This Pivot: It’s far from an easy option, but maybe we can ditch the annual budget-setting ordeal in favour of a more modern management approach.
It’s annual budget time again.
Now we get to re-live the ‘unders and overs’ from last year, and gaze into the next 12 months in an oracle-like trance and foretell what’s going to happen.
Sadly, budgets are a time-consuming ritual that nearly all managers go through.
It’s not fun, but it goes with the territory.
We have no choice, right?
Why Do We Do It?
Annual budgets are deeply rooted in our collective management and governance mind-sets; in fact, so deeply rooted that it’s hard to imagine any alternative.
We just take for granted that it's essential for any business to plan ahead and to tightly manage its financial performance. Working with a budget is the most effective way to keep a business and its finances on track.
Budgets are how we ensure we can continue to fund our operations and ensure we have enough money for the future.
That’s why we need a budget.
What about the Disadvantages?
The budget is a tool for repression rather than innovation. – Bob Lutz, Ex-CEO, Chrysler
The budget is an unnecessary evil. – Dr. Jan Wallander, Honorary President, Svenska Handelsbanken
The budget is the bane of corporate America. – Jack Welsh, Ex-CEO, General Electric
Search the Internet for ‘beyond budgeting’ and we see that many institutions and organisations are coming to realise that preparing an annual budget is not the best use of their leader’s time and resources - it may be doing far more harm than good.
There are a lot of criticisms of budgets.
- Time: Budgets take too long to prepare.
- Cost: Preparing budgets costs the organisation more than they’re worth.
- Obsolescence: Budgets go out of date within weeks of being settled due to ongoing changes in the business environment.
- ‘Silos’: Budgets encourage groups or teams to protect their own interests at the expense of the organisation.
- 'Sandbagging’: Budgets provoke the padding of expenses and under-estimating of revenues so staff can make their performance look good.
- Waste: Budgets invite frivolous spending (especially near the end of the budget period) for fear that future budgets will be cut if not used in full. It’s ‘use it or lose it’.
- Inflexible: Budgets don’t allow for emergencies or changes in the business environment that happen during the period, so they suppress timely reactions (“Where will the money to deal with this new issue come from?”).
- Bean-counting: Budgets are a fiscal exercise that ends up disconnecting leaders from their strategy, and the spending needed to implement it. Budgets force managers to focus too much on their numbers.
- Politics: Setting budgets can become a political exercise - the loudest voice is not the best option for allocating resources.
- Short-term thinking: Budgets encourage staff to confine their attention to the current budget period and not think and plan for what’s best in the long-term.
- Underperformance: Set budgets can promote the message that achieving the target is enough; that there is no need to attempt to do better.
- Undesirable behaviour: Pushing staff into achieving budgets can result in unethical actions or outcomes (like delaying expenses into next year, or giving inappropriate discounts to meet income targets).
Here's the problem: when we set a budget, we are attempting to:
- forecast the future,
- set targets (for the manager), and
- allocate resources.
These three objectives conflict with each other.
A good forecast (budget) should be realistic and unbiased, but if we use our forecast as a target, it then creates a contradiction; because targets should be realistic and ambitious.
We end up pitting the need to be unbiased against the need to be ambitious.
To allocate resources correctly, we need an unbiased forecast and we need to be able to change the targets as we go along. Again, a conflict.
The organisations and thinkers challenging budget setting aren’t looking to abandon financial caution and let staff spend as they wish. Rather, they are seeing the need to go beyond the single concept of ‘budgeting’ and to think of it in terms of its core components: the specific tasks they are trying to achieve. Then organisations can develop their own processes around forecasting, setting targets and allocating resources.
Traditional budgeting is firmly seated in the top-down, command-and-control, authority-comes-from-the-top camp. It’s been seated there for a long, long time!
A more modern approach was developed by Jeremy Hope and Robin Fraser in their book, Beyond Budgeting – How Managers Can Break Free from the Annual Performance Trap. Hope and Fraser argued for doing away with the annual budget in favour of a more agile, decentralised, value creation model.
Their book laid the groundwork for the international movement Beyond Budgeting Round Table (BBRT), which advocates the replacement of traditional budgetary control by a variety of ‘adaptive processes’.
(The following is taken from here – emphasis ours.)
The BBRT have created a 12-step model for going 'budgetless'. Passing down authority to lower levels within the organisation from stage to stage is a main theme throughout. Their model advocates decentralising the entire budgeting process and empowering frontline teams with resource allocation responsibilities.
The 12 steps are as follows:
- Build a basis for devolution through clarity of purpose. Don't exert control from a central location.
- Empower staff to act without constraints.
- Hold leaders accountable for hitting performance targets, not budget numbers.
- Organise the business around customer-oriented business units, not hierarchical departments.
- Let market-like forces dictate resource allocation requirements, not central planning and budgeting.
- Don't command and control people. Challenge and coach them.
- Beat the competition by setting and hitting performance targets, not budget targets.
- Make strategy an ongoing process, not an annual event.
- Use technology to keep abreast of performance in relation to strategies, and change strategies when conditions warrant.
- Allocate resources when needed, not according to an annual budget.
- Avoid micromanagement, and provide quick access to up-to-date information about the company.
- Reward on the basis of reaching performance targets, not predetermined negotiated targets.
The above Beyond Budgeting principles can be condensed around three central concepts:
- Management style
- Seat of authority
- Performance assessment
(Command and control vs. empower and coach)
Traditional budgeting and Beyond Budgeting are fundamentally different in how they view an organisation’s leadership.
Traditional budgeting assumes the manager is best equipped to make the decisions and that staff don’t have the skill sets, motivation or integrity to act in a way that aligns with the organisation's objectives. Staff are not trusted, and information is not widely shared.
Beyond Budgeting takes an empowering and coaching approach. Employees are seen as trustworthy and capable of assuming responsibility for actions and outcomes. Work is approached from a holistic, partner-based vantage point and the manager supports high levels of access to information. Transparency is seen as essential to better decision-making and greater accountability.
Seat of Authority
(Centralised management vs. decentralised teams)
Traditional budgeting sees authority coming from the top. Decisions are handed down and staff are micromanaged to deliver results.
With a Beyond Budgeting approach, power is delegated to teams: teams that are allowed to act. Decisions are moved closer to the organisation’s customer base, and the teams are able to access the resources they need and have the freedom to take action.
(Fixed targets vs. relative targets)
Traditional budgeting sets fixed targets for staff, such as generating a certain level of revenue or limiting expenses. Targets are set at the beginning of the budget cycle and are expected to apply throughout.
A Beyond Budgeting approach favours relative targets. Team performance is compared to dynamic and relevant yardsticks like peer or competitive performance, industry benchmarks, best practices or prior years. Performance is not compared to a budget set in advance, and which may have been affected by external circumstances over which the staff have no control.
There's strong evidence (see links below) that organisations that embrace a Beyond Budgeting approach perform better than their counterparts who stick to traditional budgeting. However, the transition requires a manager to shift authority to front-line teams, give them the information they need and the authority to act, and then coach them towards victory.
It does not mean going without financial controls.
It’s not an easy transition to make, but it just might yield better long-term results for our centre (and free us from the annual aggravation of budget setting).
Food for Thought…
- Budgets are an almost universal fact of life for managers.
- There are many, many disadvantages to setting budgets.
- Budgets are a manifestation of a command and control management style.
- Budgets are used for conflicting purposes (forecasting, setting targets and allocating resources).
- The Beyond Budgeting philosophy advocates decentralising budgeting and empowering front line staff with resources and the authority to act.
- We are not being irresponsible (or worse) to question the value of our annual budget-setting exercise.