Document Citation: 108 & “The University of Sydney Library sia) Electronic Reserve Document ‘y cram bane tthe Univeraty of Syarey pureuart to Pan VB ofthe Copyriant Ac 1058 Ge Ac ‘Copyright under the Act Any further eoroducton ot comnmeenton eit mata! by yourtay ge the cules, Harvard Business Review 81(2) 2003 pp.108-115. Modern companies reject centralization, inflexible planning, and command and control. So why do they cling to a process that reinforces those things? Who “= Budgets? JeDGETING, as most corporations practioe I, shouldbe abolished. ‘That may sound like radical proposition butt would be merely the culmination of long-running efforts to transform organirations from central ‘ned hierarchies into devolved networks that allow for nimble adjustments to ‘market conditions. Most of the other ‘bulldng block rein place. Companies have invested huge sums nT network, process reengincerng, and a range of ‘management tols inching EVA (E2o- nomi Value Added), balanced seore- cards, and activity accounting, But they have been unable to establish a new ‘onder because the budget and the com. ‘mand and control cufre that it sup- ports remain predominant. ‘Senior executives ave been heardto ‘proclaim that thelr people have all the Authority ofthe chairman. In practice, by Jeremy Hope and Robin Fraser they marshal the power of computer systems to uncover mind-numbing ler els of detall and, using the budget as 4 ‘benchmark demand toknow why asses ‘cam has rung up higherthan-normal telephone charges fr instance or way ‘thas underspent the quarter's enter tainment allowance. And where ial ‘the authority ofthe chairman whentbe ‘team finds it can't meet the budgets sale targets? Fearing the consequence, the tam will Ieanon customers toodet ood they have every intention of re turning. And if by some chance the ‘cam thinks it will exceed ts target it ‘will press customers to accept delivery Inte next fiscal period, delaying wah abl cash Rows. Inextreme cass us ofthe budget 10 {ore performance improvements may Jead toa breakdown incorporate ethic. People who worked at WorldCom,"‘bankrupt and under criminal invest ‘ation, said CEO Bernard Ebbers's rigid demands were an overwhelming fact of lie there."You would have a budget, and he would mandate that you had to bbe ak under budget" sida person who worked at WorldCom, according to an article in Financial Times last year Nothing else was acceptable” World- ‘Com, Enron, Barings Bank, and other faled companies had tight budgetary contro procesesthat funneled informa- ‘ion only tothose with ‘need to know? In short, the same companies that vow to stay close to the customer, 50 that they can respond quickly to pre- ious inteligence about market shifts, ling tenaciously to budgeting pro- cas that dsempowers the front line, iscourages information sharing, and slows the response to market develop- rents unt too late, FeaRvAry 2003, ‘Arnumber of companies have recog- nized the fallextent ofthe damage done by budgeting. They have rejected the reliance on obsolete data and the pro- tracted, selfinterested wrangling over ‘what the data indicate about the future ‘And they have rejected the foregone conclusions embedded in traditional ‘budgcts-conclusons that render point Jes the interpretation and cirultion of current market information, the stock Itrade of the knowledge-based, net ‘worked company. Inthe absence of budgets alternative ‘goals and measures ~ some financial, such a5 cos to-income ratios, and some nonfinancal, such as time to market ‘move tothe foreground. And business ‘units and personnel, now responsible for producing results are no longer ex pected to meet predetermined, inter nally selected financial targets. Rather, every part of the company is judged on how well its performance compares with its pees’ and against worklass ‘benchmarks. In companies using these standards of performance, busines units become smaller,more numerous, and more en ‘wepreneuril Strategy becomes a grass roots endeavor. The aggregate result of ‘many small teams exploiting local op- portunities is a much more adaptive ‘organization. But that’ not to say these companies abandon their high expectations They don't naively assume that everyone Who 's given more autonomy will improve his or er performance. tn fact they r- (quire employees todo something much tougher than meet a fixed target. They ask them to chase a wilkothe-wisp, to ‘measure themselves against how well ‘comparable groups inside and outside 10TOOL KIT + Who Needs Budgets? the company willtum out have done nthe same period given the economic conditions prevailing a the time. Be- cause employees won't know whether they/ve succeeded orby how much until the petiod is ver, they must use every ‘ounce oftheir energy and ingenuity to ensure that their performance is better than that oftheir peers. Busines nits, plants, branches, and other groupings can measure their progress against comparable units within the company ‘through the use ofa few key financial measures. In order to measure them selves agaist external peers they can tse operational benchmarks based on industrywide best practices. (In some cases companies that have rejected bud jets rely on benchmarks collected and reparedby specialist firms that under- stand the particular industry.) As in ‘works. This shifts the emphasls from ‘meeting short-term promises to im- roving our competitive position year after year. The result is much more ae ‘urate interpretation of our results and ‘news flow, meaning les volatility in our shares. Analysts lke and respect our ap- roach. They nolonge ask for numbers ‘based forecasts” The willingness ofthe ‘company’s investors to live without ‘such promises has inspired UBS to shi Its focus from detailed plan to trend analyses and rolling forecasts. Breaking Free from the Budget Vise ‘Though the fist companies to reject yond budgeting can be found today {na range of countries, industries and ‘The same companies that vow to respond quickly to market shifts cling to budgeting a process that slows the response to market developments until its too late. ‘sports the objective sto keep improv. Ing your position unt you become the league leader. ‘Abandoning budget targets ~ those solemn but ultimately hollow promises ‘tw investors~fees a busines to give a ‘wide varity of emerging information its due. Sharing that information can form the basis of @ new kind of rel ‘tionship with the capital markets. UBS, the Swiss financial services company, hasn't discarded budgets, but it has ‘hanged how it communicates *We pro- vide very few financiak performance ‘commitments says Mark Branson the ‘company's chief communications of. ficer. "Our experience shows they are counterproductive, building pressure for short-term ation to save the cred bility of forecast. In effect, we show an- alyts and investors how the business cultures. They include two banks, @ petrochemicals company a distributor, a car manufactures, brewer, a furni- ture reals, a truck manufacturer, an ‘eyecare company, a computer manu- factuer, a telecommunications com- ‘pany balt-bearings manufacturer, food producer and a specialty chemi- ‘als company. They range from small~ ‘a250-employe charity dedicated to pre venting and curing blindness to huge and comple, as inthe case of ne global Industrial organization with thousands of products. ‘At these companies, an annual fxed- performance contract nolonger defines what subordinates must deliver to su petiors inthe year abead. Budgets no Jonger determine how resources are a- Joeated or what business units make and sell or how the performance of those Jeremy Hope and Robin Fraser are directors ofthe Beyond Budgeting Round Table (BRD, an international management research concertium (www.brtor). The ‘book Beyond Budgeting is being published this month by Harvard Business School ‘Pres. Hope canbe reached at eremyhope@bbrt.rg: Fraser cam be reached at obin- Sraserabbreorg. 110 ‘units and their people willbe evaluated and rewarded, Some project leaders er timate that they have saved 95% of the time that used tobe spent on budgeting and forecasting Instead of adopting fixed annual tar es business units set longer term goals ‘based on benchmarks such as retumon capital. The elements of factors mea sured are key performance indcaton~ PIs~such a5 profits, cash flows, cost ratios, customer saistaction, and qual: lity The criteria of measurement are the performance of interal or external per {groups and the ests in prior periods. “Two ofthe important comporate goals at Borealis, a Danish petrochemicals company, have been the reduction of fixed costs by 30% over five years anda decrease in time lost to acidents in ts plants. However, the company’s bu ‘ess units and personnel are measured ‘and rewarded onthe basis of how well ‘they reduced fixed costs and improved uptime in comparison to best inclas Industry benchmarks. ‘man empovered organization people are free to make mistakes and equally ‘ree to fx them. Managers have wide discretion in making decisions a8 a r- sul, they can obtain resources more ‘quickly than in traditional companies ‘and without having to document need ‘uites0 elaborately partly because they are accountable for the profitably of ‘their units and can therefore be ex- pected to shed any exces inthe event ‘that demand fll In such a system, the “spend itor lose i philosophy that workin traditional ganizations has10 ‘meaning. And employees, because they ‘dont require much supervision, dont ‘eed the extensive central services that ‘most organizations provide Eliminating those services hata dramatic effect on acompany/scost structure. Key performance indicators ~ which tend to be financial atthe top of an ‘organization and more operational he ‘nearer a units tothe front ine—ful, theselfregulatory functions ofbudgets. ‘But KPIs dort need tobe so precise. UK charity Sight Savers Intemational, for ‘example, has begun to develop target ranges fr its KPIs. While managers aeThe New Performance Contract ‘Companies that move beyond budgeting shit decisionmaking from ‘the core tothe periphery. Instead of negotiating in advance the targets ‘managers must reach, te resources they wll ave, and their reward for simply doing what's expected, these companies trust the managers to claim the resources they need to seize the opportunities they se. In short an everchanging marke, not dated plan, dictates behavio« And ies beating the competition that brings renards. oy wy: free to devise ways of achieving reslts within these ranges, senior executives Took atthe risks and test the assump- tions of strategic nities that require ‘very substantia resources. ‘Atmany such companies, rong fore- cast that look five to eight quarters Into the future play an important role in ‘the strategic proces. The forecasts YP- sally generated each quartet helpman- agers to continually reassess current sctlon plans as market and economic conditions change. (For more informa tion on how rolling forecasts work, the sidebar “An EverChanging View ofthe Future") eonuaty 2005, a i “oe Fired targets lead to only LL. | Reatve targets push employees {incremental improvements. Tpoutdo themsetves I 7 Rewards based on relative Fixed incentives instill iy }—* { performance give people the for ofa | ‘confidence to take risks. I Rigi plans focus people |_. { continuous panning focuses ‘on compliance. people on value creation. I Preset allocation ofresources | _, { On-demand allocation of resources encourages hoarding minimizes costs. I Decision making by local units ‘Centralized decision making }—+ in touch with one another makes gemmc [-(Seeee Without budget expectations to wory bout staff members can do something with the nonconforming customer and ‘market information they cllect-other than hide it.The reporting of unusual pattemsand trends as they unfold helps ‘the business avoid shortages or overages and formulate changes in direction. In- stead of being imposed from above, strategy seeps up from below, How the Budget Problem Grew For most participants, the traditional budgeting process stats atleast four ‘months before the begining of the fi- LIT + Who Needs Busgete? ‘al year. Operating divisions business ‘unis, and department receive "budget packs" that include forms asking for forecasts of sales, profits and capital ex penditures. The Forecasts ae reviewed st ahigh level, and ater several rounds of give-andtake, the budget document isfinalized. “The budget i avast compendium of, etals. I lists the eapital and opers- ‘ional resources that the corporate cen- ter is to make avallable to operating nls the obligations made by each unit for the coming year, and the commit ‘ments that business or operating units Ihave made to one another, such a5 @ production units pledge to mest the Sales plan. 1 also states wat will ap- ‘pen to individuals’ compensation if targets are missed or surpassed. Over ‘the course ofthe fiscal year, each unit Is expected to file regular reports on its progress toward meeting the targets. Despite the numbercrunching abil ‘es of powerful computers, budgeting remain protracted and expensive pro- cess, absorbing up to 30% of manage- ment’ time. A1998 study of global com- panies showed that on average they {invested more than 25,00 persor-days per 4 billion of revenue in the plan- hing and performance-measurement processes. Ford Motor Company i re ‘ported tohave figured that its toa ost amounted to $12 billion per year. For companies involved in mergers, acqu sition, spin-off, and other reorganlza- tions, the budgeting workload can be overnbelming. ‘Increasingly, even finance people question the value of budgeting. One published report says nine out of ten thinkitis cumbersome and unreliable. ‘Among their complains I takes time ‘away from activites that ad greater val, such s supplying managers with the information they need to make decisions. A 1999 global best practices study concluded that finance personnel spent only 2 oftheir time analyzing and interpreting the numbers; they spentthe restdoing"lowervalue-dded activities" such as gathering and pro- cesing dita, often for budgetseated discussions, mm Many ofthe companies that have gone beyond budgeting enrich and aceler at thei information flow through the se of rong forecasts, which are ce- ated every three months oF and always cover the ‘same period=typcally five to eight quarters. Be- ‘cause these forecast are regularly revised, they support managers ability to fashion strategies that continuously adapt to market conditions. Roling forecasts fer from budgets in several ways. They dott envision a fied “nish ine” atthe ‘end ofthe fiscal year when income, costs, and other tlements are measured against the budget’ (by ow) stale targets. They Include only fen key var ables such as orders sales, costs, and capital expen-