How Much Should It Cost? by Kevin McManus
First published in Industrial Engineer magazine January 2002
Like many of you who serve in a management role, I recently participated in, and have thankfully completed, the annual budgeting process. Also like many of you, I felt like a huge burden had been lifted from my shoulders once my cost projections had been approved. Now my focus could be returned to the real tasks at hand – helping to improve the systems and develop the people that I am responsible for each day.
Before you get too far into this article, I perhaps should let you know where I come from regarding this traditional, annual process. I do not like it, and I think that in most organizations, it is a significant waste of time. For the past six years, I was lucky, at least from my perspective, as I did not have to prepare an annual budget for the cost centers that I was responsible for. Being able to experience what happens, or does not happen, in a consistently profitable organization where expense budgets were not used only further enhanced my bias towards disliking the process. Returning to this annual exercise in cost projection and debate was not easy to say the least.
As an Alumni Examiner for the Malcolm Baldrige National Quality Award, I have also been privileged to read about and visit other companies who did not use a formal expense budgeting process, and yet were highly successful on a consistent basis. Those of you who are convinced that such budgets are central to organizational effectiveness may think that this apparent correlation is merely dumb luck. I believe that it is not. In most cases, annual budgeting is a lot like strategic planning – we prepare the documents, debate them, and file them, only to go about our daily work with little behavior change occurring as a result of our efforts.
Don't get me wrong. The concepts and principles behind budgeting are sound. I would not have realized the magnitude of my family's monthly donations to fast food restaurants without preparing at least one for my personal use. I also have worked for companies that have attained consistent cost reductions from year to year because they used a formal budgeting process. That said, it was extremely enlightening to work in a place where budgets were not used at all and watch the profits continue to improve. This experience led me to ask myself “Why do companies do this each year?” and “What is the best way to invest our time in a budget-based effort?”
Pondering these two questions helped me better identify the systemic failures of the expense budgeting process as most organizations execute it. First of all, many people do not know how they are spending the money that they are responsible for each day. Secondly, many organizations penalize people for not spending all of their budgeted monies each year. I have personally had the luxury of buying over $3,000 of training materials one December just so I could keep my training budget alive. Finally, we all too often do not understand the important relationships between different cost drivers and the cost centers they most directly impact.
Yes, I am an advocate of activity based costing. I am also a person who focuses more on reducing my costs each day through systems improvement and people development, as opposed to simply making sure that I stay below the budget limits and in turn keep my name off of the list of ‘bad' managers. The way I look at it, I have wasted enough time preparing the stupid spreadsheet – I don't need to waste additional time in someone's office or in a meeting room trying to explain how the unexpected deal that Bill made in sales to help him get his bonus totally altered the product mix that my budget was based on.
The key to escaping from this annual, and often monthly, investment in futility lies in both behavior and methods change. The primary perspective to adopt is one of “How much should it cost?” versus “How much does it cost?”. As you can see, activity based costing should serve as the main tool of choice for helping us answer the first question. If we project next year's costs only by looking at we spent last year, or if we fail to both anticipate and recognize what system features actually cause our costs to go up or down, we only have ourselves to blame when we have to gather up the spreadsheets and variance reports, and head down the hallway to the corner office.
I understand that the organization needs to know how much I plan on spending next year to make its own investment and pricing decisions. The organization however needs to also understand that I am passionately pursuing lower production costs, excellent quality, and higher levels of employee morale. Unless business really picks up or the product mix changes significantly, I will spend less than I did the year before. In turn, last year's numbers should serve as an indication of the most I will spend (not what I plan on spending).
Fifteen years ago, we were just beginning to use technology to help us understand how we spend our money. Today, many companies are just as ignorant of their true spending behaviors as they were then, even though the technology has gotten cheaper and the activity based costing tools are more refined. In a business environment that is much more dynamic, we really need to stop doing those things that we have done over the years and expecting different results. It all comes down to value. If we did not waste so much time and energy on budgeting activities that have a minimal return, we could instead focus on defining and making those system improvements that actually lead to lower costs. How should we spend our time (and money)?
Most of us have witnessed the games that get played at budget time. We have suffered the pain of having the training or recognition budget cut because the paybacks of these cost centers are less tangible or longer term in nature. We have watched the Marketing department and Sales departments get away with not being able to explain their ‘spending versus results' relationships while we struggle to tell our people why they will only get a three percent raise next year.
We can only wonder how long these behaviors, and others, will continue. Fortunately, the first step towards stopping this insanity is free, as all that is involved is questioning our assumptions, and making a personal choice to think and behave differently. You can do that in the car as you drive to and from work. Hopefully this article finds it way into some mailboxes along with next year's cost projections. Keep improving!
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“The only thing I know is that I do not know it all.” -- Socrates