Jeremy Hope is the author of a number of articles and books on performance management and associated leadership issues. He is co-author with Robin Fraser of Beyond Budgeting (based on an article they wrote for Harvard Business Review, “Who Needs Budgets?”) as well as co-author, with his brother Tony Hope, of two earlier books, Transforming the Bottom Line and Competing in the Third Wave. Both books have been translated into many languages and won coveted awards in the USA. His most recently published book is Reinventing the CFO: How Managers Can Transform Their Roles and Add Greater Value. Hope has given many keynote speeches at major conferences on performance management topics. He began his career as a chartered accountant and has since had experience in venture capital and business management. For the past five years his work has been focused on “Beyond Budgeting” and he is currently research director of the Beyond Budgeting Round Table (BBRT), an organization dedicated to helping firms improve their performance management processes.
Morris: You and your brother, Tony Hope, co-authored two books in which you explain why traditional accounting is no longer able to provide managers with relevant information for decision making. What led you to reach that conclusion?
Hope: Johnson and Kaplan’s book Relevance Lost brought together many of the ideas that Tony and I were also thinking about. The main problem is that strategy is divorced from execution at both the planning and control stages. Accountants manage budgets and numbers rather than the business. This can lead to catastrophic failure as managers have no way of knowing if their strategy is working or whether their actions are creating value. Nor do most of them know where they are until mid-way through the following month.
Morris: If budgeting, as most corporations practice it, should be replaced, with what?
Hope: I use the word “budgeting” as a surrogate for command and control management. So it’s not just a matter of replacing the budget. It’s about replacing the whole performance management model. This means that you need some ‘process’ changes such as moving from annual negotiated targets to measures based on relative improvement against, for example, peers and best practices; moving from annual to continuous planning supported by rolling forecasts, and from annual resource allocations to more dynamic resource management. But you also need some ‘leadership’ changes. These include devolving more strategy, planning, forecasting and decision-making to front line teams and giving them more freedom and capability to act. It also means providing fast, open and transparent information. This is the real control system in any organization. The result is more speed and innovation as managers are not working under the threat of a fixed performance contract that drains energy and stifles initiative.
Morris: Heads of HR as well as CFOs are frequently not included in high-level decisions made by senior management in many organizations. I think that is a serious mistake. Do you agree? If so, how do you explain that exclusion?
Hope: I totally agree. The only way I can explain it is that the senior executive team still perceives HR directors as people who deal with recruitment and benefits and have little to say about strategy. The sad thing is that they’re probably right. But the answer is to find the right people who can take HR into the boardroom. “Getting the right people on the bus and in the right seats” as Jim Collins said is critical to future success. Also finding ways to create self-managed teams and reward these teams effectively are key success factors.
Morris: In your opinion, what specifically can CFOs do to convince other senior-level executives (especially their CEO) that traditional budgeting practices and procedures must be replaced?
Hope: The key step is to build a case for change. There is plenty of evidence to suggest that the budgeting process is broken. Some CFOs have organized internal surveys that invariably show that functional and business unit managers believe that budgeting adds no value (but a lot of cost). Another option is to go to the Beyond Budgeting Round Table (BBRT) website (www.bbrt.org) where you’ll find a free diagnostic that will help the CFO to gather evidence and present a comprehensive report. Another approach is to examine those companies that have recently abandoned budgeting. These include American Express, Unilever and UBS Wealth Management. Many others are ‘on the journey’. Joining the BBRT is a great way to network and learn.
Morris: Given your response to the previous question, which barriers must CFOs be prepared to overcome to achieve that replacement?
Hope: By far the greatest barrier is the control mindset. Most finance people have a deeply embedded view that targets drive performance improvement and budgets control that performance. But most of the evidence suggests otherwise. Targets and budgets drive dysfunctional behavior as executives and managers play games with the numbers. Overcoming this barrier means convincing the CFO that the new control system is more effective than budgeting. This means knowing where you are today on all key indicators; knowing where you’re going through quality rolling forecasts; knowing how you’re doing against peers, prior years and best practices; knowing if your strategy is working through managing gaps and monitoring KPIs; knowing your key value drivers and so forth. With less time wasted on budgeting and more time spent on providing performance insights and effective control systems, the CFO and the Finance team will be welcomed as business partners.
Morris: You and Robin Fraser co-founded the Beyond Budgeting Round Table (BBRT). What is it and what does it do?
Hope: The BBRT is a members’ consortium with networks in Europe, North America, South America and Asia/Pacific. Members pay a modest annual fee (around $12,000) and they join a learning network that provides case studies, research papers, CFO interviews, and diagnostics. There are regular meetings in all world centers that are packed with cases and workshops.
Morris: Now please focus specifically on Beyond Budgeting. In it, you and Fraser assert that the Balanced Scorecard provides a framework that helps to overcome some problems but still “plays second fiddle to a core management process driven by the annual budgeting cycle.” How so?
Hope: The reason is that with both the budget and the scorecard running in parallel it’s like driving a car with two steering wheels. While the scorecard has a 2-5 year strategy perspective, the budget is focused on the current quarter and year. The management dynamics are quite different. Few organizations have overcome this problem. So they pretend that the scorecard is just another top-down annual performance contract. The evidence is in the reporting system where you tend to see target-actual-variance with happy/miserable faces or colored traffic lights. There are other problems with the way that scorecards are used. For example, they take some putting together and coordinating across the business so changing them to reflect a change of direction is not easy. The organization becomes too “glued together” making the so-called adaptive organization seem like a long way away.
Morris: What is “the annual performance trap” and how can senior-level executives break free from it or, better yet, avoid it?
Hope: The annual performance trap typically starts with the negotiation of an annual fixed target. This might be a commitment to meet a profit figure that is communicated to investors and then cascaded down the business. The problem is that everyone from senior executives down to lowly managers is driven to ‘make the number’. This obsession with ‘managing earnings’ is pervasive. But according to recent research by McKinsey & Co it is a waste of time. McKinsey & Co recently asked executives why they issued guidance and the answers were uniform: “higher valuations, lower share price volatility and improvements in liquidity.” But their review of around 4,000 companies failed to support these perceptions. In fact they found no evidence that issuing frequent earnings guidance affects valuation multiples, improves shareholder returns, or reduces share price volatility.
The only impact was the increase in trading volumes that only affects companies with illiquid shares. On the contrary, the evidence suggested that providing quarterly guidance has real costs including the time that senior management must spend preparing the reports and an excessive focus on short-term results. So the answer is to stop making promises and managing earnings. The alternative approach is to define success in terms of relative improvement against peers etc. This avoids the short-term performance trap, as there is no ‘game’ or ‘number’ to meet.
Morris: Please cite an example or two of organizations that have used beyond budgeting principles to implement more adaptive processes.
Hope: American Express has now abandoned annual budgeting and moved to a continuous planning process supported by rolling forecasts and dynamic investment optimization. Unilever is another company that has now abandoned budgeting. It calls its new system ‘dynamic performance management’. In both cases they claim that the organization is more adaptive. Also American Express CFO Gary Crittenden believes that the organization has more control than before.
Morris: How can abandoning the traditional budgeting process enable radical decentralization?
Hope: Decentralization is often taken to be the same as delegation; that is, giving managers the authority to make certain decisions within fairly narrow tramlines usually defined by the budget. This is not real autonomy or empowerment. To achieve that you have to eliminate the fixed performance contract, otherwise managers will feel no ownership or commitment. In other words, if the CEO tells managers that they are ‘empowered’ to make decisions this will mean nothing if they are still held to a fixed contract. That’s why it needs removing. Managers (in teams) need to set their own goals and plans (challenged by senior executives) to build ownership. It’s motivation 101!
Morris: Here’s a related question. How can the adaptive and decentralized organization meet the vision of business leaders in the twenty-first century?
Hope: Think about how critical success factors have changed over the years. In the industrial age they were about efficiency and control but today they are about fast response and innovation. How can we grow the top line organically, is a key question today. The trouble is that, unlike cost reduction, growth cannot be mandated from the corporate center. It can only be enabled and encouraged by the performance management system. And targets and budgets are the barriers that must be removed. Anton Stadelmann, CFO of UBS wealth management, has removed the budget because it is the primary impediment to growth thinking. As Jack Welch once said, budgeting is an exercise in minimalization.
Morris: You assert that budgets and fixed performance contracts “assume an absence of trust.” Why do they do that?
Hope: Trust and empowerment go together, as do budget and contract. They come from different cultural worlds. Empowerment cannot be ‘given;’ it can only be ‘taken.’ And for that to happen, managers must trust their superiors. What’s needed is a ‘no blame’ culture, but that’s not usually the case in the budgeting world.
Morris: For those who have not as yet read Reinventing the CFO, in it you explain how financial managers can transform their roles and thereby add greater value to their respective organizations. How can managers do that if other senior-level executives (especially the CEO) have fallen victim to “the annual performance trap?”
Hope: I agree there is a real difficulty here. CFOs must stand up and be counted. They need to be more effective at influencing their colleagues. They need to convince them that all the detail, complexity and micro-management that goes on is a waste of everyone’s time. A strong CFO should be able to do this. But then of course they must deliver. Showing their boardroom colleagues new performance insights such as rolling forecasts and trend analysis will help to get their attention.
Morris: What must CFOs take into full account when re-thinking their planning, resource allocation, and performance measurement systems so as to enable managers to focus on new success drivers?
Hope: The key change is moving to driver-based rolling forecasts. This means focusing on only 8-12 lines on the forecast making it regular (monthly or quarterly) and fast (no more than a few days to complete and consolidate). These forecasts will be of much higher quality if bias is removed and the key to this is removing the fixed performance contract. A well-prepared forecast supports resource and capacity management, and is a key element of the new measurement and control system.
Morris: Almost everyone agrees on the importance of “measuring what matters.” Must not the measures employed be appropriate to the given process level and based on the given purpose?
Hope: Absolutely right. But how often does that happen? The typical measures that Finance uses are the nemesis of lean thinking. While lean and six sigma managers are focusing all their attention on process improvement what do finance people do? They continue to set targets and measure performance around all the old boxes (i.e., functions and departments) on the organization chart. Clarifying the purpose of a process should tell managers what they should measure and how they can improve. It is a self-fulfilling cycle of improvement.
Morris: Please share your thoughts about enterprise risk management (ERM) and why, in your words, ERM “represents a shift from managing risk in functional silos to managing them across the whole organization.”
Hope: Most CEOs and CFOs have nightmares about being taken away in handcuffs with the TV cameras filming every moment. So managing risk effectively is high on the agenda. But risks are not easily subjected to check lists. They are not always foreseen and can arise at any time. That’s why a culture of trust and transparency is so important. Some organizations have gone some way to improving the management of risk. Enterprise risk management gives boards the ability to assess all the risks of the company and understand them, separately and in relation to each other, potentially identifying risks they may not otherwise have identified, and then making a determination to either mitigate that risk or choose to accept it. It’s by no means perfect, but it’s a step in the right direction.
Morris: One final question. In effect, you are asking CFOs to “reinvent” themselves to become effective change agents when setting out to transform their respective organizations. What are the most important lessons learned from other CFOs who have already done that successfully?
Hope: All successful CFOs have created more time and capacity for Finance to add more value. They have cut back on measures, reports, IT systems, projects and so forth. They have centralized the routine back office work and decentralized decision support. They have simplified everything. They have improved the skills and capabilities of their teams. And they have also rationalized their systems. But above all, they have shown a determination to succeed. They have all demonstrated courage, perseverance and leadership. I never said it was easy!
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