HBR
FROM THE HARVARD BUSI NESS REVI EW
OnPoint
A R T I C L E
Budgeting as most
Who Needs Budgets?
corporations practice it
by Jeremy Hope and Robin Fraser
should be abolished.
New sections to
guide you through
the article:
" The Idea in Brief
" The Idea at Work
" Exploring Further. . .
P R ODUC T NUMB E R 3 0 6 X
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T H E I D E A I N B R I E F Who Needs Budgets?
Budgeting as most companies practice fraud. After all, how likely are managers to re-
it should be abolished. Radical? No, simply port bad financial news if the result is a verbal
the next logical step following everything else beating or report good news if their reward is
you ve already done to eradicate command- more ambitious targets? And how tempting is it
and-control hierarchies in your company and for sales teams struggling to meet impossible
enable it to nimbly adapt to changing market targets to pressure customers to order goods
conditions. Abolishing budgets will free up they have every intention of returning?
even more of your employees creativity, self-
No longer able to ignore these realities, compa-
motivation, and willingness to share informa-
nies are breaking free of the budgeting vise.
tion essential ingredients for any firm s agility.
Here s how they re benefiting.
By contrast, traditional budgeting often spawns
earnings games and sometimes even outright
T H E I D E A A T W O R K
Raising the Bar
Abandoning budgets doesn t mean abandoning
Many companies that have rejected detailed
high expectations. On the contrary, you raise
budgets in favor of KPIs also use rolling
the bar even higher. Instead of demanding
forecasts. Created every few months, these
that managers and business units meet fixed
forecasts typically cover five to eight quarters.
targets, you ask them to do something much
They re revised regularly, allowing companies
tougher: measure themselves against how well
to continuously adapt to shifting market
their competitors will have done during the
conditions.
same period.
EXAMPLE:
Unable to discern whether they ve succeeded
The Swedish international bank Svenska
until the period ends, they exert every ounce
Handelsbanken replaced budgeting with new
of energy and ingenuity to best the competition.
organizational structures and performance
And rather than taking short-term actions
metrics. To promote a sense of ownership and
designed solely to save the credibility of fore-
accountability, it created 600 profit centers
casts, they focus on improving their long-term
making them responsible for reducing costs,
competitive position.
satisfying customer needs, and boosting income.
Regions and branches compete with one another
Key Measures
 spurred by prominently displayed standings.
When you abandon budgets, you enable alter-
Branch managers determine resource allocation,
native measures both financial, such as cost-
staffing levels, and salaries. Rolling forecasts signal
to-income ratios, and nonfinancial, such as
cash-flow improvements or declines and trigger
time to market to move to the foreground.
the actions required to ensure adequate liquidity.
In companies that have rejected detailed bud-
The payoff? Since the early 1970s, the company
gets, business units set long-term goals based
has outperformed its Scandinavian rivals on
on benchmarks such as return on capital. And
almost every measure, including return on equity,
they measure key performance indicators
total shareholder return, and customer satisfaction.
(KPIs) such as profits, cash flows, customer sat-
It s also one of the world s most cost-efficient
isfaction, and quality. KPIs fulfill the self-regula-
banks achieving a cost-to-income ratio of 45%.
tory functions of budgets. They tend to be
And few of its loans go bad because frontline
financial at the top of the organization and
people have the authority to approve loans.
operational in units closer to the front line.
HBR OnPoint © 2003 by Harvard Business School Publishing Corporation. All rights reserved.
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TOOL KIT
Modern companies reject centralization, inflexible
planning, and command and control. So why do
they cling to a process that reinforces those things?
Who
Needs
Budgets?
by Jeremy Hope
and Robin Fraser
udgeting, as most corporations they marshal the power of computer
practice it, should be abolished. systems to uncover mind-numbing lev-
That may sound like a radical els of detail and, using the budget as a
B
proposition, but it would be merely the benchmark,demand to know why a sales
culmination of long-running efforts to team has rung up higher-than-normal
transform organizations from central- telephone charges, for instance, or why
ized hierarchies into devolved networks it has underspent the quarter s enter-
that allow for nimble adjustments to tainment allowance. And where is  all
market conditions. Most of the other the authority of the chairman when the
building blocks are in place. Companies team finds it can t meet the budget s
have invested huge sums in IT networks, sales targets? Fearing the consequences,
process reengineering, and a range of the team will lean on customers to order
management tools including EVA (Eco- goods they have every intention of re-
nomic Value Added), balanced score- turning. And if by some chance the
cards, and activity accounting. But they team thinks it will exceed its targets, it
have been unable to establish a new will press customers to accept delivery
order because the budget and the com- in the next fiscal period, delaying valu-
mand and control culture that it sup- able cash flows.
ports remain predominant. In extreme cases, use of the budget
Senior executives have been heard to to force performance improvements
proclaim that their people have all the may lead to a breakdown in corporate
authority of the chairman. In practice, ethics. People who worked at World-
2 Copyright © 2003 by Harvard Business School Publishing Corporation. All rights reserved.
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Com, now bankrupt and under criminal portunities is a much more adaptive meeting short-term promises to im-
investigation, said CEO Bernard Eb- organization. proving our competitive position year
bers s rigid demands were an over- But that s not to say these companies after year. The result is much more ac-
whelming fact of life there. You would abandon their high expectations. They curate interpretation of our results and
have a budget, and he would mandate don t naively assume that everyone who news flow, meaning less volatility in our
that you had to be 2% under budget, is given more autonomy will improve shares. Analysts like and respect our ap-
said a person who worked at WorldCom, his or her performance. In fact, they re- proach. They no longer ask for numbers-
according to an article in Financial quire employees to do something much based forecasts. The willingness of the
Times last year.  Nothing else was ac- tougher than meet a fixed target. They company s investors to live without
ceptable. WorldCom, Enron, Barings ask them to chase a will-o -the-wisp, to such promises has inspired UBS to shift
Bank, and other failed companies had measure themselves against how well its focus from detailed plans to trend
tight budgetary control processes that comparable groups inside and outside analyses and rolling forecasts.
funneled information only to those with the company will turn out to have done
Breaking Free
a  need to know.  in the same period, given the economic
from the Budget Vise
In short, the same companies that conditions prevailing at the time. Be-
vow to stay close to the customer, so cause employees won t know whether Though the first companies to reject
that they can respond quickly to pre- they ve succeeded or by how much until budgets were located in Northern Eu-
cious intelligence about market shifts, the period is over, they must use every rope, organizations that have gone be-
cling tenaciously to budgeting  a pro- ounce of their energy and ingenuity to yond budgeting can be found today
cess that disempowers the front line, ensure that their performance is better in a range of countries, industries, and
discourages information sharing, and than that of their peers. Business units, cultures. They include two banks, a
slows the response to market develop- plants, branches, and other groupings petrochemicals company, a distributor,
ments until it s too late. can measure their progress against a car manufacturer, a brewer, a furni-
A number of companies have recog- comparable units within the company ture retailer, a truck manufacturer, an
nized the full extent of the damage done through the use of a few key financial eye-care company, a computer manu-
by budgeting. They have rejected the measures. In order to measure them- facturer, a telecommunications com-
reliance on obsolete data and the pro- selves against external peers, they can pany, a ball-bearings manufacturer, a
tracted, self-interested wrangling over use operational benchmarks based on food producer, and a specialty chemi-
what the data indicate about the future. industrywide best practices. (In some cals company. They range from small 
And they have rejected the foregone cases, companies that have rejected bud- a 250-employee charity dedicated to pre-
conclusions embedded in traditional gets rely on benchmarks collected and venting and curing blindness  to huge
budgets conclusions that render point- prepared by specialist firms that under- and complex, as in the case of one global
less the interpretation and circulation of stand the particular industry.) As in industrial organization with thousands
current market information, the stock- sports, the objective is to keep improv- of products.
in-trade of the knowledge-based, net- ing your position until you become the At these companies, an annual fixed-
worked company. league leader. performance contract no longer defines
In the absence of budgets, alternative Abandoning budget targets  those what subordinates must deliver to su-
goals and measures  some financial, solemn but ultimately hollow promises periors in the year ahead. Budgets no
such as cost-to-income ratios, and some to investors  frees a business to give a longer determine how resources are al-
nonfinancial, such as time to market  wide variety of emerging information located or what business units make and
move to the foreground. And business its due. Sharing that information can sell or how the performance of those
units and personnel, now responsible form the basis of a new kind of rela- units and their people will be evaluated
for producing results, are no longer ex- tionship with the capital markets. UBS, and rewarded. Some project leaders es-
pected to meet predetermined, inter- the Swiss financial services company, timate that they have saved 95% of the
nally selected financial targets. Rather, hasn t discarded budgets, but it has time that used to be spent on budgeting
every part of the company is judged on changed how it communicates. We pro- and forecasting.
how well its performance compares vide very few financial-performance Instead of adopting fixed annual tar-
with its peers and against world-class commitments, says Mark Branson, the gets, business units set longer-term goals
benchmarks. company s chief communications of- based on benchmarks such as return on
In companies using these standards ficer.  Our experience shows they are capital. The elements or factors mea-
of performance, business units become counterproductive, building pressure sured are key performance indicators 
smaller, more numerous, and more en- for short-term action to save the credi- KPIs  such as profits, cash flows, cost
trepreneurial. Strategy becomes a grass- bility of forecasts. In effect, we show an- ratios, customer satisfaction, and qual-
roots endeavor. The aggregate result of alysts and investors how the business ity. The criteria of measurement are the
many small teams exploiting local op- works. This shifts the emphasis from performance of internal or external peer
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TOOL KIT " Who Needs Budgets?
groups and the results in prior periods. within these ranges, senior executives ter is to make available to operating
Two of the important corporate goals look at the risks and test the assump- units, the obligations made by each unit
at Borealis, a Danish petrochemicals tions of strategic initiatives that require for the coming year, and the commit-
company, have been the reduction of very substantial resources. ments that business or operating units
fixed costs by 30% over five years and a At many such companies, rolling fore- have made to one another, such as a
decrease in time lost to accidents in its casts that look five to eight quarters production unit s pledge to meet the
plants. However, the company s busi- into the future play an important role in sales plan. It also states what will hap-
ness units and personnel are measured the strategic process. The forecasts, typ- pen to individuals compensation if
and rewarded on the basis of how well ically generated each quarter, help man- targets are missed or surpassed. Over
they reduced fixed costs and improved agers to continually reassess current the course of the fiscal year, each unit
uptime in comparison to best-in-class action plans as market and economic is expected to file regular reports on its
industry benchmarks. conditions change. (For more informa- progress toward meeting the targets.
In an empowered organization,people tion on how rolling forecasts work, see Despite the number-crunching abili-
are free to make mistakes and equally the sidebar  An Ever-Changing View ties of powerful computers, budgeting
free to fix them. Managers have wide of the Future. ) remains a protracted and expensive pro-
discretion in making decisions; as a re- Without budget expectations to worry cess, absorbing up to 30% of manage-
sult, they can obtain resources more about, staff members can do something ment s time. A 1998 study of global com-
quickly than in traditional companies with the nonconforming customer and panies showed that on average they
and without having to document need market information they collect  other invested more than 25,000 person-days
quite so elaborately, partly because they than hide it. The reporting of unusual per $1 billion of revenue in the plan-
are accountable for the profitability of patterns and trends as they unfold helps ning and performance-measurement
processes. Ford Motor Company is re-
ported to have figured that its total cost
The same companies that vow to respond quickly
amounted to $1.2 billion per year. For
companies involved in mergers, acqui-
to market shifts cling to budgeting  a process that slows
sitions, spin-offs, and other reorganiza-
the response to market developments until it s too late.
tions, the budgeting workload can be
overwhelming.
their units and can therefore be ex- the business avoid shortages or overages Increasingly, even finance people
pected to shed any excess in the event and formulate changes in direction. In- question the value of budgeting. One
that demand falls. In such a system, the stead of being imposed from above, published report says nine out of ten
 spend it or lose it philosophy that s at strategy seeps up from below. think it is cumbersome and unreliable.
work in traditional organizations has no Among their complaints: It takes time
How the Budget Problem
meaning. And employees, because they away from activities that add greater
Grew
don t require much supervision, don t value, such as supplying managers with
need the extensive central services that For most participants, the traditional the information they need to make
most organizations provide. Eliminating budgeting process starts at least four decisions. A 1999 global best-practices
those services has a dramatic effect on months before the beginning of the fis- study concluded that finance personnel
a company s cost structure. cal year. Operating divisions, business spent only 21% of their time analyzing
Key performance indicators  which units, and departments receive  budget and interpreting the numbers; they spent
tend to be financial at the top of an packs that include forms asking for the rest doing  lower-value-added activ-
organization and more operational the forecasts of sales, profits, and capital ex- ities such as gathering and processing
nearer a unit is to the front line  fulfill penditures. The forecasts are reviewed data,often for budget-related discussions.
the self-regulatory functions of budgets. at a high level, and after several rounds Used in a responsible way, budgets
But KPIs don t need to be so precise. UK of give-and-take, the budget document provide the basis for clear understand-
charity Sight Savers International, for is finalized. ing between organizational levels and
example, has begun to develop target The budget is a vast compendium of can help senior executives maintain
ranges for its KPIs. While managers are details. It lists the capital and opera- control over multiple divisions and busi-
free to devise ways of achieving results tional resources that the corporate cen- ness units. In the wrong hands, however,
budgets can result in  earnings man-
Jeremy Hope and Robin Fraser are directors of the Beyond Budgeting Round Table agement or even outright fraud. Such
(BBRT), an international management research consortium (www.bbrt.org). Their problems are more apt to occur as the
book Beyond Budgeting is being published this month by Harvard Business School pressure to improve performance in-
Press. Hope can be reached at [e-mail]; Fraser can be reached at robin- creases, especially when economic con-
[e-mail]. ditions are deteriorating.Few CEOs want
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TOOL KIT " Who Needs Budgets?
manufacturers entry into domestic
The New Performance Contract
markets, and the ratcheting up of com-
petition. Business units became preoc-
cupied with meeting sales targets rather
Companies that move beyond budgeting shift decision-making from
than satisfying customers. Salespeople
the core to the periphery. Instead of negotiating, in advance, the targets
eager to try new tactics were thwarted
managers must reach, the resources they will have, and their reward for
by rules requiring multiple signatures
simply doing what s expected, these companies trust their managers to
authorizing any change in plan.
claim the resources they need to seize the opportunities they see. In
Eventually, a few companies realized
short, an ever-changing market, not a dated plan, dictates behavior. And that budgeting played a powerful role in
defining and enforcing cultural norms
it s beating the competition that brings rewards.
that discourage frontline people from
taking responsibility for performance.
These companies decided to take the
Fixed Relative
plunge and dispense with the tradi-
performance performance
tional budgeting process. Two of the
contract contract
most enthusiastic adopters of the new
approach are described below.
Svenska Handelsbanken
Fixed targets lead to only
Relative targets push employees
Though not large by international bank-
incremental improvements.
to outdo themselves.
ing standards  it has 550 branches in
the four Scandinavian countries and the
Rewards based on relative UK and 20 offices in major cities around
Fixed incentives instill
performance give people the
the world this Swedish company offers
fear of failure.
confidence to take risks.
corporate finance, home and consumer
financing, life insurance, mutual funds,
Rigid plans focus people Continuous planning focuses and banking by telephone and the In-
on compliance. people on value creation.
ternet. Since it abandoned budgeting
in the early 1970s, the bank has outper-
formed its Scandinavian rivals on just
Preset allocation of resources On-demand allocation of resources
about every measure, including return
encourages hoarding. minimizes costs.
on equity, total shareholder return,
earnings per share, cost-to-income ratio
Decision making by local units
Centralized decision making
(or cost-to-revenue ratio, in the termi-
in touch with one another makes
ignores market feedback.
nology of other industries), and cus-
full use of market feedback.
tomer satisfaction. It produced an an-
nual total shareholder return of 24%
between 1979 and 2001  a rate 33%
to miss their earnings targets and risk nies used accounting results not just to higher than its nearest rival. Annual
ridicule by investors and the media. And keep score but also to dictate the actions earnings per share grew at a rate of
few operating managers are willing to of people at all levels of the company. 10.9% from 1990 to 2000. Handels-
be up-front about bad news if it means By the early 1970s, a new generation of banken is also one of the world s most
incurring the wrath of superiors and for- leaders schooled in the finer arts of fi- cost-efficient banks, achieving a cost-
feiting bonuses. nancial planning had begun to rely on to-income ratio of 45% in 2001; at most
The budgeting process emerged in financial targets and incentives  in lieu international banks, the ratio is over
the 1920s as a tool for managing costs of such benchmarks as productivity and 60%. Few of its loans go bad, largely be-
and cash flows in large industrial or- marketing effectiveness  to drive per- cause the bank has a policy of giving
ganizations such as DuPont, General formance improvement. frontline people responsibility for au-
Motors, and Siemens. It wasn t until But rigid adherence to annual fixed thorizing loans.
the 1960s that it mutated into a fixed plans and budgets stifled innovation, In the late 1960s, it was a different
performance contract. It was at this hindering the corporate response to the story. The bank was losing customers,
time, according to Tom Johnson, coau- earnings and cost pressures that arose in especially to a smaller rival run by Jan
thor of Relevance Lost: The Rise and Fall the 1980s and 1990s from the demands Wallander. So Handelsbanken invited
of Management Accounting, that compa- of institutional shareholders, foreign him to become its CEO. He accepted on
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TOOL KIT " Who Needs Budgets?
An Ever-Changing View of the Future
Many of the companies that have gone beyond completed, new data start coming in. Once three
budgeting enrich and accelerate their information months worth is in hand, the process begins again.
flow through the use of rolling forecasts, which are A new five-quarter forecast updates the projections
created every three months or so and always cover for the period covered by the previous forecast and
the same period  typically, five to eight quarters. creates a brand-new projection for the quarter
Because these forecasts are regularly revised, they farthest in the future, July September 2004.
support managers ability to fashion strategies that Volvo relies on several types of rolling forecasts.
continuously adapt to market conditions. Every month, it orders up a  flash forecast that
Rolling forecasts differ from budgets in several looks three months ahead, informing managers
ways. They don t envision a fixed  finish line at the about current demand and helping them deter-
end of the fiscal year when income, costs, and other mine whether, for example, price promotions
elements are measured against the budget s (by should be introduced or curtailed. Every quarter,
now) stale targets. They include only a few key vari- a 12-month forecast updates the managers work-
ables, such as orders, sales, costs, and capital expen- ing assumptions about customer behavior and
ditures, which means they can be compiled rela- economic trends. And every year, two additional
tively easily and quickly, sometimes by a single forecasts  one looking four years ahead, one look-
person in a single day. (Budgets and even conven- ing ten years ahead  help managers assess the
tional budget  updates, by contrast, involve de- company s market positioning and determine
tailed recompilations of data and require several schedules for phasing out old models and phasing
layers of approval.) in new ones.
Most important, rolling forecasts are more accu- Unlike budget updates, whose forecast period
rate, for two reasons. First, they are constantly re- becomes shorter and shorter as the end of the
freshed by the latest estimates of economic trends fiscal year approaches, rolling forecasts always
and customer demand and by emerging data from look the same distance into the future, allowing
the most recent quarter. Second, no one has a rea- the company to see whether performance is on
son to manipulate or spin the numbers, because a trajectory to meet goals that are a year or more
there are no fixed profit targets  or penalties for away. Rolling forecasts enable finance people to
missing them. Anyone who tried would probably collect and manage the cash needed for tax pay-
fail: Organizations that use rolling forecasts rely on ments and capital expenditures, and they help
information and control systems that allow every- operational managers estimate capacity and thus
one in the company to see the same information at plan for expansions or contractions in demand.
the same time. As managers become more adept at preparing and
Here s how rolling forecasts usually work. Let s interpreting rolling forecasts, the CEO is able to
say that in the middle of March 2003, a company anticipate performance changes sooner, thereby
creates a five-quarter forecast that covers the improving his or her ability to establish, well ahead
period from the beginning of April 2003 through of time, realistic expectations in the investment
the end of June 2004. From the moment it is community.
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TOOL KIT " Who Needs Budgets?
the condition that the bank agree to According to Wallander, now the hon- is governed by peer pressure exposes
drastically decentralize operations. His orary chairman, We just communicate free riders very quickly.
years as an economist and nonexecutive to people the average and a ranking that Resources. Each branch manager de-
director of Ericsson, the Swedish elec- shows which branches are above and cides what resources the unit needs.
tronics company, taught him that few which are below. The system works on Managers have had the authority to de-
forecasts are worth the paper they are its own. Managers know what is  ac- termine staffing levels since the early
written on. His conclusion was that ceptable performance you can t linger 1990s, and now they can set staff salaries
 either a budget will prove roughly in the depths of the league table for and negotiate property leases as well. If
right and then it will be trite, or it will be long. Peer pressure plays an important demand falls or new IT systems take over
disastrously wrong and in that case will part in this process. No branch manager functions formerly performed by the
be dangerous. Here is what Handels- wants to let down the regional team. staff, it is the local manager who is best
banken looks like today. The head office monitors transaction positioned to decide whether to redeploy
Organization. The bank has only volumes, fluctuations in numbers of cus- employees or let them go. Experienced
three layers branch managers, regional tomers, customer profitability, branch managers at the company expected an
managers, and the chief executive and profits, cost patterns, productivity, and increase in the number of workers when
no organization chart. The spans of con- much more. If it notices that a branch is unit heads were given staffing authority,
trol are therefore very wide, precluding underperforming, someone will make but the opposite happened.
micromanagement. The few decisions sure the region s controller knows about In a traditional budgeting system, in-
that require high-level approval are it. It is then up to the branch to take ac- flexible cost targets can have the per-
kicked upstairs almost immediately. An tion  or not. verse effect of limiting the amount of
answer usually arrives within 24 hours. In a traditional company, teams that business a unit takes on. At Handels-
To promote a sense of ownership and are fighting one another for customers banken, branches have the authority to
accountability among as many people as and resources are unlikely to share data, decide whether the income generated
possible, the bank has created some 600
profit centers, including regions and
In companies that have gone beyond budgeting,
branches. Though each branch is free
to set prices and discounts and decide the  spend it or lose it philosophy that s at work
which products to sell, it knows that
in traditional organizations has no meaning.
costs must be around 40% of income and
that this requires every staff person to
contribute to profitability. leads, or insights. Two policies at Han- by, say, opening many new accounts is
In contrast to the approach at many delsbanken keep competition and co- worth the higher costs those accounts
other financial services companies, Han- operation in balance. One requires every will entail.
delsbanken dispenses with a central customer to be attached to a particular Information. Of course, a company
marketing function (except in the case branch; this avoids disputes over who without a budget requires a fast and ef-
of product launches) and sales targets. gets the benefit of a customer order that fective information system capable of
Instead, the individual branches are has been handled by two branches. The monitoring tens of thousands of trans-
given responsibility for reducing costs, other puts a portion of the company s actions. Handelsbanken has the ability
satisfying customer needs, and boost- profits in a companywide pool from to monitor region and branch prof-
ing income. Because half of Handels- which every employee derives an equal itability on-line and to analyze patterns
banken s staff has lending authority, share, irrespective of seniority or indi- of excessive discounts, defecting cus-
customers receive answers quickly. vidual performance. Thus, apart from tomers, and unusual transaction vol-
Performance. Regions and branches, securities traders, no one at the bank is umes. Rolling cash forecasts, prepared
in effect, set their own targets on the rewarded for reaching a predetermined every quarter, signal whether cash flow
basis of the improvements they want target nor are branches even rewarded is improving or declining; if a problem
to make. The company s 11 regions, com- for doing well in a performance-league looms, they make clear that steps need
peting like teams in a league, try to top table. Individual and unit rewards con- to be taken to ensure adequate liquidity.
one another on return on equity, a mea- sist of peer recognition and praise. Con- The cash forecasts are prepared by the fi-
sure the markets use to judge the bank sequently, branches feel safe sharing in- nance department and seen by the vice
and its rivals. Branches compete with formation about customers. president of finance and the CEO only.
one another on their cost-to-income Some might argue that such a reward  Other banks have access to the same
ratio as well as on profit per employee structure gives a free ride to managers technology, so the difference must be
and total profit. Standings are promi- who produce little in the way of results. down to how we work, says Arne Mår-
nently displayed in what the company On the contrary, a team-based and open tensson, the bank s chairman.  We are
refers to as league tables. organization like Handelsbanken that quick to spot any changes in trends
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TOOL KIT " Who Needs Budgets?
within regions and branches, and this Because unit managers also have the ing the] lowest-cost transactions, value-
leads to searching questions being asked authority to adjust resource levels in re- added services, or a closer, more strate-
on the telephone. Problems are trans- sponse to changing demand, they now gic relationship  and which customers
parent; they are not hidden within the recruit staff or order layoffs as required, offer the best profit-making opportuni-
nooks and crannies of management lay- rather than according to the timing and ties. This is gradually improving our cus-
ers and allowed to fester. constraints of the annual budget cycle. tomer portfolio.
(Staff turnover is less than 5% per year Rolling forecasts are now prepared
Ahlsell
the lowest in the industry.) The func- quarterly by staff members at the head
Since this Swedish wholesaler aban- tion of the regional leadership, mean- office, who make phone calls to a few
doned budgeting in 1995, its main lines while, has changed from providing key people over the course of a few days
of business  electrical products and detailed planning and control to coach- each quarter. Results from the previous
heating and plumbing have overtaken ing and supporting the frontline units. quarter are available with little delay,
their Swedish counterparts in prof- To help the local units manage them- and employees at every level in the com-
itability. After suffering through a se- selves more effectively, the finance staff pany see them simultaneously. At the
vere business slowdown in the early teaches everyone how to interpret a end of each year, unit managers  there
1990s, the company realized it could profit and loss statement. are now many of them receive bonuses
achieve substantial savings and opera- Key performance indicators are now based on how the year s return on sales
tional improvements by centralizing used to set goals and impose controls. compares with the previous year s.
warehousing, administration, and logis- In the central warehouse, for example, " " "
tical support while devolving responsi- the KPIs are cost per line item, costs as So long as the budget process dominates
bility to large numbers of profit centers. a percentage of stock turnover, stock business planning, a self-motivated and
adaptable workforce is a fantasy, how-
ever many cutting-edge tools and tech-
So long as the budget dominates business planning,
niques a company embraces. That s be-
a self-motivated workforce is a fantasy, however many cause all of the principles and practices
of budgeting assume, and perpetuate,
cutting-edge techniques a company embraces.
central control. People at the front line
of a top-down operation are hardly
At one time, there were only 14 such availability, level of service, and turn- likely to report bad news if the inevi-
centers; now, after a series of acquisi- over rate. The key indicators for the table result is a verbal beating or to re-
tions, there are more than 200. Business- sales units are profit growth, return port good news, for that matter, if their
area teams (such as heating and plumb- on sales, efficiency (determined by di- reward is more ambitious targets.
ing) within each local unit are now viding gross profit by total salary cost), In contrast, companies that dispense
separate profit centers, and they re and market share. with budgets can unleash the full power
fiercely competitive with one another. In the days when Ahlsell kept bud- of modern information systems and
Detailed sales plans are no longer gets, it didn t monitor how profitable in- tools. Corporate planning ceases to be a
made centrally; headquarters communi- dividual customer accounts were or series of breathless sprints and instead
cates only general aims, such as becom- what it cost to replace them. Selling was becomes an endless conversation.Knowl-
ing number one in electrical products treated as an end in itself, and the com- edge flows from frontline people to head-
within two years. The local units have pany simply paid its salespeople for sell- quarters and back again, permitting the
been freed to develop their own ap- ing products. Since the abolition of bud- full potential of a radically decentral-
proaches in response to local conditions gets, the accounting system has been ized organization to be realized.
and customer demands. The new orga- producing information on customer
nization recognizes that customer rela- profitability. According to finance direc- Product no. 306x
tionships are forged by frontline units, tor Gunnar Haglund, the architect of To place an order, call 1-800-988-0886.
which can now set salary levels and cus- Ahlsell s management model,  Sales- To further explore the topic of this article,
tomer discounts and even decide to ob- people now have a different approach. go to http://explore.hbr.org.
tain supplies from outside vendors if that They know how every customer wants
is expected to save money. to deal with us  whether [they re seek-
8
harvard business review
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E X P L O R I N G F U R T H E R . . . Who Needs Budgets?
ARTICLES
 Corporate Budgeting Is Broken Let s Fix It Large companies concerned about operational
by Michael C. Jensen (Harvard Business efficiency may want to focus on budgeting s
Review, November 2001, Product no. 813X) control aspects, while small, innovative firms
Jensen shines the spotlight on the lying, may emphasize planning.
cheating, and scheming that budgets can
The planning and control functions raise
inspire especially when tied to bonuses.
different concerns. For example, to use bud-
Most managers earn bonuses after they reach
geting as a planning tool, managers must
a minimum performance hurdle (usually 80%
link the budget to the strategic planning
of budget target) and until they reach a cap
process and decide who should participate
(often 120% of budget target). This system
in budget preparation. To use it for control,
encourages gaming. Managers may manipu-
they must decide how much  stretch to in-
late budget targets by withholding informa-
clude, and whether budgets should remain
tion about their unit s capabilities. If they
fixed or be revised during a period. Any bud-
think they can make the minimum hurdle,
get s effectiveness depends on how top man-
some pad this year s earnings at the expense
agement uses it, and whether it aligns with
of next year s. If they think they can t make
existing management systems.
the hurdle, they might move earnings into
the future. Results? Distorted information
and misguided decisions. BOOK
Beyond Budgeting: How Managers Can
Suggestions for discouraging gaming include:
Break Free from the Annual Performance
Set bonuses for a number of years out based
Trap by Jeremy Hope and Robin Fraser
on longer-term growth and profitability pro-
(Harvard Business School Press, 2003,
jections. Raise bonus caps well above tradi-
Product no. 8660)
tional levels. And establish a single measure
The authors expand on  Who Needs Budgets? ,
of overall business success, such as economic
describing more fully how to replace traditional
value added.
budgeting with a radical new model linking
performance measurement to evolving com-
 Budget Choice: Planning versus Control
petitive benchmarks. This approach combines
by Neil C. Churchill (Harvard Business Review,
a leadership vision that gives more authority
July August 1984, Product no. 84403)
to operating managers and a finance vision
Churchill agrees that budgets can encourage
that enables fast decision making through
earnings games. But he disagrees that they
appropriate tools and accessible information.
should be abolished. Instead, companies must
Detailed examples illustrate how companies
distinguish between budgets two primary
can implement these visions and reap the
functions planning and control then decide
resulting long-term benefits.
which to emphasize, depending on their needs.
Visit us on the Web at:
U.S. and Canada: 800-988-0886
617-783-7500 " Fax: [phone]
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