Are there any key principles a company should follow when attempting to change the planning process?
In the book we have identified six principles relating to process changes and six principles relating to organization and cultural changes. However, we can summarize them in four key points:
- Firms need to break free from an annual fixed performance contract that leads to incremental targets and move to a goal-setting process based on relative measures and rewards aimed at continuously improving performance against internal and external peers and benchmarks.
- They need to move from annual fixed plans and variance controls to a process of continuous planning supported by continuous feedback and learning based on Key Performance Indicators (KPI) and rolling forecasts.
- They need to move from the annual allocation of resources and central coordination to a system that enables frontline teams to access resources as they need them and to coordinate their actions across the business dynamically as they respond to current customer demand.
- They need to abandon the command and control management model and transfer performance responsibility and decision making to teams closer to the customer and focus all their energy on value creation.
Many middle and senior managers, as well as CEOs and business owners, know no other process than setting budgets and working to meet their goals. How can you help those people let go of the budgeting process?
We always find that operating managers find little value in budgets and so they welcome the change (especially when you think that this change process is as much about not doing something as much as learning new ways of managing). CEOs can also appreciate the benefits although they will be concerned about how to convince others that the risks are acceptable. The problems are usually with middle managers who find that their 'reason for being' has changed. In other words, information becomes much more open and transparent and there are fewer opportunities (or reasons) to 'fudge the numbers' in order to present a better picture than the reality. Also with more performance responsibility given to front line teams (and more education and information to support it), the role of the middle manager becomes less important.
There are a number of new tools that can help people at every level make the change. For example, the Balanced Scorecard can play a central role in helping managers at every level to understand and articulate their strategy. And rolling forecasts help them to focus on managing the future rather than the past. Moreover, there are more controls than before. Rolling forecasts, fast actuals compared with prior years, trends and moving averages, KPIs, performance league tables, horizontal 'value-based' information (such as customer profitability) -- these all provide a richness that is lacking in the traditional reporting system.
What, in your view, is the most important outcome of abandoning the use of budgets as a financial management tool?
Perhaps the most important outcome is that managers start to really focus on the central purpose of every commercial organization -- to satisfy customers profitably. It is this change from making decisions based on meeting some arbitrary negotiated internal target to making decisions based on meeting customers changing needs that is at the core of the new way of managing.
Explanation of Terms
Balanced Scorecard: A strategic management and measurement framework that views a business unit's performance from four perspectives: financial, customer, internal business process, and learning and growth. It enables managers to map and describe a business unit's strategy, and review its progress periodically.
Customer Relationship Management: The process of knowing and satisfying customer needs profitably.
Economic Value Added: An evaluation of a business unit or product line's financial desirability using its residual income. EVA is defined as the (adjusted) after-tax profit for the period less the (weighted average) cost of capital. Thus, if a company has after-tax profits of $20 million, shareholder funds of $100 million (with a cost of capital of 12%), and borrowings of $50 million (with a net of tax interest cost o 4%, its EVA would be $6 million (profit of $20 million less equity cost of $12 million and debt cost of $2 million).
Key Performance Indicators: Performance measures used to set goals and assess an organization's performance based on its critical success factors.
Rolling Forecasts: A financial forecast (usually including a few high-level figures such as sales, costs, and cash flows) that is updated on a rolling basis. A typical rolling forecast would be prepared each quarter to cover the following five quarters. It is not tied to a particular fiscal year-end review but enables managers to continuously review strategy and cash requirements.
