Written Article Management Control System 11/4/2007

Article Summary - Who Needs Budgets? (Hope and Fraser, 2003[1]) In Who needs a budget, the authors advocate abolishment of budgeting in favor of decentralized, flexible planning that empowers managers to make wiser and quicker decisions with focus on meeting the needs of customers and responding to market shift. Rigid budgetary control processes drain valuable resources, stifle innovation, and discourage front line managers from making responsive decision. The use of the budget to force performance improvement may lead to a breakdown in corporate ethics. Many companies have dispensed with traditional budgeting process. Instead, they set longer-term goals and use key performance indicators and compared them with the best-in-class industry benchmarks. Employees are required to measure themselves against the performance of competitors and against internal peer groups. As a result, people are more risk taking, managers have more discretion in making decisions, resource deployment are quicker, and information sharing become easier. Companies that have rejected the budget rely on rolling forecasts, which are created every few months and typically cover five to eight quarters. Because the forecasts are regularly revised, they allow companies to continuously adapt to market conditions. The author cited examples of two European companies - the bank Svenska Handelsbanken and the wholesaler Ahlsell to demonstrate in detail how breaking free from budgets has helped them unleash the power of management tools and potential of decentralize organization. At the end of the article, the author brought to the table the contrast of two performance measurement systems - fixed performance contract vs. relative performance contract - so one can easily see the benefit of relative performance measures which have used successfully in Svenska Handelsbanken and Ahlsell.

[1] Jeremy Hope, Robin Fraser, Who Needs Budgets?, Feb 2003, Harvard Business Review http://my.ltu.edu/webapps/portal/frameset.jsp?tab_id=_2_1&url=%2Fwebapps %2Fblackboard%2Fexecute%2Flauncher%3Ftype%3DCourse%26id%3D_896_1%26url %3D

My learning and comments on article as it is related to course material: In most of organizations, budget is used to influence a managers performance before the fact and to appraise performance after the fact [2]. In that sense, it is a control tool that is devised to ensure companys strategic plan implementation would not be derailed. Ideally, it should be challenging but attainable. However, as pointed out in Hopes article, budget often involves inflexible processes and tight targets that it becomes a fixed performance contract which has many drawbacks such as instilling fear of failure, focusing people on compliance, encouraging hoarding, and ignoring market feedback. In spite of these difficulties, abolishing budgeting entirely would forfeit the benefits of budgeting brought to an organization. First, without budgeting process, it is difficult to estimate the profit potential of business units. Second, budgeting assign responsibility to line managers and obtain their commitment. Third, budgeting helps coordinate the activities of the several parts of the organization. Fourth, budgeting helps fine tune the strategic plan [2]. The last point highlights the benefit of budgeting as a planning tool. A good budget should be attainable. Therefore it requires revisiting the strategic plan and budget forecast. Budgeting should involve all levels in the organization, and consider external and internal changes, in order to provide opportunities for line managers to challenge the viability of strategic plan and validity of forecast. Facing these seemingly paradoxical properties, what do we do with budgets? The answer from Hopes article is not as drastic as it first seemed. In my view, switching from fixed performance contract to relative performance contract was

really about adopting an informal control process that combines financial budgets with non-financial objectives. It make sense to give more weight to key performance indicators that measures the return on investment, customers satisfaction and quality aspect of products and services. While the informal control and relative performance measure take the budget burden away from front line so they can adjust the resources deployment to changing demand, it does not necessarily undermine the role of corporate leaderships. In fact, this approach frees corporate staff from detail planning and control, so they can spend more time to monitor the overall status of business and engage in continuous improvement of the process. Take Svenska Handelsbanken [1] for example, The head office monitors transaction volumes, fluctuations in numbers of customers, customer profitability, branch profits, cost patterns, productivity, and much more. [1] As mentioned in the article, doing away with the formal and tight budget doesnt mean companies are abandoning their high expectations. Rather, with implementation of powerful management tools, they can now rely on rolling forecast that focuses on a few key variables, and revises constantly to reflect changing economic conditions and customer demands. It is worth noting that after abandoning formal budgets, both Svenska Handelsbanken and Ahlsell have reorganized into more profit centers or shifted focus to branches. This indicates to me that an organization must link their control system with the structure of responsibility centers. The profit center approach certainly fosters autonomy of business unit and requires less detailed budget control from corporate level. As stated in the text book [2], the purpose of management control system is to encourage the managers to be effective and efficient in attaining the goals of the organization. Therefore, budgeting or not depends a great deal on what it takes to motivate an organization. When done right, a participative budgeting process does have motivational power that aligns lower level managers objectives with company strategy. Hope and Fraser has concurred this view point in the article, when used in a responsible way, budgets provide the basis for clear understanding between organizational levels and can help senior executives maintain control over multiple divisions and business units.

Ultimately, as Hope and Fraser have pointed out, an organization must adopt an ever-changing view of future. As customer demand changes and new management tools become available, it is important for companies to continuously review their control systems and use ones that best support their strategy.

Reference: [1] Jeremy Hope, Robin Fraser, Who Needs Budgets?, Feb 2003, Harvard Business Review http://my.ltu.edu/webapps/portal/frameset.jsp?tab_id=_2_1&url=%2Fwebapps %2Fblackboard%2Fexecute%2Flauncher%3Ftype%3DCourse%26id%3D_896_1%26url %3D [2] Robert N. Anthony, Vijay Govindarajan, Management Control Systems, 12th edition, McGraw-Hill