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Budgets: the hidden

barrier to success in
the information age
In the first of two articles,
Jeremy Hope and Robin
Fraser argue that budgets
need more than
improvementthey need
dismantling altogether.
Next month they explain
how a number of
companies have
abandoned budgeting and
adopted a new
management model

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March 1999

ost senior executives know

that the competitive battles
ahead will involve not only
getting better at what their
organisations do, but also being
different from others. To achieve this
they need talented managers who
can produce more imaginative
strategies for growth and
improvement, make faster decisions,
be more flexible and responsive to
customers, be better prepared to
anticipate threats and opportunities,
and consistently improve quality and
customer satisfaction. To this list you
can add any number of other key
competitive issues that have become
more important as the service
economy gathers speed. But
executives also know that none of
these aspirations are attainable
without changing the way the
business is managed. While most
companies have tried to address
these issues by reducing
management layers, introducing
team working, and focusing on the
customer, few have been successful.
One of the reasons is the inability to
shift the management philosophy
from one of top-down control to
bottom-up empowerment. It is
because budgets are most commonly
used by organisations to exercise
control that they find themselves at
the centre of this thorny issue.

Why budgets must go

There are two main strands to the
argument. One is that budgets are
barriers to change and the other is
that they dont do well what most
managers think they do wellthat is,
provide order and control. Budgets
are barriers for many reasons. Here
are a few.
They reinforce the command and
control management model and
thus undermine attempts at
organisational change such as
team working, delegation and
empowerment.
They encourage incremental
thinking and tend to set a ceiling
on growth expectations and a floor
for cost reductions, thus stifling
real improvement break-throughs.
They fail to deal with most of the
important drivers of shareholder
value todayknowledge or
intellectual capital. Strong brands,
skilled people, excellent
management processes, strong
leadership, and loyal customers are
assets that are outside the
measurement orbit of the
accounting system.
They fail to provide the CEO with
reliable numbers, both current and
forecast. Budgets are typically
extrapolations of existing trends
with little attention being paid to

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anticipatory models.
They act as barriers to exploiting
synergies across the business units.
Budgets encourage parochial
behavioura defend your own
turf attitudethat is only
reinforced by recognition and
rewards linked to achieving the
budgeted numbers.
They are bureaucratic, timeconsuming exercises, and the time
taken would be better redeployed
in more value creating activities.
If asked why we use budgets, most
managers would likely answer to set
targets and control business
operations. But budgets evolved in
the 1920s to help growing businesses
manage their capital resources and
plan their 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, we believe that
setting targets and controlling and
evaluating performance using
budgets is fundamentally flawed
because it directs managerial
behaviour towards achieving
predetermined financial targets
rather than harnessing the energy
and imagination of people at all levels
towards continuously improving
competitive strategies and customeroriented processes. This is also the
view of the quality gurus such as
Deming and Juran (one of Demings
famous 14 points was to eliminate
numerical quotas). In other words,
the quality movement believes that if
a financial number is seen as a
commitment (as in a negotiated
budget contract) then managers will
be tempted to manipulate processes
to achieve a desired financial
outcome (especially if high financial
rewards are involved). Thus, they will
reduce costs by eliminating people
(without considering the work that
they do) or resort to a variety of
budgeting games that help to
protect vested interests or present a
better short-term result. The
outcome, more often than not, is to
destabilise the rhythm and pattern of
work causing employee cynicism,
lower morale, poor quality, and

Traditional budgeting sets not only a ceiling on costs

but also a floor. It promotes centralisation of decisions
and responsibility, makes financial control an annual
autumn event, absorbs significant resources across
the organisation, and acts as a barrier to customer
responsiveness Bjartes Bognses, VP Corporate Control, Borealis
declining customer service. This
leads to a more risky and variable set
of results over the medium term and
thus lowers shareholder value. The
counter view is that setting broad
medium term goals is fine and this
should set the strategic direction. But
good and sustainable financial
performance is the result of
imaginative strategies and process
improvement (how work can be done
not just faster and more reliably but
differently). And this is achieved by
focusing on the key value drivers,
reducing delays, eliminating
constraints, and increasing
innovation, quality, speed, and
service.

Better budgeting is not

the answer
So, if existing budgeting systems have
such crucial weaknesses, why do we
still rely on them? The answer lies in
their history and their unchallenged
position in the top division of
accepted management practices. This
is not to suggest that accountants
dont try to improve them. They do.
Zero-base budgeting and activitybased budgeting represent valiant
efforts to update the process, but they
tend to be complex project-driven
approaches that fail to evolve into

standard management practices.

Some companies are re-engineering
their budgeting processes to make
them faster and cheaper, but such an
approach also fails the test, as they
leave the behavioural weaknesses in
place. Lets face it, budgets are the
biggest roadblock (both systemic and
mental) to the future. Its now time to
abandon them and develop
alternative and much more effective
management processes.

The CAM-I Research

In 1998, 33 (mostly large European)
companies joined the CAM-I Beyond
Budgeting Round Table (BBRT). As
the title suggests, this was a research
project set up to examine why
budgets are barriers to change and
what should replace them. The task
of the research team was first to
identify those companies that had
abandoned budgeting, visit them,
and through case reports and
presentations, report back to the
BBRT members. The group then
pieced together an emerging model of
how to manage without budgets.
Which companies have abandoned
budgeting? The earliest convert we
know of is Svenska Handelsbanken,
Scandinavias most profitable bank
with the lowest costs of any bank in
Europe. Handelsbanken abandoned

The budget is the bane of corporate America. It never

should have existed Making a budget is an exercise
in minimalisation. Youre always getting the lowest out
of people, because everyone is negotiating to get the
lowest number. Jack Welch, CEO, General Electric
March 1999

25

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Strategies and plans need to un-fold continuously as new knowledge emerges.

Management accounting is moving from a discipline that seeks to manage costs to
one that seeks to manage value
budgeting in the 1970s and its senior
executives ascribe much of its
subsequent success down to this one
visionary act. More recent converts
include Volvo Cars, IKEA, SKF,
Borealis (one of Europes largest
petrochemical companies),
Schlumberger, and Boots. All these
firms are now managing successfully
(in whole or in part) without budgets.
Others including Ericsson are also on
the way.

The changing role of

management accounting
What does all this mean for the role
of management accountants? Many
accountants now accept that setting
fixed financial targets and measuring
performance against them makes
little sense when the competitive
environment is subject to continuous

26

March 1999

change. Strategies and plans need to

unfold continuously as new
knowledge emerges. Management
accounting is moving from a
discipline that seeks to manage costs
to one that seeks to manage value.
But above all it should be concerned
with the future and ensuring that the
right questions are asked and the
right decisions taken that add
maximum long-term value. It is hard
to see how these changes can be
managed successfully while leaving
the budgeting system in place. The
problem is that no one can measure
the damage that budgets do (in the
same way that they cant easily
measure the benefits of higher
quality).
As Oscar Wilde might have said,
traditional accounting systems
appear to report the cost of
everything and the value of nothing.

It is time to manage for value and

this means travelling in a different
direction. The BBRT has the
compass. It is now working on the
road map.
Companies joining the 1999 BBRT
will receive the 1998 research
deliverables and a catch-up
workshop. If you wish to consider
joining the BBRT in 1999, you may
obtain a prospectus by contacting Dr
Peter Bunce at CAM-I on Tel: +44
(0)1202 670717 or Fax: +44 (0)1202
680698.
Jeremy Hope (e-mail: lh23@dial.pipex.
com) is co-author of Transforming the
Bottom Line and Competing in the Third
Wave, both published by Harvard Business
School Press. Robin Fraser (e-mail:
RobinFraser@Compuserve.com) is a
management consultant, formerly a partner
in PricewaterhouseCoopers.