Book Notes: The Little Book of Beyond Budgeting

16 Jun 2020

These are my notes on The Little Book of Beyond Budgeting by Dr Steve Morlidge, subtitled “A new operating system for organisations: what it is and why it works”. My specific thoughts are in italics.

You should read this book, not just my notes: it’s tiny, dense and just makes sense.

Beyond Budgeting (BB) seems to be agile for budgeting. If you’re into agility then this will be a bit of a no-brainer.

The old model — “budgeting” — is annual batch planning process:

Apparently one company was able to spend 13 months putting together their annual budget. Not doubt the execs were still paid millions.

Budget control in this context means monitoring reality vs the plan:

(This sounds like bonus-linked OKR systems, which suck)

In this model:

This clearly has all the same issues we know and love from waterfall software development and annual OKRs as mentioned above

There are lots of problems with this:

In summary, “budgeting” is bad because it’s bureaucratic, inflexible, sub-optimal and political.

Enter Ashby’s Law of Requisite Variety, to give us a (dubious) scientific basis for not doing it this way.

Here’s the law, paraphrased:

The variety of the regulator must be equal to or greater than the variety of the environment divided by the variety of the goal.

As an equation: varietyregulator ≥ varietyenvironment ÷ varietygoal

For example, imagine a home heating system for (simplified) weather, where it’s either warm enough that you don’t need the heating on, or it’s freezing and you do:

Stretched to vast organisations and their financial planning, the author says the equation tells us that, if the commercial environment is highly dynamic, the organisation also needs to be highly dynamic.

If you’re reading this, you probably don’t need convincing that that’s true, so I won’t try to convince you.

In the book, this equation is flipped so that it is: varietygoal x varietyregulator ≥ varietyenvironment

That allows the author to say: if the regulator (i.e. the budget system) is inflexible, but the environment is highly variable, then the goal variety must increase, or the environmental variety must decrease.

He uses this to explain why people miss their goals in such a situation: the goal variety was low — meet business targets and stick to the budget — but must necessarily increase to meet the environmental variety. So, people miss their targets, cancel projects, overspend, reallocate people, or stretch the rules or their ethics.

Although I agree, I find this to be an over-reach: applying a three variable equation to groups of humans and their behaviour is questionable at best. But it’s a nice metaphor.

The final point here is that:

…it is only possible to meet all budget goals if the environment is highly predictable — if it [also] has a very low variety. If the environment is not predictable, the variety equation does not balance and something has to give way to restore equilibrium.

Budgeting can therefore be viewed as deficient through this lens because:

So! What should be done about all this? Dr Morlidge says:

… an organisation’s operating model should be designed around the nature of the market and the way it chooses to compete within them.

Makes sense.

Step 1 is to measure your organisation in a meaningful way.

The section on this is very good, and you should read it, but I’ll summarise:

Step 2 is to forecast, but only if you need to.

You should forecast to a horizon that is appropriate for the business. If you’re making planes, that might be a while. Otherwise you can get away with much shorter forecasts.

Forecasting happens, “at the rate of change in the environment”. Forecasts in this context are “expectations” to identify a gap to a target, and to ensure plans change if they need to.

Step 3 is to plan and reallocate resource continuously.

Step 4 is to reward shared success.

In a single sentence: reward your people based on a fair share of the wealth created by the business. Not though OKR-linked bonus plans; not through complex “reward matrices” or opaque scoring systems.

And that’s kinda it.

There’s a great table in the book that summarises the approaches. The BB approach is captured like this:

“Alarms” and “dynamically synchronised coordination” are not hitherto defined in the book; perhaps we’ll get to them.

Ashby’s Law is then repurposed to point out an apparent paradox: you can’t increase the flexibility of the organisation to meet the variety in the environment to such an extent that the organisation falls apart.

How then should the requisite variety (flexibility) of the internal environment be balanced with organisational cohesion and alignment?

Dr Morlidge says you can’t just change the budgeting technique: lots more has to change.

To demonstrate this, the author summarises a normal “command and control” organisation. I won’t bring that over — the symptoms are well known:

There are times and places where this might work (e.g. everything and everyone is on fire) but that’s a corner case.

The point is: in complex and dynamic environments, this doesn’t work. Push too far and you’ll see people bending and breaking the rules, including crossing ethical boundaries.

In these kind of environments, management will respond by restating the rules: “We don’t do this! It’s not our culture! These are the rules!”

Instead, the approach is to decentralise decision-making and build flexible governance systems to cope with the high variety in the internal environment.

What are the characteristics of a “devolved” BB organisation?

This is a world where management create a framework of principles, values, guidelines, goals and information that guide good decision-making.