Ep. 131: Marco Otti - Budgeting Revisited

Marco Otti, Group Controller at Autoneum, joins Count Me In to talk about budgeting. Marco is a finance business partner who supports the decision-making of Autoneum’s top management and Board of Directors. He ensures transparency and visibility of financial data and he contributes to group-wide annual budgeting, monthly forecasting, and 3-year financial planning process. In this episode, he talks about some of the issues with traditional and better budgeting, the essential functions of budgets, and why now is the time for CFOs to rethink how they plan. Marco is a 2021 IMA Exemplary Young Professional and recently wrote an article published in Strategic Finance titled "Budgeting Revisited". Download and listen to the episode now!

Mitch: (00:00)
Welcome back to Count Me In, IMA's podcast about all things affecting the accounting and finance world. I'm your host Mitch Roshong and this is episode 131 of our series. For today's conversation my co-host Adam spoke with Marco Otti about possible solutions in different approaches to budgeting. Marco is a group controller who acts as a finance business partner to support the decision-making of Autoneum, the global market leader in acoustics and thermal management. In their conversation, Marco discusses some of the common issues with traditional budgeting and explains why CFOs need to rethink how they plan and execute their budgets. Keep listening as we head over to their conversation now.

Adam: (00:50)
So let's start by talking about some of the issues with traditional and better budgeting. Why change?

Marco: (00:56)
Yes, why is innovation in budgeting needed, right? I mean, as a group controller, I contribute to our company's annual budgeting, monthly forecasting and three-year financial planning process, and I often ask myself, how can we as management accountants do a better job at budgeting, right? Kind of process be simpler or different. I'm sure most listeners have been involved with the budgeting process in one way or another. Maybe ask yourself as well, what do you consider the most significant barrier to improving or changing your budgeting process? There can be many barriers of course, for example, organizational attitudes towards budgeting, time, cost, inflexible IT systems, or the process being controlled by another group/department, or maybe you think there are no barriers at all, then that's great. One thing to remember is that traditional budgeting is still used in the maturity of companies. At the same time, many of these organizations identify agility as their strategy, which is quite surprising because traditional budgeting is too rigid to support agility well. And if you read Kaplan and Norton, they say that the ineffectiveness of many budgets also comes from the fact that almost 60% of organizations don't link budgets to their strategy and only 25% of managers have incentives linked to the company's strategy. Most of us are aware of the limitations of traditional budgeting. So it can be a very time-consuming exercise with limited value, as assumptions are quickly outdated. Also decisions are often made too early and other to senior level. And based on my own experience, having been involved in a budgeting process, the issue with traditional budgeting is really the amount of work compared to the benefit. I mean, having annual and detailed discussions with cost centers can be quite time-consuming and usually the complaints come from us, the finance function, finance organization who manage and execute this process. So depending on how lean and improved your process is, it can be an efficient exercise as well. With better budgeting you can substantially reduce the planning effort, for example, with less meetings, less reporting requirements, more top-down guidance, shorten the process to maybe one or two months every year. However, process improvements are still a continuation of the traditional budgeting approach and does not bring fundamental changes of instruments.

Adam: (03:30)
So then what are the essential functions of budgets and what are they used for?

Marco: (03:34)
That's a good question because, the functions and what budgets are used for, are quite relevant and important, like translating your company strategy into targets, which refers again to the strategy execution, Kaplan and Norton are talking about. Budgets are, if you will, the tactical implementation of the strategy, they are about resource allocation, which again, starts with developing and validating the company strategy. Therefore, I would say you cannot just remove the budget with its functions and manage your costs and business because planning is still important to coordinate activities, in your own organization. As an example, let me share some of the different functions the budget has at my company, Autoneum. We use the budget for setting absolute targets for the year and to support the performance management throughout the year, for example, every month. So the budget really serves as a reference point for performance and based on many assumptions, it gives a prediction of the next year and how we plan to control costs. Also it is used for resource allocation and managing continuous improvement initiatives. In any organization, traditional and better budgeting is really a mix and let's say a compromise of some of these and other functions.

Adam: (04:57)
Okay, then, so in the context of traditional budgeting and VUCA environments, how did your company respond to the crisis last year?

Marco: (05:04)
Yes, I mentioned agility before, of course, in a VUCA environment, like in 2020 with the COVID-19 pandemic, traditional budgets were not very useful to compare performance against because they were basically irrelevant by the end of the first quarter. So how did we respond? On the top line we planned for different scenarios and updated them weekly. In terms of costs, we used the most recent rolling forecasts, which are updated monthly. And in discussions with the business unit locally agreed on how to best cut costs. In some cases we instructed some top-down adjustments, based on the revenue levels. So for a time really stopped focusing on a budget, right, and shifted the attention to the monthly forecast and came up with intermediate targets based on the circumstances. This is also something to think about when you put yourself in the shoes of the decision makers. What did you or your company do to respond and manage costs during the pandemic? Did you empower your local teams because they know best how to manage costs. Or on the other hand, did you centralize decisions as much as possible because in a crisis there is a need for strong leadership, right? Actually, I mean, this spectrum of self-control versus command and control is relevant when thinking about new budgeting approaches. You can manage costs with detailed annual cost budgets or increase autonomy and flexibility by using absolute or relative KPIs, or even no targets at all. Of course, this then needs strong company values and a clear direction.

Adam: (06:45)
What are the possible solutions for more business agility and changing to different budgeting approaches like beyond budgeting?

Marco: (06:52)
Actually this question, was the reason why the president of the IMA Switzerland chapter, Hessel Brouwer and myself, reached out to CFOs and academics in Switzerland to learn from their experiences of moving to more modern and agile budgeting techniques and then also publish an article in strategic finance. One of the main ideas of the beyond budgeting theory is to separate the budget functions as outlined before. The key budget functions, are target setting, forecasting, and resource allocation. So instead of having one compromised number for all these functions, you would in a first step separate targets from forecasts and from resource allocation. With that, you would have three different numbers serving different purposes. A key tool is forecasting or rolling forecast, which supports the ongoing planning and forecasts are used for the purpose of better decision-making and not as a target or application for resources. Forecast should reflect the best estimates with as little details as possible and be again, decoupled from target discussions. Forecasts, again are not targets, you don't want to hit them. They measure and correct the gap with the strategic target or your ambition and the frequency and time horizon of forecasts will depend on the business cycle. And actually the best way to start to try a different approach is by changing the target setting. This means to introduce more stretch targets that are VUCA robust as we call it and reflect the comprehensive performance evaluation. For example, by using relative instead of absolute targets, this means comparing actuals with actuals of previous periods. And it also means the focus is more on midterm relative calls, where you analyze the trend or the improvement rather than an absolute figure. Another element would be the use of benchmarks that could be external or internal instead of working with fixed targets and for resource allocation of operation expenses, again use relative KPIs with trend monitoring. The same thing can be applied to compensation using relative targets based on group performance while comparing to benchmarks. And if you look up the 12 principles of beyond budgeting theory, what I mentioned so far are mostly changes in management processes like targets, forecasts, resource allocation, performance evaluation, but it is important to be aware that management processes can influence and change your company's culture. And what is needed is really a comprehensive approach that reflects leadership principles as well.

Adam: (09:49)
Okay. So then did you find use cases of companies that have successfully abandoned the budgets?

Marco: (09:56)
Yes, there were several actually, for instance, the case of the manufacturer Hilti, which has also highlighted in a strategic finance article, so let me share some details on how they manage their business more dynamically. Hilti’s former global head of finance initiated the changes during the same time as beyond budgeting came around in the early 2000s and Hilti’s model is very much based on beyond budgeting, but it also differs, especially with respect to the focus on leading with strategic targets. And the company's current global finance director, told us that being able to adapt quickly as an organization has really become a competitive advantage in today's environment. So what's particularly interesting is what motivated Hilti to change to an innovative approach, to measure performance. Because they noticed that their financial control system was working against Hilti's company culture. So the company had invested a lot in culture development and for example, with high transparency being one of the cultural principles, the leadership saw that traditional budgets weren't really supporting building trust in the organization. So Hilti decided to replace traditional budgeting with flexible planning. First, they changed the target setting and realigned to their bonus system, linking it to the company's progress towards strategic targets, instead of linking it to short term budget targets and individual targets. And with the implementation of a rolling forecast, they were able to replace the annual budgeting process as their measurements switched from budgets to actual comparisons, to monitoring actual to actual trends. Also Hilti defined a simple financial KPI structure that fits their business model. Ambitions are derived directly from the strategy to give the organization a long-term top-down orientation and to keep the system lean and flexible. Costs are seen as an input factor to achieve those strategic targets and are managed on a continuous basis and decentralized using the rolling forecast process. Coming back to culture, Hilti believes by setting a few relative strategic targets and delegating decisions and trusting their employees while ensuring a high level of transparency on progress also creates a culture of performance. And the overall financial planning at Hilti really starts with downhill strategy review they call game planning and then the cycle of the flexible planning follows with three rolling forecasts per year. This means that they don't wait for the next budgeting process to start in order to calibrate their planning. And again, as the COVID pandemic hit, it was impossible to plan for the next quarter while having to act and respond quickly. So management at Hilti at the time had to decide whether to implement short term measures or structural adjustments. And to guide their actions, they used the updated rolling forecast as a pulse check, and they're beyond budgeting, bottom up approach and empowered the regional markets to make the decisions. This self-control mechanism helps them to take the best actions tailored to each market. Also, it isn't just about transparency, but actively engaging and moderating the decision-making process of the management. At Hilti, the finance function is very much involved at the outset of the strategy review and the finance people take part in business discussions. This really helps to improve the overall alignment within the organization.

Adam: (13:43)
So Marco you've made some really good points as you've been going through this whole process. And we've been talking through these questions, but I have to ask why is now the time for CFOs to rethink how they plan?

Marco: (13:54)
Well, if we take the case of Hilti, that decision wasn't against budgeting, but rather challenging the assumptions of how performance was measured and looking for a comprehensive approach that's in line with the company's culture. And then in the process, traditional budgets became obsolete. And again, the main idea is to incentivize the organization to achieve long-term targets and measure the progress by continuously improving towards those targets. Success ultimately depends on how well such high-level target setting is aligned between the top management, the department and the team level by using our channel methods. To answer your question what I can say is that all CFOs we spoke to conveyed a new urgency to change the budgeting process and for any CFO, it comes down to a fundamental decision whether to make incremental changes to their budgeting practices, to lower the burden on the finance organization or alternatively to reassess everything and to try innovative budgeting. And the key question to answer is not only how well your present planning and budgeting approach fits the business environment, but also how committed the company is about transforming to agile ways of working.

Adam: (15:14)
I mean, that makes sense. So just to kind of wrap up our conversation, could you summarize the main lessons you've learned?

Marco: (15:21)
Sure. We already mentioned several aspects and I can summarize them with let's say six major lessons learned from our interviews. And overall business agility is really the biggest challenge for companies continuing to operate with traditional budgets. But whether your approach can or should be changed depends on the business environment and the culture readiness of the organization. This means it might be very challenging if you have a strong existing budgeting culture so the culture aspect must be addressed first. This also means that getting buy in from the top management and board of directors is crucial. So thinking about corporate culture is really the first lesson learned. Then it also needs to be a comprehensive approach aligned with the compensation and bonus system by replacing individual bonuses with team or group bonuses for example. So lesson two would be to go with an integrated performance management system for your planning and budgeting approach. And three, adjust your compensation and bonus system to share the company's success. And next I would say is relative target setting. Using relative instead of absolute targets for the key KPIs combined with long-term financial targets. Also implementing flexible planning with frequently updated rolling forecast that are most importantly decoupled from targets. And the last lesson is conducting rigorous scenario planning to review your strategy and include the finance function in the process. The CFOs were also clear about the need for finance professionals to take the lead and become true business partners.

Closing: (17:06)
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