The 3 Masters that Traditional Budgets Serve

Once upon a time, traditional management practices were a new thing. For all the ink that is spilled calling to revolutionize things like annual budgeting cycles or performance management, these were once very effective innovations. Simply put, without them we wouldn’t be where we are today: needing to revise them to help organizations perform even better so they don’t fall prey to disruption.

On a recent Agile Amped episode titled “Your Budgets Are Undermining Your Values,” Bjarte Bogsnes helped us recognize this point saying:

“We should remember that what we are criticizing today was actually management innovation. One, it was invented a long time ago. Take budgeting, where the inventor actually was James O. McKinsey, the founder of McKinsey Consulting. You had the best of intentions back then a hundred years ago. The purpose was to help organizations perform better… But things have changed…”

Bogsnes has written much on the topic of evolving beyond traditional management: he is the author of “Implementing Beyond Budgeting: Unlocking the Performance Potential.” In this same episode, Bogsnes also revealed a dark secret hidden in the innovation known as “annual budgeting” – an ugly truth that plagues organizations trying to respond to constant change: a budget is a three-headed dragon, each head serving a different master.

It isn’t really a “dragon” but, Bogsnes argues, your budget is unwittingly performing triple duty – and few organizations are better for it.

Who Does the Budget Serve?

Why do we budget? What is the purpose of a budget? Bogsnes often asks leaders these seemingly philosophical questions, and he has learned that a budget serves three purposes, three different “masters”:

  1. The budget is a target.
  2. The budget is a forecast.
  3. The budget allocates people and resources.

Some might think that this is a good thing. As Bogsnes says, “It may seem very efficient to do three things in one process.” But for reasons that will be clear soon, we now know that this sort of process coupling is messy and actually quite inefficient. So let’s look at each of these masters – Target, Forecast, and Resource Allocation – and we will see that their requirements are at cross purposes without each other.

Budget as Target

“Budgets are used to set targets, financial targets, sales targets, production targets,” says Bogsnes. “Let’s assume that an organization is on its way into a budget process… It’s important to understand cash flows and financial capacity moving forward. So people out there ask, ‘What’s your best sales number for next year?’ Everybody knows that the sales number I’m sending upstairs now will come back to me as a sales target for next year and maybe there’s a sales bonus linked to hitting that sales number. We all know what’s happening with numbers sent up when people know that this is just not the forecasting process: ‘I’m negotiating my own pay here next year.’”

This means that the first master, the Target, encourages people to choose a mark that will work most in their favor. This could be high, especially if a bigger bonus can be expected after achieving it.

This master asks, “What do you want to happen?”

Budget as Forecast

Now let us consider the cost side.

Bogsnes again: “We ask people, ‘What’s your best cost number or investment number for next year?’ But Everybody knows that this is my only chance at getting access to resources for next year. I recall what happened last year. They cut my number [by] 30%. Well, then we know what happens with numbers being sent upwards [to leadership for consideration].”

The second master then, the Forecast, encourages people to inflate the budget – just in case it’s the only time to ask for money. In Bogsnes’s experience, this “stimulates behavior that is borderline unethical: the low balling, the gaming, the internal negotiations.” And many are familiar with what happens at the end of the traditional annual budget cycle: a race to spend so you don’t lose your budget next year.

This master asks, “What do you think will happen?”

Budget As Resource Allocation Scheme

Finally, budgets are how the business knows who to give money to and how much. This master asks, “What does it take to make it happen?”

This just makes sense: of course, you take an educated guess about how much money you need to operate our organization or team for the year.

The problem is not that you guess but that the business fixes that guess for the year, even after more information becomes available. It’s all too common that by the time an annual budget has been completed, it is already inaccurate and unactionable. And yet people continue blithely on, knowing that the budget doesn’t pencil and that they have no other recourse.

Budgets Stifle Agility – so Go Beyond Budgeting

That we need a way to strive for better, to take stock of progress and to distribute resources and people – and cash – is not in question in here. That we need budgets specifically to do these is. And yet, Bogsnes says, cutting this three-headed dragon down to size is as “easy” as creating three separate processes for the three different purposes: create one process for setting sales targets, one for forecasting costs, and another for allocating resources.

Beyond Budgeting enables business agility – it enables organizations to look at their leadership and management processes and evolve them to achieve the business goals that they themselves identify. It isn’t just about budgets but, as Bogsnes puts it, “you will never succeed with an Agile transformation without also addressing the budgeting process and also the budgeting mindset.”

Joining Forces

Beyond Budgeting unlocks stalled agile transformations. Simultaneously addressing agility and Beyond Budgeting involves:

  • Separating budget purposes while having discussions about better targets.
  • Enforcing better resource allocation.
  • Integrating HR processes into budgeting e.g. target-setting motivation.
  • Enabling performance instead of managing performance, moving away from simply hitting the number.

“We need a rich, broad and more intelligent definition of performance and evaluation of performance. We call it the holistic performance evaluation, looking going beyond measurement.”

 

We interviewed Bjarte Bogsnes for the Agile Amped podcast Business Agility Series about “Beyond Budgeting” – listen to the full episode here.

Further Reading