Budgets with Vision

Without an explicit link that identifies strategic investments, an organisation has no way to distinguish between strategic and operational activities. Predictably, operational management pre-empts strategic management, short-term actions pre-empt long-term actions, and tactics pre-empt strategy.

Unless strategic investments are identified explicitly and managed separately, the funds allocated for them will simply become a piggybank that managers can tap to meet their quarterly targets - a measure that, while convenient in the short-term, sacrifices the long-term viability of the organisation.

DEFINING ISSUES

The design of an effective strategy planning / budgeting system is driven by two issues. First, the need for cross-business integration results from the structural conflict between strategy, which is holistic, and organisation design, usually siloed.

Strategy, by nature, requires the integration of money, people, customers, suppliers and processes into activities that span the entire business.

Resource allocation, on the other hand, is designed around the architecture of the organisation (silos) in order to promote accountability within organisation units.

Resource allocation systems do a notoriously poor job, however, in promoting desired cross-business behaviour, resorting to complex transfer-pricing mechanisms which always seem to complicate the job of management. If siloed functional resources cannot be integrated around holistic strategic directions, then strategy cannot be executed. The first design challenge, then, is the creation of a process that allocates resources to the strategy in a cross-business framework.

The second issue, the complexity of linking a long-term strategy with a short-term budget, also results from the structural incompatibility of the strategic planning and budgeting process. Strategic planning is a future-oriented, visionary and proactive process in which accuracy and currency of information are of secondary importance. Budgeting is a conservative process, oriented towards the present and past; accuracy and currency of information are of primary importance.

The two processes are structurally different and must be managed separately, yet they must be synchronised. The second design challenge, then, is creating an effective, structural link between the two processes.

FOUR DESIGN PRINCIPLES

Through our research into the management practices of successful organisations, we've identified four principles that address these issues and, we believe, should form the foundation of a new strategy planning/budgeting process:

• Create a strategic architecture
• Assign accountability for strategic themes.
• Develop a portfolio of cross-functional initiatives for each strategic theme
• Create a special budget category ('STRATEX', or 'strategic expenditures') to separate strategic investments from operational investments

STRATEGIC ARCHITECTURE

The architecture shapes the way in which the process will be used. The budget, for example, is designed around the chart of accounts and the departmental structure of the organisation, both of which are hierarchical.

What, then, is the equivalent architecture for an organisation's strategy? We have found that the concepts of strategy maps and balanced scorecards provide organisations with an effective way to represent their strategies.

Every strategy map contains between three and five strategic themes. For example, the strategic themes for a consumer bank might be:

• Growth through innovation
• Increasing demand from customer partnerships
• Building loyalty though operational excellence

Because themes are holistic, transcending organisational and functional silos, they provide a foundation for the cross-silo management of such things as accountability, resource allocation, goal-setting, monitoring, networks and communities.

ACCOUNTABILITY

Establishing performance accountability is the bane of complex enterprises. Organisations like DuPont or IBM must achieve accountability for a range of dimensions, such as product, customer, region, and channel. Accountability for executing the strategy is no less complex.

Because strategy is holistic, overlaying the traditional physical structure of the organisation, accountability for strategy execution cannot be linked to an existing structure. How can accountability be established? We have observed more and more organisations using their strategic themes as a framework to establish accountability.

ATT/Canada, for example, created four executive councils, based on its themes, to oversee the execution of the strategy: growth, productivity, professional development and management.

The city of Charlotte in North Carolina created five executive level committees, aligned with their five strategic themes: community safety, economic development, transportation, housing and neighborhood development, and restructuring government.

The executives of one organisation concluded that they now had a 'day job' and a 'night job'. The day job was their traditional responsibility for line or department functions while the night job required their sponsorship of strategic themes that transcended traditional organisation silos. With the 'day-job / night-job' approach, the strategic themes overlay the traditional organisational structure, providing a framework for management and accountability.

Increasingly, organisations like Mellon / Europe are finding that strategic themes are an effective foundation for the organisation structure itself.

CROSS-FUNCTIONAL INITIATIVES

Achieving a strategic objective generally involves several initiatives from different parts of the organisation. So, how do you prioritise investment? Most approaches look at each initiative on a standalone basis. Sometimes an ROI analysis or a strategic impact analysis is used to rank the initiatives. Such analyses ignore the integrated impact of multiple initiatives.

The budgeting system creates a further set of distortions, forcing each investment to be assigned to a host department. For example, all IT initiatives show up in the IT department's budget, even though they will support the entire organisation and its strategy execution. Accounting conventions also dictate that some initiatives be capitalised while others are expensed.

Executing a strategy requires a group of complementary initiatives, including a mix of IT systems, training programmes, incentive programmes, change programmes, and more. Initiatives should be bundled into a portfolio and associated with a strategic theme. The portfolio should reflect the total investment required to achieve the theme objective.

STRATEGIC EXPENSES EFFECT THE WHOLE BUSINESS

While the responsibility for each initiative will belong to a different part of the organisation (because of the functionally oriented structure of organisations), the executive sponsors of the strategic themes must bear overall strategic responsibility for these investments.

For example, an Enterprise Resource Planning (ERP) implementation might be the responsibility of the chief technology officer, while an HR executive would be responsible for specific training programmes. But the senior corporate executive who is responsible for the strategic theme that requires the ERP and the training programme would ultimately be accountable for both.

This approach reflects the holistic nature of strategy - each initiative is necessary to execute the strategy but not sufficient by itself. If any initiative is cancelled, the associated objective/measure/target would be missed and the strategy would be jeopardised.

Since budgets are short-term, conservative and departmental, what is the appropriate mechanism by which to synchronise them with a planning process that is long-term, visionary and holistic? The answer lies in the funding process: what is to be funded and how it will be funded. Executing strategy is based on executing the initiatives tied to strategic objectives. The method for funding these initiatives thus becomes the link between strategy and budgeting.

RECOGNISING STRATEGIC EXPENDITURE

The problem with the budgeting process is that it does not recognise strategic investments as such. Rather, these investments are scattered throughout departmental budgets and accounted for through a variety of accounting conventions, creating further confusion (IT investments, for example, are often capitalised, while training programmes are typically expensed). With this lack of visibility, strategic expenditures are treated as discretionary and often vanish under the pressure to meet quarterly targets by reducing costs.

A successful strategy planning / budgeting process must overcome two types of structural hindrances. First, it must facilitate the holistic, cross-silo nature of strategy. An organisation's strategic themes provide an architecture that permits cross-business approaches to target setting, investment portfolios, and executive accountability.

Secondly, it must allow the synchronisation of long-term strategy with short-term budgets. Initiative management and STRATEX allow the integration of functional plans and budgets with the strategy. By defining linkage mechanisms that reflect the structural differences, we can build planning and budgeting systems that meet the needs of two very different worlds.