Feature Beyond Budgeting ures of hate Traditional budgets hold companies back, restrict staff creativity and prevent them from responding to customers. Jeremy Hope and Robin Fraser suggest a better way forward ‘ Independent research into the need to® tackle Beyond Budgeting has been mounting. ever since we raised the issue in our previous articles (Management Accounting, December 1997 and January 1999). For example, fewer firms are satisfied with their budgeting pro- ‘cesses: in a 1998 CFO Europe survey, 88 per centofrespondentssaid they were dissatisfied. with thebudgeting model’ ‘Many companies are spending more time on budgeting and less on strategy. Research hhasshownthat78 percent donotchangetheir budgets in the fisealeyele’; 60 per cent don't link strategy and budgeting’; and 85 per cent ‘of management teams spend less than one houramonthdiscussingstratogy. ‘And the value of budgetinggis even less than expected. A recent report noted that its value had diminished because’: ‘e the mechanies of the budgeting. process areinetficient; 1 budgets are prepared in isolation from, and notalignedito, company strategyand goals; the focus is on financial outputs and cexcludesother performance measures; « the budgeting time horizon is not linked to the“rhythm” ofthe business -long horizons in rapidly moving sectors and short hori- zonsinrelativelystablesectors; ¢ information on current performance is not easilyaccessible; ‘¢ managers tend to play games with, and managearound,plans; 2 February 2001 ‘¢ employee goals and the appraisal process arenot linked to business objectives. ‘At the same time, budgeting has become even more expensive, vet adds less value than expected. A199 benchmarking studyshowed the costs of operating with the budgeting ‘model: the average company invests more than 25,000 person days per billion dollars of revenue in the planning and performance measurement processes; the average time taken to develop a financial plan is four and a half months; and companies need an average ‘of 21daystocompleteaforecast’. ‘A KPMG study showed that inefficient budgeting eats up 20 to 30 per cent of senior ‘executives and financial managers’ time. This iseonfirmedbytwolarge European companies, ‘Volvo Cars and Borealis, which have calculated that aver 20 per cent of management time is taken up by budget and reporting processes. John Fanning of KPMG believes that com- panies couldsave, onaverage,£4millionayear, ifthey replaced their budgetingsystems” ‘The early work of the Beyond Budgeting Round Table (BBRT) focused on new steering ‘mechanisms to replace budgeting, but we are row focusing on the organisational and bichavioural changes needed to support these * new mechanisms, This is reflected in the latestsetof12 Beyond Budgeting principles 1. Governance = use cleat values and bound- aries as aasis oration, not mentsandplans. 2. Performance responsibilty ~ make man- agers responsible for competitive ests, notformectingthebudget. 2. Deegation-vepeopethe fresdomandabil itytouct.doritcontrolandconstranthem. 4. Streture~onganise around the networks nd process otfunctionsand departments. 5.Covordination ~ corortinate cross-com- pany interactions through process design tnd fast information systems, not detailed. actions throughbudgets. 6.Leadership ~ challenge and coach people, don'teommand andcontol them 7. Goalsetting- heat competitors notbudgets 8. Strategy process ~ make the strategy pro- ‘cess continuousand inclusive proces, not atop-downannualevent. sion state-9. Anticipatory management ~ use antii- ppatory systems for managing strategy, not formakingshort-termcorretions. 10.Resourve management — make resources available to operations when required at a faireostdonitallocatethem fromthecentre, Measurement and control ~ use a few key indicators to control the business, not a ‘mass detailed reports, 12.Motivation and rewards base rewards on ‘company and unit-level competitive per- formance, notpredeterminedtargets. Principles1to 6 concer effective organisa- tion and behaviour,and prineiples7to12.con- cereffective performance management. Inessence, Beyond Budgetingentailsashitt ‘roma performance emphasis on numbers to ‘one based on peopl. It assumes that perfor- ‘mance improvement is more likely to come from giving capable people control over deci- sions (and making them accountable for results), than from simply adopting different rmeasuresandineentives ‘This isnot comfortable message for a mea- surement industry that believes that imple- ‘menting Economic Value Added or Balanced Scorecard are enough on their own to change performance Itisthe combination of effective “organisation and behaviour and effective per- formance management that leads to success (see figure 1). And, just like any mathematical equation with multiplicative variables ifany of the variables is zero, the net result willbe zero. ‘The failure to recognise this has wrecked many sttemptsat performanceimprovement. ‘A recent Business Week feature on organisa- tions inthe 2st century warned managers: “If you'veworked asamanagerforatleastadecade, ‘youcan forget mich of what you'velearntsofar. Prepare to toss out your business-school case studies and set aside many of the time-hon- ‘ured pringiples that have guided generations ‘of managers. The vast changes reshaping the ‘world’s business terrain are that far-reaching, ‘hatfundamental, that profound” And accord- ing to Gary Hamel : “ts universally apparent that wear living in aworld so complex and so ‘uncertain that authoritarian, control-orien- tated companies arebound to fail” ‘The concept of how a successful company ‘operates in the information age is shifting from ‘makeand-sell” to “sense-and= respond”. Make-and-sellisan industrial-age ‘movdl based on transactions, capital assets, ass production, economies of scale and product margins. Sense-and-respond i¢ an information- and serviee-age model, which emphasises client relationships, intellectual assets, mass customisation, economies of scopeand value creation Tocompete successfully in the information Feature Beyond Budgeting Figure1 Effectiveorganisation Effective performance Competitivesuccess andbehaviour management age, managers must be exceptionally good at six key issues. They must create a climate for fast response, engage the best people, gener- ate new business concepts, operate with low costs, find and keep the right customers and oepsharcholderssatistied. ‘Table 1 sets out these concepts of success aand shows how budgets can block their achievement. And Beyond Budgeting princi- plesunderpin these key success actors Forastart, Beyond Budgetingenablesfirms to respond faster and, therefore, cope better with uncertainty. In days when competitor actions were largely predictable andsuppliers held sway over customers, firms could plan, ‘make and schedule activities to optimise the efficiency of their intemal processes. But inereasing uncertainty makes such practices Ineffective ~ firms eannot prediet new com- petitors or what business concepts they will tuse. Such change wreaks havoe with tradi- ‘ional planning nd budgeting, Fast response means making strategy an adaptive process. Managers must be put in ‘charge of strategy and be able to monitor it ‘continuously, rather than once a year. And if now initiatives are needed, managers must hhave fast access to resourees. 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 asthey arise (not as predicted inan outdated plan);and toacquire and deploy resources when necessary (not as allocatedbyhead office) ‘The attitude to change is also important. Beyond Budgetingcompaniessee changeasan ‘opportunity, not a threat. They probe con~ stantly for signs of impending change and pre- cempt competitors’ actions and customers needs. They prepare rolling forecasts that sup- port strategy reviews and investment decisions Gheing careful not to distort the forecasting process by allowing senior managers to influ ence the outcome). And they have up-to-the~ ‘minute information about customers, costs, profits, market changes and anything else «essential forrapidresponseand good decisions. Beyond Budgeting also helps firms to find and keep the best people. A 1998 MeKinsey report, The War for Talent, pointed out that bigcompanies arefindingit difficult toattract and retain good people’. The top three rea sons why managers chose one firm over another were “values and culture” (58 per cent), “freedom and autonomy” (56 per eent) and-exciting challenge’ (stpercent)’ Offering a challenging environment is era cialto engaging and keeping the right people, but the budgeting model with its overarching bureaucracy, head-office memos and direc tives, and detailed rules and procedures, undermines such an environment. At one time this didn't matter. Competitive salaries, and good career prospects meant large firms could usually attract the people they needed, but talented managers today are much more ‘demandingabouttheirfutureemployers. In addition, Beyond Budgeting supports the new generation of business concepts. Product and strategy lfeeyeles are shrinking rapidly as new product ideas are copied and firms cannibalise existing products so they ‘anbefirsttomarketnewones. Itis increasingly clear that businesses can~ not plan and control their way to the faturein incremental steps. They must innovate and they must think differently. This means usi the reativity oftheir people to develop imagi- native strategies, new business models, and more relevant management practices. Bloated bureaueracies and budgetary eon- trols are the enemies of insight and inno vation. They stifle creativity with a rigid system of budgetary controls that reward 00d housekeeping, but fail to acknowledge creativity or innovation. And they fail to pro- vide _amanagement climate that encourages creativepeopletothrive. ‘Managers in Beyond Budgeting companies foster insight and innovation by sharing knowledge aeross networks. They encourage new ideas by breaking free from incremental thinking, And ther leaders act more ike ven- ture capitalists who oversee a portfolio of businesses with a diverse range of risks and February 2001 2Feature Beyond Budgeting Br Weer re UC uC isinguncertainty Environmentisnow unstableand unpredictable; competitorscancomefrom ‘anywhereatany time Intellectualcapitalis increasinginimportance Talented people arehardto findandevenharderto attract Increasingpaceof innavation Tocompete,firmsmust constantiyrefreshtheir productsandstrategies, and generatenewbusiness concepts Fallingpricesandcosts Pricesarefalling andcosts ‘mustbereducedicost reasescannolonger be passedontocustomers Deciiningcustomerloyaly Customersnowhave ‘extensive choiceandwill switchloyaltiesifnot totallysatisfied ‘Moredemanding shareholders Shareholdersnow demand betterreturnsthan competitorsandconsistent results 1.Coping withrisinguncertainy ~adaptquicklytocompetitive changesandcustomerneeds, don'trelyon improving forecastingand scheduling processes 2.Findingandkeeping talentedpeople-providea challenging workenvironment thatenablespersonal development. Don'tassume thatpeople illbeatiractedby payor perks 3.Generating new business concepts~createaclimate forself.questioningand innovation, notoneof ssubordinationand controls A Operating withowcosts— challengeandreducecosts. Don'tprotectandincreasethem 5.Findingandkeeping the rightcustomers-focusstrategy ‘andbehaviouronserving customers, notselling products 6.Creating consistentvaiue forshareholders-align targets, ‘measuresandrewards with long-term value,notwith short-term profits 2 February 2001 Radicaldevolution-devolveauthority forfastaction don'tcentraliseand delaydecisions ‘Adoptivestrategies -makestrategyan adaptiveprocess,don'tmakestrategy afixedanddeterministicplan Fastinformation-providefastand ‘openinformationsystems.Don'trestrict informationtothosewhoneedtoknow Rightpeople-recruitanddevelopthe rightpeople.Don'tsimplyfillvacancies ‘Scope toperform-providemultiple ‘esponsibility centres,Don'tconsolidate thestructureintolarger units L Tnspiationalleadership-dontadoptthe artotandstickapproach ‘Share inwealth use fair reward system, notonethatbenefitsafewpeople Venturecapitalmodel—viewtheb asaportfolioofinvestments,notas sub-setsofthebudget ‘Stretchelmate-createaclimateot ‘challengeand stretch, notcaution andcontrol Learning andsharing-shareknowiledge, don'tkeepittoyourself Lowcostnetwork-adoptalow-cost networkstructure,notan expensive andcomplexhierarchy Strategicalignment-alignresource usageandcostswithstrategy,notwith departmental budgets Challenge costs don‘tallowihem tobecomebudgetenttlements Customer relationships satisfy customer ‘needs quickly and profitably.Don'tjust seecustomersas buyersofproducts ‘Customerfocus—focusstrategy on ‘customers, notproducts Alignmentwithvaluecreation-align keydecisionswith long-termvaive creation notshort-term profits Rangeofcontrols-basecontrolsona range of futureindicatorsand relative performance, noton financialbudgets Rulesand proceduresandbudgetary controlundermineempowerment Fhredstrateqyandbudgetingyelesare bouitintothetradtionalmodeland diffcultochange Knowiedgeisassumediobe accumulatedatthecentreleading to restiictedflowsofinformation Budgetsdon'tconnectpeoplewith valuecreation Traditonalcost-cuttingmentalty leadstolargerunitstogaineconomies cofscale ; Budget-based perfoimancecontiact createsaclimateofmanagement by ear Incentivesusvaliylinkedto budgets Centralplanningapproach seesonly short-termimpactofrisky investment proposals Bureaucracyandcontvalsstine challengeandcreativity Budgetcelisencourage'‘defendown tuff attitude Hierarchy meansthathighcostsare “hard wired’ intothesystem Budget view fllstosupportstrategic costalignment Budget process preveniscost- reduction issuesbeing addressed Salestargetsandincentivesrun countertomeetingcustomerneeds Productfocusisdifficulttoshift Budgetcontractdrivesshort-term decisions “Rear-viewminror contielsbasedon budgetsfailtogivemanagersafuturerewards, than like central bankers who are interested only in low-risk projects. They know that people will perform better only if they are emotionally committed and this ‘means working formorethan money. ‘And Beyond Budgeting leads tolowercoss For decades, firms have passed internal cost increases on to their customers. But enter- prising firms are now using technology and slobalmarketstoofferradically different (and often cheaper) waysto deliver customervalue, ‘The downward pressure on prices and mar- sins has never been so intense and enduring, But,often, company hierarchy isnot wired for low cost of speed itis wired for control, and budgetingsystemsareitstraffclights SoBeyond Budgetingcompaniesoperatewith lower costs. They align products, processes, pro- jects and cost structures with their stratesy, “They also avoid fixing their capacity too far in advanee. Beyond Budgetingalso leads to find~ ing and keeping the right customers. As we travel further into the information age, customers are presented. with ‘more choices (often at the click of mouse) and more information on Which to base these decisions. Conse- quentlycustomerchurnisinereasing, Frederick Reichheld notes that, ‘on average, US corporations lose half their customers every five years". Firmsneed to know their customers and nnon-customers) and must be able to identity and target the right" ones. They need toknow hhow to satisfy them (their value needs) and hhow to maximise profits from them. But finding the “ight” customers is rarely on the agenda ofsaes planning meetings. Most sales budgets are constructed and monitored on the basis that customers are segmented by produet group, size, lifestyle, or some other srouping. They don't segment customers by theirvalueneeds. Beyond Budgeting companies, however, place customer value needs at the centre of strategy. They distinguish between customers who want transactional sales (Qhey want to buy the cheapest produets and serviees, perhapson the internet); those who want additional servie (they are prepared topay for advice about the most appropriate solution); and those who require customi- sation (they need their exact requirements to he addressed and satisfied). Clarifying eustomer ownership is crucial to maintain ingastrongrelationship. ‘And Beyond Budgeting leads to consistent shareholdervaluecreation. As fund managers fight to head the performance league tables {or economie value and shareholder returns, and increasing numbers of “day-traders” play Feature Beyond Budgeting Swedish bank getsa handle on costs Accordingto Sven Grevelius, EVP financeat Swedish bankHandelsbanken, challenging costsis fundamental to the Handelsbanken philosophy. Why do wehave lowercoststhan other banks? Isnoteasy tobe specific butthereare anumberofissuesthat spring tomind,"he says, "First, wehave few people atheadoffice controlling thebusiness. econd,andrelated tothefirst point, peoplein theregions and branchesareself sufficient They run theirownpartofthe business without much help fromabove and, becausethey aremeasured ontheircompatitive resultsinstead of anegotiated budget, they are much moreconcemedaboutcosts.Evenbranch secretariescan query expensesifthey lookout ofline. he group profit-sharing schemehasmuch todowith thisatttude of weeding out unwarranted expensesandimproving profits "Third, we havelowercreditosses.Thisisrelated tothe second point Becausewe give responsibilty tomany frontline people, they feel that they own their decisionsandaremore concemed thatthese arebased on goodinformation. "Fourth, wedon’tsimply allocate central coststo regionsand branches We exposetheseservices tothepressureofnegotiation. branches don'twant certain servicesorfeelthat theyare paying toomuch, theywill make their feelings known, Last, weusetechnologytoreducecosts.Ourinter- net banking serviceshave been very successful, but wearecarefultoensurethatallinternet ttansactionsendupatthe customer sownbranch Thisensuresthatbranchpperformance benefitsfomthelow costofinterettransactions whichfurterencouragestheruse. “Devolvingresponsibily for esuts,tuming costcentresintoproitcentres, squeezing central + cots. using technology, anderadicating thebudgetingcostentilement mental, aresomeoftheactionswehavetaken toplacecostsunderconstantpressure” the market, there is little doubt that investors are becoming more ‘demanding, while their loyalty isweakening. Failure to meet profit promises can Tead to stock price falls and senior executives can lose fortunesastheirstockoptions depreci- ate. The rection of many companies using the budgeting modesto eutcoststo support quar terly profits but this results in fewer good peo- pledoingmoreworkand workinglongerhours. And tougher targets are intensifying pres- sure, Downsizing, layoffs, short-term con- tracts and higher produetivty demands are pushing workers to the verge of nervous breakdowns. It is small wonder that a recent TLO report, Mental Health in the Workplace, concluded: "Workers worldwide confront, as never before, an array of new organisational structures and processes whieh ean affect their mental heath. These trends represent a ‘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 reeruiting and training replacement staff Beyond Budgeting companies aim to create consistent value streams. Giving managers control oftheir actions and usin simple mea- sures based on key value drivers and geared to beating competition is all that most cases require Leadingand lagginginlicatorshelpto ‘monitor value reation and provides an early ‘wamingsystem againstafinancial downturn, Companies interested in participating ina slobal benchmarking projet on the Beyond site at wrw-beyondbudgeting.org Particip tion will help you to relate the concepts in thi article to your unique circumstances. I's the first step to breaking out ofthe industrial age strait-jacket and moving towards a manage- ‘ment model that really supportsstrategy: Robin Fraser is programme director of the ANI Beyond Budgeting Round Table and Jeremy Hopeisaconsultant, ‘These issues wil be excrined in the CIMA Master ‘course Beyond Budgeting on 22 February in Dublin. 22May in London, 27 September in Edinburgh and 3NovemberinLondon.Te:02079179244 Fterences 1 ss Banham, “Reolton in planning’ CRO Mapas, ‘Raguet999 2. “Corporate tata pling ser rom neice" Hacketdencrarhing PRNeswre 250caber 1959 $¥A.Rober Kalan and David Noto, The Sroegy Focused ‘Orgerizaton HanardBusinee Schoo Pres 2001 5: ohn Fanning, 2st Centuy Budgeting, ICAEW, sue 23, 6 HckettenchmaringSokionsweiconpen 7, Fra Utewoed, “a0k beyond the budge, the Fines "Hawary 2000 {John Byne, “Management by web", desness Mek 2ehugun 2000 9. Gary Hamel, Leading the Reoltion, Hanard Busnes: Schoo Pres oeton Stephan Haeckel Adoptive Entre, Harvard Business 11/12. flzabethChamberset al The narfortalenkiney ‘Quer 1988 1 FederkkRechteld eariogfomcistrer defections” ‘M-Andrew Osbom "Worolacebues ave employersiathe "ed theGuarin, 120102000 Febmuary 2001 2