THE STORY
Well, here we are in the middle of March Madness, when Americans go nuts over college basketball. Millions of people choose who they think is going to win all the games. Warren Buffet is giving out a billion dollars to anyone who chooses the correct outcome for every game in the NCAA basketball tournament.
The Wall Street Journal has come up with their own version
of how to pick the teams. They put together a site where the names of the
colleges are eliminated. All you have to look at are statistics. Over the
years, they have found that people are more accurate at choosing winners if
they are not biased by seeing the team name before making their choice.
They call it the “blind” bracket. I guess sometimes we see
better when we are blind.
We all have built-in biases. These biases affect our objectivity. Eliminate the bias and we make better choices. This is true in picking the winning college basketball team. I believe it would also be true in business budgets.
Most companies have horribly uncreative budget processes.
They consist of little more than just taking last year’s numbers and tweaking
them a little (sales go up a little and costs go down a little). And even with
that, the budget targets are often missed.
I think the problem has to do with too much familiarity with
the company divisions. This creates biases anchored around the status quo (what
we know). I believe we would get better budgets if we could do it more blindly
(like the Wall Street Journal Blind Brackets).
Why do I say this? Look at how most companies do M&A
work. The M&A folks tend to know less about who they acquiring than what
their company knows about their own divisions. Yet the M&A people tend to
do a much better job of thinking through their forward forecasts than the
budget folk.
The M&A crew tends to look as much as 10 years out and
do sophisticated discounted cash flow (DCF) analyses. They try multiple
scenarios, with different levels of investment and synergies. They look at ways
to change the business model in order to justify the acquisition premium.
All this for an outside company they are somewhat blind to.
Yet, for our own divisions, which we should know far more intimately, we take a
far less sophisticated approach—just look out a year or so and do a small tweak
on what was done last year. Something here just doesn’t seem right.
The principle here is that budgeting processes won’t dramatically improve unless we find ways to reduce the bias towards the status quo. There is no reason to believe that the status quo optimizes the current portfolio. We don’t expect the status quo for acquisitions. Why should we expect any less for our divisions?
Short Time Frame
The problem with a one year budget time frame is that one
year is usually too short to complete a radical transformation of a division. In
a radical transformation, the first year typically has added investments and a
disruption of sales. As a result, if you are only looking one year out, the
budget for a radical transformation scenario looks awful.
What executive wants to accept a budget where sales go down
and costs go up? They know that the status quo looks a lot better than that, so
they opt for a minor tweak of incremental improvement rather than the first
stage of a radical transformation into a far better future.
That’s why companies like Kodak couldn’t make the radical
transformation to digital imaging. The bias towards the status quo looks so
much better only one year out. Unfortunately, as you string together a series
of these “one year out” budgets, you never get around to making the
transformation. It keeps getting tabled for an unknown future date until it is
too late.
I’ll bet that if Kodak had not already been in the
photography business, and had their M&A team examine the business (more
blindly), they would have come back with an aggressive transformation to
digital imaging as a condition to purchase.
Go Blind
Is there anything we can do to reduce the bias and budget
our divisions more blindly? Sure, perhaps we could make the budgeting team act
more like an M&A team that looks at outside businesses more objectively on
a longer DCF basis. Or maybe you could disguise a few of your divisions (without
the division name) and give it to the M&A team to look at as an acquisition
and see what they come up with.
I know that many investment bankers (and activist investors)
look at companies from the outside (somewhat blindly) and make proposals about
how a company can do something radically different with their assets. I’m not
saying they are always right, but at least it can stimulate some non-status quo
thinking.
Right now, a lot of these suggestions come unsolicited. What
if you proactively sought out more of these less-biased points of view from trusted
outsiders?
Even something as simple as benchmarking and best practice
analyses could provide a new perspective on what to do differently. These potential
budget-line inputs are not biased by what YOU do, but by what best-in-class do.
And it could be something radically different.
The Importance of
Pursuit
Over the years, I have continually stressed the threefold strategy
requirements of:
1.
Positioning (A place where you can win)
2.
Pursuit (Having the Competencies and Capabilities
needed to win)
3.
Productivity (A business model that can earns an
optimal profit off the winning position)
In the typical one-year budget cycle, it is usually assumed
that the positioning stays about the same and the focus turns towards getting
more productivity out of the status quo model. The issues of pursuit are rarely
discussed.
But pursuit is a critical component to success. If you want
to grow, you need to build the capacity to effectively handle that growth. This
includes the size of your sales force, the limits on your current supply chain,
the capacity of your IT systems, and so on. If you don’t plan in radical
changes to capacity, then you won’t effectively be able to capture that growth.
You also need to build in radical improvements to
competencies. The world is changing. Today’s status quo is tomorrow’s obsolescence.
Are you staying on top of what you need to know to win in the future? How’s
your R&D spending? How about educational programs? Are you pro-actively bringing
in new talent with the new knowledge you will need?
We can often miss these pursuit issues in a typical
budgeting process because of that bias towards the status quo. It makes us
falsely believe that we already have the capacity required and competencies
needed. After all, we are only tweaking the status quo for the next year.
As a result, the needed step-wise leaps in capacity and
competencies never get into the budget. Eventually, that chokes the division’s
ability to do what is needed. Then, even the status quo no longer works any
more.
I dare say that if we were looking at are divisions more
blindly, as we would an acquisition, we would do a better job of factoring
these types of investments into our analysis.
Biases tend to cloud our judgment and make us less objective. This is particularly true when it comes to annual budgets. The bias towards the status quo keeps us from seeing a more radical—and much brighter—future. By changing up the typical budgeting process and adding blinder, more objective eyes, we can find these radical transformations and incorporate into the budgets the radical “pursuit” changes needed to make them a reality.
Most vision statements talk in some way about being leaders or best-in-class. Achieving exceptional results like that don’t come from perpetuating the mediocre status quo past. So why accept a budgeting process which encourages perpetuating the mediocre status quo past?
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