of a mouse) and more information on which to base those choices. Consequently, customer churn is increasing. Reichheld notes that on average, the CEO’s of US corporations lose half their customers every five years11. Firms need to know their customers (and non customers) and identify and target the ‘right’ ones. They need to know how to satisfy them (their value needs) and how to maximize profitability from them. Finding the ‘right’ customers, however, is not often included on the agenda of most sales planning meetings. Most sales budgets are constructed and monitored on the basis that customers are segmented by product group, size or lifestyle, or some other grouping that reflects ‘inside-out’ thinking or ways of selling products or services through segments and channels. They don’t segment customers by their value needs. BBRT companies, however, place customer value needs at the centre of strategy. Clarifying customer ownership is crucial. Handelsbanken lays great emphasis on customers being attached to one branch no matter where their transactions take place. Multiple responsibilities caused by internal boundary disputes are destined to drive customers to the competition. Satisfying customers also means responding quickly and effectively to their needs. Thus front line people need to be

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empowered to make decisions at the point of contact with the customer, and to fix problems as and when they arise. BBRT companies also recognize the importance of satisfying customer needs profitably. Knowing customer profitability is important to the success of a devolved management model. It makes people conscious of the resources being used and the costs of those resources. It also makes them aware of which customers add value and which destroy value and whether or not the benefits of customization outweigh the costs.

6. The BBRT model leads to more consistent shareholder value creation As fund managers compete vigorously to head the performance league tables for economic value and shareholder returns, and increasing numbers of ‘day-traders’ play the market, there is little doubt that investor loyalty is becoming more fragile and their requirements more demanding. The reaction of many companies is to eke out more cost savings to support quarterly profits, but the real results are invariably fewer good people doing more work and working longer hours. And with tougher targets to meet, the pressure is intensifying. Downsizing, layoffs, short-term contracts and higher productivity demands have all exacted their toll leaving many workers frazzled and on the verge of a nervous breakdown. Creating consistent value streams is the objective of BBRT companies. Placing managers in control of their actions and using a few simple measures based on key value drivers and geared to beating the competition is as much as is required in most cases. The evidence so far is that BBRT companies that have adopted competitive measures have experienced a smoother growth path. Firms such as Handelsbanken, AES, and GE have all delighted shareholders with their consistent delivery of increasing returns. Handelsbanken has beaten the average return-on-capital in its sector every year for 28 years. None of this is rocket science. All banks have access to the same resources as Handelsbanken – the difference must lie in its concept of business – especially the way it manages its people and its costs. This has much to do with devolving responsibility for results to front line managers. Less direction from the centre and more from people in touch with the market is the clear lesson to be learned. The role of tools and techniques The 1990s has been the decade of the management model, tool, and technique. From quality management and reengineering to the balanced scorecard and activity-based management, these tools and techniques have been used by many corporations in their attempts to deal with a range of problems from inadequate accounting systems to inflexible management structures. But most have failed the test of time as external and internal champions move on and other problems arise that take priority over scarce resources. However, many of these tools are extremely useful if carefully selected and implemented in the right way. Six popular management tools and techniques (i.e. enterprise wide management information systems, the balanced scorecard, shareholder value models, activity-based management, rolling forecasts, and benchmarking), are particularly relevant to the BBRT model. • Enterprise-wide management information systems – Effective implementation of the

BBRT principles will be impossible without the effective use of information technology. The IT system should be derived from and thus support business strategy and not be left in the hands of IT specialists. Strategic enterprise management systems will be increasingly useful to the BBRT manager, but they must be flexible enough not to constrain the business.

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• Balanced scorecard (BSC) – The BSC will be an increasingly important tool in the BBRT model. If well implemented, the BSC provides a solid strategy framework within which management teams at all levels can operate. It provides strong alignment between targets, strategy, measures and rewards, provided it is not used as an immutable fixed plan. But the BSC should be used to support local managers in their efforts to improve strategy rather than be used as a tool of top-down control (akin to a budget with non-financial targets and measures).

• Shareholder value models – Economic value-added (EVATM) and value-based

management (VBM) models can help BBRT managers take decisions that are aligned with shareholder value and that don’t need prior approval from a higher authority. They can also be used as target guidelines and thus help to drive innovative strategies. However, as with the BSC, they must support rather than undermine the efforts of local managers.

• Activity-based management (ABM) – ABM is a vital tool for enabling empowerment

of front line units through the measurement of their customer profitability, and benchmarking of support services through the measurement of activity and process costs. In addition, ABM is a useful tool for capacity planning and improvement for the beyond budgeting manager. Not only should managers be asking whether or not a particular process (or activity) can be improved but is it worth doing at all? Challenging people to think imaginatively about step changes in their business units often involves more than continuous improvement.

• Rolling forecasts. In the traditional company, forecasts are aimed at helping managers

to focus on meeting the current year’s budget. They have no other strategic purpose. They are, more often than not, no more than a recompilation of the budget and lead to managers taking appropriate actions that enable them to meet their agreed targets. In BBRT companies, rolling forecasts have a different purpose. They principally help managers to break away from the annual budgeting cycle and take decisions based on a moving picture of information concerning the likely outcome of existing trends. This supports the devolved management process by placing front line people more in control of their actions than would otherwise be the case. The important issue is that forecasts are separated from the line management system.

• Benchmarking. While benchmarking is still in its infancy in many firms, its use is, by

and large, limited to quality or process improvement. In the BBRT model, however, benchmarking becomes even more important as success at every level is measured against peers either internally (e.g. branch to branch) or externally (e.g. company to company). Performance league tables are the result and it is these that drive the continuous improvement process. These point companies toward the management processes that need improvement and trigger a more detailed benchmarking exercise.

Implementing the new model What is clear from the cases we have studied is that successful implementation of the BBRT model can only be assured if the budgeting problem is dealt with correctly. Building the model, which is fundamentally a major cultural shift towards devolution, is driven by the business need for greater responsiveness and enterprise. Freed of the budgeting system that

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would otherwise pull the company back towards command, compliance and control, the company can build its new management model more quickly and realize its benefits fully. Dismantling the budgeting process is a radical step in any company and not everyone will be comfortable with the changes. Success depends on obtaining “buy-in” from influential people across the organization and (crucially) from top management. In common with any other major change program, the full fruits of adopting the BBRT model take time to emerge. However, there are some “quick wins”. For example, some companies have found that huge amounts of time can be saved (several believe that they have saved 15% - 20% of the time of their entire management team). Others report significant cost reductions by, for example, not paying overtime for staff to complete budgets as well as their other work and from finance staff not working 14-hour days through the budget period. Complex reports that take many man-days to complete suddenly become irrelevant (in fact, no one will own up to why they were prepared in the first place!). The longer-term benefits of more radical thinking, faster decision-making, and the acceptance of more responsibility at the front line depend on a number of factors such as senior managers “walking the talk” of the new management model and thus building confidence at all levels. In all the cases we examined there was a gradual process of devolution. Typically decisions concerning capital investments, improvement projects, strategic initiatives, and effective process changes, were all taken in incremental steps, and were accompanied by extensive support and education programs that provided the tools needed to do the job effectively. Conclusions Devolving accountability for results and replacing plans and budgets with more adaptive performance management processes will provide senior executives with: • An organization that is more responsive to change and better able to deal with increasing levels of uncertainty.

• An organization that is more attractive to talented managers and potential strategic partners

• A far better climate for generating breakthrough strategies aimed at improvement and growth

• A lower cost organization

• An organization that finds and keeps the right customers

• An organization that creates sustained increases in shareholder wealth.

If firms want their front line managers to be more responsive to market demands and be accountable for their actions, then budgets provide the wrong performance drivers and control systems and must be replaced by management processes and steering mechanisms that support a culture of responsibility and enterprise. The BBRT model is the way forward.

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References __________________________________ 1 Russ Banham Revolution in Planning CFO Magazine, August 1999 2 Cathy Lazere Altogether Now CFO Magazine February 1998, p29 3 “Corporate Strategic Planning Suffers from Inefficiencies” Hackett Benchmarking PR Newswire, 25 October 1999

4 Robert S. Kaplan and David P. Norton The Strategy Focused Organization Harvard Business School Press, 2001, p274 5 Robert S. Kaplan and David P. Norton The Strategy Focused Organization Harvard Business School Press, 2001, p274 6 New Math for a New Economy Alan M. Webber Fast Company, January – February 2000, p215 7 Hackett Benchmarking Solutions http://www.thgi.com/pprfax.htm 8 Thomas A. Stewart Why Budgets are Bad for Business Fortune Magazine, June 4, 1990, p115 9 Chambers Elizabeth G, Mark Foulon, Helene Handfield-Jones, Steven M. Hankin, and Edward G Michaels III The War for Talent McKinsey Quarterly 1998,3,45 10 Chambers Elizabeth G, Mark Foulon, Helen Handfield-Jones, Steven M. Hankin, and Edward G Michaels III The War for Talent McKinsey Quarterly 1998,3 11 Frederick F. Reichheld: Learning from Customer Defections Harvard Business Review March – April 1996, p56

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Acknowledgements CAM-I Inc is a not-for-profit international research consortium that undertakes management and technical research into issues of common interest to a number of companies that pool their resources to find practical solutions. In the late 1980s for example CAM-I led the development of Activity Based Costing (ABC) and is today the leading forum for cost management in the USA. The companies that have supported the Beyond Budgeting Round Table (BBRT) project since its inception in 1998 are: ABB ABC Technologies ACCO Europe Accenture Alstom Energy Anheuser Busch Armstrong-Laing Arthur Andersen Ascom Barclays Bank Bass Brewers BG Transco Boots the Chemists Burmah Castrol Cadbury Schweppes Chartered Institute of Management Accountants (CIMA) De Beers Deutsche Bank

DHL Diageo – UDV ENiklas Ernst & Young European Bank (EBRD) Halifax Hammond Suddards Housing Associations Interbrew Kingfisher KPMG Consulting HP Bulmer Mars Confectionery National Power Navigant Consulting Novartis Parker Hannifin Pentland Group Port of Tyne Authority

PricewaterhouseCoopers proDacapo Royal Mail Rugby Group Sainsburys Siemens Sight Savers International SKF Southco Standard Life TNT Texas Instruments Thames Water UBS United Engineering Forgings Valmet Corporation (Metso) Van den Bergh Foods West Bromwich Building Society

The academic advisers to the project are Professor Michael Bromwich (London School of Economics), Professor Michel Lebas (Group HEC, France), and Professor David Otley, Lancaster Business School. The research leaders are Jeremy Hope, co-author of Competing in the Third Wave and Transforming the Bottom Line, and Robin Fraser, management consultant, formerly a partner with Coopers & Lybrand, now PricewaterhouseCoopers. We would like to thank all those people who have participated and supported the BBRT since it started life in 1998. These include all participating companies and their representatives and all those we visited at “benchmark” companies. Further information on the BBRT 2001 project may be obtained from: Dr Peter Bunce CAM-I Europe 20 Market Street, Poole Dorset BH15 1NF, UK

Tel: +44 1202 670717 Fax: +44 1202 680 698 Email: peter@cam-i.demon.co.uk

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CAM-I

CAM-I Inc. – Europe 20 Market Street, Poole

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Tel: +44(0) 1202 670717 Fax: +44(0) 1202 680 698

CAM-I Inc. Europe – USA 3301 Airport Freeway, Suite 324

Bedford, Texas 76021, USA

Tel: +1 817 860 1654 Fax: +1 817 275 6450

Web site: www.bbrt.org

©2001 CAM-I, All Right Reserved

No part of this publication may be reproduced or transmitted in any form or by any means without permission in writing from the copyright owners, unless by members

of the Beyond Budgeting Round Table reproducing it for internal use within their companies.