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6 Steps for Linking Corporate Strategy to the Budget
Linking Corporate Strategy to the Budget is also known as :
linking strategy to budget,
linking strategy,
linking strategy to operations,
linking corporate strategy to budget,
linking operations to strategy and budgeting,
monitoring return on strategy,
linking strategy and planning to budgets,
linking strategy and project selection,
linking stategies & linking strategy,
linking strategy & campaign,
internal linking strategy,
linking strategy to operations for competitive.
The budget is supposed to be the tool by which an organization transforms its
strategy into action. Unfortunately, up to 60 percent of organizations do not
link their corporate strategy to their budget. This paper will show you how to
link these related management processes and strengthen your business performance
management capabilities.
TABLE OF CONTENTS:
Why Budget?
The Role of Budgeting in Performance Management
Best
Practices in Strategic and Operational Planning
The Process for Linking
Strategy to the Budget
Step 1: Define Key Objectives.
Step 2: Identify
Strategies and Impact
Step 3: Document Assumptions
Step 4: Develop
Tactics and High-Level Operational Budgets.
Step 5: Assess and Mitigate
Risks.
Step 6: Check the Plan for Completeness and Finalize It
Cause and
Effect Visibility and the Role of Technology
Creating the Strategic Plan with
Extensity MPC
Reviewing the Operational Plan
Monitoring Actual
Performance
Why Linking Strategy to the Budget Makes Sense
Why Budget?
Ask any three people in an organization why they budget and you are bound to
get three different answers. They usually include such statements as, "It is
something we do every year," "It is a big stick we use to cane those who don't
perform," and "It is the mechanism for setting the managers' bonuses." Is this
really the intended purpose of budgeting? Consider the typical budgeting cycle.
It lasts four months up to 25,000 person-days per year for the average
billion-dollar company1 and starts with senior managers asking the rest of the
organization to "guess" the financial numbers that they already hold for next
year. That guessing is facilitated by a set of spreadsheets that are handed out
to budget managers for completion. Once completed, the spreadsheets are returned
and numbers are consolidated, only to reveal that the budget managers' guesses
weren't right.
So the second round starts with senior managers asking budget managers to
guess again. This time, the budget managers are now focused on what set of
numbers senior managers hold and whether they can guess the right ones. Strategy the
"how" of achieving the numbers has been replaced by a numbers guessing game. If
the organization is fortunate, then senior managers will reveal their guess by
doing a top-down pass to the budget holders who now have a great excuse for
missing the budget: it wasn't their guess.
With this type of process in place, it is no wonder, then, that no one says
they budget in order to direct the way in which their organization will achieve
its strategic goals the intended purpose of the budget. According to data cited
by Kaplan and Norton, creators of the Balanced Scorecard, 60 percent of
organizations do not link strategy to their budgets.2 For budgeting to become
the relevant process it was meant to be and can be, this gap must be fixed.
The Role of Budgeting in Performance Management
The budget is similar to a car's gearbox: it doesn't work in isolation. A
gearbox's function is to transfer the power of an engine to a chassis so that
the driver can move towards a predetermined destination. If the gearbox is
designed without reference to the engine that will power it, the car won't work
and the driver won't go anywhere. Similarly, if a budget is designed without
reference to the strategies it is supposed to support and the resources
available, the corporation will not move towards its desired goals.
Budgeting is part of a larger, closed-loop process called "performance
management." Performance management is a holistic approach to the way
organizations direct and manage resources to achieve objectives. In the context
of performance management, budgeting's central role is to support execution
through the allocation of resources to the activities that drive value.
Jack Welch suggests that budgeting can be a productive and "wide-ranging,
anything-goes dialogue between the field and headquarters about opportunities
and obstacles in the real world" if organizations concentrate on two questions:
"How can we beat last year's performance?" and "What is our competition doing,
and how can we beat them?"
The answers to these key questions typically appear in a strategic or
operational plan, against which budgets can be set and monitored for
effectiveness. But if that plan is vague or incomplete, the resulting budget
will not help the organization implement its strategy.
Best Practices in Strategic and Operational Planning
Most organizations have plans. There is, however, a huge difference between a
good plan and a bad plan. A bad plan, for example, is one that consists only of
costs and revenues. This plan provides no guidance for the organization
regarding how it is to achieve the revenue targets. There is no linkage between
the high-level goals and the day-to-day activities necessary to achieve them.
- Loren Gary, "Why Budgeting Kills Your Company," Harvard Business School
Working Knowledge, August 11, 2003 (http://hbswk.hbs.edu/).
- Robert S.
Kaplan and David P. Norton, The Strategy-Focused Organization (Boston: Harvard
Business School Press, 2001), p. 274.
- Jack Welch with Suzy Welch, Winning
(New York: Harper Business, 2005), p. 197.
Performance management is all about managing the activities that generate
results. Those activities should directly support the organization's strategic
objectives. Therefore, a good plan acts as a road map, showing the organization
how it should move from its current level of performance to the desired level of
performance, based on the perceived economic environment. The plan accounts for
the activities, dependencies, assumptions, time scales, and resources necessary
to support an overall strategic objective.
When one looks at best practices studies such as those conducted by The
Hackett Group, an Answerthink company, and research reported in the book The
Strategy Gap, eight planning best practices of high-performance organizations
present themselves:
- Good plans answer key directional questions. Some are, "Where are we
going?," "How are we going to get there?," and "What happens if things do
not turn out as planned?" High-performing organizations do not assume that
Plan A will always work. Instead, they prepare alternatives in case they are
needed.
- Good plans typically address three activities. They are (1) how the
organization will maintain current operations, (2) how it will improve the
efficiency of current operations, and (3) which new ventures or initiatives
the organization will implement. In this way, any change in performance can
be assessed in terms of the type of activity.
- Good plans-and organizations-are focused. High-performing
organizations do not plan in detail. For example, they may plan around 40
accounts compared with 220 accounts for the average organization. More
detail does not equal more accuracy. More detail does, however, negatively
affect the time available for analysis.
- Good plans include all aspects of the business. In addition to
detailing how goals will be achieved, good plans also describe how the
organization can continue to be effective and generate programs into the
future. In Norton and Kaplan's Balanced Scorecard methodology, these areas
form part of the "internal business process" and "learning and growth"
perspectives. Interestingly, this means that many of the measures within a
plan will not be financial. Employee knowledge, customer relationships, and
the culture of innovation may create the bulk of value for any organization.
In fact, this value can be as much as 75 percent of the total value of the
organization.4 This is perhaps the greatest reason why organizations cannot
use their general ledger to collect and hold a performance management
budget.
- Good plans link strategies to activities. Activities in a
high-performing organization are linked into a cause and- effect hierarchy
(Figure 1) because the achievement of an objective is the result of doing
the right things well. Activities as well as their impact on achieving
strategic goals are monitored. By understanding these relationships,
organizations begin to understand and can build on the true drivers of
success.
- Good plans are measurable. Objectives and strategies have measures of
success, while activities have measures of implementation. In this way, the
completeness of an activity can be correlated with the success of an
objective.
- Good plans include assignments for accountability. In high-performing
organizations, specific people are made responsible for individual
activities. They are empowered, rewarded, and have control of the resources
to ensure the delivery of the activity.
- Good plans include the recording and monitoring of assumptions.
High-performing organizations monitor a range of business assumptions that
are tied to the targets set for corporate objectives. If the organization
discovers that their business assumptions are incorrect, they reconsider the
associated plan targets and adapt accordingly.
The Process for Linking Strategy to the
Budget
Given the preceding best practices, it is obvious that the creation of a good
plan requires far more than just collecting a set of financial estimates. To
achieve a best-practices plan that is linked to a budget, use the following
six steps:
Senior Management (Corporate) Activities
- Define key objectives.
- Identify strategies and impact.
- Document assumptions.
Operational Management Activities
- Develop tactics and high-level operational budgets.
Management Review Activities
- Assess and mitigate risks.
- Check the plan for completeness and finalize it.
Let's look more closely at each one.
Step 1: Define Key Objectives
The first step, a senior-executive activity, is the setting of short- and
long-term objectives for each portion of the strategic plan. In Figure 2, the
objectives are revenue growth and operating efficiency. Executives also assign a
value (i.e., a measure) that denotes the success of each objective. Most
organizations establish between five and seven of objectives.
Step 2: Identify Strategies and Impact
The second step, also for senior executives, is to describe the strategies
that, when executed properly, will enable the organization to achieve its
objectives. For example, in Figure 2, the strategies for obtaining the revenue
growth objective include maintaining the base (measured by number of
distributors maintained) and achieving new sales (measured by revenue from new
contracts). Executives should assign and record the percentage weight (i.e., the
influence) each strategy has on achieving an objective. The total of all
strategies for a given objective must equal 100 percent. Team members use their
experience and business understanding to assign the relative importance of each
strategy. Next, the executive team should note which department(s) is
responsible for implementing each strategy. The team also should determine how
they will measure the success of each strategy.
Step 3: Document Assumptions
Next, senior executives document the key assumptions and measures about
business environment factors that could affect the organization's ability to
successfully achieve its strategic objectives (Figure 3). If the strategy is to
control costs, for example, one assumption might be that inflation remains
steady (the assumption) at two percent (the measure). If the objective is
revenue growth, an assumption could be that the number of distributors remains
the same in the coming year, whatever that number may be.
Step 4: Develop Tactics and High-Level Operational Budgets
At this point, senior executives give the plan to the operational managers,
who are responsible for implementing the documented strategies. For each
strategy, operational managers must develop tactics to implement their part of
the strategic plan. For each tactic they should record the following:
- A measure that will be used to monitor the implementation of the action.
- The weight (i.e., impact) of each tactic on achieving the success of the
strategy.
- The person responsible for carrying out the action.
- The time scale being set (i.e., the start date and the duration, because
not all tactics are of the same duration).
- The frequency of measurement (e.g., calls per hour, revenue per month).
- The type of activity (i.e., whether it is an activity for sustaining the
business, improving the efficiency of an existing activity, or something
completely new). This delineation will help to identify what kinds of
activities are having the most impact.
- The estimated cost and revenue impact of executing each tactic. Look at
these figures by major cost groupings (we'll call these "variables" later
on) such as salaries, material costs, equipment, etc.
In Figure 4, the objective is revenue growth and the strategy is to maintain
the base. Marketing is responsible for executing this strategy. The operational
manager from marketing has recorded three supporting tactics: a communication
program, a conference, and a loyalty program.
Step 5: Assess and Mitigate Risks
Once operational managers have developed their tactics, the completed plan
can be assessed. Ask the following questions:
- Is the plan realistic? Make sure that the planned tactics will really
help to make the strategy successful.
- Is the plan affordable? Make certain that the financial benefits will
outweigh the costs.
- What risks do you run in implementing the plan and how can you negate
those risks?
- How far will you let variances go before taking action? Setting up "best
case," "expected," and "worst case" scenarios for each measure can help
support those decisions.
- What alternative plans are there for overcoming the biggest risks? The
organization may need to create an alternate version of the complete
tactical plan.
Step 6: Check the Plan for Completeness and Finalize It
The last step is to come to agreement on the amended tactics and the
costs/revenues assigned to each activity. Once completed, the plan can now serve
as the starting point for a more detailed budget breakdown, if required. The
high-level costs and revenues from the plan become budget targets.
Cause-and-Effect Visibility and the Role of Technology
You have a plan. You have a budget that supports it.
Only one thing is
missing: a way to easily view and analyze the cause-and-effect relationships
between all the plan elements and the resources that support them. This is a
common complaint among senior executives who are responsible for managing and
reporting on the execution of corporate strategy.
Technology often complicates the situation. For example, organizations
typically create their strategic and operational plans using a word-processing
application. The documents are owned and stored by a single user, cannot be
easily updated to support the monitoring process, and have no analytical or
version control facilities. Similarly, organizations may use spreadsheets still
the most popular tool for collecting financial data to create and maintain their
budgets. Although spreadsheets are much easier to update than text documents and
they may provide analytical capabilities, they typically cannot handle the
"soft" side of the plan such as descriptions, comments, non-financial measures,
and the impact of cause-and-effect relationships. As a result, these documents
do not provide a clear and visible way of showing how user activity is impacting
both financial results and strategy.
In recent years, there have been a number of breakthroughs in the way
technology can be applied to performance management. The following example uses
Extensity® MPC performance management software to illustrate how technology can
improve the visibility of the cause-and-effect relationships of corporate
strategies, day-to-day activities, and the resources that support them.
Creating the Strategic Plan with Extensity® MPC
Extensity MPC's strategy management capabilities enable senior executives and
operational managers to work together in creating plans. It supports a range of
management methodologies, including the Balanced Scorecard, as well as allows
organizations to customize a methodology to suit their needs.
Application users are identified through a log-in procedure that governs what
actions they can perform and what level of detail they can see. In the following
example, the user has been defined as a "planner," which allows him to create
and modify plans. He creates plans in MPC by linking plan "objects," the
building blocks of a corporate or operational plan. For our sample organization,
five objects have been established (see Figure 5). Later in the process, a
"variable" screen will be attached to each object. The high-level budgets are
attached to these screens, enabling people to link budgets to the strategic
plan. You will see how this is done later in this paper.
Objective
This object represents the high-level objectives for the
organization, such as profitable growth, operating excellence, and brand
leadership.
Strategy
This object represents specific strategies and associated key
performance indicators that will allow the organization to achieve its
objectives.
Tactic
This object represents action programs that, when implemented, will
allow the organization to execute its strategies.
Risk
This object represents risks that could potentially affect
performance and, therefore, should be monitored.
Assumption
This final object represents assumptions made during plan
development. Assumptions are reviewed in conjunction with plan results and
are adjusted if data proves the assumptions to be false.
Extensity MPC supports a multistage approach to developing plans. Senior
executives establish the high level objectives and strategies to be adopted
over the coming years. They communicate the plan to operational managers who
then develop the operational plan that links detailed activities for the year to
the corporate strategy.
Using MPC, people physically create the plan by dragging and dropping plan
objects into a cause-and-effect structure. In the following example (Figure
6), the executive team has identified four main objectives: (1) operating
excellence, (2) maintaining existing business, (3) profitable growth, and (4)
brand leadership.
Next they link each objective to the strategies that describe how the
objectives are going to be met. For example, the "maintain business"
objective will be achieved through tactics designed to retain customers and
control costs. Profitable growth will be attained through sales effectiveness,
operating efficiency, and new product launches.
The team assigns properties to each objective and strategy. In this example
(Figure 7), according to the assigned properties, the "retain customers"
strategy starts in quarter one and continues for the next 12 quarters. The
strategy's success will be measured by the number of customers with repeat
orders. Geoff Warren will be responsible for the successful execution of this
strategy.
In addition to assigning properties, organizations can attach documents and
links to websites and other supporting systems to each object, further
clarifying the object's purpose. A flag (triangle) on the left edge of an
object such as the one shown on "control cost" in Figure 7 indicates that there
is an attachment.
Once the strategies have been established, the senior management team assigns
responsibility for implementing each strategy. They do this by simply
selecting each object and associating it with the relevant department or
departments. In Figure 8, management has assigned "retain customers" to the
marketing department.
Next, the organization assigns performance targets to each objective and
strategy. Measures can be logical (e.g., yes or no) or value based (e.g., a
number, a percentage, a monetary value). When setting up these measures
(Figure 9), the system user must tell the program how a measure is to be
formatted (e.g., percent), the desired direction (e.g., "increasing" sales),
and how results are to be accumulated over time and department (e.g.,
summed).
Multiple targets can be set for each measure. For example, the organization
can define "expected" and "best case" measures for a strategy. Extensity MPC
also captures actual results, which then can be compared to planned results.
The high-level plan is complete. Senior management now can hand it off to
operational managers. They will develop the operational plan that will show
exactly how the company's strategy is to be executed.
|Creating the Operational Plan and Linking It to the Budget with Extensity
MPC In this process, operational managers attach tactics or action programs
to the defined strategies. When they log into the system, they see only the
strategies that have been assigned to them. In Figure 10, for example, the
marketing manager can view only his portion of the plan.
For each tactic, the owner defines the person responsible, the start date,
and the type of program, just as the senior management team did in Figure 7.
As each tactic is created, users also can enter high-level budget estimates
for each initiative (Figure 11). This is the point at which the high-level
budget is linked to the strategic plan. The variables (i.e., key business
metrics) shown in Figure 11 are defined by the senior management team, but
operational managers enter the estimates for each activity that they define. The
system will consolidate these budget estimates, enabling the departmental
managers to see how defined activities will impact revenue and costs.
Reviewing the Operational Plan
Although operational managers can only see the strategies and tactics that
directly affect them, senior managers can review the entire plan (Figure 12),
including detailed operational tactics. Doing so will help them assess
whether the plan is likely to work.
The team also can view total costs and revenues by any combination of
department objective, strategy, and tactic by selecting one of several
built-in reports (Figure 13) that come with the system. At this point, these
costs and revenues become targets for a more detailed budgeting process, if
required.
Monitoring Actual Performance
As tactics are executed, the organization must monitor various financial and
non-financial results. Extensity MPC can download these results directly from
supporting systems such as general ledgers, ERP systems, and data warehouses.
Data can be presented as a set of financial reports, tables, graphs, and more.
Extensity MPC also comes with a range of built-in reports that compare actual
results against the planned results, helping system users determine whether
the plan is working. From within these built-in reports, people can drill
down into the supporting systems to perform further analyses. These reports are
flexible in that they can be tailored by end users, who can analyze measures
by any object property. For example, a senior manager could look at the
results for all strategies assigned to a certain individual, one of the
properties established during plan creation.
In addition, Extensity MPC automatically supplies two performance measures.
The first is "outcome," which shows how close actual performance is to the
target levels that were set. The second is "activity," which shows at
objective/strategy level how well the supporting programs have been implemented.
With these two measures, the system is able to give users a measurement of
how goals are being met through user activity.
Let's look at some of the built-in reports that MPC offers.
Plan
Overview. The plan overview report shown in Figure 14 shows the cause-and-effect
linkage between objectives, strategies, and tactics at the corporate level.
Each plan object is color-coded to show the current "outcome" value of the
actual versus expected target for the third quarter of 2005. In other words, the
color-coding tells the reviewer how close the organization came to hitting the
target. The thin bar underneath each object serves as a visual "thermometer"
of completeness. Managers can quickly identify what is working and what
isn't.
Performance Results. The performance results report (Figure 15) enables
managers to see the relationship between activities (i.e., tactics) and
outcomes. In other words, the report reveals whether activities are actually
being implemented, and whether they are contributing to the achievement of the
high-level goals. This report shows actual and target values, the outcome
(i.e., whether the organization achieved the performance goal), and the
activity (i.e., the weighted measure that indicates the implementation progress
of initiatives).
In this example, the objective brand leadership is below target at 66
percent, yet the tactics established to achieve this strategy have been fully
implemented at 129 percent. This indicates that something else is impacting
this objective something that has not been thought about or planned. In
contrast, another strategy, retain customers, is ahead of target at 101
percent, yet only 88 percent of the supporting activities have been
implemented. This could indicate that the target was set too low or that the
tactics do not have to be completed to the depth planned. As a result, the
organization could move resources from these programs to others that are
falling behind.
Trends. When investigating performance, organizations can use Extensity MPC
to see whether a particular result is better or worse compared with the
previous period. They do this by looking at the trends report (Figure 16).
This report shows actual and target values, along with an icon that indicates
performance compared to in this case the previous quarter. The report also
shows who is responsible for each component of the plan. In this example,
"sales training" is below target. Harry Manning has responsibility for it. To
investigate what else Harry Manning may be working on and the results, the
system user could select (i.e., click on) Harry's name and then select the
"responsibilities" report from the left-hand column of the screen.
Responsibilities. The responsibilities report (Figure 17) reveals a number of
issues associated with Harry. Extensity MPC allows users Harry or his boss,
for example to enter explanations in the form of notes and discussions. It
also allows them to attach status or correction plans.
This sample report also reveals that the "recruit locally" tactic has not
been fully implemented. To find out what impact this could have on the
overall strategic plan, the user would select the tactic and then select the
"impact on plan" report from the left-hand column of the screen.
Impact on Plan. The impact report (Figure 18) reveals that, if not
implemented, the "recruit locally" tactic will affect the "social awareness"
strategy, which in turn will affect the "operating excellence" objective. In
this way, Extensity MPC warns the organization of the impact of programs that
look likely to fail.
Plan by Category. Extensity MPC is Balance Scorecard Collaborative
Certified&8482;. In the final built-in report (Figure 19), the "plan by category"
report, the viewer has chosen to look at tactics grouped into the perspectives
defined by the Balanced Scorecard methodology. Extensity MPC accommodates other
planning methodologies as well.
Why Linking Strategy to the Budget Makes Sense
This paper focuses on just one aspect of Extensity MPC's
functionality strategy management. When it is used in conjunction with
Extensity's integrated financial planning, budgeting, forecasting, financial
consolidation, reporting, and analysis functionality, the result is a
comprehensive, closed-loop performance management system. This system can be
accessed through an enterprise-wide, web-based management portal for the
ongoing monitoring, measurement, and management of the organization's
performance.
There is evidence to support the contention that organizations that focus
on performance management outperform those who don't. In a survey of 437
publicly traded organizations, those that had structured performance
management systems (205) produced better results than those who didn't
(Figure 20).5 Industry analyst group Gartner predicts that enterprises that
effectively deploy performance management solutions will outperform their
industry peers6 and that by 2006, 50 percent of Global 1000 enterprises will
implement all or part of a performance management solution.7
In Europe, legislation may be the catalyst for strategy management
adoption. In the UK, for example, all listed organizations are now required
to produce an Operating and Financial Review (OFR) that must include a
statement of business objectives and strategies, enabling shareholders to
assess the potential for those strategies to succeed.8 Without completing the
link to budgets, strategies are in danger of becoming invisible and, as a
result, will not be adequately resourced.
About Extensity MPC
Linking strategy to budgets is one of the most challenging of all management
activities. In the absence of this link, budgets become an exercise in
generating variances that have no focus. Extensity's approach which enables
a single version of data to be shared across management processes such as
strategy management, budgeting, reporting, forecasting, financial
consolidation, and more helps organizations transform activities such as
budgeting into a valuable, collaborative process in which individuals have a
clear line of sight as to how their daily activities affect corporate results
and strategic initiatives. Not all performance management applications can
deliver this functionality, however. In an application audit, Butler Group, a
premier European provider of information technology research, analysis, and
advice, commented:
Tying 'strategy to execution' has already become a cliché for the nascent
Corporate Performance Management (CPM) market with a raft of vendors claiming
they deliver this capability like it is a triviality. Strategy Management
from [Extensity] is the first offering we have seen that leads the organization
through the process of strategy development, the setting of related goals,
targets, measures, and responsibilities with highly capable strategy analysis
and reporting features. Furthermore, the entire solution can be used on top
of [Extensity's] modular MPC framework, which provides the budgeting and
planning, Business Intelligence (BI), and monitoring capabilities.9
In their independent evaluation, Ventana Research, a leading performance
management research and advisory services firm, rated MPC first in all three
categories it evaluated, among a field of more than 30 companies and 70
products. Results were published in their 2005 Performance Management Vendor and
Product Scorecard.
About Infor
Infor delivers fully integrated enterprise solutions as well as best-in-class
standalone products that address the essential challenges its customers face
in areas such enterprise resource planning, supply chain planning and
execution, customer and supplier relationship management, asset management,
product lifecycle management, financial management, performance management
and business intelligence. With more than 8,100 employees and offices in 100
countries, Infor provides enterprise solutions to more than 70,000 customers.
For additional information, visit www.infor.com.
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