Hope, J. and R. Frazer. 2003. Who needs budgets? Harvard Business Review (February): 108-115.
Summary by Lori Meister
Master of Accountancy Program
University of South Florida, Summer 2003
Budgeting Main Page | Controllership Main Page
The purpose of this article is to look at why companies today are working towards a decentralized environment that is flexible, but are still bound to the endless budget. Companies have been spending millions of dollars reengineering their processes, focusing on ideas like just-in-time, and attempting to trace costs with activity based costing. The authors state that all of these things can lay the foundation for change, but budgets are still restraining them from establishing a new system.
Focusing too much on budgets can lead to problems. When you are forcing performance to match a budget, there could be some ethical breakdowns. In the past few years we have seen numerous companies collapse, and many of them were trying to make the numbers look good in order to meet their budget. Another problem is the fact that information sharing is not encouraged. Companies that rely too heavily on budgets are not able to respond to market developments quickly enough.
If a company does decide to get rid of budgets, then there are alternative ways to measure the company. It will start to have a larger number of smaller business units. An individual unit will then be able to evaluate its performance by comparing itself to the other units. Benchmarks will be used to compare the units to other companies.
When you decide to get rid of budgets, you must understand that you no longer will have that budget to determine how you are going to allocate resources or to evaluate the company. You also will not have the short-term one-year goals as before, and your performance indicators are going to be changing as well.
Benchmarking enables a company to look at goals in the long-term. The factors measured are key performance indicators, which could be profits, cash flows, cost ratios, customer satisfaction, and quality (110). Measurement of these indicators will be compared to other business units within the company, and also outside companies in the same industry. These companies can also use rolling forecasts in order to help managers continually reassess current action plans as market and economic conditions change (111). The following table was adapted from an illustration on page 111 and captures many of the ideas Hope and Frazer discuss in the paper.
|Fixed Performance Contract||Relative Performance Contract|
| Fixed targets lead to only
targets push people to outdo
|Fixed incentives instill fear of failure.|| Rewards based
on relative performance give
people the confidence to take risks.
|Rigid plans focus people on compliance.||Continuous planning focuses on value creation.|
| Preset allocations of
allocations of resources minimizes
|Centralized decisions ignore market feedback.|| Decisions by
local units in touch with one
another makes full use of market feedback.
Budgets have never been easy or enjoyable. It takes into account so many details, that it quickly becomes cumbersome. Creating budgets is not an easy project either. It was estimated that budgets take up to 30% of management’s time, and can cost companies millions of dollars (112).
Budgets were first introduced in the 1920s as a tool to manage costs and cash flows in large industrial organizations (113). Tom Johnson stated that it was during the 1960s when companies began to use budgets to dictate what people needed to do. In the 1970s, performance improvement was based on meeting the financial targets rather than effectiveness. Companies then faced more problems in the 1980s and 1990s when they were not willing to spend money on innovation in order to stay within the rigid budgets. Companies no longer were concerned about how customers were being treated, only that they met their sales targets no matter what it took.
The authors discuss two companies that decided to stop using budgets:
This is an international bank based out of Sweden. They decided to stop using budgets in the early 1970s, and now the bank has outperformed its Scandinavian rivals on measurements such as earnings per share, cost-to-income ratio, and customer satisfaction (113).
Svenska decided to get rid of their organization chart and only have branch managers, regional managers, and the CEO as the layers of management. The individual branches themselves are responsible for customer satisfaction, increasing sales, and cost reductions. They set their own goals and then compete with the each other to measure their performance. Instead of having individually based incentives, there is a company-wide pool from which every employee gets an equal share of the profits (114). Since they only have three layers of management, information is given freely and quickly.
This is a Swedish wholesaler who abandoned budgeting in 1995 (114). They increased their number of profit centers from fourteen to over two hundred. Due to decentralization of the company, the profit units are now able to develop their own strategies. Unit managers have the authority to adjust resource levels based on the market rather than budget cycles. They use key performance indicators to set goals. Ahlsell also monitors carefully just how profitable customer accounts are, which was not possible with budgeting.
In conclusion, if companies continue to use budgets, they will not be able to create an environment with a self-motivated and adaptable workforce. The budgeting process’s key purpose is control. If you let go of that tool for control, you can actually be able to start planning on a regular day-to-day basis, rather than the seemingly endless budget.
An Ever-Changing View of the
As an alternative to budgeting, companies are now starting to use rolling forecasts. They are usually created every three months, and always span the same time period of each forecast. An advantage of these forecasts is that they are refreshed by the latest economic trends from the most recent quarter. More importantly, it can help deter employees from “cooking the books” since there are no fixed profit targets, or penalties for not making them. Overall, these rolling forecasts can enable managers anticipate performance changes sooner and improve their strategies.