Budgeting is a wasteful and destructive relic from the past
Let’s say Mike, a department head at a big corporation, is working on the budget for his department. He estimates the revenue by looking at figures from previous years, he forecasts that his department should be able to grow this year, and comes up with a number.
Mike knows that whatever number he gives to his manager will become a target for him. A target which will have bonuses linked to it. It doesn’t make sense for him to give a number he won’t be able to reach. Mike revisits his forecast to get a lower number. It’s better to underpromise and overdeliver.
Luke, Mike’s manager, knows people tend to downplay their revenue estimates. When Mike presents his estimates, Luke knows his role is to get the numbers up. Luke and Mike negotiate and, eventually, settle with a number. Either Mike feels like a winner for keeping his number down or Luke for bringing it up.
The numbers in the budget become fixed. Mike will do anything and everything to make those numbers. Focus on the short-term, forego maintenance, postpone trainings, the usual. Mike will also make sure he spends all the money allocated in the budget since otherwise Luke might cut down on it next year.
This whole charade is repeated annually with different actors all around the company. Jack Welch, former CEO of GE, says “the budgeting process at most companies has to be the most ineffective practice in management.” Welch has seen the amount of time and effort corporations waste with the budgeting process.
In short, budgeting is the process through which corporations spend ridiculous amounts of time and effort compiling semi-random numbers into a spreadsheet they then use for command & control leadership.
It doesn’t have to be that way.
Statoil, Scandinavia’s largest company with a turnover of 130 billion USD, stopped doing budgeting in 2005. They switched to a model in which budget decisions are made continuously as new information emerges.
My homebase, Reaktor, has never done budgeting. We’re a creative technology company with 300 people. We construct exceptionally well-functioning services. On the side, we create phenomenons like Hello World Open, the Coding World Championships, and organize conferences such as Reaktor Dev Day and Reaktor Design Day. No budgeting necessary.
Budgeting is a relic from the past we have to get rid of. Budgeting decisions should be embedded in the work and made continuously with the best available information by the person most suitable to make that decision.
If you want to learn more on how to get rid of budgeting, I suggest reading Implementing Beyond Budgeting.
Ps. It is important to distinguish between budgets and budgeting. Budgeting is a destructive and wasteful practice, but budgets are a great tool for making better decisions. This will be covered in my next blog post, which will be released on Wednesday.
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