Budgeting in an ever-changing economy

Right about now you’re probably wondering if you need to tear up your budgets for 2009 and start again. No one can place much faith in any of the economic forecasts, which are all over the place, as are interest rates, exchange rates, demand projections and your cashflow expectations.

Whatever you do, don’t tell Eddie Obeng. He is the founder of Pentacle, a so-called virtual business school. And if you tell him about your budget, he will shriek with laughter. He’s heard the same “joke” before, countless times. And that, more than anything, is what makes your predicament so funny to him. Companies just don’t learn.

More precisely, Obeng’s point is that companies don’t learn quickly enough; people can’t learn quickly enough. The pace of change, he says, is accelerating – ­ that much isn’t a revelation – ­ but it is now faster than the rate at which people can learn.

While change increases exponentially, “our ability to learn and change has gone linear, if not flat”, he says. Pentacle, he says, was created to help companies deal with this post-crossover environment ­ – what Obeng calls the “new world”.

Related to the pace of change is the problem of volatility. “For weeks after commodity prices started a downward slide, many people still thought they were going up. When you look at a lot of markets what you see is volatility is getting really high. What volatility is telling you is that there are surprises.”

Past experience
Despite the pace of change and volatility, Obeng explains, “When people approach business problems, they assume the experience they have built up and which is broadly known out in the world is going to resolve issues.” The truth, he believes, is that “anything based on experience is probably already out of date. Therefore, you almost have to learn as you go – learn from other people and look for patterns rather than events.”

Patterns are important. A bee is a bee. Forty bees are 40 bees. Make the 40 bees angry and you have a swarm. “You can’t predict a swarm from a bee,” he says. The predicament of the current economic circumstances, he says, is that “There have been loads of events, but they are all just part of one pattern. When you’re in a complex environment, by understanding the pattern, you can do much better.”

Back to your budget. He plucks a few random assumptions out of the air: a few hundred highly paid managers spending a lot of time working on the budget and suddenly, bang, “Do you realise you’ve spent £20m of resources on this plan?” he says. Then he has an idea: “Here’s a deal. Give me £5m and I’ll make a budget just as rubbish as yours! You keep £15m!”

Back to the problem. “The reason we do budgets is because traditionally you could learn faster than the world was changing. If you took the time to understand what was going on, by the time you’d learnt that the world would be roughly the same. So while you are putting the budget together the world is the same. But today, as you spend three months putting the budget together, what you discover is that the hole is much deeper than you thought it was.”

Obeng has two points. The first is that budgets are trying to do two jobs at the same time. “They are trying to set objectives and they are trying to measure performance.

The truth is you need to split the two. You need to have the objective-setting, where you say, ‘We don’t care how you do it ­ deliver!’ And you have to have the performance management. You put the two together then you tell the City what’s happening. But we haven’t understood that yet.”

Linked to this is the inherent failure of the traditional, hierarchical management structure. The chances are “You don’t really understand what some of the people who report to you actually do,” he says. The point of functional hierarchy is that “You have the most senior person helping the other people below them to function. You don’t know whether they’re doing the right thing so you can’t necessarily control them.”

The solution lies, in part, in interaction and interdependence between people and teams in the organisation. “You maintain co-ordination,” Obeng says, “because it’s difficult to control things. Unless people are interdependent you can get rogue managers and nobody can catch them out.” And that, as much as the rapidly changing financial world, can wreak havoc with your budget ­ – even if it’s wrong, anyway.

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