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Budgeting a thing of the past for Statoil. By John Stokdyk

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9th Jan 2007
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"I don't like budgeting and I don't like performance management either. I don't think you can manage performance. What you can do is create the environment and conditions for good performance to take place."

That's the view of Bjarte Bogens, a project manager with Norwegian oil giant Statoil, who oversaw the elimination of traditional budgeting from the company's management and reporting processes.

Scandinavians have often embraced radical management ideas without the dire consequences that paralyse less adventurous executives. In a talk at the CFO Conference in London in December 2006, Bogens pointed out that Svenska Handelsbanken abandoned traditional budgeting in the 1970s. The bank has consistently topped international tables for profitability. And it has done just as well at managing its costs without budgets.

"That puts a hole in the budget myth," he told the audience.

Statoil decided to drop its budgeting round in 2005 and did not set budgets for the 2006 financial year, he explained. "For us the goal of going beyond budgeting was not to save time and simplify - that's a bonus. We had to take away the budget because it was a barrier to what we wanted to achieve.

"A traditional budget is not the way to manage a global oil exploration company. The world has changed. Our business environment is much more turbulent, dynamic and demanding than even five years ago. We have to change the model because the world has changed."

Bogens asked the audience of senior finance executives to suggest what budgets were used for in their organisations. The consensus was:

  • Cost control
  • Resource allocation
  • Target-setting, reporting and discussing future performance.

"The problem is to trying to do these three things at the same time and produce one number," Bogens commented.

From his experience working with line managers in international oil production, Bogens remembers asking them to put forward their best forecasts for the next and subsequent years.

The managers knew how their business worked, and their bonuses were based on production targets, so they played down their numbers because they knew the forecasts would become their targets for the next year.

Linking budgeted expenditures to the performance process also caused distortions that hampered performance. In Statoil's previous regime, it was always assumed to be a good thing not to overspend on budgets.

"But it depends on what you get back from the money you put in," said Bogens. "Traditional cost budgeting is a one-eyed view of the world."

Not long ago, Statoil's global exploration director earned kudos for returning portions of his operational budget for two years running. "We had a KPI for exploration costs and this needed to be green for him to get a bonus," Bogens explained.

"When we looked deeper, the reason the budget hadn't been spent is because he didn't move into areas he needed to. It was a stupid KPI based on a cost budget. We have no exploration budget any more.

"The objective is to get the optimum cost level to maximise value. Search for the differences between good and bad costs. Good costs generate more income than you put in. Bad costs generate losses."

Under the company's new "Ambition to Action" regime, the key measure for exploration is how much it costs to find the equivalent of one barrel of oil's production over a three-year cycle. Some of the factors that affect this measure include oil rig drilling costs, which can triple over the three-year cycle, and the potential return of new fields that might be opened up by exploration.

"We used to think that $45-65 million was the right figure. Budgets tend to be spent even if the conditions have changed. How could we be so stupid to give him so much money a year? We don't do that anymore," Bogens said.

Statoil's new forecasting and strategy processes
Statoil's new approach is based on the idea of giving more freedom and responsibility to managers, he explained. "Our managers are responsible for running machines, refineries and oil traders. The company has no problems trusting them with these responsibilities - but not when it comes to managing their own costs.

"We spent too much time crunching too many numbers - there was too much detail," Bogens said. The company's solution to the budgeting conundrum was "disappointingly simple" and did not involve introducing any new techniques, he continued.

Statoil's corporate strategy is designed around a core measure of total shareholder return, which translates into objectives that are monitored via key performance indicators (KPIs), which are triggered by the completion of specified actions. The overall programme is called "Ambition to Action".

"If you have an ambition to action, you set delivery targets. That's half of the performance evaluation," said Bogens. "The rest is behaviour. If you change targets, you have to change behaviour. We have moved from annual command and control to something more dynamic. We do this because it gives better performance."

An important principle underpinning all this is that Statoil wants its people to apply sound business judgement and do the right things in day-to-day situations. As part of the new corporate language, performance evaluations are based a 50:50 split between delivery and behaviour, he explained. This is typically mapped on a matrix with up to five components (eg 5 x 5 cells correlating delivery against performance).

Forecasting still takes place at different levels of the organisation, but as part of detailed planning processes where they can provide line managers with more relevant targets. There is also a fairly simple formulation for planning within Statoil, Bogens explained. "Our plans are typically words with some figures attached: what we need to do (words- 90% of the plan content) and what we expect to happen (figures - the other 10%).

These plans provide the basis for resource allocation within the organsiation. "If there's an action, it should be in the plan, with resources attached."

Bogens added that just because an action is included in an operational plan, that does not necessarily mean that the action has been approved. "We find the money when it's appropriate to take action on the plan," he said.

"The forecast is just a model, and we don't have to build it from the highest level."

As a result, Statoil crunches fewer numbers and has done away with the stupid game where forecasts "ride the elevator" several times between board executives on the top who want executives on lower levels to come up with better figures.

In place of game-playing around particular milestones and triggers, the planning and performance regime set out by Bogens has attempted to move the management mindset from a mechanical to a holistic understanding of the business.

"Very rarely does a KPI tell the whole story - it is first an indication that you are moving towards what you want to achieve," he said. "You have to use common sense and take different KPI glasses to look at all the things not in the indicator."

Executive decisions within the company are also "pressure tested" through various gates, he added. "We haven't stopped accounting. We do a lot of monitoring and forecasting." In some instances, forecasts will be prepared against KPIs to measure expected performance, but this only happens in exceptional cases where managers "are not mature enough or are trying to manipulate the system", he added.

"In the old system, the rotten eggs were winners, because they knew how to manipulate the system. The leaders are winning under this system."

The monthly budget attached to the actual performance figures has now disappeared. Instead, financial controllers are tasked with monitoring where the allocation of resources might have gone wrong or to discover and explain why any variances may have occurred between forecasts and targets.

"I'm not into accountant-bashing," Bogens said. "You have to understand accounts to know where you are heading. But it also requires more business understanding from the accountant to participate in that conversation."

Along with the total shareholder return, the ultimate measure of success for Statoil is how it compares with the competition. "Corporate performance is not absolute, but relative," he said. "It's about out-performing the opposition."

For example, he pointed out that Manchester United does not set out at the beginning of the season with a target to score 45 goals and achieve 39 points. It aims to top the league table. "We do that with return on capital employed. We have a leauge table of 11 oil companies and set targets of where we want to be on that table."

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John Stokdyk, AccountingWEB head of insight
By John Stokdyk
12th Jan 2007 12:02

Getting the story across
Thanks for your input Gordon. Actually my plan is to tackle the theory of budgeting and beyond in a follow-up article.

I'm pretty certain Bjarte did his research and is aware of the academic theories, but he showed a real flair as a speaker for throwing out provocative soundbites, eg: "Traditional cost budgeting is a one-eyed view of the world..." "In the old system, the rotten eggs were winners, because they knew how to manipulate the system...." and budget figures "riding the elevator" up and down between the board and line managers.

By sticking pretty closely to the content of his talk, I aimed to capture his almost punk rock-like distain for traditional methods and illustrate how "blowing up the budget" affected a specific company - Statoil.

From the positive responses to the piece, it looks as though ordinary managers are more interested in reading entertaining, first-hand accounts of business processes than they are in reading up on the academic theory.

Of course, in an ideal world the two go together. I am just getting ready to tackle the theory article. Are there any thinkers, articles or concepts you would urge me to include?

Expanding on your own views would also be welcome. As I mentioned, we really appreciate feedback, and I'm looking forward to a continuing discussion around the topic of budgeting.

Regards
John Stokdyk
Technology editor
AccountingWEB.co.uk

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