MANAGEMENT ACCOUNTING – PERFORMANCE EVALUATION

MANAGEMENT ACCOUNTING – PERFORMANCE EVALUATION

Scarlett, Bob

Bob Scarlett charts the rise of the Beyond Budgeting movement and explains how it differs from traditional approaches to financial control.

Budgeting is what’s known as a dependency model, whereby action is guided by fixed plans that are based on information that quickly becomes obsolete. It is most suitable for use in a centralised organisation where actions are decided at the top and delegated to subordinates for execution. This approach gives rise to various problems, which have been widely discussed in the management literature. Beyond Budgeting (BB) is the generic name given to a body of practices that are intended to replace budgeting. Its core concept is the need to move from a business model based on centralised hierarchies to one based on devolved networks.

In essence, BB places modern management practices within a cultural framework. It is identified with the Beyond Budgeting Round Table (BBRT), which is “at the heart of a new movement that is searching for ways to build lean, adaptive and ethical enterprises that can sustain superior competitive performance”, according to the introductory text on its home page. The BBRT was set up in 1998 as consortium to promote research into the subject. At its centre is the eight-strong “BBRT team”, the best known of whom are Robin Fraser and Jeremy Hope. These two have jointly written various books, including Beyond Budgeting: How Managers Can Break Free from the Annual Performance Trap (Harvard Business School Press, 2003).

The BBRT has about 60 corporate members that fund its studies and benefit from access to its research reports, forums and conferences. It also provides them with strategic and management support. The full round-table community consists of the core team, the member companies and its academic and business associates.

Budgeting is a pervasive exercise that provides the administrative basis for organisational planning and control in many traditionally run organisations. The chief executive’s vision is translated into a plan that is expressed in the form of a budget. Once this is adopted, the management team’s task is to secure compliance with it. Budgeting is a core management process that provides stability and reduces risk. This becomes a cultural phenomenon reflecting a hierarchical method of management under which those further down the organisation are judged on to extent to which they succeed in complying with orders. The approach has been linked to some high-profile business failures. For example, managers at WorldCom claimed that working life was all about satisfying the demands of the chief executive, Bernie Ebbers, that they had to stay two per cent within budget.

The BBRT advances the idea that budgeting should be abolished and replaced by an alternative business model. BB is a “responsibility model”, whereby managers are given goals based on benchmarks linked variously to world-class performance, peers, rivals and/or earlier periods. This requires an adaptive approach that devolves authority to managers. An organisation run in this way will be more of a network than a hierarchy.

The whole spectrum of modern management techniques and tools should be adopted in any BB implementation. IT networks improve communication among different parts of an organisation and between it and its customers, associates and suppliers. Total quality management (TQM) programmes, business process re-engineering (BPR), supply chain management (SCM), balanced scorecards and activity-based accounting all have a role here.

Advocates of BB claim that it does not provide a “softer” management environment than budgets. Both individual and team performance should remain highly visible in a devolved management culture. For example, a performance control report based on the scorecard principle might appear as in the panel on page 56. That gives a fuller impression of performance than a straight actual-to-budget comparison – and the approach can be refined much further. It is possible to adopt industry averages or trend analysis based projections as the relevant benchmarks instead of fixed targets.

A BB implementation should incorporate the following six main principles:

* The organisational structure ought to have clear boundaries. Managers should have no doubts about their responsibilities and what they have authority over. The concept of the internal market for business units may be relevant here.

* Managerial targets should be based on relative success and linked to shareholder value. Such targets may be based on key performance indicators and benchmarks following the balanced scorecard principle.

* Managers should have a high degree of freedom to make decisions. This is consistent with TQM and BPR. The organisational chart should be flat.

* Front-line teams should have responsibility for decisions that generate value. Again, this is consistent with TQM and BPR.

* Front-line teams should also be responsible for relationships with customers, associate businesses and suppliers. Direct communication among all the parties involved should be facilitated. This is consistent with the SCM concept.

* Information support systems should be transparent and ethical. An activity-based accounting system may be useful here.

Researchers have explored BB implementations to determine whether or not these have improved results. The BBRT has reported several case studies, the best known of which is that of Svenska Handelsbanken. The Swedish bank abandoned budgeting in 1972 and switched to a delegation model (involving 600 autonomous work units) that avoids formal planning and target setting. Branch managers run their own businesses and can decide how many employees they need, where they obtain support services from and which products they market to which customers.

The Svenska Handelsbanken model might indicate a higher level of risk and all that would imply for cost of capital and market capitalisation. But it is claimed that the model favours flexibility. In the absence of a fixed plan, products and projects are designed to allow easy modification and exit routes. This view suggests that the model invites a different approach to risk management from the mere acceptance of higher risk.

From all the various case studies, the following benefits for BB have been claimed:

* Faster response times. Operating inside a flexible organisational network and with strategy as an “adaptive process” allows managers to react quickly to customers’ requests.

* Greater innovation. Managers working in a system where performance is judged on the basis of team results encourages the adoption of new innovations. Relations with customers and suppliers through SCM may aid the adoption of advanced working methods and technologies.

* Lower costs. In the context of BB, managers are likely to see costs more as scarce resources that have to be used effectively than as a budget “entitlement” that has to be used. BB is also likely to increase awareness of the purposes for which costs are being incurred and, therefore, of the potential for cost reduction.

* Improved customer and supplier loyalty. The leading role of front-line teams in dealing with customers and suppliers is likely to deepen the relevant relationships.

Like many innovations in management practice, BB is a creature of its time. It emerged in the mid-nineties at a period when increasing globalisation and advances in IT were giving customers greater choice and raising expectations of faster service. The main competitive constraint in most situations is no longer land, labour or capital. If labour is scarce locally, for example, work can be outsourced to India. In many cases the key factor is likely to be intellectual and knowledge-based in character.

Defenders of the traditional approach to budgeting claim that, while it may be associated with a command-and-control management style, it’s the latter that’s the problem and not budgeting itself. Penelope and Ralph Greenberg, writing in Strategic Finance (“Who needs budgets? You do”, August 2006), make the following argument: ‘Talk regarding the budgeting process frequently revolves around target revenues and costs and how those targets are set, used and misused. Rather than dumping the budget, a much better approach is to determine why problems exist and fix them.”

Preparing and using a traditional budget provides an exercise in communication, both within an organisation and between it and the other entities it deals with. The budget is a cheap and proven method for guiding action and reducing risk. It is likely to remain a ubiquitous feature of management for the foreseeable future.

Bob Scarlett is an accountant and consultant.

Copyright Chartered Institute of Management Accountants Sep 2007

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