Thursday, July 7, 2011

How Budgets Ruin Value Creation and Delivery

Everyone has to deal with budgeting.  Budgeting is simply the process of determining how to fund your expected needs in a project.  Budgeting is not a process with an extensively long history.  Much like most modern management it is a function of how organizations with tremendous growth planned spending. They determine how people behave in any given situation. Focusing leaders' minds on the stewardship of shareholders' funds and ensuring that managers worried about controlling costs were its original functions, and leaders and managers, by and large, behaved accordingly. But budgets have since been hijacked by a generation of financial engineers that have used them as remote control devices to "manage by the numbers." They have turned budgets into fixed performance contracts that force managers at all levels to commit to delivering specified financial outcomes, even though many of the variables underpinning those outcomes are beyond their control. This leads to undesirable and, in many cases, unethical behavior.

How has budgeting and the finance process stiffed innovation to the extent where over 90% of professionals look at budgets in negative terms.  Why is there not more outrage regarding how the process denies agility?  Lean and agile models work towards delivering value while adapting to changing business needs.  I believe there is nothing more threatening to an agile and lean process then the limitations set forth with a budgeting process.  When budgets are calculated to forecast something a year to six months out how can this possibly foster value creation? Budgets are a modern day contract where the budget contract is usually fixed for a period of twelve months. Its purpose is to commit a subordinate or team to achieving an agreed-upon outcome and then to enable a superior to control the results against that outcome (reserving the right to interfere and change the terms if necessary).

How have we arrived at such high levels of dissatisfaction with budgeting? There are three primary factors: (1) Budgeting is cumbersome and too expensive, (2) budgeting is out of kilter with the competitive environment and no longer meets the needs of either executives or operating managers, and (3) the extent of "gaming the numbers" has risen to unacceptable levels. Few senior executives seem to be aware of these problems. They see outcomes in terms of numbers rather than behaviors. In this context, budget contracts can act like drugs. They seduce executives into believing that they have control over their future financial outcomes. But, like most drugs, they have serious side effects. They lead both senior executives and operating managers into an annual performance trap from which it is difficult to escape.

In these turbulent times the budgeting process struggled to cope. Goals and measures were internally focused. Intellectual capital was outside the orbit of the budgetary control system. Innovation was stifled by rigid adherence to fixed plans and resource allocations agreed to twelve to eighteen months earlier. Costs were fiercely protected by departmental managers who saw them as budget entitlements rather than scarce resources. The internal focus on maximizing volume collided with the external focus on satisfying customers' needs. And far from being empowered to respond to strategic change, front-line people found that it was easier to do nothing than to try to get multiple signatures on a document authorizing a change in the plan.

The organizations I have worked with used to set targets on the basis of financial numbers that, more often than not, were negotiated between superiors and subordinates before the start of the year. These numbers were fixed for the year ahead and represented the key component of the annual fixed performance contract. All actions were then focused on meeting the numbers not on value delivery. However, whether this process maximized the profit potential  is doubtful given the desire for superiors to stretch ambition and the desire for budget holders to play safe.

What does the Lean Technology Transformation do to solve this?  Well it's not so simple but here are some ideas.  What holds your organization together is not a plan, but a commitment to a clear purpose and to a set of clearly articulated principles and values.  To create value intellectual capital needs to be set free from stifling bureaucracies, free from the restrictions of predetermined plans, free from the fear of failing to meet fixed targets, and free from the forced cross-company actions designed by central planners.  Agile leaders set targets based on high-level key performance indicators (KPIs) such as return-on-capital, free cash flows, or cost-to-income ratios. Goals are typically set at levels aimed at maximizing short- and medium-term profit potential at every level of the business. Managers are willing to accept (or propose) these stretch goals because their performance will not be evaluated and rewarded against them. They will subsequently be measured and rewarded using a range of relative indicators such as peer group performance, internal and external benchmarks, and prior years' results. "Baseline" goals set a lower reference level of expectations. Though goals are primarily financial at the highest level, they become more operational the nearer they are to the source of value delivery.

By making this transition The benefits are that the process of setting targets is fast (days rather than months) and because it is based on relative measures it will seldom need to be reset. Also, because the benchmarking bar is always being raised, it is more likely to maximize profit potential. Some project leaders figure they have saved 95 percent of the time that used to be spent on budgeting and forecasting. This time is more usefully spent on planning how to create more value for customers and shareholders as well as how to respond more effectively to change.

Changing to a more updated model fundamental matches the goals of a lean organization.  The impact on the behavior of front-line people must not be underestimated. It leads to what Harvard professor Chris Argyris calls "internal commitment." The hidden problem, according to Argyris, is that people have to deal with two types of commitment. First, there is external commitment, which, by and large, leads people to fulfill contractual obligations specified by others, and in which performance goals are top down. Second, there is internal commitment, which allows individuals to define their own plans and the tasks required to fulfill them, and which is participatory, comes from within the individual, and leads to people taking risks and accepting responsibility for their actions.This is the behavior that the relative improvement contract seeks to encourage. The rhetoric of leaders does not produce internal commitment any more than it leads to effective empowerment or personal responsibility. Such changes require a fundamental change in the process that determines the behavioral context.

Finally, what needs to happen in the firm is a decentralization which enables leaders in your high performance teams.  Below are six common principles which organizations who have made this break posses:

1. Built a governance framework based on clear principles and boundaries
2. Created a high-performance climate based on the visibility of relative success at every level
3. Provided front-line teams with the freedom to make decisions that are consistent with governance principles and strategic goals
4. Placed the responsibility for value creating decisions on teams
5. Focused teams on customer outcomes
6. Supported open and ethical information systems

The leaders in question have abandoned the notion that employees base their commitment on mission statements and detailed plans prepared by someone else. They have abandoned the command, compliance, and control approach that assumes that strategy formulation and execution take place in separate compartments. And they have abandoned the assumption that front-line managers cannot be trusted with the responsibility to think and act on the latest information in the best interests of the firm as a whole. They have built a relative improvement contract based on mutual trust, with clear responsibilities for high-level performance from front-line people. They have also built a community spirit that reflects the interdependence of the organization and that supports seamless solutions for customers. Above all, they have recognized that people respond more positively to clear values and principles than to nebulous mission statements and detailed plans.

Sunday, July 3, 2011

The Informal Insurance Policy

"Why is this not what we asked for?
This is what you asked for.
No it's not.
Yes it is!
No it's not!
Look at your documentation it's just like you asked for it!
I never signed this document!"

How many of us have had discussions like this in our organization? How did documentation become the insurance policy between the business and IT?  Why is it that a signature on requirements documents are never completed until the last minute in the project?  Of course we all know why, regardless if we will ever publicly disclose it.

Okay I will spill the beans, it's because everyone reserves the right to change it up until the last minute before delivery.  They reserve that right because they often don't know what the customer wants or IT does a poor job delivering what the business wants. By holding documentation hostage, business and IT will use that document as an insurance policy.  Some call it CYA while I just say it's creating an environment of tremendous waste.  Often in organizations the collaboration between IT and the business (yes most of you know I hate that phrase) is so tense that a requirements documents is used as a mechanism to cover your backside.  Agile's answer is customer collaboration over contract negotiation and/or working software of comprehensive documentation.   Lean likewise is similar with focusing our energy on delivering customer value over wasteful activities.  These philosophies have taken a distinct position against unnecessary documentation because they know it prohibits collaboration and any resemblance of value based delivery.

The majority of organizations believe that documentation is the collaboration tool which delivers the right solution to the customer.  This rarely is true if ever and I often see when consulting a client that documentation is used as a reason (or excuse) not to deliver value to the customer.   For those of you who as an organization live and die by documentation ask yourself, what real value does documentation serve in my job?  Does it serve as my professional insurance policy?  When does the document get signed?  Why does it even need to be signed?  What purpose does a signature even serve?  How often is the document used as a device of threat and intimidation?

I'm not suggesting that there is no need for documentation as I believe there's plenty need in plenty of activities.   Arguably though I believe 90% of the perceived need disappears when organizations value stream their process and measure if it's delivering value to their customer.  Documentation is an important part of any organization, but unlike traditionalists who often see documentation as a risk reduction strategy, value based delivery sees documentation as a strategy which increases overall risk the more emphasis placed on it.  The answer is simply to write documentation when that's the best way to achieve the relevant goals.  Question what those goals are though that require documentation that ask for signatures or are used as clarification.  If documentation is being used in place of collaboration then you should be worried as an organization. 

If you're organization is heavy in documentation I would like to hear from you.  Is the reason you document to act as an insurance policy?  If it's an insurance policy how is trust viewed in your environment?  How is your relationship with other business groups?  How often does your customer accept your first pass as acceptable? How does your organization understand the concept of value delivery?  My experience tells me that if any of these questions are answered in a negative light then you are document process intense.  Likely if you are document heavy then you work in a command and control environment with contentious relationships.  If you work in a trusting environment where the distinction between you and other business units is blurred and you have a great collaborative relationship with your peers then I will go out on a limb and propose you have limited documentation.  Environments of trust create minimal documentation.  Which environment do you work?  I'm interested to hear how your firm uses documentation and how you collaborate.   

Friday, July 1, 2011

Agilepalooza July 15th

I will be speaking at Agilepalooza in Chicago July 15th.  If you're in Chicago please come visit me.

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