Business Policy, MBA 698 Wednesday, 16 May 2007
Professor Benain
Beyond Budgeting at UBS,
a Strategic Choice
By Dekin O’Sullivan
Table of contents
Table of contents ...... Executive summary...... Introduction ...... I. Positioning...... a) The UBS-SBC merger...... b) The industry...... c) The “Beyond Budgeting” book...... II. Options ...... a) How to theoretically drop budgets ...... b) How dropping budgets works in practice for a bank: the Svenska Handelsbanken case...... c) Strategic objectives ...... III. Implementation...... a) Managing change ...... b) Organization and resources ...... c) Performance ...... d) A perfect system?...... IV. Evaluating the strategy and its execution...... a. The bank as a whole...... b. The International wealth management and Swiss retail and corporate businesses division...... c. Non-financial indicators...... Conclusion...... References ...... Exhibits......
Executive summary
In 2004 – as part of a program to foster a more entrepreneurial culture – UBS decided to do away with the annual budgeting process in its International Wealth Management and Swiss Retail and Corporate Businesses division. In this paper our aim shall be twofold: first to assess the execution of the strategy, second to come up with a recommendation on the basis of what conclusions can be drawn from the assessment. There are mainly three reasons why the division chose to do away with budgets: first, the increase in market volatility due to the recent surge of derivatives; second, the shortening life cycle of financial products (new products are coming out every day, increasing trend towards customization); third, the publishing of a book in 2003, “Beyond Budgeting”, which gave UBS’s executives the idea of abandoning budgeting as a ways of gaining a competitive edge in these new conditions. The strategic issues are clear: need for a more flexible, agile and adaptive organization which can take on more risk and adapt quickly to the market whilst being able to take on difficult economic times without collapsing. This leads to the formulation of strategic objectives by UBS which it is pursuing with this strategy: growth, cost reduction and the implementation of a new entrepreneurial spirit within the organization. The assessment of the execution of the strategy is clear: it is a success both on the financial measures side (growth and cost reduction) and the non-financial ones (culture change). In view of this success, we think that the organization as a hole can benefit from this strategy. We therefore strongly recommend that UBS extend the “Beyond Budgeting” strategy beyond the single Wealth Management and Swiss Retail and Corporate Businesses to its other divisions (Asset Management, Investment Banking, etc.).
Introduction
UBS AG is a diversified global financial services company, headquartered in
Basel and Zürich, Switzerland. It is the world's largest manager of Private
Wealth assets, and is also the second largest bank in Europe, by both market capitalisation and profitability. UBS has a major presence in the U.S., with its
American headquarters located in Manhattan (Investment Banking);
Weehawken, New Jersey (Private Wealth); and Stamford, Connecticut
(Capital Markets). UBS's retail offices are located throughout the United
States, and in over fifty other countries. UBS's global business groups are
Private Banking, Investment Banking, and Asset Management. Additionally,
UBS is one of the leading providers of retail banking and commercial banking services in Switzerland. It currently employees some 78,140 people.
In 2004 – as part of a program to foster a more entrepreneurial culture – UBS decided to do away with the annual budgeting process in its international wealth management and Swiss retail and corporate businesses division. In this paper our aim shall be twofold: first to assess the execution of the strategy, second to come up with a recommendation on the basis of what conclusions can be drawn from the assessment.
In order to assess the strategy, we first need to understand what objectives
UBS was aiming for when it decided to implement its strategy. To do this we therefore start with a positioning analysis where we will try to show that the causes which motivated the decision to “drop budgets” were mainly the enhanced risks of today’s financial markets and the shortening life cycles of financial products. It is important to note that the point we are here trying to make is not that there was a problem with UBS’s budgeting system as such (it
was just as good as any other’s) but that it is certain key issues relating to changes in the financial industry which led UBS to consider dropping budgets as a means to overcome these issues. Once the strategic issues discovered, we then, in a second part, try to show how the option to drop budgets can be considered as, in the present state of things, the only option allowing UBS to achieve a competitive advantage. This second part will end with the statement of the strategic objectives UBS was pursuing, which is to say cost reduction, growth and an enterprise culture change to foster a more entrepreneurial spirit within the organization. We then, in a third part, go on to analyze the actual way UBS implemented and executed the chosen strategy. We finally, in a fourth part, attempt to assess the strategy execution by analyzing its impact on financial and non-financial measures.
In the conclusion, we shall finish with the second aim of this paper, to come up with a recommendation for the future. The reader should always keep in mind that it is not all of UBS’s departments which dropped budgeting budgeting but only one of them, the International Wealth Management and Swiss Retail and
Corporate Businesses Division. This is the bank’s largest division (it accounts for roughly half of its profits) and most successful (world leader in wealth management). One could wonder why then is it that we don’t only focus our analysis on this branch but, for example, analyze trends which affect the banking sector as a whole. It is that, the aim of our recommendation will be to either suggest that UBS stop the strategy, continue as is, or extend it to other sectors of its operations or even to the bank as a whole. What is at stake here is therefore not only one branch of UBS but the company’s future as a whole.
I. Positioning
a) The UBS-SBC merger
Positioning is an analysis which usually contains an external and internal
analysis. Such tools as PESTEL, Porter analysis and SWOT are used.
However, we feel that these tools are best suited for acquiring general
knowledge about an industry, an economy, and how a given company fits into
its environment. This type of knowledge is useful when one either doesn’t
have a strategy yet and needs the necessary information to come up with one
or when one wants to see whether a given strategy idea could be viable given
the conditions. Our case is quite different however. Indeed, we are dealing
with a strategy which has already been put into place. Our aim is to
understand not the general but the specific issues and reasons which led to its
implementation so as to be able to assess the implementation and results to,
finally, deliver a recommendation whether or not to continue with the strategy,
expand it or drop it. We can therefore directly go to the reasons which
motivated the strategic move. In this regard, we must first wonder why is it that
UBS decided to implement its new strategy in 2004 and not before (or later for
that matter) when other banks have abandoned budgeting as early as the
1970s?
A first answer lies in UBS’s recent history. One reason could indeed be that, in
1998, UBS merged with SBC. One of the key success factors was then cost
discipline, as UBS itself admits to on its web site: “During that time, traditional
targets helped management and staff to achieve the efficiency objectives
defined for the post-merger integration.” 1 However, this explanation fails to
explain why UBS had to switch its whole budgeting system, the necessity of
the change once the turmoil caused by the merger had passed.
According to the UBS web site, traditional targets “rarely provided guidance on
how to capture revenue opportunities – a feature that became important in the
following cycle of Global Wealth Management & Business Banking’s
development – the phase of growth and market expansion.” Therefore,
according to this view, there was first a phase of consolidation were traditional
budgets were required, and then a phase of expansion were a new approach
was necessary. The problem is that the new budgeting system is known to
reduce costs compared to the old system, so why not adopt it straight away?
The reason could be that in the post merger turmoil, the new budgeting
system was too demanding and the organization not ready to implement it. But
why then not have implemented it before the merger? And what was the
urgency driving such a big decision? To answer this question we are now
going to look at the changes that have affected the financial industry in recent
years.
b) The industry
In the last decade, the trend in the financial sector has been the explosion of
the derivatives market. Increasingly, multinationals to hedge their risks and
1 http://www.ubs.com/1/e/handbook/0019.html
hedge funds and banks for speculative purposes, have been investing and
trading in ever more complex and volatile derivative products. The complexity,
volatility and novelty of these products have made it increasingly hard for the
financial sector to predict stable earnings or patterns. Big multinationals have
lost a lot of money on the derivatives market and some banks have even gone
bust as in the case of the Barings bank in 1995. A good example of these
derivative products are credit derivatives which are financial instruments that
“derive” their value from the bond market. Credit-default swaps (a type of
credit derivative) reached $20 trillion by June last year. With volumes almost
doubling every year since 2000, some reckon the credit derivative market will
be worth more than $30 trillion 2. Their risk comes from the fact that they can
cover any bonds that are not issued by governments – that is, where investors
face the risk that the borrower may not repay. As Warren Buffet puts it, they
are “financial weapons of mass destruction” 3.
Parallel to this development, banks have been getting ever more creative with
the investment products they offer their clients. There use to be a very small
variety to choose from (stocks, bonds, funds). Now, several new products are
coming out every day, some could be custom made to suit the needs of just
one client. An example of these new “financial vehicles” are for example
exchange traded funds (ETFs). Created in 1990, ETFs are part fund, part
stock. Like an index mutual fund, they track baskets of assets, such as
stockmarket indexes or commodities. But unlike standard funds they can be
bought and sold throughout the trading day, so investors can make, or
2 Cf. “Credit Derivatives, At the Risky End of Finance”, in The Economist , April 21 st 2007 3 Ibid.
reverse, broad bets quickly, without having to buy dozens of stock separately.
Assets held by American-listed ETFs rose about 40% last year 4. Private equity
and hedge funds are some more examples of these financial instruments
which have recently taken on immense importance in the markets. Not all of
these instruments are new but what is is that, thanks to the computerization
and deregulation of the world’s financial markets, they are much easier to
manipulate and can be offered to a much wider range of investors. For
instance, the swap market grew by 1,800 percent between 1991 and 2001 5.
These new products are not just new versions or mixes of old services but are
entirely new classes of products which offer infinite possibilities of variation
(de-correlation from market cycles (ex. : weather derivatives), absolute returns
which is to say increasing returns regardless of whether the market is going up
or down (hedge funds), etc.).
These two developments have therefore forced the industry to move towards
ever greater flexibility as strategic cycles have become ever faster and shorter
and uncertainty has increased. However, this is a situation which is faced by
all banks, but all banks (actually none except for UBS and another we shall
discuss) have dropped budgeting. It is therefore still not sufficient to help us
understand why UBS dropped budgeting. There is indeed a third reason which
is the publishing of a new book in 2003, which we shall now discuss.
c) The “Beyond Budgeting” book
4 “ETFs, Revolution or Pollution?”, in The Economist , April 21 st 2007 5 International Financial Management , by Eun and Resnick, McGraw-Hill, 2004, p. 228.
UBS’s executives read a book published in 2003, Beyond Budgeting by two
Harvard professors, Jeremy Hope and Robin Fraser. In this book, the authors
try to demonstrate that budgeting is, in itself, an obstacle to achieving superior
performances. As Peter Thurneysen, Head Group Controlling & Accounting at
UBS, puts it: “"Beyond Budgeting has inspired UBS not only to shift its focus
away from traditional, detailed budgets but also to take the next steps and
implement plans with adequate levels of detail; and further redirect its focus
toward trend analysis, scenario planning, and rolling forecasts." 6
Why are budgets so bad according to Beyond Budgeting ? It’s that they
represent a fixed performance contract. Rigid adherance to annual fixed plans
and budgets stifle innovation, hindering the corporate response to the
earnings and cost pressures, foreign manufacturers’ entry into domestic
markets, and growing level of competition. Business units become
preoccupied with meeting sales targets rather than satisfying customers.
Salespeople eager to try new tactics are thwarted by rules requiring multiple
signatures authorizing any changes in plan. And above all, the budgeting
process is time consuming and expensive, taking valuable time away from
activities that add greater value. Indeed, for most participants, the traditional
budgeting process starts at least four months before the beginning of the fiscal
year. Operating divisions, business units, and departments receive “budget
packs” that include forms asking for forecasts of sales, profits, and capital
expenditures. The forecasts are reviewed at a high level, and after several
rounds of give-and-take, the budget document is finalized. The budget is a
vast compendium of details. It lists the capital and operational resources that
6 http://www.bbrt.org/bbbook.htm
the corporate center is to make available to operating units, the obligation
made by each unit for the coming year, and the commitments that business or
operating units have made to one another, such as a production unit’s pledge
to meet the sales plan. It also states what will happen to individuals’
compensation if targets are missed or surpassed. Over the course of the fiscal
year, each unit is expected to file regular reports on its progress toward
meeting the targets. Despite the number-crunching abilities of powerful
computers, budgeting remains a protracted and expensive process, absorbing
up to 30% of management’s time. A 1998 study of global companies showed
that on average they invested more than 25,000 person-days per $1 billion of
revenue in planning and performance-measurement processes.
As far as strategy is concerned, the final word is that budgets are divorced
from strategy. According to a recent cover article in Fortune magazine, around
70 percent of companies surveyed were poor at executing strategy-a massive
indictment of the performance management capabilities of budgets 7. The
‘Fixed Performance Contract’ is a coherent part of the ‘Command and Control’
management model, widely used today but now outmoded. In a fast changing
economy and under high competitive pressures, managers are driving the
traditional approach well beyond its design limits, and the cracks are becoming
evident.
II. Options
7 “Who needs Budgets?”, in Harvard Business Review, Feb. 2003
a) How to theoretically drop budgets
Where does UBS go from here once their external analysis has revealed the
need to become a more agile organization and the internal analysis that a
great part of the problem could be coming from the way they manage
budgets? What options are available? One could ask whether there were no
other options than abandoning budgeting. The answer is obviously yes. One
can hire and train more derivative and risk management experts, expose
themselves less to risk by reducing their exposure to risky markets, hire more
researchers to come up with new products (new financial investment tools,
etc.). However, like all banks, UBS has done this. But, unlike all other banks,
one of its divisions has abandoned budgets. This is thus clearly a strategy
aimed at giving them a competitive advantage. This reason alone justifies that
we now focus on the budgeting strategy to see whether it has, or not, achieved
the desired results.
So again, back to our question, what do you do once you have recognized that
budgeting is a problem? How do you drop budgets? Again, the answer comes
from Beyond Budgeting . Its authors argue that, in the absence of budgets,
alternative goals and measures – some financial, such as cost-to-income
ratios, and some non-financial, such as time-to-market – move to the
foreground. And business units and personnel, now responsible for producing
results, are no longer expected to meet predetermined, internally selected
financial targets. Rather, every part of the company is judged on how well its
performance compares with its peers’ and against world-class benchmarks.
Some project leaders estimate that they have saved 95% of the time that used
to be spent on budgeting and forecasting. In companies using these standards
of performance, business units become smaller, more numerous, and more
entrepreneurial. Strategy becomes a grassroots endeavour. The aggregate
result of many small teams exploiting local opportunities is a much more
adaptive organization. In other words, exactly what UBS needs to cope with an
ever faster market and strategic cycle. In many companies who have
abandoned traditional budgets, rolling forecasts that look five to eight quarters
into the future play an important role in the strategic process. The forecasts,
typically generated each quarter, help managers to continually reassess
current action plans as market and economic conditions change. Without
budget expectations to worry about, staff members can do something with the
nonconforming customer and market information they collect – other than hide
it. The reporting of unusual patterns and trends as they unfold helps the
business avoid shortages or overages and formulate changes in direction.
Instead of being imposed from above, strategy seeps up from below.
b) How dropping budgets works in practice for a bank: the Svenska Handelsbanken case
All of this isn’t just nice theory. Many companies have actually abandoned
budgeting in practice. But how can UBS know it is a workable solution for a
bank? The answer is by looking at how it worked for the only bank who had
adopted it at the time, the Svenska Handelsbanken. Actually, the Svenska
Handelsbanken is a perfect case study because, having abandoned budgeting
as early as the early 1970s, one can see the long term viability of such a
move, or in other words, its real value as a strategy. Since it abandoned
budgeting, the bank has outperformed its Scandinavian rivals on just about
every measure, including return on equity, total shareholder return, earnings
per share, cost-to-income ratio, and customer satisfaction. It produced an
annual total shareholder return of 24% between 1979 and 2001 – a rate 33%
higher than its nearest rival. Annual earnings per share grew at a rate of
10.9% from 1990 to 2000. Handelsbanken is also one of the world’s most
cost-efficient banks, achieving a cost-to-income ratio of 45% in 2001; at most
international banks, the ratio is over 60%. Few of its loans go bad, largely
because the bank has a policy of giving frontline people responsibility for
authorizing loans. c) Strategic objectives
Now that UBS has identified their strategic problem (shortening strategic life
cycles due to higher market volatility and shortening product life cycles), have
found an option to pursue (abandon budgets) and received proof of the
option’s viability (through the Handelsbanken case study), we can understand
the strategic aims set by UBS executives which they hope to achieve by
abandoning budgeting. In an interview given to Zfo, Anton Stadelmann, Chief
Financial Officer of the Wealth Management and Business unit of UBS and
member of the Group Managing Board, gives three strategic objectives
pursued by the division by abandoning budgeting. The two first ones are
financial: “We are pursuing the aims of cost reduction at the same time as
growth.” 8 The third is non-financial and relates to enterprise culture: “Whether
you can stand by this model depends on your view of human nature. We trust
our employees to be able to live this culture, that they want to be better every
day, and that they want to help others to be better too. That is our view of
human nature. If we succeed in persuading the majority of our employees to
live this consistently, then we will be an attractive employer for
entrepreneurially-oriented employees. We will be attractive to people who are
committed to this view of human nature. This would be a great competitive
advantage in the longer term... We would like to be seen as the bank of choice
by people on the job market who want to take entrepreneurial action. Perhaps
UBS can also make a modest contribution to increasing understanding that
people can actively create their own future.” How are these objectives related
to the issues we previously discussed? Obviously, by pursuing them, the
Wealth Management branch of UBS will be able to become leaner (cost
reduction), meaner (growth strategy), both of which will help it to at the same
time take advantage of new opportunities in the markets (risk) and overcome
the downturns in rough times (quick response time, financial cushions). It will
also be able to better cope with increasing customization demands and
shortening life cycles of products (the entrepreneurial spirit which allows
employees to take on responsibility for dealing with these situations).
However, we can see that the strategic objectives go beyond the only issues
of market volatility and product life cycles. Whilst permitting to cope with thises
issues, they are much broader and general. This is because the move to go
“Beyond Budgeting” was not only motivated by an analysis of industry trends
8 “Leadership statt Budgetierung”, in zfo, April 2005
and UBS’s position in the market, but also by the publishing of a book. UBS
can therefore also pursue the other benefits which come with abandoning
budgets. Indeed, the move to go “beyond budgeting” frees the company to
adjust much better and quicker to any new issues and situations. In this sense
it is kind of a meta-strategy, meaning that it is a strategy which enables other
strategies and their creation. It is also from this perspective that going beyond
budgeting can help UBS achieve more growth, cost reduction and an
entrepreneurial culture.
We can see here that the main issue is not how to achieve greater
predictability in the face of ever more volatile markets and changing customer
demands. On the contrary, the move aims at achieving more flexibility as to
better respond to an unpredictable environment. We shall now look at how
UBS implemented (executed) the strategy. This will then bring us to our last
part which deals with assessing the strategy’s execution.
III. Implementation
a) Managing change
The most crucial part in the implementation phase of a strategy is first
convincing the executive board to give strong financial or moral support,
second to convince the rest of the organization to endorse it and change their
old ways of doing things. This is why UBS put into place a three step
communication plan at the beginning of the project. Indeed, according to
Anton Stadelmann, before deciding to go ahead with the project, the
company’s top executives all met in a room for three days to discuss the
viability of the strategy and its implementation 9. Once all executives were
convinced of the need for change, that the new strategy was the right thing to
do and consensus was reached, UBS then moved on to communicate with its
key stakeholders. Finally, it communicated its new strategy to all its
employees, mainly through seminars. The main sort of resistance UBS
encountered at the beginning was that people had a hard time getting used to
working without fixed guidelines, so the emphasis in the seminars was not put
so much on training than on informing, getting the employees to feel the need
to change and feel secure about taking on more initiative.
b) Organization and resources
Entrepreneurial leadership involves decision-making, taking a commercial
approach that balances income, cost and risk. This had a direct implication on
the role of managers – and on the scope of their authorities. They decide on
staffing levels for their units, on the skills required by their teams and on local
marketing activities – and they are held accountable for them and, ultimately,
for the unit’s performance 10 . In other words, additional investments are
expected to yield additional revenues. Employees also have more
responsibility. Client advisors now formulate their own business goals, and
decide how best to achieve them. In traditional budgeting systems, inflexible
cost targets can have the perverse effect of limiting the amount of business a
unit takes on. At UBS, branches have the authority to decide whether the
9 Cf. “Leadership statt Budgetierung”, in zfo, April 2005 10 http://www.ubs.com/1/e/handbook/0019.html
income generated by, say, opening many new accounts is worth the higher
costs those accounts will entail 11 .
c) Performance
How does UBS set and manage performance targets in the absence of
budgets? As Stadelmann puts it: “We are replacing the budget with internal
benchmarks as our reference points for performance appraisal.” 12 The new
process ensures clear strategic direction by a simplified top-level five-year
business plan 13 . It focuses on strategic projects and initiatives that support the
priorities of the business. Operational leadership is supported by a five-quarter
rolling forecast which allows senior management to react quickly to changes in
the market environment and initiate corrective measures immediately, if
required.
This type of decision-making requires enhanced transparency and granularity
in management information. As budget figures – the traditional point of
reference – are no longer available, current performance is measured against
actual results achieved in the previous periods and benchmarked to the
performance of a defined group of peers 14 . This encourages managers, client
advisors and other employees to identify best practices and, through an active
exchange of ideas, ways to learn from each other. In this context, managers
11 Ibid. 12 “Leadership statt Budgetierung”, in zfo, April 2005 13 http://www.ubs.com/1/e/handbook/0019.html 14 Ibid.
increasingly take the role of coaches who encourage and support their
employees to exploit their full potential and fulfil their own ambitions.
Some might argue that putting each part of the organization in competition
with the others might be destructive to the company as a whole, leading to
such behaviours as not wanting to share information and the like. Anton
Stadelmann’s answer to that is that such behaviour is not compatible with the
company’s new culture and that UBS is, more and more, institutionalizing the
information collection (making it compulsory for teams to store and report what
they learnt from their projects) so as to turn UBS into a knowledge center that
feeds on its experience 15 . Moreover, departments don’t just compete on
internal benchmarks but on external ones as well (the performance of
competitors with respect to the same measure), which forces the different
teams to work in cooperation so that the organization doesn’t lag behind as a
whole.
It is thus fair for the wealth management division of UBS to claim: “We have
not partially abolished budgets, we have abolished them altogether. We only
budget at management board level, and that in the sense of strategic
considerations, without breaking these down further.” 16 But, one could argue,
doesn’t the system introduce a risk of chaos, every department and team
going its own way, rendering any overall strategy impossible? Stadelmann
says no: “ “beyond budgeting” does not mean, “beyond planning.” In fact, there
15 “Leadership statt Budgetierung”, in zfo, April 2005 16 Ibid.
is more planning than before: “We have probably never planned as intensively
as we are doing today. However we are planning something quite different
now. We are not planning more budget figures, but instead, actual market
activities, and are finding out where we can create value and where we can
tap potential. This planning is being done much more seriously. But it has
nothing to do with bureaucracy.” 17
d) A perfect system?
Even though all of these measures are steps in the right direction, does UBS
stand the comparison in this operational level with competitors who have gone
the same way? Here we realize that there are certain areas which can be
improved upon.
Firstly, the idea to drop budgets completely is not applied to all of UBS’s
departments but only to one, its international wealth management and Swiss
retail and corporate businesses, which is itself a sub-division of the global
wealth management and business banking unit. Even though this is UBS’s
largest division, which inevitably has an impact on the company’s culture as a
whole, this seems to indicate a certain reticence in the administration of the
strategy which is made apparent when one compares UBS to a bank like the
Svenska Handelsbanken which has been using such a system since the
seventies and is considered best-in-class for its use of the system in the
industry.
17 Ibid.
Indeed, a comparison first shows that UBS did not go the full way in its pursuit
of a flexible, open organization. Handelsbanken seems to have taken the
issue a step further by doing away with organizational charts all together 18 .
The spans of control at Handelsbanken are therefore very wide, precluding
micromanagement. “The few decisions that require high-level approval are
kicked upstairs almost immediately. An answer usually arrives within 24
hours.” 19
Another part of the organization which seems weak when compared with
Handelsbanken is the compensation scheme. UBS still has the traditional
team bonus for performance system which, when coupled with the inherent
competition amongst the company’s teams brought about by the new
organization, can lead to disruptive behaviour (not sharing of information,
stealing each others’ customers, etc.) which destroys the cohesiveness of the
company as a whole. We saw that UBS had answers to such concerns
(institutionalization of information, company culture, etc.), but Handelsbanken,
again, went a step further. Indeed, two policies at Handelsbanken keep
competition and cooperation in balance 20 . One requires every customer to be
attached to a particular branch; this avoids disputes over who gets the benefit
of a customer order that has been handled by two branches. The other puts a
portion of the company’s profits in a companywide pool from which every
employee derives an equal share, irrespective of seniority or individual
18 Cf. “Who needs Budgets?”, in Harvard Business Review, Feb. 2003 19 Cf. “Who needs Budgets?”, in Harvard Business Review, Feb. 2003 20 Ibid.
performance. Thus, apart from securities traders, no one at the bank is rewarded for reaching a predetermined target-nor are branches even rewarded for doing well in a performance-league table. Individual and unit rewards consist of peer recognition and praise. Consequently, branches feel safe sharing information about customers. Some might argue that such a reward structure gives a free ride to managers who produce little in the way of results; On the contrary, a team-based and open organization like
Handelsbanken that is governed by peer pressure exposes free riders very quickly.
So the question is why did UBS not go all the way in implementing its strategy? One answer can be that this probably constitutes a big pilot project.
Instead of going full on with such a complex and daring project, management preferred to use the company’s division which was most fit to experiment with such a system. Expansion to the rest of the divisions would then be conditioned on the success of this “pilot” project (we put brackets here because pilots are usually small projects). If this is the case, it is a wise decision, but this answer only tells us why UBS didn’t apply the strategy to all of its divisions not why it didn’t apply the strategy fully in its pilot division (the international wealth management and Swiss retail and corporate businesses division). To explain this we could probably argue that UBS is a too big of a bank to do away with things like organizational charts and traditional compensation schemes. Handelsbanken is, indeed, a midget compared to
UBS (2.8 bn Swiss Francs of profit for Handelsbanken in 2006 and 10,000 employees against over 11 bn for UBS and 80,000 employees), probably
making it easier to cope with such a flexible and open organization. There is
also a cultural aspect to be considered. Indeed, Handelsbanken has been
experimenting and implementing this strategy for decades, UBS for barely two
years, the corporate culture thus had the time to adapt. Also, the Nordic
countries are much more collectivist, so a collective reward system is probably
more natural to them than it would be in a bank that operates all around the
world. Here we see that the implementation of a strategy is in itself a strategic
issue.
Only time will tell which one of these theories is the right ones and if UBS used
the right method to implement its strategy. We can, however, try to assess the
impact and the success of the strategy execution up till now.
IV. Evaluating the strategy and its execution
The question now becomes: how do you assess the execution of a strategy
when you don’t have a budget? Budgets give financial targets against which
one can easily compare the actual figures to measure the degree of success
of strategy execution. These are precisely the kind of tools we don’t have any
more. Another issue is that UBS has only carried out its new strategy for about
two years whereas such an ambitious move can only really be assessed in the
long run, giving time for the whole company culture to change. In the absence
of budgets we shall see if we can infer, from some key financial indicators, that
UBS has been moving towards the stated strategic financial targets: cost
reduction and growth 21 . Due to the fact that the strategy has only been put into
21 Cf. “Leadership statt Budgetierung”, in zfo, April 2005
execution for a short time, we shall try to identify trends which suggest future
directions the business is going. We shall then finish with an assessment of
the non-financial objectives.
a. The bank as a whole
The bank as a whole saw its operating income grow by 35% since it
abandoned budgets in 2004 22 (against 10% from 2002-4). Though operating
income stayed at the same level of growth from 2004 to 2005 than from 2003
to 2004 (11%), growth nearly doubled from 2005 to 2006 (18.23%). On the
other hand, even though 2006 profits reached a record high (SF. 11.249
billion), they only represented a 19% increase compared to 2005, whereas
2005 and 2004 profits represented 28% and 27% increases respectively
compared with previous years. However the cost over income ratio has been
steadily declining from 2003 to 2006 (73.2%, 70.1% and 69.7%), suggesting
that costs are being controlled and even curbed.
One can argue that these excellent results could be only due to the fact that
2006 was simply an excellent year for Switzerland as a whole, every major
Swiss company beating expectations and breaking profit records. To test
whether this hypothesis is true, we can compare UBS’s results with
Switzerland’s second biggest bank, Credit Suisse. 2006 was also a record
year for Credit Suisse with SF.11,3 billion in net profit (even though 1.3 bn
come from the sale of Winterthur, an insurance company). However, Credit
22 Refer to exhibit 1 for this analysis.
Suisse’s cost trends tell a whole different story. In 2003, the cost over revenue ratio was a whopping 94.49%. Things normalized after this exceptionally bad year in 2004 with the ratio going down to 81% only to go up to 85% the next year and back down to 78% in 2006 (however, if we exclude the Winterthur sale which came a little as a last minute surprise the ratio would have probably stagnated around the 80% mark). In any case, the Credit Swiss cost over income ratio follow an erratic trend, to say the least. This simply reflects the industry’s high cost ratio and unpredictable nature as we discussed in the beginning of our paper. What is here remarkable is that, even though in the same industry and country, of comparable size and competing on the same markets, UBS has a 10% lower cost to income ratio than Credit Suisse and it is declining on top of that. The difference must therefore be in the management strategy of the bank. What is for sure is that the bank is achieving its aim of managing growth whilst curbing costs. But how much can be attributed to dropping budgets? Since it is the International Wealth
Management and Swiss Retail and Corporate Businesses division which fully implemented this strategy, we can only answer this question by analysing the division’s financial data and how it relates to the business as a whole. b. The International wealth management and Swiss retail and corporate businesses division
The division is itself a sub-division of UBS’s global wealth management and business banking unit. The division’s total income for 2006 was SF. 10,798 bn, its total operating expenses were SF. 5,595 bn and total profit before taxes
was SF. 5,203 bn 23 , that is 23%, 17% and 46% respectively of the bank’s total
income, operating expenses and profits. The division’s performances thus
have a great and fundamental impact on the group as a whole. How, precisely,
do the division’s performances relate to the bank’s?
Income from the division rose by 17% and 20% through 2004 to 2006.
However, expenses only rose 13% and 15% through the same period (as a
comparison, the bank’s expenses rose by 6% and 18% respectively. The
division thus has much more stable and controlled cost curb). This allowed the
profits of the division to keep an amazing 22.5% and 25% growth in 2005 and
2006 (remember that the same figures for the bank gave 28.3% and 19.14%
respectively). This is after experiencing negative growth in 2002 after the dot-
bubble burst. Income before taxes only begins to really going up again in
2004, when the strategy was implemented 24 .
The most impressive remains the cost over income ratio which dropped by
6.3 percentage points (from 61.6% to 55.3%, a 45 percent drop) in 2004, the
year the division implemented the strategy 25 . The ratio was, from 2004 to
2006, 55.8%, 53.7% and 51.7% respectively 26 (a 4 percentage point decrease
in 3 years). Recall that the bank’s cost over income ratio was 73.2%, 70.1%
and 69.7% over the same period. The division’s cost over income ratio is thus
18 percentage points below the bank’s in 2006 and 11 percentage points
23 Refer to exhibit 4. 24 Cf. exhibit 3 25 Cf. exhibit 7 26 Cf. exhibit 6.
below the global wealth management and business banking unit 27 . How does
the division explain such a good performance? “The cost / income ratio
improved to 51.7% in 2006 from 53.7% a year earlier. The cost / income ratio
has improved for the fourth consecutive year despite the rise in costs in pursuit
of our global expansion strategy. This improvement reflects the strong rise in
income due to a higher asset base and higher volumes in Lombard lending,
which more than offset the increase in personnel expenses (mainly headcount
increase and performance-related compensation) and higher general and
administrative costs.” 28 This statement seems to show that the division’s
performances are indeed at least partly coming from the implementation of the
new strategy since it seems to have encouraged the division to take on more
risks to take advantage of a bullish market (increase in Lombard lending)
whilst curbing costs (probably due to management’s new found ability to
directly decide their level of staffing and resource needs). In a traditional
budgeting environment, the level of new business the unit could take on would
have been limited a priori by the imposed budget envelop at the beginning of
the year (they couldn’t have taken on more business because this would have
obliged them to go over their budget allocated for expenses). Given the
division’s extremely heavy weight in the company, we can thus conclude that
it’s strategy helps the bank as a whole to improve profitability by generating
more income (through more aggressive and creative tactics to gain market
share), lowering the cost and cost over income ratio curbs and thus finally
greatly contributing to profits (nearly 50% of UBS’s total profits).
27 Refer to exhibits 1, 4 and 5 for this analysis. 28 Cf. 2006 Financial Report.
c. Non-financial indicators
But financial performances are not the only objectives of the bank. Going
beyond budgets has also brought the company other advantages. First of all,
in the way it communicates to markets: “We provide very few financial-
performance commitments,” says Mark Branson, the company’s chief
communications officer 29 . “Our experience shows they are counterproductive,
building pressure for short-term action to save the credibility of forecasts. In
effect, we show analysts and investors how the business works. This shifts the
emphasis from meeting short-term promises to improving our competitive
position year after year. The result is much more accurate interpretation of our
results and news flow, meaning less volatility in our shares. Analysts like and
respect our approach. They no longer ask for numbers-based forecasts.”
There is another non-financial objective the company had in mind when
implementing its strategy: “ “Whether you can stand by this model depends on
your view of human nature. We trust our employees to be able to live this
culture, that they want to be better every day, and that they want to help others
to be better too. That is our view of human nature. If we succeed in persuading
the majority of our employees to live this consistently, then we will be an
attractive employer for entrepreneurially-oriented employees. We will be
attractive to people who are committed to this view of human nature. This
would be a great competitive advantage in the longer term... We would like to
be seen as the bank of choice by people on the job market who want to take
29 Cf. “Who needs Budgets?”, in Harvard Business Review, Feb. 2003
entrepreneurial action. Perhaps UBS can also make a modest contribution to increasing understanding that people can actively create their own future. This could be an approach that has an impact and encourages people.” It is obvious that such an objective is impossible to measure on a two year time span as implies a complete change of culture. There is, however, one way of assessing what the bank’s future employees might look like. Indeed, the type of people the bank wants to attract are often seeking for companies that not only display strong financial results but that also stand out from a management point of view and for the prestige their name carries with it. One of the most commonly used ways of assessing these two types of factors are awards. In
2004 (the year UBS’s wealth management and Swiss retail and corporate businesses division launched its beyond budgeting strategy), BusinessWeek named UBS the world’s 45 th most valuable brand in the Global Scoreboard. In
2005, Business upgraded UBS to 44 th spot. Since 2004, UBS won twice in a row Euromoney’s “Best Global Private Bank” award (an award which directly relates to the wealth management division…). But UBS doesn’t just receive awards for its performances. Indeed, the company was named one of the 100
Best Companies for Working Mothers living in the U.S. in 2006 for the fourth consecutive year by U.S. based Working Mothers magazine. In the light of these awards and of the many more that it will probably receive, it is of little doubt that the bank will encounter little trouble in attracting the kind of people it wants. As for the employees whom are already part of UBS, only time will tell if they will be able to change.
Conclusion
Our aim at the beginning of this paper was twofold: first assess the execution of the “going beyond budgeting” strategy. As far as this point is concerned, one thing is for sure: given the company’s incredible success these last few years, the strategy to go “beyond budgeting” has not broken the tremendous winning machine UBS has become in its 95 years of existence. This means that, at the least, it is not a harmful strategy. Only time will tell just how much this new strategic inflexion will bring more to the company. The strategy’s ultimate test will probably be to see if it is capable of keeping UBS above competition in times of turmoil and not just in times of strong economics, as was the case till now. As UBS is the only bank to have undertaken this strategic move and that it is precisely a branch which is world leader in its sector (wealth management), there are strong reasons to believe that this new strategy is a competitive advantage. Indeed, from what we have seen and tried to show, the implementation of the strategy has been a great success, both on financial and non-financial grounds.
The second aim of this paper was to come up with a recommendation for UBS concerning its strategy: should it drop it, keep it or extend it? In view of the evidence our analysis has discovered, we can only encourage UBS to now extend the implementation of the strategy beyond the Global Wealth
Management and Swiss Retail and Business Banking division to other parts of its business and, why not one day, to all of it. One could question whether it could work as well in divisions which serve different functions and aims
(investment banking, asset management, …). Our answer is that, first, the
issues encountered by the private banking division (global wealth management) affect the banking and financial sectors as a whole. Second, dropping budgets is not simply a strategy, it is also a meta-strategy, meaning that it normally allows an organization to become more flexible and enables it to better implement and change any other past, present or future strategies.
The hole of UBS could thus drop budgets and still have its different units pursue various sub-strategies whilst unifying the hole company as regards to key strategic aims: cost reduction, growth and an entrepreneurial culture.
References
Publications:
“Who needs Budgets?”, in Harvard Business Review , Feb. 2003
Beyond Budgeting , by Jeremy Hope and Robin Fraser, Harvard
University Press , 2003
“Leadership statt Budgetierung”, in zfo , April 2005
“Credit Derivatives, At the Risky End of Finance”, in The Economist ,
April 21 st 2007.
“ETFs, Revolution or Pollution?”, in The Economist , April 21 st 2007
International Financial Management , by Eun and Resnick, McGraw-
Hill, 2004.
Internet resources
UBS financial report 2003, 2004 and 2006 at :
http://www.ubs.com/1/e/investors/annualreporting.html
The beyond budgeting approach explained on UBS’s website:
http://www.ubs.com/1/e/investors/annual_reporting2005/handbook/0019.htm
l
The website of the Beyond Budgeting book: www.bbrst.org
Exhibits
1. UBS Income statement, 2006
Source: http://www.ubs.com/1/e/about/keyfigures.html
2. Wealth Management International & Switzerland compared to other
units.
Source: 2006 Financial Report, p. 29.
Exhibit 3
Wealth Management International performances before tax
6000
5000
4000
3000 Series1
2000 CHF million CHF
1000
0 2001 2002 2003 2004 2005 2006
Sources: 2003 and 2006 Financial Reports.
5. Wealth Management International and Switzerland Income Statement, 2006
Source: 2006 Financial Statement, p. 33.
6. 2006 Cost/income ratio for UBS’s Wealth Management International and
Switzerland
Source: 2006 Financial Report, p. 33.
7. Cost / income ratio 2002-2004
Source: 2004 Financial Report