Exasperated by budgets that hamstring creativity, a growing number of companies are tossing off financial constraints--and still holding the line on spending.
Over the past 15 years, Bill Kling has built Swiss-American Products Inc. into a consumer-products juggernaut, with 52 employees manufacturing and marketing 21 medical skin care products. This year, he expects sales of sterilized dressings, eyewashes, and the like to approach $10 million. Keeping tabs on the company is a complex juggling act. At any given moment, the Dallas entrepreneur must stay abreast of the impact of the falling dollar on the cost of European imports; monitor more than a dozen production lines; devise new ways to market to super-sophisticated consumers in the medical community; and ensure that the numerous regulatory filings required by the Food and Drug Administration are up-to-date and accurate. And all the while, just like any business owner, Kling must handle such chores in a way that ensures that expenses don't overwhelm his profit margins.
All managers, of course, are obsessed with controlling costs and protecting profits.
But the unusual thing about Kling is that he does these things without the most basic tool that is available to business owners--a formal, written budget. "A budget," Kling says, "has nothing to do with whether or not we perform."
Managing a growing, 52-employee, $10 million company without the guidance of a budget? It sounds crazy. After all, it's an article of faith that you sit down at the beginning of each fiscal year and draft a budget, in which you allocate resources, set priorities, establish production goals and sales targets, and provide incentives for employee bonuses. Fail to budget properly, managers are warned, and insolvency looms around the corner.
But a growing number of managers like Kling are taking a tough new look at the way most companies go about budgeting. And they don't much like what they see. Call it the Beyond Budgeting Movement.
The strict cost-containment efforts that are embodied in many budgets, they say, prevent managers from thinking on their feet, shifting strategy, and tackling new opportunities. Inflexible budgets, they insist, create a "use it or lose it" mentality, which leads to the absurd spectacle of department heads scrambling to spend every last dime of their travel or marketing budgets in the final months of the year--regardless of whether that last-minute spending generates revenue--lest their allocations be cut next year. Even more ominously, they argue that budgets can lead to book-cooking and even outright malfeasance because pay and bonuses are often linked to the ability to meet or exceed budgetary goals. Look no further, they say, than the recent scandals at places like WorldCom and HealthSouth--where bonus-hungry executives turned to fraud to cover up billions of dollars in losses.
"Being budget-free doesn't mean you don't know the numbers," argues one entrepreneur.
To be sure, no one is advocating the idea of abandoning financial discipline altogether and simply letting the money flow. But they are suggesting that there may be better, more flexible ways to run a business. "I'm not opposed to a budget as a financial statement, but to the way it's used as an almost fixed performance contract on which employees have to deliver," says Jeremy Hope, an accountant, former venture capitalist, and co-founder of the Beyond Budgeting Round Table, an international research consortium that wages the battle against the budget from its headquarters in Yorkshire, England. "The pressure to deliver on [budgets]," Hope says, "drives a lot of the irrational, stupid, and crazy behavior you see within businesses."
Hope is convinced that the kind of centralized planning that characterizes budgeting at most companies actually hampers the ability to cut costs, improve relationships with customers, develop new products, and respond rapidly to changes in the business environment. In his recently published book Beyond Budgeting (Harvard Business School Press), Hope and co-author Robin Fraser argue for a system of management that replaces annual planning and resource allocation with a system that encourages managers to adjust to short-term fluctuations in demand by making resources available when they are actually needed. The message, they add, is perfectly suited to small companies, which thrive on the ability to adapt to rapidly changing conditions on the ground.
So far, the evidence supporting the think tank's theories is largely anecdotal, based on a dozen or so case studies, mostly of companies in Europe where the Beyond Budgeting Movement began. Later this year, Hope and Fraser will launch a more rigorous quantitative study in conjunction with IBM designed to measure how companies that have dumped traditional budgets have performed relative to their peers who cling to them. But even without hard data, the idea seems to be gathering momentum. The group offers how-to seminars and workshops in Europe and North America, and it held a first-ever "summit" in London in July.
Kling, for his part, only recently learned of Beyond Budgeting. But he's been running Swiss-American according to many of the group's principles for years. Rather than relying on a formal document to guide his company, Kling manages with what he calls an "intuitive budget"--essentially, a running mental tally of resources, priorities, and expenses that is constantly subject to change and revision. In some ways, Kling is making things extra hard on himself. For the system to work, he must be familiar with all the numbers that affect his business: the cost of raw materials; production expenses; sales volumes and prices, etc. He requires the same of his managers--and, in fact, recently invested $200,000 in a new accounting system that provides company decision-makers with the most up-to-date information available. "Being budget-free doesn't mean you don't know the numbers," he says.
What it does mean is the ability to be flexible when circumstances demand it. Last April, for example, Kling was surprised to discover that the costs for testing new products had ballooned to $22,000, compared with $6,000 in a typical month. In other words, the testing department had busted its budget, big time. The problem? Swiss-American had been developing several new products simultaneously, with the goal of getting them to market as early as possible. If Kling had been managing the company with a traditional budget, the testing might have been spread over a number of months. The department would have remained within budget, but the products would have taken longer to get to market--which is unacceptable, says Kling, who was able to shift costs elsewhere to cover the overrun. "It would have been nice to keep costs within range," he admits. "But not if it means micromanaging our business" and delaying the rollout of new products.
The trickiest part, Kling says, has been crafting a compensation system, especially in the sales department. At most companies, it's simple: Bonuses are tied to the ability to meet sales call quotas and targets spelled out in the budget. Kling takes a more subjective, qualitative approach. The biggest rewards go to those who are best at explaining Swiss-American's often complex products to the company's medical-industry clientele. For Kling, selling is about the ongoing relationship between the salesperson and his or her customers. The stronger that relationship, the more robust sales will be over the long haul. "The person who makes the most calls is not always closing the most deals," Kling says.
Kling's intuitive approach is riskier than traditional budgeting, but there are potential payoffs, says Al Osborne, director of the Price Center for Entrepreneurial Studies at UCLA's Anderson School of Management. Osborne is a big believer in budgeting. "If nothing else, budgets force individuals to think about the resource requirements of different activities, and the assumed or potential returns of those activities," he says. Budgets also have a way of focusing managers on the financial consequences of the decisions they make.
But problems arise when companies cling too tightly to their budgets. After all, no manager considers a company's business plan as being set in stone for a calendar year. There's no reason for a budget to be set in stone either. "Part of my job working with entrepreneurs is trying to make them understand that budgets shouldn't be thought of as inflexible or constraining," Osborne says.
