Operating on a budget

Today's operators face many challenges. Under the dual pressures of cost and price, operations must be streamlined and efficient to survive. The pace of globalization, technological progress and brutal competition is getting faster and faster. At the same time, people have less and less confidence in the operating conditions of enterprises and the operators who provide them. Ethical conduct and transparent financial reporting have never been more important.

Meeting these challenges and succeeding requires senior executives to create a lean organization that is both profitable and efficient in meeting customer needs, flexible enough to adapt to changing business conditions, and ethically Earn investors' trust in yourself.

Before moving in this direction, businesses need to fundamentally examine how they manage. Ironically, research has shown that traditional budgeting is the root cause of many business problems. These businesses need to apply new management tools, continuous planning and flexible control to replace their current budget formation processes. Budgets and the command-and-control structures that support them should be replaced by lean, flexible, and honest processes that are mastered by front-line workers.

The goal of business simplification is to create a system that enables customers to derive value from the business without waste. The essence of streamlining is customer-first; companies should determine how to efficiently deliver the capabilities customers demand at a reasonable price. In most businesses, the old budgeting process is a major obstacle to improving efficiency.

Budgets create waste

The following example illustrates how a typical business develops departmental budgets: A department manager spends several weeks preparing the department's annual budget report. What they have to do is determine the minimum metric that is acceptable to company executives. Company executives also spend a lot of time preparing for the meeting. Department managers will raise various difficult factors when reporting, such as weak economy, fierce competition, etc., in order to strive for a lower indicator than they can actually achieve; while the company director describes the situation is quite optimistic, the purpose is to strive for a lower target. Higher indicators add weight to departmental plans.

This happens year after year, and both sides gradually learn how to negotiate, bluff, and play the budget game. After some tug-of-war, the two sides finally compromised and reached a moderate target. Line managers were satisfied with the results because they had succeeded in lowering the expectations of company management, who felt they had added value by raising the original goals of the divisions. Clearly, the focus here is on negotiating skills rather than adding value to various stakeholders.

Infighting and back-and-forth negotiations waste time and lead to inefficiencies. In addition to this, the impact of budgeting on efficiency is also reflected in the fact that it is essentially a push system. Managers work hard to predict what products and services customers will need, and put resource requirements in budgets based on projected customer needs. Budgets often leave room for shaving peaks and filling valleys, but in reality this room is for planned waste rather than for waste elimination. The budget becomes the purpose, and the allocation of resources is to promote the budget plan rather than to meet the customer's needs.

In a lean business, customers should be the determinant of business spending, with customers driving activities. Some argue that traditional budgets are necessary to control costs because they are the company's primary means of authorizing spending. But practice has proven that the budgeting process has the opposite effect. Although a budget gives an upper bound on expenses, it usually gives a lower bound as well. Managers kept spending up to authorized caps, avoiding re-approvals and guaranteeing that budget spending would not be cut for the coming year. Traditional budgets give business units a preparedness mentality that runs counter to streamlining efforts.

From push to pull

The owner and CEO of a Florida-based grocery company scrapped the old budget system because he felt the budget "gives people money before they make money" the right to spend money." In order to achieve quarterly and annual targets, many daily necessities companies will use price discounts and large-volume discounts at the end of the period to persuade customers to purchase in large quantities. The budget-busting company ditched the practice because its strategic goal emphasized product freshness, and overstocking in distribution channels would only have the opposite effect. The company's salespeople also don't get more commissions for promoting high-margin products. The boss of the company believes that he should be concerned with customer needs (pull), not trying to force them products that customers don't really need.

To achieve this, the company replaced bargained budget targets with a simple expense ratio formula that clearly communicated the goals in the company's business plan: the company wanted a minimum of 20% of operating income Growth, a 20% profit margin, complemented by a 20% increase in marketing spending or more.

A unique feature of the company's forecasting process is that each quarter the company solicits employees for some creative growth opportunities, but only approves those with great potential. The company is constantly looking for new avenues for growth. Income from new projects is used to reinvest in the company's business. As a result, the company is growing at more than 30% a year, and managers are thinking, "30% growth is great, but why can't we grow at 40%? How can we achieve higher Growth rate?"

The lean business allows leaders to focus on the entire system involved in product and service delivery, rather than how to meet budget targets. Portland State University professor Tom Johnson describes this as "management by means," and traditional budgeting is management by results.

Johnson's research draws heavily on the systematic management thinking of W. Edwards Deming. In The New Economics, Deming wrote: "Of course we need good results, but management for results is not the way to achieve good results. Management for results acts on results as if the results were Caused by a particular factor rather than by systemic or general factors. It is important to address the systemic factors that contributed to the outcome, which means starting from the system."

Some companies have found that using the Balanced Scorecard approach can Achieving a focus on means. For example, the Danish polymer manufacturer Borealis has eliminated the budgeting process. It uses the Balanced Scorecard approach as the main operational control mechanism to control operations in a no-budget environment. The company uses the non-financial indicators in the Balanced Scorecard to monitor performance and determine how far it is from its strategic goals.

The main difference between Borealis' approach and the more traditional BSC implementation is precisely an essential element of the beyond-budget model: Borealis has eliminated the budget module, which situation) separate from the strategic plan with a three- to five-year span. Borealis tracks trends, but does not relate them to artificial, financially conceptual time horizons. This practice allows managers to focus on performance across the business cycle, which is often longer than a year and more volatile.

Rolling forecasts are a key feature of the lean, agile enterprise. Such businesses typically plan nonstop business progress for the next five to eight quarters. They are not subject to financial year-end closings, nor do they specify performance targets that must be met within a specified time frame, so financial results are not measured against unrealistic budget targets.

Rolling predictions also avoid getting tangled in details. Such forecasts include only key parameters such as sales stage or order fulfillment data, sales revenue, key expense items, key operating figures and capital item investment status. Therefore, forecasting can be done very quickly by a small number of people. Data from rolling forecasts can be frequently used in various reports. Data can be continuously updated to reflect current managers' best estimates of future conditions based on foreseeable trends.

Experience has shown that predictions are more accurate this way. Thomas Boesen, director of business planning at Borealis, reports that the quality of forecasts has improved dramatically after the company replaced budgeting with rolling forecast models. International drilling contractor Transocean also recently implemented rolling forecasts. While the company is still preparing its budget, its director of budgeting and planning, Gary Taylor, said forecasts are more time-sensitive because the company's new networked system allows instant data updates from almost anywhere in the world. With the ability to plan nonstop, Transocean can focus fully on the major factors affecting rig utilization, creating clear revenue growth opportunities, with each rig even generating more than $250,000 per day.

Measuring Relative Performance

Focusing on customer needs and business operations rather than arbitrary performance metrics can improve efficiency, but the benefits of not budgeting don't end there. Governance by the facts is only possible when the facts are not manipulated. But traditional budgeting systems encourage people to make up numbers, and there is no essential difference between lying when preparing a budget and lying when reporting actual performance.

At WorldCom, everyone knows the game. An article in the Financial Times on how WorldCom achieved "child prodigy" performance stated that WorldCom's digital game was all about doing what CEO Bernard Ebber wanted : "You will be given a budget, and he will order you to only be two percent below the budget target, and nothing else." WorldCom's fate is the result of this approach. Any company using a traditional budget system should assess whether the budgeting process creates a gaming environment that undermines the foundations of business integrity.

A major solution is to separate the planning process from the compensation. The Beyond Budget model makes performance reviews independent of rolling forecasts. Honest companies can still implement incentive compensation systems, but they don't tie rewards to bargained-for targets. On the contrary, such companies base incentive compensation on relative performance, and when evaluating operating results, they must be compared with the performance of other business units.

When operating results are measured on a relative scale, they are often compared to industry-leading indicators, competitor performance, and benchmarking against similar functions within the same company or other companies. Sometimes relative scales also use prior year performance as a basis for comparison, but the focus is on the performance of one business unit relative to other business units.

Let's take the telecommunications industry in the late 1990s as an example and see how relativistic measures work in the evaluation of a company's operating results. Suppose a telecommunications company with a traditional budget system targets sales growth of 15%, and it actually achieves a 20% increase in sales, so traditional budget-linked incentive programs would generously reward this performance. But if managers look back at the markets they are in, they'll see an industry-wide growth of more than 30%. The company's actual market share did not rise but fell, but under the traditional incentive mechanism, such sales performance was still heavily rewarded.

Remuneration based on relative performance not only takes into account external environmental factors, but also encourages the team to always have higher demands on themselves. Even if your performance has improved significantly from the previous year, you have to work hard to stand out from your peers. Success becomes more difficult with relative standards, which fluctuate up and down based on the performance of others. However, the relative standard fundamentally abandons the forecasting approach in traditional budgeting systems.

A useful tool for performance comparison is a ranking table, which ranks business units within an enterprise from best to worst. From the ranking table, you can find out who is doing the best, and the pressure generated by the side-by-side comparison will also promote the department managers. Ranking tables are more effective if they are tied to rewards. Although the company stipulates in advance which indicators should be used to evaluate individual performance, the scoring is done after the fact, so the performance of one business unit relative to other business units in the same business environment is the basis for determining the level of compensation.

Handelsbanken ranks branch managers based on their performance on a key metric - cost-to-income ratio, and compares the performance of branches within the same region. The operating results of the branches in a region are aggregated to form the regional total, which can be compared among the branches. The regional totals are aggregated into bank-wide operating results, which are compared with other major Nordic banks. This system enables Handelsbanken to maintain a stable leading position in Scandinavia.

Nordic-based building materials distributor Ahlsell uses a similar regional ranking table, which divides subsidiaries into two categories based on performance. Ahlsell's primary performance measure is sales margins. Branches that barely meet or fail on this metric are grouped into a category called the "qualifier group." These business units must focus on improving returns. Affiliates with sales margins above the rated value are placed in a "super league group" that allows for both returns and growth.

Four elements drive change

Handelsbanken and Ahlsell's divisional performance measures show how a company can tell employees at all levels what is considered good performance with a key indicator. Businesses can clearly build incentives for managers and influence their performance without resorting to traditional budgeting processes. And senior executives can safely delegate a lot of responsibility to lower-level business executives, as long as they trust lower-level managers to understand what the company demands of them in terms of performance and to be motivated to meet them.

The transition to continuous planning and flexible control can be abrupt or incremental, with key elements such as rolling forecasts introduced first, followed by relativistic scaling. No matter what form a company takes, senior executives should maintain a coherent management model that aligns the various elements of the budgeting and planning process to serve the same purpose.

C-suite executives should also be mindful of how to manage the transition process. For Steve Morlidge, who was in charge of putting the over-budget concept into practice at Unilever, this was a major issue. His task is extremely difficult. Unilever has more than 400 business units, the company has achieved impressive results as one of the world's three largest manufacturers of daily necessities, coupled with this is a mature enterprise, the company's culture is deeply rooted.

In preparing to ditch the traditional budget system, Morridge developed a transformation formula that incorporates a change driver within Unilever, known as (D*V*S)>R. In the model, "D" represents dissatisfaction with an existing process; "V" represents a vision for a new process or system; and "S" represents an understanding of what steps to take first to make the vision a reality. For a transition to be successful, the product of the three elements must be greater than the transition resistance (or "R").

In this formula the three transformation push factors are multiplied, so if any of them are zero, the transformation cannot occur. Having a good vision and knowing where to start will not lead to action unless there is dissatisfaction with existing practices. Strong dissatisfaction with the status quo and a clear understanding of what is wanted, but if it is not clear where to start, the result is often a blocked transition. Dissatisfaction with the status quo and knowing where to start, but lack of an overall idea of what the future will look like—this is also a dangerous situation because it can lead to unclear requirements and a project that has a beginning and an end. Reducing resistance to transition can increase the chances of project success.

The formula applies to the entire organization, but its individual parts are fully applicable to individuals, who can be evaluated against the four elements of the formula. Individual and team dissatisfaction with the status quo drives them to look for new solutions. Having a consistent vision of how the organization should be managed is the basis for a clear new management model. Once the vision for the future incorporates all the reform initiatives that management is prepared to implement, the company can begin planning how to take the first steps to realize the vision.

Reproduced with permission from Becoming Lean, Adaptive, and Ethical: How to Move Beyond Budgeting by Robin Fraser, Jeremy Hope, and Steve Player in the November 2003 issue of Business Performance Management magazine . Copyright 2003 by Penton Media, Inc. Translated by Gong Hao.

Author Robin Fraser is Director of International Relations for the Beyond Budgeting Round Table (BBRT). The Beyond Budget Roundtable is an organization dedicated to helping businesses improve their performance management process. He co-authored the book "Beyond Budgeting" with Jeremy Hope. Author Jeremy Hope, the author of numerous articles and books on performance management and collaborative leadership, is also Director of Research at BBRT. Author Steve Player is BBRT's North American Director.

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