The Beyond Budgeting Model: Principles, Benefits and Problems

A regional bank in Kaduna spends four months every year agreeing next year’s budget. Branch managers negotiate their targets down, head office pushes them back up, and in the final month the numbers are approved, filed, and used until the following October to judge whether managers succeeded. Meanwhile, the market has moved twice.

Some firms have asked whether the effort is worth it, and a few have decided that it is not. The beyond budgeting movement argues that the fixed annual budget should be replaced altogether by a different way of managing performance: targets that are relative and ambitious rather than fixed and negotiated, forecasts that roll forward, and resources that are made available when needed.

This topic explains where the idea comes from, the criticisms of traditional budgeting on which it rests, the principles of the model, how performance is managed under it, and its benefits and problems, so that a candidate can argue both for and against it. It builds on the earlier topic on rolling, activity based, functional and master budgets. The next topic covers participation, negotiation and ethics in budgeting.

Origins and the criticisms of traditional budgeting

Origins

The Beyond Budgeting Round Table was set up in 1998 as a European research project, to investigate whether organisations would be better off without conventional budgets and budgeting. It reported that a number of successful firms, mainly in Europe, had abandoned budgets and replaced them with a model of responsibility for decisions and performance. In the United Kingdom the ideas are associated with the writings of Jeremy Hope and Robin Fraser.

The case against traditional budgets

Hope and Fraser argue that a traditional budget system is inadequate for businesses that must adapt quickly. It sets “last year’s reality” as the framework for this year, and acts as a restraint on initiative. As a result, operational managers resent the process, and management accountants are busy in a system that adds little value. The Round Table summarised ten problems:

1. Time-consuming and costly. Even with models, an annual budget in a large company can take four to five months, and use over a fifth of the time of senior managers and finance staff.
2. Adds little value and uses management time that could create value elsewhere.
3. Fails to consider shareholder value. It looks inward, at internal numbers, rather than at the market and external factors.
4. Rigid and inflexible. Managers concentrate on hitting agreed figures, which may not be in the interest of the organisation if circumstances change after approval.
5. Protects spending and does not reduce cost. Managers expect to use the whole allowance or lose it next year.
6. Discourages innovation. Fixed targets and fear of exceeding limits, which could jeopardise bonuses, stop managers from responding to events.
7. Focuses on sales targets, not customer satisfaction, which may raise sales in the short run but not long-term success.
8. Poor at executing strategy, despite the effort invested.
9. Encourages dependency. Junior managers do as they are told, reinforcing command and control and undermining teamwork and empowerment.
10. Encourages unethical behaviour, such as building slack into the allowance, by understating revenue or overstating cost.

Other criticisms:

• budgets are used for financial control when they should communicate goals and improve performance
• they concentrate on financial numbers and ignore the drivers of value that do not appear in the accounts (brands, skilled people, management processes, loyal customers)
• they are often political compromises, not the result of rational decision-making

The beyond budgeting model, its benefits and problems

The model

The model sets out principles for the way an organisation is led and the way its processes work.

In the leadership principles, people are bound to customer-focused goals rather than hierarchical targets; the organisation is a network of lean, accountable teams; everyone is expected to act and think like a leader; teams are given freedom and the ability to act; the organisation is governed by a few clear values, goals and boundaries, not detailed rules; and information is open, so that teams can manage themselves. In the process principles:

• Goals. Medium-term, ambitious goals that give direction, instead of fixed annual targets negotiated in advance.
• Rewards. Shared success, based on performance relative to a benchmark such as peers, competitors or prior periods, instead of rewards for hitting a fixed target.
• Planning. A continuous and inclusive process, with rolling forecasts rather than a once-a-year plan.
• Controls. Based on relative indicators and trends, so that managers respond to what is happening instead of to a fixed number.
• Resources. Made available as needed, within agreed limits and by return-based criteria, instead of being allocated for the year in advance.
• Coordination. Dynamic, driven by customer demand, rather than by annual plans.

Performance management without budgets

Under the model, performance is judged by comparison: with competitors, with other units in the group, and with earlier periods. A manager is not asked whether the target was met but whether the unit did better than its peers and improved on its own past. Measures are a mix of financial and non-financial indicators, including customer satisfaction, cost per unit and return on capital.

Information is shared openly so that each team can see how it stands. Forecasts are made for planning and cash management, but are separate from targets and from rewards, so there is less incentive to bias them. Costs are controlled by cost ratios, benchmarks and the discipline of the market, and by the requirement that spending must be justified by its return when it is requested.

Benefits

• Speed and flexibility. The organisation reacts to events as they occur, not at the next budget round.
• Lower cost. Less management time goes on the annual negotiation.
• Customer and strategic focus. Goals relate to the market and to customers, not to internal numbers.
• Better motivation and innovation. Teams have freedom and responsibility, and are not held back by fixed limits.
• Less gaming and slack. There is no negotiated figure to beat, so less reason to bias estimates, and ethical behaviour improves.
• Cost awareness. Resources must be justified when used, not simply spent because they were allocated.

Problems

• Culture. It requires trust, openness and a great change in attitudes of managers who are used to hierarchy; in a command-and-control culture it may fail.
• Loss of control. Senior management has less central control over spending, and the risk of overspending or inconsistent decisions rises.
• Planning and cash. Resource planning, cash needs, capacity and staffing still have to be forecast, and external reporting, lenders and investors may expect budgets and forecasts.
• Rewards. Relative performance contracts are harder to design and to explain, and benchmarks may not be comparable (different markets, sizes or circumstances).
• Suitability. It suits decentralised organisations in fast-changing markets with high skills; it may be unsuitable for organisations that are highly regulated, depend on tight cost control, operate to long fixed contracts or have a strong, stable hierarchy.
• Evidence. Successful examples are a small number of well-known firms. A change of this size is risky and takes years; benefits may come from the culture, not from abolishing budgets.

In practice many organisations take a middle course: keeping a budget for resource planning and cash while adding rolling forecasts, relative performance measures and more delegation.

The model in its standard terms: dependency, responsibility and twelve principles

The standard source presents beyond budgeting as the view that budgeting as most companies practise it, and the hierarchical structure that goes with it, should be abolished. In its place authority and responsibility go to operational managers, who work together to achieve the strategic objectives.

Traditional budgeting rests on a dependency model: a system of centralised control in which operating managers are controlled by being required to meet or beat budget targets. The alternative is a responsibility model, in which decisions and performance management are delegated to line managers, who agree performance targets that are reviewed regularly and amended as circumstances change.

Fixed annual plans are replaced by continuous rolling forecasts (or even continuous budgets); goals are set by external benchmarks, such as market share or beating competitors, and not by internally negotiated figures; managers are motivated by challenge and delegated responsibility; they use their direct knowledge of operations to react quickly; they work within agreed parameters but are not tied to line-by-line budgets; and the decentralised decisions need open communication and efficient IT systems.

Hope and Fraser set out twelve principles. Principles 1 to 6 build an effective organisation and culture; principles 7 to 12 build an effective performance system.

1. Governance: action is guided by a set of clear values, not by mission statements and plans.
2. Responsibility for performance: managers are responsible for competitive results, not for meeting the budget.
3. Delegation: people are given the ability and freedom to act, not controlled by seniors.
4. Structure: organised around processes and networks, not departments and functions.
5. Coordination: achieved by process design and fast information systems.
6. Leadership: seniors challenge and coach; they do not command and control.
7. Setting goals: the aim is to beat competitors, not to meet a budget.
8. Formulating strategy: a continuous process, not an annual event imposed from above.
9. Anticipatory management: systems that give information about events expected in the future.
10. Resource management: resources are available to operating managers at a fair cost when required, not allocated to departments in a fixed budget.
11. Measurement and control: a small number of key performance indicators, not many detailed reports.
12. Motivation and rewards: rewards at company and unit level based on competitive performance, not on predetermined budget targets.

The intended effect is a shift from a performance emphasis based on numbers to one based on people: the belief that improvement comes more from giving capable people control over decisions, and making them accountable for results, than from changing measures and incentives.

Management then needs to be good at eight things: creating a climate for fast response; taking responsibility for strategy and monitoring it continuously; getting resources quickly for new initiatives (for example hiring key people when they are available and not when there is room in the budget); employing the best people; innovating; operating at low cost; creating and keeping loyal customers; and creating shareholder value.

The same source adds two criticisms of traditional budgets: spending limits are the outcome of bargaining between departments and managers, and the budget shows the cost of departments and functions, not of the activities that employees perform, so it gives no information on cost drivers and does not help to identify costs that add no value.

In its concluding comments the source notes that the model is much easier to apply in the private than in the public sector, where activity is controlled through expenditure budgets and spending controls, accountability runs to politicians and the public, and objectives may be unclear.

It also notes that zero-based, continuous and activity based budgeting are attempts to improve the system, which Hope and Fraser describe as valiant but partial efforts that are time-consuming and complicated to manage.

Judging performance against peers and against a fixed target

1. Growth or return of each unit: (current − prior) ÷ prior.
2. Relative performance = unit result − peer benchmark (in percentage points).
3. Fixed target result = unit result − budget target.
4. Compare the two conclusions and explain which is fairer in the circumstances.

Percentages to one decimal place; money in naira.

Worked examples

1. Growth. A: 20.0%. B: 8.0%.
2. Relative to peers.
   A 20.0 − 12.0 = +8.0 points (outperformed).
   B 8.0 − 12.0 = −4.0 points (underperformed).
3. Against the fixed target.
   A 20.0 − 25.0 = −5.0 points (missed).
   B 8.0 − 5.0 = +3.0 points (beat).
4. Comment. The two systems give opposite verdicts. The fixed budget rewards B, whose target was easy, and penalises A, whose target was high. The relative measure shows that A did best in a market that grew by 12%, and that B fell behind the market. The relative comparison is fairer if the peers are comparable. It removes the gain from negotiating a low target; but if the peer group is not comparable, or A’s success was partly luck, the fixed target may still tell management something about the plan.

1. For. Branches face quick changes in demand, so a fixed annual plan quickly becomes irrelevant; the staff are skilled and can be trusted with decisions; the budget round takes a great deal of time that could be spent with customers; and relative targets would reduce the incentive to negotiate low targets.
2. Against. The company still needs cash and capacity forecasts, lenders may require a budget, and cost control would depend on branch managers choosing to behave responsibly. Rewards based on relative performance require a reliable group of comparable branches.
3. Recommendation. Adopt rolling forecasts and relative performance measures, delegate resources within limits, and keep a high-level plan for cash and capacity, moving further only as trust and information systems develop.

Expect variants: a short case asking for advice on whether to adopt the model, a requirement to list the criticisms and show how the model answers each, or a comparison of budgets, rolling forecasts and beyond budgeting.

Common mistakes

• Saying beyond budgeting means no planning. It means different planning, continuous and relative.
• Listing the criticisms without linking them to the features of the model that answer them.
• Ignoring problems. The examiner expects both sides.
• Recommending it for every organisation. Fit depends on culture, market and control needs.
• Confusing a rolling budget with a rolling forecast used outside the control process.

Quick revision

• BBRT 1998; Hope and Fraser. Ten problems: time, little value, internal focus, rigid, protects spending, no innovation, sales not customers, poor strategy execution, dependency, slack and unethical behaviour.
• Model: relative targets, rolling forecasts, shared rewards, resources on demand, decentralised teams.
• Benefits: speed, lower cost, customer focus, motivation. Problems: culture, loss of control, cash planning, reward design, suitability.

How the marks are earned

• Criticisms of budgets, explained.
• Model described accurately.
• Evaluation of benefits, problems and fit for the case.

Practice questions

These are original questions, written in the style of the Skills examination. Work each one before you open the answer.

Recall check: multiple choice

Section B style: written questions

Model answers

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