Budgeting and innovation

Budgeting and innovation

Marginson, David

Do budgets stifle creativity? David Marginson and Stuart Ogden report on a case study that has addressed this question in a leading global technology firm.

Budgets have long had a bad press, but they have attracted even more flak recently for being at best inappropriate to modern business practice and at worst potentially harmful1. The Beyond Budgeting Round Table (BBRT) has been one of their most vociferous critics. It argues, for example, that the necessary conditions of trust and empowerment in today’s organisations “are not possible with budgets still in place, because the entire system perpetuates central command and control”2. But research suggests that most businesses are still using some form of budgeting.

One important issue that relates directly to the BBRT’s criticisms concerns how firms are balancing the need to control costs on the one hand with the pursuit of innovation on the other. Innovation is crucial in a globalised economy. It requires, among other things, trust and empowerment. Budgeting stifles trust and empowerment, according to its critics, which in turn stifles innovation. But is this really the case? Do managers actually feel constrained by their budgets or can they successfully reconcile the tensions between budgetary control and innovation? If they can, how are they doing it?

We were recently engaged in a research project that sought to answer these questions. The study had four main aims:

* To ascertain how well and in what ways budgets keep pace with innovation – ie, how managers are able to innovate in a context of budgetary control (and vice versa).

* To understand how well and in what ways innovation is accommodated through changes to the design and operation of budgetary systems.

* To examine how well and in what ways the process of learning – which implies a degree of inefficiency and occasional failure – is accommodated within budgetary processes.

* To explore the extent to which budgets may inhibit the development of new ideas and initiatives.

We pursued our aims using an intensive investigation of the control processes and innovative practices of a major multinational enterprise: a provider of “document solutions”, which we called Astoria. The company is a leading player in the global technology industry and seeks to maintain its position through continual product development. It also exhibits many of the hallmarks of an innovative enterprise, including a highly organic structure and an emphasis on learning as well as innovation. Such arrangements have long been considered contextually and operationally inappropriate for traditional budgeting methods. On the other hand, the markets in which Astoria operates are fiercely competitive, so cost control is a prerequisite for survival.

This combination of factors made the company a potentially valuable research site. Our intensive case-study approach allowed us to explore the interplay between budgeting and innovation in some detail.

Management control systems as a resource, not a constraint

The critics of budgeting start from the premise that the budgetary system is a central mechanism of control in an organisation, if not the central mechanism. As the report on last year’s CIMA/ICAEW-sponsored Better Budgeting Forum argues, budgeting “provides an overall framework of control without which it would be impossible to manage”.

Such a view contrasts with the growing body of academic work that points to an expanding management control framework3. It appears from our analysis that one of the reasons why firms may be expanding their control framework is not to install further means of command and control, but to give managers the tools for reconciling tensions and possible trade-offs involving budgeting and other organisational activities – for example, innovation and learning.

Structurally, our study of Astoria demonstrates how attempts may be made to embed the pursuit of budgetary control within a wider management control framework. The company’s own framework comprised mechanisms and procedures that were called “performance excellence planning”, “benchmarking” and “customer-centred productive interactions”. Each mechanism is meant, in its own way, to help managers align their day-to-day decisions with Astoria’s corporate objectives. The emphasis is on ensuring that particular decisions are taken with the company’s overall strategy in mind, rather than local targets.

Managers at the company readily acknowledged that they would use the control processes at their disposal to resolve potential conflicts involving people’s targets. The controls allowed managers to “keep the emotion out of it”, to quote one interviewee, when trade-off decisions that could affect a particular section’s performance had to be taken.

Securing agreement on the potential localised sacrifices to be made, financial or otherwise, in the name of the bigger picture seems to be key to resolving any tensions involving budgets and innovation. These tensions are created by organisational activity and must, therefore, be resolved by the organisational participants. To this end, Astoria’s various control mechanisms were seen as a resource, rather than a constraint. They provided a means by which managers could assure themselves that a particular decision concerning a particular issue was the best decision for the organisation as a whole.

By using the organisation’s control framework, managers helped to ensure that, at the day-to-day operational level at least, their budgets and budgetary expenditure kept pace with new developments.

“Aggregated” variance analysis

Variance analysis is the mainstay of traditional budgetary control. According to the cybernetic model of control on which budgeting is based, decisions about variances should follow automatically from the information received – ie, variances should be corrected. If not, budgetary targets are likely to be missed, leading to ineffective cost control. In practice, however, decisions on budget variance correction must be taken in a wider context in the light of the pursuit of innovation, which implies a degree of inefficiency, and also of unexpected financial requirements.

Astoria’s budgetary system broadly reflected the textbook description in that resources were allocated through the major “decision points” of the company. This meant that, as is the tradition with budgeting, individual managers had designated areas of budgetary responsibility – ie, the budget framework was compartmentalised, comprising individual centres of accountability. This also meant there was the potential for localised variance analysis and correction as individual managers sought to achieve their compartmentalised budgetary targets.

Localised budget variance analysis is seen as problematic, because it’s likely to result in short-sighted behaviour. Critics have argued for changes to the design and operation of the budgetary system on this basis, but Astoria’s response to this issue tended to emphasise a managerial solution. Decisions on whether or not to correct deviations from budget weren’t taken by individuals in a vacuum. Instead, managers emphasised a team-based approach, with people meeting regularly to monitor the unit cost of products.

Managers at Astoria were free to decide the best course of action with regard to budget variances. If, for example, the estimated benefits of correcting a particular variance could be outweighed by a potential loss of revenue owing to a slippage in the launch deadline for a new product, then notions of variance correction could be overruled by the pursuit of the predetermined deadline. Of course, the manager whose budget targets might be threatened by this approach might need to be persuaded that it should happen, but this is where a wider control framework again seems to help.

Formal resolution, leading to general agreement and a potential paper trail, appears to ensure that organisational needs come before individual targets. This procedure represents a key method by which Astoria seeks to ensure that the needs and implications of innovation are accommodated within the budgetary process.

Managerial innovation and budgetary targets

Cost control is pursued by people, but so is innovation. An enduring criticism of budgets is that they stifle such human endeavour. The old command-and-control ethos of budgeting is seen as a restriction on innovation and learning, with the most entrepreneurial managers feeling the most constrained.

This view is another issue that underpins the BBRT’s deliberations, but we found little evidence to suggest that managers at Astoria were deterred from engaging in innovative activities simply because they had budget responsibilities. Of course, the amount of resources available to them may have presented a sort of boundary, but they didn’t see the presence of budgetary targets as a constraint. The closest we came to finding any suggestion that budgets might inhibit innovation was a comment from one manager who remarked that “everybody has a sandpit to play in. My sandpit financially is my control plan. If I stay within it, I’m free to play.”

More generally, managers considered that, if they felt restricted in pursuing innovation, it was the degree of general empowerment they had that mattered. One manager went so far as to say that he felt “constrained in some ways by not having enough hours in the day”. Our findings suggest that, although much of the accounting literature argues that budgets may deter innovation, this seems far from the truth.

Managing shared accountabilities and partial controllability

Traditional budgeting presumes a binary division of controllability – ie, managers are deemed to have full control over the cost items for which they are held accountable and no control over cost items that are the responsibility of others. In practice, however, factors such as task interdependence, informal control, jurisdictional ambiguity and teamworking combine to create areas of partial controllability. At Astoria this situation was exacerbated by the existence of shared accountabilities through delegated tasks, combined objectives etc. In such cases, no single manager could exert anything other than partial control over the financial results for which formal accountability had been established.

Conventional wisdom sees this as a problem. It states that partial controllability may result in dysfunctional behaviour and deter innovation, not least because managers may seek to regain as much control for themselves as possible by resorting to strategies involving individualism, instrumentalism (the view that the end justifies the means) and risk-aversion. Paradoxically, it seems that the opposite was true at Astoria. Rather than behaving in an insular way, managers at the company were observed to manage their lack of controllability through social interaction in the form of discussion and negotiation. The most popular forum for this tended to be face-to-face dialogue, either directly or via videoconferencing. These communications allowed managers to influence, where necessary, the decisions and actions of their counterparts, thereby allowing them to achieve their own targets.

It’s plausible, therefore, to argue that traditional budgeting and responsibility centres, when combined with other control processes, actually encourage managers to communicate with their colleagues and seek the help of others, with the resulting dialogue fostering new ideas and initiatives. To this end, restructuring the budgetary system, or even abandoning traditional budgeting altogether, may create as many problems as it solves.

We observed that the way in which budgetary control was exercised at Astoria allowed managers to balance the inherent rigidity of their budgets with the more organic processes of innovation. A key part of this seems to be the embedding of budgets within a wider management control framework. This gave managers the tools to reconcile the tensions between budgets and innovation, while aggregated variance analysis allowed innovation to be accounted for in the budgetary process.

Overall, our research suggests that the dovetailing of formal procedures with informal processes supports the resolution of tensions between budgeting and innovation. In the light of this case study, calls for the demise of budgeting may be overstated.


1 J Hope and R Fraser, Beyond Budgeting: How Managers Can Break Free from the Annual Performance Trap, Harvard Business School Press, 2003.

2 C Jackson, D Starovic (eds), Better Budgeting, CIMA/ICAEW, 2004.

3 Robert Simons, Levers of Control: How Managers Use Innovative Control Systems to Drive Strategic Renewal, Harvard Business School Press, 1995.

David Marginson (david.marginson@ mbs.ac.uk) is a senior lecturer in accounting and finance at Manchester Business School, where Stuart Ogden is professor of accounting and finance.

Copyright Chartered Institute of Management Accountants Apr 2005

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