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May


Tying a firm up in a budget straitjacket is madness

Sun, 7th Jan 2007

RESEARCHING a history of modern China, Jonathan Fenby notes that the Great Leap Forward of the 1950s introduced a planning system with two sets of targets. Meeting the lower set of central government goals was mandatory, the second, pitched higher, to be achieved by extra effort. Copying the centre, provincial plans also had two tiers, the first aligned with the higher set of central plans and the second more ambitious still. This multiplication continued down the administrative ladder until, by the time the plan was implemented on the ground, the figure had gone up five or six times.

One target was grain. Of course it was impossible to meet, but because their jobs depended on the result, officials lied or faked the results by gathering the entire village crop into a tiny area and pretending it was representative of the rest. The consequences were tragic. Taking the official fictions at face value, the remote government requisitioned much of the reported - and almost all the real - crop for distribution to cities while, in mass commune canteens, the rural populations were encouraged to eat as much as they liked. When the short-lived binge was over, it was too late to avert mass starvation, and between 20 million and 30 million people died.

This may be the most extreme example of damage by fixed targets. But in a small way the same corrupt process of arbitrary target-setting, fiddling numbers and offloading blame is played out every year in 99.9 per cent of all capitalist organisations that use the budget as their overarching management tool.

You think I exaggerate? In a report published by Business Intelligence, entitled (sorry) Reinventing Planning and Budgeting for the Adaptive Enterprise, Jeremy Hope, co-founder of the Beyond Budgeting Roundtable, is quoted as describing the fixed-performance contract (the budget being the prime example) as 'a management weapon of mass destruction'. Analysing what really happened at companies such as Enron, Tyco and WorldCom, he says: 'You can trace the problems back directly to aggressive targets that were linked to incentives that drive short-term actions.' Unlike in China, these cases directly cost few lives - but the destruction of livelihood and value was on a Stakhanovite scale.

Budgeting is now so completely taken for granted as the central pillar of management that managers are surprised to find it has not always existed. Dating from a time when manufacturers could pretty much sell what they made, it was a means for multi-divisional companies to co-ordinate production, allocate resources and costs, and make sure that people did what was required to achieve the schedule. For classic mass-production, command and control by the budget made sense.

But in an age where everything is in oversupply, this model no longer works. It's no longer managers who decide what will sell, but customers. Logically, the budget, the hallmark of command and control, no longer works either. To quote Hope again: 'We persist with this belief that we can predict and control performance over the next year. Therefore [the budget] becomes a rigid plan that's difficult to change. It becomes near impossible to respond to unpredictable events.'

Assailed by external volatility, the budget is also undermined by dry rot from within. A classic example of Goodhart's Law (which says that the minute you use a target to manage by it loses its value as a target because you can no longer trust the figures) budgets are typically used to do several things: set targets, forecast, and establish incentives for remuneration. As the BI report says, as a result it does none of them well and requires ever more effort - up to 30 per cent of senior executives' time - to make it work at all.

Managers have been uneasily aware of these failings for some time: GE's Jack Welch, no less, once described the budget as 'the bane of corporate life'. But while everyone agrees that the present situation is unsatisfactory, companies have been held back by the lack of an obvious alternative. If it's the budget that holds the whole management edifice together, won't the organisation just fall apart without it?

The great value of the present report is that it shows that the answer is no. Alongside the well-known example of Svenska Handelsbank - budgetless since 1972 - it outlines how organisations as diverse as Boston Scientific, Henkel, Tomkins, Herman Miller, Statoil and Scottish Enterprise have successfully stripped off the budget straitjacket to make themselves capable of managing more strategically. While individual solutions vary, all have separated goal-setting from forecasting, and, crucially, recast incentive systems. Rolling forecasts typically take the place of annual projections that are out of date the day they are made. All have broken the tyranny of the fixed performance contract.

But most companies still have to root out and destroy the hidden WMD at their heart. There will be more budget misery, more corporate scandals - in short more great leaps backward - until they do.

The Observer, 7 Janary 2007


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