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Learning Byte 160

"There are four things that hold back human progress; ignorance,
stupidity, committees and accountants." Anon

"Acquaintance; a person whom we know well enough to borrow


from but not well enough to lend to." Ambroce Bierce

About Beyond Budgeting - The


Budgeting Problem
“Budgeting is the bane of corporate America” – Jack Welch, ex CEO, General
Electric

A number of organizations have recognized the damage done by budgeting and rejected the
reliance on obsolete data and fixed plans. Organizations that have gone beyond budgeting
represent widely differing industries and vary in size. They have all found that their
performance has improved once the budgeting process was abandoned in favour of more
relative and adaptive means of planning, evaluating performance and control. They report
saving considerable amounts of time that used to be spent on budgeting.

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Here are 10 reasons why budgets cause problems:
1. Budgets are time consuming and expensive. Despite the advent of powerful
computer networks and multi-layered models, budgeting remains protracted and
expensive. The average time consumed in large companies is between four and five
months. It also involves many people and absorbs up to 20 to 30 percent of senior
executives' and financial managers' time. Ford Motor Company figured out this
amounted to $1.2 billion per annum.

2. Budgets provide poor value to users. The perception of the value provided by
the budgeting process varies widely. In one firm it was apparent that the group
board thought the budget gave them control, whereas operating managers thought it
was completely irrelevant to their needs. One of the primary reasons that financial
directors rank budgetary reform as their highest priority is that their staffs spend too
little of their time adding value. One conclusion from a 1999 global best practices
study was that finance staff spent 79 percent of their time on "lower value-added
activities" and only 21 percent of their time analyzing the numbers.

3. Budgets fail to focus on shareholder value. Budgets focus on internally


negotiated targets which tend to be incremental changes from the previous period's
outcomes. The result is a target that is inwardly comfortable to you, yet appears
outwardly difficult to your superior. There is no focus on the maximization of
customer or shareholder value.

4. Budgets are too rigid and prevent fast response. The evidence suggests that
only 20 percent of firms change their budgets within the fiscal cycle. Another survey
result shows that 85 percent of management teams spend less than one hour per
month discussing strategy

5. Budgets protect rather than reduce costs. "Use it or lose it" is the manager's
mantra. Not spending the budget is a cardinal sin in most organizations. The result is
that superiors invariably question why the resource is needed and are understandably
reluctant to allow it to pass into the budget for the next period

6. Budgets stifle product and strategy innovation. "Never take risks." It is just not
worth it. If it's not in the budget, you might be exposed. Anyhow, if you did take a

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risk and it worked out well, your superior probably thought of it first! And if it didn't
work out, your job might be on the line.

7. Budgets focus on sales targets rather than customer satisfaction. Though


everyone wants to satisfy customers, that is not how they are measured and
rewarded. So they meet the sales target, persuade customers to buy their products
and convince them that their slow-moving stock really is a great deal!

8. Budgets are divorced from strategy. According to a recent cover article in


Fortune magazine, around 70 percent of companies surveyed were poor at executing
strategy - a massive indictment of the performance management capabilities of
budgets.

9. Budgets reinforce a dependency culture. The way to survive and prosper in a


budgeting environment is to do what you're told, meet the budget (but never beat
it!).

10. Budgets lead to unethical behaviour. Managing the results (also known as
cooking the books) is a frequent outcome of budgeting. Many finance managers are
well versed in "managing the slack" and feeding it into the results when needed.
However, as we have seen, this practice can border on outright fraud.

From fixed budgets to adaptive processes and


From centralized hierarchies to devolved networks

Compared with the traditional management model, beyond budgeting has two fundamental
differences. First, it is a more adaptive way of managing. In place of fixed annual plans
and budgets that tie managers to predetermined actions, targets are reviewed regularly and
based on stretch goals linked to performance against world-class benchmarks, peers,
competitors, prior periods and strategic goals.

Second, the "beyond budgeting" model enables a more decentralized way of


managing. In place of the traditional hierarchy and centralized leadership, it enables
decision-making and performance accountability to be devolved to line managers and creates
a self-managed working environment and a culture of personal accountability. This leads to
increased motivation, higher productivity and better customer service.

Individually these two main features can produce significant benefits, but in combination they
can meet a leadership vision that has, up until now, been strong on vision but weak on
delivery. Because it is a coherent model in which all of its components work in harmony, it
can produce outstanding and sustained success.

This success is driven by four direct value drivers: innovative strategies, low costs,
loyal and profitable customers and ethical reporting.

However, these drivers will be ineffective unless front line people have the scope,
knowledge and are enabled to deliver. The result is an organization that is lean,
adaptive and ethical and that has the potential to remain at the top of its peer
group league table.

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“ … too often we have fixed targets and fixed plans. They no longer make sense. Beyond
budgeting is a provoking alternative we should take seriously” - Charles T. Horngren,
Littlefield Professor of Accounting, Emeritus, Stanford University

“Stretching allows people to constantly reach for the goal. And people are getting more
and more comfortable with the idea that you can get the best out of people not by fighting
budgets, which are all about minimal numbers, but by getting people to do the best they
can, and measuring their progress toward it – against last year, against what competitors
are doing. We’re in the process of enriching our organization through the stretch concept.
Operating margins are 50 percent higher than they were for the first one hundred and
eight years of our company, and in a tougher global environment” – Jack Welch, CEO,
General Electric

About Beyond Budgeting - The Principles


There are two sets of six principles that govern the Beyond Budgeting Model. One set relates
to adaptive management processes and the other set to a devolved organization.

Process-based Principles
The six principles of managing with adaptive processes are as follows:

1. Base goals on maximizing performance potential

2. Base evaluation and rewards on relative improvement contracts with hindsight.

3. Make action planning a continuous and inclusive process.

4. Make resources available as required.

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5. Coordinate cross-company actions according to prevailing customer demand.

6. Base controls on effective governance and on a range of relative performance


indicators.

The results of applying these principles include setting aspirational goals, reducing
gaming, encouraging ambitious strategies and fast response, reducing waste, improving
customer service, and promoting learning and ethical behaviour.

Devolution-based Principles
There are six principles that leaders should adopt:

1. Provide a governance framework based on clear principles and boundaries.

2. Create a high-performance climate based on relative success.

3. Give people freedom to make local decisions that are consistent with governance
principles and the organization's goals.

4. Place the responsibility for value creating decisions on front line teams.

5. Make people accountable for customer outcomes.

6. Support open and ethical information systems that provide "one truth" throughout the
organization.

The effects of these principles include: a clear governance framework leads to the
acceptance of local decision making by front-line teams throughout the organization; a high-
performance climate leads to sustained competitive success; the freedom to decide fosters
innovation and responsiveness; team-based responsibility results in a greater focus on
creating value and reducing waste; customer accountability builds more commitment to
satisfying customers profitably; and finally, an information culture based on openness and
"one truth" promotes ethical behaviour.

FURTHER READING

1. Who needs budgets? Jeremy Hope & Robin Fraser, Harvard Business Review, Feb
2003, pp 108 – 115
2. www.bbrt.com
3. Check out the BBRT Benchmarking diagnostic at http://www.beyondbudgeting.org/
and take the "Free Taster". This will help you benchmark your existing performance
management approach against the Beyond Budgeting model and help you make the case
for change.

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4. Beyond Budgeting, How Managers can break free from the annual
performance trap. Jeremy Hope & Robin Fraser, Harvard Business Press

Business Sculptors’ Comments

YET ANOTHER PARADIGM SHIFT!

A Paradigm is a mindset that acts as a filter through which we see and find
solutions to problems. Paradigms are very useful for rapidly finding solutions within
our mental models, but sometimes they prevent us seeing new solutions from a
different paradigm. The budgeting filter prevents us from seeing another way of
managing the problem of performance and allocation of resources in an uncertain
world.

In all likelihood, most people will resist a paradigm shift. Think of a Paradigm Shift
as a change from one way of thinking to another. It's a transformation, a sort of
metamorphosis. It does not just happen, but rather it is driven by agents of change
or, for paradigm shifters, the shift is an epiphany. Are you a change agent?”

Many of the principles of Beyond Budgeting are based on the reality of the complex and
systemic nature of business. Beyond Budgeting releases companies from many of the
negative and constraining aspects of modern business that are based on the illusion of
predictability and control.

ˆ “Uncertainty – in the economy, society, politics has become so great as to render futile, if not
counterproductive, the kind of planning most companies still practice: forecasting based on
probabilities” – Peter Drucker

ˆ “It is universally apparent that we are living in a world so complex and so uncertain that
authoritarian, control-oriented companies are bound to fail” – Gary Hamel

This does not mean that Beyond Budgeting is irresponsible. On the contrary, Beyond
Budgeting is also based on the concept of enterprise governance, which is a combination
conformance with a number of the principles of ethical and responsible stewardship of
the assists of the business, while also focusing on excellent corporate performance.

ˆ "The process of management is not about administering fixed budgets, it is about the dynamic
allocation of resources” – Lord Browne, CEO, BP

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This means its goal is both value preservation and value creation. A number of
organisations have decided to “bin the budget”, e.g. Leyland Trucks; Svenska
Handelsbanken; Ahlsell, a Swedish wholesaler & Carnaud Metal Box.

ˆ “My advice is to stop budgeting at once and start to think about your problems afresh. That is the
only way to really wipe the blackboard clean and get better and more informative figures on it. You
should brace yourself and kill the budget dragon with one blow” - Dr Jan Wallander, Honorary
Chairman, Svenska Handelsbanken

Are you ready to bin the budget?

Roger Stewart
February 2004

Note: Most of the on the previous pages come from the BBRT website and
related publications.

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