The traditional annual budget process has been widely and credibly criticized on many fronts, but it stubbornly continues unchanged in many organizations. It is hard to let go of the perception of control that the annual budget provides. It is also a game executives become skilled at, and they are loath to trade away those skills and the probability of success they feel they have.
Let’s consider the assumptions behind a traditional “command and control” annual budget:
- A clear path to a target 12 months in the future can be planned and then achieved.
- A plan remains a good measurement point for 12 months.
- People respond consistently and rationally to monetary incentives and penalties.
- Management is more knowledgeable about products, operations, and customers than responsible front line employees.
What’s the alternative? The adage—a failure to plan is a plan to fail—rings loudly, and the 12-month budget, despite its failings, is a plan.
The increasing volatility, uncertainty, complexity, and ambiguity (VUCA) in the global business and economic environment calls for more planning and adapting than the traditional once-a-year effort. Additionally, managers and workers are demanding a higher level of trust and transparency, and the flexibility to innovate and be entrepreneurial. This workforce development is a big positive for a VUCA business environment. But how do we lead and manage it, particularly for some level of financial control?
A good first step is to simplify the goals and make them more durable and long-term. For example, a goal of sales growth at 110% of an established sales growth index for your key markets. This type of goal can last for several years, end contentious internal arguments each year, and automatically adjust to the macroeconomic environment. Durable targets can also be set for quality, expense control, operational improvement, etc. Durable performance targets allow for longer term, more realistic planning at all levels of the organization.
Budgets also typically involve an annual capital or discretionary project component that pits all organizational interests against one another in gladiatorial combat for 12-month entitlements that then must be used whether they are eventually needed or not.
Why not hold much more frequent discussions of organizational performance and opportunities and then invest based on the situation as it develops; adaptations can then be made to meet the organization’s long-term goals. This approach to investment aligns with a shift to a flexible budget based on rolling forecasts that show how well plans and goals are being received in the market and achieved.
Performance and credibility
Individual performance tied to 12-month budgets can lead to undesirable behavior in several ways—upfront negotiating for lowball targets, spending that isn’t needed, uneconomic discounting, hard selling customers, and even fraud. Furthermore, it can cause dissatisfaction among employees who see managers directing actions they know to be questionable or even wrong. A move toward team based performance incentives tied to durable, long-term goals can foster more workforce innovation, engagement, and positive problem solving. It also makes the workforce more attuned to organizational goals and performance metrics and their part in contributing to them.
A final element of information to establish credibility in the organization is to ensure that organizational cost and investment measures reflect the causal operational and customer (internal and external) relationships that employees see in the resources and processes they manage and work in. Traditional financial accounting and reporting systems are typically designed for creating regulated financial reports for external investors, creditors, and other stakeholders. New managerial costing systems dedicated to creating internal decision support information often need to be established to create relevant information to guide the workforce to focus on longer term goals. Without the information to create understandable and internally credible rolling forecasts and projections and evaluate tangible and intangible investment opportunities, the best intended workforce engagement initiative can fail.
This article owes its inspiration and many of the ideas to an article titled, The Guided Self-Control Management Model, written by Franz Wirnsperger and Klaus Moeller about their experience at Hilti in the October 2021 issue of Strategic Finance magazine published by the Institute of Management Accountants.