The Idea in Brief
Budgeting—as most companies practice it—should be abolished. Radical? No, simply the next logical step following everything else you’ve already done to eradicate command-and-control hierarchies in your company—and enable it to nimbly adapt to changing market conditions. Abolishing budgets will free up even more of your employees’ creativity, self-motivation, and willingness to share information—essential ingredients for any firm’s agility.
By contrast, traditional budgeting often spawns earnings games and sometimes even outright fraud. After all, how likely are managers to report bad financial news if the result is a verbal beating—or report good news if their reward is more ambitious targets? And how tempting is it for sales teams struggling to meet impossible targets to pressure customers to order goods they have every intention of returning?
No longer able to ignore these realities, companies are breaking free of the budgeting vise. Here’s how they’re benefiting.
The Idea in Practice
Raising the Bar
Abandoning budgets doesn’t mean abandoning high expectations. On the contrary, you raise the bar even higher. Instead of demanding that managers and business units meet fixed targets, you ask them to do something much tougher: measure themselves against how well their competitors will have done during the same period.
Unable to discern whether they’ve succeeded until the period ends, they exert every ounce of energy and ingenuity to best the competition. And rather than taking short-term actions designed solely to save the credibility of forecasts, they focus on improving their long-term competitive position.
Key Measures
When you abandon budgets, you enable alternative measures—both financial, such as cost-to-income ratios, and nonfinancial, such as time to market—to move to the foreground.
In companies that have rejected detailed budgets, business units set long-term goals based on benchmarks such as return on capital. And they measure key performance indicators (KPIs) such as profits, cash flows, customer satisfaction, and quality. KPIs fulfill the self-regulatory functions of budgets. They tend to be financial at the top of the organization and operational in units closer to the front line.
Many companies that have rejected detailed budgets in favor of KPIs also use rolling forecasts. Created every few months, these forecasts typically cover five to eight quarters. They’re revised regularly, allowing companies to continuously adapt to shifting market conditions. Example:
The Swedish international bank Svenska Handelsbanken replaced budgeting with new organizational structures and performance metrics. To promote a sense of ownership and accountability, it created 600 profit centers—making them responsible for reducing costs, satisfying customer needs, and boosting income. Regions and branches compete with one another—spurred by prominently displayed standings. Branch managers determine resource allocation, staffing levels, and salaries. Rolling forecasts signal cash-flow improvements or declines and trigger the actions required to ensure adequate liquidity.
The payoff? Since the early 1970s, the company has outperformed its Scandinavian rivals on almost every measure, including return on equity, total shareholder return, and customer satisfaction. It’s also one of the world’s most cost-efficient banks—achieving a cost-to-income ratio of 45% And few of its loans go bad because frontline people have the authority to approve loans.
Budgeting, as most corporations practice it, should be abolished. That may sound like a radical proposition, but it would be merely the culmination of long-running efforts to transform organizations from centralized hierarchies into devolved networks that allow for nimble adjustments to market conditions. Most of the other building blocks are in place. Companies have invested huge sums in IT networks, process reengineering, and a range of management tools including EVA (Economic Value Added), balanced scorecards, and activity accounting. But they have been unable to establish a new order because the budget and the command and control culture that it supports remain predominant.