BUDGETING

Budgeting

Budgeting

Introduction

Corporate budgeting is a joke, and everyone knows it. It consumes a huge amount of executives' time, forcing them into endless rounds of dull meetings and tense negotiations. It encourages managers to lie and cheat, lowballing targets and inflating results, and it penalizes them for telling the truth. It turns business decisions into elaborate exercises in gaming. It sets colleague against colleague, creating distrust and ill will. And it distorts incentives, motivating people to act in ways that run counter to the best interests of their companies. (Sullivan, 2003)

Budgeting

Consider just two examples. At one international heavy-equipment manufacturer, managers were so set on hitting their quarterly revenue target that they shipped unfinished products from their plant in England all the way to a warehouse in the Netherlands, near the customer, for final assembly. By shipping the incomplete products, they were able to realize the sales before the end of the quarter and thus fulfill their budget goal and make their bonuses. But the high cost of assembling the goods at a distant location—it required not only the rental of the warehouse but also additional labor—ended up reducing the company's overall profit. (Sullivan, 2003)

Then there's the recent debacle involving a big beverage company. The vice president of sales for one of the company's largest regions dramatically underpredicted demand for an upcoming major holiday. His motivation was simple—he wanted to ensure a low revenue target that he could be certain of exceeding. But the price for his little white lie was extremely high: The company based its demand planning on his sales forecast and consequently ran out of its core product in one of its largest markets at the height of the holiday selling season.

Such cases of distorted decision making are legion in business. No doubt, you could list similar instances that you've observed—or perhaps even instigated—at your own company. The sad thing is, these shenanigans have become so common that they're almost invisible. The budgeting process is so deeply embedded in corporate life that the attendant lies and games are simply accepted as business as usual, no matter how destructive they are. (Sullivan, 2003)

But it doesn't have to be that way. Even if you grant that budgeting, like death and taxes, will always be with us, deceitful behavior doesn't have to be. That's because the budget process itself isn't the root cause of the counterproductive actions; rather, it's the use of budget targets to determine compensation. When managers are told they'll get bonuses if they reach specific performance goals, two things inevitably happen. First, they attempt to set low targets that are easily achievable. Then, once the targets are in place, they do whatever it takes to see that they hit them, even if the company suffers as a result.

Only by severing the link between budgets and bonuses—by rewarding people purely for their accomplishments, not for their ability to hit targets—will we take away the incentive to cheat. Only then will we eliminate the budgeting incentives that drive individuals to act in ways ...