Why the annual company budget no longer adds up

The pervasiveness of budgeting is matched by the fear and loathing that surrounds it

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Viewed from space, the plague of roadworks that blooms on London streets as March 31 looms might look like an effect of nature, such as tulip fields or the arrival of the first spring swallows. In fact, the cause of this and other manifestations of end-of-year madness (frenzied sales activity, a boom in finance-department overtime) is the ritual known as the corporate budget.

The budget is so ingrained in business that even fresh-minted managers can hardly imagine life without it. For 99 per cent of companies the budget is the exoskeleton of management: a framework of planning and control in which an earnings commitment made by top management is cascaded down through the organisation in a pyramid of performance contracts with underlings, backed up with incentives and variance checks against the forecast.

The pervasiveness of budgeting is matched by the fear and loathing that surrounds it. Former GE chief executive Jack Welch said it was “the bane of corporate America. It never should have existed.” For a start, it is hugely costly. Budgeting consumes up to 30 per cent of management’s time. Even around the millennium, Ford reportedly calculated that the process cost it $1.2bn a year.

Worse, it is counter-productive. Born a century ago to guide nascent mass-manufacturing, the budget was seized on by the accountants who moved into top jobs in the 1960s as a means of managing companies “by the numbers”. But what made sense in a stable sellers’ market, when compliance with the schedule was paramount, has become a liability when the priority is creative response to rapid change (oil prices, negative interest rates, technology).

The budget is an instrument of central planning and control that would not have looked out of place in Soviet Russia. A fixed contract in a volatile world, it hinders swift reaction and rewards caution over innovation. Since it works as a ratchet based on the previous year (hence the March mantra “use it or lose it”), it effectively sets a floor on cost and a ceiling on improvement, there being no incentive to beat it.

As Welch complained, conventional budgeting is an exercise in corporate gaming “because everyone is negotiating for the lowest [target]”, while pressure to “hit the budget numbers” means that no trick is off limits. Quality guru W. Edwards Deming’s observation that “people with targets and jobs dependent upon meeting them will probably meet the targets — even if they have to destroy the enterprise to do it”, was corroborated by events at Enron and WorldCom and the 2008 financial crisis.

© Andrew Baker

Gary Hamel and Michele Zanini, of the Management Innovation Exchange project, say cutting bureaucracy could add $3tn to US annual GDP. Among their solutions are “radically simplified planning and budgeting processes”.

Budgeting, a major generator of red tape, also ties it all together. So in freeing themselves from the straitjacket, “positive deviant” companies such as WL Gore, the maker of high-tech fabrics, and Svenska Handelsbanken, the Swedish bank, not only shrug off bureaucratic overheads, they also allow leaner, more flexible management models to be born.

If you do not budget, what do you do instead? Very little — but everything else changes, including remuneration and the locus of management control, says Anders Olesen, director of the Beyond Budgeting Institute, which campaigns on the issue.

Take Handelsbanken, which has opened the equivalent of more than one new UK branch a month in the past 10 years. Its philosophy is simple: it aims to be more profitable than its peers through customer satisfaction and lower costs, which is what its decentralised, self-managing branches are measured on. The bank has met its goal since 1972, from which year it has been budgetless and largely forecastless too.

Just as management and red tape feed on each other, the reverse is also true. In just 10 years, Buurtzorg, which began as a Dutch team of four nurses, has turned itself into a multiple winner of national employer of the year awards, supplying high-quality care to half the country’s homecare patients at lower costs than rivals. Buurtzorg does not do budget nor HR, and not much central management either. According to Jos de Blok, its founder, with teams being self-managing, including financially, there is not much management to do.

For some businesses, such as agriculture, an annual cycle makes natural sense. For the rest, it turns management into an endless and unwinnable battle to make reality fit the numbers. The more natural way is to run an organisation around its needs as a business rather than the accounting cycle. A liberation that would likely please London’s road users, too.

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