What do Budgets and Sales Targets have in common with reality?

What do Budgets and Sales Targets have in common with reality? Not much!

How helpful are Budgets in making our organization innovative, agile, flexible, ready to face the ever changing dynamics of today’s world? Again, not much!

How realistic are the Sales Targets we are given each year and how easy are they to adapt to changing customer situations? Again, not much!

Setting Budgets and Sales Targets are the two levers we use to plan our upcoming year. Budgets to set how much money we are gong to spend and Sales Targets to predict how much money we are going to make.

What if we could eliminate budgets and sales targets while improving results, morale and customer satisfaction? Below is a case study of a bank that did just that. There is also a report on an Oil and Gas company who removed their budgeting process.

But first…

Budgets are the best way to cement the walls of the organization’s vertical functional silos. In the usual budget arm wrestle any thought of the organization’s mission goes out the window. It is everyone for themselves as they fight for their department’s allocation of the precious money allocation. The decision criteria are about headcount, program and product dollars and covering the depreciation bill from last year’s capital expenditure. Not about delivering outcomes.

The precursor of course is, at the end of last year we made sure we spent all, or a little bit over, our budget because that demonstrates how much we need our full budget for the new year.

The way the game is played is you ask for more than you need, because in the end the financial department’s hammer comes down and cuts everyone’s requests evenly to share the pain around. At least all of the vertical functional silos are as happy or unhappy as each other. Except for those who didn’t know how to play the game, but they have now learnt, ready for next year.

Next come the sale targets negotiation.

Here the math is simple. We have locked down how much we are going to spend through the budget process. We know what profit margin we need to make to satisfy our stakeholders. Therefore, the Sales Target is the Budget amount plus the Profit Margin and “bibbidi bobbidi boo” there’s how much money you are going to make. Someone just has to tell the customers.

The next round of games is where sales teams are arguing over who should get a higher share of the target. Terms like “sandbagging” are used to accuse other teams of hiding the real size of their market opportunity. Meanwhile the first team has “bottom draw-ed” some opportunities at the end of last year because they had already made their target.

In the end we have a Budget that doesn’t align to the organization’s mission with Sales Targets that don’t reflect the market reality.

And here is what happens.

Everyone starts spending their Budget as fast as they can because they know there will be an expense freeze and possible cut sometime during the year. They know this because reality hits, the Q1 sales forecasts will come in, like they do every year, and show the numbers are behind plan.

Again the math is simple, but now in the reverse order. The money we make, less the profit margin (which is fixed), tells us how much Budget we can now spend. The first round of expense freezes is announced.

This is when even large organizations start to act as if they are poor. Most of our Budget is locked up in fixed costs, only a small percentage are the variable costs that we can manage. Which by the way we have been spending as fast as we can. The usual suspects are to cut; hiring, travel, training and marketing. Why? Because we can. Again nothing to do with achieving our mission statement.

If we actually need to travel to save an important account we need to gain approval from two levels up, which slows down our ability to make sales, which means less money, which means... To see the morale problem this causes read the example in, “What’s the missing ingredient in Employee Engagement?”. Senior executives are now spending their time approving travel requests, urgent hires, marketing exceptions and not providing Vertical Leverage.

Meanwhile the end of the quarter is coming up fast and we still need to make our Sales Target. We of course know what to do, offer our customers discounts or other incentives to sign by the last day of the quarter. This educates our customers when to buy products. Wait for the end of quarter offer to come in, squeeze a little harder and make a deal.

The real feeding frenzy happens at the end of the year.

Not only are the sales team desperate to make the year’s Sales Target, but now the customers are desperate to spend all of their Budget. The decision criteria now is how fast can we raise a purchase order on one side, with a matching invoice on the other.

This perfect storm of spending and selling creates the hockey stick curve of an organization’s annual revenue. This is where we achieve a third or more of our annual revenue in the last month of the year.

But what if we were to ban budgets?

Well that is exactly what the Beyond Budget Research Institute recommends, bbrt.org. To prove out the results they provide the case study on Handelsbanken which is a full-service bank with a nationwide branch network in Sweden, the UK, Denmark, Finland, Norway, and the Netherlands. Handelsbanken was founded in 1871 and currently has just over 11,000 employees working in a total of 24 countries.

From the Beyond Budgets case study, the bank in the early 70’s “got rid of the budgets and liberated their employees”. Absolute targets, budgets and detailed forecasts no longer exist in the bank.”

Here are Handelsbanken results;

For 41 years in a row, the bank has lived up to its financial target which is to achieve a shareholder return that is higher than the average of its peers.
In the Nordic countries, the bank is number one in customer satisfaction ratings.
In Europe, Handelsbanken is the most cost effective bank, and it has the lowest CDS level and can, therefore, borrow money at the lowest cost on the funding market.
As opposed to its peers, Handelsbanken did not require any financial support during the recent financial crisis.
Over the latest five years the bank has delivered a total positive return to its shareholders of 45 %.
This is approx. three times higher than the second most successful bank in Europe. The average return of European banks in this period was negative with 68 %.

What Handelsbanken did aligns directly to the posts of Horizontal Flow, Vertical Leverage, creating Employee Ownership and fixing the Division of Decisions.

Here is what they did;

  • Restructured their organizations around the bank branches and not vertical functional silos.
  • They decided which functions need to remain centrally managed, like credit control, but all shared services had to justify their costs and service levels towards the branch.
  • This structure means they have much less management positions. Vertical silos breed middle management!
  • The branch is free to determine its own strategy and marketing plans, aligned within the overall bank’s strategy. The key to the strategy is to have greater customer satisfaction than its competitors, which returns more income per customer.
  • The branch manager decides which products to promote and which customers to serve because Handelsbanken believes the branch “has the best knowledge of the local customers and, consequently, marketing activities are decided locally.”
  • The branches are measured on continuous improvement in Cost Effectiveness to Income Ratio. Compare that to Cost Efficiency which measures how well you are doing against your budget, not generating outcomes like income.
  • The empowerment of the branch means that customer satisfaction is improved because, “Customers prefer to meet someone who knows them and who lives in their community; and they want to meet someone who can make decisions. This is why the bank provides the branches with such high degree of autonomy. Decisions should be taken as close as possible to the customer.”
  • ·Accountability is achieved through “very few key measurements that are deeply embedded in the organization”.  Everyone’s results are completely transparent, “One very interesting element of the bank’s internal reporting is its league table which makes up the first page of its monthly reports. In the table all branches are ranked based on their latest cost to income ratio. This creates an internal peer pressure as all aspire to have a nice standing in the table. This is one good example of creating pressure for performance in a simple way without spending time on setting budget targets and subsequently spending time explaining variances between actual and budget performance.

Another company that banned budgets was oil and gas company Statoil. Researchers from NHH Norwegian School of Economics and Business Administration completed an academic study which also showed excellent results. The report is interesting because it looks at the interaction between the people within the organization. One example of this what they call the “Shift in power balance”;

Along with changes in interaction and roles, the power balance has shifted somewhat. Top management has increased its power in terms of goal setting, and they can more easily control if behaviour is in line with strategic goals. However, division management and lower-level managers and employees have increased power in terms of the means for reaching strategic goals, hence there is increased freedom to act, alongside more severe (or at least noticeable) consequences if they fail to reach goals.”

That is, Top Management are exercising Vertical Leverage while the lower levels have more empowerment and accountability which creates personal ownership as described in “What’s the missing ingredient in employee engagement?”.

Therefore, if you are bracing yourself for the next round of Budget and Sales Target meetings maybe you should take a look at Beyond Budgeting.