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Management accounting

Budgets: how to
manage without
In the second of two
articles, Jeremy Hope
and Robin Fraser
explain how a number
of companies have
abandoned budgeting
and adopted a new
management model

n the first
article we argued that
budgetary control was
the hidden barrier to
success in the information
age. But building a convincing case
for dismantling budgeting systems is
not the major challengethis
concerns the replacement of budgets
with alternative steering
mechanisms. What are they and how
do they form the basis of a new
management model? Budgeting is, of
course, much more than a financial
process. It is the glue that connects
the entire management system
together from strategy and planning
through resource and cost
management to measurement and
rewards. While there is much detail
to be understood, we will focus on
three broad issuesthe planning
process, cost management, and
measurement and control.

The planning process

One of the principal failings of the
budgeting process is that it is based
on the negotiation of a set of fixed
financial numbers. These tend to be
arbitrary and, more often than not,
they relate to previous performance
rather than shareholder expectations
or competitive measures. However, in
the age of instant information,


April 1999

whichever measure is
usedfrom shareholder
value to customer
satisfactionit is relative
success that matters. Beating last
years performance by 20% means
nothing if your competitors have
done even better. But, by definition,
competitive targets can only be
estimatedthey cannot be known in
advance. Relative targets can be
internal (e.g. branch to branch), or
external (e.g. business to business).
And they should preferably use

Relative measures are more

effective than stretch targets
because they are always
current and keep moving the
mean upwards; we just
communicate to people the
mean and a ranking that shows
which branches are above and
which are below. The system
works on its own. Senior
management dont need to
push people, they just advise.
Dr Jan Wallander, visionary architect of the
Handelsbanken management model


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Management accounting

All central costs are charged to the regions and branches. If

they do not feel they get good value for their money, they will
not demand our services. Sven Grevelius, Finance VP, Handelsbanken
measures that define the key
performance indicators that drive
competitive success within a
particular business unit. At
Handelsbanken, league tables of like
branches and regions appear every
month, maintaining a strong focus on
performance and harnessing the
power of peer pressure. While at first
this might appear to be divisive, this
competitive network also operates
within a broadly based rewards
system thus giving strong branches
ample incentive to support those that
are not performing so well. Thus,
knowledge and best practices are
quickly shared. Handelsbanken
managers believe that any specific
target is not worth the paper its
written on.
In the emerging model the
planning process is no longer
constrained by the annual cycle. In
some businesses the appropriate
cycle might be quarterly, in others,
monthly. It largely depends on the
pace of change and the planning
horizons appropriate to a particular
firm or industry. Perhaps the key
element is the use of rolling forecasts
around which new growth and
improvement strategies and action
plans are tested and co-ordinated
across the business. At Volvo Cars,
strategy and forecasts are reviewed
and updated several times a year
with four distinct cycles apparent.
Each month flash forecasts look
one quarter ahead; quarterly rolling
forecasts look one year ahead; one
year rolling forecasts look four years
ahead, and an annual strategic
planning process looks 10 years
ahead. One forecast dovetails into
another like cogs in a wheel.
According to Ole Johannesson, VP
Finance, managers build
competence in sketching the future
and within that future lie the
opportunities and threats that
traditional budget-driven processes
fail to see until its too late. These

forecasts form the core information

for the monthly meetings, the
development programs, and the
strategy reviews.

Cost management
Controlling costs through budgets
may give the impression of tight
management but the reality is that it
prevents managers from asking the
really interesting questions that
might lead not just to cost control but
to cost reduction. Which markets,
segments, and customers are
profitable after charging all the costs
they consume? Which processes and
activities add value and how can this
value be increased? How can we
manage a process differently so that
it is faster and is accomplished at a
lower cost? None of these questions
are even asked never mind answered
by the budgeting approach.
In the new model, the cost
management focus moves from costs
to value. Sometimes this can simply
be questioning why particular
activities are done. But a more
systematic approach is offered by
activity based management. Each
activity should be made to pass a
value test, that is, whether or not it
adds value to products, customers, or
other strategic business needs.
Starting with last years costs as the
basis of cost management is the
wrong approach. Cost estimates
should be a function of the resources
required to meet the agreed plan and
only by looking at resources through
a value-added lens can managers

really see what is and isnt required.

At Borealis, managers use an
advanced activity accounting system
and rolling moving averages to
provide a clear picture of cost drivers
and trends. The costs of central
service functions such as finance,
legal, human resources and strategic
planning are subject to no more than
trend analysis and step-change
control should this be thought
desirable. For 1998 the default rule
for central services costs was zero
increase. Bjarte Bogsnes, VP for
Corporate Control, believes that one
of the most insidious aspects of the
traditional budgeting process is that
it sets not just a ceiling but a floor for
costs. This mentality is at its sharpest
within central service departments or
pure cost centres. By removing this
floor the way is open to make significant inroads into these costs, many of
which have traditionally been fiercely
protected by some of the most
powerful people in the organisation.
This is an important insight into the
change of mentality that can apply if
the budgeting system is removed.
Indeed it turns the typical question
how do we maintain control of
central costs? into something of a
non-event. In the new model the
answer must be that we dont just
want to control these costs, we
want to reduce them, and the key to
achieving this is to eradicate the
(annual) budgeting mentality.

Measurement and control

The traditional measurement
emphasis is on past events and to
control current performance against
the predetermined budget. Measures
are usually derived from capital
efficiency and earnings ratios and
supported by a plethora of financial
detail by department, division, etc.

Measures are derived from strategy by identifying key

performance drivers. They are also relative to external and/or
internal competitors and are more effective if they are
discussed and agreed at operating unit or team level. The fewer
the measures the better (you only need a few crucial KPIs to
tell managers whats really happening).

April 1999



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Management accounting

Measures usually compare actual

performance with the (fixed) budgeted
numbers on a monthly basis. As no
one wants to see an adverse variance
(it often leads to difficult
explanations), gaming is rife. There
is a clear emphasis on financial
control with senior managers being
able to drill down through detailed
sets of numbers. But with so many
reports and numbers appearing each
month it is often difficult to see with
any clarity what is really happening.
In particular, financial measures fail to
record the changes in the value of
intellectual assets that now account
for 50%-90% of the market value of
many leading companies.
The new measurement emphasis
switches from past events to future
outcomes. There is, for example, a
strong link between current measures
and rolling forecasts. The gap
between current trends and targets
will have a bearing on any actions
that need might be taken. Measures
are derived from strategy by
identifying key performance drivers.
They are also relative to external
and/or internal competitors and are
more effective if they are discussed
and agreed at operating unit or team
level. The fewer the measures the
better (you only need a few crucial
KPIs to tell managers whats really
happening). By using visual reports
and moving averages and focusing by
exception on key issues, managers
can handle a far broader range of
business units and issues and provide
real feedback and learning. KPIs


April 1999

linked to action plans enable

managers to examine root causes of
differences. A good scorecard
reporting system will include both
leading and lagging indicators thus
giving managers an early warning
that results are off-track.
Handelsbanken measures its
progress on three simple measures:
return on capital employed, incometo-cost ratio, and profit per
employee. Every employee
understands these measures which
are used to create internal
competition between branches and a
sense of common purpose across the
bank. Furthermore, employees know
that by following the progress of
these measures they can monitor
how their own compensation will be
improved each year. Contributions
are made to the employee profit
sharing fund depending on the
banks performance relative to its
external competitors.

Future developments and

next steps
Of course this transformation doesnt
happen overnight. It is a gradual
process of confidence building as
managers, wary of previous false
promises, wait and see if this really is
a change worth the effort. However,
we might note that not one of over 50
senior and middle managers we
interviewed would wish to return to
the budgeting system.
The BBRT has developed a
diagnostic that any company can use

to position its existing practices and

identify any gaps. But implementing
the new model will be neither easy
nor quick. It will require an holistic
approach and an evolutionary
process that will take a number of
years. What we now need, in some
detail, is a better understanding of
the main components of the model,
an overall framework for integrating
them, and an effective approach to
implementation. We also need
guidelines for planning and selling-in
the changes, introducing the new
steering mechanisms and
dismantling the budgeting system.
These are the main aims and focus of
the BBRT programme in 1999. It will
produce deliverables that members
will be able to use in their own
companies. It will enable them to bypass years of potential trial and error
as they move towards a management
model without budgets and develop
their own performance management
systems as sources of real
competitive advantage.
To obtain a free copy of a Beyond
Budgeting White Paper please
contact Peter Bunce at CAM-I Inc on
Tel: +44 (0)1202 670717 or Fax: +44
(0)1202 680698 or e-mail:
Jeremy Hope (e-mail: lh23@dial.pipex.
com) is co-author of Transforming the
Bottom Line and Competing in the Third
Wave, both published by Harvard Business
School Press. Robin Fraser (e-mail:
RobinFraser@Compuserve.com) is a
management consultant, formerly a partner
in PricewaterhouseCoopers.