Manage Performance Better Without A Budgeting Process. 

Mitchell Max Shares Insights From the Beyond Budgeting Round Table

By: Zayna A. Khayat, The Boston Consulting Group

“The budget is a relic from an earlier age. It is expensive, absorbs far too much time and adds little value”, comments Mitch Max of the specialist management consultancy The Performax Group.  At a recent SLF research briefing entitled “Slaying the Dragon:  Managing Performance Better Without Budgets”, Mitch Max shared stimulating research findings from the Beyond Budgeting Round Table, of which The Performax Group is an associate member.

Budgeting Controls Performance

Four fundamental processes underlie the budgeting process that nearly all organizations endure annually:

  • Set strategic goals

  • Set business targets/allocate resources/make plans

  • Generate the budget

  • Control performance to keep results on track with the budget.

“It is very challenging to change the budgeting process, even though we are increasingly dissatisfied with it.”

The result?  A performance contract that is fixed.  Results are expected to be achieved within a fixed period (normally one year), with a pre-defined ceiling on revenues and floor on costs.  Controls to ensure results are on track occur at predefined time points (i.e. monthly, quarterly).  And rewards for performance are predetermined through a negotiation process with senior management.  In all, more than a year in advance of executing on a plan, employees commit to saying  ‘I will deliver X for someone else by a stated period of time, and will get Y in return’.

As Max sees it, there are three fundamental flaws inherent to the budgeting process that have serious implications on how companies operate and perform.

  1. Cultural flaws – budgets undermine performance

The underlying assumption of the budgeting process is that employees will meet targets set by senior management, and in turn shareholder value will be created.  The reality – there is a disconnect between the ‘earnings’ contract the shareholders mandate to the CEO, and the ‘budget’ contract the CEO then mandates to senior management, which then propagates down into the organization.  This decentralized process causes flexibility to be lost and leaves little room for empowerment of employees to perform.  The behaviour that ensues is what Mitchell Max describes as “playing the budget game” – people will ensure they set readily achievable targets, and will manage results to very closely meet those targets in order to protect the future (i.e. make sure this year’s results don’t exceed plan to minimize the increase in next year’s target).

  1. Strategic flaws – budgets are a barrier to change

Max points out that budgets are a product of the 1950’s and 60’s, when the business environment involved making and selling products.  Since that period, a complete shift in business practice and stakeholder expectations has occurred.  Business is now about sensing and responding to customers.  Planning horizons are shorter, as are product life cycles.  Assets are increasingly shifting from tangible to intangible.  Organizations are now accountable to the customer.  The variances in performance that result from the volatile dynamics of today’s business environment often mean that the budgets that consume hundreds of man-hours to prepare often become obsolete by the end of the first quarter! As a result, companies require strong forecasting capabilities and need to be highly adaptive to market dynamics, while still delivering against an inflexible performance contract.

  1. Financial flaws  – budgets are expensive, low value-add and are barriers to growth

“CFOs rate budget reform as their top priority.”

Budget setting is an expensive process!  Findings from the research Max and colleagues conducted revealed budgets absorb 10-20% management time, taking on average 4-5 months to complete.  Yet, finance groups believe that only 21% of their work truly adds value to their organizations.  Furthermore, 66% of managers believe their planning process is influenced more by politics than strategy.  Therefore the return on the significant investment of resources is limited.  An even more considerable financial impact of the budgeting process is the barrier to investment and growth, since risk-averse managers may resist making growth-related investments, leading to a sub-optimal level of performance.

The Need To Slay The Dragon – Emerging Model For Functioning Without Budgets

Max points out that organizations are clearly disgruntled with the fundamental flaws of the budgeting process and the impact budgets have on culture, strategy and financial performance.  Indeed, 88% of firms Max studied are dissatisfied with the budget process, and budget reform is among the top priorities of CEOs Max and colleagues talked to.    If budgets are truly the ‘bane’ of companies worldwide, how then can the ‘dragon’ be slain?

Through in-depth analysis of a handful of leading companies who have eliminated budgets, a new model of performance management is emerging.  The operating model is one of “devolution” wherein goals are set and an adaptive process is developed to achieve them.  The transformation of performance management from budgeting to a more adaptive model has 4 elements at its core:

  1. Planning – Shift from fixed planning and allocated resources to dynamic planning cycles and usage-based cost allocation.  For example, a Swedish bank that operates without a budget allocates resources on a ‘pay-for-what-you-use’ basis.  The bank has consistently been one of Europe’s most successful banks, with a superior cost/income ratio of 47.5% (2001).

  1. Controls – Shift from centralized coordination and variance controls to dynamic coordination and relative KPIs as controls.  In this new model, forecasting remains an important exercise, but only as a guide for the organization to know where it is going, and whether it is on track.  Rich, timely data is used, and employees are measured against KPIs, not forecasts.  A US$3B Swedish petrochemicals company that recently replaced its budget with an alternative model uses trends, ABC, benchmarking and internal markets to successfully control costs – not a budget.

  1. Measures and Rewards – Shift from fixed internal targets and incentives to aspirational targets and incentives that are measured relative to external peers.  The successful budget-less Swedish bank incents and rewards its employees at each branch based on performance relative to the 500 other branches within the company, as well as relative to the average performance of the other banks in the country.  The goal that employees work towards is to “beat the ROE of the other banks” – a shifting target – , instead of reaching a fixed target profitability set by the CEO.

“Performance management is more than budgeting”

  1. Culture – Shift from a commanding and controlling culture to a philosophy of coherent empowerment.  At the Swedish bank, authority to make decisions devolves all the way down to the branch manager, who is responsible for ensuring profitability of every customer.

How Do I Shift My Company’s Focus From ‘Beating the Plan’ to ‘Beating the Competition’?

Clearly, changing focus from a controlled, budget-driven performance management program to a new model where performance is managed dynamically and goals are reached through an adaptive process is no simple feat for any company.  Indeed, it took the Swedish bank 5 years to do away with budgets and transform the company’s goal into beating the competition instead of the plan.

Max stresses that, “Performance Management is more than Budgeting”. Shifting to this new model of performance management requires leaders with a long-term aspirational view of where the company is going, and what it wants to be.  Interestingly, the few organizations that currently operate without budgets are primarily based in North-Western Europe – North American business leaders continue to be more conservative and focused on the short-term.

But Max’s challenge to all of us is to begin by building a case for change and developing a vision of what the impact of the change will be.  Based on in-depth research into leading companies, Max offers the following 8 key enablers for beginning the momentum for change:

  • Shareholder Value Models – set medium-term aspirational goals

  • Benchmarking – evaluate competitive success, set relative measures, recognize and reward

  • Balanced Scorecard – align goals, actions and measures: not as a budget substitute

  • Activity-Based Management – resource management; benchmark measures; activity-based planning

  • Internal Markets Capabilities – understand full cost of internal support services; charge-out model for accountability

  • Rolling Forecasts – sense and respond; guide market expectations; scenario/sensitivity analysis with action

  • Fast & Open Information Systems – provide front-line people with information for decision-making

  • Enabling Culture and Leadership – open and honest sharing of information; empowerment with trust

Taking action along even one of these dimensions is the first step in breaking free from the annual performance trap created by the budgeting process, and unlocking real growth.

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About Amr Badran

An Egyptian Business Consultant and Corporate Trainer since 1997. I've trained on Management, Leadership and Soft Skills to thousands of people from many nationalities, backgrounds and professions in more than 10 countries across the Middle and Far East. Holder of an MBA and a Candidate for Doctorate in Business. Find more about my Management and Personal Skills Courses at AmrBadran.com and feel free contacting me at Amr@AmrBadran.com
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