Budget Quadrille

Perhaps the most irritating thing about people who are very good at what they do — aside from how easy they make the job look — is that most of the time they can’t quite explain how they do it. If you can get an answer at all, it’s rarely more enlightening than Fred Astaire’s explanation of how he danced: “I just put my feet in the air and move them around.”

As straightforward as operations budgeting might seem (how much money is it going to cost me to send X goods to Y customers?), when you find that rare person who knows and will talk about how to budget for operations, the reality is that it’s fairly complex.

It turns out that Fred had it easy. In writing a budget, an operations manager isn’t responsible just for two flying feet, but the choreography of dozens of elements — almost all of them outside his control. Will sales hold steady next year? Will the mix of goods sold stay the same, or are customers going to buy more bulky things? How many people will we need on staff next Christmas? How many of my vets will even be here by the fourth quarter? And where can I cut the 15% the CFO wants every department to cut this year?

  1. Forecasting all those elements is challenging even in good times. In a down year, operational budgeting gets even tougher. “It’s harder because there’s less margin for error,” says Ron Nichol, a Dallas-based senior vice president of Boston Consulting Group. “There’s less forgiveness.”

    The key, experts say, is not so much knowing exactly how sales will do this year as knowing the most important relationships between volume and the cost of each line item on your profit-and-loss statement. “If the business grows 10%, what percentage does that line item grow?” asks Roger Cunningham, a partner in supply chain consultancy DCB and Company Inc. of Marietta, GA. “If you get a grasp on how that line item grows relative to your true volume growth, or decline, for that matter, you can get a better footing on which you can plan your budget.”

    But what if some of the line items are too broad to calculate that relationship? Cunningham says that P&Ls were designed by the Big Eight accounting firms to help companies make financial decisions, not necessarily decisions about operations. Redesign the form to make it more useful internally, he suggests, or produce a second plan for your own use. “It’s more important to understand why we’re spending, not just what we’re spending,” he says.

  2. Next, you need to find out where volume is heading, which is also easier said than done. What makes it tricky is not just figuring out how much is going to be sold, but the underlying product mix. Experts say that an unexpected shift from small to large goods — say from folded sweaters to clothes on hangers — can wreak havoc on a budget. You may find you need bigger boxes and more packing material. “By the time you fill a truck trailer, you may have eliminated X number of boxes that would have fit in there, so now you’ve got more trailer runs to make as well,” says Jerry E. Owens, a Memphis-based managing director of The Ansley Group, an executive recruiting firm. Owens’ long career included directing store distribution and direct fulfillment for Williams-Sonoma’s six divisions.

    In a fulfillment center, where so little of what you do is discretionary, where can you look to save money? One way is to adjust service levels, says Owens. “Sometimes there’s a lot of pride in being able to turn orders fast, and sometimes that might get ahead of what the customer’s looking for.” For instance, it is not necessary to deliver in two days if the customer is happy with three. Another possible source of savings, according to Owens, is to put off expansion plans. He also suggests delaying training if it is not the kind that would immediately affect customer satisfaction.

    But experts agree that the biggest opportunities for savings are usually in labor — provided you can figure out how to keep costs down without hurting your service quality. “One of the things that makes sense in operations is to really keep the emphasis on productivity rates, because that’s something that you control,” says Owens.

    How can you tell if your lean machine has put on a few pounds? Try charting your center’s productivity versus fluctuations and see if “they dance on a graph one-for-one,” Cunningham advises. If they do, he says, “that means your facility is fat and you’ve got a lot of opportunity.”

  3. Another way to look at productivity: Look at your bottom performers and your top performers and see what that range is, Cunningham suggests. “That’s another good indicator of how much blood you can squeeze out of a stone here,” he says.

    Cunningham warns against being fooled by your budget into thinking that your operation is more efficient than it actually is. If you have expeditors and others on your staff who just help out with packing at peak times but are paid through a direct, fixed-labor line item, your actual costs may be higher than you’ve been led to believe, he says. “That’s the crevice between the up-line understanding of your finances and the down-line floor execution. That’s the crevice where people get sucked into and hide. You’ve got to really understand and control what resides inside those cost categories.”

    Experts caution that layoffs should be an absolute last resort. Owens, for example, says, “You don’t want to lay off really good people and then turn around and call them back next quarter and have them not be available. Then the costs would be greater than whatever you might have saved in that very short term.”

    At the same time, don’t assume that people who’ve been with you through thick and thin will be sticking around for more of the thin. Although current economic conditions may limit turnover to a certain extent, employees are still likely to jump ship.

    “If you don’t plan for a certain amount of turnover and associated training and productivity ramp-up, you’ll underestimate the cost of turnover and the underlying cost per package,” says Chris Merritt, a principal at Kurt Salmon Associates in Atlanta.

  4. One of the first casualties of department budgeting is a company-wide focus. Experts suggest taking care to make sure that decisions that affect your department, and the decisions that you make, aren’t having some unintended financial consequences for the company as a whole. “The biggest gap or crevice into which finances fall is between the merchants and the operators,” Cunningham says. In many retail operations, he points out, merchants will focus on what’s selling and overlook the total costs of moving an item through the supply chain.

    Trying to cultivate a sense of responsibility for company-wide costs is a persistent challenge, but better inter-departmental communication can help bridge that gap. Owens, for instance, says he would sometimes send lists of the lengths of time different items were sitting in inventory, to help buyers understand the true costs of some of their decisions.

    But perhaps a greater challenge is how to interpret outright lies. “What happens with many companies is that managers who will be held responsible for the budget try to low-ball the budget, and senior management is in a position to try to make the budget more consistent with what they’re trying to do with the company,” says Nichol of Boston Consulting Group. “So you have the second- and third-tier managers pitted against the first-tier managers.”

    One way to cope with such gamesmanship is by coming to an understanding with other departments. “It’s actually a good idea to sit down with marketing and say, ‘OK, I can handle a 10%-15% variation in plan, but beyond that, I start to get really out of control from a cost perspective,’” says Kurt Salmon Associates’ Merritt.

    But industry consultants warn that if you’re in a company where a lot of budgetary game-playing is going on, only the people at the top can change the rules. Says Nichol: “If you can’t change the rules, don’t be a masochist and say, I’m going to do the right thing anyway.”

  5. The last but perhaps most essential element of operations budgeting is learning to thrive in spite of whatever numbers you’re finally given. In some companies, this is easy: Budgets are painstakingly assembled and then routinely ignored. This is not always a bad thing; Nichol remembers one company that BCG studied several years ago where analysts discovered that the company’s budget didn’t make sense — the plan, if executed, would have destroyed value. The good news? People didn’t actually follow it. “Thank God they aren’t very good at doing what they say they’re going to do,” he says.

Academics have also noted that the process itself can lead to all kinds of dysfunctional behavior. As long ago as 1953, Harvard Business School professor Chris Argyris wrote in a landmark Harvard Business Review article titled “Human Problems with Budgets” that because budgets are used as a tool to pressure people, “they tend to generate forces which in the long run decrease efficiency.”

Argyris studied how budgets in manufacturing plants were used to affect behavior, and found that the results were mostly negative. A kind of Dr. Spock of the management world (pediatrician Benjamin Spock began arguing around this time that for a child, the principal lesson of spanking was that “the larger, stronger person has the power to get his way”), Argyris contended that sparing the budget wouldn’t spoil the employee. In fact, he claimed that the use of budgeting as a managerial tool often served to create suspicion and anxiety among employees, and thereby to limit their effectiveness.

Fifty years may have changed some aspects of budgeting — for instance, with the aid of computers, company-wide budgets can now be prepared in days rather than months. But Argyris, now retired from Harvard and a consultant with the Monitor Group in Cambridge, MA, says that although the process has improved at some organizations, many corporate budgets still have “pernicious effects” on a company’s well-being.

Dale L. Flesher, an accounting professor and historian at the University of Mississippi at Oxford, says that one kind of contrary behavior is alive and well, in spite of technological advances — “the fear [that] ‘hey, if we don’t spend it, we’ll lose it for next year, so therefore let’s spend it.’ That hasn’t changed, computer or not.”

Although Argyris maintained that in tough times budgets were often used in ways that often hurt employees’ individual and collective spirits, Owens of The Ansley Group believes that it’s challenging but not impossible to keep morale up through a difficult budgetary period.

“It can be tough, but it depends on how you go about maintaining a tight budget,” he says. “If you can actually make achieving productivity levels — the part that people control — in the budget a matter of pride, it can become a very positive environment, and it might be that you might even give some incentive related to productivity improvement. It doesn’t have to be negative.”

Bennett Voyles is a business writer living in New York City. He can be reached by e-mail at benvoyles@yahoo.com.

From Whence ‘Bougette’?

Financial budgets go all the way back to Babylonian times, but you can blame the budgets of our civilization on the troubadours of medieval France. The same folks who brought us chivalry and romantic love gave us the word for another somewhat problematic concept — the budget. Dale L. Flesher, a professor of accounting at the University of Mississippi at Oxford, and an accounting historian, says that the word “budget” comes from the French word bougette, or bag, in which wandering minstrels would carry their money. The bougetter was the musician responsible for holding the bag.

But those lutists with loot just gave us the B-word. Budgets in the modern sense were at first a royal habit: Henry I of England is credited with writing the first budget during his reign in the early 1100s. His practice reportedly gave the English crown tremendous financial advantages in subsequent generations, but it caught on with commoners only slowly.

Here in the U.S., the modern era of budgeting began in the first decades of the twentieth century, according to Flesher. Some cities and states wrote budgets, but it wasn’t until 1921 that Congress created the first formal budget for the federal government.

This trend toward forward-looking public financial accounting helped inspire James O. McKinsey, an accounting professor at Northwestern University (and later founder of the McKinsey & Co. consulting company) to write a book called Budgetary Control that same year, a book that made budget-making popular among large corporations.

But Flesher says that corporate budgeting really came into vogue during the hard times of the 1930s, when budgets were seen as a vital survival tool. He says that historians trace the suspicious feelings people have about budgeting today to the ways in which budgets were sometimes misused during this period.

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