Thursday, January 22, 2009

Reinventing Budgeting

I was talking the other day with a friend of mine who was preparing for lessons in budgeting on his MBA class. I know January is normally not the time for budgeting, but I decided to write about budgeting anyway, because

So many companies are currently revising their sales estimates and cutting costs

In other words they are revising their sales and cost budgets.

About a year ago I was reading Winning by Jack Welch. One of the chapters in the book is about Reinventing the Ritual – about reinventing budgeting, where Welch is giving a totally different approach to budgeting.

Budgets the wrong way

Before describing how to devicse budgets the right way, he describes two common approaches to budgeting – Negotiated Settlement and Phony Smile.

In Negotiated Settlement (also known as Split the Difference) people in the field come up with conservative targets they absolutely think they can meet, because they are rewarded for hitting budget. Back in headquarters senior managers want to see significant growth in sales and profits, because they are rewarded for increased earnings. Finally and inevitably the sides split the difference, both sides are more or less satisfied and think they can live with the numbers.

In Phony Smile (also known as Everyone Make Nice) people in the field are filled with good ideas, exciting opportunities and bold dreams on where they can go given the right amount of investment. The headquarters smiles and listens to these ideas, but already has plans how to invest and what revenues and earnings they expect. The meeting ends with smiles, but afterwards field gets only part of the investment but is expected to produce higher revenues.

That's budgeting, isn't it? Welch asks, and adds that it's done backwards without thinking of execution.

He then presents a better way – an operating plan that looks forward to hows
  • How can we beat last year's performance?
  • What is our competition doing, and how can we beat them?
  • How can you find out every possible opportunity for growth?
  • How various moving parts will be synchronized to achieve targets?

Operating plan needs to include realistic, debated, synchronized and executable product launches, marketing plan, sales plan including new market opportunities, manufacturing plan and productivity plan for improved efficiency in each process.

These should be dealt with simultaneously, since they all interact - optimally in a management workshop where they can be debated.

Jack Welch adds that this kind of budgeting can only happen if compensation is not linked to budget but to actual performance against previous year and competition.

I am yet to participate such a management workshop.


Anonymous said...

At least a partial answer to the everlasting dilemma of budgeting can be found in the first bullet point of the Benefits of a Better Corporate Culture:

"Leadership is critical in codifying and maintaining an organizational purpose, values, and vision. Leaders must set the example by living the elements of culture."

The real "living" should mean more brave hands-on attitude from the executives. Sometimes the devil is really in the details and an executive without operational understanding or experience is on the edge. Whether to participate and/or even arrange operational budgeting workshops - or continue to keep just smiling.


Samuli said...

Thanks Daddy for a good comment.

Here's the link to the earlier post Benefits of a Better Corporate Culture you referred to.