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Budgeting Practices – Research Bob Turco Doug Bennett. D.L. J.P. Masco BCG “F.M.” Budget Sub-Process. Research Sources. Turn Your Budgeting Process Upside , Robert A. Howell, Harvard Business Review, August 2004
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D.L. J.P. Masco BCG “F.M.” Budget Sub-Process
Research Sources • Turn Your Budgeting Process Upside, Robert A. Howell, Harvard Business Review, August 2004 • Corporate Budgeting is Broken, Let’s Fix It, Michael C. Jensen, Harvard Business Review, November 2001. • High-Performance Budgeting, Harvard Management Update, Harvard Business Review, January 1999. • Who Needs Budgets, Jeremy Hope and Robin Fraser, Harvard Business Review, February 2003.
Topics • We are not alone • Case Study – two real live examples • Boiling down what the research suggests • Approach, Motivation and Mindset • Process improvements • Compensation linkage
Budget Reality - we are not alone! • “Corporate Budgeting is a joke causing short term actions to hit budget or under promising to over deliver, which negatively impacts capacity planning and customer service.” • Major issue is use of budget to set compensation targets. The motivation is to set low targets and… • Do anything to achieve them. • Make short term decisions that hurt the company in the long run. • Commit fraud. • “The Dreaded ‘B’ Word” - The budgets are out-of-date before it is completed but we still spend a significant amount of resources on an unproductive exercise. • Budgeting is the “Information Super Highway of Hierarchies” • Traditional budgeting takes 4+ months, 30% or management time and, on average, take 25,000 person days per $1 billion in revenue.
Case 1: Svenska Handelsbanken • International Bank, with 550 branches in 4 countries, abandoned budgeting in the early 1970’s • It has outperformed its rivals on every measure including return on equity, shareholder return, earnings per share, cost-to-income ratio and customer satisfaction “Either a budget will prove roughly right and then will be trite or it will be disastrously wrong and, in that case, will be dangerous.” – Jan Wallander, Handelsbanken CEO
Case 1: Svenska Handelsbanken • Budgeting was only one aspect of the reinvention • Org structure changed to three layers (branch manager, regional manager, CEO). There was no organization chart. • Span of control was wide, limited micro management • Few decisions require executive level approval (and those were made quickly). • 600 profit centers = ownership and accountability • High level targets: costs at 40% of income (industry was at 60%). Free to set prices and discounts based on market. • Branches are responsible for reducing costs, satisfying customer needs, and boosting income. Each had loan approval authority.
Case 1: Svenska Handelsbanken • The company’s 11 regions competed like athletic teams in a league, trying to top one another on key measures • Standings, based on average and ranking, are prominently displayed in “leagues tables” • Managers know what is acceptable performance – “you can’t linger in the depths of the league table for long.” • Peer pressure plays an important part in the process – no manager wants to let the regional team down. • Balancing of competition and cooperation • Every customer must be attached to only one branch • A portion of the overall company profits are put in a companywide pool • Every employee gets an equal share regardless of seniority or performance • There are not rewards based on targets or “league performance” (peer pressure only) • Resources: individual managers determine staffing needs and salaries. • Information: fast, effective and transparent to all. Problems also transparent to all. It is not just the budget, it is the overall management system
Case 2: Ahlsell • Swedish wholesaler abandoned budgeting in 1995 • Main lines of business – electrical, heating and plumbing products – have overtaken their Swedish counterparts in profitability. • Centralized warehousing, administration and logistics • Formed numerous profit centers (200) and business area teams within each local unit (e.g., heating and plumbing). • Profit centers are fiercely competitive with each other. • Process Highlights • Detailed sales plans are no longer made centrally • Headquarters communicates only general aims (#1 in electrical products within two years). • Local units have been freed to develop their own approaches to local conditions and customer demand • Have authority to adjust resource levels to respond to changes in demand rather than wait until annual budget cycle. • Function of leadership has changed from planning and control to coaching and supporting the frontline units.
Case 2: Ahlsell • Process Highlights - continued • Finance teaches and helps units interpret the profit and loss statement • KPI’s: key performance indicators are now used to set goals and impose controls. Include cost per line times, availability, level of service, sales growth, profit growth. • Financial systems were switched from focus on peformance vs. budget to a focus on customer profitability including insight on cost to serve. • Sales now knows how every customer wants to deal with them; low-cost transactional, value added services, strategic relationships and which customers offer the best profit making opportunity. • Rolling forecasts are prepared quarterly by staff at headquarters quarterly with input from the field. • Results are available with little delay and employees at every level in the company see them simultaneously. Outcome is a self-motivated and adaptable workforce
Approach, Motivation and Mindset Practices • Use budget as a tool to introduce and reinforce a growth Mindset • Rolling plan of 2-3 years to keep management eyes on the more distant horizon • Focus should be on growth drivers: investment (capital, R&D, process improvement, share, new markets/customers, value creation) • Rename budget: "Profitable Growth Plan" • Budgets can be a powerful instrument for forecasting, planning and employee involvement • Begin with objectives / outcomes instead of numbers • Answer the question "what are you going to do with the resources we are going to give you?"
Approach, Motivation and Mindset Practices • Six Point Check List • Begin with objectives / outcomes instead of numbers and answer the question "what are you going to do with the resources we are going to give you?" • Ensure objectives align and define "winning" for the year upfront in the process • Link budget to performance drivers: quality, speed, service, share, productivity, etc. • Turn budgeting into a team building exercise to drive "thumb prints of ownership“. • Don't put it in the filing cabinet - put it on the wall or intranet. • Explain payoffs: momentary and non-monetary (e.g., developing of management and leadership skills) • Transform culture from command and control / centralized hierarchies to devolved networks that allow for nimble adjustments to market conditions
Approach, Motivation and Mindset Practices • Abolish the budget - every part of the company should be judged on how well it performs compared with its peers, competitors and world class benchmarks (internal and external) • Financial and non-financial measures • Foster entrepreneurial actions • Strategy becomes grass roots effort • Many small teams exploiting local opportunities • Create a much more adaptive organization • Measuring against comparable groups inside and outside, which won't be known until end of period, driving high energy and ingenuity to ensure performance is better than peers. • Keep improving position until you become the leader • Companies have saved 95% of the time that used to be spent on budgeting and forecasting • Creates an empowered organization: accountable for overall results, free to make mistakes / take risks, wide discretion on decisions, obtain resources quickly without huge documentation requirements
Budget Process Practices • Budget is on a rolling basis with updates semi-annually • Timing consistent with normal business cycle, not financial / fiscal calendar • Use key performance indicators • Financial at the top level • Operational at the unit level
Compensation Linkage Practices • De-couple budget from compensation. • Use a linear bonus methodology • Base rewards on performance relative to market • Reward people for what they actually do, not what they do in comparison to what they say they will do. • Choose the right performance measures; think broadly and carefully • single, clearly defined metric for success that can be the basis for trade-offs (EVA, Cashflow) • Use of cash flow instead of accounting profit to prevent gamesmanship (cooking the books)
Summary • All the principles and practices of budgeting assume, and perpetuate, central control. • People at the front line of a top-down operation are hardly likely to report bad news if the inevitable result is a verbal beating – or to report good news if their reward is more ambitious targets. • Companies that dispense with budgets can unleash the full power of modern information systems and tools • Corporate planning ceases to be a series of breathless sprints • It becomes an endless conversation • Knowledge flows from frontline to headquarters and back again, permitting the full potential of a radically decentralized organization to be realized
The Opportunity • The current budget process is a symptom of a bigger issue… • It is the way it is for a reason • What is the root cause? • The Opportunity - to design a process which; • Drives a conversation around what is really possible for the business • Shares the leadership and accountability with the Executive Team • The business is growing too fast and is too large for a command and control environment • Identifies the real competition and an develops an plan to beatthem Let’s start the change over the next two days!
MASCO Benchmarks Best 2 weeks Best Worst 4 months Worst >20 Best 0-10 Worst
Alternatives to Budgeting • Traditional budget is a “fixed performance contract” • On year • Fixed Target • Allocated resources • Monthly control • Predetermined rewards • Result of negotiation • Alternative: Continuous Planning and Adaptive Control
Beyond Budgeting • Drive performance by • Comparison to peers and world class benchmarks • Focus on strategy and balanced scorecard • Non financial and financial – relative to market • Focus on trends and graphs • Backwards actual and forward forecast • Rolling forecast with limited involvement • Focus discussion on gaps and how to close
Output from BCG • Assessment • We are ready for change Full report from survey
