Stop Budgeting & Start Adding Value
The ritual yearly finance dance needs to stop.The music is old fashioned and we are just fooling ourself
Marty de Jonge
How to make a shift towards Beyond Budgeting
The Swedish ‘Svenska Handelsbanken’ operates from the idea that every branch is “the bank” in itself. This means that the more than 800 branches are free to make their own decisions about granting loans, their spendings on marketing, sponsoring, etc.
The head office in Stockholm is only there to support the branches on overarching areas. There are no yearly targets set in concrete imposed from above. Instead, they work with relative targets in order to compare performance based on the market average and between the branches.
This way of looking at budgets is not totally unique, but Jan Wallander the CEO of Svenska commercial bank in the seventies was one of the first to take such a rigorous step in a financially driven industry such as banking.
The reason for this decision was the fact that he was already aware at the time that annual budgets simply don’t work.
If they turned out to be correct, it was a lucky shot. The information on which the budget was based is already outdated so this success can not be reproduced and when the budget turns out not to be correct, it is often too late to take effective action.
The bank relies on dynamic financing and just-in-time spending, supported by an ongoing dialogue between the branches and head office.
Nor does the bank offer a hefty performance bonus for the C-level alone. instead, the bank has set up an innovative profit-sharing and equity programme that benefits all employees on a pro-rata basis.
And this profit-sharing, based on the same relative target approach, is only applicable if the bank outperforms the market average for the banking sector. (Something it almost always did, even in the recent credit crisis)
To properly allocate our resources, we think we need a budget. There is probably no other process that is as awe-inspiring and hated as the annual planning and budgeting process.
Perform the ritual dance
The ‘culprit’ for this budgeting process is James O. McKinsey. (Yes, the one from the same-named consultancy firm) . In 1922 he published his first major work, entitled Budgetary Control, that has roughly the following approach, which we still carry with us to this day 100 years later:
- A business plan is made based on bottom-up and top-down negotiations between headquarters and business units. Assumptions are made about what internally and externally is going to happen in the coming twelve months.
- Management anchors a version of the plan which they believe strikes the precarious balance between what satisfies shareholders and what is theoretically achievable. This forms the basis of the budget for the coming year.
- The budget contains a wide range of targets for sales and profitability, as well as financial commitments to support operations and investments. All this is underpinned by a comprehensive range of financial incentives to ensure that everyone sticks to the set budget!
- During the following twelve months, the actual performance is closely compared to the planned budget. Any deviation is put away as a good or bad performance of the team. Managers are expected to close performance gaps, preferably without adjusting the resource allocation. (The idea that the underlying budget assumptions may have been unrealistic is hardly ever seriously considered.
- Halfway through the same year, the process is restarted for the coming year. The resulting workload comes on top of the day-to-day implementation of the existing plan and budget.
There are only a number of problems with this approach. To start with, budgeting takes a lot of time. Ford Motor Company once estimated that its planning and budgeting process cost around $1.2 billion a year.
And that’s how it is with many more companies. They often spend almost one-quarter of the year checking, measuring and ‘fine-tuning’ the current budget and another quarter preparing the budget for next year. Of course, this is at the expense of their ‘real’ work.
In addition, budgets are too rigid and too inflexible. Circumstances change rapidly in this complex world, but traditional budgets cannot respond to this. An annual budget doesn’t take this volatility into account.
All developments in the market are interrelated and interlinked. This means that a small change creates a wave of adjustments that nobody wants.
Even if this change leads to positive deviation, few are willing to implement it. A manager is probably not eager to change his budget to help a division in financial difficulties if this means he will be cut down on his next years budget.
The system doesn’t want to play jazz, just sheet music.
— Aaron Dignan
In his book The Little Book of Beyond Budgeting, Dr. Steve Morlidge gives a simple explanation for the fact that the Mc Kinsey method is not working anymore:
“ Budgets create sub-optimal performance by forcing the company to use the same figures for conflicting purposes”.
Targets must be:
It is simply impossible to cast these three purposes in one figure!
As a result, all those involved try to manipulate the process to their advantage. Hoping to get what they want, leaders ask for targets that they know are too high. Managers, on the other hand, want targets that they can easily meet because they assume that they will be forced to aim higher anyway.
“We’re deliberately fooling each other, but we’re all playing along.”
It is all relative. Imagine that a dated organization has set itself the target of 10 percent growth. They meet this target, but the market is growing by 20 percent. So does everyone deserve a bonus?
The Beyond budgeting institute advises beating the average performance of the competition. Why?
Suppose instead of growing, the market shrinks 20 percent, but your company performs the same as before.
In those circumstances, that would be a fantastic result. But with the traditional approach, no one would be rewarded for this.
In an uncertain world, relative performance is the only good measure. So companies are compared with other companies and teams with other teams.
What’s the alternative?
Which form of financial management fits well in this current VUCA and Agile world?
One of the successfully used modern budgeting methodologies is Beyond Budgeting. A complete system of principles, processes and tools to work without fixed budgets, but with common sense, transparency and trust.
Beyond Budgeting is not designed to work without budgets or a budget. The goal of Beyond Budgeting is to bring back common sense in our organizations. How do you do that?
You go back to what the budget is meant for. To do this, you cut it up into parts and make it an ongoing process rather than an annual one.
Advantages of Beyond Budgets
By Beyond Budgeting, you bring the value back into the budgeting process. You simplify the process and save time by saying goodbye to unnecessary steps.
You improve financial management by not allocating resources in advance, but where and when they are needed. You assess performance based on reality and not on the prediction made in advance.
And, not unimportantly, you ensure that decisions are made on the basis of knowledge and not on the basis of assumptions.
From control-based management to trust-based management.
When you want to adopt this completely, it requires a transformation of the organisation. Fortunately, you can also start smaller.
Start by examining the current processes and chart the mismatch with Beyond Budgeting. Do you use a budget with targets, a forecast and a budget?
Disconnect these processes from each other and give them their own interpretation, according to the intention of these resources.
Moreover, start steering on the basis of trust. Give a team a credit card instead of a budget. If you make all expenses transparent and transparent to everyone, then budgets are superfluous. Each individual will behave like a financial manager.
What is Beyond Budgeting in practice?
In its core Beyond Budgetting works along 12 principles. These twelve principles are divided into two aspects: leadership principles and management processes.
These two elements need to be aligned to avoid ambiguity between what is said and what is done. The purpose of these principles is to lead and inspire organizations in the transition to Beyond Budgeting.
The involvement of employees partly determines the success of the organisations. By sharing a common, daring and noble goal, employees become more committed than by striving for and controlling short-term financial and individualistic goals.
In combination with the goal of the organization, the values of a company provide encouragement and pride to the employees. Values provide a guideline for employees to do their work independently and freely. Values stimulate creativity, initiative and a greater sense of responsibility. All these factors benefit the performance of the organisation.
Transparency means that information is kept open for self-regulation, innovation, learning opportunities and control. Transparency is an important element for organizations because it creates a positive image, both inside and outside the organization. It also works as a social control mechanism.
The organisation must be set up in such a way that the self-managing units are autonomous and independent. They must operate in a customer and market-oriented manner in order to respond flexibly to the changing wishes of the customer. This structure also makes it possible to quickly anticipate threats from the market in which they operate.
The hierarchical organisational structure should be decentralised by setting up self-managing units. This will give the individual managers the authority to run their own piece of business. The hierarchical structure of the organisation may only be used when making decisions that affect all units of the organisation. Self-directed units are smaller and therefore more flexible and cheaper.
The sixth principle is to link the work of all employees to customer needs and to prevent conflicts of interest. In this way, the customer is central and the activities and processes are tailored to the amount of client value they add. A conflict of interest can play a role, for example, when receiving sales bonuses. By only focusing on the sales figures, customer needs may be ignored. This approach is not desirable because it is clearly focused on the short term.
Rhythm is about the dynamic organisation of management processes. It is often planned and evaluated per quarter, but it is more effective to respond to changes and events throughout the year in smaller iterations. However, this requires a decentralized and flexible organizational structure.
8. Targets and objectives
Organisations develop and disseminate too many objectives. Valuable objectives provide the employees with guidance and coaching instead of precise targets. It is also important that these objectives are relative and not fixed. In a world full of uncertainties and dynamics, they need to be able to change quickly.
9. Plans & forecasts
Activity planning and forecasting must be carried out objectively and without systematic errors. The difference with targets and objectives is that they may be ambitious, whereas prognoses and plans must be realistic and accurate.
10. Resource allocation
Resources should be allocated where they are needed and not just on the basis of the budget. The self-managing units within an organisation must be given the freedom to apply for the amount of resources they need. There should therefore not be a fixed budget for each department.
11. Performance evaluation
Beyond Budgeting calls for a more holistic approach to performance evaluation. It should not only look at figures and results, with possible related bonuses, but especially at how these results have been achieved. There should be room for feedback regarding learning and development, and it is important that this feedback is not only given by managers. Direct colleagues often have a better idea of the performance of another colleague.
The rewards that are distributed must be determined on the basis of the results of the organisation and the independent units. The level should depend on the relative performance compared to the competition. Thus, remuneration should not be predetermined and granted on an individual basis. In this way, the team spirit will be strengthened and a sense of belonging will be created.
Benefits Beyond Budgeting
The transition to a Beyond Budgeting oriented structure is intensive and comprehensive but brings valuable benefits. The BBRT mentions on their website some concrete advantages of using the Beyond Budgeting model:
1. Shorter response time
By introducing relative objectives, less bureaucracy and autonomous business units, the organisation is able to respond more quickly to market developments. The flexible company network is built on values and boundaries and the strategy can be adjusted relatively quickly.
2. Development of innovative strategies
The open business structure, characteristic of the Beyond Budgeting model, ensures that there is plenty of room for self-management. Both lower-level managers and employees have greater freedom of action so that creativity can be optimally exploited.
In addition, the open company structure ensures that decisions can be taken more easily because of the lower number of management levels. Also, the traditional remuneration structure, purely focused on results, is abolished and a relative remuneration system is introduced in return. In this way, developments and innovations are stimulated more.
3. Lower costs
The main advantage of abolishing the short-term mentality is that unnecessary work is eliminated. The traditional budgeting process is replaced by a motivated search for customer focus in order to structurally reduce costs in the long term.
4. More loyal customers
Now that customers have the central role within an organisation, their needs are also met more quickly. Because the Beyond Budgeting model allows for a faster response to these needs than the traditional model, this can lead to more customer acquisition. This can greatly improve the competitive position of the organization.
Now it is your turn
What do you think? Are you familiar with the Beyond Budgeting model? Do you recognize the above explanation or do you have additions? What do you think are factors that can contribute to a good elaboration of Beyond Budgeting?
Share your knowledge and experience via the comment field at the bottom of this article.
If you found the article useful or practical for your own knowledge, especially share it with your network of friends and business relations.
Hope, J., & Fraser, R. (2003). Beyond budgeting: how managers can break free from the annual performance trap. Harvard Business Press.
Hope, J., & Fraser, R. (2003). Beyond budgeting. Harvard Business School Press, Boston.
Daum, J. H. (2002). Beyond budgeting: a model for performance management and controlling in the 21st century. Controlling & Finance, 5, 33–34.
Marty de Jonge
As an agnostic change agent, I am constantly amazed at what happens in organizations and learn every day. Enthusiastic writer and always open for discussion.