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BEYOND BUDGETING
Budgeting is at the heart of the performance management process in most companies. It leads to the preparation of an operational and financial plan, and is used to control its execution. It involves an annual cycle to agree targets, set rewards, plan actions, allocate resources, coordinate plans across the organization, and then measure and control performance against the agreed plan. It results in a "fixed performance contract" between subordinates and their bosses at every level in the hierarchy to deliver an agreed outcome. This contract is the main cause of the problems that organizations experience with the budget model, especially in today's fast moving and competitive business conditions. Most companies today are dissatisfied with budgeting. Many have tried unsuccessfully to improve it, but few have really challenged the validity of the process itself. The BBRT, an international research organization, after extensive research, believes that budgeting, as most corporations practice it, should be abolished. That may sound like a radical proposition, but it would be merely the culmination of long-running efforts to transform organizations from centralized hierarchies into devolved networks that allow for nimble adjustments to market conditions. Most of the other building blocks are in place. Most companies have invested huge sums in IT networks, process reengineering, and a range of management tools including EVA (economic value added), balanced scorecards, and activity accounting. But they have been unable to establish a new order because the budget and the command and control culture it supports remain predominant. "Beyond Budgeting" is a leadership philosophy based on an integrated, coherent set of alternative processes underpinned by a number of key principles. Compared with the traditional management model, it has two fundamental differences:
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First, it is a more adaptive way of managing. In place of fixed annual plans and budgets that tie managers to predetermined actions, targets are reviewed regularly and based on rolling medium-term stretch goals linked to performance against world-class benchmarks, peers, competitors, or even prior periods. Managers are evaluated and rewarded with hindsight according to how they performed against those standards in the light of the circumstances that actually prevailed. Thus the "fixed" performance contract has been replaced by a "relative" improvement contract underpinned by mutual trust. Front line teams adapt to change by continuously reviewing their plans and performance. Resources are available on-demand within agreed parameters based on key performance indicators. Actions are coordinated across the business based on real-time demand and rolling forecasts. And these forecasts combine with other sources of information to provide managers at all levels with essential controls Second, the "beyond budgeting" model enables a more decentralized way of managing. In place of the traditional hierarchy and centralized leadership, it enables decision-making and performance accountability to be devolved to front line managers and creates a self-managed working environment and a culture of personal responsibility. This leads to increased motivation, higher productivity and better customer service.
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EXCELLENT IDEAS, SMART SOLUTIONS Individually these two main features can produce significant benefits, but in combination they can meet a leadership vision that has, up until now, been very difficult to implement. And because it is a coherent model in which all of its components work in harmony, it can produce outstanding and sustained success. This success is driven by four direct value drivers: innovative strategies, low costs, loyal and profitable customers, and ethical reporting. However, these drivers will be ineffective unless front line people have the scope, knowledge and power to deliver. The scope and knowledge is supplied by adaptive processes (supported by tools as appropriate). And the effectiveness of adaptive processes and tools is reinforced by the leadership principles that govern the decentralized organization. The result is an organization that is lean, adaptive and ethical and that has the potential to remain at the top of its peer group league table. Companies working in conditions where exchange rates fluctuate, inflation and growth rates are relatively high, and competitor actions and much else are uncertain, will recognize a strong prima facie case for adopting "Beyond Budgeting". But there are still many questions that need to be answered. Should companies, for example, first improve conventional ways of managing based on "command and control" (with budgeting), or should they adopt the "Beyond Budgeting" management model directly and thus gain real competitive advantage by leapfrogging the practices of their competitors? Another key question is how quickly employees can develop a culture of enterprise and high personal responsibility, particularly if they are starting from a position where their attitudes have been conditioned by years of working within a bureaucratic and centralized culture. These and other such questions are addressed in our public and in-house workshops.
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Why go Beyond Budgeting?
Over the past six years the BBRT, an international research organization, has found many examples of companies that have abandoned annual budgets and fixed performance contracts altogether and used more imaginative ways to manage their business performance. These organizations range across industries, countries and cultures, but we found a common set of principles and some common aims. Here are five examples of how performance improved in the years following the change to the beyond budgeting model:
> Carnaud Metal Box. Under the leadership of Jean-Marie Descarpentries, this Anglo-
French packaging company was transformed from a debt-laden company worth only $19m in 1982 to a market value of $3bn in 1989. By abandoning the fixed performance contract and encouraging business unit teams to set stretch targets (disconnected from a rewards system based on relative performance) he achieved what Fortune Magazine described as one of the best European corporate performances of the 1980s. > Fokus Bank. After abandoning the budgeting model in 1997, this small bank transformed itself from the worst performing bank in Norway with the highest costs to the best performing bank with the lowest costs and the highest return-on-capital-employed. Fokus Bank was acquired by Danish bank, Den Danske Bank, in 1999 at almost three times its flotation value four years earlier. 4|Page
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> Alshell. This Swedish wholesaler of heating, plumbing, refrigeration, and electrical products abandoned budgeting in 1995. A fast, open information system with a strong emphasis on relative performance now provides the necessary controls for selfgovernance by local units. Ahlsell is now the sector's most profitable company in Sweden in both of its main lines of business (heating and plumbing, and electrical products) - a major turnaround from its position in the early 1990s. > Leyland Trucks. This UK truck manufacturer had tried every improvement initiative from total quality to process reengineering but none of them led to improved performance. The difference came when CEO John Oliver abandoned piece work and the fixation with volume on the assembly line. In the first two and a half years after making these changes (from 1989 to 1991), the company reduced its operating costs by 24 percent (halving its breakeven level), and improved its return on sales to over ten percent (beating most of its European rivals). It was later sold to the US company, PACCAR, to gain access to greater sources of development capital. > Svenska Handelsbanken. Since abandoning the budgeting model in the 1970s Handelsbanken has produced outstanding returns for shareholders, consistently beating all its rivals in Europe on the key ratios of cost-to-income and costs-to-total-assets. It is interesting how it communicates with investors. The CEO's annual message in the shareholders' report focuses on competitive performance. It shows a league table of costto-income and share price performance against its main competitors. It also spells out how its radically decentralized management model is a major source of competitive advantage.
Benefits of Beyond Budgeting
Most companies start the journey to the new, emerging management model with limited objectives. Reducing the costs of budgeting and making the performance management process more relevant to its users were uppermost in their minds. In this sense they have scaled the first peak of beyond budgeting. Staying with the mountaineering metaphor, it is only when they have reached this peak that many of them realized that the results would be more sustainable if they were supported by leadership actions that were more in tune with a radically decentralized organization model. This is what the next peak offers. This is not to say that these companies didn't achieve real benefits from reaching the first peak. Indeed, most organizations achieved significant cost savings, less gaming, faster response, better strategic alignment, and more value from the finance team. This last benefit was a surprise to many companies. For example, finance people are no longer seen as bean counters but as people who really help front-line managers with operational decisions. Leaders that saw the beyond budgeting opportunity in terms of radical decentralization 5|Page
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EXCELLENT IDEAS, SMART SOLUTIONS believed that it would ultimately provide a significant competitive advantage. Transforming the performance potential of the organization by breaking free from the annual performance trap and releasing the full capabilities of front-line people is the ultimate vision of beyond budgeting. Implementing more adaptive management processes does not mean that project managers need to stray too far from their comfort zones. Importantly, though, it is a necessary first step, without which no organization can proceed to decentralize. Devolving performance responsibility to front-line people, however, is more radical and needs strong and determined leadership from the top of the organization. But the potential benefits are far greater and more enduring.
The BBRT
The Beyond Budgeting Round Table (BBRT) was set up in response to growing dissatisfaction with the traditional budgeting process. It is an international network of organizations that are seriously evaluating, implementing and gaining value from the "Beyond Budgeting" management model. This model is based on practical case studies in successful, leading-edge companies. Since its inception in January 1998, over sixty (mostly large) European organizations have participated in the BBRT. Its origins were in the UK, but it now has members from many countries including: France, Germany, Switzerland, UK and USA. There are sister BBRT's in North America and Australasia, and others in the process of formation. The BBRT provides the following benefits to its members: A forum for shared learning on the principles of Beyond Budgeting and experience in implementing new management models based on them. A research program addressing the implementation agenda. Case studies of leading-edge companies that are implementing the model. Quarterly meetings of BBRT members and ad hoc and special interest groups providing opportunities for members to network and learn from each other, and from acknowledged experts. Exchange of information among members in the international BBRT network.
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Beyond Budgeting is a White Paper written by the BBRT and encompassing substantial factors incorporated by RK&S Smart Solutions in variable budgeting initiatives.
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