Authored by Ravi Gilani, Founder and Managing Consultant, Goldratt India and Ira Gilani, Director, Goldratt India
This article was originally published in Outlook Business Magazine.
It seems that as there are seasons in nature, there are seasons in large organizations as well. For example, people in many large organisations are totally occupied in the last quarter of the financial year in an activity called budgeting. You can observe this even as an outsider, since you can see people hurrying from one place to another, with all the meeting rooms being completely booked; so much so that even family members know not to disturb the employees unless there is some life-threatening situation. After the budget season comes the appraisal or review season. Once again, one can observe anxiety writ large on the faces of employees. It does not matter whether one is in the top 10% or bottom 10%.
Though organisations invest a lot of time in these annual rituals, what is the net impact? I have never witnessed any budget where budgeted profit is less than the previous year’s profit. Are companies able to increase their profits year after year? As per a survey published in a business newspaper on September 24, 2005, only 23 out of 3,000 organisations listed on the BSE could continuously increase their profits year after year in the previous decade. And since there was no meltdown from 1995-2005 in India, most organisations were not able to achieve the goal of making more and more money period after period. I believe that the situation is not better in 2015 either. Each year, managers and top management spend weeks and months negotiating targets, with both sides playing the regular annual game. At the end of the day, the entire process leaves the team exhausted.
Most organizations have a large number of metrics for every business unit, division, department, employee level and band. I have observed that most senior executives are familiar with local measurements but are ignorant of the overall financial measurements. Most organisations measure a large number of local metrics and, at times, local measurements are in conflict with each other. For the average employee, seeing the effect that any action has on net profit or return on capital employed or free cash flow is impossible. Often, the constraint of the organisation is a wrong measurement.
The only purpose of measurements is to take appropriate corrective actions. At the organization level, a few simple parameters are good enough. I have observed that at every organization, there is a missing link between global and local parameters. Measurements are useful only if everyone is able to relate these to global parameters. In case of conflict, global parameters supersede local parameters. This requires challenging the commonly held belief that financial measurements cannot be simplified enough to be understood by everyone. Finance can and should be simplified as there is a definite need for financial literacy across corporate India.
In one of my previous assignments, the unit had been losing money for the previous seven years and the decision-makers were considering closing the unit. Here, the constraint of the unit was cash availability for meeting the vendor payments on time. Correspondingly, all the supplies were also delayed, resulting in delay in dispatch of finished products to its customers. Cash was available from the head office but the finance manager was not seeking it because interest cost would increase, and his KRA was interest cost control.
Before suggesting any changes to the current process, let us first understand why budgets are required in the first place. What are the desirable effects of annual budgets? Is it to achieve higher performance or prevent complacency? Or is it to identify high performers and segregate good from bad? How about motivating everyone to give their best?
Most Indian organisations have severe negative side effects built in the budgeting process. Managers take conservative targets. On the other hand, top management then demands totally unrealistic targets. A significant amount of time of managers and top management is invested in the budgeting process. If the objective of budget process is to set ambitious targets and enable employees to take ownership of these targets, could there be an alternative process? The team could set and try to achieve ambitious targets if and only if they have a safety net in case these ambitious targets aren’t achieved. The decision-makers must assure the managers that in case the ambitious targets are not achieved, there will be no repercussions as long as these are better than the past results. Will this not lead to people becoming complacent? My experience has been the other way round.
I have experienced that a small change in the approach to budgets can lead to a huge transformation in the outcome. To set ambitious targets, the focus should be on a few parameters chosen by decision-makers. Now, the managers need to collectively decide the ambitious targets without taking into account current perceived constraints. Once the targets are decided, team members detail the possible obstacles for achieving these targets. Thereafter, the team generates a game plan for overcoming all the possible obstacles raised by everyone involved. Expansion plans are to be planned on current cash availability rather than expected cash generation during the year.
Most organizations do have some form of periodic formal review, where the CEO reviews with the mangers either individually or collectively. Often, the review frequency is monthly. But what is the purpose of the review? Is it to find the reason for variance of actual results with budget parameters or find the culprit? Or take corrective action? In my experience, the current review process in most organisations is rather quite frustrating. In the rare event of targets being achieved, complacency sets in.
I once participated in the quarterly review of a global software organization. The participants travelled from all parts of the globe for this one-day review. First, there were severe disputes about the data presented. In all, it took six hours to correct and validate the data presented. The next 90 minutes were invested in sharing the reasons for variance. Just about 30 minutes were left for corrective actions. One can understand the feelings of the mangers who flew all the way from the other side of the globe.
So, what should be done? Since the purpose of reviews is corrective action, the shorter the interval between reviews, the better they will be. In most cases, a week is good enough. There should be no exceptions for not holding the review meetings on time and reports for the period must be available on time. There should be no questioning of data in the review meeting and no analysis paralysis. Too much time should not be wasted in analysing the reasons for not achieving the target. The focus should always be on corrective action only.