BEYOND BUDGETING in an International Manufacturing Company

PIERRE PALUDGNACH WRITTEN AND PRESENTED: MAY 2002 MODIFIED: NOVEMBER 2003

TABLE OF CONTENTS

2 2.1 2.2 2.3 2.4 3

INTRODUCTION ....................................................................................................................... 9 BACKGROUND COMPANY ORGANISATION IN THE THIRD WAVE.................................................. 9 PROBLEM ...................................................................................................................................... 12 OBJECTIVES .................................................................................................................................. 12 RESEARCH METHOD ..................................................................................................................... 13 PART I THE THEORY OF BEYOND BUDGETING........................................................ 14 3.1 BEYOND BUDGETING - DEFINITION .............................................................................................. 14 3.2 DRIVING ASSUMPTIONS - CASE SCENARIO................................................................................... 14 3.3 TEN REASONS TO REPLACE THE BUDGETING SYSTEM .................................................................. 16 3.3.1 Budget and Command-and-Control Management............................................................ 17 3.3.2 Budgets and Financial Incentives ....................................................................................... 17 3.3.3 Budget Rhythm and Business Rhythm ................................................................................. 18 3.3.4 Budget Focuses on Financial Outputs ................................................................................ 18 3.3.5 Budget gets the lowest of the People ................................................................................... 18 3.3.6 Budget encourages incremental Thinking ........................................................................... 19 3.3.7 Budgets fails to challenge Managers .................................................................................. 19 3.3.8 Costs of the Budget.............................................................................................................. 20 3.3.9 Budgets and Strategy........................................................................................................... 20 3.3.10 Budget fails to do its Job ..................................................................................................... 21 3.4 PRINCIPLES OF SUCCESS IN THE INFORMATION AGE ..................................................................... 21 3.5 INEFFECTIVE SOLUTIONS TO IMPROVE BUDGETING ...................................................................... 23 3.5.1 Decentralisation .................................................................................................................. 24 3.5.2 Better Budgeting is not the Answer ..................................................................................... 24 3.5.3 Improving Resource Management only goes so far ............................................................ 24 3.6 BEYOND BUDGETING CASES ........................................................................................................ 25 3.6.1 What organisations have adopted Beyond Budgeting ......................................................... 25 3.6.2 Beyond Budgeting leads to better Performance .................................................................. 25 3.6.3 Successful Budgeting Organisations ............................................................................... 26 3.7 BEYOND BUDGETING PRINCIPLES ................................................................................................ 27 3.7.1 How Diageo and Ericsson got involved .............................................................................. 27 3.7.2 The 12 Beyond Budgeting Principles .................................................................................. 28 3.8 IMPLEMENTATION ........................................................................................................................ 32 3.8.1 Implementation Getting started........................................................................................ 32 3.8.2 Implementation Phased Approach ................................................................................... 32 3.8.3 Coping with Analysts without budgets ................................................................................ 33 3.9 LIMITATIONS, TOOLS AND WARNINGS ......................................................................................... 34 3.9.1 Different Countries and Cultures ........................................................................................ 34 3.9.2 Different Industries.............................................................................................................. 35 3.9.3 The Public and non-profit Sectors....................................................................................... 36 3.9.4 Governance ......................................................................................................................... 37 3.9.5 Economic Value Added ....................................................................................................... 37

3.9.6 3.9.7 3.9.8 3.9.9 3.9.10 4

Balanced Scorecard ............................................................................................................ 37 Activity-based Management ................................................................................................ 38 Rolling Forecasts ................................................................................................................ 38 Information Systems ............................................................................................................ 39 Warnings ............................................................................................................................. 41

PART II THEORY INTO PRACTICE THE CASE OF KONE OYJ ........................... 42 4.1 COMPANY PRESENTATION ............................................................................................................ 42 4.1.1 History................................................................................................................................. 44 4.1.2 KONE Organisation ............................................................................................................ 44 4.2 KONES ACTUAL SITUATION ....................................................................................................... 46 4.2.1 The Capla the forecasts and strategic planning, input for the budget.............................. 46 4.2.2 KONE Capla compared with Beyond Budgeting Rolling Forecasts ................................... 48 4.2.3 The Case for Change........................................................................................................... 49 4.3 IMPLEMENTATION ........................................................................................................................ 51 4.3.1 Phase 1 The Vision of the New Management Model........................................................ 51 4.3.2 Phase 2 Design and Implementing Systems The 10 Organisational and Behavioural Changes ....................................................................................................................................... 53 4.3.3 Phase 3 Progressive Devolution...................................................................................... 64

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CONCLUSIONS ........................................................................................................................ 66 BIBLIOGRAPHY...................................................................................................................... 69 APPENDIX 1: THE CASE FOR CHANGE............................................................................ 72

INTRODUCTION
This Thesis is divided in two parts, the first one argues about the theory of beyond budgeting, while the second part will apply the theory in the case of KONE OYj, the Finnish elevator and escalator manufacturer and service provider. The PART I THE THEORY OF BEYOND BUDGETING - will start with background information about the changing environment and how it has affected company organisational structures. Later, ten good reasons to abandon budgeting will be followed by the existing alternatives. Then the 12 best practices to succeed in beyond budgeting will be reviewed. The limitations will close the chapter. The PART II THEORY INTO PRACTICE THE CASE OF KONE OYj will start with a brief introduction of KONE, its history, its actual organisational structure and its actual budgeting process. Then KONE will be compared with companies that joined beyond budgeting based on the on-line questionnaire A Case for Change. Then the 10 necessary structural changes to gain competitive advantage through beyond budgeting will be discussed in three phases: the vision, the design and the progressive devolution.

1.1 BACKGROUND COMPANY ORGANISATION IN THE THIRD WAVE

Much has already been written about how traditional management accounting fails to support hard-pressed managers in todays highly competitive world. But simply adopting new techniques such as activity-based costing and the balanced scorecard will not bring the expected benefits if they do not fit well with the chose management structure and style [HOPE & FRASER, Management Accounting, Dec 1997]. Accounting systems invariably mirror the existing management structure and, as this structure evolves, so should the accounting model. The problem is that firms try to adopt more flexible and responsive management approaches to focus on the customer, they often fail to support these changes by adapting the old accounting system that were designed for a different competitive era. Indeed, according to Hope and Fraser, many of these firms are finding (often too late) that the second wave economic model that stressed volume, scale and the recovery of fixed costs, doesnt sit well in the competitive climate of the third wave where innovation, service, quality, speed and knowledge sharing are the defining factors.

1.2 PROBLEM
The underlying philosophy of the N-form organisational model is one of maximising value rather than minimising costs, and the focus of measurement systems is on strategic performance, value-adding processes and knowledge management. But most important of all, it is a model based on trust between managers, customers, employees and partners. And as many firms have discovered, this trust can be easily undermined when managers (typically when the going gets tough) are quickly driven back to managing by numbers a path that invariably leads to arbitrary cost reductions, declining morale and falling profits. Whether they recognise it or not, many firms have already adopted many elements of the N-form model. TQM, BRP, decentralisation, process-based approach, empowerment, economic value added and the balanced scorecard are all important factors in succeeding in the N-form model. Many companies invested heavily towards the N-form, often without reaching the success they expected. The failures are, more often than not, put down to poor communication or lack of top management commitment, but the real culprit is likely to be hidden within the accounting system itself [HOPE & FRASER, Management Accounting, Dec 1997]. Many well planned changes and many attempts to shift the culture from one of compliance and control to enterprise and learning have foundered when management behaviour have been snapped back into old shape by the invisible power of the budgeting system.

1.3 OBJECTIVES
Jack Welsh, former CEO of General Electric, called the budgeting exercise the bane of corporate America. Bob Lutz, former vice-chairman of Chrysler, saw it as a tool for repression. And Jan Wallander, former chief executive of Svenska Handelsbanken, the Swedish Bank, called it an unnecessary evil. An increasing number of companies recognise that the budgeting system is perhaps the greatest barrier to change. Ikea, the Swedish furniture group, SKF, the bearing maker, Schlumberger, the oil services company, Borealis, the Danish petrochemical group, and Boots, the UK retailer, have all abandoned budgeting in some ways. Why are companies scrapping what they previously saw as their best tool for planning, control and performance evaluation? What are the benefits in doing so? Can every company avoid budgeting? How to do it in practice and what are the best practices? The first objective of this thesis is to answer these questions.

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The second objective of this thesis to apply the theory in the specific case of KONE OY, the Finnish elevator and escalator company. Because, as it will be explained in PART I, implementing beyond budgeting requires typically few years and involves at least the CEO and CFO of the company, this work will only aim at establishing a preliminary framework to introduce the subject and the new ideas to key people. Nothing more.

1.4 RESEARCH METHOD

In 1998, 33 companies (mostly large European) joined the CAM-I Beyond Budgeting Round Table (BBRT) to set up in response to growing dissatisfaction, indeed frustration, with traditional budgeting. The task of the research team was first to identify those companies that had abandoned budgeting, visit them, extract the best-practices and through case reports and presentations, report back to the BBRT members in order to find a solution. The group then pieced together an emerging model of how to manage without budgets. The CAM-I (Consortium for Advance Manufacturing) has unveiled their findings with parsimony, more for marketing purposes than creating public knowledge. Articles were published very selectively: the Financial Times, the Financial Management, the Management Accounting, the Accounting & Business etc. The PART I The Theory of Beyond Budgeting will review, and restructure and bind the essence of the BBRT through a collection of best of all articles aggregated together in a coherent flow of ideas, and explained with other sources as McKinsey Quarterly newsletters for instance, which May 2002 article Tired of strategic planning? has come with very similar ideas about the ineffectiveness of the strategic planning when linked to the budget. PART I will be based on primary research methods. The PART II Theory into Practice The case of KONE OYj will be based on secondary research methods, mainly interviews, discussions, phone calls that occurred during two years of work experience in KONE, in two locations and two jobs. The first job was Logistics Engineer in the corporate offices in Brussels (BE), dealing with order book dynamics (how to improve the flexibility, robustness and reliability of the Supply Chain). During this first job I had the opportunity to visit and interview key people in Belgium, the UK, France, the Netherlands and Italy, as well as the managers of the factory in Pero (Italy). The second job was as Project Manager at the Factory in Hyvink (FIN), creating tools for rolling forecasts and inventory management. The second job focused more on the bottom line.

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2 PART I THE THEORY OF BEYOND BUDGETING

2.1 BEYOND BUDGETING - DEFINITION

Beyond budgeting is about releasing capable people from the chains of the top-down performance contract and enabling them to use the knowledge resources of the organisation to satisfy customers profitably and consistently beat the competition. With intellectual assets accounting for more than 50% of shareholder value today, people really are the organisation s most valuable asset. But the way the annual budget contract works means that their energy and ingenuity is used more for negotiating the budget than for creating value for customers and shareholders. The budget contract is a relic from an earlier age. It is expensive, absorbs far too much time, adds little value and should be replaced by a more appropriate performance management model [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct. 2001].

2.2 DRIVING ASSUMPTIONS - CASE SCENARIO.

In this section, two scenarios will introduce the main differences between the industrial age control management with the information age empowerment management. In the rush for sustainable competitive advantage companies hope that by eliminating management layers and devolving authority and decision-making down through the organisation, particularly to strategic business units (SBUs), companies hope to sharpen their competitive edge by improving customer responsiveness and reducing costs. If managers can think and act like owners, they will become more willing to take risks, stand by targets, be accountable for performance, and improve the bottom-line. But the reality is often very different and the results are, more often than not, bitterly disappointing, why is it so? There are many reasons, ranging from lack of top management commitment, poor communication, inadequate training and education, to lack of buy-in from key people who wield power and influence. These are indeed essential to effective organisational change, but there are reasons that are not as readily acknowledged. These include the failure to understand the interrelationships between targets, measures, rewards and management behaviour. Hope and

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Fraser described in two cases what typically happens [HOPE & FRASER, Management Accounting, June 1998].

Figure 3 - [Dilbert.com]

A company reorganises its business, cutting management layers and redefining its reporting structure. SBU managers (a SBU is defined as a business unit that has external customers) are told they are now in charge of their own business. They are now expected to contribute to strategy formulation and told to go for stretch targets to meet shareholder expectations (at least beating the cost of capital). And as an extra carrot they are told that the achievement of such targets will be well rewarded with a large stretch bonus at the end of the year. What does the manager now do? Commit himself to such a stretch target knowing that the management culture promotes winners and punishes losers, or act more cautiously, knowing that the negotiation of a more manageable (or incremental) target will maintain his steady rise through the ranks? After all, he has invested a great deal of time and effort into mastering the target-setting and negotiation process with a clear emphasis on establishing a clear outwardly tough but an inwardly comfortable budget. Stretch in this organisation has little appeal. It increases the risk of failure and, even if the right improvement measures are implemented, they might take well over 12 months to bear fruits, thus combining costs rather than benefits to the current years result. Moreover, with monthly performance review focusing on actual versus budget numbers, a prudent manager would realise that the first blip in progress would probably trigger a series of meetings and re-forecasts, with the prospect of achieving the original target becoming increasingly remote. Such a prospect is unlikely to appeal to most SBU managers leaving both the organisation and its managers worse off. Now consider a different approach. The SBU manager is once again asked for a stretch target. However, under this management model the manager knows that stretch really means his best shot with full support from the centre (including investment funds and improvement

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programmes) and a sympathetic hearing should he fail to get all of the way. Moreover, he alone carries the responsibility for achieving these targets. There is neither any micro-management from above, nor any actual versus budget reports. Targets are both strategic and financial, and they are underpinned by clear action plans that cascade down the organisation, building ownership and commitment at every level. Monthly reports comprise a balanced scorecard set of graphs, charts and trends that track progress (e.g. financial, customer satisfaction, speed, quality, service and employee satisfaction) compared with last year and with other SBUs within the group and, where possible, with competitors. Quarterly rolling forecasts (broad-brush numbers only) are also prepared to help manage production scheduling and cash requirements but they are not part of the measurement and reward process. Of course, if there were a significant blip in performance (and the fast/open information system would flag this immediately), then a performance review would be signalled. Such reviews focus on the effectiveness of action plans and what further improvements need to be made, and maybe even whether the targets (and measures) themselves are still appropriate. Companies operating in a rapidly changing environment need to adopt this model, but it is vital that all the elements of the system work in unison, especially target-setting measures and rewards.

2.3 TEN REASONS TO REPLACE THE BUDGETING SYSTEM

Fewer and fewer firms are satisfied with their budgeting processes [HOPE & FRASER, Financial Management, Feb. 2001]. In a 1998 CFO Europe survey, 88 percent of respondents said they were dissatisfied with the budgeting model [BANHAM, August 1999]. Many companies are spending more time on budgeting and less on strategy. Research has shown that 78 percent do not change their budgets in the fiscal cycle [Hackett Benchmarking Newswire, 25 October 1999]; 60 percent don t link strategy with budgeting; and 85 percent of management teams spend less than one hour per month discussing strategy [KAPLAN & NORTON, 2001]. Janet Kersnar argued in The Economist that: Time consuming, labour intensive and seemingly never-ending, the annual budget is, at best, an excuse for senior managers to gather numbers they should have at their fingertips anyway and, at worst, one of a companys biggest competitive handicaps [KERSNAR, May 1999]. CAM-I argues that for decades accountants have planned, controlled and evaluated performance using budgeting measures such as product profitability, department costs, unit sales and capital efficiency ratios. These tools are increasingly unsuited to modern business [HOPE & FRASER, Financial Times, May 1999]. There are two main strands to the argument. One is that budgets

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are barriers to change and the other is that they dont do well what managers think they do well that is, provide order and control [HOPE & FRASER, Accounting & Business, March 1999]. Budgets are seen as barriers for 10 main reasons, listed below. 2.3.1 Budget and Command-and-Control Management

Budgets reinforce command-and-control management and undermine attempts at organisational change such as team working, delegation and empowerment. Employee goals and the appraisal process are not linked with the business objectives of the budget. According to Jay W. Forrester, Former Professor Emeritus at the Massachusetts Institute of Technology: Many senior executives see that their primary role is no longer to exert direct control, but to educate their people [KEOUGH & DOMAN, 1992]. 2.3.2 Budgets and Financial Incentives

The vast majority of organisations regularly experiment with different ways to tie pay to individual performance [PFEFFER, 1998]. Clearly many leaders appear to believe that the performance holy grail is finding the right mix of targets and incentives within the budget contract. But the link between incentives and profit performance is tenuous at best. In 1993, Alfie Kohns article in the Harvard Business Review entitled Why Incentive Plans Cannot Work generated many answers. When asked, Do rewards work? Kohn replied that the answer depends on what it is meant by work. Research suggests that, by a large, rewards succeed at securing one thing only: temporary compliance. When it comes to producing lasting change in attitudes and behaviour, however, rewards, like punishment, are strikingly ineffective. Once rewards run out, people revert to their old behaviours They do not create an enduring commitment to any value or action. Rather incentives merely and temporary, change what we do [KOHN, 1993]. There is a deep dissatisfaction with incentive schemes. Surveys conducted by William M. Mercer, for example, led them to conclude that they absorb vast amount of management time and resources, and they make everybody unhappy [PFEFFER, 1998]. This is not to say that rewards are not appropriate. They are, but they should be seen as a share of success (like a dividend of intellectual capital) rather than a do this, get that type of incentive linked to the target. They should also be based on the whole team and geared to competitive success, not on a few people meeting some negotiated number.

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Figure 4 - Bad management practices [Dilbert.com]

2.3.3

Budget Rhythm and Business Rhythm

The budgeting time horizon is not linked with the rhythm of the business (i.e. long horizons in rapidly moving sectors and short horizons in relatively stable sectors). The financial annual cycle is unsuitable for companies facing rapidly changing markets. 2.3.4 Budget Focuses on Financial Outputs

The focus is often on financial outputs. Budgets ignore the important factors in improving shareholder value today: knowledge or intellectual capital. Strong brands, skilled people, excellent management, clear leadership and loyal customers are not easily measured by an accounting system. 2.3.5 Budget gets the lowest of the People

Budgets discourage the exploitation of synergies across business units by encouraging parochial, defend your own turf attitudes. Jack Welsh, the former boss of General Electric once described the budget as the bane of corporate America. It never should have existed Making a budget is an exercise in minimisation. You re always getting the lowest out of people, because everyone is negotiating to get the lowest number. Managers tend to play games with the budget, at an operational point of view, budgeting means agreeing on minimal targets so that they can be exceeded.

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Figure 5 - Budgets as 'defend your own turf ' attitude [Dilbert.com]

2.3.6

Budget encourages incremental Thinking

Budget encourages incremental thinking and tends to set a ceiling on growth expectations and a floor for cost reductions, stifling real breakthroughs in improvement. It is like telling a motor racing driver to achieve an exact time for each lap of the race before starting the race and without knowing many of the factors that will determine the outcome (such as performance and behaviour of the other drivers, reliability of the car, weather conditions, etc.) In other words, it cannot predict and control extraneous factors, any one of which could render the target totally meaningless. Nor does it help to build the capability to respond quickly to situations. But above all, it doesnt teach people how to win. 2.3.7 Budgets fails to challenge Managers

Beyond budgeting offer a challenge to managers and help to retain talents. A 1998 McKinsey report, The War for Talent, pointed out that big companies are finding it difficult to attract and retain good people. The top three reasons why managers chose one firm over another were values and culture (58 percent), freedom and autonomy (56 percent) and exciting challenge (51 percent) [CHAMBERS & Al, 1998]. Offering a challenge environment is crucial to engaging and keeping the right people, but the budgeting model with its overarching bureaucracy, head-office memos and directives, and detailed rules and procedures undermines such an environment. At one time this didnt matter. Competitive salaries and good career prospects meant large firms could usually attract the people they needed, but talented managers today are much more demanding about their future employers. In the war for talent, part two,

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the update found that 89 percent of those surveyed (6,900 managers at 56 large and mid-size US companies) thought it is more difficult to attract talented people even after the recession that started in year 2000, than previously, and 90 percent thought it is more difficult to retain them. Just 7 percent of the survey s respondents strongly agreed that their companies had enough talented managers to pursue all or most promising business opportunities [AXELROD & Al., McKinsey Quarterly Newsletter, 2001]. 2.3.8 Costs of the Budget

At the same time, budgeting has become even more expensive, yet adds less value than expected. 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 of dollar of revenue in the planning and performance measurement process; the average time taken to develop a financial plan is four and half months; and companies need an average of 21 days to complete a forecast [Hackett Benchmarking Solutions, web]. A KPMG study showed that inefficient budgeting eats up 20 to 30 percent of senior executives and financial managers time. Volvo Cars and Borealis have calculated the budget and the reporting process take over 20 percent of management time [LITTLEWOOD, 2000]. The mechanics of the budgeting process and its information systems are inefficient. Janet Kersnar argued that: even today, the budget is done with the good of spreadsheets [KERSNAR, May 1999]. 2.3.9 Budgets and Strategy

Budgets are prepared in isolation from, and not aligned to, company strategy and goals. If asked why budgets are used, most managers would likely answer to set targets and control business operations [HOPE & FRASER, Accounting & Business, March 1999]. But budgets evolved in the 1920s to help growing businesses manage their capital resources and cash requirements. It wasnt until the 1960s that budgets were used to set targets, control operations and evaluate managerial performance. While planning remains an important part of the management process, one can believe that setting targets and controlling and evaluating performance using budgets is fundamentally flawed because it directs managerial behaviours towards achieving predetermined financial targets rather than harnessing the energy and imagination of people at all levels towards continuously improving competitive strategies and customer oriented processes. This is also the view of the quality gurus such as Deming and Juran: the 11th of Demings famous 14 points was to eliminate numerical quotas [DEMING Web Site].

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2.3.10 Budget fails to do its Job Beinhocker and Kaplan found the evidence (from research on the planning processes at 30 companies and work with more than 50 additional companies) that: the annual strategy review frequently amounts to little more than a stage on which business unit leaders present warmedover updates of last year s presentation, take few risks in broaching new ideas, and strive above all to avoid embarrassment. Rather than preparing executives to face the strategic uncertainties ahead or serving as the focal point for creative thinking about a company s vision and direction. The planning process is like some primitive tribal ritual, with a lot of dancing, waving of feathers, and beating of drums. No one is exactly sure why we do it, but there is an almost mystical hope that something good will come out of it. [BEINHOCKER & KAPLAN, 2002] Budgets fail to provide reliable numbers, both current and forecast. They are typically extrapolations of existing trends with little vision of the future. In Strategy under uncertainty, a McKinsey report, it was argued that the process of applying powerful strategic analytic tools to predict the future often involves underestimating uncertainty. When the future is truly uncertain, the analytical approaches are at best marginally helpful and at worst downright dangerous: underestimating uncertainty can lead to strategies that neither defend a company against the threats nor take advantage of the opportunities that higher levels of uncertainty provide. Another danger lies at the other extreme: if managers can t find a strategy that works under traditional analysis, they may abandon the analytical rigor of their planning process altogether and base their decisions on gut instinct [COURTNEY & Al., McKinsey Quarterly Newsletter, 2000 Number 3].

2.4 PRINCIPLES OF SUCCESS IN THE INFORMATION AGE

The vast changes reshaping the world business terrain are far-reaching, fundamental and profound. According to Gary Hamel, author of Competing for the Future and Leading the Revolution: 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 [HAMEL, 2000]. The concept of how a successful company operates in the information age is shifting from make-and-sell to sense-and-respond. Make-and-sell is an industrial-age model based on transactions, capital assets, mass production, economies of scale and product margins. Sense-and-respond is an information- and service-age model, which emphasises client relationships, intellectual assets, mass customisation, economies of scope and value creation. To compete successfully in the information are, managers must be exceptionally good at six key issues. They must create a climate for fast response, engage the best people, generate new business concepts, operate with

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low costs, find and keep the right customers and keep shareholders satisfied. Table 1 Principles of Success in the Information Age [HOPE & FRASER, Feb. 2001] sets out these concepts of success and shows how budgets can block their achievements.

Table 1 Principles of Success in the Information Age [HOPE & FRASER, Feb. 2001]
Change in environment Rising uncertainty Environment is now unstable and unpredictable; competitors can come from anywhere at any time New success concepts Coping with rising uncertainty. Adapt quickly to competitive changes and customer needs, don t rely on improving forecasting and scheduling processes Key success factors Radical devolution Devolve authority for fast action, dont centralise and delay decisions Adaptive strategies Make strategy an adaptive process, not linked with a fixed and deterministic point Fast information Provide fat and open information systems. Dont restrict information to those who need to know Right people Recruit and develop the right people. Dont simply fill vacancies Scope to perform Provide multiple responsibility centres. Dont consolidate the structure into larger units Inspirational leadership Dont adopt the carrot and stick approach Share in wealth Use fair rewards system, not one that benefits a few people Venture capital model View the business as a portfolio of investments, not as sub-sets of the budget Stretch climate Create a climate of challenge and stretch, not caution and control Learning and sharing Share knowledge, dont keep it to yourself Barriers Rules and procedures and budgetary control undermine empowerment Fixed strategy and budgeting cycles are built into the traditional model and difficult to change Knowledge assumed to be accumulated at the centre leading to restricted flows of information Budgets dont connect people with value creation Traditional cost-cutting mentality leads to larger units gain economies of scale Budget based performance contracts creates climate of management by fear Incentives usually linked to budgets Central planning approach sees only short term impact of risky investment proposals Bureaucracy and control is stifle challenge and creativity Budget cells encourage defend own turf attitude

Intellectual capital increasing in importance Talents are hard to find and even harder to attract

Finding and keeping talented people Provide a challenging work environment that enables personal development. Dont assume that people will be attracted by pay or perks

Increasing pace of innovation To compete, firms must constantly refresh their products and strategies, and generate new business concepts

Generating new business concepts Create climate for self-questioning and innovation, not one of subordination and controls

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Falling prices and costs Prices are falling and costs must be reduced; costs increases are no longer be passed on to customers

Operating with low costs Challenge and reduce costs. Dont protect and increase them

Declining customer loyalty Customers now have extensive choice and will switch loyalties if not satisfied More demanding shareholders Shareholders now demand better than competitors and consistent results

Finding and keeping the right customer Focus strategy and behaviour on serving customers, not selling products Creating consistent value for shareholders Align targets, measures and rewards with longterm value, not with short-term profit

Low cost network Adopt a low-cost network structure, not an expensive and complex hierarchy Strategic alignment Align resources usage and costs with strategy, not with departmental budgets Challenge costs Dont allow them to become budget entitlements Customer relationships Satisfy customer needs quickly and profitable. Dont just see customers as buyers of products Customer focus Focus strategy on customers, not products Alignment with value creation Align key decisions with long-term value creation Range of controls Base controls on a range of future indicators and relative performance, not financial budgets

Hierarchy means that high costs are hard wired into the system Budget views fails to support strategic cost alignment Budget process prevents cost-reduction issues being addressed Sales targets and incentives run counter to meeting customer needs Product focus is difficult to shift Budgets contracts drives short-term decisions Rear-view mirror controls based on budgets fails to give managers a future view

2.5 INEFFECTIVE SOLUTIONS TO IMPROVE BUDGETING

The weaknesses of the budget contract have been recognised for decades. Quoting Hope and Fraser, Writers such as Mayo, McGregor, Maslow, and Herzberg have all argued in one form or another that superior performance is not driven by planning, controls and incentives, but by team working, self-esteem and personal development. And more recently, such writers as Senge, Wheatley, Johson, Mintzberg, Schein and Argyris have all argued that the budget contracts seduces leaders into believing they can control the business through the numbers when, in reality, this is a dangerous illusion [HOPE and FRASER, Beyond Budgeting Questions and Answers, Oct 2001]. The attempted solutions broadly fall into three categories: decentralisation, process improvements, and resource management improvements.

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Figure 6 - Bad decisions [Dilbert.com]

2.5.1

Decentralisation

Decentralisation, team working and empowerment have all been used to try to cut the costs of the corporate bureaucracy and increase the speed of decision-making, but all have met with limited success. Most have been attempts to fine-tune rather than challenge the traditional model. One problem has been the lack of understanding of the changes required. In practice, decentralisation often means no more than the delegation of control within a strict regime of coordination and accountability, with the performance contract as the primary weapon for policing this control. It is the power of the group finance team to demand fixed plans and budgets and control performance against them that reinforce the centralised model and mindset. 2.5.2 Better Budgeting is not the Answer

Many progressive companies today are introducing rolling forecasts, and more frequent, and much streamlined, planning and budgeting processes, in an attempt to address the demands of a business that is rapidly changing. But they do not provide long-term solutions because they do not address many of the fundamental weaknesses (e.g. poor strategic linkage) of the budgeting contract. In fact they often create more work (and costs) rather than less. As a Fortune Magazine article noted: The value of an annualised budget depreciates fast. Simply revising it every few months may tighten the budgetary coils instead of releasing managers to act strategically [STEWART, 1990]. 2.5.3 Improving Resource Management only goes so far

According to Hope and Fraser [HOPE & FRASER, Accounting & Business, March 1999], the only significant attempt in the past 30 years to address the weaknesses of traditional budgeting has been the development of Zero Base Budgeting (ZBB). ZBB is a highly effective process for

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occasional reviews to improve resource reallocation and make significant cost reductions. Moreover, linking ZBB with Business Reengineering Processes (BRP), activity based budgeting and other improvement techniques can enhance its effectiveness for enterprise-wide cost reduction. But such one-off project should not disguise the fact that ZBB is not suitable as an on-going budgeting system. It is too bureaucratic, internally focused and time consuming [HOPE & FRASER, Management Accounting, Dec 1997]. All the approaches to improve the budget failed the test, as they leave the behavioural weaknesses in place. According to Hope and Fraser: budgets are the biggest roadblocks (both systemic and mental) to the future. It is now time to abandon them and develop alternatives and much more effective management processes [HOPE & FRASER, Accounting & Business, March 1999].

2.6 BEYOND BUDGETING CASES

2.6.1 What organisations have adopted Beyond Budgeting

While Dr Jan Wallander was transforming Handelsbanken into one of Europe s most successful banks of recent decades, few companies took the trouble to find out what he had done, and more importantly, how to turn his philosophy into a set of guiding principles. It was only in the 1980s that Jean-Marie Descarpenties was to follow a similar approach, first at a packaging company, CarnaudMetalBox, and then at Computer Company, Bull. At the same time Dennis Blake and Roger Sant were establishing an electric utility company in America, known as the AES corporation, and based on a core set of principles that both Wallander and Descarpenties would have approved. In the 1990s, the word got around and a number of other companies started to follow. Furniture manufacturer and retailer, IKEA, abandoned budgeting in 1994, car giant, Volvo cars in 1995, and petrochemical company Borealis, also in 1995. Norwegian based, Fokus Bank, and Swedish plumbing and heating distributor, Ahlsell, soon followed. And more recently two UK-based organisations, cider-maker, Bulmers, and charity Sight Savers International have started the process. Other companies including Siemens, Diageo and UBS are just starting their beyond budgeting journeys. 2.6.2 Beyond Budgeting leads to better Performance

The evidence from the BBRT observations and from the surveys that were conducted suggests that it does, but it is much stronger in those organisations that have gone all the way (that is changed the culture) than those that had more limited objectives (that is, restricted changes to performance management processes).

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Handelsbanken has outperformed its Nordic rivals on just about every measure you can think of including return-on-equity, total shareholder return, earning-per-share, cost-to-income ratio, and customer satisfaction. And it has done this year-in, year-out, for the past 30 years. It is the most efficient bank in Europe and has been voted one of Europe s best Internet banks. CarnaudMetalBox was transformed from a debt-laden company worth only $19m in 1982 to a market value of $ 3bn in 1989 and described by Fortune Magazine as one of the best European Corporate of the 1980s. Bull had had a similar experience under the leadership of Descarpenties (though in both cases results went into decline when he departed and the management model reverted to the traditional budgeting model). Volvo made significant progress and moved from number nineteen to number two in the world profitability by 1997 (it has since been acquired by Ford). Borealis has met its ambitious return-on-capital targets and reduced costs by 30% over 5 years. Fokus Bank came from nowhere to be the most cost efficient bank in Norway and was then acquired by Danske Bank of Denmark. Ahlsell is now the sectors most profitable company in heating and plumbing, and in electrical a major turnaround from its position in the early 1990s. Bulmers is growing revenue and profitability at a much higher rate than the industry average and there have been some significant cost savings. And AES has been one of Americas wonder stocks of the 1990s (total shareholder return was top of the Fortune rankings in the Utility sector for 1999). 2.6.3 Successful Budgeting Organisations

Some might note that many organisations can be successful with traditional budgeting in place. According to Hope and Fraser, performance contracts are less harmful when conditions are stable and companies are operating in a growth market. As soon as the market turns down, however, many of them are found out. Look at how many successful companies were suddenly writing off huge sums and downsizing their operations as soon as they had the excuse of a serious business downturn in 2001. The other point is that because so few companies have so far adopted beyond budgeting principles, most business sector performance league tables only include traditional budgeting companies. It is only when you have a beyond budgeting company operating in a business sector that a real comparison can be made. And whenever this happens, they shine through [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct 2001]

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2.7 BEYOND BUDGETING PRINCIPLES

Implementing beyond budgeting will start with ideas developed by Diageo and Ericsson. Then some general guidelines will be reported along with the 10 organisational and behavioural changes. This section will conclude by explaining why all the organisational and behavioural policies have to be harmonised. 2.7.1 How Diageo and Ericsson got involved

Diageo, the UK consumer goods giant generated by the merger in 1997 of Guinness and Grand Metropolitan, whose brands include Guinness, United Distillers, Burger King and Pillsbury, gathered 60 of its top senior managers to rethink the planning process. We asked people to be radical in their thoughts and we wanted them to understand that this wasnt game playing, said Philip Yea, CFO of Diageo. By the end of the meeting, the executives had agreed to scrap the firm s annual budget and replace it with a totally different approach. Of course, not every CFO is in Yeas enviable position of essentially starting from scratch in a brand new organisation, but that should not deter finance executives from taking a long, hard look at a process that often earns the finance function plenty of criticism from business-unit managers who have to struggle to pull together facts and figures [KERSNAR, May 1999]. The guys out in the branches have to be working towards targets that are consistent with what they are expected to achieve on an operational level, warns Brian Lever, a consultant at PricewaterhouseCoopers. In replacing the budget with new tools and approaches, finance is making the difference by making operational what from the beginning [should be] seen as a strategic tool" notes Yea. Companies are spending hundreds of millions of dollars on these types of projects, but they fail to recognise the staying power of the budget, says Jeremy Hope, author of Competing in the Third Wave and Transforming the Bottom Line. Hopes argues that because so many firms launch re-engineering drives with neither the full support of key parts of their organisations nor a willingness to devote the necessary time and resources to the projects, it is not very surprising that few of them succeed. Most of the companies who noticed the problems linked to budgeting replace it with rolling forecasts or balanced scorecards (or a combination of both of them). In many cases firms choose to hand on to the budget but reduce the weight it has in corporate decision-making before during the time needed to set up a new system. In Ericsson the solution found to cope with the problems of the budget was to break free [KERSNAR, May 1999]. Carl Wilhelm Ros, former senior executive vice president and CFO of Ericsson, explained, We still think that the budget has a value as it gathers the organisation

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around discussion of the bottom line. But the figures that are in the budget today don t give as much of an indication [of what happens in the telecom industry] as they did ten years ago because things are changing so fast. The first step of the process took place when Ericsson managers set their so-called rolling forecast. These are tailored to the specific market segment in which they operate, such as mobile phones or switching systems, and are based on specific targets, which are a mix of financial and non-financial items. Each quarter we update the rolling forecasts the 12 to 18 months ahead, said Ros. We put less effort into details of the budget, and more effort into the market changes, he explained. Of course, we check the bottom line and work with the balance sheet, but we dont go through the details like we did before. 2.7.2 The 12 Beyond Budgeting Principles

In days when competitor actions were largely predictable and suppliers held sway over customers, firms could plan, make and schedule activities to optimise the efficiency of their internal processes. But increasing uncertainty makes such practices ineffective firms cannot predict new competitors or what business concept they will use. Such change wreaks havoc with traditional planning and budgeting. In today s world, SBU managers need to make fast decisions to counter threats and take new opportunities as they arise. There is no time for approval procedures and management meetings. Fast response means making strategy an adaptive process. Managers must be put in charge of strategy and able to monitor it continuously, rather than once a year. To identify new initiatives is needed; managers must have fast access to resources. They need, for example, the authority to acquire key people when they are available (not when there is room in the budget); to react to competitive threats and opportunities as they arise (not as predicted in an outdated plan), and to acquire and deploy resources when necessary (not as allocated by head office). None of this is new, but so many companies attempt to implement the new type of business model without appreciating the hidden barriers that lie in wait within the budgeting, performance measurement and rewards systems. The successful implementation of the new model is a painstaking process. It can take years rather than months and needs constant reinforcement, particularly of core values [HOPE & FRASER, Management Accounting, June 1998]. Such words as openness, trust, integrity, cooperation, loyalty and ownership define its values. Indeed, many firms use these words in their mission statements and quality programmes, but they are much harder to apply in practice. The attitude to change is also important; beyond budgeting companies see change as an opportunity, not as a threat. They probe constantly for signs of impending change and pre-empt competitors actions and customers needs. They prepare rolling forecasts that support strategy

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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 anything else essential for rapid response and good decisions. It is increasingly clear that businesses cannot plan and control their way to the future in incremental steps. They must innovate and they must think differently. This means using the 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 with a rigid system of budgetary controls that reward good housekeeping, but fail to acknowledge creativity or innovation, and fail to provide a management climate that encourages creative people to thrive. Managers in beyond budgeting companies foster insight and innovation by sharing knowledge across networks. They encourage new ideas by breaking free from incremental thinking. And their leaders act more like venture capitalists that oversee a portfolio of businesses with a diverse range of risks and rewards, than like central bankers who are interested only in low risks projects. They know that people will perform better only if they are emotionally committed and this means working for more than money. And beyond budgeting companies target lower costs by aligning products, processes, projects and cost structures with their strategy. They also avoid fixing their capacity too far in advance. Beyond budgeting is also about finding and keeping the right customers. As we travel further in the information age, customers are presented with more choices and more information on which to base these decisions. Consequently, customer churn is increasing. Frederick Reichheld notes that on average, US corporations loose half of their customers every five years [REICHHELD, April 1996]. They need to know how to satisfy them (their value needs) and how to maximise profits from them. But finding the right customers is rarely on the agenda of sales planning meetings. Most sales gadgets are constructed and monitored on the basis that customers are segmented by product group, size, lifestyle, or some other grouping. They don t segment customers by their value needs. Beyond budgeting companies, however, place customer value needs at the centre of strategy. They distinguish between customers who want transactional sales (they want the cheapest products and services, perhaps on the Internet); those who want additional service (they are prepared to pay for advice about most appropriate solutions); and those who require customisation (they need their exact requirements to be addressed and satisfied). Clarifying customer ownership is crucial to maintaining a strong relationship.

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Failure to meet profit promises can lead to stock price falls. The reaction of many companies using the budgeting model is to cut costs to support quarterly profits, but this result in fewer good people doing more work and working longer hours. Tougher targets are intensifying pressure. Downsizing, layoffs, short-term contracts and higher productivity demands are pushing workers to the verge of nervous breakdowns. It is small wonder that a recent ILO report, Mental health in the workplace, concluded: Workers world-wide confront, as never before, am array of new organisational structures and processes which can affect their mental health. These trends represent as wake-up call for business. For employers, the costs are felt in terms of low productivity, reduced profits, high rates of staff turnover and increased costs of recruiting and training replacement staff [OSBORN, Oct 2000]. Beyond budgeting companies aim to create consistent value streams. Giving managers control of their actions and using simple measures based on key value drivers and geared to beating competition is all that most cases require. According to Hope and Fraser, budgeting is so ingrained that many managers and management accountants cannot see how it might be replaced [HOPE & FRASER, Financial Times, May 1999]. The pioneering companies developed systems that often shared the characteristics of Table 2: The 12 Beyond Budgeting Principles.

Table 2: The 12 Beyond Budgeting Principles

Key performance management processes 1. Beat the competition 2. Reward success team-based Key leadership actions 7. Create a performance climate based on sustained competitive success competitive 8. Build the commitment of teams to a common purpose, clear values and shared rewards

3. Make strategy a continuous and inclusive 9. Devolve strategy to front line teams and process provide the freedom and capability to act 4. Draw resources when needed 10. Champion frugality and challenge the value-added contribution of all resources

5. Co-ordinate cross-company interactions 11. Organise around a network of teams that through market-like forces dynamically connect their capabilities to serve the external customer 6. Provide fast, open information for multi- 12. Support transparent and open information level control systems

These mechanisms must be tailored to deal with particular business pressures. At Handelsbanken, Mr. Wallander introduced league tables to measure the bank s performance relative to its competitors, and of branches relative to their peers. Branch managers work out
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their own improvement plans, hire their own staff and focus on selling customer solutions rather than products [HOPE & FRASER, Financial Times, May 1999]. They are supported by an accounting system that provides information not only on branch, but also on customer profitability. This decentralisation gives senior managers more time to stretch their managers thinking. While the emphasis at Handelsbanken is on managing customer relationships, companies with rapidly changing products such as Volvo Cars and Ericsson concentrate on innovation and fast response. Managers in these companies rely more on forecasts and leading indicators than historic accounting reports. At Volvo Cars strategy and forecasts are reviewed and updated several times a year in four distinct cycles. According to Ole Johansson, vice-president of finance, managers build competence in sketching the future and within that future lie the opportunities and threats that traditional budget-driven processes fail to see until its too late. At Borealis, the emphasis is on managing performance over the business cycle. The balanced scorecard process sets the targets; fixed costs are controlled through trend reporting, activitybased management and cost targets, higher level financial and tax planning relies on rolling financial forecasts. The new system is not just simpler it gives us far more control than the traditional budget ever did, says Bjarte Bogsnes, vice-president for corporate control [HOPE & FRASER, Financial Times, May 18 1999]. One of the biggest criticisms of the budgeting system is that it is time consuming. At many firms, the process takes so long that no sooner has the final documents come out of the system, than its already out of touch with the reality [KERSNAR, May 1999]. In the early 1990s the executives of Ericsson, the Swedish Telecommunications Company, realised that the company s traditional planning methods were inadequate for the fast growing technology markets. Ericsson relied for years on the traditional budget, the preliminary figures were set in August, and the final budget in October November, and presentation to the board took place in December. Both increasing deregulation and ever changing technology made it impossible for managers to stick to using the figures that were determined the previous calendar year. Once a member of the board of Ericsson saw the transition from electromechanical switches to electronic switches mismanaged. The company s budgets and forecasts gave the illusion of control; but actually made it harder to reach quickly to business opportunities [KERSNAR, May 1999]. Handelsbanken abolished budgeting in 1979. As Mr. Wallander once explained: either a budget will prove roughly right and then it will be trite, or it will be disastrously wrong and in this case it will be dangerous. My conclusion is to scrap it!

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2.8 IMPLEMENTATION
2.8.1 Implementation Getting started

According to Hope and Fraser, there types of people that drive the change program. The first is the visionary leader who either joins the organisation with a philosophy and mandate for change or who is persuaded by the evidence that beyond budgeting is necessary to bring about their vision of the organisation. Visionary leaders make powerful sponsors. The second is the highlevel sponsor who is persuaded by the argument, but sees the project as a more effective way to manage the organisation in the information age. Sponsors are people with the legitimacy to sell the change program and mobilise the people and resources necessary to make it happen. They are usually the CEO or the CFO-CEO partnership. The third is the change advocate who must first sell the ideas to potential sponsors before they can mobilise people to accept the change. They see beyond budgeting as a way to break free from the overpowering constraints of the performance contract. Change advocates need to persuade high-level sponsors and gain legitimacy needed to drive the project forward. Each driver of the change program will make little progress unless they convince key influencers that the case for change is strong and the change program is necessary. These are the people that are most affected by the beyond budgeting program. They typically include functional directors (e.g. finance, sales, marketing, operations, IT and human resources) and business unit teams. Experience has shown that these people are not hard to convince since they see budgeting as a drain on their time with few obvious benefits [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct 2001]. 2.8.2 Implementation Phased Approach

If the firms leaders continue to insist on retaining tight central control with performance contracts based on short-term predictions, there is little point in changing the performance management processes to support a more adaptive, devolved model. The best way forward is to proceed with a three phase approach to beyond budgeting. Phase 1 sets out the Vision, Phase 2 is to design and implement the new system and Phase 3 is progressive devolution and rollout. Before attempting to start on the Vision phase, preparing a case for change is needed. Getting approval to this will ensure that sufficient resources can be deployed to phase 1 for it to be successful. Creating and agreeing a vision for the new management model includes that aims and principles on which the model will be designed, and the first level of details behind the 12 principles. It then needs to come together into a document and be discussed and approved by top management, and the board, and be widely sold to key influencers inside the organisation. It

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will also include the plans and resources needed to make it happen. The main resource is training. Preparing templates for how to engage in the strategy and action planning processes, for example, will be a valuable investment. However, it should not be sold as yet another major change program [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct 2001]. If the CEO or CFO doesnt sign up to the vision, then think long and hard before proceeding. Beyond budgeting cannot be implemented by stealth. It needs reinforcement from the top. Phase 2 is about designing and implementing the new systems and taking out the old ones, including budget contracts. This phase would normally be led by the CFO. Phase 3 (intensive at the beginning but it never ends) is progressive devolution, using the new system to show which teams are performing well compared with their peers or external competitors. This leads on to capacity building through training and if necessary switching people. Some large companies will want to do a pilot and rollout. Others will want to just take out the budget and hope that the training provided will be sufficient for all business units to cope with the new approach. Each will follow these 3 Phases, but the rollout will be much quicker (typically a year) because the new system already exists. 2.8.3 Coping with Analysts without budgets

According to Hope and Fraser, instead of promising an earning number to analysts, companies should rather share with them details of the business strategy and key performance indicators and let them work out what they think is the value of the business. This frees the company from the burden of making some specific number and encourages them to build their confidence in the future of the business and the strength of its management. It also enables you to manage their expectations more efficiently. There will be fewer surprises, so the share price should have a smoother ride. Let the analysts judge your performance, not your promises! [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct. 2001]. When the budgeting system has gone, shareholder should not perceive a weakening of control because there are many other information streams that provide better view of what is happening to performance. According to the CAM-I research, in all the visit cases, senior managers felt they had better control than before because they got fast and untreated information on what is happening at the front line. Investors are delighted when information systems enable good decision-making and faster anticipation of events. Shareholders are betting on the future, not on the present and what is needed is a management process that builds future value, not just fix short-term problems.

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There are few companies in the world over the past thirty years that have created more shareholder value than General Electric, Toyota and Handelsbanken. While GE and Toyota exhibit many of the features of beyond budgeting (Toyota, for example, never uses fixed targets or performance contracts to drive results), Handelsbanken exhibits them all. For other evidence, we can point to some recent surveys that indicate a strong link between devolution and shareholder value. For example, Watson Wyatt has constructed a Human Capital Index that shows a clear relationship between the effectiveness of a company s human capital and the creation of superior shareholder returns. They surveyed more than 400 US and Canadian publicly traded companies with at least three years of shareholder returns and a minimum of $100 million in revenues or market value. The conclusion was that 30 key human resource practices (under four broad headings) make a difference of around 30% to shareholder value. They include finding and keeping the right people (10.1%), clear rewards and accountability (9.2%), collegial, flexible workplace with flat structures (7.8%), and communications integrity with a policy of sharing information (4.0%) [WYATT, 1999]. In another survey, McKinsey found that companies scoring in the top quintile of top talent-management practices outperform their industrys mean return to shareholders by a remarkable 22% [AXELROD & Al, 2001].

2.9 LIMITATIONS, TOOLS AND WARNINGS

2.9.1 Different Countries and Cultures

There are four reasons why Scandinavian organisations adapt readily to a more-market responsive and devolved style of management. First Scandinavia is a closely-knit business community where imaginative ideas travel quickly. Secondly, Scandinavia has a high proportion of global companies relative to its size, and thus they have plenty of experience in uncertainty. Thirdly, financial budgeting conflicts with the notion of intellectual capital an idea that also had its genesis in Scandinavia. And fourthly, Scandinavian companies are fortunate in having a predominance of well-educated people with the self-confidence to accept the high-levels of responsibilities demanded by the new model. According to Hope and Fraser, beyond budgeting will work elsewhere because it is not a peculiar cultural phenomenon: both Japanese quality methods in the 1980s and Scandinavian Knowledge Management in the 1990s have been successfully applied in all parts of the world, in different cultures. Therefore beyond budgeting can also be applied elsewhere than Scandinavia [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct 2001]. In the UK, organisations such as Bulmers, Sight Savers International and Leyland Trucks have adopted the ideas in a serious way. And large

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organisations such as BP-Amoco and Diageo have taken more than tentative steps. In continental Europe, Rhodia (France) and Phillips (Holland) have embraced the ideas as well as UBS (Switzerland) and Siemens (Germany). In North America, AES is a supreme example, CIBA Vision has made real progress, and GE has many of the hallmarks of adopting the principles. In Japan, Toyota has operated without performance contracts for decades. The AES experience is particularly interesting. AES is a global electricity supplier with operations in every continent and many third world countries. Perhaps the greatest challenge was in the old Soviet bloc. But when asked about this they replied that their employees in the Hungarian plant just took longer to grasp the issues and change behaviours. It took about three to four years instead of the usual one or two. But eventually all employees in all countries become comfortable with the responsibility culture. 2.9.2 Different Industries

Maybe the capital industries are better suited to the traditional budgeting approach. Indeed budgetary controls were designed to fit large manufacturing firms in the 1920s. But it is important to remember that these firms were investing huge sums in productive capacity often to supply an insatiable demand for new products, especially in the decades after Second World War when consumer expectations were rising. Their problems were concerned with production planning, scheduling, and distribution all processes well suited to the capabilities of the budgeting model. Now it is very different. Consumers have almost too much choice. They can change their minds at the click of the mouse, and new competitors with different business models can spring from anywhere often making your costs appear too high of your technology look outdated. The result is that customers are at risk. Besides, manufacturers today often take as much, if not more, profits from services than products. Thus for many reasons, manufacturers have as many reasons to challenge the budget contract as service and high-tech organisations. While many make and sell organisations still exist, their ability to compete in the information age with operational excellence (or lowest cost producer) strategies has been challenged by no lesser authorities than two of the world s best known strategy experts. Both Michael Porter and Gary Hamel agree that it is becoming harder and harder to forge competitive advantage from operational excellence [PORTER, 2001] [HAMEL, 2001]. Rather like quality, being operationally excellent is becoming a prerequisite rather generating differentiation. This confuses many companies that believe that smart and rapid use of the Internet allows them to steal a march on their competitors. Most of the productivity gains are passed on to customers in the form of lower prices, thus reducing margins across the whole industry. There is little doubt that innovation and customer intimacy are now the only two sustainable sources of competitive

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advantage and both depend (much more than operational excellence) on decentralisation and the right climate for attracting good people. 2.9.3 The Public and non-profit Sectors

Accountability in the public sector comes from the political process, not through profit or even targets. Numerical targets can never capture the quality of a good public service. Elected politicians need to set broad goals and trust their managers to get on with it. Having said that, there are improvements that can be made in areas such as resource utilisation. This is one of the biggest problems confronting both public and non-profit sectors [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct 2001]. Both sectors are dominated by budgets to best utilise their limited resources to meet the unlimited public need. The problem is that the budgeting process is all about justifying existing resources (use them or lose them] and acquiring as many new resources as possible. Decisions about priorities are based on budget submissions and taken by people far removed from action. Resource are then allocated and fixed for the year ahead. While applying market principles to public organisations is not always a wise approach, there is much to learn from the internal market system that operates within some beyond budgeting organisations. If resource buckets were allocated to users and they had the scope to spend that money in the way they thought best to maximise their performance and they had the cost information to understand their inputs and the flexibility to buy in their resources from an internal (and external) market, then they might have the incentive to take a harder look at their costs. Kaplan provides an interesting example from the City of Indianapolis in the USA. After many years of budget overruns the new major decided to put a number of contracts out to tender. One included the paving of the roads, filling potholes, sweeping streets, and collecting garbage. He first asked for current costs. No one had a clue. He then shared the information with departmental workers who decided to bid for the contract. Armed with the new information, the workers bid was by far the lowest cost ($286 per ton against the previous cost of $640). Cost savings came from fewer supervisors, reduced work crews (labourer, vehicle drivers and equipment operators) and more efficient use of vehicles. The lessons were that once the full information was shared with the workers (they had no idea about the central service costs), and once they had the freedom to act, they were in the best position to make improvements [KAPLAN, 1996].

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2.9.4

Governance

Though governance statements usually mention that budgets and controls should be adequate, that was without counting on the side effects of dysfunctional behaviour. So instead of budgets reinforcing good governance, they often undermine it. In fact, many blue chip organisations have been caught falsifying accounts and engaging in other shady practices in desperate attempts to meet their performance contracts (i.e. Enron of the US in 2001, Lernout & Hauspie of Belgium in 2000, etc.) So replacing governance will benefit governance rather than jeopardising it. This does not mean that internal controls are diluted. Firms that have implemented beyond budgeting have kept strong internal audit departments, but they are focused on strategic issues as well as risk management [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct. 2001] 2.9.5 Economic Value Added

EVA is rooted in the Newtonian concept of the organisation-as-a-machine. It uses numbers to make decisions. But not everything can be reduced to a series of future cash flows. These are based on long-term forecasts that can be highly unreliable. Front line managers need to use their intuition to make quick decisions and they must have the freedom to do it. If EVA models enable them to do this more effectively, then that is supportive. But if they are used as a way of forcing managers to reduce every decision to a detailed shareholder value-based proposal that requires higher-level approval, then that would not be supportive. But, according to Hope and Fraser, if they are used as the basis for performance contracts, then they can be potentially disastrous as there are so many uncertainties inherent in the numbers [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct. 2001]. 2.9.6 Balanced Scorecard

The balanced scorecard can work with beyond budgeting, but it depends of how it is used. If the balanced scorecard is used to build a picture of strategy that can be described and communicated to a number of teams, then the scorecard has a strong contribution to make. And if it is used to provide managers with a strategic framework that shows a moving picture of change from their perspective, then again, it has a valuable role to play. It is the ability to focus on continuous feedback and learning that is perhaps its greatest strength. But it is when the scorecard is used to set targets, and place numbers on cause-and-effect linkage that dictate actions to manager, that the scorecard starts to run into difficulties (both conceptual and practical).

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How targets are set using the Balanced Scorecard is a good test of ho to get it right or wrong. The wrong way is to link targets to rewards in a performance contract. If the scorecard appears as just another budget with annual negotiations of targets and resources, then it is not surprising that local managers will fail to embrace its real strengths. In such a situation, the message will be a familiar command and control one, thus undermining any notion of empowerment and trust. It simply appears as a better tool for financial control. The scorecard is an excellent tool for educating and engaging people in the strategy process. For example, identifying whether customer intimacy or product leadership is your core value proposition and which business processes are critical to supporting it, enables managers to determine the key performance indicators that should be monitored. It is the feedback loops that tell managers what to do next rather than remain stuck with predetermined plans. Surprises should be taken in their stride and not ignored if they dont fit the anticipated result. 2.9.7 Activity-based Management

Activity-based management (ABM) can be helpful to the beyond budgeting manager in four ways. First, activity-based budgeting (ABB) can help managers to estimate the need for capacity. By using current forecasts and prevailing trends, managers can quickly work backwards from the level of customer demand to the resources that are required to sustain it. ABB is not easy to implement but, if done correctly, it can help managers identify excess capacity and thus reduce costs or, perhaps more realistically in the short-term, deploy that capacity elsewhere in the business. Secondly ABM is useful for computing the full costs of transactions, especially in those subjects to significant customisation. Many firms adopt these solutions without having information systems in place to calculate whether these solutions are really profitable. The real profit or loss can be revealed only when the full costs of serving or supporting a customised transaction are taken into account. Thirdly, ABM can help managers avoid those costs that should not be incurred at all. This applies not only to process improvements but also to whether the whole process is worth doing. And finally, ABM supports a horizontal process view of the organisation and thus supports the concepts of the organisation as a web of supplier-customer relationships. 2.9.8 Rolling Forecasts

Rolling forecast is another tool that can work well with beyond budgeting. Rolling forecasts in the traditional company are aimed at helping managers to focus on meeting the current year s budget. They have no 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
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meet their agreed targets. In beyond budgeting 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 move 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. Borealis achieves this by looking at forecasts from the perspective of legal entities within the group rather that from the perspective of legal entities within the group rather than from the perspective of business divisions. While in the line management runs through the division, the legal entity view does not have anyone at its head with line responsibility. So local managers use forecasts for local purposes and senior executives use forecasts for cash flow and tax planning. The two purposes are different and do not overlap. There is, however, one major caveat with rolling forecasts. They will be of little or no value if senior managers see them as a tool for questioning and reassessing performance targets. Nor must they be used to demand changes or improvements. If senior executives use forecasts to micro-manage or demand immediate action, then trust and confidence will rapidly evaporate. The only time such questions can be fairly asked is if forecasts show a significant change and such a change has not been explained beforehand. Managers should be responsible for dealing with problems and reflecting any corrective actions they have taken in their revised forecasts. 2.9.9 Information Systems

Most information systems mirror the organisational structure and, for most firms, this means improving the plumbing and wiring of the hierarchy. Early enterprise-wide systems offered the prospect of cross-functional integration by enabling firms to set switches to turn integration capabilities on-and-off. But its very rigidity forced firms to make compromises and fit into the system template rather than design their own requirements into the system. And, even recent systems on the market have showed no signs of breaking this trend. Talk of information cockpits, for example, suggests a highly centralised view of information management. And the power of drill down facilities shows no understanding of what devolution is about. Information systems designers often assume that it is the speed and power of data analysis that user value. Hence the notion of the information cockpit with a few senior executives pulling levers and pressing keys to make decisions that are, more often that not, far better done by front line managers. The problem is that such systems appear to offer better controls, but this is a fallacy [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct. 2001].

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Bill Gates idea of a digital nervous system comes pretty close to the suggested right approach. It is much more in tune with the idea of an organisation as a web of relationships rather than a machine with multiple parts. He starts by explaining that the biological nervous system triggers your reflexes so that you can react quickly to danger or need. It gives you the information you need as you ponder issues and make choices. You are alert to the most important things, and your nervous system blocks out information that isnt important. He then goes on to explain why companies need to have the same kind of nervous system: the ability to run smoothly and efficiently; to respond quickly to emergencies and opportunities; to quickly get valuable information to the people in the company that need it; the ability to make decisions quickly and interact with customers A digital nervous system consists of the digital processes that enable a company to perceive and react to its environment, to sense competitor challenges and customer needs and to organise timely responses. A digital nervous system requires a combination of hardware and software. It s distinguished from a mere network of computers by the accuracy, immediacy and richness of the information it brings to knowledge workers and the insight and collaboration made possible by the information. According to Hope and Fraser, the digital nervous system idea may sounds like unstructured, unbounded information roaming around the organisation, but the other way around, the whole idea of controlling and restricting information is a bit ridiculous. As James Gleick put it, information is the solar energy of organisation [WHEATLEY, 1999]. If a company really wants to foster insight and collaboration, then it must open up the information system (IS) to all those than can gain from it. The notion that only people at the centre can use it wisely is just plain wrong headed [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct. 2001]. People need to see what is happening right now. They need to be constantly exposed to breaking news in media terminology. The IS should be designed to scan and probe for patterns of change in the marketplace. All points of contact with customers and the market in general should be tuned to feeding back data into the IS. This enables use of data warehousing capabilities and tools to search for patterns of change that are not readily observable in any other way. The IS should also support anticipatory management by bridging the time elapsed between lagging and leading indicators. For example, customer acquisitions and defections can be monitored as they happen (at least in industries with regular ordering patterns); strategic initiatives can be monitored as they unfold; and trends come alive as they appear instantly on the screen. Data warehouses are now commonly used to see patterns within large volumes of information that cannot be readily observed with the human eye. Popular aphorisms such as what you measure is what you get need to be reconsidered. Most of the cultural factors that create winning organisations cannot be measured. Indeed, financial

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accounting numbers are given too much visibility. They are not the hard stuff that macho managers believe. The rule of thumb should be that the fewer the measures, the less opportunity there is for misinterpretation and dysfunctional behaviour. When used to evaluate outcomes they have many imperfections. Opening up the data flows to many more people and many new interpretations is the way to enrich understanding. 2.9.10 Warnings Beyond Budgeting doesnt start, but do end, with scrapping the budget. Even if the budget holds back the company, it gathers the key people around a table to discuss about the future The budget is also the main tool for controlling and financing and therefore it can t be replaced in one day, one month or even one year. It involves deep restructuring of the most basic policies of the company. Those policies are typically the ones inherited from the industrial age that hold back today s attempts to succeed in the networked organisational structure beyond budgeting might take typically three to four years during which most of the basic policies of the company will have to be changed. During those three to four years, beyond budgeting requires full commitment from top management.

Figure 7 - Fast implementation of beyond budgeting [Dilbert.com]

According to Fraser and De Waal, the bigger the company that engages, the bigger the return but also the longer time required. Still according to Fraser and De Waal, there is no particular limitation concerning the Industry, the size of the location of the company that wants to engage in beyond budgeting [FRASER & DE WAAL, Dec. 2001]. Therefore the principles and theory of gathered in the PART I - The Theory of Beyond Budgeting can be applied to KONE OYj.

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PART II THEORY INTO PRACTICE THE CASE OF KONE OYJ

If the order of a country depends of the judgements of the family, it will attain supremacy; if it depends on the judgements of the officials, it becomes only strong; if it depends on the judgements of the prince, it becomes weak [Shang Yang, 350 BC]

Note from the author: PART II aims at establishing a preliminary framework for discussing the beyond budgeting approach further. Budgeting is reserved to senior managers and there are 5 hierarchical levels between the CEO and me. That has made things difficult. Therefore I want to apologise in advance for the lack of depth of this study, especially in the field of budgets linked to rewards.

In this work KONE OYj will only be described as briefly as possible. If the reader is interested in the products or services or additional information, he can visit the companys web pages at the following http address: www.kone.com. Because the history is important to understand the present and is the only basis to forecast the future, the summary of KONE Company history will be reported after the company presentation. The organisational structure of KONE will follow with the process of the actual budgeting exercise. Then KONE will be benchmarked with the other beyond budgeting companies at the time they got involved in the BBRT. At last recommendations and comments concerning the path to follow to implement beyond budgeting will be reported.

3.1 COMPANY PRESENTATION

KONE is one of the leading companies in the global elevator and escalator business. The company is headquartered in Espoo. KONE develops, manufactures, installs, modernises and

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services elevators, escalators and autowalks. The company also seeks growth from servicing automatic building doors. KONE Corporation was founded in Finland in 1910. Class B KONE shares have been quoted on the Helsinki Exchanges since 1967. An international expansion strategy based on business acquisitions, adopted in the 1960s, fuelled KONE's development into a worldwide organisation. KONE hires more than 23,000 employees and operations in some 800 locations in about 40 countries. KONE supplies more than 20,000 new elevators and escalators annually and services almost 500,000 elevators and escalators as well as 140,000 automatic building doors. KONE is a service company: maintenance and modernisation business accounts for more than half of our net sales (58% on the 2001 Annual report). For the 2001 Exercise Europe accounted for 57% of the total sales, then came North America with 31% and Asia Pacific with 10%, then other countries accounted for 2%. KONEs mission is to develop a sustainable urban living by moving people in a safe, reliable and environmentally responsible way.

Figure 8 - KONE global coverage [company presentation, 2002]

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3.1.1

History

KONE was founded in 1910. The relatively small market in Finland saturated soon. The view that internationalisation was paramount to the growth of the company gained ground in the 1960s and was realised in the form of acquisitions. Securing the required channels to internationally launch their Finnish products led to a strong expansion abroad. In the latter part of the 1960s, KONE's internationalisation gained momentum. The company made bold moves in the acquisitions front and became known as Finland's first multinational company. The early policy was to gain a majority in international elevator companies, but let local management handle the operational side of the business based on its knowledge of local circumstances. The corporate world during the internationalisation wave of the 1960s was not what it had become when integration moved on in the 1990s. External strengths have been acquired through alliances and corporate acquisitions. Not only external growth has contributed to KONE's evolution into one of the top names on the approximately $25 billion world elevator market. Organic growth was driven by KONE s industrial heritage: The conviction that in-house engineering and manufacturing capabilities and technological expertise are competitive has always been strong. Stable ownership 'four generations of the same family at the helm over a period of 90 years' created a safe and fruitful environment for development. An important catalyst was the majority owner's will to raise the company to the forefront of the international elevator business. In 1996, KONE became the first elevator manufacturer to introduce a machine-room-less elevator. The KONE MonoSpace elevator concept (based on EcoDisc technology) has become the new standard for the industry, quickly replacing traditional types of elevators and winning prestigious awards worldwide. 3.1.2 KONE Organisation

Figure 9 - KONE organisational structure [company personnel presentation, 2002] reports the main organs of KONE s organisation. Markets are divided into five areas: North America, North Europe, Central Europe, Southern Europe and Asia Pacific. Products and services are organised into three divisions are: the new elevator and escalator business (42% of sales), the service and modernisation business (58%) and the building door business (new division, values not available).

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Figure 9 - KONE organisational structure [company personnel presentation, 2002]

In the beginning of the nineties, KONE still has factories producing elevators in many countries in Europe (resulting of the many acquisitions). In the late 1990s, KONE concentrated its production as in Figure 10 - KONE Manufacturing Facilities [Company presentation, 2002]. Elevators are produced in Finland (BU2 for engineered-to-order elevators), China, the USA and Italy (standard elevators). Escalators are manufactured in Germany, the UK, China and the USA. A unit in Bristol (UK) manufactures building doors and one unit in Hmeenlinna manufactures the EcoDisc engines used to power the elevators. Nowadays, each front line (i.e. KONE France, KONE UK, KONE China, etc.) is basically supplied by the production facility that is closer to them and manufactures the right product.

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Figure 10 - KONE Manufacturing Facilities [Company presentation, 2002]

3.2 KONES ACTUAL SITUATION

3.2.1 The Capla the forecasts and strategic planning, input for the budget

The Capla (standing for capacity planning) is a gathering of sales figures for the main products in the main markets. The Capla is an input for the budgeting process and therefore it has both a strategic function and a budgeting function. The Capla is run in September. There are three other rounds during the year to fine-tune the existing figures, the three other rounds are called rush. There are therefore a total of four Capla rounds per year, a major one in September and three rush ones typically in March, June and December. The whole process to deliver the final figures takes typically one month, 4 times per year. 3.2.1.1 Step 0 The Global Supply Line prepares the Spreadsheets Files KONE Corporation Offices in Brussels have been for years in charge of gathering the figures but the task was transferred in March 2002 to the Global Supply Line Organisation. The Business Unit 2 (BU2 Hyvink elevator supply unit) was in charge to prepare the files in Spreadsheet format.
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3.2.1.2 Step 1 The Front Line Executives fill the Tables A front-line specific spreadsheet is sent to the 25 major front-line organisations (France, Italy, Spain, the UK, the USA, Germany, the Netherlands, Finland, China, etc.) that account for most of the total sales, the remaining percentages of the sales are dropped. The spreadsheet (see Figure 11 - The Capla Spreadsheet, 300 out of the 10,000 Cells) typically includes information concerning how many elevators and escalators (per elevator and escalator types) the front-line is likely to order and install per month. The time window is about 18 months

Figure 11 - The Capla Spreadsheet, 300 out of the 10,000 Cells

Front lines are not asked to fill all the cells, hopefully, because filling the file completely means filling more than 10,000 cells! The delegates in the front lines are typically the New Elevator and Escalator Business Manager, with the Sales Manager and the Installation Manager with the service business manager, its sales manager and the managing director. When the front-line specific spreadsheet is filled, it is sent both to BU2 (who aggregates all the values) and to each Business Unit that supplies that specific Front-line (i.e. KONE UK will send the file to Hyvink and Milan Business Units for elevators, Germany and UK for escalators; while

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KONE US will send the sheets to McKinney -TX- for elevators and Moline -IL- for escalators). About two weeks are needed for step 1. 3.2.1.3 Step 2 The Global Supply Line aggregates the Figures At this point, each business unit has received the number of elevators and/or escalators per front-line, that they will aggregate to determine their production forecasts. Hyvink BU2 has received every file. The figures received are pondered (even based on experience, it is bad practice) and BU2 aggregates the figures at the Global Supply Line level. All the business units execute steps 3 and 4. 3.2.1.4 Step 3 The Forecasts are exploded into components Then the figures received at an elevator and escalator level are exploded into components using probabilities based on order book trends and components life cycles. This procedure requires a lot of time but is not redone for each round, it is prepared in advance so that it doesnt add-up time to the length of the project. 3.2.1.5 Step 4 The Components are priced After determining the quantity of components and types, the price information is added to generate the budgets related to each component facility (i.e. for BU2: the car and door factory, the electrification and signalisation factory, the MX engine factory, and the material management team who handles most of the outsourced material). 3.2.1.6 Step 5 The budget When the main Capla is ready, senior managers gather to agree on the budget for the following year. 3.2.2 KONE Capla compared with Beyond Budgeting Rolling Forecasts

The KONE Capla isnt too far from the beyond budgeting rolling forecasts. The time horizon is similar, more than a year. KONEs Capla is run 4 times per year (one major and 3 updates), the same applied in the case of Borealis. The figures inserted by the front lines are considered as best-shots and there is little actual vs. forecast questioning as required by the beyond budgeting idea. The Capla is seen as a strategic tool to unveil uncertainties and increase the visibility of the manufacturing units (BU), which is also in line with the theory. The Capla is

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used both by the factory managers to adjust their capacity and by the financial managers to plan the cash flows. Even if KONEs Capla isnt bad, it has two major defects: The first one is that the process to collect the figures is long (spreadsheets arent that easy to aggregate without mistakes, especially 25 front-lines multiplied by 10,000 cells!), the Capla is expensive to run because it is filled by the most expensive managers, and then why expensive managers would spend much time filling 10,000 cells with their best shots (do best shots become fastest shot?). The second defect is that the figures are corrected before they are aggregated. This means that depending on which front line is sending the forecasts (and its reputation for selling constantly more or less that the budget) the figures are pondered up or down, meaning that it is not the true forecast from the front lines that are then split into components and priced. One might ask what is the point of asking the front lines their so many figures if a remote expert carefully changes them afterwards. 3.2.3 The Case for Change

Before attempting to start on the Vision phase, preparing a case for change is needed. Getting approval to this will ensure that sufficient resources can be deployed to phase 1 for it to be successful. Creating and agreeing a vision for the new management model includes that aims and principles on which the model will be designed, and the first level of details behind the 12 principles. It then needs to come together into a document and be discussed and approved by top management, and the board, and be widely sold to key influencers inside the organisation. It will also include the plans and resources needed to make it happen. If the CEO or CFO doesnt sign up to the vision, then think long and hard before proceeding. Beyond budgeting cannot be implemented by stealth. It needs reinforcement from the top [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct 2001]. The Case for Change is the resulting report of the questionnaire 1 [BBRT benchmarking project] that can be filled on line on the following site: http:\\project.bbrt.org. The logic of the BBRT benchmarking project (see also Figure 12 - Project Architecture Chart) is to link: 1. The changing environment 2. The factors required to succeed in that environment 3. The devolutionary framework required to implement those success factors 4. The management processes needed to execute them 5. The barriers that need to be eradicated, and the tools that are needed to support a successful transition

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6. The resultant competitive performance

Figure 12 - Project Architecture Chart

The BBRT benchmarking resulted in KONEs overall position on the Devolution Index equal to 64%, while KONE scored 46% on the Adaptive Process Index. The table of the results of the basis 6 issues is reported below (but the complete results are available in Appendix 1: The Case for Change).

Table 3: The 6 Keys Issues and KONE's performance

Key Issues Score Today (from 0 to 7) Business Environment How unpredictable is your business 4.2

environment and to what extend are you exposed to external pressures? Success Factors To what extend have you identified the right factors and taken effective steps to cope with these pressures Devolutionary framework To what extend have you engaged all your people in supporting your competitive success? Management processes To what extend are your management processes supporting your competitive success? 3.2 4.5 3.0

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Barriers to success to what extend are your management practices a barrier to meeting your success factors Competitive performance How does your performance rate against your competitors in each of your success factors?

3.8

5.0

It is interesting to note that the competitive performance factor is 5 out of 7 (see Table 3: The 6 Keys Issues and KONE's performance well above the average of the other factors (3.74). This ), might be explained by the fact that KONE has advance on its competitors in its industry, even if compared to the other industries, the results are average.

3.3 IMPLEMENTATION
The implementation paragraph 3.8.2 Implementation Phased Approach recommended an implementation in 3 phases. The first phase is focusing on the vision, the second on the design and the implementation of the systems, and the third one on the progressive devolution. 3.3.1 Phase 1 The Vision of the New Management Model

The future of companies in the information age is the network organisation because it emphasises speed, innovation, customer satisfaction, adaptability and knowledge creation. But before beginning to think about deploying a network strategy, managers must realise that not every company is cut out for the conductors role (the central position and owner of the network). According to a study from McKinsey, the future of the network company, each company that has built a successful network began with a strong and close relationship with the ultimate consumer of the network s products. Unless a business has already created demand among end users and developed insight into their needs from having served them, it isnt likely to succeed in persuading other businesses to clamber onto its platform. A would-be network conductor will then of course have to promise them a continuous flow of market intelligence and new strategic opportunities not to mention lots of paying customers and a reasonable allocation of financial rewards [HCKI & LIGHTON, 2001]. Companies that are equipped to serve as conductors will evaluate candidates for network membership on the basis of criteria such as size and maturity as well as their cultural and performance traits. The functioning networks McKinsey studied typically included uniform standards governing the exchange of information, rigorous performance standards maintained mostly through customer evaluations and partner incentives built by the network with all partners, an on-line presence for all key

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business processes, and the development and dynamic testing of new opportunities with network partners. 3.3.1.1 The New Structure Playing the conductors role is KONEs future. KONEs Global Supply Line will be at the centre of a network of suppliers and front lines. The Global Supply Line order handling becomes virtual, orders pass by instead of going through administrative steps. The front lines won t be centralised in countries at it is nowadays but split in regions. The regional offices will be composed of, for instance, 20 people, out of which a region manager, two salesman, two supervisors, an administrative and 14 field employees. The knowledge of the local conditions specific to each construction site will be concentrated in few hands, the ones that are best to satisfy the customer. The regional offices will be supported by a country office for medium-size projects and national customers and, one level higher, by the major project unit for the large projects (already existing). Today s environment is similar but too often, the offices at the country level bottleneck the information flow with administrative procedures. The country offices will be also composed of the minimum of people: a managing director, a sales director, a marketing director, an installation director, a human resource director and a pool consisting of the best specialised supervisors and salesman available to be sent anywhere in the country, mainly for special projects, acting like account managers. The role of the directors will be to train, consult, inform and enable the possibilities at the regional levels, not to control the activities. The region manager will also be the one to have the keys (at his regional level) to decide which company can join the network as subcontractor (supplier of sales consulting, sales agent, installation service provider, etc.) The building door business, the elevator and escalator business and the service businesses are in the responsibilities of the same salesmen and supervisors at the regional level, because they are the ones who have met the customer and visited the building. There shouldnt be an elevator salesman, an escalator salesman, a maintenance salesman and so forth. The credo should be: One customer, two guys: a salesman responsible of the contracts and a supervisor responsible of the operations.

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3.3.2

Phase 2 Design and Implementing Systems The 10 Organisational and Behavioural Changes

Changes are needed at an organisational and behavioural point of view. Ten policy changes have been defined as critical by the beyond budgeting round table consultants [HOPE and FRASER, Financial Management, Feb 2001]. The 10 changes are reported separately, all in a table format in order to enable the direct visual comparison between industrial age management principles with those of the information age. 3.3.2.1 Performance Responsibility make managers responsible for competitive results, not for meeting the budget It is easy for managers to agree to a number knowing from experience that they can meet it, and even if they cant, they will have enough plausible excuses to maintain their jobs. Moreover, how does anyone know if the numbers are too high or too low? Negotiated financial targets are notorious for leading to incremental thinking and safety-first strategies. If you really want people to do their best and stretch their performance, then a different approach is needed. Most organisations that have gone down this path use relative measures. This means that everyone is always trying to best the competition and climb their way to the top of the performance league table. Business-to-business, plant-to-plant, branch-to-branch, there are many ways to compare performance both inside and outside the organisation. In some cases, where there is a lot of catching-up to be done, business leaders will set themselves benchmarks as most desired targets. There are fine provided that they are not seen as commitments. Getting most of the way is usually sufficient to make significant improvements.

Table 4 Performance Responsibility

Implement approved plans Senior management roles Senior managers act like commanders and controllers, they are the decision-makers and they control local actions. Local management roles Doers. Local managers are implementers of the plan. Management competencies Job or task oriented. Managers are trained to perform their jobs. Information Slow, restricted and financial. Make autonomous decisions Senior management roles Senior managers are coaches and co-ordinators, they act as coaches and mentors and as crossborder integrators. Local management roles Thinkers and doers. Local managers are planners and implementers of the plan. Management competencies Decisionmakers. Managers are trained to think and act on their feet, making decisions in response to changing markets. Information Fast. Open and strategic.

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Information is geared to central control. Local managers only see what they need to know. Access to resources Through budget negotiation. Resources are agreed through annual budget process for a given set of assumptions. Changes require approval.

Information is geared to local control and learning but piped to all parts of organisation at the same time. Access to resources When required. Managers are free to buy in resources as needed through internal or external market provided they meet their goals (e.g. cost/income ratio)

Senior managers act like coaches, co-ordinators, consultants and cross-border integrators. Local managers are the thinkers and the doers, they plan and implement their decisions. They are trained to think and act on their feet, making fast decisions in response to changing markets. The information is transferred fast, openly and is basically strategic, the aim is to create learning. Managers have access to internal and external resources freely, provided that that they meet their goals (i.e. cost/income ratio). KONE evolves towards a devolved market-like network, where information and ideas travels fast. The Global Supply Line aims at becoming transparent and represents the knot of the network that connects suppliers and the regions. 3.3.2.2 Governance, Leadership and Devolution give people the freedom and ability to act, don t control and constraints them Devolution, or empowerment, has got a bad name because many firms empower people without giving them both the freedom and capability to make decisions. The trouble is that the budgets and control systems are never far away. It is like telling people they can take decisions but always being on their backs to ensure they are making the right ones. In the beyond budgeting model, the micro-controls disappear. People know the boundaries and values within which then can act and they gradually build up the confidence to take decisions. Firms that have don this successfully find that their response to threats and opportunities is much faster. People need training and access to information, but also the right attitudes. According to Hope and Fraser, two main problems can be encountered when a company tries to change its governance mechanisms [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct 2001]. One is stopping senior managers interfering with lower level decisions. And the other is getting the message across to people that empowerment isnt a free ride. On the first point, leaders need to really believe in devolution, and be incredibly disciplined not to interfere even when they can see mistakes being made. Hammering out an agreed set of principles and values is also a crucial step. This establishes the framework that everyone operates within and ensures that they can take decisions with confidence. On the second point,

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perhaps the most difficult problem is how different people interpret their new freedom. For example, some people think that empowerment means that leaders have no right to make decisions that affect their work. In other words, they see empowerment as a charter for free riders. Firms have to recognise that despite trying hard to bring everyone up to par in terms of strategy and decision-making, there will always be people who cant make it. According to Hope and Fraser, either they don t have the right attitudes or other traits essential to working in this new environment. Team leaders still have to make hard decisions and this sometimes means weeding out their weakest members. These people can either be transferred to other roles where their strengths can be better utilised, or they will have to leave the organisation altogether. People must have trust and confidence in each other. If this doesnt exist because of a few people, they must be dealt with.

Table 5 Governance, Leadership and Devolution

Within Budgetary controls Compliance With rules and procedures. Local managers must comply with operating rules and procedures Strategy formation At the top. Strategies are developed periodically and handed down like tablets of stone. Plans are approved before implementation. Scope of action Limited. Local managers are accountable for implementing approved plans and meeting short-term financial targets (often under contract) Follow-up Prescribed reporting. Managers must report any variations to plan and gain approval for changes. Bad news is often suppressed as it reflects adversely on manager performance. Within strategic boundaries Compliance With shared values. Local managers operate within agreed values and strategic boundaries. Strategy formation Locally. Strategies are the responsibility of the local team and may be developed continuously as opportunities arise or conditions change. Scope of action Extensive. Local managers are accountable for meeting high-level medium-term goals but are free to decide for themselves how best to achieve them. Follow-up By exception. Managers are trusted and operate under a no blame culture. They take risks (and make mistakes). Bad news is immediately shared with seniors who may give coaching and support.

In KONE employees are trusted (and trustworthy) and have the freedom to act within agreed values and strategic boundaries, not anymore complying with rules and procedures. Once the network is in place, strategies are formed locally and continuous developed as opportunities arise and conditions change. Local managers are accountable for meeting high-level mediumterm goals but are free to decide for themselves how best to achieve them. Managers take risks and are allowed to make mistakes but bad news is immediately shared with seniors who may give support or training.

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The country managing directors and the corporate offices give the regional managers the freedom and ability to act, they dont control and constraints them. Similarly in the supply line, the emphasis goes from the business units to the suppliers. 3.3.2.3 Structure and Organisation From centralised functional hierarchy towards devolved market-like network
Centralised Functional Hierarchy Predominant form Hierarchy. Designed from inside out. Few units. Facing the hierarchy. Boundaries are functional and geared to financial targets Delegation Limited. Centralised decisionmaking. Authority only delegated to lower levels with strict rules of control. Many management layers. Unit size Large. Larger units lead to greater scale and lower unit costs. Devolved market-like network Predominant form Network. Designed from outside in. Many Units. Market (or internal customer) facing. Boundaries are strategic and geared to delivering value to customers. Delegation Extensive. Authority is devolved to managers who have autonomy to run their own business. Few management layers. Hierarchy used for cross border decisions. Unit size Small. Smaller units lead to greater flexibility, simplicity and total lower costs

Performance focus Product. Profit and cost Performance focus Customer. Value centres define production-oriented creation centres define customer-oriented performance responsibilities. performance responsibilities Control Centralised. Variance analysis aims to keep Corporate Centre and senior like managers in control Control Distributed. Rolling forecasts and strategic indicators aim to facilitate learning at local level

The organisation is devolved in a market-like network. There are many units of small size oriented to generate value for their own customers, by increased flexibility and simplicity. The customer is at the centre of the performance focus, the control is distributed. The concept of Business units disappears, the orders are placed to the Global Supply Line and go directly to the suppliers, with a step in engineering if necessary. The suppliers now are responsible for punctuality, quality, flexibility etc. directly towards the regional offices. The regional managers are responsible for competitive sales, installation results, and customer value. It is one level below compared to the situation today and it aims at improving the bottom line.

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3.3.2.4 Co-ordination co-ordinate cross-company interactions through process design and fast information systems, not detailed actions through budgets Most organisations declare that their aim is to be customer focused or market responsive. But implementing a market-responsive strategy and then trying to co-ordinate plans centrally makes no sense at all. Business units need to co-ordinate their plans dynamically, as the market dictates. Units need to see themselves (and other teams) as suppliers of products or services to both internal and external customer, as elements in a coherent value delivery system. In other words, instead of being directed to supply a particular product or service to another unit, business units are tied together with ad-hoc agreements that are made according to the prevailing demand in the (internal or external) market. Of course some agreements need to cover, say, a quarterly or even an annual period, because central service facilities need time to increase or decrease their capacity. The fundamental change is from central planning to dynamic supplier-customer relationships. This means that teams are accountable for satisfying customer requirements. It is a responsibility model based on the outcomes.

Table 6 Co-ordination
Through plans and budgets Co-ordination Recognised techniques. Normal Channels of communication are restricted to within hierarchical groups, but processes like VBM, BSC, ABM and budgeting are used to make the hierarchy work better. They enforce alignment and co-ordination across the business and are used for causeand-effect management. Knowledge sharing No inclination. Performance measures and incentives are departmental or individual and tend to encourage parochial attitudes. Improvement initiatives are based on departments. External alliances Uncoordinated. Alliances with suppliers, customers and partners are often uncoordinated Through market-like forces Co-ordination Market-like forces. Channels of communication are operand based on the network of work units. Coordination happens naturally in a market-like network through alliances between internal suppliers and customers (not through central planning) especially when units are value (no cost) centres. Knowledge sharing Mutual benefit. Sharing of knowledge and best practices is encouraged through values, performance visibility and group-wide rewards. Cross business initiatives are based on processes and projects. External alliances Co-ordinated. Alliances with suppliers, customers and partners are coordinated (e.g. through e-business networks)

Channels of communication are open and based on the network of work units. Co-ordination happens naturally in a market-like network between internal suppliers and customers. Sharing of the knowledge and best practices is encouraged through values, performance visibility and group-wide rewards.

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The senior staff co-ordinates, through process design and fast information systems, both crosscountry and cross-regional interactions. 3.3.2.5 Goal Setting beat competitors, not budgets Investors want to place their money in firms that will be at the top of their sector league table. So gearing every business unit and team to beating the competition is the best way to achieve this. People should always be striving to improve their position in the league table. That is what stretches performance.

Table 7 Goal Setting

Negotiated and incremental Process Internal. A lengthy exercise in negotiating and co-ordinating numbers. Value added Low. Budgeting can take months and many man-years of time, but produces little more than numbers. Goals Incremental and fixed. Goals are the result of negotiation about improving current financial numbers Link to value creation Financial. ROCE is proxy for shareholder value Frequency Annual. Budgeting cycle based on financial year. Degree of ownership Weak. Top-down targets and a numbers oriented process Link to rewards Connected with goal setting. Goals are performance contract agreed in advance. Relative to competitors Process External. A brief process of setting goals relative to external measures. Value added High. Value-adding process as strategy is understood and improved, and action plans are created and aligned with goals. Goals Stretched and relative. Goals are impossible dreams that drive continuous planning and improvement. Link to value creation Strategic. KPIs provide clear link to increasing shareholder and customer value. Frequency Continuous. Self-regulating relative measures used, making cycle irrelevant. Degree of ownership Strong. Compelling logic If competitors and benchmarks can do, why cant we? Link to rewards Disconnected from goal setting. Rewards based on actual performance with benefit of hindsight.

The targets might be described briefly but are not binding because they are stretched and relative. KPIs provide clear links to increasing shareholder and customer value; relative measures are used making cycles irrelevant. The suppliers enter in competition among each other and with external competitors on ratios like punctuality, quality, and customer value. The regional offices compete internationally and nationally with peers and with competitors on ratios as customer satisfaction, customer

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retention, profit/employee, average installation time, costs/income ratio, market share in the area, etc. Good financial results are supposed to be the result of the competitiveness of the business model. Financial results are therefore not the aim, but the result. 3.3.2.6 Strategy Process make the strategy process a continuous and inclusive process, not a top-down annual event
Annual top-down Direction Tightly defined. Top-down process with middle managers given the strategy that should drive their budgets. Communication Restricted. Strategic thinking is restricted to authorised people. Frequency Annual. Planning and budgeting process typically take 6-12 months to complete. Responsiveness Fixed. Strategy is fixed for the year ahead. Ambition Incremental. Limited by income ceiling and cost floor mentality. Improvement scope Departmental. Focuses on cost cuts, not customer benefits Learning not invented here mentality erects barriers to improvement. Continuous and inclusive Direction Within boundaries. A clear statement of business purpose gives managers the freedom to act. Communication Inclusive. Channels open to all those who can make a valid contribution to strategy. Frequency Continuous. Managers redefine local strategy and they anticipate or react to competitive actions and internal events. Responsiveness Flexible. Strategy remains flexible and responds to changing conditions. Ambition Stretch. Planning is driven by external benchmarks and competitive performance. Improvement scope Process. Concerned with customer benefit and cross-functional improvement. Learning Relentless search for best practices wherever they occur

Clear statements of business purpose give managers the freedom to act. The communication channels are opened to anyone who can contribute to strategy. The frequency of the strategy is continuous and the responses are flexible to respond with changing conditions. Planning is driven by external benchmarks and competitive performance. The scope of improvements is the process that aims at cross-functional improvements and customer benefits, rather than cutting costs and customer benefits. Managers have to search relentlessly for best practices wherever they occur. The network is based on proximity to customer, devolution and learning. Because the command chain is shorter, the strategy is more flexible and adaptive to the local, actual situation. The aim is to maximise opportunities and minimise threats, not to meet budgets.

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Every force of the company should be involved in strategy but Henry Mintzberg, professor of management at the McGill University argues that real strategies are rarely made in panelled conference rooms, but are more likely to be cooked up informally and often in real time in hallway conversations, casual working groups, or quiet moments of reflection on long aeroplane flights [MINTZBERG, 1987] In Tired of strategic planning?, a report published by McKinsey in May 2002, companies should avoid combining strategy reviews with discussions of budgets and financial targets, because when the two are considered together, the short-term financial issues [BEINHOCKER & KAPLAN, 2002]. 3.3.2.7 Forecasting and Anticipatory Management use anticipatory systems for managing strategy, not for making short-term corrections
Used to keep on track Purpose Control. Another weapon for senior management in controlling units Performance management Linked. Forecasts linked to budgeting process with implications for measures and rewards. Time Horizon Year-end. Forecasts usually prepared quarterly but only up to financial year-end. Effort and involvement Heavy. Based on full recompilation of budget. Takes weeks of effort and significant management time. Involves all budget holders and finance people. Links to strategy Weak. Forecasts financial indicators only. No KPIs. Support tools Budgets. These are invariably the basis of re-forecasts. Used to inform strategy Purpose Anticipation. Assist local and senior managers to identify actions needed. Performance management Disconnected. Forecasts are separate from performance targets, measures and rewards, and are impartial best estimates. Time horizon Rolling. Forecasts always look one or more year (usually 5 quarters) ahead. Updated frequently. Effort and involvement Light. Build a broad-brush picture of key financial numbers that are quick to prepare (hours rather than weeks), and only involve senior business unit or divisional managers and finance people. Links to strategy Strong. Forecasts KPIs (e.g. customer retention), as well as financial numbers. Support tools Forecasting models. These may be used to collate and present information.

dominates

The purpose of forecasting is anticipation, not short-term corrections. The time horizon is rolling, typically 5-6 quarters and updated frequently. The involvement required is light, it should be quick and easy to prepare, and only involves high-level managers. The forecasts are oriented to collect KPIs (i.e. customer retention) as well as financial numbers.

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The regional offices update frequently very few KPIs, the values represent their best shots and it doesnt matter too much whether the values are smaller or higher in reality. The front lines are not measured on actual vs. forecast ratios. The stress is on local market changes. The figures are not manipulated at any step of the process. Anybody has access to the forecasts; the financial department uses it to predict cash flows, the factories use it to plan their load, and the corporate and country offices use it to gather intelligence. 3.3.2.8 Resource Management make resources available to operations when required at a fair cost, dont allocate them from the centre
Allocated annually Approval criteria all expenditure. Annual budget submissions are on basis for approval by the centre of all capital and revenue expenditure. Resource allocation Predetermined. Capacity levels are set when budgets are agreed and used as the basis for allocating resources. Central services Arbitrary allocation. Costs of central services and other resources are allocated indirectly. Internal customers have little say over prices and service levels. Accounting focus Departments. Costs managed through budget variances, and whether they go up or down. Decision-making is difficult as focus is department. Available when required Approval criteria Discretionary only. Project plans are the basis for approval of major capital and discretionary revenue expenditure in a continuous process. Resource allocation Continuous matching. Units are managed against goals (e.g. Costs/income ratio) and themselves regulate resources levels in accordance with changing demand. Central services Internal market. Central services and operational resources (e.g. people skills) are acquired through an internal or the external market. Units are changed directly and have a strong say. Accounting focus Value chain. Costs are managed using moving averages and league tables. Decision-making is made easier through designing units as stages in the value chain.

Resources are available to operations when required at a fair cost; little questions are to be asked to performing managers. All the units regulate their resource levels according to the demand, Central services and operational resources are acquired through an internal and external market. Units are charged directly and have a strong say. Costs are managed using moving averages (i.e. 1 year or 2) and league tables, not through budget variances. 3.3.2.9 Measurement and Control use a few key indicators to control the business, not a mass of detailed reports
Compliance with plan Self-regulation

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Purpose Senior managers. To check that local managers are on track in implementing their plans, and complying with rules and procedures. Measures Financial and fixed. Capital and earning measures provide detail by department. Adverse variances vs. budget are highlighted for explanation. Analysis Hierarchical. Budget reports by department with expense category details. Clarity Numbers. Very detailed sets of numbers enable micro-management. Feedback and learning Limited. Financial variances don t explain root causes. Early warning Unlikely. Reports usually contain only lagging indicators.

Purpose Local units. To use controls (dispersed across the network) to have a good knowledge of whats going on for selfregulation. Measures Strategic and relatives. A range of KPIs is used as the basis for performance comparisons with targets, competitors, peers and last year. Analysis Customer profitability. Fast and open information based on activity accounting. Clarity Visual. Graphs and charts clearly show trends and moving averages. Feedback and learning Extensive. KPIs linked action plans enable managers to examine the root causes. Early warning Likely. Reports give leading and lagging indicators thus giving early warning.

The purpose is to generate intelligence about what is going on at the local level. A range of KPIs is used as the basis for performance comparisons with targets, competitors and last year. The feedback and learning can link KPIs to action plans to examine root causes. Reports are visual (rather graphs then numbers) and give leading and lagging indicators only. Only a few key indicators are needed to control the business. These key indicators should be the same than the ones used in goal setting, typically profit/employee, customer satisfaction, customer retention, punctuality, etc. 3.3.2.10 Motivation and Rewards base rewards on a company and unit-level competitive performance, not predetermined targets The beyond budgeting view is that while incentives (or a do this, get that approach) dont work, the recognition of a team-based success is important. This can be done in a variety of ways. One is a profit share based on a winning margin. Another is a judgmental evaluation of how well the team did in the context of competitive conditions. And another is to compare teams with internal or external competitors or benchmarks. It is crucial, however, to recognise that teams should be the focus of rewards. In modern organisations it is well nigh impossible to relate extra revenue or profit to a marginal activity or piece of work. The scope of the team should equate with the level of direct dependencies. Anything less than this is, to some degree or other, likely to be divisive.

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Table 8 Motivations and Rewards

Individual, fixed incentives Linkage Internal. Usually linked to budget, or other internal measures (e.g. past unit or company performance) Focus Individual. Based on budget holder and/or the business unit. Motivation Money. Belief that financial incentives drive performance. Visibility Low. Financial rewards may have evolved into a labyrinth of incentives Related to future results Unlikely. Rewards based on outcome measures. Basis Contract. Incentives based on targets negotiated in advance. Recipients Few. Incentives are for senior people (e.g. Stock Options) Group-wide, relative rewards Linkage External. Rewards based on relative competitive performance (ROCE or total shareholder returns). Focus Teamwork. Profit sharing based or unit, company or group-wide performance. Motivation Success. Beating the competition or one s peer is the motivational force. Visibility High. League tables motivate through peer pressure and pride in achievement. Related to future results Likely. Related to leading indicators (e.g. quality or customer satisfaction). Basis Hindsight. Rewards based on actual results, knowing how things turned out. Recipients Everyone receives reward, helping to create a culture of teamwork.

Rewards are based on relative competitive performance (e.g. ROCE or total shareholder return). They are earned by beating competitors, and the previous year at a company level (not unit level), but the market changes and other peculiarities have to be considered. Since rewards are calculated at the KONE level, the force that thrives motivation is not anymore a direct financial award but direct success: managers want to ramp up the league table because it means pride and high achievement; everybody can see also their names. Everyone receives a reward, not only the senior staff, this helps to create a culture of teamwork bottom-up. 3.3.2.11 Systems Dynamic The motivation, the monitoring, the resource management, the attitude to anticipatory management, the strategy process, the goal setting, the co-ordination among divisions, the structure and the organisation, the governance and leadership and the responsibilities; they all effect (or affect) one another and the total picture represents the company as a whole entity. The field of Systems Dynamic, pioneered in 1956 by Jay W. Forrester, provides an organising framework for analysing policies and decisions interact in a total system (society, corporation, etc.). Every action happens as part of a structural loop in which each decision causes a result

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that influences future decisions, wrote Jay W. Forrester [FORRESTER, 1961]. When the basics of the theory of Systems Dynamics is applied to a corporation it is easy to understand that only the combination of effective organisation, behaviour and effective performance management leads to success, (see Table 9 Management success as multiplication of variables [HOPE & FRASER, Feb. 2001]. And, just like any mathematical equation with multiplying variables, if any of the variables is zero, the net result will be zero. The failure to recognise that it is the combination that matters has wrecked many attempts at performance improvement [HOPE & FRASER, Financial Management, Feb 2001].

Table 9 Management success as multiplication of variables [HOPE & FRASER, Feb. 2001]
Effective Organisation and boundaries Clear values and boundaries Responsibility for results Freedom and capacity to act Fat networks and processes Co-ordination with an internal market Challenge and stretch Effective performance Relative targets Adaptive strategies Competitive success Fast response Best people Innovative strategies Low costs Loyal customers Satisfied customers

Anticipatory management Internal market for resources Fast, distributed controls Relative team rewards

3.3.3

Phase 3 Progressive Devolution

Phase 3 (intensive at the beginning but it never ends) is progressive devolution, using the new system to show which teams are performing well compared with their peers or external competitors. This leads on to capacity building through training and if necessary switching people. As Hope and Fraser acknowledged, not every manager can do it. Some large companies will want to do a pilot and rollout. Others will want to just take out the budget and hope that the training provided will be sufficient for all business units to cope with the new approach. Each will follow these 3 Phases, but the rollout will be much quicker (typically a year) because the new system already exists. Beyond Budgeting is more a revolution rather than an evolution. Revolutions are always to be planned carefully. Pilot testing could be appropriate, but beyond Budgeting generates above average results in the medium- or long-term. Waiting for the pilot tests to give their true colours might take too long and the company could be stacked, for a few years, in running both the budgets and the league tables. When the aim was to simplify, there are two organisational

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models to run at the same time. I would recommend the targeted blitzkrieg method, starting from Sweden, Holland and Italy, where SAP is already widely implemented. Then the others will follow when they feel ready, but they should not wait for the results.

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4 CONCLUSIONS
Both Michael Porter and Gary Hamel have agreed that it is becoming harder and harder to forge competitive advantage from operational excellence [PORTER, 2001] [HAMEL, 2001]. Rather like quality, being operationally excellent is becoming a prerequisite rather is generating differentiation. In the information age, little doubt remains that innovation and customer intimacy are the only two sustainable sources of competitive advantage. Both depend (much more than operational excellence) on decentralisation and the right climate for attracting good people. Many companies tried to decentralise adopting a network model organisation. According to Jeremy Hope and Robin Fraser, very few of them have reached the candies because they failed to notice the problem that lies in the traditional budget, especially when it is linked to performance evaluation and rewards. Jack Welsh was quoted talking about the budget: the bane of corporate America. It never should have existed Making a budget is an exercise in minimisation. You re always getting the lowest out of people, because everyone is negotiating to get the lowest number. There are many reasons for companies to scrap their budgets. The costs of budgeting is high and the results are below expectations, budgeting is a relic of the industrial age, it reinforces commandand-control management, the rhythm of the budget is not linked to the rhythm of the business, the focus is often on financial outputs leading to cutting costs rather than creating value for the customer, budgets encourages incremental thinking, and, above all, it fails to really challenge managers. There have been attempts (especially ZBB linked to BRP) to improve the budget but all failed. In 1998 a group of companies, mainly European (including Handelsbanken, Borealis, Volvo Cars, SKF), launched a joint-research: the BBRT (Beyond Budgeting Round Table), led by Jeremy Hope and Robin Fraser. The aim was to identify companies that scrapped their budgets, to generate best practices and case scenarios and to share the knowledge. The research showed that all the companies that have abandoned budgeting have all outperformed their direct competitors on every possible measure (both financial and non-financial), and that none of the managers of the beyond budgeting companies interviewed for the research desired to come back to an old budgeting model. The 12 principles of the BBRT are: (1) to beat the competition; (2) to reward team-based competitive success; (3) to make strategy a continuous and inclusive process; (4) to draw resources when needed; (5) to co-ordinate cross-company interactions through market-like

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forces; (6) to provide fast, open information for multilevel control; (7) to create a performance climate based on sustained competitive success; (8) to build the commitment of teams to a common purpose, clear values and shared rewards; (9) to devolve strategy to front line teams and provide the freedom and capability to act; (10) to champion frugality and challenge the value-added contribution of all resources; (11) to organise around a network of teams that dynamically connect their capabilities to serve the external customer and (12) to support transparent and open information systems. There are no basic limitations to the study concerning the country or culture nor the industry. The following specific tools should be used with care: balanced scorecard, ABM and rolling forecasts because they can have negative effects. Implementing beyond budgeting typically lasts a few years and requires the CEO and the CFO, at least, full commitment. KONE is a good target for beyond budgeting. The company structure, inherited from the industrial age, needs to be updated. KONE has grown through acquisitions and, historically, units have enjoyed freedom. KONEs front line senior managers are willing to take their responsibilities and be accountable for their results. The existing budgeting exercise starts with the capacity planning (called Capla), it has mostly a strategic objective. The process requires typically one month that is lower than most companies. However, according to the study, there is no good budgeting, and therefore it should be replaced. The Case for Change (a questionnaire benchmarking companies willing to start beyond budgeting) has highlighted KONE as average on its devolution and adaptive process index. The first phase of the implementation is the vision of KONE as a network company, where regional offices (staffed but not controlled by their country offices) would be ordering to the Global Supply Line, and where the GSL would be the centre of the company but would also be as transparent as water. The second phase has described the ten organisational and behavioural changes needed to implement beyond budgeting, all triggered by the creation of league tables where each region would compete for the highest rank. The league tables are composed of few indicators like customer retention, cost/income ratio, market shares, installation time, etc. The challenge to have their name on top will drive managers to continuously stretch to improve their position better than any budget could do ever it. Managers are to be responsible for competitive results, not for meeting the budget. People need the freedom and ability to act, they shouldnt be controlled or constrained. The structure should evolve towards a devolved market-like network. Cross-company interactions are to be co-ordinated through process design and information systems. The goal is to beat competition, not the budget. Rolling forecasts should be used for
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managing strategy, not for making short-term corrections. Resources should be available when required, and at a fair cost, they should not be allocated based on the budget. A few key indicators (i.e. customer retention, costs/sales, etc.) are enough to control the business. Rewards shouldnt be for limited to seniors and they are based on a company and unit-level competitive performance. The third phase of the implementation is about devolving power, it is never-ending.

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