Peter Ryan, Corporate Performance Manager, Christchurch City Council, New Zealand talks about what it takes to become an adaptive organization.
How would you define an adaptive organization?
An adaptive organization is structured around defined outcomes and the strategies for getting there. By outcomes I mean the effects the organization is trying to achieve and not merely the quantities it trades. So there is some specificity around the effects it is trying to achieve and the strategies for doing so and the structure that mirrors that strategy.
In terms of resource allocations the adaptive organization has the budget up for grabs so as to be responsive to changes in the outcomes. To change the outcomes adaptive organizations move money around fluently.
Relationships are effective because you’re straight away into the world of partnerships as turfs do not start and end here. In terms of decision-making you are into management by fact – opinion based on merit rather than rank. So you’re into a different cultural structure as well.
In terms of process it’s about stopping low value activities very early because you can test them for validity – you know the outcomes you want, you know the strategies you have and you can recognize something that doesn’t fit.
If you add this all up, an adaptive organization means you don’t have to right-size or slash the budget every 4 or 5 years, which is a chief hallmark of low adaptability in any organization – 4 or 5 years of status followed by a complete meltdown.
Please summarize what you perceive as the main strengths of the conventional budgeting process?
Form a public sector perspective, which I know best, it satisfies the basic needs of the communities or shareholders in that it is seen as reducing the potential for corruption or insolvency. It generally seeks efficiencies in some ways and it leads to some transparency in that it makes it hard to steal public money.
Please summarize what you perceive as the main weaknesses of the conventional budgeting process?
It is commonly applied with two fundamental flaws. One is that it tests excessively for efficiency – can we shave 5% off X but not on effectiveness – are we doing the right things or the right group of things in the right sequence. In other words the focus is on the operational end and not the strategic end.
The second thing is that it allows base budget creeping. By base I mean recurrent spending, which is the chunk of the budget that is allocated every year for asset management etc. In other words, initiatives that are meant to be ephemeral, in that they are supposed to have a life of a year or two, become permanent and are rolled into base, causing it to blow up a little bit at a time. There’s no discretionary money available which means no new projects. If you have this base budget creep then every few years the organization will have to do some rightsizing, either because there’s no money left to do interesting projects, or the board has no money left to do anything innovative with the business.
So we either have a huge haircut for everyone as you look for ways to shave off money or you go for redundancies and cut 10% of the workforce. This 4-5 year boom/bust cycle has a tremendous social and economic impact on employees and also on the organization as it creates bad corporate memories, scar tissues and lots of costs. Base budget creep is probably the chief fault of conventional budgeting.
Typically, the budgeting process is deployed as an annual performance contract. How relevant do you consider annual performance contracts to be in the knowledge-era?
I don’t think it’s a particularly effective contract for the knowledge-era or the commodity-era that preceded it. It tends to focus on the quantity of things generated as the measure of performance, rather than the effect of them. In other words, you can meet the annual performance contract, if you perceive the budget that way, yet the organization may have been ineffective, because they are output targets not in terms of effect.
How satisfied are finance professionals with the conventional budgeting approach?
It varies a great deal depending on their personal outlook. It’s roughly divided into two camps – process versus outcomes base outlooks. If your view of budgeting is that it is a process that has to be navigated with the least damage to myself and my staff and that key stakeholders are happy that the process was observed, that’s the process based view. The outcome-based view asks did we have the effect we were looking for, how do we know we have the money in the right places to get the right results – it’s very much a view of effect as the primary driver and effect as merely an enabler. These two camps have very different people and tend to be polarized.
How satisfied are planning professionals with the conventional budgeting approach?
I’ve never met a planner in any country that was happy with their organizations budgeting process. There is a fairly well founded belief from most planners that their organizational approach is that planning is something of a retrofit to the budget. There’s a strong view that budgeting is something you do first and then you plan once you’ve figured the budget out, which is back to front. You should have strategy and planning done first and then figure out what to do with the budget to make the strategy happen. What happens is that the budget is carved up arbitrarily and then people are told to go and plan with it.
You do the planning and strategy first and then begin the budge negotiations, which is at the pragmatic level. Is there enough money to meet all the strategies? Then you get involved in the trade-offs in how to service the most important strategies - that’s markedly different than slicing up the budget pie and then telling people to go away and plan with the slide they have.
In most organizations the budget is not based on strategic outcomes but on administrative blocks. Department X gets so many millions and the department, because it is a silo, doesn’t really have a hold on outcomes because it’s only a piece of the chain. Planning is really nonsensical at that level.
How satisfied are line managers with the conventional budgeting approach?
They have very mixed feelings. Many seem to be uncomfortable with the reality of the budget when considered against a strategic approach. However, when you talk about not doing budgets as we did in the past, last year’s budget plus inflation as a right, then they can be uncomfortable with that as they enter the world of uncertainty. In this new world they have to fight for money on merit and they are also unhappy about letting go of the past when the money landed on their doorstep every year.
How effective is the budgeting process for goal setting? And what (if at all) would you suggest as better alternatives?
In most organizations it is an effective process for goal setting if your goals are outputs. It’s not effective if your targets are outcomes. For example consider Best Value, the UK Government initiative. In this approach you can set goals around outputs, e.g. how many light-posts were put up, which is profoundly different than the outcome-based approach, which the New Zealand local governments are taking and where they are looking for effects.
How effective is the budgeting process for resource allocation? And what (if at all) would you suggest as better alternatives?
I don’t think there is a widespread belief in the organizations that I have worked in that it is effective for resource allocation if getting the right balance of effects is what the organization is looking for. A city has many competing outcomes, some slightly contradictory such as economic development versus preserving our local character for example. So if you’re looking for resource allocation for getting the recipes right, getting the tensions right, traditionally resource allocation is done on a one item in and one item out basis, therefore it cannot be good at giving strategic resource allocation to competing priorities. It’s more about getting a pile of beans to balance than getting the right strategic outcomes.
How effective is the budgeting process for planning? And what (if at all) would you suggest as better alternatives?
If it’s more about piles of beans balancing, or about status in the organization or whatever then by definition you are not planning well for the right strategic outcomes for the organization.
How effective is the budgeting process for performance evaluation and reward? And what (if at all) would you suggest as better alternatives?
In the public sector there is seldom a strong link. By and large the budgeting process and performance evaluation of executives are not heavily linked.
Most leaders are fully cognizant of the shortcomings of the traditional budget, but hesitate to move to a new model. Why do you believe this is the case?
I think it’s the bird in the hand syndrome. The traditional model is that you get a very large part of last year’s budget as a right. And they get very cranky about the discretionary part not being the way they would like. They may carp about the traditional model but they worry that any different approach will not give them that money as a right, so they tend to point very squarely to the traditional model.
What are the favored alternative frameworks being used to replace the conventional budget?
I’ve heard a lot about zero-based budgeting, but I have yet to see it implemented in any meaningful way. Often it is piloted then isn’t extended across the organization. Or if it is then it is done in a much diluted version that doesn’t involve hitting reset every year. The reason is that financial managers are typically risk-averse, so if you go back to the process comments, they want the process to move smoothly, so starting from scratch every year or every three years even and saying we are going to re-examine everything we do carries a certain amount of risk, in terms of systems, and politics and a raft of other features.
We also see some companies looking to simplify the budget, doing it quicker and with less line items. This is a process-based view and often leads to you doing the wrong things quicker.
How would organizations decide on the content of the ‘new’ performance contract and the process for agreeing that content?
The contract is very much that I will give you money and I expect you to go away and do certain things with it. But if you want to make those things meaningful, rather than just quantities of things, we have to start talking about the effects they have. But once you start talking about effects you’re talking about a number of people around the organization working in a chain. Being outcome-focused means joint accountabilities and joint incentives and punishments. We will have the contract with all in the organization who are responsible for an outcome. This is very difficult for most organizations to do.
The last person in the chain is not the person responsible for success or failure. What organizations have to trade is one difficulty, which is we are going to pretend that the chain doesn’t exist and just talk about the last person in the line to another difficulty in acknowledging that there are a lot of people involved in delivering this and that implies a lot of clarity around responsibility. There’s nothing intellectually difficult about this. It’s no more difficult than thinking that just one person is responsible for everything.
What do you see as the major cultural barriers to transforming the conventional budgeting process? And how can they be overcome?
A problem is that most people, say at departmental level, have very little chance of bettering their position. If you are the CEO or Mayor or whatever then your job is to make change happen because your environment is changing. Those captains just below you are probably at the peak of their careers, as they can’t all become CEO after you. So most change has little chance of bettering their position and probably will make it worse. So it’s about keeping an empire.
How will incentive-compensation be assessed if annually negotiated targets are missing?
In the public sector looking wider than money is better than tinkering with annually negotiated targets. Incentives in the public sector can never be big enough to change behavior. Ten per cent of a public sector salary is not a great deal, and giving it is normally a sliding scale. You’re talking about 4-5%, that’s not enough cheese to spring the trap.
In the absence of annual targets how will organizations communicate financial projections and ongoing performance to the investment community?
Legislation is the big driver here. Very few public sector organizations will report beyond what they have to report. In the UK you report outputs, whereas many in New Zealand are reporting on outcomes – here is what is happening in our communities, this is how we are contributing to this and here are the partners we are working with. It’s a more complex view but more clearer. It doesn’t mean targets are missing but they are in the context of the effects that are desirable rather than then quantity of what’s being delivered.
Do you believe the annual performance contract will lessen in importance within most organizations over the next three years? If yes, what will drive this change? If no, what will ensure the status quo?
Probably not. Most organizations deliver the rhetoric of the adaptive organization – outcome-focused, team-driven, flat, flexible, resources where they are needed but they are basically unwilling to give up the laws of physics within their old organization. It’s still run on a list of projects, budget based on base, structured to silos, their targets are outputs. It’s very much about turf and compliance. And seniority holds sway when it comes to decision-making, irrespective of merit of management by fact. While those laws govern the rules of the organization it’s very difficult for the new rhetoric to break through.
You have to not just change the leadership of the organization but the very rules that make it go.
What do you believe a truly adaptive organization will look like three years from now?
They will be delivering on clearly defined outcomes. Another characteristic is the budget is fluid. There will be a realization that outcomes are delivered across silos so there will be more teams and more integration. By definition this also means moving into the world of partnerships. Decisions will be made by people with the merit to make them not just the rank. Leadership has to recognize that wisdom is not necessarily based on appointment. And they will stop low value-adding activities quickly.
The proof will be that they will not have to sack 10% of their workforce suddenly or give everybody a 20% budget cut after 4 or 5 good years. They won’t operate on the boom/bust cycle or the oscillating universe cycle. They know what they are doing and make minute adjustments almost every day so they never have to amputate.