“An organization can never be truly agile unless it also addresses the budgeting mindset and the budgeting process.”
—--Bjarte Bogsnes
Taming the budgeting process is a key step in achieving business agility. I spoke recently with Bjarte Bogsnes about his book Implementing Beyond Budgeting: Unlocking the Performance Potential, and Equinor’s decades-long quest to tame the notorious problems of the annual budgeting process. Bogsnes is the Chairman of the Beyond Budgeting Institute and Senior Advisor Performance Framework at Equinor, the Norwegian oil company, which became famous for abolishing its budgeting process in 2005, although as Bogsnes explains, the story is a lot more complicated than that.
The Beyond Budgeting movement, which began in 1998, is broader than budgeting. “The main purpose,” says Bogsnes, “is liberation from dictatorship, micromanagement, number worshiping, bureaucracy, calendar periods, secrecy, sticks and carrots, and all the other management myths about what is best for achieving great performance in teams and organizations.” The movement now espouses twelve management and leadership principles as shown in the diagram below.
Despite the wider purview, the Beyond Budgeting movement and Equinor (before 2018, its name was Statoil) have been particularly concerned with taming the budget process. “That’s because,” says Bogsnes, “the budgeting process and the budgeting mindset are at the core of traditional management. The budget is 'the elephant in the room.’ An organization can never be truly agile unless you also address the budgeting mindset and the budgeting process.”
Equinor
Equinor is a Norwegian multinational energy company headquartered in Stavanger Norway and founded in 1972 with the name, Statoil. It is a petroleum company with operations in thirty-six countries. It recently added wind and solar to its operations. By revenue, Equinor was ranked by Forbes Magazine (2013) as the world's eleventh largest oil and gas company. It has around 20,000 employees. In 2017, its revenues were US$61 billion, and its net income was around $5 billion. Its total equity is around $40 billion.
There are five aspects of Equinor’s operations that need to be kept in mind when considering the broader replicability of its example in abolishing the budget process.
No customers: One is that as a company producing a commodity like petroleum, Equinor has no customers in the normal sense of the word. Its goal is to produce more petroleum more cheaply and safely. Equinor, therefore, sidesteps almost all of the questions that firms with customers must address at a time when power in the marketplace has decisively shifted from producers to consumers. Equinor is happily living in the world that most big firms enjoyed in the 20th Century world when they didn’t have to worry much about customers: big firms were in charge of the marketplace.
Government ownership: Although Equinor is a publicly listed firm, 70% of its shares are held by the Norwegian government. As a result, Equinor doesn’t have to worry about hostile takeovers or the attacks of hedge funds hungry for short-term profits.
Lower risk of disruption: Equinor doesn’t have to worry whether it will be disrupted by a company that meets customers’ needs by providing something other than petroleum. Despite the rapid advance of wind and solar energy, the central place of petroleum in the world economy is relatively secure.
“The paradigm shift that might hit Equinor,” says Bogsnes,” is more about completely new energy sources or radical innovation in existing renewables, rather than a technology shift in how oil and gas are produced. Equinor fully acknowledges global warming and knows that it is part of the problem. Equinor believes it can be part of the solution. Short term this is about providing more natural gas to Europe, replacing coal. Longer term it is about leveraging Equinor’s technical competence in new areas. Equinor is good at building big stuff at sea. It has just built the world’s first floating windmill farm, operating in Scottish water. ‘Low carbon’ is a key part of the Equinor strategy.”
Relative performance: As a result, performance in Equinor is essentially relative. Is Equinor performing better than the other big petroleum companies? “Winning” at Equinor is about doing better than its competitors, not about absolutely adding value to customers, or matching the performance of the entire S&P500 index. Equinor thinks in relative terms as this gives a better picture of true performance than just hitting a budget number.
Trust: Equinor has spent many years developing and strengthening its values of integrity and frugality and has achieved high levels of trust. It is much easier to consider abolishing the budget in such a setting than in an organization without those values. Statoil hit the ground running in 1972 and had to catch up with the big guys very fast. Trust, empowerment, and collaboration were not a conscious strategy in those pioneer days. There was simply no alternative. It shaped the culture of the company.
Nevertheless, Equinor has faced some of the relentless pressure on public companies to achieve short-term performance. Thus, Equinor “lost two great and brave CEOs because of bulges in expenses. The narrow-minded media didn’t understand that cost is less important than value. The investments that brought them down turned out to be among the best in the Equinor portfolio."
Equinor’s Ambition To Action
Like many firms frustrated by the narrow focus of the annual budget, Equinor began its journey to reform the budget process some twenty years ago by experimenting with “balanced scorecards,” which examined a wider array of performance inputs and outputs than merely financial data.
Equinor called its scorecard “Ambition to Action.” This started out merely as a place in the management information system to document strategic objectives, Key Performance Indicators (KPIs) and actions for local units. Initially, the Ambition to Action was a “dead” document and a voluntary exercise, aimed at helping teams develop their KPIs and document their work.
At first, the Ambition to Action process operated in parallel to the budgeting process. There were often conflicting signals coming from the two. Almost always, the budget won, undermining the importance of the Ambition to Action process. It was only when the budget was abolished in 2005 that the concept of the Ambition to Action was “turbocharged.”
Thereafter, the Ambition to Action became the cornerstone of Equinor’s management process. It was the existence of the Ambition to Action process that created the necessary comfort to abolish the budget. “There would not be a big black hole,” says Bogsnes, “where the budget had been. Abolishing the budget also solved another problem, the conflict between scorecards and budgets.”
The Ambition to Action operates within four constraints or “walls.”
- Values and leadership principles: It is about “how we want to be and how we do things in Equinor.” It starts out with values and leadership principles, particularly “doing the right thing.”
- The higher level Ambition to Action, which provides concrete guidance and direction through strategic objectives, KPIs, and actions.
- Decision criteria: a set of financial and non-financial decision criteria, combined with a set of decision authorities stating how big an individual decision a manager can make before having to go one level up. This obviates “double decision making” with regard to also approving, for instance, annual investment budgets.
- Sound judgment. The power of common sense and judgment are stressed.
Within this framework, resources are made available or allocated case-by-case, taking into account dynamic resource allocation, forward and action-oriented business follow-up, and holistic performance evaluation.
Balanced scorecards are of course far from unique. What distinguishes Equinor is the way its balanced scorecards are implemented. “A scorecard can protect and reinforce a command-and-control regime, or it can do the opposite,” says Bogsnes. “Too many companies are in the first category. We aim to be in the second.”
Equinor did not just put Ambition to Action on top of the existing budgeting process. They also took the budget away. By taking the budget away, the conflict was eliminated, enabling Ambition to Action to become the central management process for the whole organization.
As Bogsnes explains:
“We have used Ambition to Action to build bridges, not just toward the strategy process but also toward HR and the people process. The focus on integrated performance management has been very well received in the organization, again because it better reflects the reality of how things actually work in the line. This integration has brought synergies well above our expectations. Ambition to Action is now a household term both in Strategy and HR.”
Recently, Risk Management has also been included in Ambition to Action.
Do Costs Go Up Without A Budget?
Denning. What happens when a budget is abolished? If you think that the budget is useful in containing costs you would expect costs to go up when the budget is abolished. If on the other hand, you see the budget has inflating costs, you would expect costs to go down, when the budget is abolished. What happens in practice?
Bogsnes. At Borealis, a petrochemicals company where the budget was eliminated in 1995, costs came down when the budget was eliminated, as people weren’t defending their budgets against other units anymore. But at Equinor when the budget was eliminated, costs increased somewhat. But that had nothing to do with Beyond Budgeting. It was because as cash and opportunities were plentiful at the time. Cash flows were good. The focus in the whole industry was on volume and growth. So, we took advantage of the opportunities. Costs were not a concern at the time. That changed dramatically with the collapse in the price of oil over the last five years.
Spending Limits Reintroduced
Denning: You mention in the book that Equinor reintroduced indicative or notional levels of investment about five years ago. Why is that? Is this budgeting by another name?
Bogsnes. In the years immediately after abolishing the budget, we had not even any notional indicators or limits. In those years, money was not a constraint. The capital was there. So spending wasn’t an issue. More recently with the collapse in the oil price, cash has been a serious constraint. So now we have a kind of self-imposed level. We say, “This is what we think we have the capacity to invest going forward. But it is not a fixed limit. It’s indicative or guiding burn-rate guiding. And it is not a pre-approval of specific projects, as in a budget. The principle is: the bank is always open. You can always forward a project for approval. Yes or no depends on the quality of the project and our capacity to fund it and if we have the capacity to implement it, as things stand. Capacity information comes from our dynamic forecasting, where we constantly monitor future cash flows. It’s about making better decisions, making these at the right time (as close to the project startup as possible) and at the right level (as far out as possible). This is the Beyond Budgeting version of Agile’s continuous delivery because the annual budget is too big a batch of decisions.
Firms with budgets typically have an exact number as the total and then they split it up on each project and hand out these packages of money as the budget for the next year. That is problematic. There are too many decisions all at once, with too much pre-allocation and premature decisions. It also means a much slower process if there is a need for a significant change of course, as when the oil price collapsed. Because Statoil hadn’t pre-allocated, it could move much faster than its budgeting competitors who first had to recollect allocated project funds before making a new pre-allocation through an equally detailed but lower budget.. The implication is that the bank isn’t open. That’s not the case at Equinor where the bank is always open to considering new business even if the notional spending limit might be exceeded. So what we do is not budgeting by another name.
Separating Targets, Forecasts, And Resource Allocation
A key feature of the Beyond Budgeting movement is the separation of targets, forecasts and resource allocation.
“How far organizations go in exploring improvement opportunities varies,” says Bogsnes. “Some do little beyond the separation, which still brings major benefits. Others go further and find they can radically improve each process. Some go for the ultimate simplification of setting no or only a few targets, and also dropping forecasting. Again, there is no one right answer, but a lot of great alternatives to choose from or still to be discovered. Many also find that they get braver along the way, and go for more radical change after a period of operating with separated numbers only.”
The Ambition to Action at Equinor is a multi-faceted process. It describes:
“Where are we going, and what does success look like? (Ambition and Strategic Objectives) How do we get there? (Actions) How do we measure progress? (Indicators) We ask these questions within each of the four standard balanced scorecard perspectives: Finance, Market, Operations, and People and Organization. We have added a fifth, Health, Safety, and Environment (HSE), due to the extreme importance of this dimension in our business.”
“The process should be more about strategy translation than cascading, with each level interpreting and translating what other relevant Ambition to Action levels around them should mean for them. They need to look up to the unit above, and maybe further up, sometimes all the way up to the corporate Ambition to Action. It might also be necessary to look left and right if there are interfaces with neighboring units.”
Within the framework of upper-level guidance, the spirit is bottom-up.
“Each unit should run its own strategy process as necessary. This might add on themes and objectives that cannot be read out of messages from above. It can also bring out new strategic issues that might influence strategies above. It is critical for ownership and commitment that teams feel they are not just passive backseat passengers when their own Ambition to Action is developed.”
“Today, there are around 600 Ambition to Action initiatives in Equinor. Most organizational units of a certain size have, however, their own. The Equinor Ambition to Action is what the board approves instead of a budget. In addition, the board approves the largest projects, but continuously and not through an annual investment budget.”
It is not mandatory to have an Ambition to Action.
Managers often ask us if their team should have one. We absolutely recommend trying it out, but we advise yes only if the team itself experience this as a sensible and value-adding way of managing themselves. If not, they are better off without. The management job still has to be done, however: providing direction, planning and executing actions, and measuring that things are moving in the right direction. If the team prefers PowerPoint, Word, and Excel, it is their choice.”
Institutional Performance At Equinor
The two main financial KPIs on Equnor’s board-level Ambition to Action are both relative, the first being Relative Return on Average Capital Employed (Relative RoACE) and Relative Total Shareholder Return (TSR), which is the dividend-adjusted share price development compared to the same peer group. These two KPI targets are the main financial targets that the board approves.
“There is no need for a big annual exercise,” says Bogsnes. “We call them ‘evergreen’ targets. They stand until there is a need to change them. We have done so only a few times since the introduction almost ten years ago. These two KPIs also drive our common employee bonus scheme.”
Overall, Equinor has performed well as compared to its competitors.
“These relative financial targets are not cascaded mathematically to business areas,” says Bogsnes. “They are instead translated in various ways. Some units follow the group level, others set their own, while other units have no overall profitability targets as they aren't profit centers. But if they deliver on their own Ambition to Action, they will definitely contribute toward Equinor doing well and beating the competition.”
The Role Of Targets
The Ambition to Action process enables Equinor to distinguish clearly between targets, forecasts and resource allocation.
“The more ambitious a target is, the less it must be perceived as imposed from above,” writes Bogsnes. “Without ownership and commitment, ambitious targets become nothing but a numbers game. Unfortunately, the market and the external world do not always seem to appreciate this way of looking at performance and targets. Here, ‘aim low and hit’ is often better received than not meeting a demanding stretch target. Sometimes it even seems like performance is about hitting the analysts' consensus expectation, because they do not like surprises. There are companies that have been able to leave this game, giving no promises, no guidance, and not holding any “Capital Market Day” for investors and analysts. Getting there is achieved only by consistently delivering good performance. The Catch-22 is that the singing and dancing around guidance and quarterly results might actually prevent companies from reaching the performance level required to quit the game.”
“We constantly discuss how ambitious our targets should be, often quoting Michelangelo and his wise words about aiming high and missing versus aiming low and hitting, where the latter is the problem, not the first,” says Bogsnes. “We do this because it is easy to forget the purpose of goals and targets. The purpose is to motivate and drive, to secure the best possible performance, even when this turns out to be lower than targeted.”
Do We Really Need Targets?
“We have spent years discussing the separation of forecasts, targets, and allocations,” says Bogsnes. “And we have spent years improving targets. Now we have opened a discussion: do we need targets at all? Firms are addicted to targets. We think if we measure something, we also need a target on what we measure. We are mindful of Goodhart’s law: ‘When a measure becomes a target, it ceases to be a measure.’”
We have come to see, writes Bogsnes, that
“a target is actually not the target or the goal. What we really want is the best possible performance, given the circumstances. Setting targets is one way of achieving this, but it is a medicine that often comes with a number of negative side effects. These include lowballing, negotiations and hidden (or not-so-hidden) agendas, and even more of it if a bonus is linked to target achievement. The rational (or cynical) manager has no reason whatsoever to set ambitious targets. On the contrary, it only reduces the chance of hitting the number and getting the reward.”
“We realize that we need direction,” says Bogsnes, “but do we also need so many targets? This is the journey we are now on. It’s a discussion we couldn’t have had five years ago. We’ll see where it ends up.”
“What if we could find other ways of getting people to do their best without these side effects? Relative benchmarking KPIs without targets is one alternative. When we moved toward a more dynamic and more continuously updated Ambition to Action in 2010, we knew that we gave up this sequencing mechanism as a way of separating target setting and forecasting. On some KPIs we introduced rolling three-year averages. This was typically done where the business has a longer-term nature (exploration, for example).
Ambition to Action has given us a richer and broader performance language,” says Bogsnes. “First, evaluation of delivered results is no longer based on KPIs only, but on the whole Ambition to Action through a holistic assessment. Second, the introduction of behavior with a 50 percent weight provided us with a completely new dimension in our performance language.”
Equinor is well aware that the “I” in KPI stands for “Indicator”. They provide indications but ate
e not necessarily telling the full truth. “They are not called KPT’s, Key Performance Truth#, says Bogsnes. Equinor, therefore, uses five questions to test measured KPI results as the art of holistic performance evaluation:
- Did delivered results contribute toward the strategic objectives?
- How ambitious were the targets?
- Are there changes in assumptions that should be taken into account?
- How was risk handled?
- Are the results sustainable?
In addition, “how” results are delivered, as defined by the Equinor values”, counts 50% in the overall evaluation.
The Central Role Of Trust
Denning: In many other organizations, where there are disagreements about goals and significant levels of distrust, it can be perceived as much more problematic to abolish the budget. In effect, the budget is the one thing that is holding the organization together.
Bogsnes: In Equinor, in terms of getting people heading in the same direction, the Ambition to Action process has been crucial at Equinor in securing a reasonable alignment and get “a line of sight” throughout the organization. It also comes back to the CEO, who became CEO 4 years ago. He is not running after short term benefits. He has a very long-term view. He is very serious about the dimensions of people and their values. He started just as the oil price was collapsing. He handled the crisis in a fantastic way.
Handelsbanken
Another celebrated member of the Beyond Budgeting movement is Svenska Handelsbanken AB, a Swedish bank providing universal banking services including traditional corporate transactions, investment banking, and trading as well as consumer banking including life insurance. Handelsbanken is one of the major banks in Sweden with over 460 branches. Since the mid-1990s Handelsbanken expanded its banking operations into the other Nordic countries, and also in the United Kingdom, where it has over 200 branches.
Handelsbanken has also abolished the budgeting process as part of a radical decentralization processed launched by Jan Wallander who became CEO in 1970. Under Wallander's leadership, many changes were introduced which have continued to be characteristic of Handelsbanken since that time.
During 1970–1972, Handelsbanken created eight regional banks with a high degree of independence. That is actually the bank's simple strategy, to create long - term value through higher customer satisfaction and lower costs than its competitors. Growth has no place in its strategy; it has instead been a consequence of great performance. Wallander's bold steps included much greater branch authority; “the branch is the bank”; a flat structure with only a few layers; a focus on customers instead of products, transparent performance data; a strong values-based culture and no formal budgeting process.
“Many see eliminating budgets as Wallander's main and bravest decision,” says Bogsnes, “but this was just as much a natural consequence of all the other things he was aiming for.
In 1973, a particular form of profit sharing scheme was introduced. Payment only takes place after retirement, which means that all employees are interested in securing the long-term profitability of the bank.
“Wallander wanted to replace traditional controls like budgets, hierarchy, centralization, and individual rewards with very different ‘controls,’” says Bogsnes. “He strongly believed a new model would stimulate and drive good performance much more effectively, and deliver what he did not regard as conflicting purposes: high customer satisfaction and low cost.”
Denning: What are the controls in place?
Bogsnes: Each month, the head office in Stockholm provides the status on a few selected key performance indicators. These include the return on capital, cost/income ratio, and customer satisfaction. How are comparable branches doing on each one? These KPIs are not perfect but are accepted throughout the bank as good enough.
Within a few boundaries, branches have the necessary authority to take all actions required. This includes not only wide lending authorities and all marketing activities ( the bank runs almost no central marketing ) but also the full cost side, including manning and salary levels.
Denning: Was Handelsbanken’s organizational decentralization a key enabler of removing the budget, almost a precondition to doing it? They decentralized organizationally and shifted responsibility to branches, and each branch was being run as a business, with a goal of adding value, not just growth. It was almost as if decentralization was a pre-condition to resolving the budget problems.
Bogsnes: Removing the budget actually went hand-in-hand with decentralization. Getting rid of the budget was a way of making the decentralization real. Decentralization was a key to getting beyond budgeting. It’s an amazing story of what they have achieved. For the CEO, it wasn’t about getting rid of budgets. For him, getting rid of budgets was a minor detail in what he wanted to achieve in terms of decentralizing and mobilizing energy and talent in a world of transparency.
Beyond Budgeting
“We need to recognize,” says Bogsnes, “that the Beyond Budgeting movement is not just about budgets. It’s about reflecting on the world we see around us and the people we have in the organization and the illusions we have around that, for instance, that our business environments are predictable, and that people can, and must, be managed. Those are the illusions that traditional management counts on. And if you challenge those two assumptions and want to do something with it, you also have to do something with the budgeting process and the budgeting mindset, which are at the core of traditional management. It’s encouraging that companies undertaking Agile transformations are finally discovering that we cannot succeed unless we also address this topic and this area.”
And read also:
How Budgeting Kills Agile And Innovation
