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Managing cost causes cost

31st Jan 2018
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Few would argue that budget management is without fault. Many despair at the time consumed, too few are honest about the games played, but how many are prepared to recognise that budget management is like driving a car while looking through the rear-view mirror?

Budget management was invented a hundred years ago by James McKinsey – he of the eponymous consulting firm. It appeared to solve a problem for Alfred Sloan in that it created some form of order in the amorphous mass that was General Motors but quickly became the norm and is now institutionalised. It may be normal but it is a disease.

Budget management will tell you what is spent or generated but not how it is spent. If you run a service business you spend money in two ways: doing things that are directly of value to your customers and doing other things. Budget management makes no such distinction. Rather, budget management dictates the time and resources service activities ‘should’ take, creating a constraint on those delivering the service which, amongst other things, creates what I call ‘failure demand’ – demands customers place on service businesses that have failed to do something or do something right for them.

Unaware that this is a self-inflicted cost, the higher volumes of work to be done become enshrined in the next budgeting round. Off on the downward spiral we go.

Switching to focus on effectiveness rather than efficiency, leading companies work out the actual cost of giving customers what they need, removing any budget-based constraint. The three key controls are a thorough knowledge of customer demand, a focus on doing only what matters to customers and measuring achievement of purpose in customer terms. Once working this way is embedded, operations managers firstly experience a reduction in operating costs, as failure demand and other activity that is of no value to customers is removed. Secondly they see a rise in customer satisfaction and this then feeds into growth. Customers like services that work.

Managers are able to predict their (lower) costs, provided demand remains stable – as is usually the case. They are now in the driving seat looking through the windscreen. The immediate consequence is no requirement for monthly budget reviews of variance from line items. Longer term it becomes apparent there is no need for so many management accountants.

It’ll never catch on.

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