Robin Fraser International Director, BBRT SEUGI Executive Management Stream Vienna, 17 June 2003 the Budget Model: a Universal Problem

Home , Bank of Ireland, Bulmers, Handelsbanken

Robin Fraser International Director, BBRT SEUGI Executive Management Stream Vienna, 17 June 2003 The budget model: A universal problem

BBRT members (1998 to 2003) - A wide spectrum of industries and regions

ABB Deutsche Bank Port of Tyne Authority ABC Technologies DHL ProDaCapo Accenture Diageo – UDV Royal Mail ACCO Europe eNiklas Rugby Group AC Nielsen Ernst & Young Sainsburys Adaytum European Bank (EBRD) Schneider Electric Alstom Halifax Scottish Enterprise Anheuser Busch Hammond Suddards Siemens Armstrong-Laing Housing Associations Sight Savers International Arthur Andersen IBM Business Consulting SKF Ascom Interbrew Southco Barclays Bank Kingfisher Standard Life BG Transco KPMG Consulting TPG (TNT Post Group) BootsThe Chemists Bulmers Texas Instruments BP/Burmah Castrol Mars Thames Water BT Mencap UBS Cadbury Schweppes National Power United Engineering Forgings Clariant Navigant Consulting Valmet Corporation (Metso) CIMA Novartis Unilever Best Foods Coors Brewers (Bass) Omgeo West Bromwich Building Soc. De Beers Parker Hannifin Whitbread Deloitte & Touche Pentland Group World Bank

“Beyond budgeting is … a positive idea that uses the abandonment of budgeting as a trigger for improving the entire management control process.”

Foreword by Dr. Charles T. Horngren, Littlefield Professor of Accounting, Emeritus, Stanford University, to the book “Beyond Budgeting” by Jeremy Hope and Robin Fraser, published by Harvard Business School Press in April, 2003. Dr Horngren is the author of “Cost Accounting”, now in its 11th edition.

Beyond Budgeting, 18 June 2003 3 © BBRT 2003 - All rights reserved The message 1. There is an alternative to the 'command and control' management model 2. Abandoning 'fixed performance contracts' is the key to adopting the ‘new model’ 3. This model leads to superior cost management - Case example 4. The first step you can take is to evaluate your ‘case for change’. Dissatisfaction is widespread

Low value process • Takes too much time • Rapidly out-of-date • Adds little value

Goals and strategic guidelines Unresponsive to change Petrochemical Industry Profitability Index in W Europe 600

500 Set targets 400 300 Align incentives 200 Agree actions “Keeping Allocate resources 100 0 on track” Coordinate plans 1984 1986 1988 1990 1992 1994 1996 1998 2000 Source: Chem Systems

Dysfunctional behavior Budget

Control performance

The conventional, but “Fixed” fallacious belief is … Performance Contract

• Period [Fixed] Rising competitive • Target [Fixed] pressure • Rewards [Fixed] Tougher • Plan [Fixed] performance • Resources [Fixed] contracts • Coordination [Fixed] • Control [Fixed] Better performance • Agreed by [Negotiation] • Signed by [Mgr/Dir]

Rolling Shareholder forecasts value models

Budgets Budgets lead to support distortion of short term information decisions

Customer Budgets Aimed at Budgets focus relationship stress sales central on internal Benchmarking comparisons management targets control

Budgets focus Budget contracts on departments dominate rather than strategic activities imperatives

Activity-based Balanced management Scorecard

• ABB, Sweden/Switzerland, Various • Leyland Trucks, UK, Truck manufacturing • AES, USA, Power generation • Rhodia, France, Specialty • Ahlsell, Sweden, Distribution chemicals • Boots, UK, retailing • SKF, Sweden, Ball bearings • Borealis, Denmark, Petrochemicals • Schneider Electric, France, • Bulmers, UK, Brewing industry Electrical products • Ciba Vision, USA, Eye care • Sight Savers Int’l, UK, Charity • Emerson, USA, Electrical products • SlimFast, USA, Food sector • Fokus Bank, Norway, Banking • Sprint, USA, Telecomms • Groupe Bull, France, Computer • Svenska Handelsbanken, manufacturing Sweden, Banking • IKEA, Sweden, Furniture mfg and • Volvo Cars, Sweden, Car retailing manufacturing

Comparison with largest listed universal banks in Europe, Jan-Dec 2001 (after loan losses ) 0.5

Handelsbanken 1.0 HBOS HypoVereinsbank Danske Bank

Commerzbank BNP Paribas %

s 1.5 t e Dresdner* FöreningsSparbanken l ass

a Bank of Ireland* t o ABN Amro Barclays Lloyds TSB 2.0 S E B Nordea Royal Bank of Scotland nses/t Société pe Générale HSBC Den Norske Bank Ex 2.5 Credit Lyonnais Banca di Roma UBS San Paolo-IMI Standard Chartered Deutsche Bank CS Group 3.0 Banca Nazionale del Lavoro BSCH IntesaBci BBVA Unicredito Italiano * Dresdner Bank & Bank of Ireland as at Sept 2001. Source: Deutsche Bank. Running the numbers, March 2002 3.5 100 90 80 70 60 50 40 30 Beyond Budgeting, 18 June 2003 Cost/Incom9 e ratio % © BBRT 2003 - All rights reserved Handelsbanken: Why costs are lower

1. Head office - Fewer layers and people ‘controlling’ the business. Customers 2. Regions and branches - Set up as profit, not cost centres. 3. Group profit sharing scheme - Creates 560 Branch Managers a culture of thrift and cooperation. 4. Frontline responsibility - Leads to lower credit losses. 11 Regional Managers 5. Central services/costs - Exposed to pressure of negotiation, not allocated. CEO 6. Technology - Used to reduce costs Product Companies Treasury, IT etc where possible. 7. Budgeting - Abandoned, and ‘cost entitlement’ mentality eradicated.

Bank to banks (RoE) Region to regions 1. Bank D 31% (RoE)Branch to branches 2. Bank J 24% 1. Region D 38%(Cost/Income etc.) 3. Bank I 2. 20%Region J 27% 1. Branch D 28% 4. Bank B 3. 18%Region I 20% 2. Branch J 32% 5. Bank E 4. 15%Region B 17% 3. Branch I 37% 6. Bank F 5. 13%Region E 15% 4. Branch B 39% 7. Bank C 6. 12%Region F 12% 5. Branch E 41% 8. Bank H 7. 10%Region C 10% 6. Branch F 45% 9. Bank G 8. 8Region% H 7% 7. Branch C 54% 10. Bank A 9. (2%)Region G 6% 8. Branch H 65% 10. Region A (5%) 9. Branch G 72% 10. Branch A 87%

‘Centralized’ ‘Devolved’

KEY Abandon ‘Fixed’ “FIXED” ‘Adaptive’ performance Mission/Vision contracts RadRadicalical devolution Strategy devolution

Annual budget

“Keeping on track” Adaptive Control processes (Versus budget)

Incentives (Versus budget)

“Fixed cycles” “Adaptive processes”

Incremental Aspirational targets goals

Incentives Rewards in advance with hindsight

Annual Continuous ‘Fixed’ planning planning ‘Relative’ Performance Improvement Contracts Variances Relative KPI Contracts against budget controls

Resources Resources Allocated as required

Planned Dynamic coordination coordination

(1) Adaptive processes (2) Devolved organization High • To reduce costs • To retain capable and committed people • To create value continuously • To be innovative • To operate with low costs • To reduce gaming • To be responsive to customers • To encourage congruent behaviour

mance • To be ethical and socially responsible r • To enable devolution. • To create superior shareholder value.

(2)

Competitive Perfo (1) Adaptive & devolved Adaptive organization Traditional processes organization (without budgets) Low (with budgets)

Go to www.beyondbudgeting.org

Market turbulence Market turbulence External pressures Low value processes External pressures Low value processes Dysfunctional behaviour Need Dysfunctional behaviour Need Ineffective use of tools Internal pressures Ineffective use of tools Internal pressures

Strategic goals Importance of goals Strategic goals Importance of goals VisionVision Principles of new model Belief in principles Principles of new model Belief in principles

Setting targets Setting targets Rewarding people Rewarding people CASE Action planning 1. Capable people CASE Action planning 1. Capable people Controlling performance for Controlling performance 2. Innovation for Managing resources 2. Innovation CHANGE Managing resources 3. Operational excellence Change CHANGE Coordinating actions 3. Operational excellence Change Coordinating actions Governance framework 4. Customer intimacy required Governance framework 4. Customer intimacy required Performance climate 5. Ethical behaviour Performance climate 5. Ethical behaviour Freedom to decide Freedom to decide 6. Value creation Capability to act 6. Value creation Capability to act Customer accountability Customer accountability Access to information Access to information

Capability for change Capability for change Capacity for change Change management Readiness Capacity for change Change management Readiness

Robin Fraser [email protected] SEUGI Executive Management Stream Vienna, 17 June 2003