Bottom Line on Budgeting --Dickeson

"Beyond Budgeting" is a new book by Jeremy Hope and Robin Fraser recently published by Harvard Business School Press that's been provoking comment in the trade press. It's subtitled "How Managers Can Break Free from the Annual Performance Trap." It has a message for those few printing companies still spending time and effort at annual budgeting exercises.

Back in an earlier day, I can recall the annual budgeting routine at printing companies. Along about two months before the close of a fiscal year, the company accountant would send out a form asking each department to predict their annual revenues and expenditures for the coming year. Then, over the next couple of months, there'd be guessing and haggling over those inputs until, finally, the accountant would issue the BUDGET for the year ahead.

Why we did this and what useful purpose it would serve was hazy at best. I guess we did it because the accountants and the banking community said we should. Besides, everyone else was doing it and that, in itself, was reason enough. If you were a publicly held company, the stock investors wanted something they could base a PE (Price Earnings) ratio on, whether real or not, for valuing the stock.

If you weren't a publicly traded company, it was seen as a cause for joy or guilt as the year went along. There was always that column in the financial statements headed "Budget," followed by an "Over or Under Budget" column. Something had to appear in those columns.

Unfortunately this took a lot of time and effort, both for the accountants and for the staff that were entailed. And there was the "gaming" involved. Department heads always started with a fat estimate expense, knowing they'd be cut back in the budget process.

They still kept a bit of the fat for a "rainy day" when things ran a bit over. But wait until the year-end drew close and it would need to be spent on the "use it or lose it" theory.

Budgeting Woes

Pity the salespeople. The budget always started with "Sales" for each month of the year. How do you predict sales by the month when the month hasn't even begun? Take last year and increase it by 5 percent or so to make management happy? How in the name of sanity were you supposed to know what was going to happen three months from now, let alone 10 or 12 months hence?

Next would come "Cost of Goods Sold" that the accountant would fill in using percentages of last year, with only a faint notion of what would be required for jobs in the following year. That was followed by a gross profit number that was pure fiction.

And then came a loss reserve for doubtful accounts, plus another reserve for inventory shrinkage. Always, always, we'd estimate these at more than we really anticipated. Management hates bad-news surprises, but is pleased when things turn out better than expected.

Budgeting, say Hope and Fraser in their book, almost always results in a fixed performance contract between superiors and subordinates, and becomes one of the principal drivers of managerial behavior. Was that true in the typical printing company that budgeted? Well, sort of, but not entirely.

By the time a month or two had ticked away in the new year, the budget had become more of a relic. It had become a sort of joke, showing you just how poorly you could predict. That's okay if you limit it to that and don't try to make it a promise, say the authors.

Put In, Get Out

Where in their book do Hope and Fraser acknowledge what is now known as Chaos Theory—that small changes in input cause profound changes in output? For example, small changes in job mix we learned early on, much to our chagrin, can cause substantial changes in outcome for a month. But Hope and Fraser tend to ignore this fact of life.

If you're still using budgets as annual contracts, here are 10 rules for budget-gaming you can follow, according to the authors:

1) Negotiate the lowest targets and highest rewards;

2) Always make the bonus, whatever it takes;

3) Don't put customer care above sales targets;

4) Never share knowledge with other teams;

5) Ask for more than you need, expecting to be cut back;

6) Always spend what's in the budget;

7) Always have the ability to explain adverse numbers;

8) Never provide accurate forecasts;

9) Always meet the numbers, never beat them; and

10) Never take risks.

Hope and Fraser studied a number of companies for their book. Almost all of them were European, where budgeting had been abandoned. (Had they studied printing companies in the United States, they could have saved a lot of travel expenses!) But, in this country, miss the budget by a few pennies and suffer the consequences in the stock market. Truly amazing that we are still so dense!

Lessons Learned

But times they are a changin', aren't they? We've been through Enron, World-Com, Martha Stewart, HealthSouth and all the rest. We know what happens when you live by budgets that can't predict what will happen to customer demands, to changes in technology, to shifts in competition. We've seen what happens when the investment banking firms come up against Elliot Spitzer, New York's Attorney General.

Budgeting just doesn't work. Never has. That's what Harvard University Business Press is telling us in the book they recently published.

We've known, or have suspected as much, for a long time. If you want something to compare a month or period against, the same period last year is as good as anything. But what's even better is to run an XmR analysis on some rolling period, such as 13 weeks or a year.

Pity the poor printing companies still using contract budgeting. They just don't get it.

Ah, well.

—Roger V. Dickeson

About the Author

Roger Dickeson is a printing productivity consultant based in Tucson, AZ. He can be reached via e-mail: rogervd2@cox.net.