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Beyond Budgeting on the move – report from the First Annual Beyond Budgeting Summit in London, 1-2 July 2003

News categories: Enterprise and business strategy, Finance and  accounting, Performance management and controlling, Information Technology

             

Why Beyond Budgeting?

The Beyond Budgeting Management Model

The Beyond Budgeting pioneers

The Beyond Budgeting Round Table (BBRT)

The First Annual Beyond Budgeting Summit

Summary

Additional Resources (updated Jan 2005)

 

 


 

“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 that it was right. To be effective in a global economy with rapidly shifting market conditions and quick and nimble competitors, organization have to be able to adapt constantly their priorities and have to put their resources where they can create most value for customers and shareholders. In order to do that, they need the right concepts, management processes and tools – concepts such as the Beyond Budgeting Management Model. The introduction of new management instruments such as the Balanced Scorecard, which help to better align the entire organization with corporate strategic objectives and to focus it on the essentials, has created the right foundation. Because if corporate strategy and the objectives are clear for all people in an organization, one can principally react faster to changing market conditions.  But then the fixed budget comes into their way and prevents them from really doing the right things. Though what is often missing is a more flexible operational planning and control model. The Beyond Budgeting model wants to fill exactly this gap.”   
   
                                                 Juergen H. Daum
 


New! - visit J.H.D.'s Beyond Budgeting Info Center 
- including latest BB insight materials, interviews with BB pioneers etc. - here an extract:

| J.D.'s insight article "Beyond Budgeting" | Interview with Lennart Francke, CFO of Svenska Handelsbanken | Panel Discussion with Borealis, Nestlé, and Unilever | Interview with Jeremy Hope – co-founder of the Beyond Budgeting Round Table | Interview with J.D. on finance and IT


 

Why Beyond Budgeting?

 

Today we can sense a growing dissatisfaction among CEOs, CFOs and business managers and across the whole business community with the traditional general management approach, which is based on budgetary control - with a fixed annual performance contract, fixed action plans for an entire year and a higly politcal budgeting process dominated by "gaming" as the result. Managers increasingly doubt if today's pervasive budgeting culture in many large organizations can support successful enterprise management and robust and proper corporate governance. Jack Welch, former CEO of General Electric, once described this with his often quoted statement: “The budget is the bane of corporate America. It should never have existed. It is an exercise in minimalization. You always are getting the lowest out of people”[1]. What he was meaning was, that the budget based management systems will lead always to the lowest targets through the gaming it introduces into a company’s management culture. In addition, because the budget is functioning as a fixed annual performance contract, it forces managers to stick to the budget, no matter what changes, opportunities and threats occur on the market. 

 

Therefore, the annual budget, which represents the core of the traditional enterprise management systems, has become in today’s dynamic market environment often a hurdle rather than an enabler for corporate success. While the budget above all focuses managers and controllers on keeping budget targets and limits that were agreed months ago, in today’s dynamic economic environment increasingly the opposite is expected of companies. By adapting operational plans and activities, managers and their companies should be able to react more quickly to market changes. They shouldn’t be restricted to an artificial and too long period such as the fiscal year to reconcile plans with the business environment and to adapt them. On the other hand, the fiscal year seems at the same time to be a too short-term time horizon for planning and steering some major activities of today’s companies. Most companies are more and more engaged in activities such as long term R&D or brand and relationship building with business partners and potential customers in new markets that require a constant outlook beyond the border of the fiscal year. In addition, the budget-based performance management system is too inwardly focused. It guides managers to look in the wrong direction and to pay too much attention to input factors such as costs and nearly no attention on output factors, such as customer satisfaction or in general, what a company is able to achieve with its inputs on the market compared with its peer group. Budgets are also often blamed to stimulate a culture of mistrust. Every manager tries to negotiate the lowest target for him- or herself, turning the budgeting process into a big annual gaming ritual, which is adding no value but is rather destroying value. Managers are putting cost “buffers” in their budgets and even tend to manipulate the actuals if it seems that they will not be able to meet their budget. That is the reason why Jack Welsh named the budget “the bane of corporate America”. No wonder, that many companies are looking for improving the traditional budget-based way of steering and managing their business. In a recent survey, conducted by The Hacket Group among European companies, 69% of the companies reported that they are still using traditional budgeting (3% have already no budgets, 28% use a reengineered approach), but that most of them intend to replace it within the next 2 years through a reengineered approach or even abandon budgeting at all. They have realized that they have to tackle the budget – it is not enough to add new tools for e.g. strategic management.

 

Many innovations in enterprise performance management in the last couple of years are failing to achieve its goals. In reality most of the new tools and techniques that companies were trying to develop and implement were not fully working. Take the Balanced Scorecard as an example. The Balanced Scorecard was designed to enable managers to map and describe their strategy, to balance short- and long-term goals, initiatives and measures, to align the actions of the ‘top floor’ and the ‘shop floor’, and to focus on the real drivers of financial performance. As most managers will recognize, while these issues are partly related to the financial accounts like marketing or fixed costs, they are much more concerned with how well firms are meeting their customers needs, how well their internal processes are organized and how well they are preparing for the future. In other words, it says something about how successful the firm is at innovation. This has created in many organizations a framework for a more flexible strategy management process geared much more to value creation. But if the budgeting system and culture remains in place, there is no way that the strategic management process will really change the operational manager’s day-to-day behaviour in the company. Managers will remain focused on achieving short-term financial results even if this involves cutting key ‘strategic’ investments in people development, training, and customer service. You can have the best Balanced Scorecard possible, but if you still use your old budgeting system and a fixed annual performance contract to commit managers to fixed plans and targets, you will fail to achieve the objectives of the Balanced Scorecard and you will fail to become a more strategy-focused and adaptive organization.

 

 

 

The Beyond Budgeting Management Model – result of the work of the Beyond Budgeting Round Table (BBRT)

 

The mission of the Beyond Budgeting movement and of the Beyond Budgeting Round Table (BBRT – see http://www.bbrt.org/) – it’s initiator, is to overcome the limits of the budgeting based general management model. The BBRT is both a research project and an active network of companies who are sponsoring the continuing research and are now at various stages of implementing the model. Since its foundation in 1997 in the UK, the BBRT has analysed 25+ cases of companies that manage without a fixed budget and that are using a different more flexible management model that empowers frontline people and managers instead of restricting and “commanding” them by a centrally controlled budget. The aims of the BBRT are to develop a management model “beyond budgeting” and to help its members to implement it. It’s work over the past five years has ended up in the development of a “Guide”, based on a set of the Beyond Budgeting principles (6 “Leadership Principles” and 6 “Performance Management” principles – see below) and other key requirements for success. “The Guide”[2] will help member companies to design and implement budget-free performance management systems that are in tune with today’s competitive conditions, and gain a real source of competitive advantage.

 

Compared with the traditional management model, Beyond Budgeting has two fundamental differences. First, it is a more adaptive way of managing. In place of fixed annual plans and budgets that tie managers to predetermined actions, targets are reviewed regularly and based on stretch goals linked to performance against world-class benchmarks, peers, competitors and prior periods. Second, the Beyond Budgeting model enables a more decentralized way of managing. In place of the traditional hierarchy and centralized leadership, it enables decision-making and performance accountability to be devolved to line managers and creates a self-managed working environment and a culture of personal responsibility. This leads to increased motivation, higher productivity and better customer service. Individually these two main features can produce significant benefits, but it is in their combination where its real strength lies.

 

The BBRT has identified for each of the two foundations of the Beyond Budgeting model – adaptive processes and devolved decision-making – six principles. The six principles of managing with adaptive performance management processes are:

 

1.      Set stretch goals aimed at relative improvement based on external benchmarks;

2.      Base evaluation and rewards on relative improvement contracts with hindsight;

3.      Make action planning a continuous and inclusive process;

4.      Make resources available as required;

5.      Coordinate cross-company actions according to prevailing customer demand; and

6.      Base controls on effective governance and on a range of relative performance indicators.

 

The overall effect of the switch to Beyond Budgeting is a performance management process based on a relative improvement contract rather than on a fixed performance contract. It assumes that it is not wise to make managers commit to a fixed target and then control their future actions against it when in fact the world is constantly changing. The implicit agreement is that executives will provide a challenging and open operating environment and that employees will deliver continuous performance improvement using their knowledge and judgement to adapt to changing conditions. It is based on mutual trust, but it is not a soft alternative to the fixed performance contract. High visibility of individual and team performance offers no hiding place. Manages must perform to high levels of expectations – relative to peers – or face the consequences. The result of applying the adaptive performance management principles includes the setting of more aspirational goals, reduced gaming, more ambitious strategies and fast response, less waste, improved customer service, and a greater focus on learning and ethical behaviour.

 

Graph 1a: The new Beyond Budgeting Performance Management Paradigm

 

 

Graph 1b: The new Beyond Budgeting Performance Management System

 

And the six principles of radical decentralization (the new leadership model) are:

 

1.      Provide a governance framework based on clear principles and boundaries;

2.      Create a high-performance climate based on relative success;

3.      Give people freedom to make local decisions that are consistent with governance principles and the organization’s goals;

4.      Place the responsibility for value creating decisions on front-line teams;

5.      Make people accountable for customer outcomes;

6.      Support open and ethical information systems that provide “one truth” throughout the organization.

 

Consequences for the leadership model in switching to Beyond Budgeting: The delegation of decision-making and spending authority has always been one of the key functions of budgeting. However, this delegation usually occurs strictly within a regime of compliance and control. It differs significantly from the approach taken by Beyond Budgeting organizations such as Svenska Handelsbanken which have gone much further and transferred power from the centre to operating managers and their teams, vesting in them the authority to use their judgement and initiative to achieve results without being constrained by some specific plan or agreement. Thus devolution of responsibility is about enabling and encouraging local decisions, not dictating and directing them. The result of applying the six principles of managing with a devolved organization include: a clear governance framework leading to the acceptance of local decision making by front-line teams throughout the organization; a high-performance climate leading to sustained competitive success; the freedom to decide leading to innovation and responsiveness; team-based responsibility resulting in a greater focus on creating value and reducing waste; customer accountability leading to greater commitment to satisfying customers profitability; and finally, an information culture based on openness and “one truth” leading to more ethical behaviour.

 

Graph 2: The new Beyond Budgeting Leadership Model

 

It is important to understand that these principles represent the ‘best of the best’ common practices of the organizations that the BBRT has visited and reported upon. What makes Beyond Budgeting different from other management models is that it provides a comprehensive management model that does not just look at one area or tool while overlooking others, rather it seeks to ensure that all the pieces of the management model are coherent with each other. It is because it is a coherent model in which all of its components work in harmony that it can produce outstanding and sustained success (you find more information about the Beyond Budgeting model at Juergen Daum’s Beyond Budgeting Information Center). 

 

 

The Beyond Budgeting pioneers

 

How does it work in practice – managing without budgets? Svenska Handelsbanken, a Swedish bank with branches all over Northern Europe and in Great Britain, has shown that it is possible. They have had no budgets, no absolute targets, and no fixed plans since 1970. Nevertheless, it is one of the most successful banks in Europe and has outperformed all Scandinavian competitors with regard to the most important performance measures of banks such as return-on-equity, cost-to-income ratio and customer satisfaction  – and this consistently over 30 years. And the enterprise management system at Svenska Handelsbanken works in a completely different way to how it typically is in many companies today: At the bank, controlling is not done by the controllers but by the managers and employees on the spot. More than 50% of Handelsbanken staff has some form of lending authority. The business responsibility is decentralized to a great extent in the branches that are managed as profit centers. The targets for the profit centers are defined relatively, as relative targets to the market. Performance measurement takes place using benchmarking with the competitors, where possible. Profit center managers have free access (within certain agreed performance parameters based on the cost-to-income ratio) to resources ad-hoc when they are needed. Internal service areas must “sell” their services competitively to the operational units, there is no “political” pricing. Therefore, the focus at Svenska Handelsbanken is on the market or beating the competitor, and producing the necessary flexibility for this  - not on meeting a budget agreed on in the past. Two elements are of considerable importance that create the prerequisite for the high level of freedom of operational managers and employees: The management culture in the company and the availability of a cleverly devised information system as the basis for performance management processes. This system determines the total performance of the branches on the basis of a few KPIs and makes this information available to all managers at the same time. In addition, customer behavior is recorded and analyzed in detail and customer profitability is monitored regularly. As a result, it is always possible for every branch manager to make a direct comparison with colleagues. The company uses this to encourage sporting, internal competition with performance league tables. The clues to Handelsbanken’s exemplary performance can be found not in the use of modern management tools - though it used activity-based costing principles long before they were developed elsewhere - but in the management model itself. A flat, simple hierarchy with few controllers; well-trained staff; no budgets to act a barriers to cost reduction; and a few simple-to-understand measures - these are all factors that contribute to maintaining a simple organization and a low cost base. In other words, responsible people with the right information don’t need much support. The Handelsbanken management model introduced by Dr. Jan Wallander, who became CEO of the bank in 1970, is predicated on the belief that the only sustainable competitive advantage available to a firm in a fast-changing world, and especially in a service business, lies with its people – especially their creativity, insights, and judgements – a model in vivid contrast to the numbers-driven alternative so prevalent elsewhere (see interview with Lennart Francke, actual CFO of Svenska Handelsbanken and the report on his presentation at the summit below).

 

Another pioneer of Beyond Budgeting is Borealis. Borealis, which is a leading polyolefin plastics producer in Europe today, was founded in 1994 trough the merger of the petrochemical businesses of two Nordic oil companies, Neste of Finnland and Statoil of Norway. The petrochemical industry has always been a very cyclical business challenging companies with fluctuating raw material and sales prices. The traditional budgeting approach was very badly prepared to deal with such an environment. So Borealis took the post-merger phase and the change spirit, which was predominant at that time, as an opportunity to abandon budgeting. Thus, Borealis introduced in 1995 an alternative more flexible management system that suited its specific business management requirements better, than the traditional budgeting approach. The new tools helped Borealis to become more flexible in enterprise management. Today Borealis is owned by Statoil (Norway), OMV (Austria), and IPIC (Abu Dhabi). The new owners brought some additional changes to the performance management tool set at Borealis namely the introduction of a fifth tool called “Business Planning” – a high level financial plan targeted towards shareholder value management that serves as the interface for the communication with the owner company OMM (see the report on his presentation at the summit below).

 

Other cases include Carnaud Metal Box (CMB), an Anlgo-French packaging company, which was transformed under the leadership of Jean-Marie Descarpentries from a dept-laden company worth only $19m in 1982 to a market value of $3bn in 1989. By abandoning the fixed performance contract and encouraging business unit teams to set stretch targets – based on relative performance (and disconnected from the rewards system) – he achieved what Fortune Magazine described as one of the best European corporate transformations of the 1980s. Later, when Descarpentries was recruited from CMB to transform the French government owned mainframe computer company Groupe Bull in the early 1990s, he deployed the same management principles that the used so successfully at CMB. Again the transformation was remarkable. He turned around Groupe Bull from making heavy losses into achieving respectable profits. The change was such that the French government was able to privatise the company in 1997. After abandoning the budgeting model in 1997, Fokus Bank, a small Norwegian bank, transformed itself from the worst performing bank in Norway with the highest costs to the best performing bank with the lowest costs and the highest return-on-capital-employed. Ahlsell, a Swedish wholesaler of heating, plumbing, refrigeration, and electrical products abandoned budgeting in 1995. A fast open information system with a strong emphasis on relative performance now provides the necessary controls for self-governance by local units. Ahlsell is now the sector’s most profitable company in Sweden – a major turnaround from its position in the early 1990s. Other cases are SKF, IKEA and Volvo Cars in Sweden, Borealis in Denmark, Boots and Sight Savers (a charity) in the UK, and CIBA Vision in the US. A number of other organizations are now making progress. Deutsche Bank, UBS and Schneider Electric are among this group.

 

 

The Beyond Budgeting Round Table (BBRT)

 

The BBRT has been sponsored and funded since 1998 to date by over 70 companies, mostly large European multi-nationals that include companies like: include: Anheuser Busch, Barclays Bank, Boots The Chemist, Clariant International, Coors Brewers, Diageo, Deutsche Bank, DHL, Novartis, Royal Mail in the UK, Scheider Electric, Siemens, SKF, Standard Life, Texas Instruments, The World Bank, UBS, Unilever Best Foods and many others. 

 

The BBRT’s work is driven mainly by the interest of its member companies. The first focus of BBRT’s work and their researchers Jeremy Hope and Robin Fraser was to identify those companies that had abandoned the budgeting model, visiting them, and through case reports and presentations, reporting back to the BBRT members, who were funding their research with their membership fees. After this first phase, by extracting best practices, they gradually pieced together a coherent set of common principles – the 12 principles that form the framework of what has since become the Beyond Budgeting model. This was the second phase. Having now successfully finished the two initial phases of their mission, the BBRT is now focusing on implementation. That includes for example the development of a so called web-based diagnostic tool: you can log on to a diagnostic tool at BBRT’s website and, guided through a questionnaire, evaluate against your peers the effectiveness of your performance management model according to the Beyond Budgeting principles. It has taken a few years for many BBRT members to move from being curious observers to committed implementers. They needed to be convinced by the evidence. The founders of the BBRT believe that their step-by-step approach to producing a set of principles, then a diagnostic that helps them to create their internal case for change, and other implementation guides is the right approach to move forward.  

 

 

 

The First Annual Beyond Budgeting Summit: Culmination point of the Beyond Budgeting research project of the last 5 years and launch pad for the next phase focused on “going public” and on “spreading the news”

 

When the BBRT became operational early in 1998 it focused on research and on developing the Beyond Budgeting model by working with its members. There hadn’t been much activity since then until recently that promoted the Beyond Budgeting model to a broader community beyond its member companies – except for some very few articles that Jeremy Hope and Robin Fraser published in finance magazines. This has changed begin of 2003: in February they published an article in Harvard Business Review to kick-off a broader awareness for the Beyond Budgeting model (Jeremy Hope and Robin Fraser: Who Needs Budgets?, in: Harvard Business Review, February 2003) and in April their book came to market “Beyond Budgeting: How Managers Can Break Free from the Annual Performance Trap” (Harvard Business School Press), which is a summary of the outcome of the first five years of the BBRT research program.  The publication of their book and article in Harvard Business Review this spring generated a lot of awareness about Beyond Budgeting, particularly in North America. In parallel the European BBRT, the nucleus and initiator of the Beyond Budgeting movement, has set up ‘sister’ BBRT’s in North America and in Australasia. The First Annual Beyond Budgeting Summit, held on 1-2 July 2003 in London can therefore be regarded first as the culmination point of the development work of the past 5 and a half years of the BBRT (in fact it was the first public event of the BBRT) and as a launch pad for spreading the news further and for entering the “marketing phase” of the Beyond Budgeting movement.

 

The two day conference was packed with speeches from the Beyond Budgeting pioneers, from BBRT members who followed them, from the founders of the BBRT and from other thought leaders and experts (program of the summit):

 

 

In his opening presentation, Jeremy Hope, BBRT Research Director, summarized the journey of the BBRT during the last five years. The motivation to start the BBRT research project was to overcome the limitations of the traditional performance management process (which is based on budgeting) of which 90% of firms are dissatisfied. One reason for the need for change according to Jeremy is, that the environment in which companies operate today is so much different from the one in which the budgeting model was developed 80 years ago. Another reason is, that budgeting has developed in most companies from a once helpful support process into a pervasive budgeting culture that undermines true performance of modern organizations:

-        Budgets do not work in turbulent markets and are ineffective tools in times of rapid change

-        Budgets stimulate the wrong behaviour and encourage even unethical behaviour as managers do anything to meet the numbers

-        Budgets are divorced from strategy and focus on functions & departments rather than on strategy and value

-        Budgets are too expensive and do not create much value: budgets absorb over 20% of total management time; 77% of time does not add value

 

The mission of the BBRT was thus to develop a new model that helps companies to steer and manage in the information age. Whereas in the industrial age business models where based on the “plan-make-and-sell” paradigm (because of steady, continuous change) and hard assets drove value creation, in the information age business models have to be based on an “anticipate-and-respond” paradigm (because of unpredictable, discontinuous change) and soft/intangible assets drive value creation. This requires other steering tools but, more important, also an other leadership model. Here are the main differences between the old budget based on the new Beyond Budgeting model as outlined by Jeremy Hope:

 

 

 

 

 

Traditional (budget based) Management Model

 

 

Beyond Budgeting Management Model

 

.

Target & rewards

 

 

-     Incremental targets

-     Fixed incentives

 

 

-     Stretch goals

-     Relative rewards

 

Planning & controls

 

-     Fixed annual plans

-     Variance controls

 

 

-     Continuous planning

-     KPI’s & rolling forecasts

 

Resources & coordination

 

-     Pre-allocated resources

-     Central coordination

 

 

-     Resources on demand

-     Dynamic coordination

 

Organization & culture

 

 

-     Central control

-     Focus on managing numbers

 

-     Local control of goals/plans

-     Focus on value creation

 

 

 

A range of companies have undergone already significant change or have started recently in order to implement a new Beyond Budgeting model. Jeremy named companies like Svenska Handelsbanken, Fokus Bank, Unilever, IKEA, Norsk Hydro, UBS, Schneider Electric, Deutsche Bank and others.

 

At the center of the Beyond Budgeting model that these companies have introduced or are still implementing are not any more central headquarter staff and managers, who “steer” and control front line people, but the front line people themselves with the freedom and capability to act. This together with adaptive performance management processes helps to establish in a company a culture of empowerment and entrepreneurship - in contrast to a culture of mistrust and bureaucracy, which the budget based model often stimulates. This leads to more innovative strategies, lower costs, loyal and profitable customers and more ethical behaviour – what all drives shareholder value creation. The key to success is, that the Beyond Budgeting model introduces coherence in changing a company’s general management concept. It doesn’t just focus in the change process on specific tools or just on a few selected areas – such as performance measurement for instance -, which is one of the major reason why many initiatives to improve the management system have fallen short in recent years in many companies. Instead, the Beyond Budgeting model represents a management model that brings coherence to all 4 key areas of a companies general management systems and makes sure that they fit to each other: target & rewards, planning & control, resources & coordination and organization & culture.

 

The BBRT helps companies to evaluate, implement, and benefit from the Beyond Budgeting management model. To facilitate the first step in the process, the BBRT introduced recently the so called BBRT diagnostic and survey. Interested companies can log on to the BBRT website (link to the BBRT diagnostic and survey), answer a list of questions and thus benchmark their existing management model and processes with the results of other companies in the BBRT’s data base. They receive a detailed feedback report that identifies their problem areas and helps them to understand, where and why they need to change/improve their management model. To create the internal case for change, including a vision for a new model, definition of plans for new processes and concepts etc., the BBRT offers membership in one of the regional BBRTs and various services (see graph 3 below).

 

  

 

Graph 3: How the BBRT supports companies in introducing a Beyond Budgeting management model (source: Jeremy Hope)

 

 

Lennart Francke, CFO of Svenska Handelsbanken (see interview with Lennart Francke), who replaced Jan Wallander at the conference, reported in his presentation about Handelsbanken’s Beyond Budgeting journey, a retail bank that abandoned budgeting already in 1970. At the core of Handelsbanken’s management model lays the decentralised organization: most of the decision power has been transferred to branch managers and 50% of all employees are authorized to grant credits. This allows Handelsbanken to react fast to customer requiremen