Reality Budgeting

By Russ Banham  |  Posted 08-13-2002

Reality Budgeting

When the September 2001 quarter rolled around, computer chip maker Xilinx Inc. had missed its quarterly earnings forecast four times in a row. By then, of course, the company knew something was seriously wrong. Hard as it tried, it simply couldn't get its budget numbers in sync with customer demand—in part because it couldn't get the right information concerning the extent of business its customers, such as Nortel Networks, Lucent and Cisco Systems, did with their customers, such as MCI and Sprint. And that made planning and budgeting at the San Jose, Calif.-based company a shot in the dark. "It was like flying a plane at night without instruments," says Xilinx CFO Kris Chellam.

For example, some $50 million had been budgeted for a new product rollout, but when it was time to ship, demand had all but dried up amid the industrywide recession of 2001. "We invested heavily in building the inventory of one of our newest products that was designed into base stations for the rollout of the latest in wireless devices globally," Chellam says. But because so many equipment makers were betting—wrongly, as it turned out—on winning DoCoMo's business in Japan and getting new orders out of Europe, Xilinx "ended up with too much inventory."

When the telecom industry took another downturn last fall, Xilinx got hit hard once again. "Our customers overforecasted demand from their customers, so we essentially did the same," says Chellam. And because Xilinx based its budget on those woefully inaccurate forecasts, its ability to allocate resources collapsed as well. "Our budgeting became very difficult because confidence in the data deteriorated," Chellam says. "We were focused only on what our customers were telling us rather than paying attention to the global wireless market." The result: Xilinx was forced to write off some $100 million in excess inventory last year.

Xilinx is not alone in its struggle to get its numbers right. Companies across the corporate landscape face increasing pressure to do a more precise job matching their budgets with business strategy—and the fast-changing realities of the marketplace. "Today, if you can't budget faster, you waste time, money and, worst of all, you risk losing touch with your customers completely," says Haim Mendelson, an e-business expert at Stanford University. Says John Dunleavy, a financial consultant for PricewaterhouseCoopers and a coauthor of the book eCFO: "One of the hottest topics for our Fortune 500 clients today is this: 'How do I get the disaster of the last 18 months of missing forecasts and missing budgets behind me? Why am I tied to a restrictive and static budgeting process that's based on costs and on last year, when Wall Street is beating me up because I'm not flexible to the moment and fluid?'" Today, says Dunleavy, "it's all about achieving fluidity. It's all about getting real budgets and forecasts"—or should be.

Need for Speed

Need for Speed

Call it the real-time budgeting imperative. Traditional budgeting has long fostered a disconnect between promise and reality. The chief problem? Budgets are often way too old by the time they are put into action—and worse, they're based on old numbers. Indeed, by the time most budgets are completed, they're irrelevant. As many as three-quarters of all budgets and plans are never executed, according to Lawrence Serven, a principal at The Buttonwood Group, a Stamford, Conn.-based performance management consultancy. Planning, says Serven, "is nothing without execution."

The usual gambit is for business managers to dummy up a budget based on history and on the loose expectations of top management. More often than not, those expectations are reviewed and revised by senior management, sent down for perusal and kicked back up again in a process that's repeated so many times that when it's finally over, the budget bears little or no relationship to business strategy.

Truth is, though, many companies simply can't afford to keep doing things so slowly. "We are moving toward a real-time economy with much more direct feedback," says Andrew Odlyzko, director of the Digital Technology Center at the University of Minnesota. "What that means is companies are going to have to more closely monitor projects so they can make faster mid-course maneuvers." That means, of course, using technology to help close the reality gap. Wal-Mart, says Odlyzko, is a great example. "Its extensive use of technology helps it to keep track of inventory and respond to immediate changes in demand. If you have that, you'll kill the other guy. It's a do-or-die situation."

The Reality Gap

Such gaps between budgets and reality can cost millions. Consider Xilinx. Its forecast for the first quarter of 2001 was for 10 percent revenue growth, but by quarter's end, growth came in at just 3 percent. The following quarter, Xilinx expected –3 percent growth. That turned out to be –7 percent. The next quarter's revenues were expected to fall 10 percent; they fell instead by 22 percent. A 20 percent expected decline the following quarter ended up closer to 29 percent. "We just had to find a way to get a better feel for where we were," says Xilinx CIO Sheri Anderson.

Cluelessness at this level doesn't just affect strategy; it can also rob your firm of important mind share. "If you've got four or five financial analysts spending 24 weeks a year working and reworking the budget, that's 24 weeks of salary that could have been earmarked for financial analysis," says Delbert Krause, senior product marketing manager at Burlington, Mass.-based Cognos Inc. Traditional budgets contain roughly 230 line items and take four months to prepare, says David Axson, managing director of Answerthink, a Hudson, Ohio-based consultancy, yet only 20 percent of the time put into the budget actually goes to strategic planning. "The rest of the time is devoted to data collection, validation and endless manipulation," Axson says.

What to do? Many companies are turning toward a new breed of fast-track planning, budgeting and forecasting systems and analytical software designed to provide executives with a precise snapshot of financial conditions at any one time. "It's all about improving the inside visibility of the corporation so that executives can act faster to avert a problem or gain an edge in the marketplace," says PwC's Dunleavy.

These systems—sold by IT consulting service providers such as Cognos, Hyperion and Adaytum—have been on the market for the last three or four years, but so far, they've been slow to catch on. Cultural resistance is one reason. According to Paul Hamerman, a research director at Giga Information Group, moving to real-time budgets means "a big cultural change for companies to manage, and many simply aren't up to the job." Even more significantly, faster and more realistic budgeting requires a rethink of the way entire corporations are organized and built.

At Xilinx, for example, it required moving the financial organization into each of the business units and rebuilding the financial infrastructure of the company so management would be part of the budget and planning process. "We didn't want finance guys sitting in the corporate headquarters pulling up numbers in some crunching exercise," Chellam says. The change, he acknowledges, "produced some hiccups"—at one point early on in the process, finance executives refused to tell division general managers how inventory valuations work. At first, Chellam recalls, that led to some inventory write-downs. Now, though, finance has its ear to the ground, working more closely with the business unit executives to develop spending plans more grounded in reality—and to manage realistic long-term goals and strategies. According to CIO Anderson, the integration of internal data with external, point-of-sale data held by Xilinx distributors helped executives follow the ups and downs of the marketplace every day—and improve their ability to synchronize company operations with customer needs. That integration has also helped encourage managers to work more closely together on budgeting. "Finance is now working with marketing people to benchmark at different revenue levels to determine how much they should be spending at a company like ours," Chellam says.

The CIO Role

In this new world of real-time budgeting and planning, CIOs must play a more significant role. "CIOs must share the driver's seat with the CFO," says Clarence Bastarache, CIO of DaimlerChrysler Capital Services, which completed a switch to a new planning and budgeting process in March 2001. "IT has a planning culture that other parts of the organization, such as the business lines, do not necessarily have," he explains. "We bring to the table a horizontal view of the enterprise, since we deal with all the different business lines in the organization, whereas business lines have a vertical view of just their department or function."

Further, says Xilinx CIO Anderson, it's critical in companies seeking to move toward more real-time operations for CIOs to sit at the strategy table along with other corporate executives. Anderson, who reports directly to Xilinx's CEO, says she doesn't have to rely on the CFO to learn about what's going on business-wise. "I have a macro level view of the business," she says. "I'm not treated as a cost center but as a profit center." In that way, she says, there's more pressure on her and her IT staff "to help deliver better data, and the move to better numbers is part of that."

Trouble is, though, says Anita Tilley, such reporting relationships are more the exception than the rule. Tilley, managing director in financial consulting at KPMG Consulting, says many companies fail to tap the strategic value of their CIOs when trying to fix the disconnect. "Since most of the technology out there is viewed as user-friendly, and the user often is finance, IT often gets involved only when it comes to the need to manage information," Tilley says. "That's a mistake. Any new technology requires process redesign and people skill retrofits. IT must be in this from the get-go."

Just ask Nationwide Financial. The Columbus, Ohio-based financial services company, with $3.2 billion in 2001 sales, decided to switch to real-time budgeting in 2000. "We used to budget a certain dollar amount for a project and kick it into gear only to find that our revenues could not support the project's ongoing costs"—and some projects would have to be slowed down or scrapped, says John Davis, vice president of financial operations.

Nationwide wanted a way to "provide guidance to Wall Street analysts sooner," says Davis. "We also wanted a better decision-making process and a way to make everyone here more aware of our financial and nonfinancial objectives." Nationwide turned to Hyperion for the software, which collects data from Nationwide's Peoplesoft enterprise system.

Quick Adjustments

Quick Adjustments

The idea is to reforecast expectations, and then change plans and budgets to reflect the new climate. At Nationwide Financial, Davis says when a change in the top line looms, "we adjust our bottom-line expenses, reprioritizing tactical objectives and then rebudgeting accordingly." Rather than revise forecasts each quarter, Nationwide now revises its forecasts continuously. Each month, a resource allocation committee—composed of the CFO, Mark Thresher; the CIO, Mark Phelan; and the head of marketing, Susan Wolken—meets to revise Nationwide's department budgets based on an analysis of the company's rolling forecast. Says Davis: "We set targets around earnings, revenues, sales and so on, then build tactical and financial plans that close the gap between the current forecast as it exists each month, and our targets up to 21 months (seven quarters) down the road."

The committee then prioritizes the requests it receives from the business units for new projects. The committee knows how much it costs to run the company at any given time, and how much those costs change monthly, Davis says, so it's up to that panel to decide how much money each department will get—or lose—each month. Now, he says, the budget is always the last thing compiled, not the first and most likely to go stale. "Five years ago, someone might say, 'You can spend this much money,' and then the business would figure out what to do with it," Davis says. "Now, you get the money that reality dictates."

Nationwide has also gained speed. Case in point: Based on the company's improved ability to budget costs and forecast revenues, it recently was able to accelerate a project to reduce the amount of money it spent to issue insurance policies. Rather than paying for the project over three-and-a-half years, Nationwide was able to pay for it in three—to realize a savings of $3 million in the first year, Davis says. The goal of the switch was to shrink the cost of issuing life policies by paring the department's administrative costs and thus reducing budgeted resources.

To be sure, making such switches isn't easy. Cultural resistance to the new way of budgeting can run high. At Nationwide, Davis recalls, buy-in was achieved only when Nationwide decided to link improved budget accountability to employee paychecks. "We now have a scorecard that lists a dozen measurements, including traditional financial measures like return on equity, as well as nonfinancial measures such as customer retention and back-office productivity, and we use them to determine bonuses," he adds.

High Fashion

What it really boils down to is speed. Consider watch retailer Fossil Inc., with $546 million in 2001 revenues. For Fossil, based in Richardson, Texas, the switch to real-time budgeting meant being able to match resources to demand in the fast-changing world of fashion.

Each year, each department at the fashion accessories marketing and distribution company would submit a budget consisting of 90 spreadsheets that went up and down the chain of command so many times the strategic intent eventually was lost. "By the time we were happy with a department's budget, it was pure luck if it matched the corporate directive," says Christopher Lee, the company's finance manager.

So Lee and Randy Kercho, Fossil's executive vice president, spearheaded a two-month effort to consolidate dozens of spreadsheets into a single database—Fossil's general ledger—adding multiple charts of accounts across the global enterprise, all part of preparing for the advent of a planning and budgeting system from Cognos. "We had to make sure every line of data—and there were thousands—had a home," Lee recalls. "The volume was enormous."

But so was the change in how the company has been able to respond to the market. In the past, Kercho says, "we were so consumed with the budgeting process, analyzing each department's budget through multiple iterations, that we were unable to analyze whether it met our overall strategy." And the budgets that were produced could not reflect quickly enough where the demand was coming from, and where it would be coming from in the future.

Smarter Budgets

Smarter Budgets

Now, though, thanks to the company's switch to real-time budgeting, "we know more about this company in-depth," Lee says. Finance people work alongside the sales force and the design and development group to input demand forecasts into the system. Then comes the actual budgeting. "People are budgeting for their own responsibility areas based on the sales forecast," says Lee. "Once that's fine-tuned, we can roll that back out to our departments so we can do expense-based planning based on those units or dollars shipped in the budget. Now the units have much more of a hand in the budgeting process, and we're putting financial forecasts in senior managers' hands every two weeks—not every two months as in the past."

The result: Executives can respond faster to shifts in the marketplace. "Now, if we have a slow month with a particular product," Lee says, "the company can respond quickly to manage inventory cycles or press marketing and sales to beef up their efforts." The budget system was up and running by August 2001, and Lee notes that it was critical in spotting the downturn in the fourth quarter of that year. "We were able to recycle through our budgeting in reaction to the economy much quicker than we would have been in an Excel environment."

Xilinx knows that better, perhaps, than most. "We now have an ongoing quarterly forecasting process, which we review and update monthly," says Chellam. "Each month, we take numbers up and down based on our forecast of nine parameters, including return on assets, return on equity, revenue per employee, market share, percentage of revenue from new products, and so on." CIO Anderson says, for example, the improved visibility helped the company know that its newer products were selling well enough to justify continued investment in new-product research—despite the downturn in the economy. "We kept investing in new products at a time many companies cut such spending," she says.

Xilinx's forecasting process and software also takes into account Xilinx's customers' customers' business—the end markets. "We now track capital spending by the telecom industry," Chellam says. "We also track the profit performance of the S&P 500 to determine if Corporate America is making enough cash flow to spend on IT." Altogether, Xilinx' system collects external data from 15 top global customers and 20 strategic customers like Nortel, tracking their shipments by product, geography, division and other metrics.

The result? Since implementing the new system, Xilinx has met its last three forecasts and exceeded the past two, lifting its stock to a new high of around $40 a share in mid-May. "We've muted the element of surprise," Chellam says.

Russ Banham is a business journalist, playwright and author of six books. Debra D'Agostino also contributed to this article. Please send comments on this story to editors@cioinsight.com.

Real

-Time Budgeting">

Real-Time Budgeting

FOSSIL INC.

before Each department had to submit a budget consisting of 90 spreadsheets that took weeks, if not months, to get approved.

now Spreadsheets were collapsed into a single database, so senior managers get financial forecasts every two weeks instead of every two months, as before.

NATIONWIDE FINANCIAL CORP.

before Forecasts did not come close to actual costs, forcing key initiatives to be slowed or scrapped.

now New software revises forecasts continuously and lets the CIO, CFO and CMO review the changes, enabling $4.5 million in savings on one recent project alone.

XILINX INC.

before Bad forecasts in the face of a collapsing telecom market led to $100 million of excess inventory last year and a plummeting stock price.

now Technology ties point-of-sale data from distributors to in-house marketing and inventory data, helping to keep inventories low amid a volatile market.

Resources

Resources

BOOKS

eCFO: Sustaining Value in The New Corporation
By Cedric Read, Jacky Ross, John Dunleavy, Donniel S. Schulman and James Bramante
John Wiley & Sons Inc., 2001

Value Planning: The New Approach to Building Value Every Day
By Lawrence B. MacGregor Serven
John Wiley & Sons Inc., 2001

Performance Management and Reporting Best Practices
By David Axson
John Wiley & Sons Inc., March 2003