Historical Budgeting kills Business Agility

Ever been on a project where everyone (including the project sponsor) has come to the realisation that the project will never deliver the value that was promised? And despite this common understanding, the project just carries on regardless?

Blame historical budgeting.

Traditional (historical) budgeting, whether bottom-up or top-down, typically involves taking last year’s revenue and expenses and adding a growth factor to each side of the ledger (usually a higher growth factor on the revenue side than the expense side).  This then sets the playing field for the year ahead (i.e. the revenue that the business needs to bring in and the expense that it is permitted to spend, with the planned profit as the remainder).

The expense is further broken down into capital expenditure (capex) and operating expenditure (opex).  Capital expenditure, in particular, may span over multiple years.  Further complicating matters is that both types of expenditure have rules that dictate what can be categorised as capex or opex (as the categorisation can have a significant impact on financial performance reporting and tax liabilities).

While I understand that many of you reading this article will know most of this already, where I’m heading to is the adverse behaviour that this budgeting approach results in, and what can be done to change it.

So, what are the problems with this approach to budgeting?

The major drawbacks include:

• Internal Focus
• Budget Hoarding by Silos
• “Use It or Lose It”
• Annual Planning Mindset

Internal Focus: as the key determinant of the size of the budget is “what we did last year”, the plan is almost totally determined by the organisation’s past performance (an internal measure), not market dynamics (e.g. changing preferences, entry/exit of major competitors, substitution, innovation, etc.).  To be fair, most organisations do a “reality check” on the numbers, by comparing with sales forecasts and other leading indicators, but the key driver of this year’s plan is nonetheless last year’s performance.

Budget Hoarding by Silos: given the self-reinforcing nature of the historical budgeting cycle, departments/divisions/teams hold on dearly to any expenditure budget they are allocated.  By way of example: if my division gets $1m to spend this year, and we then find that $0.5m can be invested elsewhere for a higher ROI, that should be seriously considered, right?  The problem for me is that then means I only ‘spent’ $0.5m this year (which becomes the baseline for next year’s plan – $0.5m less than the year before!).  Which also leads to…

“Use It or Lose It”: Similar to the example above, if I underspend my expenditure budget this year, I am actually penalised under the historical budgeting model for saving money! For example, underspending $200K on a $1m budget this year means that $800K becomes the new baseline for next year.

Annual Planning Mindset: Perhaps worst of all, historical budgeting means revenue and expenditure plans are reviewed and agreed only once a year.  Given that the process often begins 6 months before the start of the new financial year, this means that the impact can stretch over 18 months!  This effectively creates a huge damper to business agility, with organisations unable to move quickly to adapt to new opportunities and rapid changes in the business environment.

So what to do about it?

Beyond Budgeting is a good place to start.  The Beyond Budgeting Roundtable articulated 12 principles underpinning an alternative management model, including making “planning a continuous and inclusive process; not a top-down annual event” and making ”resources available just-in-time; not just-in-case”.  (A full list of the principles can be found at: http://www.bbrt.org/beyond-budgeting/bb-principles.html).

Ultimately, the key to Business Agility from a financial perspective is flexibility in implementation.  It’s not that the original plan is necessarily wrong, but more that the plan itself becomes “the written word”, instead of being a starting point that is continually adapted as new information becomes available.  The greater the flexibility in implementation, the more responsive the business can be to market shifts and (often fleeting) opportunities in the marketplace.

© Eric Jansen 2012. All rights reserved.

Business Agility Defined

The term ‘Business Agility’ gets a lot of airplay these days – but what does it actually mean?

Much as the term agile has been increasingly used (abused?) in the IT industry to describe a high-performing software development team, Business Agility is now also becoming a term that is increasingly heard in business circles.  Like the term agile, however, people often find it difficult to be specific when describing what business agility actually means.  Responses are usually of the kind: “being flexible”, “capitalising quickly on new opportunities”, etc. – which is fine, but how does an organisation actually do this?

The following diagram depicts six key components of an organisation that exhibits Business Agility:

• Adaptive Planning: Above all, the organisation needs to be able to plan and execute simultaneously.  Sequential planning leads to a very rigid implementation approach, whereas adaptive planning allows (indeed, encourages) many course-corrections along the way.
• Focus on Time to Value: There is an almost obsessive focus on getting new products/services/features to market as soon as possible.  This enables a shorter feedback cycle and, equally importantly, an quicker timeframe to earn a return on the investment made.
• Decoupling: This is where a lot of businesses (particularly larger enterprises) find it very difficult to move quickly to exploit new opportunities.  The more each business process is intertwined (coupled) with others, the harder it is to implement change quickly.
• Low Latency: While this attribute could be consider an underlying theme, it is worth calling out as a specific component.  The quicker a decision can be acted upon, the sooner the business knows whether the decision was right and what else needs to be done to achieve the underlying goal.
• Economic Efficiency: A lazy, bureaucratic organisation will protect its turf at the cost of progress and innovation.  Lean operations that minimise waste have the added incentive of promoting new and innovative ways of doing things, and being able to implement them quickly.
• Rapid Adaptation: While similar to Adaptive Planning, this component really refers to the mindset of continual monitoring of, and adaptation to, changing market conditions.  It is the ultimate feedback mechanism that ensures the product/service offering is continually refined to best meet the needs/constraints of customers, suppliers and partners.

Focusing on how you can introduce/expand the above disciplines in your organisation will bring real meaning to the term Business Agility.  As a result, the business will be better placed to exploit new business opportunities in today’s rapidly-changing competitive marketplace.

© Eric Jansen 2012. All rights reserved.

Harvesting Gold from business investment opportunities

Successful businesses often face the kind of problem that struggling businesses would die for: a plethora of interesting investment opportunities – but which one to implement first?

From my work in applying agile principles to business change programs, I’ve come to the conclusion that there are two main drivers of success in project implementation:

• Impact; and
• Time to Value

Some may argue that there are more important variables to consider (such as NPV, payback time, strategic alignment, etc.).  Whilst all of these are indeed important aspects of investment decisions, in my experience it is rare that a project that either a) takes inordinate time to deliver or b) has minimal impact, is successful.

When next deciding which projects should be allocated scarce financial (and even scarcer time) resources, I would recommend using the following Impact Value evaluation matrix:

Not going to happen: If a project is going to take a long time to deliver, for little benefit, don’t even start it.  It may be tempting to do so if the capital requirements are (seemingly) small, but in my experience these projects either never finish, or invariably fail to deliver even the minimal benefits articulated in the business case that supported them.

Filler: This is a project that can be completed quickly, but does not have a great impact on the performance of the organisation.  Consider these as tactical projects that can be initiated at short notice (to make productive use of slack in organisational capacity).

Fundamental Shift: These are often mandatory, or ante projects (i.e. projects that you need to do to stay at the table/remain competitive) or core changes to the organisation’s direction and/or purpose.  While by their very nature these projects often must be done, one must resist the temptation to only do these long, enduring projects at the expense of harvesting Gold.

Gold: these are the projects that bring money to the bottom line quickly, and should therefore be prioritised over all others.  Whether it be an opportunity to quickly exploit a new market opportunity, make a considerable saving on an ongoing expense line, or significantly differentiate from the competition on customer experience, these projects are the ones that truly make a difference.

© Eric Jansen 2011. All rights reserved.

Authentic Leadership

Is authentic leadership a rarity in the modern world?

The political discourse in both the USA and Australia would suggest that populism is at an all-time high (at a tipping point, perhaps?).  Both sides of politics in each country seem to be driven by short-term poll results and (in the US in particular) a deep-seated fear of taking a stand on anything that might be controversial.

To take Australia as an example, despite the views that some might have held about Paul Keating or John Howard, one would be hard-pressed to make a case that, by and large, they didn’t stand by their convictions.  They also made some hard (and sometimes unpopular) decisions while in the hot-seat.

But the current Australian political landscape is in danger of slipping into the poll-driven mentality of American politics – much vitriol, but little substance.  This approach has the potential to foment complacency and a ‘head-in-the-sand’ mentality that will cost us dearly in the future.

Authentic leaders are very clear and passionate about their core beliefs and values.  The constructive debate that arises between people who hold deeply-held opposing views usually delivers much better outcomes than avoidance by both sides of confronting the difficult issues.

But what about the corporate domain?  Are we seeing the same pattern evolving in corporate stewardship, or is authentic leadership becoming more valued (and therefore more prevalent) in the modern-day organisation?

I’d be interested to hear your views and recent experience.

 

© Eric Jansen 2011. All rights reserved.

Systems Thinking creating Business Value

We were very fortunate to have Professor John Seddon, lead consultant and owner of Vanguard, visit us last week here in Melbourne.

John is a leader in Systems Thinking for Services Organisations.  Under John’s leadership, Vanguard has developed a methodology (known as the ‘Vanguard Method’) that adapts the teachings of W. Edwards Demings and Taiichi Ohno for the service industry. The wisdom of Demings and Ohno has had great positive impact on the manufacturing industry over the past 40-50 years, and Vanguard have been able to emulate this success with many service organisations over the past 25 years.

In our discussions last week, we hit upon a topic that causes much frustration amongst IT professionals these days: as a profession, we have made great strides over the past 10 years in bringing quality software into production in a much shorter timeframe and with significantly less resources.  Agile principles, in particular, have helped organisations to get a much better return on their IT investment (in comparison to using a waterfall approach to software development).

Despite these gains, there is much frustration in the IT community regarding true Business Value.  John made what I felt was a pertinent comment: “Agile is doing the wrong thing faster”.  While I would argue that the iterative process that Agile engenders actually surfaces the wrong things faster (and therefore permits us to change track to building the right things instead), I agree with John that we need to be starting from a point that is much closer to perfect that we currently do.

Under the Vanguard Method, we are called upon to define the purpose of the system from the customer’s point of view, and then design the system against customer demand.  While these concepts are plainly common sense, it is remarkable how often we are asked to build applications that clearly do not meet these criteria.

In particular, there are two key areas that contribute to the failure of IT systems to deliver the gains that they are theoretically capable of producing:

• Ignoring (and even automating) failure demand.  John defines failure demand as “demand caused by a failure to do something or do something right for the customer”.  A good example can be found with call centres, where “cost to serve” and “time to serve” are often (in fact, almost pervasively) key performance indicators.  These are false metrics, as unless the customer need has been met* during the call, the call actually failed to deliver value.  Under a scenario where the customer needs to call 5 times before the problem is solved (e.g. missed appointments, didn’t fix the problem first time, etc.), there are clearly 4 calls that represent failure demand in that scenario.
• Sub-optimising end-to-end value delivery, by independently optimising steps in the process.  This is a conundrum we encounter consistently in software development.  For instance, we may optimise the way payments are handled for an online transaction, but at the cost of asking the buyer to once-again (possibly for the third time!) enter their personal details, etc. – even for existing customers.

The challenge for those of us working in the IT community is how to design and build the right software the first time (not just building it right).

Systems Thinking brings an approach to the table that can certainly help in this regard.  By focusing on demand, value & flow (rather than functional specialisation), and designing software to deliver on customer demand in particular, we have the opportunity to drive much greater value from (and avoid considerable waste in) our investment in IT.

* Obviously the service to be provided may need to be scheduled during the call, for later delivery of the service.  In that case, as long as the service is indeed delivered and completed to the customer’s satisfaction at the agreed date and time, the original call can safely be classed as being successful.

When did Enterprise Software Development become a commodity?

I recently received a Request for Tender (RFT) from a large financial services company for the supply of specialist IT skills across a range of disciplines and technologies. In general, the RFT was fairly standard in the information being sought, although I was surprised, and somewhat perturbed, to see the following question near the end of the questionnaire:

“Would your organisation be prepared to participate in eNegotiations as part of this procurement process?”

For those not familiar with eNegotiations, a good overview can be found at http://www.tradeinterchange.com.au/leftnav_educational/reverse_auctions.htm. In essence, eNegotiations are online ‘reverse auctions’, where the purchaser seeks the lowest price for a particular commodity from the vendors participating in the auction, typically during a one-hour timeframe. During that hour, the bidders usually see the ‘current winning bid’ and have the option of become the new ‘winning bidder’ by lower their previous best price.

This process may seem to create significant economic value for the purchaser, until one asks the questions “what am I actually buying?” and “what will I actually get from the winning supplier(s)?”

One of the core tenets of reverse auctions is that the goods and services being purchased are for all intents and purposes ‘commodities’ (i.e. a physical substance … which is interchangeable with another product of the same type ). Sure, there is usually a minimum qualitative bar that organisations participating in the auction must exceed, but after that, it’s all price, price, price.

Which begs the question: is one Project Manager/ Enterprise Architect/ [insert skill set] really interchangeable with the next?

To illustrate my concern with this question, let’s just change the context to another provider of professional services – the legal profession.

Suppose you have just been wrongly accused of a traffic violation and you need a lawyer. Do you look for the cheapest lawyer you can find, or do you try to find one with a good track record of getting the charge dismissed? Sure, you don’t want to pay too much for the advice, but what is the main driver in your thought process – getting a cheap deal or getting the right outcome? I would suggest the latter is usually the main consideration in most people’s minds.

Which brings me back to the financial services organisation’s intention to use reverse auctions to get the cheapest price for specialist, professional services. As professionals (and the services they provide) do not even come close to the definition of commodities, the likely outcome is that the lowest-cost provider will prevail in the auction process, but the ‘winner’s curse’ will be that they will most likely have bought the professionals with the poorest past performance.

So given that financial services organisations usually demonstrate considerable acumen in business dealings, why would they seriously consider treating IT professionals as commodities in the procurement process?

Unfortunately, the answer is probably an indictment of the IT industry in general. With IT projects continuing to suffer from late deliveries, bloated software, project cancellations and budget blow-outs, executive management is increasingly viewing IT spend as a ‘cost of doing business’, rather than a means of creating competitive advantage. This being the case, anything that can reduce this overall cost will, by inference, increase bottom line returns.

The IT industry needs to take on the challenge of changing this mindset in the executive management community. Otherwise, the software profession will become increasingly marginalised, which will bring real costs to the wider community, in particular the potential loss of the productivity dividend that has underpinned much of the economic growth the developed world has experienced in the past few decades.

The next article in this series will present some thoughts on how the IT industry can improve it’s reputation in the executive boardroom.