All managers know the scene. Hours are spent over spreadsheets. Days of meetings, discussions and debates. Draft budgets, revisions and redrafts. Months are spent estimating this that and everything down to the last paper clip. Finally the budget is accepted. Yet even by the end of Week 1, most assumptions the budget was built upon will be out of date, the constraints set will be inhibiting action and business opportunities will be lost.
Fixed budgets don’t work today. A budget is a too static instrument and locks managers into the past - into something they thought last year was right. To be effective in a fast moving economy with rapidly shifting market conditions and quick and nimble competitors, organisations have to be able to adapt constantly their priorities and put their resources where they can create most value for customers and shareholders.
Budgets, as practiced by most organisations today should be abolished! A growing number of companies have decided that conventional budgeting is no longer worthwhile. To them, the reassurance budgets give to a nervious chief executive is outweiged by the flexibility needed in todays organisations.
The weaknesses of traditional budgeting processes have been the subject of much attention and many commentators. Hope and Fraser consider that such weaknesses include the following:
• Budgets prepared under traditional processes add little value and require far too much valuable management time which would be better spent elsewhere.
• Too heavy a reliance on the 'agreed' budget has an adverse impact on management behaviour, which can become dysfunctional with regard to the objectives of the organisation as a whole.
• The use of budgeting as a base for communicating corporate goals - setting objectives, continuous improvement etc - is seen as contrary to the original purpose of budgeting as a financial control mechanism.
• Most budgets are not based on a rational, causal model of resource consumption, but are often the result of protracted internal bargaining processes.
• Conformance to budget is not seen as compatible with a drive towards continuous improvement.
• Traditional budgeting processes have insufficient external focus.
Rolling or perhaps monthly budgets focus management attention on current and likely future events. But is this managing change? Or merely an attempt to keep ahead of change.
‘Beyond Budgeting’ could be the answer. ‘Beyond Budgeting’ is about releasing people from the chains of top down management and enabling them to use the knowledge resources of the organisation to increase profitability. With intellectual assets accounting for 80-90% of shareholder value today, people really are the organisation’s most valuable asset. But the way the annual budget round works means that their energy is used more for negotiating the budget than creating shareholder wealth.
In the private sector managers should consider current and future opportunities with a focus on non-financial ‘value drivers’ as performance indicators. This should create and foster a climate based on competitive success. Goals are agreed against external benchmarks rather than against internally negotiated fixed targets. Managerial focus shifts from beating other managers for a slice of resources to beating the competition. It empowers operational managers to act by removing resource constraints. Key ratios are set, rather than detailed line-by-line budgets. Access to resources is based upon agreed parameters rather than line-by-line budget authorisations. This is aimed at speeding up the response to environmental threats and enabling quick exploitation of new opportunities.
Can ‘Beyond Budgeting’ work in the public sector? This would require a change in mindset. Senior managers and politicians would need to set broad goals and trust in their managers to ‘get on with it’ One of the biggest problems confronting the public sector is how do they best utilise their limited resources to meet the public’s unlimited needs? The problem we have today is that in the public sector the budget process is often about justifying existing resources and acquiring new resources. Priorities are based upon budget submissions and taken by people far removed from the action. Resources are then allocated for the year ahead. If ‘resource ‘buckets’ were allocated to users and they had the scope to spend the money in the way they thought best to maximise their performance and they had the information to understand their inputs and the flexibility to buy their resources from an internal or external market then they might have the incentive to take a long look at their costs.
Kaplan (no relation!) provides an interesting example. In the City of Indianapolis and after many years of budget overruns the new mayor decided to put a number of contracts out to tender. One included the paving of roads, filling potholes, sweeping streets, and collecting rubbish. He first asked for current costs. No one in the council had a clue. He then commissioned an a costing study. This showed a different view of costs. He then shared the information with departmental workers who decided to bid for the contract. Armed with the new information, the workers’ bid was by far the lowest cost ($286 per ton against the previous cost of $640). Cost savings came from fewer supervisors, reduced work crews (labourers vehicle drivers, and equipment operators) and more efficient use of vehicles. The lessons learned was that once the full information was shared with the workers (they had no idea about the central service costs), and once they had the freedom to act, they were in the best position to make improvements.
References:
Coombs, H M and Jenkins, D E Public Sector Financial Management, 3rd edition, Thomson Learning Press, 2003.
Hope, J and Fraser, R Beyond Budgeting, 1st edition, Harvard Business School Press, 2003
www.beyondbudgeting.org
Robert S. Kaplin Indianapolis: Activity-Based Costing of City Service
Wednesday 12 September 2012
Thursday 5 July 2012
Answer the question!!
When I was an examiner we would spend over two hours at an examiners meeting discussing one word in a question. Tempers would get frayed but we would eventually all agree on that word. The exam would be sat and I as an examiner would sit and mark papers in my study at home.
Do you know the one thing that really got to me?
You would sit and look at a script. The candidate obviously had attended classes, revision, question based day, bought the podcast and probably even the t-shirt, knew the subject inside out, could quote every theory going. But guess what? They didn’t read that one word we argued over – the verb!!
The verb – the ‘doing’ word. What the examiner is asking you to do! Ignore it and you will fail. Understand it and success is in sight.
Different levels in your studies you will get different verbs. Lower levels you will get things like List, State, Define then as you move up you get verbs like Identify, Illustrate Apply. At the highest level you will get Evaluate, Advise, Recommend. My favourite verb and the one students find hardest is – Explain.
When examiners ask candidates to explain something more often than not they would get a description instead. Put it this way, if I asked you do describe a cat, it’s easy: Furry, cute and goes meow. Now explain a cat. Not so easy is it? You can’t explain what a cat is, but you can explain why people keep cats as pets, or how to litter train one. So in the exam if you asked to explain something, use a paragraph. Write a sentence that makes your point and then write another one to explain why the first sentence is so, or the consequences of the first sentence. To make your point even clearer, write a third sentence.
So play ‘Spot the Verb’
Ok guys?
Gearing, Culture and Management Style
Over the last few decades, ideas about management styles have been dominated first by the American management model and later by the Japanese. The underlying assumption has always been the existence of a country specific management model as a result of the national cultural heritage. Does it seem viable to claim that management style is highly influenced by deep-rooted cultural forces of a nation? Do the French in general manage their enterprises differently from the Danes? Are German managers always engineers and like everything ‘ordered’?
The variety of cultures has influenced the national style of management, however, talking about a national management style should be done with caution because it operates with stereotypes based on an average view of society.
Some countries have a legal system that relies upon a limited amount of statute law, which is then interpreted by the courts, which build up large amounts of case law to supplement the statutes. Such a ‘common law’ system was formed in England primarily after the Norman Conquest, by judges acting on the King’s behalf. It is less abstract than codified law; a common law rule seeks to provide an answer to a specific case rather than formulate a general rule for the future. This naturally influences company law that traditionally does not prescribe rules to cover the behaviour of companies. Other countries have a system of law that is based upon Roman Law. Here, rules are linked to ideas about justice and morality; they become a doctrine. The word ‘codified’ is associated to such a system. This has an important effect upon company law in that it is much more regulated with detailed rules
The prevalent types of business organization and ownership also differ. In Germany France and Italy, capital provided by the banks is very significant, (high geared companies) as are the small family-owned business. By contrast in the United Kingdom there are a large number of companies that rely on millions of private shareholders for finance (low geared companies).
Incidentally, the country with the longest history of ‘public’ companies is the Netherlands. Although it has a fairly small stock exchange, many multinationals (Unilever, Philips) are listed on it.
In such countries as Germany, France or Italy, the banks or the state will, in many cases, nominate directors and thus be able to obtain information and affect decisions.
How do you think this affects the business strategy?
Over the next few weeks it is my intention to examine this. Your input to this discussion is welcome!
Peter
The variety of cultures has influenced the national style of management, however, talking about a national management style should be done with caution because it operates with stereotypes based on an average view of society.
Some countries have a legal system that relies upon a limited amount of statute law, which is then interpreted by the courts, which build up large amounts of case law to supplement the statutes. Such a ‘common law’ system was formed in England primarily after the Norman Conquest, by judges acting on the King’s behalf. It is less abstract than codified law; a common law rule seeks to provide an answer to a specific case rather than formulate a general rule for the future. This naturally influences company law that traditionally does not prescribe rules to cover the behaviour of companies. Other countries have a system of law that is based upon Roman Law. Here, rules are linked to ideas about justice and morality; they become a doctrine. The word ‘codified’ is associated to such a system. This has an important effect upon company law in that it is much more regulated with detailed rules
The prevalent types of business organization and ownership also differ. In Germany France and Italy, capital provided by the banks is very significant, (high geared companies) as are the small family-owned business. By contrast in the United Kingdom there are a large number of companies that rely on millions of private shareholders for finance (low geared companies).
Incidentally, the country with the longest history of ‘public’ companies is the Netherlands. Although it has a fairly small stock exchange, many multinationals (Unilever, Philips) are listed on it.
In such countries as Germany, France or Italy, the banks or the state will, in many cases, nominate directors and thus be able to obtain information and affect decisions.
How do you think this affects the business strategy?
Over the next few weeks it is my intention to examine this. Your input to this discussion is welcome!
Peter
CIMA - It's all in the scenario!
For my sins (and oh what a sinner I must be) I teach on all the main accountancy courses, CIMA, ACCA and ICAEW. Are there any differences between the exams? Well yes and no. All are quite tough and testing and many of the techniques taught are the same but CIMA exams really rely much more on the scenario type question.
Many subjects have quite a large amount of theory but what often makes CIMA exams challenging is relating this theory to the scenario. And that’s the key to passing many CIMA exams – relate your knowledge to the scenario!
The suggested approach is:
- Start by reading the first paragraph only – this usually sets the scene. Large/small Company. Local/multinational, 1000’s of employees. Listed etc
- Now read the requirements before reading the rest of the question. Play three games - Spot the verb – that’s what the examiner is asking you to do after all. Spot the word ‘AND’ - this ensures you answer all the requirements. Finally play spot the marks – You don’t have to write as much for an eight mark question as you do a sixteen. Obvious I know but you’d be surprised how many students don’t appear to realise this. These requirements should give you the headings for your answer plan and your answer.
- Now read the rest of the question. As you read the question consider how the facts and theories you have learned apply in the scenario given. Wherever you can use definitions. If the question is about let’s say derivatives, define them.
Avoid writing everything you know about a topic. Memory dumps will not score well. Answers should be specific to the issues raised in the question and the scenario.
Most students fail not because they don’t know their stuff but because they don’t RTFQ!!
Good luck.
Peter
Dont blame the instrument!
When Nick Leeson joined the Barings group and went to work as a clerk at SIMEX in Singapore who would have thought he would single-handedly break the bank?
In 1994 Leeson’s department made profits of $30.7 million which was one-fifth of the group’s profit. Although the bank set up a Group Treasury and Risk function to manage its risk exposure better, Leeson was allowed to adopt a new strategy of buying and selling options on the Nikkei 225 index. He was in effect betting that the market would not have any sharp movements. Up or down. Who was to know what was about to hit Japan?
On 17th January it happened. An earthquake hit the country, causing great damage and loss of life. This led to the collapse of the Nikkei, exposing Barings to huge losses.
What was Leeson’s response? Invest heavily in buying Nikkei futures in an attempt to support the price. It’s like a punter on the horses doubling his stake each time he loses – ‘double-or-quits’ approach. This strategy inevitably failed, he lost £860 million resulting in Barings being sold to ING for £1.
Leeson sent his boss a fax: ‘Sincere apologies for the predicament I have left you in’ (I must try that one).
So what went wrong? Was it the use of derivatives that brought the bank down? Well derivatives were used but they are not to blame. It was the lack of risk controls that were the real problem. Banning the use of derivatives is like banning motor cycles because they kill more people than cars. It’s not the instrument that causes the problem but the person in control.
Were lessons of Leeson learned at Northern Rock?
Trouble Brewing in Hedges
As a lad, over 18 of course, I can remember sitting in a big, dank pub somewhere in the Midlands, drinking fizzy brown beer. This pub was owned by Bass a brewer of some note who was later taken over by Mitchell & Butlers.
Mitchell & Butlers, now owners of All Bar One and Harvester Inns, decided, like several other major British brewers, that it was best to leave the actual brewing to Johnny Foreigner and much better returns were to be had from rolling out trendy pub and ‘leisure’ formats, and try and make money out of property and derivatives.
In 2007 they decided you didn’t need to be a giant multinational bank to make a giant loss trading in obscure instruments that your director doesn’t understand. This was the ‘90s. In the 21st century, even dull old pub companies with flat beer and flat profits that want to turn themselves into hot young pub companies with whizzing shareholder returns can do it. In M&B’s case, they did it in bucket loads.
What better way to generate profits than to embark on a sale-and-leaseback joint-venture with a property tycoon involving some 1,300 of their pub properties? M&B were persuaded by their City advisers, Citigroup and Royal Bank of Scotland, to take out huge future hedging contracts against the risk of rising interest rates and future trends in pub rents. But the pub-property deal never went ahead, leaving the hedging contracts as an open one-way bet, which is of course the very opposite of a hedge. As Bank of England interest rates started to fall and rents started to move the wrong way, M&B’s position looked worse and worse. Finally, M&B’s board decided to close out the hedge contracts, crystallise the loss at £274 million, part company with finance director, and in an exquisitely rare act of corporate penitence, cancel their own annual bonuses.
Remember if you are not careful hedges do have a downside risk if they do not match an underlying transaction.
Company Valuations
Company valuations are often tested in accountancy exams. We know of methods using DVM and also using DCF and PE but does this really value the company?
Gerald Ratner former CEO of Ratners jewellers managed to devalue his company by £500 million overnight by probably one of the worst business decisions ever!
Ratner, for reasons best known to himself, gave a speech at the Institute of Directors in 1991. Joking about the cheapness of his wares, he described a £4.95 Ratners decanter (I had just been given one as a birthday present) as ‘total crap’ and further said that the firm’s 99p earrings were ‘cheaper than a prawn sandwich from Marks & Spencer, but probably wouldn’t last as long’.
His was a very famous and popular company, but if he said his products were crap, why should anyone like you and me buy them? Before he addressed the meeting and made these statements everyone knew that the products were cheap, but once they had been officially branded as such, they lost their glamour. Jewellery is after all a ‘glamour’ item. And that was that. The share price collapsed. He tried to justify his comments but these were worthless, the damage had been done – value and subsequently the company gone.
Making such a gaff is known now as 'doing a Ratner' But would history repeat itself?
Asked in an interview in 2001 to clarify the target market for the Topman clothing chain, the firm's brand director, David Shepherd, replied: "Hooligans or whatever." He went on: "Very few of our customers have to wear suits for work. They'll be for his first interview or first court case." The company later suggested that the word "hooligan" would not be seen as an insult among its customers.
In 2003, Matt Barrett, the Barclays chief executive, shocked observers by suggesting that consumers should stay clear of his company's product, the Barclaycard, because it was so expensive. Giving evidence to a panel of MPs, he admitted he would not use one himself. He said: "I do not borrow on credit cards. I have four young children. I give them advice not to pile up debts on their credit cards."
So remember with company valuation it’s not a science but an art and so is making gaffs!
Tuesday 12 June 2012
How to Design an Effective Bonus Plan
So, what are the key ingredients of an effective bonus plan? This question is one that I have wrestled with over a number of years. Based on experience, I have learned that a bonus system should incorporate 5 specific elements to in order to be an effective motivator. I discuss these below.
My philosopy of bonuses is straightforward. A person's paypacket is for his or her regular work. The paypacket should suffice as appropriate compensation for someone who performs as expected. If she performs her duties as requested, and does an adequate job in that effort, then the paypacket is her reward.
A bonus, on the other hand, is a reward for doing something more and it has a two fold objective. It is, foremost, compensation for work performed at a level above what is expected. But it is also a tool. A very effective tool I might add. It allows a CEO to put a spot light on a specific objective that must be accomplished in a particular time period. Achieve that objective, and you will be rewarded with cash or stock remuneration. It is this aspect of the bonus that I like best. People can be motivated by money. If you want to motivate a person to achieve a certain objective, put a price tag on what it is worth to you. When an employee hears "get that system installed and operational in one quarter and you will earn £20,000 in bonus money", that tends to focus his mind on making sure it happens.
Now, onto the elements that must be incorporated in any bonus plan to maximize its effectiveness.
Timely - This means quarterly, not annually. An annual bonus simply takes to long to bear fruit. Also, consider the challenge of laying out a specific set of objectives in January that will still be relevant to the company in December. Not very likely. The quarterly bonus has one more attractive dimension. It gives the management team and the board a reason to evalute people on a frequent basis - and adjust priorities as needed. That is extremely valuable.
Meaningful - The reward being offered has to be a motivator. What that extra pound or stock grant amount is depends on a lot of factors. Just make sure the bonus matters.
Predictable - The best bonus plans are ones in which a person can easily calculate what he is going to earn. This means emphasizing objective measures of performance. I hate subjective standards when it comes to bonus plans. Making an employee guess what he might earn is not a motivator. Lay it out in with simple maths. To that end, the components of the bonus calculation should include no more than 3 variables. For instance, a head of Operations might be bonused on 3 measurements: COGS, product shippments and customer satisfaction results. I have seen too many bonus plans with 15 + factors driving the bonus award. That is too many. It makes it nearly impossible for the employee to quickly assess how his contribution to a given task will affect his bonus. And ultimataly, you want him thinking that way. You want to influence how he spends his time. When an employee must make the inevitable trade-off between doing one thing versus another, you want the information provided by the bonus to guide his efforts.
Consistent - The structure and mechanics of the bonus plan should be remain consistent over time (as much as possible). This means that things like the payout frequency (quarterly), the bonus amount (% of salary for instance) and the number of variables in the bonus (2 or 3 is best) should remain constant. What can change - and likely should - is the specific activity or result that the bonus will be based on. For instance, the Head of Engineering may have her bonus for Q2 based 50% on the delivery of a certain product and 50% on hiring objectives. The next quarter, all of her bonus might be based on opening an offshore development center by a certain date. It is fine to change the specific activity being bonused, what should not change (at least not often) is the method by which a bonus is calculated and paid.
Fair - The purpose of a bonus is to motivate certain behavior to obtain certain results. So it makes a lot of sense to ensure that the employee can actually influence the results she is being bonused on! That is what I call fair. Seems obvious but it doesn't happen often enough. In my opinion, "group goals" suck! Remember what the bonus is for. It is to communicate to the employee what you - the CEO or board - find important and to motivate him to achieve certain results that you desire. This requires a bonus scheme that he can influence.
My final advice. As you put together your bonus plan, ask yourself, is the reward being offered Timely, Meaningful, Predictable, Consistent and Fair. If so, you probably have the makings of a bonus plan that will drive the results you are looking for.
(with thanks to Big Billy)
Saturday 26 May 2012
To explore strange new worlds, to seek out new life and new civilisations, to boldly go where no man has gone before.
Ah the company mission statement.
According to my CIMA E3 notes it should be designed to put in writing the basic purpose of the organisation and what it is trying to achieve. As an employee we need direction we need to understand where the company that pays us and feeds our children is heading. We all need to be singing of the same hymn sheet.
Evidence of mission statements can be traced back to the early 1900’s. One of the earliest is from Henry Royce – ‘We build the best motor car’. But they began to appear more and more often during the late 1980 – In the USA naturally.
Some mission statements are long and basically unintelligible:
Our mission is to produce superior financial returns for our shareholders by providing transportation, high value-added logistics and related information services through focused operating companies. Customer requirements will be met in the highest quality manner appropriate to each market segment served. We will strive to develop mutually rewarding relationships with our employees, partners and suppliers. Safety will be the first consideration in all operations. Corporate activities will be conducted to the highest ethical and professional standards.
- Fedex
Whilst others are a bit more to the point:
To crush Reebok.
- Nike
Beat Coke.
- Pepsi
We will crush, squash, and slaughter Yamaha.
- Honda
I must add these are not current, interesting, but not current.
Can you tell an organisation from its mission statement? Which company had the following statement?
Our mission is to conduct all of our businesses, both energy and financial related, with four key values in mind: respect, integrity, communication and excellence. All business dealings must be conducted in an environment that is open and fair.
Yes you guessed it! Enron who in 2001 were implicated in a massive fraud
How about:
A specialised lending and savings bank which aims to deliver superior value to customers and shareholders through excellent products, efficiency and growth.
Northern Rock – good isn’t it?
How about:
Our mission is to make, distribute and sell the finest quality ice cream and euphoric concoctions with a continued commitment to incorporating wholesome, natural elements and promoting business practices that respect the Earth and the Environment.
- Ben & Jerry's
To enable people and businesses throughout the world to realize their full potential.
- Microsoft.
So where are we now? After about 10 years of use mission statements became less popular. Where is the competitive advantage of having a mission statement if everyone has one?
So bye-bye mission statement and hello Noble Purpose, a cross between a mission statement and an advertising slogan. Shorter and snappier. Examples include:
To make people happy.
- Walt Disney
Beyond Petroleum.
- BP
To give ordinary folk the chance to buy the same things as rich people.
- Wal-Mart
I'd be interested in hearing your examples.
Cheers Peter
Kaplan – Building Futures One Success Story At A Time!
According to my CIMA E3 notes it should be designed to put in writing the basic purpose of the organisation and what it is trying to achieve. As an employee we need direction we need to understand where the company that pays us and feeds our children is heading. We all need to be singing of the same hymn sheet.
Evidence of mission statements can be traced back to the early 1900’s. One of the earliest is from Henry Royce – ‘We build the best motor car’. But they began to appear more and more often during the late 1980 – In the USA naturally.
Some mission statements are long and basically unintelligible:
Our mission is to produce superior financial returns for our shareholders by providing transportation, high value-added logistics and related information services through focused operating companies. Customer requirements will be met in the highest quality manner appropriate to each market segment served. We will strive to develop mutually rewarding relationships with our employees, partners and suppliers. Safety will be the first consideration in all operations. Corporate activities will be conducted to the highest ethical and professional standards.
- Fedex
Whilst others are a bit more to the point:
To crush Reebok.
- Nike
Beat Coke.
- Pepsi
We will crush, squash, and slaughter Yamaha.
- Honda
I must add these are not current, interesting, but not current.
Can you tell an organisation from its mission statement? Which company had the following statement?
Our mission is to conduct all of our businesses, both energy and financial related, with four key values in mind: respect, integrity, communication and excellence. All business dealings must be conducted in an environment that is open and fair.
Yes you guessed it! Enron who in 2001 were implicated in a massive fraud
How about:
A specialised lending and savings bank which aims to deliver superior value to customers and shareholders through excellent products, efficiency and growth.
Northern Rock – good isn’t it?
How about:
Our mission is to make, distribute and sell the finest quality ice cream and euphoric concoctions with a continued commitment to incorporating wholesome, natural elements and promoting business practices that respect the Earth and the Environment.
- Ben & Jerry's
To enable people and businesses throughout the world to realize their full potential.
- Microsoft.
So where are we now? After about 10 years of use mission statements became less popular. Where is the competitive advantage of having a mission statement if everyone has one?
So bye-bye mission statement and hello Noble Purpose, a cross between a mission statement and an advertising slogan. Shorter and snappier. Examples include:
To make people happy.
- Walt Disney
Beyond Petroleum.
- BP
To give ordinary folk the chance to buy the same things as rich people.
- Wal-Mart
I'd be interested in hearing your examples.
Cheers Peter
Kaplan – Building Futures One Success Story At A Time!
Budgeting - What's the point?
All managers know the scene. Hours are spent over spreadsheets. Days of meetings, discussions and debates. Draft budgets, revisions and redrafts. Months are spent estimating this that and everything down to the last paper clip. Finally the budget is accepted. Yet even by the end of Week 1, most assumptions the budget was built upon will be out of date, the constraints set will be inhibiting action and business opportunities will be lost.
Fixed budgets don’t work today. A budget is a too static instrument and locks managers into the past - into something they thought last year was right. To be effective in a fast moving economy with rapidly shifting market conditions and quick and nimble competitors, organisations have to be able to adapt constantly their priorities and put their resources where they can create most value for customers and shareholders.
Budgets, as practiced by most organisations today should be abolished! A growing number of companies have decided that conventional budgeting is no longer worthwhile. To them, the reassurance budgets give to a nervious chief executive is outweiged by the flexibility needed in todays organisations.
The weaknesses of traditional budgeting processes have been the subject of much attention and many commentators. Hope and Fraser consider that such weaknesses include the following:
• Budgets prepared under traditional processes add little value and require far too much valuable management time which would be better spent elsewhere.
• Too heavy a reliance on the 'agreed' budget has an adverse impact on management behaviour, which can become dysfunctional with regard to the objectives of the organisation as a whole.
• The use of budgeting as a base for communicating corporate goals - setting objectives, continuous improvement etc - is seen as contrary to the original purpose of budgeting as a financial control mechanism.
• Most budgets are not based on a rational, causal model of resource consumption, but are often the result of protracted internal bargaining processes.
• Conformance to budget is not seen as compatible with a drive towards continuous improvement.
• Traditional budgeting processes have insufficient external focus.
Rolling or perhaps monthly budgets focus management attention on current and likely future events. But is this managing change? Or merely an attempt to keep ahead of change.
‘Beyond Budgeting’ could be the answer. ‘Beyond Budgeting’ is about releasing people from the chains of top down management and enabling them to use the knowledge resources of the organisation to increase profitability. With intellectual assets accounting for 80-90% of shareholder value today, people really are the organisation’s most valuable asset. But the way the annual budget round works means that their energy is used more for negotiating the budget than creating shareholder wealth.
In the private sector managers should consider current and future opportunities with a focus on non-financial ‘value drivers’ as performance indicators. This should create and foster a climate based on competitive success. Goals are agreed against external benchmarks rather than against internally negotiated fixed targets. Managerial focus shifts from beating other managers for a slice of resources to beating the competition. It empowers operational managers to act by removing resource constraints. Key ratios are set, rather than detailed line-by-line budgets. Access to resources is based upon agreed parameters rather than line-by-line budget authorisations. This is aimed at speeding up the response to environmental threats and enabling quick exploitation of new opportunities.
Can ‘Beyond Budgeting’ work in the public sector? This would require a change in mindset. Senior managers and politicians would need to set broad goals and trust in their managers to ‘get on with it’ One of the biggest problems confronting the public sector is how do they best utilise their limited resources to meet the public’s unlimited needs? The problem we have today is that in the public sector the budget process is often about justifying existing resources and acquiring new resources. Priorities are based upon budget submissions and taken by people far removed from the action. Resources are then allocated for the year ahead. If ‘resource ‘buckets’ were allocated to users and they had the scope to spend the money in the way they thought best to maximise their performance and they had the information to understand their inputs and the flexibility to buy their resources from an internal or external market then they might have the incentive to take a long look at their costs.
Kaplan (no relation!) provides an interesting example. In the City of Indianapolis and after many years of budget overruns the new mayor decided to put a number of contracts out to tender. One included the paving of roads, filling potholes, sweeping streets, and collecting rubbish. He first asked for current costs. No one in the council had a clue. He then commissioned an a costing study. This showed a different view of costs. He then shared the information with departmental workers who decided to bid for the contract. Armed with the new information, the workers’ bid was by far the lowest cost ($286 per ton against the previous cost of $640). Cost savings came from fewer supervisors, reduced work crews (labourers vehicle drivers, and equipment operators) and more efficient use of vehicles. The lessons learned was that once the full information was shared with the workers (they had no idea about the central service costs), and once they had the freedom to act, they were in the best position to make improvements.
References:
Coombs, H M and Jenkins, D E Public Sector Financial Management, 3rd edition, Thomson Learning Press, 2003.
Hope, J and Fraser, R Beyond Budgeting, 1st edition, Harvard Business School Press, 2003
http://www.beyondbudgeting.org/
Robert S. Kaplin Indianapolis: Activity-Based Costing of City Service
Fixed budgets don’t work today. A budget is a too static instrument and locks managers into the past - into something they thought last year was right. To be effective in a fast moving economy with rapidly shifting market conditions and quick and nimble competitors, organisations have to be able to adapt constantly their priorities and put their resources where they can create most value for customers and shareholders.
Budgets, as practiced by most organisations today should be abolished! A growing number of companies have decided that conventional budgeting is no longer worthwhile. To them, the reassurance budgets give to a nervious chief executive is outweiged by the flexibility needed in todays organisations.
The weaknesses of traditional budgeting processes have been the subject of much attention and many commentators. Hope and Fraser consider that such weaknesses include the following:
• Budgets prepared under traditional processes add little value and require far too much valuable management time which would be better spent elsewhere.
• Too heavy a reliance on the 'agreed' budget has an adverse impact on management behaviour, which can become dysfunctional with regard to the objectives of the organisation as a whole.
• The use of budgeting as a base for communicating corporate goals - setting objectives, continuous improvement etc - is seen as contrary to the original purpose of budgeting as a financial control mechanism.
• Most budgets are not based on a rational, causal model of resource consumption, but are often the result of protracted internal bargaining processes.
• Conformance to budget is not seen as compatible with a drive towards continuous improvement.
• Traditional budgeting processes have insufficient external focus.
Rolling or perhaps monthly budgets focus management attention on current and likely future events. But is this managing change? Or merely an attempt to keep ahead of change.
‘Beyond Budgeting’ could be the answer. ‘Beyond Budgeting’ is about releasing people from the chains of top down management and enabling them to use the knowledge resources of the organisation to increase profitability. With intellectual assets accounting for 80-90% of shareholder value today, people really are the organisation’s most valuable asset. But the way the annual budget round works means that their energy is used more for negotiating the budget than creating shareholder wealth.
In the private sector managers should consider current and future opportunities with a focus on non-financial ‘value drivers’ as performance indicators. This should create and foster a climate based on competitive success. Goals are agreed against external benchmarks rather than against internally negotiated fixed targets. Managerial focus shifts from beating other managers for a slice of resources to beating the competition. It empowers operational managers to act by removing resource constraints. Key ratios are set, rather than detailed line-by-line budgets. Access to resources is based upon agreed parameters rather than line-by-line budget authorisations. This is aimed at speeding up the response to environmental threats and enabling quick exploitation of new opportunities.
Can ‘Beyond Budgeting’ work in the public sector? This would require a change in mindset. Senior managers and politicians would need to set broad goals and trust in their managers to ‘get on with it’ One of the biggest problems confronting the public sector is how do they best utilise their limited resources to meet the public’s unlimited needs? The problem we have today is that in the public sector the budget process is often about justifying existing resources and acquiring new resources. Priorities are based upon budget submissions and taken by people far removed from the action. Resources are then allocated for the year ahead. If ‘resource ‘buckets’ were allocated to users and they had the scope to spend the money in the way they thought best to maximise their performance and they had the information to understand their inputs and the flexibility to buy their resources from an internal or external market then they might have the incentive to take a long look at their costs.
Kaplan (no relation!) provides an interesting example. In the City of Indianapolis and after many years of budget overruns the new mayor decided to put a number of contracts out to tender. One included the paving of roads, filling potholes, sweeping streets, and collecting rubbish. He first asked for current costs. No one in the council had a clue. He then commissioned an a costing study. This showed a different view of costs. He then shared the information with departmental workers who decided to bid for the contract. Armed with the new information, the workers’ bid was by far the lowest cost ($286 per ton against the previous cost of $640). Cost savings came from fewer supervisors, reduced work crews (labourers vehicle drivers, and equipment operators) and more efficient use of vehicles. The lessons learned was that once the full information was shared with the workers (they had no idea about the central service costs), and once they had the freedom to act, they were in the best position to make improvements.
References:
Coombs, H M and Jenkins, D E Public Sector Financial Management, 3rd edition, Thomson Learning Press, 2003.
Hope, J and Fraser, R Beyond Budgeting, 1st edition, Harvard Business School Press, 2003
http://www.beyondbudgeting.org/
Robert S. Kaplin Indianapolis: Activity-Based Costing of City Service
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