Jeremy Hope believes that the annual budgeting process and the fixed contracts it produces are of little value in today's quick changing business environment. A codirector of the Beyond Budgeting Round Table (www.bbrt.org), Hope is coauthor of Beyond Budgeting (2003, Harvard Business School Press). The book argues that traditional budgets -- those that focus on fixed targets and encourage top-down management -- hamper an organization's ability adapt quickly to economic changes. It also leaves front-line employees, those in contact with customers, out of the picture, impeding their ability to positively affect customer relationships. Hope discusses the need for businesses to reevaluate the annual budgeting process as a financial planning tool with Inc.com's senior editor Carole Matthews.
Why the high levels of dissatisfaction with the traditional budgeting process?
First let me say that "Beyond Budgeting" is not a crusade against the purposes of budgeting (setting targets and rewards, formulating plans, controlling performance, managing resources and coordinating actions). Far from it.
The purposes of budgeting are exceedingly important. The problem is that they are all tied together into a "fixed" performance contract. This contract may be explicit (a written agreement) or implicit (custom and practice dictate the outcomes). It leads to a number of serious problems.
First, the fixed plan is unresponsive to change. Secondly, the process that leads to the contract is protracted (4 to 5 months is the average), very expensive (takes 20 to 30% of management's time), and delivers poor value to users (90% of users are dissatisfied). Thirdly, it is not aligned with strategy -- budgets focus on functions and departments, strategy focuses on customer needs. Fourthly, it leads to dysfunctional behaviour. A quote from an Enron employee neatly captured the problem: "It was demanded that we come in 2% under budget. Nothing else was acceptable." And finally, a fixed plan undermines decision support tools such as the Balanced Scorecard (BSC), Economic Value Added (EVA), Customer Relationship Management (CRM), and rolling forecasts.
These models should focus on the medium-term and support front line people but fail to overcome the short-term drivers of the budget and the top-down control orientation of senior executives. It also causes stress to countless numbers of people. In fact, it is a miserable way to run a business and should be abandoned.
Consider this: over 75% of us organizations change their incentives schemes at least once every 2 years. Isn't that staggering? This tells us one thing: Leaders believe that just getting the mix of targets and incentives right is the key to performance heaven. This is what they do when the going gets tough. They set tougher performance contracts with bigger incentives on the assumption that they will lead to better performance. But in practice they rarely do. They just lead to more time being spent negotiating budgets, less flexibility, and more parochial attitudes as the numbers become harder to achieve leading to more gaming and even fraudulent practice.
What opportunities does abandoning the annual budgeting process immediately present to business owners and CEOs?
There are many opportunities. The annual budgeting and reporting process was designed for command and control, and so, if CEO's are really serious about moving to a culture of 'enterprise and learning', 'empowerment', or to a more 'networked organization', then removing the budget fixed performance contract is a key step.
There are many benefits. For example, it results in lower costs. Not only is there a saving in the time not spent on budgeting but more importantly the whole corporate bureaucracy that supports the compliance and control model can be gradually dismantled. Another major benefit is that performance responsibility is transferred from the corporate center to teams closer to the customer. This enables the organization to be much more responsive to change as frontline teams have the scope and the information to review strategy and not be constrained by some plan agreed upon months earlier. Frontline teams like this extra freedom and are more inclined to stretch their goals and produce more imaginative ways to increase customer and shareholder value.
It also reduces 'gaming the numbers' which is so prevalent in today's organizations. With no fixed target to aim for there is no need for 'gaming'.
You cite many large company examples in your book. Is abandoning the budget just as easy, and effective, for small and mid-size companies? What are some of the challenges a small or mid-size company might face?
Many of the problems associated with budgeting are concerned with the bureaucracy that it requires. These problems should not be so evident in smaller organizations. However, it is just as important in these businesses that owner managers focus on the future rather than being a slave to some target that have made in the past (perhaps making it a commitment to the bank).
We need to be careful about what we mean by words like 'budget' and 'forecast'. What we mean by 'budgeting' is the commitment to achieve an agreed contract between one management level and another. A forecast is just the 'most likely' estimate of future financial outcomes and of course is an essential tool of any management process. Smaller businesses should continuously prepare rolling forecasts so that they are anticipating future outcomes (and therefore cash requirements).
