pierre paludgnach thesis 2
TRANSCRIPT
BEYOND BUDGETING in an International Manufacturing Company
PIERRE PALUDGNACH
WRITTEN AND PRESENTED: MAY 2002
MODIFIED: NOVEMBER 2003
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TABLE OF CONTENTS
2 INTRODUCTION ....................................................................................................................... 9
2.1 BACKGROUND – COMPANY ORGANISATION IN THE THIRD WAVE.................................................. 92.2 PROBLEM...................................................................................................................................... 122.3 OBJECTIVES .................................................................................................................................. 122.4 RESEARCH METHOD ..................................................................................................................... 13
3 PART I – THE THEORY OF BEYOND BUDGETING........................................................ 14
3.1 BEYOND BUDGETING - DEFINITION .............................................................................................. 143.2 DRIVING ASSUMPTIONS - CASE SCENARIO. .................................................................................. 143.3 TEN REASONS TO REPLACE THE BUDGETING SYSTEM .................................................................. 16
3.3.1 Budget and ‘Command-and-Control’ Management............................................................ 173.3.2 Budgets and Financial Incentives ....................................................................................... 173.3.3 Budget Rhythm and Business Rhythm ................................................................................. 183.3.4 Budget Focuses on Financial Outputs ................................................................................ 183.3.5 Budget gets the lowest of the People ................................................................................... 183.3.6 Budget encourages incremental Thinking ........................................................................... 193.3.7 Budgets fails to challenge Managers .................................................................................. 193.3.8 Costs of the Budget.............................................................................................................. 203.3.9 Budgets and Strategy........................................................................................................... 203.3.10 Budget fails to do its Job ..................................................................................................... 21
3.4 PRINCIPLES OF SUCCESS IN THE INFORMATION AGE..................................................................... 213.5 INEFFECTIVE SOLUTIONS TO IMPROVE BUDGETING ...................................................................... 23
3.5.1 Decentralisation .................................................................................................................. 243.5.2 Better Budgeting is not the Answer ..................................................................................... 243.5.3 Improving Resource Management only goes so far ............................................................ 24
3.6 BEYOND BUDGETING CASES ........................................................................................................ 253.6.1 What organisations have adopted Beyond Budgeting ......................................................... 253.6.2 Beyond Budgeting leads to better Performance .................................................................. 253.6.3 Successful «Budgeting» Organisations ............................................................................... 26
3.7 BEYOND BUDGETING PRINCIPLES ................................................................................................ 273.7.1 How Diageo and Ericsson got involved .............................................................................. 273.7.2 The 12 Beyond Budgeting Principles .................................................................................. 28
3.8 IMPLEMENTATION ........................................................................................................................ 323.8.1 Implementation – Getting started........................................................................................ 323.8.2 Implementation – Phased Approach ................................................................................... 323.8.3 Coping with Analysts without budgets ................................................................................ 33
3.9 LIMITATIONS, TOOLS AND WARNINGS ......................................................................................... 343.9.1 Different Countries and Cultures ........................................................................................ 343.9.2 Different Industries.............................................................................................................. 353.9.3 The Public and non-profit Sectors....................................................................................... 363.9.4 Governance ......................................................................................................................... 373.9.5 Economic Value Added ....................................................................................................... 37
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3.9.6 Balanced Scorecard ............................................................................................................ 373.9.7 Activity-based Management ................................................................................................ 383.9.8 Rolling Forecasts ................................................................................................................ 383.9.9 Information Systems ............................................................................................................ 393.9.10 Warnings ............................................................................................................................. 41
4 PART II – THEORY INTO PRACTICE – THE CASE OF KONE OYJ ........................... 42
4.1 COMPANY PRESENTATION ............................................................................................................ 424.1.1 History................................................................................................................................. 444.1.2 KONE Organisation............................................................................................................ 44
4.2 KONE’S ACTUAL SITUATION ....................................................................................................... 464.2.1 The Capla – the forecasts and strategic planning, input for the budget.............................. 464.2.2 KONE Capla compared with Beyond Budgeting Rolling Forecasts ................................... 484.2.3 The Case for Change........................................................................................................... 49
4.3 IMPLEMENTATION ........................................................................................................................ 514.3.1 Phase 1 – The Vision of the New Management Model........................................................ 514.3.2 Phase 2 – Design and Implementing Systems – The 10 Organisational and Behavioural
Changes ....................................................................................................................................... 534.3.3 Phase 3 – Progressive Devolution...................................................................................... 64
5 CONCLUSIONS ........................................................................................................................ 66
6 BIBLIOGRAPHY...................................................................................................................... 69
7 APPENDIX 1: THE CASE FOR CHANGE............................................................................ 72
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INTRODUCTION
This Thesis is divided in two parts, the first one argues about the theory of beyond budgeting,
while the second part will apply the theory in the case of KONE OYj, the Finnish elevator and
escalator manufacturer and service provider.
The PART I – THE THEORY OF BEYOND BUDGETING - will start with background
information about the changing environment and how it has affected company organisational
structures. Later, ten good reasons to abandon budgeting will be followed by the existing
alternatives. Then the 12 best practices to succeed in beyond budgeting will be reviewed. The
limitations will close the chapter.
The PART II – THEORY INTO PRACTICE – THE CASE OF KONE OYj – will start with a
brief introduction of KONE, its history, its actual organisational structure and its actual
budgeting process. Then KONE will be compared with companies that joined beyond budgeting
based on the on-line questionnaire ‘ A Case for Change’. Then the 10 necessary structural
changes to gain competitive advantage through beyond budgeting will be discussed in three
phases: the vision, the design and the progressive devolution.
1.1 BACKGROUND – COMPANY ORGANISATION IN THE THIRD WAVE
Much has already been written about how traditional management accounting fails to support
hard-pressed managers in today’s highly competitive world. But simply adopting new
techniques such as activity-based costing and the balanced scorecard will not bring the expected
benefits if they do not fit well with the chose management structure and style [HOPE &
FRASER, Management Accounting, Dec 1997]. Accounting systems invariably mirror the
existing management structure and, as this structure evolves, so should the accounting model.
The problem is that firms try to adopt more flexible and responsive management approaches to
focus on the customer, they often fail to support these changes by adapting the old accounting
system that were designed for a different competitive era. Indeed, according to Hope and Fraser,
many of these firms are finding (often too late) that the second wave economic model that
stressed volume, scale and the recovery of fixed costs, doesn’t sit well in the competitive
climate of the third wave where innovation, service, quality, speed and knowledge sharing are
the defining factors.
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1.2 PROBLEM
The underlying philosophy of the N-form organisational model is one of maximising value
rather than minimising costs, and the focus of measurement systems is on strategic performance,
value-adding processes and knowledge management. But most important of all, it is a model
based on trust between managers, customers, employees and partners. And as many firms have
discovered, this trust can be easily undermined when managers (typically «when the going gets
tough») are quickly driven back to «managing by numbers» – a path that invariably leads to
arbitrary cost reductions, declining morale and falling profits. Whether they recognise it or not,
many firms have already adopted many elements of the «N-form» model. TQM, BRP,
decentralisation, process-based approach, empowerment, economic value added and the
balanced scorecard are all important factors in succeeding in the «N-form» model. Many
companies invested heavily towards the N-form, often without reaching the success they
expected. The failures are, more often than not, put down to poor communication or lack of top
management commitment, but the real culprit is likely to be hidden within the accounting
system itself [HOPE & FRASER, Management Accounting, Dec 1997]. Many well planned
changes and many attempts to shift the culture from one of compliance and control to enterprise
and learning have foundered when management behaviour have been «snapped back» into old
shape by the invisible power of the budgeting system.
1.3 OBJECTIVES
Jack Welsh, former CEO of General Electric, called the budgeting exercise the «bane of
corporate America». Bob Lutz, former vice-chairman of Chrysler, saw it as a «tool for
repression». And Jan Wallander, former chief executive of Svenska Handelsbanken, the
Swedish Bank, called it an «unnecessary evil».
An increasing number of companies recognise that the budgeting system is perhaps the greatest
barrier to change. Ikea, the Swedish furniture group, SKF, the bearing maker, Schlumberger, the
oil services company, Borealis, the Danish petrochemical group, and Boots, the UK retailer,
have all abandoned budgeting in some ways.
Why are companies scrapping what they previously saw as their best tool for planning, control
and performance evaluation? What are the benefits in doing so? Can every company avoid
budgeting? How to do it in practice and what are the best practices? The first objective of this
thesis is to answer these questions.
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The second objective of this thesis to apply the theory in the specific case of KONE OY, the
Finnish elevator and escalator company. Because, as it will be explained in PART I,
implementing beyond budgeting requires typically few years and involves at least the CEO and
CFO of the company, this work will only aim at establishing a preliminary framework to
introduce the subject and the new ideas to key people. Nothing more.
1.4 RESEARCH METHOD
In 1998, 33 companies (mostly large European) joined the CAM-I Beyond Budgeting Round
Table (BBRT) to set up in response to growing dissatisfaction, indeed frustration, with
traditional budgeting. The task of the research team was first to identify those companies that
had abandoned budgeting, visit them, extract the best-practices and through case reports and
presentations, report back to the BBRT members in order to find a solution. The group then
pieced together an emerging model of how to manage without budgets.
The CAM-I (Consortium for Advance Manufacturing) has unveiled their findings with
parsimony, more for marketing purposes than creating public knowledge. Articles were
published very selectively: the Financial Times, the Financial Management, the Management
Accounting, the Accounting & Business etc. The PART I – The Theory of Beyond Budgeting -
will review, and restructure and bind the essence of the BBRT through a collection of ‘best of’
all articles aggregated together in a coherent flow of ideas, and explained with other sources as
McKinsey Quarterly newsletters for instance, which May 2002 article «Tired of strategic
planning?» has come with very similar ideas about the ineffectiveness of the strategic planning
when linked to the budget. PART I will be based on primary research methods.
The PART II – Theory into Practice – The case of KONE OYj – will be based on secondary
research methods, mainly interviews, discussions, phone calls that occurred during two years of
work experience in KONE, in two locations and two jobs. The first job was Logistics Engineer
in the corporate offices in Brussels (BE), dealing with order book dynamics (how to improve
the flexibility, robustness and reliability of the Supply Chain). During this first job I had the
opportunity to visit and interview key people in Belgium, the UK, France, the Netherlands and
Italy, as well as the managers of the factory in Pero (Italy). The second job was as Project
Manager at the Factory in Hyvinkää (FIN), creating tools for rolling forecasts and inventory
management. The second job focused more on the bottom line.
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2 PART I – THE THEORY OF BEYOND BUDGETING
2.1 BEYOND BUDGETING - DEFINITION
Beyond budgeting is about releasing capable people from the chains of the top-down
performance contract and enabling them to use the knowledge resources of the organisation to
satisfy customers profitably and consistently beat the competition. With intellectual assets
accounting for more than 50% of shareholder value today, people really are the organisation’ s
most valuable asset. But the way the annual budget contract works means that their energy and
ingenuity is used more for negotiating the budget than for creating value for customers and
shareholders. The budget contract is a relic from an earlier age. It is expensive, absorbs far too
much time, adds little value and should be replaced by a more appropriate performance
management model [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct.
2001].
2.2 DRIVING ASSUMPTIONS - CASE SCENARIO.
In this section, two scenarios will introduce the main differences between the ‘ industrial age’
control management with the ‘information age’ empowerment management.
In the rush for sustainable competitive advantage companies hope that by eliminating
management layers and devolving authority and decision-making down through the
organisation, particularly to strategic business units (SBUs), companies hope to sharpen their
competitive edge by improving customer responsiveness and reducing costs. If managers can
think and act like owners, they will become more willing to take risks, stand by targets, be
accountable for performance, and improve the bottom-line. But the reality is often very different
and the results are, more often than not, bitterly disappointing, why is it so?
There are many reasons, ranging from lack of top management commitment, poor
communication, inadequate training and education, to lack of ‘buy-in’ from key people who
wield power and influence. These are indeed essential to effective organisational change, but
there are reasons that are not as readily acknowledged. These include the failure to understand
the interrelationships between targets, measures, rewards and management behaviour. Hope and
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Fraser described in two cases what typically happens [HOPE & FRASER, Management
Accounting, June 1998].
Figure 3 - [Dilbert.com]
A company reorganises its business, cutting management layers and redefining its reporting
structure. SBU managers (a SBU is defined as a business unit that has external customers) are
told they are now in charge of their own business. They are now expected to contribute to
strategy formulation and told to go for ‘stretch’ targets to meet shareholder expectations (at least
beating the cost of capital). And as an extra carrot they are told that the achievement of such
targets will be well rewarded with a large ‘stretch’ bonus at the end of the year.
What does the manager now do? Commit himself to such a ‘stretch’ target knowing that the
management culture promotes winners and punishes losers, or act more cautiously, knowing
that the negotiation of a more manageable (or incremental) target will maintain his steady rise
through the ranks? After all, he has invested a great deal of time and effort into mastering the
target-setting and negotiation process with a clear emphasis on establishing a clear outwardly
tough but an inwardly comfortable budget. ‘Stretch’ in this organisation has little appeal. It
increases the risk of failure and, even if the right improvement measures are implemented, they
might take well over 12 months to bear fruits, thus combining costs rather than benefits to the
current year’s result. Moreover, with monthly performance review focusing on actual versus
budget numbers, a prudent manager would realise that the first blip in progress would probably
trigger a series of meetings and re-forecasts, with the prospect of achieving the original target
becoming increasingly remote. Such a prospect is unlikely to appeal to most SBU managers
leaving both the organisation and its managers worse off.
Now consider a different approach. The SBU manager is once again asked for a ‘stretch target’.
However, under this management model the manager knows that ‘stretch’ really means his best
shot with full support from the centre (including investment funds and improvement
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programmes) and a sympathetic hearing should he fail to get all of the way. Moreover, he alone
carries the responsibility for achieving these targets. There is neither any micro-management
from above, nor any ‘actual versus budget’ reports. Targets are both strategic and financial, and
they are underpinned by clear action plans that cascade down the organisation, building
ownership and commitment at every level. Monthly reports comprise a balanced scorecard set
of graphs, charts and trends that track progress (e.g. financial, customer satisfaction, speed,
quality, service and employee satisfaction) compared with last year and with other SBUs within
the group and, where possible, with competitors. Quarterly rolling forecasts (broad-brush
numbers only) are also prepared to help manage production scheduling and cash requirements
but they are not part of the measurement and reward process. Of course, if there were a
significant blip in performance (and the fast/open information system would flag this
immediately), then a performance review would be signalled. Such reviews focus on the
effectiveness of action plans and what further improvements need to be made, and maybe even
whether the targets (and measures) themselves are still appropriate.
Companies operating in a rapidly changing environment need to adopt this model, but it is vital
that all the elements of the system work in unison, especially target-setting measures and
rewards.
2.3 TEN REASONS TO REPLACE THE BUDGETING SYSTEM
Fewer and fewer firms are satisfied with their budgeting processes [HOPE & FRASER,
Financial Management, Feb. 2001]. In a 1998 CFO Europe survey, 88 percent of respondents
said they were dissatisfied with the budgeting model [BANHAM, August 1999]. Many
companies are spending more time on budgeting and less on strategy. Research has shown that
78 percent do not change their budgets in the fiscal cycle [Hackett Benchmarking Newswire, 25
October 1999]; 60 percent don’ t link strategy with budgeting; and 85 percent of management
teams spend less than one hour per month discussing strategy [KAPLAN & NORTON, 2001].
Janet Kersnar argued in The Economist that: «Time consuming, labour intensive and seemingly
never-ending, the annual budget is, at best, an excuse for senior managers to gather numbers
they should have at their fingertips anyway and, at worst, one of a company’s biggest
competitive handicaps» [KERSNAR, May 1999].
CAM-I argues that for decades accountants have planned, controlled and evaluated performance
using budgeting measures such as product profitability, department costs, unit sales and capital
efficiency ratios. These tools are increasingly unsuited to modern business [HOPE & FRASER,
Financial Times, May 1999]. There are two main strands to the argument. One is that budgets
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are barriers to change and the other is that they don’t do well what managers think they do well
– that is, provide order and control [HOPE & FRASER, Accounting & Business, March 1999].
Budgets are seen as barriers for 10 main reasons, listed below.
2.3.1 Budget and ‘Command-and-Control’ Management
Budgets reinforce command-and-control management and undermine attempts at organisational
change such as team working, delegation and empowerment. Employee goals and the appraisal
process are not linked with the business objectives of the budget. According to Jay W. Forrester,
Former Professor Emeritus at the Massachusetts Institute of Technology: «Many senior
executives see that their primary role is no longer to exert direct control, but to educate their
people» [KEOUGH & DOMAN, 1992].
2.3.2 Budgets and Financial Incentives
The vast majority of organisations regularly experiment with different ways to tie pay to
individual performance [PFEFFER, 1998]. Clearly many leaders appear to believe that the
performance ‘holy grail’ is finding the right mix of targets and incentives within the budget
contract. But the link between incentives and profit performance is tenuous at best. In 1993,
Alfie Kohn’s article in the Harvard Business Review entitled «Why Incentive Plans Cannot
Work» generated many answers. When asked, «Do rewards work?» Kohn replied that the
answer depends on what it is meant by «work». Research suggests that, by a large, rewards
succeed at securing one thing only: temporary compliance. «When it comes to producing lasting
change in attitudes and behaviour, however, rewards, like punishment, are strikingly ineffective.
Once rewards run out, people revert to their old behaviours… They do not create an enduring
commitment to any value or action. Rather incentives merely – and temporary, change what we
do» [KOHN, 1993]. There is a deep dissatisfaction with incentive schemes. Surveys conducted
by William M. Mercer, for example, led them to conclude that they absorb vast amount of
management time and resources, and they make everybody unhappy [PFEFFER, 1998]. This is
not to say that rewards are not appropriate. They are, but they should be seen as a share of
success (like a dividend of intellectual capital) rather than a «do this, get that» type of incentive
linked to the target. They should also be based on the whole team and geared to competitive
success, not on a few people meeting some negotiated number.
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Figure 4 - Bad management practices [Dilbert.com]
2.3.3 Budget Rhythm and Business Rhythm
The budgeting time horizon is not linked with the «rhythm of the business» (i.e. long horizons
in rapidly moving sectors and short horizons in relatively stable sectors). The financial annual
cycle is unsuitable for companies facing rapidly changing markets.
2.3.4 Budget Focuses on Financial Outputs
The focus is often on financial outputs. Budgets ignore the important factors in improving
shareholder value today: knowledge or intellectual capital. Strong brands, skilled people,
excellent management, clear leadership and loyal customers are not easily measured by an
accounting system.
2.3.5 Budget gets the lowest of the People
Budgets discourage the exploitation of synergies across business units by encouraging
parochial, «defend your own turf» attitudes. Jack Welsh, the former boss of General Electric
once described the budget as «the bane of corporate America. It never should have existed…
Making a budget is an exercise in minimisation. You’ re always getting the lowest out of
people, because everyone is negotiating to get the lowest number». Managers tend to play
games with the budget, at an operational point of view, budgeting means agreeing on minimal
targets so that they can be exceeded.
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Figure 5 - Budgets as 'defend your own turf ' attitude [Dilbert.com]
2.3.6 Budget encourages incremental Thinking
Budget encourages incremental thinking and tends to set a ceiling on growth expectations and a
floor for cost reductions, stifling real breakthroughs in improvement. It is like telling a motor
racing driver to achieve an exact time for each lap of the race before starting the race and
without knowing many of the factors that will determine the outcome (such as performance and
behaviour of the other drivers, reliability of the car, weather conditions, etc.) In other words, it
cannot predict and control extraneous factors, any one of which could render the target totally
meaningless. Nor does it help to build the capability to respond quickly to situations. But above
all, it doesn’t teach people how to win.
2.3.7 Budgets fails to challenge Managers
Beyond budgeting offer a challenge to managers and help to retain talents. A 1998 McKinsey
report, The War for Talent, pointed out that big companies are finding it difficult to attract and
retain good people. The top three reasons why managers chose one firm over another were
«values and culture» (58 percent), «freedom and autonomy» (56 percent) and «exciting
challenge» (51 percent) [CHAMBERS & Al, 1998]. Offering a challenge environment is crucial
to engaging and keeping the right people, but the budgeting model with its overarching
bureaucracy, head-office memos and directives, and detailed rules and procedures undermines
such an environment. At one time this didn’t matter. Competitive salaries and good career
prospects meant large firms could usually attract the people they needed, but talented managers
today are much more demanding about their future employers. In the war for talent, part two,
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the update found that 89 percent of those surveyed (6,900 managers at 56 large and mid-size US
companies) thought it is more difficult to attract talented people even after the recession that
started in year 2000, than previously, and 90 percent thought it is more difficult to retain them.
Just 7 percent of the survey’ s respondents strongly agreed that their companies had enough
talented managers to pursue all or most promising business opportunities [AXELROD & Al.,
McKinsey Quarterly Newsletter, 2001].
2.3.8 Costs of the Budget
At the same time, budgeting has become even more expensive, yet adds less value than
expected. A 1998 benchmarking study showed the cost of operating with the budgeting model:
the average company invests more than 25,000 person days per billion of dollar of revenue in
the planning and performance measurement process; the average time taken to develop a
financial plan is four and half months; and companies need an average of 21 days to complete a
forecast [Hackett Benchmarking Solutions, web]. A KPMG study showed that inefficient
budgeting eats up 20 to 30 percent of senior executives and financial managers’ time. Volvo
Cars and Borealis have calculated the budget and the reporting process take over 20 percent of
management time [LITTLEWOOD, 2000]. The mechanics of the budgeting process and its
information systems are inefficient. Janet Kersnar argued that: «even today, the budget is done
with the good of spreadsheets» [KERSNAR, May 1999].
2.3.9 Budgets and Strategy
Budgets are prepared in isolation from, and not aligned to, company strategy and goals. If
asked why budgets are used, most managers would likely answer «to set targets and control
business operations» [HOPE & FRASER, Accounting & Business, March 1999]. But budgets
evolved in the 1920s to help growing businesses manage their capital resources and cash
requirements. It wasn’t until the 1960s that budgets were used to set targets, control operations
and evaluate managerial performance. While planning remains an important part of the
management process, one can believe that setting targets and controlling and evaluating
performance using budgets is fundamentally flawed because it directs managerial behaviours
towards achieving predetermined financial targets rather than harnessing the energy and
imagination of people at all levels towards continuously improving competitive strategies and
customer oriented processes. This is also the view of the quality gurus such as Deming and
Juran: the 11th of Deming’s famous «14 points» was to eliminate numerical quotas [DEMING
Web Site].
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2.3.10 Budget fails to do its Job
Beinhocker and Kaplan found the evidence (from research on the planning processes at 30
companies and work with more than 50 additional companies) that: «the annual strategy review
frequently amounts to little more than a stage on which business unit leaders present warmed-
over updates of last year’ s presentation, take few risks in broaching new ideas, and strive above
all to avoid embarrassment. Rather than preparing executives to face the strategic uncertainties
ahead or serving as the focal point for creative thinking about a company’ s vision and direction.
The planning process is like some primitive tribal ritual, with a lot of dancing, waving of
feathers, and beating of drums. No one is exactly sure why we do it, but there is an almost
mystical hope that something good will come out of it». [BEINHOCKER & KAPLAN, 2002]
Budgets fail to provide reliable numbers, both current and forecast. They are typically
extrapolations of existing trends with little vision of the future. In Strategy under uncertainty, a
McKinsey report, it was argued that the process of applying powerful strategic analytic tools to
predict the future often involves underestimating uncertainty. When the future is truly uncertain,
the analytical approaches are at best marginally helpful and at worst downright dangerous:
underestimating uncertainty can lead to strategies that neither defend a company against the
threats nor take advantage of the opportunities that higher levels of uncertainty provide. Another
danger lies at the other extreme: if managers can’ t find a strategy that works under traditional
analysis, they may abandon the analytical rigor of their planning process altogether and base
their decisions on gut instinct [COURTNEY & Al., McKinsey Quarterly Newsletter, 2000
Number 3].
2.4 PRINCIPLES OF SUCCESS IN THE INFORMATION AGE
The vast changes reshaping the world business terrain are far-reaching, fundamental and
profound. According to Gary Hamel, author of Competing for the Future and Leading the
Revolution: «It is universally apparent that we are living in a world so complex and so uncertain
that authoritarian, control-oriented companies are bound to fail» [HAMEL, 2000]. The concept
of how a successful company operates in the information age is shifting from «make-and-sell»
to «sense-and-respond». Make-and-sell is an industrial-age model based on transactions, capital
assets, mass production, economies of scale and product margins. Sense-and-respond is an
information- and service-age model, which emphasises client relationships, intellectual assets,
mass customisation, economies of scope and value creation. To compete successfully in the
information are, managers must be exceptionally good at six key issues. They must create a
climate for fast response, engage the best people, generate new business concepts, operate with
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low costs, find and keep the right customers and keep shareholders satisfied. Table 1 Principles
of Success in the Information Age [HOPE & FRASER, Feb. 2001] sets out these concepts of
success and shows how budgets can block their achievements.
Table 1 Principles of Success in the Information Age [HOPE & FRASER, Feb. 2001]
Change inenvironment
New successconcepts
Key success factors Barriers
Radical devolutionDevolve authority for fastaction, don’t centralise anddelay decisions
Rules and proceduresand budgetary controlundermineempowerment
Adaptive strategiesMake strategy an adaptiveprocess, not linked with afixed and deterministicpoint
Fixed strategy andbudgeting cycles arebuilt into the traditionalmodel and difficult tochange
RisinguncertaintyEnvironment isnow unstable andunpredictable;competitors cancome fromanywhere at anytime
Coping with risinguncertainty.Adapt quickly tocompetitive changesand customer needs,don’ t rely onimproving forecastingand schedulingprocesses
Fast informationProvide fat and openinformation systems. Don’trestrict information to thosewho need to know
Knowledge assumed tobe accumulated at thecentre leading torestricted flows ofinformation
Right peopleRecruit and develop theright people. Don’t simplyfill vacancies
Budgets don’t connectpeople with valuecreation
Scope to performProvide multipleresponsibility centres. Don’tconsolidate the structureinto larger units
Traditional cost-cuttingmentality leads to largerunits gain economies ofscale
Inspirational leadershipDon’t adopt the carrot andstick approach
Budget basedperformance contractscreates climate ofmanagement by fear
Intellectualcapital increasingin importanceTalents are hardto find and evenharder to attract
Finding and keepingtalented peopleProvide achallenging workenvironment thatenables personaldevelopment. Don’tassume that peoplewill be attracted bypay or perks
Share in wealthUse fair rewards system,not one that benefits a fewpeople
Incentives usually linkedto budgets
Venture capital modelView the business as aportfolio of investments, notas sub-sets of the budget
Central planningapproach sees only shortterm impact of riskyinvestment proposals
Stretch climateCreate a climate ofchallenge and stretch, notcaution and control
Bureaucracy and controlis stifle challenge andcreativity
Increasing paceof innovationTo compete,firms mustconstantly refreshtheir productsand strategies,and generatenew businessconcepts
Generating newbusiness conceptsCreate climate forself-questioning andinnovation, not oneof subordination andcontrols
Learning and sharingShare knowledge, don’tkeep it to yourself
Budget cells encourage‘defend own turf’ attitude
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Low cost networkAdopt a low-cost networkstructure, not an expensiveand complex hierarchy
Hierarchy means thathigh costs are ‘hardwired’ into the system
Strategic alignmentAlign resources usage andcosts with strategy, not withdepartmental budgets
Budget views fails tosupport strategic costalignment
Falling prices andcostsPrices are fallingand costs mustbe reduced; costsincreases are nolonger be passedon to customers
Operating with lowcostsChallenge andreduce costs. Don’tprotect and increasethem
Challenge costsDon’t allow them to becomebudget entitlements
Budget process preventscost-reduction issuesbeing addressed
Customer relationshipsSatisfy customer needsquickly and profitable. Don’tjust see customers asbuyers of products
Sales targets andincentives run counter tomeeting customer needs
Decliningcustomer loyaltyCustomers nowhave extensivechoice and willswitch loyalties ifnot satisfied
Finding and keepingthe right customerFocus strategy andbehaviour on servingcustomers, notselling products Customer focus
Focus strategy oncustomers, not products
Product focus is difficultto shift
Alignment with valuecreationAlign key decisions withlong-term value creation
Budgets contracts drivesshort-term decisions
MoredemandingshareholdersShareholdersnow demandbetter thancompetitors andconsistent results
Creating consistentvalue forshareholdersAlign targets,measures andrewards with long-term value, not withshort-term profit
Range of controlsBase controls on a range offuture indicators andrelative performance, notfinancial budgets
‘Rear-view mirror’controls based onbudgets fails to givemanagers a future view
2.5 INEFFECTIVE SOLUTIONS TO IMPROVE BUDGETING
The weaknesses of the budget contract have been recognised for decades. Quoting Hope and
Fraser, « Writers such as Mayo, McGregor, Maslow, and Herzberg have all argued in one form
or another that superior performance is not driven by planning, controls and incentives, but by
team working, self-esteem and personal development. And more recently, such writers as Senge,
Wheatley, Johson, Mintzberg, Schein and Argyris have all argued that the budget contracts
seduces leaders into believing they can control the business through the numbers when, in
reality, this is a dangerous illusion» [HOPE and FRASER, Beyond Budgeting Questions and
Answers, Oct 2001]. The attempted solutions broadly fall into three categories: decentralisation,
process improvements, and resource management improvements.
24
Figure 6 - Bad decisions [Dilbert.com]
2.5.1 Decentralisation
Decentralisation, team working and empowerment have all been used to try to cut the costs of
the corporate bureaucracy and increase the speed of decision-making, but all have met with
limited success. Most have been attempts to fine-tune rather than challenge the traditional
model. One problem has been the lack of understanding of the changes required. In practice,
decentralisation often means no more than the delegation of control within a strict regime of co-
ordination and accountability, with the performance contract as the primary weapon for policing
this control. It is the power of the group finance team to demand fixed plans and budgets and
control performance against them that reinforce the centralised model and mindset.
2.5.2 Better Budgeting is not the Answer
Many progressive companies today are introducing rolling forecasts, and more frequent, and
much streamlined, planning and budgeting processes, in an attempt to address the demands of a
business that is rapidly changing. But they do not provide long-term solutions because they do
not address many of the fundamental weaknesses (e.g. poor strategic linkage) of the budgeting
contract. In fact they often create more work (and costs) rather than less. As a Fortune Magazine
article noted: «The value of an annualised budget depreciates fast. Simply revising it every few
months may tighten the budgetary coils instead of releasing managers to act strategically»
[STEWART, 1990].
2.5.3 Improving Resource Management only goes so far
According to Hope and Fraser [HOPE & FRASER, Accounting & Business, March 1999], the
only significant attempt in the past 30 years to address the weaknesses of traditional budgeting
has been the development of Zero Base Budgeting (ZBB). ZBB is a highly effective process for
25
occasional reviews to improve resource reallocation and make significant cost reductions.
Moreover, linking ZBB with Business Reengineering Processes (BRP), activity based budgeting
and other improvement techniques can enhance its effectiveness for enterprise-wide cost
reduction. But such one-off project should not disguise the fact that ZBB is not suitable as an
on-going budgeting system. It is too bureaucratic, internally focused and time consuming
[HOPE & FRASER, Management Accounting, Dec 1997]. All the approaches to improve the
budget failed the test, as they leave the behavioural weaknesses in place. According to Hope and
Fraser: «budgets are the biggest roadblocks (both systemic and mental) to the future. It is now
time to abandon them and develop alternatives and much more effective management
processes» [HOPE & FRASER, Accounting & Business, March 1999].
2.6 BEYOND BUDGETING CASES
2.6.1 What organisations have adopted Beyond Budgeting
While Dr Jan Wallander was transforming Handelsbanken into one of Europe’ s most successful
banks of recent decades, few companies took the trouble to find out what he had done, and more
importantly, how to turn his philosophy into a set of guiding principles. It was only in the 1980s
that Jean-Marie Descarpenties was to follow a similar approach, first at a packaging company,
CarnaudMetalBox, and then at Computer Company, Bull. At the same time Dennis Blake and
Roger Sant were establishing an electric utility company in America, known as the AES
corporation, and based on a core set of principles that both Wallander and Descarpenties would
have approved. In the 1990s, the word got around and a number of other companies started to
follow. Furniture manufacturer and retailer, IKEA, abandoned budgeting in 1994, car giant,
Volvo cars in 1995, and petrochemical company Borealis, also in 1995. Norwegian based,
Fokus Bank, and Swedish plumbing and heating distributor, Ahlsell, soon followed. And more
recently two UK-based organisations, cider-maker, Bulmers, and charity Sight Savers
International have started the process. Other companies including Siemens, Diageo and UBS are
just starting their beyond budgeting journeys.
2.6.2 Beyond Budgeting leads to better Performance
The evidence from the BBRT observations and from the surveys that were conducted suggests
that it does, but it is much stronger in those organisations that have «gone all the way» (that is
changed the culture) than those that had more limited objectives (that is, restricted changes to
performance management processes).
26
Handelsbanken has outperformed its Nordic rivals on just about every measure you can think of
including return-on-equity, total shareholder return, earning-per-share, cost-to-income ratio, and
customer satisfaction. And it has done this year-in, year-out, for the past 30 years. It is the most
efficient bank in Europe and has been voted one of Europe’ s best Internet banks.
CarnaudMetalBox was transformed from a debt-laden company worth only $19m in 1982 to a
market value of $ 3bn in 1989 and described by Fortune Magazine as one of the best European
Corporate of the 1980s. Bull had had a similar experience under the leadership of Descarpenties
(though in both cases results went into decline when he departed and the management model
reverted to the traditional budgeting model). Volvo made significant progress and moved from
number nineteen to number two in the world profitability by 1997 (it has since been acquired by
Ford). Borealis has met its ambitious return-on-capital targets and reduced costs by 30% over 5
years. Fokus Bank came from nowhere to be the most cost efficient bank in Norway and was
then acquired by Danske Bank of Denmark. Ahlsell is now the sector’s most profitable
company in heating and plumbing, and in electrical – a major turnaround from its position in the
early 1990s. Bulmers is growing revenue and profitability at a much higher rate than the
industry average and there have been some significant cost savings. And AES has been one of
America’s «wonder» stocks of the 1990s (total shareholder return was top of the Fortune
rankings in the Utility sector for 1999).
2.6.3 Successful «Budgeting» Organisations
Some might note that many organisations can be «successful» with traditional budgeting in
place. According to Hope and Fraser, performance contracts are less harmful when conditions
are stable and companies are operating in a growth market. As soon as the market turns down,
however, many of them are found out. Look at how many «successful» companies were
suddenly writing off huge sums and downsizing their operations as soon as they had the excuse
of a serious business downturn in 2001. The other point is that because so few companies have
so far adopted beyond budgeting principles, most business sector performance league tables
only include traditional budgeting companies.
«It is only when you have a beyond budgeting company operating in a business sector that a
real comparison can be made. And whenever this happens, they shine through»
[HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct 2001]
27
2.7 BEYOND BUDGETING PRINCIPLES
Implementing beyond budgeting will start with ideas developed by Diageo and Ericsson. Then
some general guidelines will be reported along with the 10 organisational and behavioural
changes. This section will conclude by explaining why all the organisational and behavioural
policies have to be harmonised.
2.7.1 How Diageo and Ericsson got involved
Diageo, the UK consumer goods giant generated by the merger in 1997 of Guinness and Grand
Metropolitan, whose brands include Guinness, United Distillers, Burger King and Pillsbury,
gathered 60 of its top senior managers to rethink the planning process. «We asked people to be
radical in their thoughts and we wanted them to understand that this wasn’t game playing», said
Philip Yea, CFO of Diageo. By the end of the meeting, the executives had agreed to scrap the
firm’ s annual budget and replace it with a totally different approach. Of course, not every CFO
is in Yea’s enviable position of essentially starting from scratch in a brand new organisation, but
that should not deter finance executives from taking a long, hard look at a process that often
earns the finance function plenty of criticism from business-unit managers who have to struggle
to pull together facts and figures [KERSNAR, May 1999]. «The guys out in the branches have
to be working towards targets that are consistent with what they are expected to achieve on an
operational level», warns Brian Lever, a consultant at PricewaterhouseCoopers. In replacing the
budget with new tools and approaches, «finance is making the difference by making operational
what from the beginning [should be] seen as a strategic tool"» notes Yea.
«Companies are spending hundreds of millions of dollars on these types of projects, but they
fail to recognise the staying power of the budget», says Jeremy Hope, author of Competing in
the Third Wave and Transforming the Bottom Line. Hopes argues that because so many firms
launch re-engineering drives with neither the full support of key parts of their organisations nor
a willingness to devote the necessary time and resources to the projects, «it is not very
surprising that few of them succeed».
Most of the companies who noticed the problems linked to budgeting replace it with rolling
forecasts or balanced scorecards (or a combination of both of them). In many cases firms choose
to hand on to the budget but reduce the weight it has in corporate decision-making before during
the time needed to set up a new system.
In Ericsson the solution found to cope with the problems of the budget was to break free
[KERSNAR, May 1999]. Carl Wilhelm Ros, former senior executive vice president and CFO of
Ericsson, explained, «We still think that the budget has a value as it gathers the organisation
28
around discussion of the bottom line. But the figures that are in the budget today don’ t give as
much of an indication [of what happens in the telecom industry] as they did ten years ago
because things are changing so fast.» The first step of the process took place when Ericsson
managers set their so-called «rolling forecast». These are tailored to the specific market segment
in which they operate, such as mobile phones or switching systems, and are based on specific
targets, which are a mix of financial and non-financial items. «Each quarter we update the
rolling forecasts the 12 to 18 months ahead», said Ros. «We put less effort into details of the
budget, and more effort into the market changes», he explained. «Of course, we check the
bottom line and work with the balance sheet, but we don’t go through the details like we did
before».
2.7.2 The 12 Beyond Budgeting Principles
In days when competitor actions were largely predictable and suppliers held sway over
customers, firms could plan, make and schedule activities to optimise the efficiency of their
internal processes. But increasing uncertainty makes such practices ineffective – firms cannot
predict new competitors or what business concept they will use. Such change wreaks havoc with
traditional planning and budgeting. In today’ s world, SBU managers need to make fast
decisions to counter threats and take new opportunities as they arise. There is no time for
approval procedures and management meetings. Fast response means making strategy an
adaptive process. Managers must be put in charge of strategy and able to monitor it
continuously, rather than once a year. To identify new initiatives is needed; managers must have
fast access to resources. They need, for example, the authority to acquire key people when they
are available (not when there is room in the budget); to react to competitive threats and
opportunities as they arise (not as predicted in an outdated plan), and to acquire and deploy
resources when necessary (not as allocated by head office). None of this is new, but so many
companies attempt to implement the new type of business model without appreciating the
hidden barriers that lie in wait within the budgeting, performance measurement and rewards
systems. The successful implementation of the new model is a painstaking process. It can take
years rather than months and needs constant reinforcement, particularly of core values [HOPE
& FRASER, Management Accounting, June 1998]. Such words as openness, trust, integrity, co-
operation, loyalty and ownership define its values. Indeed, many firms use these words in their
mission statements and quality programmes, but they are much harder to apply in practice.
The attitude to change is also important; beyond budgeting companies see change as an
opportunity, not as a threat. They probe constantly for signs of impending change and pre-empt
competitors’ actions and customers’ needs. They prepare rolling forecasts that support strategy
29
reviews and investment decisions (being careful not to distort the forecasting process by
allowing senior managers to influence the outcome). And they have up-to-the-minute
information about customers, costs, profits, market changes and anything else essential for rapid
response and good decisions.
It is increasingly clear that businesses cannot plan and control their way to the future in
incremental steps. They must innovate and they must think differently. This means using the
creativity of their people to develop imaginative strategies, new business models, and more
relevant management practices. Bloated bureaucracies and budgetary controls are the enemies
of insight and innovation. They stifle creativity with a rigid system of budgetary controls that
reward good housekeeping, but fail to acknowledge creativity or innovation, and fail to provide
a management climate that encourages creative people to thrive. Managers in beyond budgeting
companies foster insight and innovation by sharing knowledge across networks. They
encourage new ideas by breaking free from incremental thinking. And their leaders act more
like venture capitalists that oversee a portfolio of businesses with a diverse range of risks and
rewards, than like central bankers who are interested only in low risks projects. They know that
people will perform better only if they are emotionally committed and this means working for
more than money.
And beyond budgeting companies target lower costs by aligning products, processes, projects
and cost structures with their strategy. They also avoid fixing their capacity too far in advance.
Beyond budgeting is also about finding and keeping the «right» customers. As we travel further
in the information age, customers are presented with more choices and more information on
which to base these decisions. Consequently, customer churn is increasing. Frederick Reichheld
notes that on average, US corporations loose half of their customers every five years
[REICHHELD, April 1996]. They need to know how to satisfy them (their value needs) and
how to maximise profits from them. But finding the «right» customers is rarely on the agenda of
sales planning meetings. Most sales gadgets are constructed and monitored on the basis that
customers are segmented by product group, size, lifestyle, or some other grouping. They don’ t
segment customers by their value needs. Beyond budgeting companies, however, place
customer value needs at the centre of strategy. They distinguish between customers who want
transactional sales (they want the cheapest products and services, perhaps on the Internet); those
who want additional service (they are prepared to pay for advice about most appropriate
solutions); and those who require customisation (they need their exact requirements to be
addressed and satisfied). Clarifying customer ownership is crucial to maintaining a strong
relationship.
30
Failure to meet profit promises can lead to stock price falls. The reaction of many companies
using the budgeting model is to cut costs to support quarterly profits, but this result in fewer
good people doing more work and working longer hours. Tougher targets are intensifying
pressure. Downsizing, layoffs, short-term contracts and higher productivity demands are
pushing workers to the verge of nervous breakdowns. It is small wonder that a recent ILO
report, Mental health in the workplace, concluded: «Workers world-wide confront, as never
before, am array of new organisational structures and processes which can affect their mental
health. These trends represent as wake-up call for business. For employers, the costs are felt in
terms of low productivity, reduced profits, high rates of staff turnover and increased costs of
recruiting and training replacement staff» [OSBORN, Oct 2000].
Beyond budgeting companies aim to create consistent value streams. Giving managers control
of their actions and using simple measures based on key value drivers and geared to beating
competition is all that most cases require.
According to Hope and Fraser, budgeting is so ingrained that many managers and management
accountants cannot see how it might be replaced [HOPE & FRASER, Financial Times, May
1999]. The pioneering companies developed systems that often shared the characteristics of
Table 2: The 12 Beyond Budgeting Principles.
Table 2: The 12 Beyond Budgeting Principles
Key performance managementprocesses
Key leadership actions
1. Beat the competition 7. Create a performance climate based onsustained competitive success
2. Reward team-based competitivesuccess
8. Build the commitment of teams to acommon purpose, clear values and sharedrewards
3. Make strategy a continuous and inclusiveprocess
9. Devolve strategy to front line teams andprovide the freedom and capability to act
4. Draw resources when needed 10. Champion frugality and challenge thevalue-added contribution of all resources
5. Co-ordinate cross-company interactionsthrough «market-like» forces
11. Organise around a network of teams thatdynamically connect their capabilities to servethe external customer
6. Provide fast, open information for multi-level control
12. Support transparent and open informationsystems
These mechanisms must be tailored to deal with particular business pressures. At
Handelsbanken, Mr. Wallander introduced league tables to measure the bank’ s performance
relative to its competitors, and of branches relative to their peers. Branch managers work out
31
their own improvement plans, hire their own staff and focus on selling customer solutions rather
than products [HOPE & FRASER, Financial Times, May 1999]. They are supported by an
accounting system that provides information not only on branch, but also on customer
profitability. This decentralisation gives senior managers more time to stretch their managers’
thinking.
While the emphasis at Handelsbanken is on managing customer relationships, companies with
rapidly changing products such as Volvo Cars and Ericsson concentrate on innovation and fast
response. Managers in these companies rely more on forecasts and «leading» indicators than
historic accounting reports. At Volvo Cars strategy and forecasts are reviewed and updated
several times a year in four distinct cycles. According to Ole Johansson, vice-president of
finance, «managers build competence in sketching the future and within that future lie the
opportunities and threats that traditional budget-driven processes fail to see until it’s too late».
At Borealis, the emphasis is on managing performance over the business cycle. The «balanced
scorecard» process sets the targets; fixed costs are controlled through trend reporting, activity-
based management and cost targets, higher level financial and tax planning relies on rolling
financial forecasts. «The new system is not just simpler – it gives us far more control than the
traditional budget ever did,» says Bjarte Bogsnes, vice-president for corporate control [HOPE &
FRASER, Financial Times, May 18 1999].
One of the biggest criticisms of the budgeting system is that it is time consuming. At many
firms, the process takes so long that no sooner has the final documents come out of the system,
than its already out of touch with the reality [KERSNAR, May 1999]. In the early 1990’s the
executives of Ericsson, the Swedish Telecommunications Company, realised that the company’
s traditional planning methods were inadequate for the fast growing technology markets.
Ericsson relied for years on the traditional budget, the preliminary figures were set in August,
and the final budget in October November, and presentation to the board took place in
December. Both increasing deregulation and ever changing technology made it impossible for
managers to stick to using the figures that were determined the previous calendar year. Once a
member of the board of Ericsson saw the transition from electromechanical switches to
electronic switches mismanaged. The company’ s budgets and forecasts gave the illusion of
control; but actually made it harder to reach quickly to business opportunities [KERSNAR, May
1999].
Handelsbanken abolished budgeting in 1979. As Mr. Wallander once explained: «either a
budget will prove roughly right and then it will be trite, or it will be disastrously wrong and in
this case it will be dangerous. My conclusion is to scrap it!»
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2.8 IMPLEMENTATION
2.8.1 Implementation – Getting started
According to Hope and Fraser, there types of people that drive the change program. The first is
the visionary leader who either joins the organisation with a philosophy and mandate for change
or who is persuaded by the evidence that beyond budgeting is necessary to bring about their
vision of the organisation. Visionary leaders make powerful ‘sponsors’. The second is the ‘high-
level’ sponsor who is persuaded by the argument, but sees the project as a more effective way to
manage the organisation in the information age. Sponsors are people with the legitimacy to sell
the change program and mobilise the people and resources necessary to make it happen. They
are usually the CEO or the CFO-CEO partnership. The third is the change advocate who must
first sell the ideas to potential sponsors before they can mobilise people to accept the change.
They see beyond budgeting as a way to break free from the overpowering constraints of the
performance contract. Change advocates need to persuade high-level sponsors and gain
legitimacy needed to drive the project forward. Each driver of the change program will make
little progress unless they convince “key influencers” that the case for change is strong and the
change program is necessary. These are the people that are most affected by the beyond
budgeting program. They typically include functional directors (e.g. finance, sales, marketing,
operations, IT and human resources) and business unit teams. Experience has shown that these
people are not hard to convince since they see budgeting as a drain on their time with few
obvious benefits [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct 2001].
2.8.2 Implementation – Phased Approach
If the firms’ leaders continue to insist on retaining tight central control with performance
contracts based on short-term predictions, there is little point in changing the performance
management processes to support a more adaptive, devolved model. The best way forward is to
proceed with a «three phase» approach to beyond budgeting. Phase 1 sets out the Vision, Phase
2 is to design and implement the new system and Phase 3 is progressive devolution and rollout.
Before attempting to start on the Vision phase, preparing a case for change is needed. Getting
approval to this will ensure that sufficient resources can be deployed to phase 1 for it to be
successful. Creating and agreeing a vision for the new management model includes that aims
and principles on which the model will be designed, and the first level of details behind the 12
principles. It then needs to come together into a document and be discussed and approved by top
management, and the board, and be widely sold to ‘key influencers’ inside the organisation. It
33
will also include the plans and resources needed to make it happen. The main resource is
training. Preparing templates for how to engage in the strategy and action planning processes,
for example, will be a valuable investment. However, it should not be sold as yet another major
«change program» [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct 2001].
If the CEO or CFO doesn’t sign up to the vision, then think long and hard before proceeding.
Beyond budgeting cannot be implemented by stealth. It needs reinforcement from the top. Phase
2 is about designing and implementing the new systems and taking out the old ones, including
budget contracts. This phase would normally be led by the CFO. Phase 3 (intensive at the
beginning but it never ends) is progressive devolution, using the new system to show which
teams are performing well compared with their peers or external competitors. This leads on to
capacity building through training and if necessary switching people. Some large companies
will want to do a pilot and rollout. Others will want to just take out the budget and hope that the
training provided will be sufficient for all business units to cope with the new approach. Each
will follow these 3 Phases, but the rollout will be much quicker (typically a year) because the
new system already exists.
2.8.3 Coping with Analysts without budgets
According to Hope and Fraser, instead of promising an earning number to analysts, companies
should rather share with them details of the business strategy and key performance indicators
and let them work out what they think is the value of the business. This frees the company from
the burden of making some specific number and encourages them to build their confidence in
the future of the business and the strength of its management. It also enables you to manage
their expectations more efficiently. There will be fewer surprises, so the share price should have
a smoother ride.
«Let the analysts judge your performance, not your promises!»
[HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct. 2001].
When the budgeting system has gone, shareholder should not perceive a weakening of control
because there are many other information streams that provide better view of what is happening
to performance. According to the CAM-I research, in all the visit cases, senior managers felt
they had better control than before because they got fast and untreated information on what is
happening at the front line. Investors are delighted when information systems enable good
decision-making and faster anticipation of events. Shareholders are betting on the future, not on
the present and what is needed is a management process that builds future value, not just fix
short-term problems.
34
There are few companies in the world over the past thirty years that have created more
shareholder value than General Electric, Toyota and Handelsbanken. While GE and Toyota
exhibit many of the features of beyond budgeting (Toyota, for example, never uses fixed targets
or performance contracts to drive results), Handelsbanken exhibits them all. For other evidence,
we can point to some recent surveys that indicate a strong link between devolution and
shareholder value. For example, Watson Wyatt has constructed a ‘Human Capital Index’ that
shows a clear relationship between the effectiveness of a company’ s human capital and the
creation of superior shareholder returns. They surveyed more than 400 US and Canadian
publicly traded companies with at least three years of shareholder returns and a minimum of
$100 million in revenues or market value. The conclusion was that 30 key human resource
practices (under four broad headings) make a difference of around 30% to shareholder value.
They include finding and keeping the right people (10.1%), clear rewards and accountability
(9.2%), collegial, flexible workplace with flat structures (7.8%), and communications integrity
with a policy of sharing information (4.0%) [WYATT, 1999]. In another survey, McKinsey
found that companies scoring in the top quintile of top talent-management practices outperform
their industry’s mean return to shareholders by a remarkable 22% [AXELROD & Al, 2001].
2.9 LIMITATIONS, TOOLS AND WARNINGS
2.9.1 Different Countries and Cultures
There are four reasons why Scandinavian organisations adapt readily to a more-market
responsive and devolved style of management. First Scandinavia is a closely-knit business
community where imaginative ideas travel quickly. Secondly, Scandinavia has a high
proportion of global companies relative to its size, and thus they have plenty of experience in
uncertainty. Thirdly, financial budgeting conflicts with the notion of intellectual capital – an
idea that also had its genesis in Scandinavia. And fourthly, Scandinavian companies are
fortunate in having a predominance of well-educated people with the self-confidence to accept
the high-levels of responsibilities demanded by the new model. According to Hope and Fraser,
beyond budgeting will work elsewhere because it is not a peculiar cultural phenomenon: both
Japanese quality methods in the 1980s and Scandinavian Knowledge Management in the 1990s
have been successfully applied in all parts of the world, in different cultures. Therefore beyond
budgeting can also be applied elsewhere than Scandinavia [HOPE & FRASER, Beyond
Budgeting Questions and Answers, Oct 2001]. In the UK, organisations such as Bulmers, Sight
Savers International and Leyland Trucks have adopted the ideas in a serious way. And large
35
organisations such as BP-Amoco and Diageo have taken more than tentative steps. In
continental Europe, Rhodia (France) and Phillips (Holland) have embraced the ideas as well as
UBS (Switzerland) and Siemens (Germany). In North America, AES is a supreme example,
CIBA Vision has made real progress, and GE has many of the hallmarks of adopting the
principles. In Japan, Toyota has operated without performance contracts for decades.
The AES experience is particularly interesting. AES is a global electricity supplier with
operations in every continent and many third world countries. Perhaps the greatest challenge
was in the old Soviet bloc. But when asked about this they replied that their employees in the
Hungarian plant just took longer to grasp the issues and change behaviours. It took about three
to four years instead of the usual one or two. But eventually all employees in all countries
become comfortable with the responsibility culture.
2.9.2 Different Industries
Maybe the capital industries are better suited to the traditional budgeting approach. Indeed
budgetary controls were designed to fit large manufacturing firms in the 1920s. But it is
important to remember that these firms were investing huge sums in productive capacity often
to supply an insatiable demand for new products, especially in the decades after Second World
War when consumer expectations were rising. Their problems were concerned with production
planning, scheduling, and distribution – all processes well suited to the capabilities of the
budgeting model. Now it is very different. Consumers have almost too much choice. They can
change their minds at the click of the mouse, and new competitors with different business
models can spring from anywhere often making your costs appear too high of your technology
look outdated. The result is that customers are at risk. Besides, manufacturers today often take
as much, if not more, profits from services than products. Thus for many reasons, manufacturers
have as many reasons to challenge the budget contract as service and high-tech organisations.
While many ‘make and sell’ organisations still exist, their ability to compete in the information
age with ‘operational excellence’ (or lowest cost producer) strategies has been challenged by no
lesser authorities than two of the world’ s best known strategy experts. Both Michael Porter and
Gary Hamel agree that it is becoming harder and harder to forge competitive advantage from
operational excellence [PORTER, 2001] [HAMEL, 2001]. Rather like quality, being
operationally excellent is becoming a prerequisite rather generating differentiation. This
confuses many companies that believe that smart and rapid use of the Internet allows them to
steal a march on their competitors. Most of the productivity gains are passed on to customers in
the form of lower prices, thus reducing margins across the whole industry. There is little doubt
that innovation and customer intimacy are now the only two sustainable sources of competitive
36
advantage and both depend (much more than operational excellence) on decentralisation and the
right climate for attracting good people.
2.9.3 The Public and non-profit Sectors
Accountability in the public sector comes from the political process, not through profit or even
targets. Numerical targets can never capture the quality of a good public service. Elected
politicians need to set broad goals and trust their managers to «get on with it». Having said that,
there are improvements that can be made in areas such as resource utilisation. This is one of the
biggest problems confronting both public and non-profit sectors [HOPE & FRASER, Beyond
Budgeting Questions and Answers, Oct 2001]. Both sectors are dominated by budgets to best
utilise their limited resources to meet the unlimited public need. The problem is that the
budgeting process is all about justifying existing resources («use them or lose them»] and
acquiring as many new resources as possible. Decisions about priorities are based on budget
submissions and taken by people far removed from action. Resource are then allocated and
fixed for the year ahead.
While applying market principles to public organisations is not always a wise approach, there is
much to learn from the internal market system that operates within some beyond budgeting
organisations. If resource «buckets» were allocated to users and they had the scope to spend that
money in the way they thought best to maximise their performance and they had the cost
information to understand their inputs and the flexibility to buy in their resources from an
internal (and external) market, then they might have the incentive to take a harder look at their
costs. Kaplan provides an interesting example from the City of Indianapolis in the USA. After
many years of budget overruns the new major decided to put a number of contracts out to
tender. One included the paving of the roads, filling potholes, sweeping streets, and collecting
garbage. He first asked for current costs. No one had a clue. He then shared the information with
departmental workers who decided to bid for the contract. Armed with the new information, the
workers’ bid was by far the lowest cost ($286 per ton against the previous cost of $640). Cost
savings came from fewer supervisors, reduced work crews (labourer, vehicle drivers and
equipment operators) and more efficient use of vehicles. The lessons were that once the full
information was shared with the workers (they had no idea about the central service costs), and
once they had the freedom to act, they were in the best position to make improvements
[KAPLAN, 1996].
37
2.9.4 Governance
Though governance statements usually mention that «budgets and controls» should be adequate,
that was without counting on the side effects of dysfunctional behaviour. So instead of budgets
reinforcing good governance, they often undermine it. In fact, many blue chip organisations
have been caught falsifying accounts and engaging in other shady practices in desperate
attempts to meet their performance contracts (i.e. Enron of the US in 2001, Lernout & Hauspie
of Belgium in 2000, etc.) So replacing governance will benefit governance rather than
jeopardising it. This does not mean that internal controls are diluted. Firms that have
implemented beyond budgeting have kept strong internal audit departments, but they are
focused on strategic issues as well as risk management [HOPE & FRASER, Beyond Budgeting
Questions and Answers, Oct. 2001]
2.9.5 Economic Value Added
EVA is rooted in the Newtonian concept of the «organisation-as-a-machine». It uses numbers to
make decisions. But not everything can be reduced to a series of future cash flows. These are
based on long-term forecasts that can be highly unreliable. Front line managers need to use their
intuition to make quick decisions and they must have the freedom to do it. If EVA models
enable them to do this more effectively, then that is supportive. But if they are used as a way of
forcing managers to reduce every decision to a detailed shareholder value-based proposal that
requires higher-level approval, then that would not be supportive. But, according to Hope and
Fraser, if they are used as the basis for performance contracts, then they can be potentially
disastrous as there are so many uncertainties inherent in the numbers [HOPE & FRASER,
Beyond Budgeting Questions and Answers, Oct. 2001].
2.9.6 Balanced Scorecard
The balanced scorecard can work with beyond budgeting, but it depends of how it is used. If the
balanced scorecard is used to build a picture of strategy that can be described and
communicated to a number of teams, then the scorecard has a strong contribution to make. And
if it is used to provide managers with a strategic framework that shows a moving picture of
change from their perspective, then again, it has a valuable role to play. It is the ability to focus
on continuous feedback and learning that is perhaps its greatest strength. But it is when the
scorecard is used to set targets, and place numbers on cause-and-effect linkage that dictate
actions to manager, that the scorecard starts to run into difficulties (both conceptual and
practical).
38
How targets are set using the Balanced Scorecard is a good test of ho to ‘get it right or wrong’.
The wrong way is to link targets to rewards in a performance contract. If the scorecard appears
as ‘just another budget’ with annual negotiations of targets and resources, then it is not
surprising that local managers will fail to embrace its real strengths. In such a situation, the
message will be a familiar command and control one, thus undermining any notion of
empowerment and trust. It simply appears as a better tool for financial control.
The scorecard is an excellent tool for educating and engaging people in the strategy process. For
example, identifying whether customer intimacy or product leadership is your core value
proposition and which business processes are critical to supporting it, enables managers to
determine the key performance indicators that should be monitored. It is the feedback loops that
tell managers what to do next rather than remain stuck with predetermined plans. Surprises
should be taken in their stride and not ignored if they don’t fit the anticipated result.
2.9.7 Activity-based Management
Activity-based management (ABM) can be helpful to the beyond budgeting manager in four
ways. First, activity-based budgeting (ABB) can help managers to estimate the need for
capacity. By using current forecasts and prevailing trends, managers can quickly work
backwards from the level of customer demand to the resources that are required to sustain it.
ABB is not easy to implement but, if done correctly, it can help managers identify excess
capacity and thus reduce costs or, perhaps more realistically in the short-term, deploy that
capacity elsewhere in the business. Secondly ABM is useful for computing the full costs of
transactions, especially in those subjects to significant customisation. Many firms adopt these
solutions without having information systems in place to calculate whether these solutions are
really profitable. The real profit or loss can be revealed only when the full costs of serving or
supporting a customised transaction are taken into account. Thirdly, ABM can help managers
avoid those costs that should not be incurred at all. This applies not only to process
improvements but also to whether the whole process is worth doing. And finally, ABM supports
a horizontal process view of the organisation and thus supports the concepts of the organisation
as a web of supplier-customer relationships.
2.9.8 Rolling Forecasts
Rolling forecast is another tool that can work well with beyond budgeting. Rolling forecasts in
the traditional company are aimed at helping managers to focus on meeting the current year’ s
budget. They have no strategic purpose. They are, more often than not, no more than a
recompilation of the budget and lead to managers taking appropriate actions that enable them to
39
meet their agreed targets. In beyond budgeting companies, rolling forecasts have a different
purpose. They principally help managers to break away from the annual budgeting cycle and
take decisions based on a moving picture of information concerning the likely outcome of
existing trends. This move supports the devolved management process by placing front line
people more in control of their actions than would otherwise be the case.
The important issue is that forecasts are separated from the line management system. Borealis
achieves this by looking at forecasts from the perspective of legal entities within the group
rather that from the perspective of legal entities within the group rather than from the
perspective of business divisions. While in the line management runs through the division, the
legal entity view does not have anyone at its head with line responsibility. So local managers
use forecasts for local purposes and senior executives use forecasts for cash flow and tax
planning. The two purposes are different and do not overlap.
There is, however, one major caveat with rolling forecasts. They will be of little or no value if
senior managers see them as a tool for questioning and reassessing performance targets. Nor
must they be used to demand changes or improvements. If senior executives use forecasts to
micro-manage or demand immediate action, then trust and confidence will rapidly evaporate.
The only time such questions can be fairly asked is if forecasts show a significant change and
such a change has not been explained beforehand. Managers should be responsible for dealing
with problems and reflecting any corrective actions they have taken in their revised forecasts.
2.9.9 Information Systems
Most information systems mirror the organisational structure and, for most firms, this means
improving the plumbing and wiring of the hierarchy. Early enterprise-wide systems offered the
prospect of cross-functional integration by enabling firms to ‘set switches’ to turn integration
capabilities on-and-off. But its very rigidity forced firms to make compromises and fit into the
system template rather than design their own requirements into the system. And, even recent
systems on the market have showed no signs of breaking this trend. Talk of «information
cockpits», for example, suggests a highly centralised view of information management. And the
power of «drill down» facilities shows no understanding of what devolution is about.
Information systems designers often assume that it is the speed and power of data analysis that
user value. Hence the notion of the information cockpit with a few senior executives pulling
levers and pressing keys to make decisions that are, more often that not, far better done by front
line managers. The problem is that such systems appear to offer better controls, but this is a
fallacy [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct. 2001].
40
Bill Gates’ idea of a «digital nervous system» comes pretty close to the suggested right
approach. It is much more in tune with the idea of an organisation as a web of relationships
rather than a machine with multiple parts. He starts by explaining that the biological nervous
system triggers your reflexes so that you can react quickly to danger or need. It gives you the
information you need as you ponder issues and make choices. You are alert to the most
important things, and your nervous system blocks out information that isn’t important. He then
goes on to explain why companies need to have the same kind of nervous system: the ability to
run smoothly and efficiently; to respond quickly to emergencies and opportunities; to quickly
get valuable information to the people in the company that need it; the ability to make decisions
quickly and interact with customers… A digital nervous system consists of the digital processes
that enable a company to perceive and react to its environment, to sense competitor challenges
and customer needs and to organise timely responses. A digital nervous system requires a
combination of hardware and software. It’ s distinguished from a mere network of computers by
the accuracy, immediacy and richness of the information it brings to knowledge workers and the
insight and collaboration made possible by the information.
According to Hope and Fraser, the digital nervous system idea may sounds like unstructured,
unbounded information roaming around the organisation, but the other way around, the whole
idea of «controlling and restricting» information is a bit ridiculous. As James Gleick put it,
information is the solar energy of organisation [WHEATLEY, 1999]. If a company really wants
to foster insight and collaboration, then it must open up the information system (IS) to all those
than can gain from it. The notion that only people at the centre can use it wisely is just plain
wrong headed [HOPE & FRASER, Beyond Budgeting Questions and Answers, Oct. 2001].
People need to see what is happening right now. They need to be constantly exposed to
«breaking news» in media terminology. The IS should be designed to scan and probe for
patterns of change in the marketplace. All points of contact with customers and the market in
general should be tuned to feeding back data into the IS. This enables use of data warehousing
capabilities and tools to search for patterns of change that are not readily observable in any other
way. The IS should also support anticipatory management by bridging the time elapsed between
lagging and leading indicators. For example, customer acquisitions and defections can be
monitored as they happen (at least in industries with regular ordering patterns); strategic
initiatives can be monitored as they unfold; and trends come alive as they appear instantly on
the screen. Data warehouses are now commonly used to see patterns within large volumes of
information that cannot be readily observed with the human eye.
Popular aphorisms such as «what you measure is what you get» need to be reconsidered. Most
of the «cultural» factors that create winning organisations cannot be measured. Indeed, financial
41
accounting numbers are given too much visibility. They are not the «hard stuff» that macho
managers believe. The rule of thumb should be that the fewer the measures, the less opportunity
there is for misinterpretation and dysfunctional behaviour. When used to evaluate outcomes
they have many imperfections. Opening up the data flows to many more people and many new
interpretations is the way to enrich understanding.
2.9.10 Warnings
Beyond Budgeting doesn’t start, but do end, with scrapping the budget. Even if the budget holds
back the company, it gathers the key people around a table to discuss about the future The
budget is also the main tool for controlling and financing and therefore it can’ t be replaced in
one day, one month or even one year. It involves deep restructuring of the most basic policies of
the company. Those policies are typically the ones inherited from the ‘industrial age’ that hold
back today’ s attempts to succeed in the networked organisational structure beyond budgeting
might take typically three to four years during which most of the basic policies of the company
will have to be changed. During those three to four years, beyond budgeting requires full
commitment from top management.
Figure 7 - Fast implementation of beyond budgeting [Dilbert.com]
According to Fraser and De Waal, the bigger the company that engages, the bigger the return
but also the longer time required. Still according to Fraser and De Waal, there is no particular
limitation concerning the Industry, the size of the location of the company that wants to engage
in beyond budgeting [FRASER & DE WAAL, Dec. 2001]. Therefore the principles and theory
of gathered in the PART I - The Theory of Beyond Budgeting can be applied to KONE OYj.
42
3 PART II – THEORY INTO PRACTICE – THE CASE OF
KONE OYJ
If the order of a country depends of the judgements of the family, it will attain supremacy; if it
depends on the judgements of the officials, it becomes only strong; if it depends on the
judgements of the prince, it becomes weak
[Shang Yang, 350 BC]
Note from the author:
PART II aims at establishing a preliminary framework for discussing the beyond budgeting
approach further. Budgeting is reserved to senior managers and there are 5 hierarchical levels
between the CEO and me. That has made things difficult. Therefore I want to apologise in
advance for the lack of depth of this study, especially in the field of budgets linked to rewards.
In this work KONE OYj will only be described as briefly as possible. If the reader is interested
in the products or services or additional information, he can visit the company’s web pages at
the following http address: www.kone.com.
Because the history is important to understand the present and is the only basis to forecast the
future, the summary of KONE Company history will be reported after the company
presentation. The organisational structure of KONE will follow with the process of the actual
budgeting exercise. Then KONE will be benchmarked with the other beyond budgeting
companies at the time they got involved in the BBRT. At last recommendations and comments
concerning the path to follow to implement beyond budgeting will be reported.
3.1 COMPANY PRESENTATION
KONE is one of the leading companies in the global elevator and escalator business. The
company is headquartered in Espoo. KONE develops, manufactures, installs, modernises and
43
services elevators, escalators and autowalks. The company also seeks growth from servicing
automatic building doors.
KONE Corporation was founded in Finland in 1910. Class B KONE shares have been quoted
on the Helsinki Exchanges since 1967. An international expansion strategy based on business
acquisitions, adopted in the 1960s, fuelled KONE's development into a worldwide organisation.
KONE hires more than 23,000 employees and operations in some 800 locations in about 40
countries. KONE supplies more than 20,000 new elevators and escalators annually and services
almost 500,000 elevators and escalators as well as 140,000 automatic building doors.
KONE is a service company: maintenance and modernisation business accounts for more than
half of our net sales (58% on the 2001 Annual report). For the 2001 Exercise Europe accounted
for 57% of the total sales, then came North America with 31% and Asia Pacific with 10%, then
other countries accounted for 2%.
KONE’s mission is to develop a sustainable urban living by moving people in a safe, reliable
and environmentally responsible way.
Figure 8 - KONE global coverage [company presentation, 2002]
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3.1.1 History
KONE was founded in 1910. The relatively small market in Finland saturated soon. The view
that internationalisation was paramount to the growth of the company gained ground in the
1960s and was realised in the form of acquisitions. Securing the required channels to
internationally launch their Finnish products led to a strong expansion abroad.
In the latter part of the 1960s, KONE's internationalisation gained momentum. The company
made bold moves in the acquisitions front and became known as Finland's first multinational
company. The early policy was to gain a majority in international elevator companies, but let
local management handle the operational side of the business based on its knowledge of local
circumstances. The corporate world during the internationalisation wave of the 1960s was not
what it had become when integration moved on in the 1990s. External strengths have been
acquired through alliances and corporate acquisitions.
Not only external growth has contributed to KONE's evolution into one of the top names on the
approximately $25 billion world elevator market. Organic growth was driven by KONE’ s
industrial heritage: The conviction that in-house engineering and manufacturing capabilities and
technological expertise are competitive has always been strong.
Stable ownership 'four generations of the same family at the helm over a period of 90 years'
created a safe and fruitful environment for development. An important catalyst was the majority
owner's will to raise the company to the forefront of the international elevator business.
In 1996, KONE became the first elevator manufacturer to introduce a machine-room-less
elevator. The KONE MonoSpace elevator concept (based on EcoDisc technology) has become
the new standard for the industry, quickly replacing traditional types of elevators and winning
prestigious awards worldwide.
3.1.2 KONE Organisation
Figure 9 - KONE organisational structure [company personnel presentation, 2002] reports the
main organs of KONE’ s organisation. Markets are divided into five areas: North America,
North Europe, Central Europe, Southern Europe and Asia Pacific. Products and services are
organised into three divisions are: the new elevator and escalator business (42% of sales), the
service and modernisation business (58%) and the building door business (new division, values
not available).
45
Figure 9 - KONE organisational structure [company personnel presentation, 2002]
In the beginning of the nineties, KONE still has factories producing elevators in many countries
in Europe (resulting of the many acquisitions). In the late 1990s, KONE concentrated its
production as in Figure 10 - KONE Manufacturing Facilities [Company presentation, 2002].
Elevators are produced in Finland (BU2 for engineered-to-order elevators), China, the USA and
Italy (standard elevators). Escalators are manufactured in Germany, the UK, China and the
USA. A unit in Bristol (UK) manufactures building doors and one unit in Hämeenlinna
manufactures the EcoDisc engines used to power the elevators. Nowadays, each front line (i.e.
KONE France, KONE UK, KONE China, etc.) is basically supplied by the production facility
that is closer to them and manufactures the right product.
46
Figure 10 - KONE Manufacturing Facilities [Company presentation, 2002]
3.2 KONE’S ACTUAL SITUATION
3.2.1 The Capla – the forecasts and strategic planning, input for the budget
The Capla (standing for capacity planning) is a gathering of sales figures for the main products
in the main markets. The Capla is an input for the budgeting process and therefore it has both a
strategic function and a budgeting function.
The Capla is run in September. There are three other rounds during the year to fine-tune the
existing figures, the three other rounds are called ‘rush’. There are therefore a total of four Capla
rounds per year, a major one in September and three ‘rush’ ones typically in March, June and
December. The whole process to deliver the final figures takes typically one month, 4 times per
year.
3.2.1.1 Step 0 – The Global Supply Line prepares the Spreadsheets Files
KONE Corporation Offices in Brussels have been for years in charge of gathering the figures
but the task was transferred in March 2002 to the Global Supply Line Organisation. The
Business Unit 2 (BU2 – Hyvinkää elevator supply unit) was in charge to prepare the files in
Spreadsheet format.
47
3.2.1.2 Step 1 – The Front Line Executives fill the Tables
A front-line specific spreadsheet is sent to the 25 major front-line organisations (France, Italy,
Spain, the UK, the USA, Germany, the Netherlands, Finland, China, etc.) that account for most
of the total sales, the remaining percentages of the sales are dropped. The spreadsheet (see
Figure 11 - The Capla Spreadsheet, 300 out of the 10,000 Cells) typically includes information
concerning how many elevators and escalators (per elevator and escalator types) the front-line is
likely to order and install per month. The time window is about 18 months
Figure 11 - The Capla Spreadsheet, 300 out of the 10,000 Cells
Front lines are not asked to fill all the cells, hopefully, because filling the file completely means
filling more than 10,000 cells! The delegates in the front lines are typically the New Elevator
and Escalator Business Manager, with the Sales Manager and the Installation Manager with the
service business manager, its sales manager and the managing director. When the front-line
specific spreadsheet is filled, it is sent both to BU2 (who aggregates all the values) and to each
Business Unit that supplies that specific Front-line (i.e. KONE UK will send the file to
Hyvinkää and Milan Business Units for elevators, Germany and UK for escalators; while
48
KONE US will send the sheets to McKinney -TX- for elevators and Moline -IL- for escalators).
About two weeks are needed for step 1.
3.2.1.3 Step 2 – The Global Supply Line aggregates the Figures
At this point, each business unit has received the number of elevators and/or escalators per
front-line, that they will aggregate to determine their production forecasts. Hyvinkää BU2 has
received every file. The figures received are pondered (even based on experience, it is bad
practice) and BU2 aggregates the figures at the Global Supply Line level. All the business units
execute steps 3 and 4.
3.2.1.4 Step 3 – The Forecasts are exploded into components
Then the figures received at an elevator and escalator level are exploded into components using
probabilities based on order book trends and components’ life cycles. This procedure requires a
lot of time but is not redone for each round, it is prepared in advance so that it doesn’t add-up
time to the length of the project.
3.2.1.5 Step 4 – The Components are priced
After determining the quantity of components and types, the price information is added to
generate the budgets related to each component facility (i.e. for BU2: the car and door factory,
the electrification and signalisation factory, the MX engine factory, and the material
management team who handles most of the outsourced material).
3.2.1.6 Step 5 – The budget
When the main Capla is ready, senior managers gather to agree on the budget for the following
year.
3.2.2 KONE Capla compared with Beyond Budgeting Rolling Forecasts
The KONE Capla isn’t too far from the beyond budgeting rolling forecasts. The time horizon is
similar, more than a year. KONE’s Capla is run 4 times per year (one major and 3 updates), the
same applied in the case of Borealis. The figures inserted by the front lines are considered as
‘best-shots’ and there is little actual vs. forecast questioning as required by the beyond
budgeting idea. The Capla is seen as a strategic tool to unveil uncertainties and increase the
visibility of the manufacturing units (BU), which is also in line with the theory. The Capla is
49
used both by the factory managers to adjust their capacity and by the financial managers to plan
the cash flows.
Even if KONE’s Capla isn’t bad, it has two major defects: The first one is that the process to
collect the figures is long (spreadsheets aren’t that easy to aggregate without mistakes,
especially 25 front-lines multiplied by 10,000 cells!), the Capla is expensive to run because it is
filled by the most expensive managers, and then why expensive managers would spend much
time filling 10,000 cells with their ‘best shots’ (do ‘best shots’ become ‘fastest shot’?). The
second defect is that the figures are ‘corrected’ before they are aggregated. This means that
depending on which front line is sending the forecasts (and its reputation for selling constantly
more – or less – that the budget) the figures are pondered up or down, meaning that it is not the
true forecast from the front lines that are then split into components and priced. One might ask
what is the point of asking the front lines their so many figures if a ‘remote expert’ carefully
changes them afterwards.
3.2.3 The Case for Change
Before attempting to start on the Vision phase, preparing a case for change is needed. Getting
approval to this will ensure that sufficient resources can be deployed to phase 1 for it to be
successful. Creating and agreeing a vision for the new management model includes that aims
and principles on which the model will be designed, and the first level of details behind the 12
principles. It then needs to come together into a document and be discussed and approved by top
management, and the board, and be widely sold to ‘key influencers’ inside the organisation. It
will also include the plans and resources needed to make it happen. If the CEO or CFO doesn’t
sign up to the vision, then think long and hard before proceeding. Beyond budgeting cannot be
implemented by stealth. It needs reinforcement from the top [HOPE & FRASER, Beyond
Budgeting Questions and Answers, Oct 2001].
The Case for Change is the resulting report of the questionnaire 1 [BBRT benchmarking
project] that can be filled on line on the following site: http:\\project.bbrt.org. The logic of the
BBRT benchmarking project (see also Figure 12 - Project Architecture Chart) is to link:
1. The changing environment
2. The factors required to succeed in that environment
3. The devolutionary framework required to implement those success factors
4. The management processes needed to execute them
5. The barriers that need to be eradicated, and the tools that are needed to support a successful
transition
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6. The resultant competitive performance
Figure 12 - Project Architecture Chart
The BBRT benchmarking resulted in KONE’s overall position on the Devolution Index equal to
64%, while KONE scored 46% on the Adaptive Process Index. The table of the results of the
basis 6 issues is reported below (but the complete results are available in Appendix 1: The Case
for Change).
Table 3: The 6 Keys Issues and KONE's performance
Key Issues Score Today
(from 0 to 7)
Business Environment – How unpredictable is your business
environment and to what extend are you exposed to external pressures?
4.2
Success Factors – To what extend have you identified the right factors
and taken effective steps to cope with these pressures
3.0
Devolutionary framework – To what extend have you engaged all your
people in supporting your competitive success?
4.5
Management processes – To what extend are your management
processes supporting your competitive success?
3.2
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Barriers to success – to what extend are your management practices a
barrier to meeting your success factors
3.8
Competitive performance – How does your performance rate against
your competitors in each of your success factors?
5.0
It is interesting to note that the competitive performance factor is 5 out of 7 (see Table 3: The 6
Keys Issues and KONE's performance), well above the average of the other factors (3.74). This
might be explained by the fact that KONE has advance on its competitors in its industry, even if
compared to the other industries, the results are average.
3.3 IMPLEMENTATION
The implementation paragraph 3.8.2 Implementation – Phased Approach recommended an
implementation in 3 phases. The first phase is focusing on the vision, the second on the design
and the implementation of the systems, and the third one on the progressive devolution.
3.3.1 Phase 1 – The Vision of the New Management Model
The future of companies in the information age is the network organisation because it
emphasises speed, innovation, customer satisfaction, adaptability and knowledge creation. But
before beginning to think about deploying a network strategy, managers must realise that not
every company is cut out for the conductor’s role (the central position and ‘owner’ of the
network). According to a study from McKinsey, the future of the network company, each
company that has built a successful network began with a strong and close relationship with the
ultimate consumer of the network’ s products. Unless a business has already created demand
among end users and developed insight into their needs from having served them, it isn’t likely
to succeed in persuading other businesses to clamber onto its platform. A would-be network
conductor will then of course have to promise them a continuous flow of market intelligence
and new strategic opportunities – not to mention lots of paying customers and a reasonable
allocation of financial rewards [HÄCKI & LIGHTON, 2001]. Companies that are equipped to
serve as conductors will evaluate candidates for network membership on the basis of criteria
such as size and maturity as well as their cultural and performance traits. The functioning
networks McKinsey studied typically included uniform standards governing the exchange of
information, rigorous performance standards maintained mostly through customer evaluations
and partner incentives built by the network with all partners, an on-line presence for all key
52
business processes, and the development and dynamic testing of new opportunities with
network partners.
3.3.1.1 The New Structure
Playing the conductor’s role is KONE’s future. KONE’s Global Supply Line will be at the
centre of a network of suppliers and front lines. The Global Supply Line order handling
becomes virtual, orders pass by instead of going through administrative steps. The front lines
won’ t be centralised in countries at it is nowadays but split in regions. The regional offices will
be composed of, for instance, 20 people, out of which a region manager, two salesman, two
supervisors, an administrative and 14 field employees. The knowledge of the local conditions
specific to each construction site will be concentrated in few hands, the ones that are best to
satisfy the customer.
The regional offices will be supported by a country office for medium-size projects and national
customers and, one level higher, by the major project unit for the large projects (already
existing). Today’ s environment is similar but too often, the offices at the country level
bottleneck the information flow with administrative procedures.
The country offices will be also composed of the minimum of people: a managing director, a
sales director, a marketing director, an installation director, a human resource director and a
pool consisting of the best specialised supervisors and salesman available to be sent anywhere
in the country, mainly for special projects, acting like account managers. The role of the
directors will be to train, consult, inform and enable the possibilities at the regional levels, not to
control the activities.
The region manager will also be the one to have the keys (at his regional level) to decide which
company can join the network as subcontractor (supplier of sales consulting, sales agent,
installation service provider, etc.)
The building door business, the elevator and escalator business and the service businesses are in
the responsibilities of the same salesmen and supervisors at the regional level, because they are
the ones who have met the customer and visited the building. There shouldn’t be an elevator
salesman, an escalator salesman, a maintenance salesman and so forth. The credo should be:
«One customer, two guys: a salesman responsible of the contracts and a supervisor responsible
of the operations».
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3.3.2 Phase 2 – Design and Implementing Systems – The 10 Organisational and
Behavioural Changes
Changes are needed at an organisational and behavioural point of view. Ten policy changes
have been defined as critical by the beyond budgeting round table consultants [HOPE and
FRASER, Financial Management, Feb 2001]. The 10 changes are reported separately, all in a
table format in order to enable the direct visual comparison between ‘industrial age’
management principles with those of the ‘information age’.
3.3.2.1 Performance Responsibility – make managers responsible for competitive
results, not for meeting the budget
It is easy for managers to agree to a number knowing from experience that they can meet it, and
even if they can’t, they will have enough plausible excuses to maintain their jobs. Moreover,
how does anyone know if the numbers are too high or too low? Negotiated financial targets are
notorious for leading to incremental thinking and safety-first strategies. If you really want
people to do their best and stretch their performance, then a different approach is needed. Most
organisations that have gone down this path use relative measures. This means that everyone is
always trying to best the competition and climb their way to the top of the performance league
table. Business-to-business, plant-to-plant, branch-to-branch, there are many ways to compare
performance both inside and outside the organisation. In some cases, where there is a lot of
catching-up to be done, business leaders will set themselves benchmarks as ‘most desired’
targets. There are fine provided that they are not seen as commitments. Getting most of the way
is usually sufficient to make significant improvements.
Table 4 Performance Responsibility
Implement approved plans Make autonomous decisions
Senior management roles – Seniormanagers act like commanders andcontrollers, they are the decision-makers andthey control local actions.
Senior management roles – Seniormanagers are coaches and co-ordinators, theyact as coaches and mentors and as cross-border integrators.
Local management roles – Doers. Localmanagers are implementers of the plan.
Local management roles – Thinkers anddoers. Local managers are planners andimplementers of the plan.
Management competencies – Job or taskoriented. Managers are trained to performtheir jobs.
Management competencies – Decision-makers. Managers are trained to think and acton their feet, making decisions in response tochanging markets.
Information – Slow, restricted and financial. Information – Fast. Open and strategic.
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Information is geared to central control. Localmanagers only see what they ‘need to know’.
Information is geared to local control andlearning but piped to all parts of organisation atthe same time.
Access to resources – Through budgetnegotiation. Resources are agreed throughannual budget process for a given set ofassumptions. Changes require approval.
Access to resources – When required.Managers are free to ‘buy in’ resources asneeded through internal or external marketprovided they meet their goals (e.g.cost/income ratio)
Senior managers act like coaches, co-ordinators, consultants and cross-border integrators. Local
managers are the thinkers and the doers, they plan and implement their decisions. They are
trained to think and act on their feet, making fast decisions in response to changing markets.
The information is transferred fast, openly and is basically strategic, the aim is to create
learning. Managers have access to internal and external resources freely, provided that that they
meet their goals (i.e. cost/income ratio).
KONE evolves towards a devolved market-like network, where information and ideas travels
fast. The Global Supply Line aims at becoming transparent and represents the knot of the
network that connects suppliers and the regions.
3.3.2.2 Governance, Leadership and Devolution – give people the freedom and ability
to act, don’ t control and constraints them
Devolution, or empowerment, has got a bad name because many firms «empower» people
without giving them both the freedom and capability to make decisions. The trouble is that the
budgets and control systems are never far away. It is like telling people they can take decisions
but always being on their backs to ensure they are making the right ones. In the beyond
budgeting model, the micro-controls disappear. People know the boundaries and values within
which then can act and they gradually build up the confidence to take decisions. Firms that have
don this successfully find that their response to threats and opportunities is much faster. People
need training and access to information, but also the right attitudes.
According to Hope and Fraser, two main problems can be encountered when a company tries to
change its governance mechanisms [HOPE & FRASER, Beyond Budgeting Questions and
Answers, Oct 2001]. One is stopping senior managers interfering with lower level decisions.
And the other is getting the message across to people that empowerment isn’t a free ride. On the
first point, leaders need to really believe in devolution, and be incredibly disciplined not to
interfere even when they can see mistakes being made. Hammering out an agreed set of
principles and values is also a crucial step. This establishes the framework that everyone
operates within and ensures that they can take decisions with confidence. On the second point,
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perhaps the most difficult problem is how different people interpret their new freedom. For
example, some people think that empowerment means that leaders have no right to make
decisions that affect their work. In other words, they see empowerment as a charter for free
riders. Firms have to recognise that despite trying hard to bring everyone up to par in terms of
strategy and decision-making, there will always be people who can’t make it. According to
Hope and Fraser, either they don’ t have the right attitudes or other traits essential to working in
this new environment. Team leaders still have to make hard decisions and this sometimes means
weeding out their weakest members. These people can either be transferred to other roles where
their strengths can be better utilised, or they will have to leave the organisation altogether.
People must have trust and confidence in each other. If this doesn’t exist because of a few
people, they must be dealt with.
Table 5 Governance, Leadership and Devolution
Within Budgetary controls Within strategic boundaries
Compliance – With rules and procedures.Local managers must comply with operatingrules and procedures
Compliance – With shared values. Localmanagers operate within agreed values andstrategic boundaries.
Strategy formation – At the top. Strategiesare developed periodically and handed downlike tablets of stone. Plans are approved beforeimplementation.
Strategy formation – Locally. Strategies arethe responsibility of the local team and may bedeveloped continuously as opportunities ariseor conditions change.
Scope of action – Limited. Local managersare accountable for implementing approvedplans and meeting short-term financial targets(often under contract)
Scope of action – Extensive. Local managersare accountable for meeting high-levelmedium-term goals but are free to decide forthemselves how best to achieve them.
Follow-up – Prescribed reporting.Managers must report any variations to planand gain approval for changes. Bad news isoften suppressed as it reflects adversely onmanager performance.
Follow-up – By exception. Managers aretrusted and operate under a «no blame»culture. They take risks (and make mistakes).Bad news is immediately shared with seniorswho may give coaching and support.
In KONE employees are trusted (and trustworthy) and have the freedom to act within agreed
values and strategic boundaries, not anymore complying with rules and procedures. Once the
network is in place, strategies are formed locally and continuous developed as opportunities
arise and conditions change. Local managers are accountable for meeting high-level medium-
term goals but are free to decide for themselves how best to achieve them. Managers take risks
and are allowed to make mistakes but bad news is immediately shared with seniors who may
give support or training.
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The country managing directors and the corporate offices give the regional managers the
freedom and ability to act, they don’t control and constraints them. Similarly in the supply line,
the emphasis goes from the business units to the suppliers.
3.3.2.3 Structure and Organisation – From centralised functional hierarchy towards
devolved market-like network
Centralised Functional Hierarchy Devolved market-like network
Predominant form – Hierarchy. Designedfrom inside out. Few units. Facing thehierarchy. Boundaries are functional andgeared to financial targets
Predominant form – Network. Designed fromoutside in. Many Units. Market (or internalcustomer) facing. Boundaries are strategic andgeared to delivering value to customers.
Delegation – Limited. Centralised decision-making. Authority only delegated to lowerlevels with strict rules of control. Manymanagement layers.
Delegation – Extensive. Authority is devolvedto managers who have autonomy to «run theirown business». Few management layers.Hierarchy used for cross border decisions.
Unit size – Large. Larger units lead to greaterscale and lower unit costs.
Unit size – Small. Smaller units lead togreater flexibility, simplicity and total lowercosts
Performance focus – Product. Profit and costcentres define production-orientedperformance responsibilities.
Performance focus – Customer. Valuecreation centres define customer-orientedperformance responsibilities
Control – Centralised. Variance analysisaims to keep Corporate Centre and senior likemanagers in control
Control – Distributed. Rolling forecasts andstrategic indicators aim to facilitate learning atlocal level
The organisation is devolved in a market-like network. There are many units of small size
oriented to generate value for their own customers, by increased flexibility and simplicity. The
customer is at the centre of the performance focus, the control is distributed.
The concept of Business units disappears, the orders are placed to the Global Supply Line and
go directly to the suppliers, with a step in engineering if necessary. The suppliers now are
responsible for punctuality, quality, flexibility etc. directly towards the regional offices.
The regional managers are responsible for competitive sales, installation results, and customer
value. It is one level below compared to the situation today and it aims at improving the bottom
line.
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3.3.2.4 Co-ordination – co-ordinate cross-company interactions through process
design and fast information systems, not detailed actions through budgets
Most organisations declare that their aim is to be «customer focused» or «market responsive».
But implementing a market-responsive strategy and then trying to co-ordinate plans centrally
makes no sense at all. Business units need to co-ordinate their plans dynamically, as the market
dictates. Units need to see themselves (and other teams) as suppliers of products or services to
both internal and external customer, as elements in a coherent value delivery system. In other
words, instead of being directed to supply a particular product or service to another unit,
business units are tied together with ad-hoc agreements that are made according to the
prevailing demand in the (internal or external) market. Of course some agreements need to
cover, say, a quarterly or even an annual period, because central service facilities need time to
increase or decrease their capacity. The fundamental change is from central planning to dynamic
supplier-customer relationships. This means that teams are accountable for satisfying customer
requirements. It is a responsibility model based on the outcomes.
Table 6 Co-ordination
Through plans and budgets Through market-like forces
Co-ordination – Recognised techniques.Normal Channels of communication arerestricted to within hierarchical groups, butprocesses like VBM, BSC, ABM and budgetingare used to make the hierarchy work better.They enforce alignment and co-ordinationacross the business and are used for cause-and-effect management.
Co-ordination – Market-like forces.Channels of communication are operandbased on the network of work units. Co-ordination happens naturally in a market-likenetwork through alliances between internalsuppliers and customers (not through centralplanning) especially when units are value (nocost) centres.
Knowledge sharing – No inclination.Performance measures and incentives aredepartmental or individual and tend toencourage parochial attitudes. Improvementinitiatives are based on departments.
Knowledge sharing – Mutual benefit.Sharing of knowledge and best practices isencouraged through values, performancevisibility and group-wide rewards. Crossbusiness initiatives are based on processesand projects.
External alliances – Uncoordinated.Alliances with suppliers, customers andpartners are often uncoordinated
External alliances – Co-ordinated. Allianceswith suppliers, customers and partners are co-ordinated (e.g. through e-business networks)
Channels of communication are open and based on the network of work units. Co-ordination
happens naturally in a market-like network between internal suppliers and customers. Sharing of
the knowledge and best practices is encouraged through values, performance visibility and
group-wide rewards.
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The senior staff co-ordinates, through process design and fast information systems, both cross-
country and cross-regional interactions.
3.3.2.5 Goal Setting – beat competitors, not budgets
Investors want to place their money in firms that will be at the top of their sector league table.
So gearing every business unit and team to beating the competition is the best way to achieve
this. People should always be striving to improve their position in the league table. That is what
stretches performance.
Table 7 Goal Setting
Negotiated and incremental Relative to competitors
Process – Internal. A lengthy exercise innegotiating and co-ordinating numbers.
Process – External. A brief process of settinggoals relative to external measures.
Value added – Low. Budgeting can takemonths and many man-years of time, butproduces little more than numbers.
Value added – High. Value-adding process asstrategy is understood and improved, andaction plans are created and aligned withgoals.
Goals – Incremental and fixed. Goals arethe result of negotiation about improvingcurrent financial numbers
Goals – Stretched and relative. Goals are«impossible dreams» that drive continuousplanning and improvement.
Link to value creation – Financial. ROCE isproxy for shareholder value
Link to value creation – Strategic. KPIsprovide clear link to increasing shareholderand customer value.
Frequency – Annual. Budgeting cycle basedon financial year.
Frequency –Continuous. Self-regulatingrelative measures used, making cycleirrelevant.
Degree of ownership – Weak. Top-downtargets and a numbers oriented process
Degree of ownership – Strong. Compellinglogic – If competitors and benchmarks can do,why can’t we?
Link to rewards – Connected with goalsetting. Goals are performance contractagreed in advance.
Link to rewards – Disconnected from goalsetting. Rewards based on actualperformance with benefit of hindsight.
The targets might be described briefly but are not binding because they are stretched and
relative. KPIs provide clear links to increasing shareholder and customer value; relative
measures are used making cycles irrelevant.
The suppliers enter in competition among each other and with external competitors on ratios
like punctuality, quality, and customer value. The regional offices compete internationally and
nationally with peers and with competitors on ratios as customer satisfaction, customer
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retention, profit/employee, average installation time, costs/income ratio, market share in the
area, etc.
Good financial results are supposed to be the result of the competitiveness of the business
model. Financial results are therefore not the aim, but the result.
3.3.2.6 Strategy Process – make the strategy process a continuous and inclusive
process, not a top-down annual event
Annual top-down Continuous and inclusive
Direction – Tightly defined. Top-downprocess with middle managers given thestrategy that should drive their budgets.
Direction – Within boundaries. A clearstatement of business purpose givesmanagers the freedom to act.
Communication – Restricted. Strategicthinking is restricted to authorised people.
Communication – Inclusive. Channels opento all those who can make a valid contributionto strategy.
Frequency – Annual. Planning and budgetingprocess typically take 6-12 months tocomplete.
Frequency – Continuous. Managers redefinelocal strategy and they anticipate or react tocompetitive actions and internal events.
Responsiveness – Fixed. Strategy is fixed forthe year ahead.
Responsiveness – Flexible. Strategy remainsflexible and responds to changing conditions.
Ambition – Incremental. Limited by incomeceiling and cost floor mentality.
Ambition – Stretch. Planning is driven byexternal benchmarks and competitiveperformance.
Improvement scope – Departmental.Focuses on cost cuts, not customer benefits
Improvement scope – Process. Concernedwith customer benefit and cross-functionalimprovement.
Learning – «not invented here» mentalityerects barriers to improvement.
Learning – Relentless search for bestpractices wherever they occur
Clear statements of business purpose give managers the freedom to act. The communication
channels are opened to anyone who can contribute to strategy. The frequency of the strategy is
continuous and the responses are flexible to respond with changing conditions. Planning is
driven by external benchmarks and competitive performance. The scope of improvements is the
process that aims at cross-functional improvements and customer benefits, rather than cutting
costs and customer benefits. Managers have to search relentlessly for best practices wherever
they occur.
The network is based on proximity to customer, devolution and learning. Because the command
chain is shorter, the strategy is more flexible and adaptive to the local, actual situation. The aim
is to maximise opportunities and minimise threats, not to meet budgets.
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Every force of the company should be involved in strategy but Henry Mintzberg, professor of
management at the McGill University argues that real strategies are rarely made in panelled
conference rooms, but are more likely to be cooked up informally and often in real time – in
hallway conversations, casual working groups, or quiet moments of reflection on long aeroplane
flights [MINTZBERG, 1987]
In «Tired of strategic planning?», a report published by McKinsey in May 2002, companies
should avoid combining strategy reviews with discussions of budgets and financial targets,
because when the two are considered together, the short-term financial issues dominates
[BEINHOCKER & KAPLAN, 2002].
3.3.2.7 Forecasting and Anticipatory Management – use anticipatory systems for
managing strategy, not for making short-term corrections
Used to keep on track Used to inform strategy
Purpose – Control. Another weapon forsenior management in controlling units
Purpose – Anticipation. Assist local andsenior managers to identify actions needed.
Performance management – Linked.Forecasts linked to budgeting process withimplications for measures and rewards.
Performance management – Disconnected.Forecasts are separate from performancetargets, measures and rewards, and areimpartial best estimates.
Time Horizon – Year-end. Forecasts usuallyprepared quarterly but only up to financialyear-end.
Time horizon – Rolling. Forecasts alwayslook one or more year (usually 5 quarters)ahead. Updated frequently.
Effort and involvement – Heavy. Based onfull recompilation of budget. Takes weeks ofeffort and significant management time.Involves all budget holders and finance people.
Effort and involvement – Light. Build abroad-brush picture of key financial numbersthat are quick to prepare (hours rather thanweeks), and only involve senior business unitor divisional managers and finance people.
Links to strategy – Weak. Forecasts financialindicators only. No KPIs.
Links to strategy – Strong. Forecasts KPIs(e.g. customer retention), as well as financialnumbers.
Support tools – Budgets. These areinvariably the basis of re-forecasts.
Support tools – Forecasting models. Thesemay be used to collate and presentinformation.
The purpose of forecasting is anticipation, not short-term corrections. The time horizon is
rolling, typically 5-6 quarters and updated frequently. The involvement required is light, it
should be quick and easy to prepare, and only involves high-level managers. The forecasts are
oriented to collect KPIs (i.e. customer retention) as well as financial numbers.
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The regional offices update frequently very few KPIs, the values represent their ‘best shots’ and
it doesn’t matter too much whether the values are smaller or higher in reality. The front lines are
not measured on actual vs. forecast ratios. The stress is on local market changes. The figures are
not manipulated at any step of the process.
Anybody has access to the forecasts; the financial department uses it to predict cash flows, the
factories use it to plan their load, and the corporate and country offices use it to gather
intelligence.
3.3.2.8 Resource Management – make resources available to operations when
required at a fair cost, don’t allocate them from the centre
Allocated annually Available when required
Approval criteria – all expenditure. Annualbudget submissions are on basis for approvalby the centre of all capital and revenueexpenditure.
Approval criteria – Discretionary only.Project plans are the basis for approval ofmajor capital and discretionary revenueexpenditure in a continuous process.
Resource allocation – Predetermined.Capacity levels are set when budgets areagreed and used as the basis for allocatingresources.
Resource allocation – Continuousmatching. Units are managed against goals(e.g. Costs/income ratio) and themselvesregulate resources levels in accordance withchanging demand.
Central services – Arbitrary allocation.Costs of central services and other resourcesare allocated indirectly. Internal customershave little say over prices and service levels.
Central services – Internal market. Centralservices and operational resources (e.g.people skills) are acquired through an internalor the external market. Units are changeddirectly and have a strong say.
Accounting focus – Departments. Costsmanaged through budget variances, andwhether they go up or down. Decision-makingis difficult as focus is department.
Accounting focus – Value chain. Costs aremanaged using moving averages and leaguetables. Decision-making is made easierthrough designing units as stages in the valuechain.
Resources are available to operations when required at a fair cost; little questions are to be asked
to performing managers. All the units regulate their resource levels according to the demand,
Central services and operational resources are acquired through an internal and external market.
Units are charged directly and have a strong say. Costs are managed using moving averages (i.e.
1 year or 2) and league tables, not through budget variances.
3.3.2.9 Measurement and Control – use a few key indicators to control the business,
not a mass of detailed reports
Compliance with plan Self-regulation
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Purpose – Senior managers. To check thatlocal managers are «on track» in implementingtheir plans, and complying with rules andprocedures.
Purpose – Local units. To use controls(dispersed across the network) to have a goodknowledge of what’s going on for self-regulation.
Measures – Financial and fixed. Capital andearning measures provide detail bydepartment. Adverse variances vs. budget arehighlighted for explanation.
Measures – Strategic and relatives. A rangeof KPIs is used as the basis for performancecomparisons with targets, competitors, peersand last year.
Analysis – Hierarchical. Budget reports bydepartment with expense category details.
Analysis – Customer profitability. Fast andopen information based on activity accounting.
Clarity – Numbers. Very detailed sets ofnumbers enable micro-management.
Clarity – Visual. Graphs and charts clearlyshow trends and moving averages.
Feedback and learning – Limited. Financialvariances don’ t explain root causes.
Feedback and learning – Extensive. KPIslinked action plans enable managers toexamine the root causes.
Early warning – Unlikely. Reports usuallycontain only lagging indicators.
Early warning – Likely. Reports give leadingand lagging indicators thus giving earlywarning.
The purpose is to generate intelligence about what is going on at the local level. A range of
KPIs is used as the basis for performance comparisons with targets, competitors and last year.
The feedback and learning can link KPIs to action plans to examine root causes. Reports are
visual (rather graphs then numbers) and give leading and lagging indicators only. Only a few
key indicators are needed to control the business. These key indicators should be the same than
the ones used in goal setting, typically profit/employee, customer satisfaction, customer
retention, punctuality, etc.
3.3.2.10 Motivation and Rewards – base rewards on a company and unit-level
competitive performance, not predetermined targets
The beyond budgeting view is that while «incentives» (or a «do this, get that» approach) don’t
work, the recognition of a team-based success is important. This can be done in a variety of
ways. One is a profit share based on a «winning margin». Another is a judgmental evaluation of
how well the team did in the context of competitive conditions. And another is to compare
teams with internal or external competitors or benchmarks. It is crucial, however, to recognise
that teams should be the focus of rewards. In modern organisations it is well nigh impossible to
relate extra revenue or profit to a marginal activity or piece of work. The scope of the ‘team’
should equate with the level of direct dependencies. Anything less than this is, to some degree
or other, likely to be divisive.
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Table 8 Motivations and Rewards
Individual, fixed incentives Group-wide, relative rewards
Linkage – Internal. Usually linked tobudget, or other internal measures (e.g. pastunit or company performance)
Linkage – External. Rewards based onrelative competitive performance (ROCE ortotal shareholder returns).
Focus –Individual. Based on budget holderand/or the business unit.
Focus – Teamwork. Profit sharing based orunit, company or group-wide performance.
Motivation – Money. Belief that financialincentives drive performance.
Motivation – Success. Beating thecompetition or one’ s peer is the motivationalforce.
Visibility – Low. Financial rewards mayhave evolved into a labyrinth of incentives
Visibility – High. League tables motivatethrough peer pressure and pride inachievement.
Related to future results – Unlikely.Rewards based on outcome measures.
Related to future results – Likely. Related toleading indicators (e.g. quality or customersatisfaction).
Basis – Contract. Incentives based ontargets negotiated in advance.
Basis – Hindsight. Rewards based on actualresults, knowing how things turned out.
Recipients – Few. Incentives are for seniorpeople (e.g. Stock Options)
Recipients – Everyone receives reward,helping to create a culture of teamwork.
Rewards are based on relative competitive performance (e.g. ROCE or total shareholder return).
They are earned by beating competitors, and the previous year at a company level (not unit
level), but the market changes and other peculiarities have to be considered. Since rewards are
calculated at the KONE level, the force that thrives motivation is not anymore a direct financial
award but direct success: managers want to ramp up the league table because it means pride and
high achievement; everybody can see also their names. Everyone receives a reward, not only the
senior staff, this helps to create a culture of teamwork bottom-up.
3.3.2.11 Systems Dynamic
The motivation, the monitoring, the resource management, the attitude to anticipatory
management, the strategy process, the goal setting, the co-ordination among divisions, the
structure and the organisation, the governance and leadership and the responsibilities; they all
effect (or affect) one another and the total picture represents the company as a whole entity. The
field of Systems Dynamic, pioneered in 1956 by Jay W. Forrester, provides an organising
framework for analysing policies and decisions interact in a total system (society, corporation,
etc.). «Every action happens as part of a structural loop in which each decision causes a result
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that influences future decisions», wrote Jay W. Forrester [FORRESTER, 1961]. When the
basics of the theory of Systems Dynamics is applied to a corporation it is easy to understand that
only the combination of effective organisation, behaviour and effective performance
management leads to success, (see Table 9 Management success as multiplication of variables
[HOPE & FRASER, Feb. 2001]. And, just like any mathematical equation with multiplying
variables, if any of the variables is zero, the net result will be zero. The failure to recognise that
it is ‘the combination that matters’ has wrecked many attempts at performance improvement
[HOPE & FRASER, Financial Management, Feb 2001].
Table 9 Management success as multiplication of variables [HOPE & FRASER, Feb.
2001]
Effective Organisation andboundaries Effective performance Competitive
success Clear values and boundaries Relative targets Fast responseResponsibility for results Adaptive strategies Best people
Freedom and capacity to act Anticipatory management Innovativestrategies
Fat networks and processes Internal market forresources Low costs
Co-ordination with an internalmarket Fast, distributed controls Loyal customers
Challenge and stretch
x
Relative team rewards
=
Satisfiedcustomers
3.3.3 Phase 3 – Progressive Devolution
Phase 3 (intensive at the beginning but it never ends) is progressive devolution, using the new
system to show which teams are performing well compared with their peers or external
competitors. This leads on to capacity building through training and if necessary switching
people. As Hope and Fraser acknowledged, not every manager can do it.
Some large companies will want to do a pilot and rollout. Others will want to just take out the
budget and hope that the training provided will be sufficient for all business units to cope with
the new approach. Each will follow these 3 Phases, but the rollout will be much quicker
(typically a year) because the new system already exists.
Beyond Budgeting is more a revolution rather than an evolution. Revolutions are always to be
planned carefully. Pilot testing could be appropriate, but beyond Budgeting generates above
average results in the medium- or long-term. Waiting for the pilot tests to give their true colours
might take too long and the company could be stacked, for a few years, in running both the
budgets and the league tables. When the aim was to simplify, there are two ‘organisational
65
models’ to run at the same time. I would recommend the targeted blitzkrieg method, starting
from Sweden, Holland and Italy, where SAP is already widely implemented. Then the others
will follow when they feel ready, but they should not wait for the results.
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4 CONCLUSIONS
Both Michael Porter and Gary Hamel have agreed that it is becoming harder and harder to
forge competitive advantage from operational excellence [PORTER, 2001] [HAMEL, 2001].
Rather like quality, being operationally excellent is becoming a prerequisite rather is generating
differentiation. In the information age, little doubt remains that innovation and customer
intimacy are the only two sustainable sources of competitive advantage. Both depend (much
more than operational excellence) on decentralisation and the right climate for attracting good
people. Many companies tried to decentralise adopting a network model organisation.
According to Jeremy Hope and Robin Fraser, very few of them have reached the candies
because they failed to notice the problem that lies in the traditional budget, especially when it is
linked to performance evaluation and rewards.
Jack Welsh was quoted talking about the budget: «the bane of corporate America. It never
should have existed… Making a budget is an exercise in minimisation. You’ re always getting
the lowest out of people, because everyone is negotiating to get the lowest number». There are
many reasons for companies to ‘scrap’ their budgets. The costs of budgeting is high and the
results are below expectations, budgeting is a relic of the industrial age, it reinforces command-
and-control management, the rhythm of the budget is not linked to the rhythm of the business,
the focus is often on financial outputs leading to cutting costs rather than creating value for the
customer, budgets encourages incremental thinking, and, above all, it fails to really challenge
managers.
There have been attempts (especially ZBB linked to BRP) to improve the budget but all failed.
In 1998 a group of companies, mainly European (including Handelsbanken, Borealis, Volvo
Cars, SKF), launched a joint-research: the BBRT (Beyond Budgeting Round Table), led by
Jeremy Hope and Robin Fraser. The aim was to identify companies that scrapped their budgets,
to generate best practices and case scenarios and to share the knowledge. The research showed
that all the companies that have abandoned budgeting have all outperformed their direct
competitors on every possible measure (both financial and non-financial), and that none of the
managers of the beyond budgeting companies interviewed for the research desired to come back
to an old budgeting model.
The 12 principles of the BBRT are: (1) to beat the competition; (2) to reward team-based
competitive success; (3) to make strategy a continuous and inclusive process; (4) to draw
resources when needed; (5) to co-ordinate cross-company interactions through «market-like»
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forces; (6) to provide fast, open information for multilevel control; (7) to create a performance
climate based on sustained competitive success; (8) to build the commitment of teams to a
common purpose, clear values and shared rewards; (9) to devolve strategy to front line teams
and provide the freedom and capability to act; (10) to champion frugality and challenge the
value-added contribution of all resources; (11) to organise around a network of teams that
dynamically connect their capabilities to serve the external customer and (12) to support
transparent and open information systems.
There are no basic limitations to the study concerning the country or culture nor the industry.
The following specific tools should be used with care: balanced scorecard, ABM and rolling
forecasts because they can have ‘negative’ effects. Implementing beyond budgeting typically
lasts a few years and requires the CEO and the CFO, at least, full commitment.
KONE is a good target for beyond budgeting. The company structure, inherited from the
industrial age, needs to be updated. KONE has grown through acquisitions and, historically,
units have enjoyed freedom. KONE’s front line senior managers are willing to take their
responsibilities and be accountable for their results.
The existing budgeting exercise starts with the capacity planning (called Capla), it has mostly a
strategic objective. The process requires typically one month that is lower than most companies.
However, according to the study, there is no good budgeting, and therefore it should be
replaced.
The ‘Case for Change’ (a questionnaire benchmarking companies willing to start beyond
budgeting) has highlighted KONE as average on its devolution and adaptive process index.
The first phase of the implementation is the vision of KONE as a network company, where
regional offices (staffed but not controlled by their country offices) would be ordering to the
Global Supply Line, and where the GSL would be the centre of the company but would also be
as transparent as water.
The second phase has described the ten organisational and behavioural changes needed to
implement beyond budgeting, all triggered by the creation of ‘league tables’ where each region
would compete for the highest rank. The league tables are composed of few indicators like
customer retention, cost/income ratio, market shares, installation time, etc. The challenge to
have their name on top will drive managers to continuously stretch to improve their position
better than any budget could do ever it. Managers are to be responsible for competitive results,
not for meeting the budget. People need the freedom and ability to act, they shouldn’t be
controlled or constrained. The structure should evolve towards a devolved market-like network.
Cross-company interactions are to be co-ordinated through process design and information
systems. The goal is to beat competition, not the budget. Rolling forecasts should be used for
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managing strategy, not for making short-term corrections. Resources should be available when
required, and at a fair cost, they should not be allocated based on the budget. A few key
indicators (i.e. customer retention, costs/sales, etc.) are enough to control the business. Rewards
shouldn’t be for limited to seniors and they are based on a company and unit-level competitive
performance.
The third phase of the implementation is about devolving power, it is never-ending.
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