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ALTERNATIVE BUDGET FORMATS AND BUDGET & CONTROL REFORMS

BUDGETING & PERFORMANCE

RESPONSIBITY BUDGETING

ENTERPRISE RESOURCE PLANNING

BALANCED SCORECARDS

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BUDGETING & PERFORMANCE

Performance

Is there a relationship between budgets and performance?

What is it?

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Is Oregon making progress?

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Yes Yes, but No, but No

No

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2003 2005

How Oregon Compares

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To Washington State To U.S. Average

No

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Better Similar Worse

Oregoniansusing theINTERNET

Weakeningof some

K-12 achievement

trends

3rd Grade Reading3rd Grade MathHigh School Completion (25+)College Completion (25+)

8th Grade Reading

•3rd Grade Reading•College completion

Computer Usage

3rd Grade MathHS DropoutAdvanced DegreesInternet Use

Labor Force Training

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Questions• What do we believe about the link

between budgets and ensuing organizational (Biz/Govt/NFP) performance?

• What is the nature of the evidence or support for these beliefs?

• What are the implications for practice and research based on the findings?

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Ten Things we Believe(we = Fred and Ken)

1. Budgets focus attention – usually on some target

2. Targets should reflect agreement on what adds value

3. Ex-ante budgets focus on spending targets

4. Ex-post budgets [e.g., Responsibility Budgets]focus on performance targets

5. Stable targets focus attention on hitting the target

6. Any target that can be achieved 100 percent of the time is too easy

7. Unit cost targets can distract from focus on organization performance; *ROI* targets focus on balancing cost and organization performance

8. Ex-post budgeting increases internal conflict

9. Conflict can be mitigated – preferably via ethical argument?

10. Improved performance comes from learning a- (Learning requires both perturbation and measurement) b- (More iterations produce more opportunities for learning)

ROI is return on investment - requires difficult, but possible, discussions to define in Govt/NFP org’s.

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Budget Formats: Ex Ante Budgets

Alternative Budget Formats and Associated Features

Format Characteristics PrimaryOrganization

Feature

Orientation

Line item Expenditure bycommodity or resource

purchased

Resourcespurchased

Control

Performance Expenditure byworkload or activity

Presentation of unit costby activity

Tasks, activitiesaccomplished

Management

Program Expenditure related topublic goals

Cost data crossorganization lines

Achievements, finalproducts, outcomes,or consumer outputs

Planning

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Flow of Public-Service Provision

InputsLabor, equipment, structures

Activities, tasks, outputsStreets patrolled, bridgesrepaired, inspections made

ResultsSafe and speedy transportation,security of people and property

Well-being of people

Street Repair Illustration

Input (line items)Tons of hot mixTons of cold mixTons of crushed stone

Performance of tasksNumber of chuckholes filledSquare feet resurfaced

Outcome dataReduction in commuting timeReduction in accidents andassociated costsReduction in vehicle structuraldamage

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These Are ALL Spending Budgets!Managers are

responsible for executing the budget as enacted

Little discretion to acquire assets; no discretion to exceed authorized spending levels

In the language of Responsibility Budgeting, these are all expense budgets

OE & Program Budgets are Discretionary Expense Budgets

Performance Budgets are Engineered Expense Budgets

In the language of Responsibility Budgeting, these are all expense budgets

OE & Program Budgets are Discretionary Expense Budgets

Performance Budgets are Engineered Expense Budgets

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They ALL Promote a BUDGET MINDSET

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Budget Mindset• Focus on inputs (instead of outputs)• Emphasis on securing bigger budgets

and more spending authority. Budget authority is AN ASSET

• Emphasis on spending rates, i.e., obligating budget authority by the end of the fiscal year

• Centralized budget decisions• Little or no knowledge/understanding

of costs -- or accountability for them

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Performance Mindset• Emphasis on outputs (instead of inputs).

Budget authority is A LIABILITY• Manage both operational and financial

performance• Focus on knowing and understanding the

costs of outputs• Reward people for leadership in meeting

operational performance and cost-reduction targets

• Decentralize performance and cost management decision authority

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Budget History: Public and Private

Budgets, in the form of spending plans, are associated with development of bureaucracy and functional organizations

Budgets, in the form of targets, are associated with business

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The Rise of BureaucracyPerfected by Prussians during 19th

Century • detailed centralized materials requirements and

logistical planning (INPUT/EXPENSE BUDGETS),

• control by rules, standard operating procedures, and the merit principle,

• functional administrative design, distinction between staff and line

• decomposition of tasks to their simplest components,

• Sequential processing.

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BureaucracyResults

• made large, complex organizations possible; also made them inevitable

• POSDCORB functions were all treated as separate concerns, performed by staff specialists and coordinated by TOP MANAGEMENT

• substantial staff resources needed to gather and process data for TOP MANAGEMENT to coordinate activities and allocate resources

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Moving away from Bureaucracy/GM

Multi-product, or M-form, organizational structure • each major operating division serves a

distinct product market

Decentralized control • by the numbers, using the DuPont system of

financial controls, return-on-assets target

Coordination• short run via transfer prices• Long run via modern capital budgeting

system

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Responsibility BudgetingThe most common decentralized control system

used by large-scale organizations in the private sector. (a) units and managers are evaluated relative to the

targets they accept, (b) only financial measures are used to measure

and reward accomplishment or punish failure, and

(c) financial success or failure is attributed entirely to managerial decisions and/or employee performance.

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Types of Responsibility CentersDiscretionary & Engineered expense centers

(budgets are spending plans)Revenue centers (intermediate form)Cost centers (budgets are performance targets)

Standard cost centersQuasi-profit centers

Profit centers (budgets are performance targets)

Investment Centers (budgets are performance targets)

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Responsibility budgets I For expense centers the

budget is a spending plan• For discretionary expense

centers, fixed spending targets

• For engineered expense centers, flexible spending targets (i.e., the budget has two components, a discretionary component and a component that varies directly with volume)

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Responsibility budgets II For a cost or profit centers

the budget is a performance target or goal• For cost centers, the target is a

unit-cost standard• For quasi-profit centers, the

target is a quasi-profit measure: (Standard Cost [units delivered] – Actual Unit Cost [units delivered]).

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Responsibility budgets III For profit centers, the budget is

a profit target [revenue – cost of goods sold.]

The budget of an investment center is also a target or goal – usually return on assets [ROA or ROI] or residual income [EVA or RI]

The main difference between investment centers and all other responsibility centers is that the former approve their own capital budgets

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Capital budgeting I is concerned with changes that

have multi-period consequences for the responsibility center in question e.g. investment in new plant or equipment, a

new program, a major process enhancement, etc.

Where cost and profit centers are concerned, some higher authority must approve these kinds of projects. And, each time a project is approved, the targets for the current period should be adjusted accordingly, as should future year targets.

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Capital budgeting II

IN CONTRAST, investment center mangers make these kinds of decisions without the approval of a higher authority. Their budgets are expressed in terms of their skill in managing assets: ROA, EVA.

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Formerly, individual production units were typically standard cost centers; staff units were typically discretionary expense centers. Mission centers were investment centers.

Mission centers in private sector organizations produce final products that are easily priced and that are expensed following generally accepted accounting practice.

In contrast, support centers [e.g., staff units] produce intermediate products and these were, until recently, hard to cost, let alone price, with accuracy. Attempts to do so were often either excessively arbitrary or prohibitively costly.

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Beyond responsibility budgeting

Cycle-time burdening

Cost of Quality Analysis

Balanced Scorecards

BPR

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Modern Control Methods

New developments in management control techniques/Responsibility Budgeting & EVA aren’t good enough (DF/DI)

Businesses in Japan and Germany were producing higher quality goods and services at a lower cost:

JIT, Cycle-time analysis, Cost of Quality Analysis, Balanced Scorecards, and the Rules of BPR

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The German Critique (ABC)

• Narrow rather than comprehensive (making things vs. making money)

• Uses wrong cost drivers (labor burdening)

• Unwillingness to rely on statistical cost measures and estimates

• Poor averaging, especially temporal averaging

• Failure to distinguish between needs of financial reporting and management control

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The Japanese Critique I• Importance of inventories and

overheads, insignificance of labor hours

• Quality• Solution: manage process through

product design and process value management so as to minimize the discrepancy between Process time and Cycle time [inefficiency = 1 – (PT/CT)]

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Process value analysis (PVA)

• Chart the flow of activities needed to design, create, and deliver a service

• For each activity and step within the activity determine its associated cost and its cause

• Determine how the step adds value or, if it is non-value adding, identify ways to eliminate it and its associated cost;

• Determine the cycle time of each activity and calculate its cycle efficiency (value-added time/total time); and

• Seek ways to improve cycle efficiency and reduce associated costs due to delays, excesses, and unevenness in activities.

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Business Process Reengineering

Jobs should be designed around an objective or outcome instead of a single function.Functional specialization and sequential execution

are inherently inimical to expeditious processing.

Those who use the output of activity should perform the activity and the people who produce information should process it, since they have the greatest need for information and the greatest interest in its accuracy.Information should be captured once and at the

source.

Parallel activities should be coordinated during their performance, not after they are completed.

The people who do the work should be responsible for decision making and control built into their job designs.

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BPR reflects assumptions of flexible or lean production (JIT)

• Nobody but the front-line worker adds value (directly).

• Front-line workers can perform most functions better than specialists (lean manufacturing).

• Every step in the value chain should be done perfectly (TQM).

• This reduces the need for buffer stocks and produces a higher quality end product or service.

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BPR reflects modern IT: reduced economies of scale and scope• Multidisciplinary teams, members work together

from start of job to completion• Push exercise of judgment down to teams that do

an organization's work• More equal distribution of knowledge, authority,

and responsibility• Average firm size falling for the last twenty years

(SIC)

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The Balanced Scorecard

Four perspectives Four perspectives …………………………………. ………………………………….

• Financial• Customer• Internal Business Processes• Learning and Growth Perspective

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Learning Critique• Improving performance requires

learning• Learning requires dialogue• About purposes, goals, cause-effect

relations• Opportunities for learning• Measurement, alternative

measurements• Experimentation (perturbation)

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Summary

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Ten Things we Believe(we = Fred and Ken)

1. Budgets focus attention – usually on some target

2. Targets should reflect agreement on what adds value

3. Ex-ante budgets focus on spending targets

4. Ex-post budgets [e.g., Responsibility Budgets]focus on performance targets

5. Stable targets focus attention on hitting the target

6. Any target that can be achieved 100 percent of the time is too easy

7. Unit cost targets can distract from focus on organization performance; *ROI* targets focus on balancing cost and organization performance

8. Ex-post budgeting increases internal conflict

9. Conflict can be mitigated – preferably via ethical argument?

10. Improved performance comes from learning a- (Learning requires both perturbation and measurement) b- (More iterations produce more opportunities for learning)

ROI is return on investment - requires difficult, but possible, discussions to define in Govt/NFP org’s.

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PracticumResponsibility budgeting AFMC

General George Babbitt

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PresentationsGroup 1• What coalition came to support

the initiation of cost management?

• Why did this base of support coalesce?

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PresentationsGroup 2• How did the idea of cost management

come into existence? • What reasoning and persuasive

rhetoric were involved in selling it? • What was it about the people or the

situation – including historical background – that influenced the eventual idea?

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PresentationsGroup 3• Who were the business-area

managers?• What was their part in the cost-

management system?• Why did they apparently perform

their roles in general accord with the design of AFMC’s “cost management system”?

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Guidelines• A presentation should be crisp

– not to exceed 10 minutes• Any case facts should be

presented within the context of the reasoning/argument

• Prepare for questions