Pitfalls of Actual to Budget Exercises, Particularly in the Downturn
In my Blog on March 14, I took the position that the tax profession has evolved from an individual sport to a team sport. It is no longer possible to excel in everything with respect to global indirect tax management. Thus, some people may excel in certain areas of indirect taxation, and the overall outcome of the entire team’s effort will make the real difference with respect to a quality standard perspective.
If working as a team is part of a company’s business objective, the company’s “informal” culture or budget-based compensation targets can become a bottleneck against realizing such an objective. This Blog is about these pitfalls and gives an alternative and provides examples. The focus of this Blog is on external advisers, but the method can be used by in-house (indirect) tax managers during their discussions with top management.
Is it wise to have Stevie Wonder in the driver’s seat?
“A Ferrari is a beautiful, very fast and a state of the art car, but we should not put Stevie Wonder in the driver seat. He is an excellent song writer and performer but he never ever will be the next Michael Schumacher. It will be risky business if he controls the throttle.” - Richard Cornelisse
Although the above example might be considered somewhat ridiculous, strangely enough, the scenario occurs often in our daily practice. The current downturn might even make this situation worse.
The reason is budget-based incentive targets. Everybody today feels the pressure, and the focus is on making a personal budget first. We might know the best driver and understand that he is the best option, but that does not mean that we would actually want Michael in the driver’s seat. It does not matter that Michael works for the same company or that his driving would be in the best interest of the client. Stevie wants to make his own comfort zone first; it is in his personal interest.
- Should we be surprised?
- Is this not part of our human nature?
- Is that not the reason why we have a company culture?
Precisely, and this is the reason why proactive management of common values is needed.
“In a profession that sells a promise of performance versus a tangible product or service, a firm’s vision, values, and culture lie at the heart of that promise. Vision is where the firm is headed. Values are the behaviors the firm holds important, and culture is the feel, the energy, the society within the organization. Collectively, they form the core around which the business is built.” - Maureen Broderick
Actual to Budget Exercises
Before I continue, I should mention that I consider budget exercises to be a necessity, particularly for large organizations that need to manage the performance of many people. The budget process provides top management with a certain level of control. Actual to budget exercises are—and will remain—an important part of people’s performance targets.
It is more about being aware of the pitfalls and their impact of budgeting. Once the budget is set, manipulating the internal environment to make a budget—at any cost—could result in disconnect and internal competition. In my opinion, such behavior is in conflict with the company’s business strategy, which should include growth, increased market share and increased market leadership.
A potential reason for this conflict could be that personal performance—meeting budget-based incentive targets—is considered to be a higher priority than the company’s own business objectives. If this is something structural, it becomes the company’s “informal” culture and will result in:
- a power struggle over clients (protectionism, claiming clients and winning)
- individual’s own “people first” attitude (without a team approach)
- service offerings being proposed that are actually outside their own area of expertise (no standard quality, increased liability, pricing variation, etc.)
- lack of a willingness to share relevant client-related information (protectionism)
Budget-based compensation targets themselves might also create an incentive to underperform, even during times of growth. Substantially exceeding the budget could give rise to discussions about how much the budget has been sandbagged last year, with the result being higher targets next year. To avoid this possibility, positive results might be carried forward into the next year.
Jack Welch’s View
Jack Welch has his own view regarding budgeting. He considers budgeting to be number crunching and time that is wasted and which could be used in a more productive way. It is all about internal politics, and time could be used better by focusing on the external environment, i.e., the customer.
- What is the amount of time spent on budgeting?
The Beyond Budgeting Round Table, an industry research organization, estimates that an average corporation spends four months and 20-30% of the senior executives’ and financial managers’ time on their budget.
“Making a budget is an exercise in minimization. You’re always getting the lowest out of people, because everyone is negotiating to get the lowest number.
“The budgeting process at most companies has to be the most ineffective practice in management. It sucks the energy, time, fun and big dreams out of an organization. It hides opportunity and stunts growth. In fact when companies win, in most cases it is despite their budgets, not because of them.” - Jack Welch
I like and admire Jack Welch for making these kinds of statements.
Screw business as usual, as Richard Branson would say.
Budgeting: a Waste of Time
Jack Welch’s complaint was that he was being sandbagged in the planning process itself. A waste of productive time begins when setting the budget. It is all about managing an internal conflict. The aim of the leadership is to set the budget as high as possible, whereas the manager has the opposite strategy—“negotiation to the lowest”. This conflict is the side effect of budget-based incentive targets.
Such an approach—“passionately defending modest projections of mediocre performance”—is in conflict with business objectives, in which the company’s mission statement is to increase its market share and/or maintain or achieve market leadership. Is that not strange?
Jack Welch’s dream was not a better way to negotiate budgets, but rather an end to the negotiations. However, how likely is it that managers themselves will propose aggressive goals? And if not, does the company’s culture have to change?
Assume that the company’s business plan was to grow by 15% overall and that one of the business units exceeds this target and realizes 25% growth. The budget is already made. What does this say about the responsible manager? Did he do a good job? Should he earn a large bonus? The answer would depend on several factors. If you focus internally, only an affirmative “yes” is the obvious answer. However, this could simply be considered underperforming when the growth is the result of an unexpected increase of market demand (by external factors). The same is applicable if the competition also has much higher growth figures.
In an ideal world, everybody knows how their competition is performing, how the teams are set up and what the client portfolio is. Their own strengths and weaknesses are continuously being analyzed and measured. A gap analysis is made with the competition, and the gaps found can be prioritized and validated by top management. The impact of these gaps on the company’s overall business objectives is discussed. For the various solutions, cost-benefit analyses are made such that a constructive discussion with top management can be held regarding what is needed to close these gaps.
In the worst-case scenario, the gap(s) will not be closed, but at least you will have achieved mutual awareness and—hopefully—responsibility. Again, the scientific method was discussed in my Blog of March 14.
The above example is not only applicable to external advisers, but it can also be used by in-house (indirect) tax managers during budget negotiations (about external spending) and/or obtaining extra resources.
The strength of this approach is that you look forward and focus on what can still be managed. Budget to actual is a “looking back” exercise.
Perhaps combining the best of both worlds is the winning combination. Indeed, life is often about finding a good compromise.