write up an essay on the problems in budgeting derived from the articles (i do Upvote the answers )
Why Budgeting Kills Your Company HBSWK Pub. Date: Aug '1 1,
2003
Why doesn't the budget process work? Read what experts say about
not only changing your budgeting process, but whether your company
should dispense with budgets entirely. by Loren Gary
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 proc3ss ofter rmder.rqine this
effort.
"In tough times like these, any signifrcant real cost growth feels
imprudent and is hard to justify for most businesses," writes Mike
Baxter, a partner in the consulting firm Marakon Associates (f{ew
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
opporfunities.
The answer, some experts say, is to dispense with budgets
entirely-and The answer, some experts say, is to replace them with
a system of rolling forecasts and key performance dispense with
budgets entirely. 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.
The following discussion will help stimulate your thinking about
how your own company's budgeting process can be transformed from an
exasperating exercise in pork barreling and interdepartmental
brinksmanship to a tool for achieving strategic alignment.
How fi xed-p erfo rmanc e contracts ensure underperformanc e At its
simplist, a company's budget process consists of each unit
producing a sales forecast (assuming it's a profit center) and a
capital needs forecists. "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 *unug.*.nt 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
and20 percent of management's time.
Most companies' approach to budgeting increases the chances that
the process will be arduous, expensive, and frustrating; says
Jeierny Hope, .o*ttroi with Robin Fraser of Beyond Budgeting: How
Managers Can Break Freefrom
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the Annual Performance Trap (Harvard Business School Press, 2003).
The culprit is what he calls thefixedperformance 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
hnancial 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.
"There's terrific pressure on everyone to make those targets; hence
the distortion, misrepresentation, and gaming that can happen in
even the most ethical companies," Hope continues. "If you're a
manager trying to increase spending or get a eapital project
approved, yo,tr put'itt.fuT'5Opercent mote than you need, knowing
you''ll get argued down by senior management to what you originally
wanted."
At the same time, the fixed-performance contract fosters the fear
in managers that if they don't spend what's 1eft 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 furf
protection. The budget process may help establish a ceiling on
costs, but the intemal politics of the fixedperformance 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
approlch to management, remains in place, the newer tools designed
to decentralize strategic decision making wlti t^er'er bcnrevti
their fulIpotential, 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:
Goals based on longer-term external benchmarks instead of
internally negotiated annual targets. Adopt benchmark goals based
on "industry best-in-class performance measures or direct
competitors," Hope and Fraser write; and give teams "an extended
period of time to reach fl1srn"-two to three years. Atlanta-based
eye-care company CIBA Vision found that the move to competitor and
market performance benchmarks--chief among them sales growth, refum
on sales, and economic value-added (EVA) growth-not only helped it
shorten and simplify its budgeting process, it also reduced the
amount of budget gaming.
Evaluation and rewards based on relative-improvement contracts.
Such contracts involve "a whole team ... setting and meeting a
range of performance benchmarks over a period of time," write Hope
and Fraser. "Performance is then evaluated by a peer review group
(using relative measures) with the benefit of hindsight." At the
Swedish bank Svenska Handelsbanken, the company's eleven regions
compete like teams in a league, trying to beat one another's return
on equity. Similarly, the 550 branches compete on two other key
performance indicators: Cost to income and profit per employee. The
relative standings are publicized throughout the company. The
uncertainty of this relativeperformance approach drives success.
Each manager knows from the outset "what has to be done to improve
his or her usual performance," Hope and Fraser write. But it is
only in hindsight that they know how well they have performed
relative to the other managers. This leads them to focus on
"maximizing profits at all times rather than playing games with the
numbers" to meet artificial annual targets.
Continuous and inclusive action planning. A five-quarter rolling
forecast that provides projections for each of the five subsequent
quarters can help eliminate the distortion caused by having
financial incentives to meet a fixed target for a single fiscal
year. A typical rolling forecast may have only a few line items:
Orders, sales projections, costs, profitability, cash flow, and
capital investment. But this information is enough to enable
managers to focus on long-term issues that are fundamental to the
business's success-for example, why customers are leaving or what's
wrong with a particular product.
I've seen some annual budget processes that didn't take any time at
all. - William J. Bruns Jr., HBS professor emeritus
Resources that are made available as needed, instead of allocated
in advance. Handelsbanken gives its branch managers the freedom to
decide which products to sell and to set their own prices and
discounts. (Branch managers
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know that whatever decisions they make about prices and products,
their costs must be about 40 percent of income,) Similarly, each
branch manager gets to decide what resources the unit needs.
To make its central services more responsive to market demands,
Handelsbanken conducts an annual round of negotiations in which
cost estimates and the services underpinning them are discussed by
all involved. Regional and branch managers can challenge the prices
and even choose to go with outside vendors. Since the early 1990s,
branch managers have had the authority to determine staffing levels
and set staff salaries. At first, senior managers predicted that it
would lead to an increase in the number of workers. But the
opposite has occurred; Hope cites this as ewidence that the further
out toward the customer-facing nodes of an organization you push
the profit responsibility, the more cost-conscious and innovative
the employee behavior you get. Indeed, since Handelsbanken
abandoned budgeting in the early 1970s, it has bested its
Scandinavian rivals on return on equity, total shareholder return,
cost-to-income ratio, and customer satisfaction.
The budget as an agent of strategic alignment Other experts are not
as eager for a complete overhaul. Harvard's Bruns suggests keeping
budgets but restructuring compensation programs so that managers no
longer have an incentive to favor short-term goals over the
longer-term health of the company, By getting rid of the inflexible
approach to short-term targets, you answer the problern that lies
at the heart of Hope and Fraser's critique of budgeting.
Although Marakon's Baxter also doesn't advocate the whoreral;
-upl-cilr,c.rr of traditional budgeting, he does believe that
changes must be made to reforge the link between a company's
strategic planning and resource allocation.
"Budgeting and performance are typically overseen by the finance
department," he says, "whereas planning is coordinated by a
strategy department. Often, the two processes aren't well
integrated, resulting in strategies that are often dictated by the
budget process instead of vice versa. When it comes time for senior
management to review the units' investment proposals, their
decisions are often blind to their impact on long-term value.
"Resource allocation should be about putting funds behind the right
high-value opportunities," Baxter continues. He recommends creating
an all-in-one process in which the CEO takes the lead in setting
the strategic planning goals for all units, reviewing altemative
strategies with business units, and linking resources to delivery
of the alternatives with the highest value and best performance
characteristics. With this approach, you're more likely to get not
only the level of performance you're seeking, but also the
particular implementation path that you're after.
Although you want to encourage bottom-up thinking about how best to
achieve the desired performance, you also need to create some
discipline. "Many business unit managers are overly optimistic
about the long-run performance potential of their strategies,
leading them to overinvest in the near term," says Baxter. Senior
management can provide valuable top-down guidance here by using
three- to five-year strategic plans to define the boundaries of
these discussions and then making sure they're clearly communicated
at the outset of the resource allocation process. Next, charge each
business unit with developing several alternatives as a way of
helping the corporate center understand the highest-value, highest
near-term profit, and lor.vest-cost options that exist in each
unit. This helps create a genuine dialogue between the corporate
center and the units about the resource and perforrnance tradeoffs
involved in choosing a particular alternative.
When you're clear on your strategic goals and have a process that
integrates strategic planning with resource allocation and
performance management, budgeting can actually work, Baxter says.
It becomep a mechanism for ensuring not onlythat funds flow first
to the strongest opportunities, but also that those opportunities
actually deliver on their promise. EEI
Reprinted with permission from "Breaking the Budget Impasse
It is true that budgeting acts as a burden in the operations as a budget is only a prediction or forecast about the future operations of the company and other than the fact that its based on past trends or ratios, there not much basis to it.
Budgeting also involves senior and experienced management who are aware of the details involved in budgeting and cannot just be left for the junior management to prepare them. Hence budget preparation also has soft costs associated with it in the form of senior employees time and company's other resources.
More or less, various points have been already covered in the question itself, so I'm sorry but I don't feel I have much to weigh further on it.
Hope you are satisfied with the answer. If you have any further queries, do leave a comment. Also, please do leave a positive feedback, thanks. :)
write up an essay on the problems in budgeting derived from the articles (i do Upvote...
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