Budgets. Love them or hate them, they’ve been a staple of business management for decades. What if most companies are using budgeting for too many purposes, none of which it does well? What if we replaced budgeting with a set of tools better suited to each of those purposes? What if the management philosophy behind many budgets could be replaced with something more efficient and effective? These are the questions that leaders of Beyond Budgeting raise and for which they suggest compelling answers.
What is Beyond Budgeting?
I’ll let a few of the early leaders of Beyond Budgeting introduce the essence of it. The first is from Steve Morelidge, as quoted in the article “There are Many Ways to do Beyond Budgeting“:
“There are two fundamental ideas Beyond Budgeting is built on. One is the need to have the ability to change when the external environment changes. And the second component is creating a way of working that takes advantage of people’s knowledge, skill, and willingness to commit to an organization and in the process do something worthwhile and fulfilling in their working lives. In short, building a healthy and productive workplace.”
The second quote comes from Hope and Fraser in their book Beyond Budgeting[2]:
“Beyond Budgeting is not a toolset designed to fix a specific problem with budgets or anything else… Rather, it offers an alternative management model based on the decision-making needs of front-line managers. It is a coherent set of alternative processes that support relative rewards, continuous planning, resources on demand, dynamic cross-company coordination, and a rich array of multilevel controls.”
Bjarte Bogsnes[3] boils down Beyond Budgeting to just two main questions
- How do we define performance?
- How can we best enable the organization to deliver that performance?
The Three Purposes of a Budget
The quotes above show that Beyond Budgeting entails much more than a change to the budgeting process. The expanse of the impact of Beyond Budgeting derives from the multiple purposes traditional budgeting has been stretched to achieve.
Bjarte Bogsnes, in an article titled The Art of Managing Cost Without a Budget[4], points out that most companies ask for a budget to do three things:
- Forecast: This is what the company thinks will happen in the future. It can be replaced by rolling or dynamic forecasting.
- Set Targets: These are the levels of performance the company wants to achieve. They are inspiring and cause the company to stretch beyond what would happen naturally in the forecast.
- Allocate Resources: Many consider this the main purpose of the budget. However, a static budget struggles to optimally allocate resources in a dynamic business environment. These allocations must be made by decision criteria when reaching key targets or responding to trends.
At the heart of the critique is the idea that forecasting, resource allocation, and target setting have inherently different objectives. Forecasting should be unbiased and forward-looking, resource allocation should be flexible and responsive, and target setting should motivate performance without encouraging manipulation. Attempting to achieve all three goals within a single budgeting process creates unavoidable conflicts.
Beyond Budgeting advocates argue that separating these processes allows each to be optimized independently. Forecasts can be made more accurate, resources can be allocated more effectively, and targets can be set in ways that genuinely drive performance.
Bjarte Bognses states[5], “The three purposes should be separated and then solved in three different processes because they are about different things. A target is an aspiration, what we want to happen. A forecast is an expectation, what we think will happen, whether we like what we see or not. And resource allocation is about optimization of scarce resources.”
Let’s look at how traditional budgeting compromises each process.
Forecasting
Forecasting is meant to provide an unbiased view of future performance based on the best available information. However, when forecasting is embedded within the budgeting process, it often becomes compromised. Employees and managers tend to manipulate forecasts to influence outcomes tied to budgets, such as resource approval or performance evaluations.
For instance, managers may deliberately underestimate revenues or overstate costs to create “budget slack.” This behavior ensures that targets appear easier to meet later, increasing the likelihood of favorable performance reviews or bonuses. As a result, the forecast ceases to function as an objective prediction and instead becomes a negotiated number shaped by internal politics.
Allocating Resources
The second purpose of budgeting—allocating resources—also suffers when combined with forecasting and target setting. Traditional budgets allocate resources based on forecasts made months in advance, often before the business environment has fully unfolded. This can lead to significant inefficiencies.
For example, departments may receive funding based on projected needs that later prove inaccurate. If conditions change, the organization may still adhere to the original allocation, resulting in wasted resources in some areas and shortages in others. Moreover, managers may feel pressured to spend their entire budget before the end of the period to avoid reductions in future allocations (i.e., the “use it or lose it” mentality).
Setting Targets
Combining target setting with forecasting and resource allocation creates conflicting incentives. When targets are directly tied to negotiated budgets, employees are motivated to influence the numbers in ways that make targets easier to achieve.
This dynamic leads to gaming behavior. For example, managers may delay revenue recognition or accelerate expenses to ensure they meet budget targets in a given period. Such actions distort financial results and undermine long-term value creation. As noted earlier, managers have an incentive to create “budgetary slack” (i.e., “sandbagging”) against a negotiated fixed performance contract based on a projected number. Additionally, targets derived from static budgets can quickly become irrelevant in volatile environments, yet organizations often continue to measure performance against them.
Clarity and Confidence
We return to the question, “Why do we budget?” Many people haven’t really asked that question to clarify what they hope to accomplish. Budgeting is so common that it’s perceived as a requirement. Not budgeting is then seen by company leaders as scary and dangerous.
However, asking why we budget allows us to assess budgeting’s effectiveness in achieving the outcomes we desire. As we have seen, the conflicting three purposes compromise all of them. We can then identify alternate processes that best achieve our desired outcomes. Beyond budgeting doesn’t ignore or abandon what we want to achieve. It simply replaces a single sub-optimal process with multiple alternative processes optimized to our desired outcomes.
Beyond Budgeting Benefits
Let’s turn to some benefits of Beyond Budgeting and how they address the budgeting challenges.
Greater Agility
Annual budgeting is replaced with more frequent planning cycles when companies adopt Beyond Budgeting. Planning and implementation may also be event-driven. Does the command and control of traditional budgeting help you control actions? Yes. But that’s not the goal. The goal is to match actions to the environment. For that, budgets give the illusion of control.
Rapid Iteration
Frequent and flexible planning cycles provide quicker feedback on decisions and more rapid changes based on that feedback. Staff don’t need to wait until the next round of resource allocations to pursue opportunities. Neither do they need approval from levels of bureaucracy to terminate loser projects.
Improved Communication
Directives from the budget are replaced with more guidance. Top leaders have to inform other leaders and employees of strategic plans. Departments and teams must coordinate more with each other. Important information needs to be constantly communicated through the company to inform frequent planning cycles. Fewer top-down directives lead to more coordination between teams to achieve goals.
Greater Autonomy and Empowerment
Direction from top leadership is provided more by guidelines than by directives. Short planning cycles don’t allow large sets of directives. Middle management and employees make decisions based on the guidelines and goals. Delegated authority and decentralized decision-making allow the agility mentioned earlier.
A benefit driven by autonomy and empowerment is increased job satisfaction and employee retention. Talented people want to learn and develop. Beyond Budgeting allows them to make decisions at lower levels of the organization that train them to become better leaders as they rise through the company during their careers.
Improved Customer Satisfaction
Local empowered leaders and employees can quickly respond to customer requests or address customer dissatisfaction. Every customer is unique, and there are many unique customer segments. Top-down decisions may not allocate the types of resources to local leaders to meet the needs of the local community.
Less “Use It or Lose It” Spending Mentality
Budget allocations are replaced with metrics and goals. Teams don’t have pots of money they feel compelled to spend to get a similar amount of money in the next annual budget. Managers challenge resource consumption rather than seeing resources as entitlements.
Accountability
A lack of budgets does not mean a lack of performance measurement and accountability. Instead, performance measures are relative measures that are more relevant than the static performance contract that budgets provide. Relative performance means company units see their performance measured against competitors or internal peer departments. There is little room for excuses when those competitors and peers perform better in the same environment.
Relative ranking often means more visibility of performance across the company. Pride and a competitive spirit motivate company unit leaders not to fall to the bottom of the ranking. No one wants to let down the team (i.e., the company unit).
At the same time, all the units are part of the same company. The company culture can promote cooperation between units to improve the performance of all units. Companies that implement Beyond Budgeting tend to use companywide profit sharing and rely less on individual or small team incentives. Sharing insights within the company is one of the best ways to promote companywide performance. Once again, no one wants to let down the team, but this time it refers to the company as a whole.
Improved Efficiency
A Bjarte Bogsnes quote in an earlier lesson disparaged the belief that if we produce projections with enough decimal places, we know what will happen. Budgets often expend a great deal of effort in developing precision that is far outstripped by the uncertainty of the future. Massive sets of reporting and management communication mainly document the increasing irrelevance of dated projections.
Beyond Budgeted puts more emphasis on relevance and agility. A few key assumptions drive frequent projections. When those assumptions become outdated, managers must develop a new plan and projection.
Finance as Business Advisor and Consultant
The efficiency of Beyond Budgeting frees up time that was once consumed with the annual (or more) budget process. A company can choose to reduce finance staff. More often, finance staff help front-line managers make decisions. There is less time spent on compilation and more spent on customization of decision analysis.
Observed Results
The above benefits may appear hypothetical or anecdotal. Survey results bear them out.
A December 2020 Boston Consulting Group study confirmed that Beyond Budgeting has significant benefits: 59% of 174 finance executives surveyed reported increased sales, 56% saved significant costs in the budgeting process, and 41% freed up formerly held-back financial resources. At the same time, respondents reported important improvements in organizational effectiveness, such as better business decisions (52%), more effective performance management (51%), and greater agility in reallocating resources (45%).[6]
Challenges to Beyond Budgeting
Given all these benefits, why haven’t more companies implemented Beyond Budgeting? Many people haven’t heard of it. Like every process, its benefits come with their own set of challenges. Here are some of them:
Transition time and money: The transition to operating without a budget will take time and money. It entails a restructuring of systems, staffing, and culture.
External and regulatory reporting: Some express concern that a lack of budgets can impair their ability to comply with investor or regulatory expectations. A funding source for a nonprofit may require a budget that’s approved by the board.
Less alignment: Managing via guidelines versus directives leads to less top-down alignment. There is less control by senior leaders and more education by them.
Performance measurement challenges: Beyond Budgeting uses relative performance measurement, often against peer departments or competitors. Some companies may have a hard time getting clear competitor data. Small companies may not have multiple peer departments.
Potentially greater chance of and magnitude of errors: To reverse a well-known phrase, “With great responsibility comes great power.” Staff have the authority to make poor decisions that cost money.
Greater autonomy and empowerment: I chose to use the same wording here as I used in the benefits to show that not all people respond the same way to greater autonomy. Some will be more frustrated and have lower job satisfaction. Some people like more guidance than less. They may fear more responsibility.
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[2] Jeremy Hope and Robin Fraser, Beyond Budgeting: How Managers Can Break Free from the Annual Performance Trap (Boston: Harvard Business School Press, 2003), xix.
[3] Bogsnes, Bjarte, This Is Beyond Budgeting: A Guide to More Adaptive and Human Organizations (Hoboken, NJ: Wiley, 2016).
[4] https://www.fm-magazine.com/issues/2020/jun/how-to-manage-cost-without-a-budget.html
[5] Bogsnes, Bjarte, This Is Beyond Budgeting: A Guide to More Adaptive and Human Organizations (Hoboken, NJ: Wiley, 2016), 36.
[6] This paragraph is a quote from https://www.bcg.com/publications/2021/the-future-is-beyond-budgeting