Budgets, Plans, and Strategy
Article written for 
www.annarborbusinessmagazine.com
It’s that time of year again. Company executives pull out the annual budget and begin planning next year’s budget. At its worst, the budgeting process is a tedious process that consumes a good deal of the company’s productive resources creating an updated version of last year’s document that will not be thoroughly reviewed again until the following year.
At its best, though, the budget—and the budgeting process—can be instrumental in crystalizing strategy and sharpening plans for operations and marketing. For the budget to work, say planning experts, it must be connected to the overall strategy and company plans.
The Budget
The most difficult task in budgeting is forecasting top line revenue. Almost all other numbers in the budget—marketing, human resources, operations, etc.—depend on estimated revenues. However, with the weak economy and increased uncertainty, companies are struggling to determine exactly what revenue targets they should set for next year.
Jeff Dolowy is a Partner at Plante & Moran, LLC in the Ann Arbor office. Delowy has been with the firm since 1994 and focuses on auditing and tax work. He works primarily with family-owned and privately held businesses, such as retailers, technology companies, , and several manufacturers. His clients tend to have annual revenues in the range of $2 million to $50 million.
Dolowy argues that estimating sales is the key to determining the budget. “When you think about budgeting,’ says Delowy, “sales drives everything. If sales don’t materialize, further adjustments to your cost structure have to be made. Sales is the key driver to any organization.. You have to have a realistic process in place and get the right people involved. Today, many companies are also looking at new markets to venture into as well.”
Dolowy notes that virtually all of his clients are looking to grow their top line revenue next year, but they struggle with distinguishing from realistic targets compared to aspirational targets.
“Everybody is looking for additional topline revenue for a variety of reasons,” Dolowy explains. “I have a software developer, for example, that wants to grow the top line on a consistent basis so that in two to three years he can sell the company. Oftentimes in the software industry, the multiple with which you set the selling price of the company is based on the top line. So, what my client is looking to do is generate additional revenue for a couple of years to get a nice trend going so that he can execute his exit strategy..”
Other companies, of course, are simply looking for increased revenue to sustain or grow the business. Whatever the reason, companies are focused on the top line growth, so they need to shape their budgets around this targeted growth. The problem they’re having, however, is that they just are not sure where to set the revenue target.
“Companies are focused on growing the top line,” says Dolowy. “The issue is how to do that. Generally speaking, many of my clients are having a hard time getting their sales staff to perform the way that they think they should be performing. So, they’re having hard time getting their head around what the right number is and how to plan for the future.
The Plan
The temptation to avoid in budgeting, then, is to simply assume some percentage increase in top line revenue based on the previous year performance or budget, and then align the rest of the budget to that automatic increase. Even worse, executives may be tempted to simply tally up the operating and investment costs of initiatives they want to implement in the coming year, and then create a revenue growth target that is high enough to make the bottom line show profit.
Both approaches, of course, miss the mark. Companies need to form a careful, coherent plan for exactly what the top line revenue will be and how they plan to achieve the sales targets.
Bing Cao, Bin Jiang, and Tim Koller are consultants with the New York office of McKinsey & Company. In their article in the May 2011 issue of McKinsey Quarterly, the authors warn executives about falling into the trap of setting unrealistic growth targets.
“Many leaders,” say the authors, “set unrealistic growth targets. Often, they don’t properly consider how fast their underlying markets are growing and thus how much market share must be grabbed to meet ambitious goals. Or they ignore the likelihood that their competitors are doing many of the same things to grow. They also underestimate the ongoing need to find new products to replace revenue declines from current offerings as they mature.”
“Although the importance of growth is undeniable,” they conclude, “large companies should have a realistic view of the challenges they face and the implications of aggressive targets.”
Dolowy agrees, and he points to specific client examples where effective planning has worked well. “I’ve got a grocery store client with 13 stores. They are looking at what’s going on within their market and the affect Walmart will have on them, as Walmart moves into 4 of their 13 areas. Obviously, this will affect their business, so somehow they have to account for this in their top line estimates.”
“So, in their budgeting, he continues, “they actually planned on a significant hit to sales and, consequently, looked at their overall cost structure to adjust accordingly. So far, they haven’t seen sales drop as much as they thought they would. It’s been a much better experience than they had thought; they’ve been able to differentiate themselves from the big box retailers and hang on to their customers.”
The Strategy
If the budget comes from the plan, the plan comes from the strategy. Companies face a variety of opportunities and potential growth paths. Deciding which plan to pursue and how to apply company resources is answered by strategy.
Richard Rumelt is the Harry and Elsa Kunin Professor of Business and Society at the UCLA Anderson School of Management. In an article adapted from his recent book Good Strategy/Bad Strategy: The Difference and Why It Matters (Crown Publishing, July 2011), Rumelt discusses why a budget must be developed within the context of a sound strategy.
According to Rumelt, “Like a quarterback whose only advice to his teammates is ‘let’s win,’ bad strategy covers up its failure to guide by embracing the language of broad goals . . . If you fail to identify and analyze the obstacles, you don’t have a strategy. Instead, you have a stretch goal or a budget or a list of things you wish would happen.”
How, then, does a company develop an effective strategy? And how does the strategy relate to the plan and the budget?
Dave Haviland has some experience with strategy. Haviland is the founder of Ann Arbor-based Phimation Strategy Group. Haviland focuses on stage 2 companies, firms that that are in transition from start-up mode into a business that is a going concern. Haviland’s clients include engineering firms, retail companies, catering companies, and several other stage 2 companies in a variety of industries. The principles that apply to a stage 2 company, says Haviland, apply across virtually all industries.”
“Companies usually hit this stage 2 level at around $2 million in revenue,” notes Haviland. “I have some clients who are at $80 million who are still at the mindset of a start-up person. The company is at stage 2, but the leadership is still at stage 1.”
Haviland is adamant that for a business to effectively draft and apply a budget, it must be created within the context of the company strategy.
“One of the profiles that I see in stage 2 companies,” says Haviland, “is that they will use a budget as if that’s their strategic plan. And, of course, the interesting things about financials are almost always the assumptions that are behind the numbers in the financials. The assumptions come from the strategy and the plan. So, if people are just using a budget without a plan behind it, then the budget is really saying we’re going to mostly just do what we did before.
“This can work if the environment is mostly as it was before,” he continues. “But in today’s environment, it’s mostly not like it was before. So, using the budget as a strategic planning tool is actually ineffective. The budget needs to be part of a dance with at least an annual strategy session where you’re looking at what’s happening in the marketplace that you need to respond to, what’s happening in the company that you need to respond to, and how you prioritize initiatives. And part of the prioritizing effort, then, is determining what kind of resources you’re going to apply. That’s where the budget comes in.”
Because strategy, planning, and budgeting are interrelated, Haviland counsels his clients to begin the budgeting process earlier then they typically are accustomed to starting the budget planning process. “I think one of the things that surprise many stage 2 companies,” says Haviland, “is that you actually start the budgeting process in September. There are a lot of companies that tack it on at the end of the year.”
So, where do you begin in the planning? Havilland says it depends on the company. “One of the interesting things I have found is that you always want to start where people are most energized. There are people who are energized around doing a budget. In that case, start with the budget, but then ask the strategy questions. There are other people who are not energized by the budgets. In that case, start with the strategy.
“In the end, though, you need a strategy, a plan, and a budget. So, however you want to get there is good. It’s an iterative process.”
Going forward, executives need to manage the process. You can’t wait an entire year before reviewing the budget. According to Haviland, one of the critical things that a company has to do is develop a strategic management system.
A full planning system should include several pieces. First, you have the an annual planning session that looks out 3-5 years while also considering what you have to do this upcoming year. Then you have a quarterly meeting that reviews the plan and considers whether there are issues that have emerged over the past quarter. Then the monthly meetings and the weekly meetings becomes status checks on the plan. This forms the management system.
“What’s interesting about many companies,” says Haviland, “is that they are always doing some parts of the management system, so they’ll say that they have a planning system. But, if you talk to them about what their pains are, it’s almost always tied to whatever is missing in this management process.”
“So, if a company is doing a weekly meeting with their team, what they’re often missing is a longer-term vision of where they’re going. It’s really hard on a weekly basis to pull yourself out of the muck and look farther. On the other hand, the company may be doing the strategic plan once a year, but then not regularly monitoring their progress on that plan. You need to have a consistent look at strategy in order to be calibrating your budget with reality on an ongoing basis.”
So, feel free to pull out last year’s budget, but don’t neglect your strategy and business planning as part of the process. Be market-focused in developing your top line, and tie it all to a solid strategy.
by David Baker and Margaret Baker
www.bakerstrategy.com
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