writtenarticle budgeting nov4

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Written Article Management Control System 11/4/2007

Article Summary - Who Needs Budgets? (Hope and Fraser, 2003[1])

In Who needs a budget, the authors advocate abolishment of budgeting in

favor of decentralized, flexible planning that empowers managers to make wiser and

quicker decisions with focus on meeting the needs of customers and responding to

market shift.

Rigid budgetary control processes drain valuable resources, stifle innovation,

and discourage front line managers from making responsive decision. The use of thebudget to force performance improvement may lead to a breakdown in corporate

ethics.

Many companies have dispensed with traditional budgeting process. Instead,

they set longer-term goals and use key performance indicators and compared them

with the best-in-class industry benchmarks. Employees are required to measure

themselves against the performance of competitors and against internal peer groups.

As a result, people are more risk taking, managers have more discretion in making

decisions, resource deployment are quicker, and information sharing become easier.

Companies that have rejected the budget rely on rolling forecasts, which are created

every few months and typically cover five to eight quarters. Because the forecasts are

regularly revised, they allow companies to continuously adapt to market conditions.

The author cited examples of two European companies - the bank Svenska

Handelsbanken and the wholesaler Ahlsell to demonstrate in detail how breaking

free from budgets has helped them unleash the power of management tools and

potential of decentralize organization. At the end of the article, the author brought tothe table the contrast of two performance measurement systems - fixed performance

contract vs. relative performance contract - so one can easily see the benefit of

relative performance measures which have used successfully in Svenska

Handelsbanken and Ahlsell.


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[1] Jeremy Hope, Robin Fraser, Who Needs Budgets?, Feb 2003, Harvard Business

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My learning and comments on article as it is related to course material:

In most of organizations, budget is used to influence a managers performance

before the fact and to appraise performance after the fact[2]

. In that sense, it is acontrol tool that is devised to ensure companys strategic plan implementation would

not be derailed. Ideally, it should be challenging but attainable. However, as pointed

out in Hopes article, budget often involves inflexible processes and tight targets that

it becomes a fixed performance contract which has many drawbacks such as instilling

fear of failure, focusing people on compliance, encouraging hoarding, and ignoring

market feedback.

In spite of these difficulties, abolishing budgeting entirely would forfeit the

benefits of budgeting brought to an organization. First, without budgeting process, it

is difficult to estimate the profit potential of business units. Second, budgeting assign

responsibility to line managers and obtain their commitment. Third, budgeting helps

coordinate the activities of the several parts of the organization. Fourth, budgeting

helps fine tune the strategic plan [2]. The last point highlights the benefit of budgeting

as a planning tool. A good budget should be attainable. Therefore it requires revisiting

the strategic plan and budget forecast. Budgeting should involve all levels in the

organization, and consider external and internal changes, in order to provide

opportunities for line managers to challenge the viability of strategic plan and validity

of forecast.

Facing these seemingly paradoxical properties, what do we do with budgets?

The answer from Hopes article is not as drastic as it first seemed. In my view,

switching from fixed performance contract to relative performance contract was
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really about adopting an informal control process that combines financial budgets

with non-financial objectives. It make sense to give more weight to key performance

indicators that measures the return on investment, customers satisfaction and quality

aspect of products and services. While the informal control and relative performance

measure take the budget burden away from front line so they can adjust the

resources deployment to changing demand, it does not necessarily undermine the

role of corporate leaderships. In fact, this approach frees corporate staff from detail

planning and control, so they can spend more time to monitor the overall status of

business and engage in continuous improvement of the process. Take Svenska

Handelsbanken [1] for example, The head office monitors transaction volumes,

fluctuations in numbers of customers, customer profitability, branch profits, cost

patterns, productivity, and much more. [1] As mentioned in the article, doing away

with the formal and tight budget doesnt mean companies are abandoning their high

expectations. Rather, with implementation of powerful management tools, they can

now rely on rolling forecast that focuses on a few key variables, and revises

constantly to reflect changing economic conditions and customer demands.

It is worth noting that after abandoning formal budgets, both Svenska

Handelsbanken and Ahlsell have reorganized into more profit centers or shifted focus

to branches. This indicates to me that an organization must link their control system

with the structure of responsibility centers. The profit center approach certainlyfosters autonomy of business unit and requires less detailed budget control from

corporate level.

As stated in the text book [2], the purpose of management control system is to

encourage the managers to be effective and efficient in attaining the goals of the

organization. Therefore, budgeting or not depends a great deal on what it takes to

motivate an organization. When done right, a participative budgeting process does

have motivational power that aligns lower level managers objectives with company

strategy. Hope and Fraser has concurred this view point in the article, when used in

a responsible way, budgets provide the basis for clear understanding between

organizational levels and can help senior executives maintain control over multiple

divisions and business units.
http://web.ebscohost.com.ezproxy.ltu.edu:8080/ehost/detail?vid=1&hid=107&sid=d27cfeea-a583-40b7-ad93-3ae691c2b27a@sessionmgr109#tochttp://web.ebscohost.com.ezproxy.ltu.edu:8080/ehost/detail?vid=1&hid=107&sid=d27cfeea-a583-40b7-ad93-3ae691c2b27a@sessionmgr109#tochttp://web.ebscohost.com.ezproxy.ltu.edu:8080/ehost/detail?vid=1&hid=107&sid=d27cfeea-a583-40b7-ad93-3ae691c2b27a@sessionmgr109#tochttp://web.ebscohost.com.ezproxy.ltu.edu:8080/ehost/detail?vid=1&hid=107&sid=d27cfeea-a583-40b7-ad93-3ae691c2b27a@sessionmgr109#toc


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Ultimately, as Hope and Fraser have pointed out, an organization must adopt

an ever-changing view of future. As customer demand changes and new

management tools become available, it is important for companies to continuously

review their control systems and use ones that best support their strategy.

Reference:

[1] Jeremy Hope, Robin Fraser, Who Needs Budgets?, Feb 2003, Harvard Business

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[2] Robert N. Anthony, Vijay Govindarajan, Management Control Systems, 12th

edition, McGraw-Hill
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