Why Budgeting Kills Your Company? Which is better,the old fashioned way of TOP DOWN budgeting, or the new way as described in the article and state why you have come to this conclusion. The average billion-dollar company spends as many as 25,000 person-days per year putting together the budget. If this all paid off in shareholder return, that would be fine. But few organizations can make that claim. In fact, many firms now question the ROI of traditional budgeting altogether and are looking for alternatives that reduce time and better align spending with strategy. Look at your own company's budget process: Has it really helped you do a better job of belt tightening during the current slowdown? Many companies have reverted to more centralized command-and-control procedures to keep a tight rein on costs—but the dynamics of the budgeting process often undermine this effort. "In tough times like these, any significant real cost growth feels imprudent and is hard to justify for most businesses," writes Mike Baxter, a partner in the consulting firm Marakon Associates (New York City), in a recent company publication. "Business units have used their budgets as a bargaining chip, bidding high to get a larger slice of the pie while keeping their cards close to their chest. "The CEO has had no choice but to get them back into shape, though he lacks any clear line of sight for identifying and challenging the least valuable resources," Baxter continues. All too often, the CEO must opt for across-the-board cuts—even though he knows that this approach penalizes the high-performing units and props up the underperforming ones. The result is a decoupling of the company's resource allocation process from the highest-value strategic opportunities. THE ANSWER, SOME EXPERTS SAY, IS TO DISPENSE WITH BUDGETS ENTIRELY. The answer, some experts say, is to dispense with budgets entirely and replace them with a system of rolling forecasts and key performance indicators that shifts strategic decision making to customer-facing edges of the organization. Others advocate less sweeping but still significant changes: Housing the budgeting and strategic planning functions in one office, establishing top-down goals three to four years out, and requiring all business units to explore the budget implications of several strategic alternatives. How Fixed-performance Contracts Ensure Underperformance At its simplest, a company's budget process consists of each unit producing a sales forecast and a capital needs forecasts. "I've seen some annual budget processes that didn't take any time at all," says William J. Bruns Jr., Henry R. Byers Professor of Business Administration, Emeritus, at Harvard Business School and a visiting professor at Northeastern University. After each unit's sales and capital needs forecasts are complete, "senior management holds a three-day meeting to discuss them and then makes its decisions. Of course, at the other end of the spectrum, you have these 200-page budget books that get produced, requiring months of meetings." In some instances, the budget process consumes up to six months and 20 percent of management's time. Most companies' approach to budgeting increases the chances that the process will be arduous, expensive, and frustrating, says Jeremy Hope, coauthor with Robin Fraser of Beyond Budgeting: How Managers Can Break Free from the Annual Performance Trap (Harvard Business School Press, 2003). The culprit is what he calls the fixed-performance contract. "The targets for sales, costs, and key ratios that are spelled out in the budget become an implicit contract," he says. A recent Hackett survey found between 60 percent and 90 percent of the top 2,000 global companies have this sort of contract. "And there are usually financial incentives attached: Career prospects and bonuses ride on this contract—incentives for hitting the targets amount to as much as 97 percent of a U.S. manager's annual salary. At the same time, the fixed-performance contract fosters the fear in managers that if they don't spend what's left over in their budgets at the end of the year, their funding for the next year will be reduced. Cost discipline thus takes a back seat to turf protection. The budget process may help establish a ceiling on costs, but the internal politics of the fixed-performance contract ensure that there is also a cost floor—in other words, that the cost savings aren't as sizable as they might be. As long as budgeting, a vestige of the old command-and-control approach to management, remains in place, the newer tools designed to decentralize strategic decision making will never achieve their full potential, Hope and Fraser argue. The solution is not better budgeting "but rather abandoning budgeting entirely and building an alternative management model," they write. Among the features of the approach they recommend, which is currently being used by organizations in a range of industries and countries, are the following
Why Budgeting Kills Your Company?
Which is better,the old fashioned way of TOP DOWN budgeting, or the new way as described in the article and state why you have come to this conclusion.
The average billion-dollar company spends as many as 25,000 person-days per year putting together the budget. If this all paid off in shareholder return, that would be fine. But few organizations can make that claim. In fact, many firms now question the
Look at your own company's budget process: Has it really helped you do a better job of belt tightening during the current slowdown? Many companies have reverted to more centralized command-and-control procedures to keep a tight rein on costs—but the dynamics of the budgeting process often undermine this effort.
"In tough times like these, any significant real cost growth feels imprudent and is hard to justify for most businesses," writes Mike Baxter, a partner in the consulting firm Marakon Associates (New York City), in a recent company publication. "Business units have used their budgets as a bargaining chip, bidding high to get a larger slice of the pie while keeping their cards close to their chest.
"The CEO has had no choice but to get them back into shape, though he lacks any clear line of sight for identifying and challenging the least valuable resources," Baxter continues. All too often, the CEO must opt for across-the-board cuts—even though he knows that this approach penalizes the high-performing units and props up the underperforming ones. The result is a decoupling of the company's resource allocation process from the highest-value strategic opportunities.
THE ANSWER, SOME EXPERTS SAY, IS TO DISPENSE WITH BUDGETS ENTIRELY.
The answer, some experts say, is to dispense with budgets entirely and replace them with a system of rolling forecasts and key performance indicators that shifts strategic decision making to customer-facing edges of the organization. Others advocate less sweeping but still significant changes: Housing the budgeting and strategic planning functions in one office, establishing top-down goals three to four years out, and requiring all business units to explore the budget implications of several strategic alternatives.
How Fixed-performance Contracts Ensure Underperformance
At its simplest, a company's budget process consists of each unit producing a sales
In some instances, the budget process consumes up to six months and 20 percent of management's time.
Most companies' approach to budgeting increases the chances that the process will be arduous, expensive, and frustrating, says Jeremy Hope, coauthor with Robin Fraser of Beyond Budgeting: How Managers Can Break Free from the Annual Performance Trap (Harvard Business School Press, 2003). The culprit is what he calls the fixed-performance contract. "The targets for sales, costs, and key ratios that are spelled out in the budget become an implicit contract," he says. A recent Hackett survey found between 60 percent and 90 percent of the top 2,000 global companies have this sort of contract. "And there are usually financial incentives attached: Career prospects and bonuses ride on this contract—incentives for hitting the targets amount to as much as 97 percent of a U.S. manager's annual salary.
At the same time, the fixed-performance contract fosters the fear in managers that if they don't spend what's left over in their budgets at the end of the year, their funding for the next year will be reduced. Cost discipline thus takes a back seat to turf protection. The budget process may help establish a ceiling on costs, but the internal politics of the fixed-performance contract ensure that there is also a cost floor—in other words, that the cost savings aren't as sizable as they might be.
As long as budgeting, a vestige of the old command-and-control approach to management, remains in place, the newer tools designed to decentralize strategic decision making will never achieve their full potential, Hope and Fraser argue. The solution is not better budgeting "but rather abandoning budgeting entirely and building an alternative management model," they write. Among the features of the approach they recommend, which is currently being used by organizations in a range of industries and countries, are the following:
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