Beyond Budgeting - Leading with Flexible Targets: 2-day seminar

beyond Make it real! budgeting > transformation network. Beyond Budgeting: Leading with flexible targets. How to beat the competition – without fixed targets and with no annual planning whatsoever! Niels Pflaeging BBTN & MetaManagement Group Seminar with Uni Strategic, Kuala Lumpur 01./02.12.2008

Some introductory words… • English as a foreign language… • Opening hearts and minds for two days… • Everyone´s a CEO. • Dialogue, not monologue. • The material has changed! • Excercises • Cultural differences: We have to deal with that! Seminar – Beyond Budgeting 2 © BBTN – All rights reserved

What is it that these organizations have in common? Exceptional companies that do almost everything differently! Industry, Airline, Technology, Engin. Services, USA USA USA Brazil Retail, Services, Sweden Switzerland • Innovators: A crises within their industries Banking, or firms caused them to change radically Services, Sweden Australia • Exoten: Exceptional leadership models • Performer: Superior competetive success Industry, It´s the coherence of the Industry, USA leadership model that matters! Japan Retail, Retail, Sweden Germany Energy, Industry, Services, Retail, USA USA Brazil Germany Seminar – Beyond Budgeting 3 © BBTN – All rights reserved

The world has changed: outlining today's critical success factors high Industrial age ends: Knowledge economy advances: ”Supplies have the power“, ”Customers have the power“, Evolution of mass markets: strong competition, individualized demand: Taylorism as the superior model decentralized and adaptive model is superior! All are important today! Competitive Characteristics success factors (CSF) Dynamics and 1. Discontinuous change - Fast response complexity 2. Short life cycles - Innovation 3. Constant pressure on prices Operational excellence - Characteristics 4. Less loyal customers - Customer intimacy • Incremental change 5. Choosy employees - Great place to work • Long life cycles 6. Transparency, - Effective • Stable prices societal pressure governance • Loyal customers High financial - Sustained superior • Choosy employers expectations value creation/fin.perf. low • „Managed“ results 1890 Most organizations still use a management model 2010 was designed 2030 1980 1990 2000 that 2020 for efficiency, while the problem today is complexity. Seminar – Beyond Budgeting 5 © BBTN – All rights reserved

Our journey since 1998, within the international Beyond Budgeting movement Beyond budgeting (1998-2002) Beyond command and control (2003-2007) Beyond incremental change (2008-) … Seminar – Beyond Budgeting 8 © BBTN – All rights reserved

The new model is supported by science and practice Sciences: Practice: Thought leaders • • Stafford Beer Margareth Wheatley Industry leaders (selected) • Niklas Luhmann (selected) • Kevin Kelly • Ross Ashby • Joseph Bragdon • … • Douglas McGregor • Chris Argyris Complexity • Jeffrey Pfeffer theories Manufacturing • Reinhard Sprenger • Stephen Covey • Howard Gardner Social • Viktor Frankl sciences & HR Distribution • … • Peter Drucker Leadership & • Tom Peters Services • Charles Handy Change • John Kotter • Peter Senge Strategy & • Thomas Davenport Government performance & Not-for profit • Peter Block • … management • Charles Horngren • Henry Mintzberg • Gary Hamel • Jeremy Hope • Michael Hammer • Thomas Johnson • … Seminar – Beyond Budgeting 10 © BBTN – All rights reserved

Outlining the ‘industrial age’ model and its pitfalls “command and control“ • Too centralized • Too inward-looking • Too little customer-oriented • Too bureaucratic • Too much focused on control • Too functionally divided • Too slow and time-consuming • Too de-motivating • … film ‘Modern Times’ with Charlie Chaplin, 1936 From the Seminar – Beyond Budgeting 13 © BBTN – All rights reserved

How markets govern organizations “from the outside in” Periphery Mar ke t Center Information Decision Command Centralist command and Impulse control “collapses“ in Reaction increasingly complex environments Source: Gerhard Wohland Seminar – Beyond Budgeting 14 © BBTN – All rights reserved

From hierarchy to network structure. Traditional model New model (centralized functional hierarchy) (decentralized leadership network) Changing leadership and structure • “Bosses” rule! • “The market” rules! • Top-down • Outside-in command and control sense and respond • Top management • Front-line teams are always is always in charge in charge • Centralized leadership • Devolved leadership Seminar – Beyond Budgeting 15 © BBTN – All rights reserved

The problem observed initially, by the Beyond Budgeting movement James O. McKinsey, 1922 “Budgetary control… is urgently needed, as a foundation of control exercised by executives, and as a way to coordinate the activities of functional departments.” Dr. Jan Wallander, 1997 “Budgetary management is an unnecessary evil” Seminario Beyond Budgeting - Conferencista: Niels Pflaeging Seminar – Beyond Budgeting 18 © BBTN – All rights reserved

Traditional management processes keep teams from strategic thinking, and motivate counterproductive or unethical behavior Financial problems • Process takes too long Vision • Plans become obsolete quickly • Plans are of little or no use Targets and strategic guidelines Strategic problems Profitability in petrochemical industry in Europe 600 500 • Target negotiation 400 Fixed • Definition of incentives 300 Fixed • Activity planning 200 performance performance • Resource allocation 100 contacts and contacts and • Coordination of plans 0 0 1984 1986 1988 1990 1992 1994 1996 1998 2000 Source: Chem Systems “keep on track” “keep on track” • Approval Behavioral problems Budget Performance control (plan-actual) Bonus (vs. targets) Source: BBRT ... Seminar – Beyond Budgeting 19 © BBTN – All rights reserved

Management processes in organizations are “straight jackets” Strategy “Fixed” performance contract Strategic • Period [Fixed] learning cycle • Targets [Fixed] • Compensation [Fixed] Annual plan Fixed • Plan [Fixed] Performance Contract • Resources [Fixed] Budget • Coordination [Fixed] • Control [Fixed] Management • Agreed through [Negotiation] control cycle • Signed by: [Manager/Director] Control Tayloristic management works like this: As centralistic-burocratic hierarchies, held together through a regime of fixed performance contracts! Seminar –BBRT Budgeting Source: Beyond 20 20 © BBTN – All rights reserved

Current practices are misaligned with the Critical Success Factors Six “CSFs” Six misalignment examples • Fast response Annual planning process retards it • Innovation Centralized bureaucracy stifles it • Operational excellence ‘Spend it or lose it’ mentality fights it • Customer intimacy Short term targets prevent it • Best team Extrinsic ‘motivators’ undermine it • Ethical behaviour Dysfunctional, even unethical behavior conflicts with it • Value creation • Inferior financial results When pressure is applied, misalignment gets worse! Seminar – Beyond Budgeting 21 © BBTN – All rights reserved

Organizations need a different, trust-based form of “future-directed thinking”, NOT excessive planning! “The secret of success is not to foresee the future. But to build an organization that is able to prosper in any of the unforeseeable futures.\" Michael Hammer The problems with traditional planning and control are merely symptoms of a much deeper problem. Seminar – Beyond Budgeting 22 © BBTN – All rights reserved

From fixed to adaptive management processes. Traditional model New model (fixed performance contracts, (relative performance contracts, negotiated in advance) assessed with hindsight) Relative strategy performance contracts Changing Fixed performance processes Dynamic contracts coordination control • Fixed, annual processes • Dynamic, continuous processes • Fixed targets and incentives • Relative targets/compensation • Centralized and • Self-control, transparency and bureaucratic control peer pressure Seminar – Beyond Budgeting 23 © BBTN – All rights reserved

The proposal of Beyond Budgeting : Real change requires a coherent alternative to the command and control model “‘Beyond budgeting’ is a positive idea that uses the abandonment of budgeting as a trigger for improving the entire management model.” Charles T. Horngren, This is what Littlefield Professor of “Beyond Budgeting” Accounting, Emeritus, really is about Stanford University Source: Quoted from the preface to Fraser/Hope: „Beyond Budgeting” Seminar – Beyond Budgeting 24 © BBTN – All rights reserved

Our systems and modern management tools conflict with the old model and are not able to solve the underlying problems. ERP systems and Rolling data warehouses forecasts Provides Focuses on year information to end and distorts the hierarchy information Economic Benchmarking value added Supports Deemphasizes short term Central Local external stretch control comparisons targets Supports Creates ‘Make & Sell’ multiple Customer strategy Supports contracts relationship central decision Balanced management making Scorecard Activity-based management Seminar – Beyond Budgeting 25 © BBTN – All rights reserved

What is a ‘management model’? Industrial Age Information Age Managed stability Complex and dynamic Leadership culture + Management processes + Information systems Seminar – Beyond Budgeting 26 © BBTN – All rights reserved

From the old coherence to a new coherence. Traditional model (supports efficiency) New model (supports complexity) Centralized Decentralized hierarchy, network, “command “sense and control“ and respond“ The old model is not aligned with today’s CSF and it does not support ‘Theory Y’. > We need a new Relative strategy model to cope with performance complexity contracts > We must change Fixed the whole model! performance Dynamic contracts coordination Fixed Dynamic processes processes control Seminar – Beyond Budgeting 28 © BBTN – All rights reserved

The case of a radically decentralized organization: Handelsbanken – an extraordinary leadership philosophy The most important objective within Handelsbanken Group: “Higher Return on Equity than the average of comparable banks in the Nordic region and Europe.” Made real through: • Radical decentralization, which in turn leads to… • Best customer service • Lowest cost Alexander V Dokukin Consistently – over a period of 30 years – one of the most successful banks in Europe, measured by almost all key performance indicators (e.g. ROE, TSR, EPS, Cost/Income, customer satisfaction, …) ROE = Return on Equity, TSR = Total Shareholder Return, EPS = Earnings per share Seminar – Beyond Budgeting 29 © BBTN – All rights reserved

For more than a decade, this bank has been customer satisfaction leader among its peers, constantly Handelsbanken 75 Avrg. in sector 70 65 Data from 2005: Sweden: Corporate and Private – Best among big 60 and national competitors. Denmark: Private market – best. Norway: Corporate market - best. 55 Private market – 2nd place after substantial improvement. Finland: Corporate market - best, 50 Private market – best. 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Private Customers, Source: Svenska Kvalitetsindex Seminar – Beyond Budgeting 30 © BBTN – All rights reserved

Comparison between the major publicly listed universal banks in Europe universales in Europe. Jan-Dec 2005, after credit losses. * Refers to loans to the public or deposits if deposits > lending 1,0 Cost/Total loans*, % Danske Bank Handelsbanken FöreningsSparbanken DnB Nor 2,0 Nordea Bank of Ireland SEB HypoVereinsbank Allied Irish Banks Banco Santander KBC 3,0 Credit Agricole Royal Bank of Scotland Bank Austria Commerzbank BBVA Unicredit Lloyds TSB San Paolo-IMI Standard Chartered 4,0 Erste Banca Intesa Capitalia ABN Amro Monte dei Paschi di Siena Barclays HSBC 5,0 Deutsche Bank BNP Paribas HBOS Société Générale UBS CS Group Cost/Income ratio, % 6,0 90 80 70 60 50 40 Source: Deutsche Bank: European Banks - Running the Numbers, Spring edition. Seminar – Beyond Budgeting 31 © BBTN – All rights reserved

How “radical decentralization“ is being reflected in the company´s organizational structure and decision-making Principles Customers Customer intimacy A large network of self-managed teams with full responsibility for 600 branch managers (Profit Centers) customer results Freedom and capability to act 12 regional Fast, open “Winning“ culture, combined with the managers Fast, open (Invest Centers) information information freedom and ability to act systems systems Governance and transparency CEO, Framework for decision making with product firms, clear values, limits and relative treasury, IT etc. targets, plus transparency Leads to maximum customer satisfaction! Source: BBRT Seminar – Beyond Budgeting 32 © BBTN – All rights reserved

Relative target definition through “league tables“ (rankings) – instead of planned, fixed targets and internal negotiation Strategic „cascade” Bank to bank Bank to bank Return on Equity (RoE) Return on Equity (RoE) Region to region Principles Region to region Return on Assets(RoA)etc. 1. Bank D 31% Return on Assets(RoA)etc. 1. Bank D 31% Branch to branch 2. Bank JJ 24%1. 2. Bank Branch to branch 24%1. Region A 38% Cost/income ratio etc. Region A 38% Cost/income ratio etc. 3. Bank I I 20%2. 3. Bank 20%2. Region CC 27% Relative targets and Region 27% relative compensation 4. Bank BB 18%3. 4. Bank Region H 20%1. Branch JJ 28% 18%3. Region H 20%1. Branch 28% 5. Bank EE 15%4. 5. Bank 15%4. Region B 17%2. Region B 17%2. Branch D 32% Branch D 32% Continuous 6. Bank FF 13%5. 6. Bank 13%5. Region FF 15% 3. Region 15%3. Branch EE 37% Branch 37% 7. Bank CC 12%6. Region EE 12%4. 12%4. Branch A 39% Branch A 39% planning/control 7. Bank 12%6. Region 8. Bank H 10%7. Region JJ 10%5. 10%5. Branch I I 41% Branch 41% 8. Bank H 10%7. Region 9. Bank GG 8% 8. 9. Bank 8% 8. Region I I 7% 6. 7% 6. Branch FF 45% Region Branch 45% “On demand“ flow of 9. Region G 6% 7. Region G 6% 7. Branch CC 54% 10. Bank AA (2%)9. 10. Bank (2%) Branch 54% resources/ 10. Region D (5%)8. 10. Region D (5%)8. Branch G 65% Branch G 65% dynamic coordination 9. 9. Branch H 72% Branch H 72% 10. Branch B 87% 10. Branch B 87% Result & value contribution Leads to lowest operational cost! Seminar – Beyond Budgeting 33 © BBTN – All rights reserved

Flexible coordination and resources “on demand“ - instead of allocations and budgets Headquarters/ Headquarters/ Region Region Branches acquire resources through internal markets Resources Resources Customer Customer Branch Branch (IT, HR etc.) (IT, HR etc.) demand demand Branches Branches alone are Branches decide over responsible for efficient observe necessary use of resources customer resource levels demand Leads to eradicating and avoiding waste! Source: BBRT Seminar – Beyond Budgeting 34 © BBTN – All rights reserved

How preparing for action and forecasting (continuous previews) are used in this model – instead of centrally coordinated planning Regional managers and HQ challenge monitor check Teams close aim act to the customer (branches) plan Forecasts Leading to fastest possible reaction to change! Seminar – Beyond Budgeting 35 © BBTN – All rights reserved

Creating a “virtuous circle”– a common factor among “Beyond Budgeting” pioneers Better to do business with Better for society Better to invest in 4. Customer intimacy – Highest 5. Ethical & social standards – 6. Sustainable value – (independent) customer satisfaction Support the long term interests of Beats peer group every year scores in sector year-after-year; the bank and society. on ROE and cost-to-income lowest customer complaints; ratio; highest total monitors customer shareholder return in sector; acquisitions/defections. devolved adaptive organization is key driver of 3. Operational excellence – success. Lowest costs of any bank in Europe; lowest bad debts; cost reduction culture; flat organization (half a Better to work for head office person per branch versus five for rivals); internal 1. Best people – SHB is first choice financial services market exerts constant pressure on company in Sweden for central services. graduates; employee 2. Innovation – SHB voted joint turnover is lowest in sector; best Internet bank in Europe in challenge, personal 2000; any competitive products responsibility and freedom to and solutions are fed back from run their part of the branches to product development. Virtuous circle business; group-wide profit sharing scheme. Text relates to Svenska Handelsbanken Seminar – Beyond Budgeting 36 © BBTN – All rights reserved

Why most concepts, books and theories about leadership, as well as most advice on management are flawed “One cannot talk sensibly about leadership or people management, nor design decent management processes, if we don´t clarify beforehand our beliefs with regards to what in organizations are like. We have to develop a shared understanding of human nature and its influence on our organizations.” Leading with Flexible Targets Seminar – Beyond Budgeting 38 © BBTN – All rights reserved

The industrial age management model not only fails because markets have changed. It is also misaligned with human nature. Theory X (0%) Theory Y (100%) Attitude – Attitude - People need to work and want to People dislike work, find it boring, and will take an interest in it. Under the right avoid it if they can. conditions, they can enjoy it. Direction – Direction – People must be forced or bribed to make the People will direct themselves towards a right effort. target that they accept. Responsibility – Responsibility – People would rather be directed than accept People will seek and accept responsibility, responsibility, which they avoid. under the right conditions. Motivation – Motivation - Under the right conditions, People are motivated mainly by money and people are motivated by the desire to realize fears about their job security. their own potential. Creativity – Most people have little creativity Creativity – - except when it comes to getting round Creativity and ingenuity are widely distributed management rules. and grossly underused. Based on Douglas McGregor, ‘The Human Side of Enterprise’, 1960 Seminar – Beyond Budgeting 40 © BBTN – All rights reserved

W.L.Gore. The best-led “innovation machine“ in the world? • Consistently successful, for more than 40 years • “Most innovative company in the U.S.“ (Fast Company) • For the 8th year in a row among the 100 best employers in the U.S. (“Fortune“ – best medium-sized employer). Best employer in England for the third consecutive year. Among the best companies to work for in the EU and Germany. • All employees participate in the firm´s success and become “virtual“ shareholders. • No job titles. Little hierarchy. No job descriptions - instead: “job sculpting“. • Highly empowered teams. “Temporary leadership“ • “Since 1958, Gore has avoided traditional hierarchy. Instead, we have practiced a team-based environment that stimulates personal initiative, innovation and communcation between all our Associates.” • “The fundamental belief in the people in our organzation and in their ability continues to be the key to our success.“ Seminar – Beyond Budgeting 44 © BBTN – All rights reserved

The 12 principles of the Beyond Budgeting model are in fact a full set of “design principles“ for the new organization type. Principles Do this! Not that! Customers and Customer/outside focus Focus on the boss responsibility Responsible teams (“cells”) Centralization Leadership Performance and Performance culture Inspired by the past 6 devolved freedom Autonomy and responsibility Adherence to fixed plans leadership principles Governance and Clearly defined objectives and values Impose objectives transparency Open and shared information Restrict information Goals and Goals related to continual improvement Fiscal year fixed goals rewards Rewards related to company results Reward local fixed goals Processes Planning and 6 adaptive management down annual planning Continuous and inclusive planning Top controls process principles Variations against fixed plans Compare performance against actuals Resources and Resources on demand Annual budget allocations coordination Coordinate dynamic interactions Departmentalization Seminar – Beyond Budgeting 47 © BBTN – All rights reserved

Now, it is time for transforming your organization – by closing the gaps A typical company – results from the BBRT online diagnostic Table 1: The case for change Problems Problems Vision Vision Practice Practice Close Close the gaps! the gaps! Seminar – Beyond Budgeting 48 © BBTN – All rights reserved

There are two different ways of working on the model – evolution and transformation Low degree of decentralization/ empowerment and Differentiation Stagnation fixed performance phase within the tayloristic model contracts: in conflict with today's critical success factors! Transformation Bureaucratization through radical devolution growing hierarchy and and decentralization functional differentiation High degree of decentralization/ empowerment with relative Evolution Sustaining and performance Pioneering within the decentralized Integration deepening of the contracts: aligned phase model phase decentralized model, with today's critical through generations success factors! Organizations with Foundation Time scale: organization's age traditional models must Several decades old eventually transform themselves! Seminar – Beyond Budgeting 49 © BBTN – All rights reserved

Why traditional management with “fixed performance contracts“ regularily fools us: We have lost control a long time ago… Fixed targets Relative, self-adjusting targets Target: absolute ROCE in % (here: 15%) Target: relative ROCE in % (to market) Plan Actual Target Actual Comparison: Comparison: Market-Actual Plan-Actual Most Target: „ROCE Most important in % better important Market competitor than market Market competitor (25%) (28%) average” (25%) (28%) Actual Actual Plan (21%) (21%) (15%) [independent [expected from expected market Ø: 13%] market Ø] • Interpretation within the plan-actual- • Interpretation within actual-actual compa- comparison: Plan was outperformed by 6 rison: Performance was 4 percentage points percentage points > positive interpretation below competition! > negative interpretation • Better ROCE of the market average and the • Absolute assumptions at the moment of most important competitor remain unnoticed! planning don´t matter. • Targets always remain updated and relevant! Source: Niels Pfläging Seminar – Beyond Budgeting 51 © BBTN – All rights reserved

Simple and relevant: creating reports without actual-plan- variances, fixed targets, or plans! Company KPI Regions KPI Compe- last Same Same Ø Ø month month month last 12 Competitor A 31% Region G 7% titor A last prev.. 12 prev. Our year year mnths mnths Competitor E 24% Region E 7% unit A Competitor C 20% Region B 6% KPI 2 Us 18% Region F 4% Compe- Competitor B 13% Region A 3% Us titor B Indicators Competitor D 12% Region D 3% Our or Competitor G 10% Region C 1% unit B Groups of accounts Competitor F 8% Region H 0% KPI 1 Ranking (League table) ext./intern. Snapshot (static) with benchmarks Accouts/KPIs vs. Previous periods (A) Maximum Tolerance levels Us (B) Gliding average KPI KPI KPI Us Competitor A Curve with variance Time (Actuals) Time (Actuals) Time (Actuals) Trend with tolerance Trend with benchmark Trend with references Seminar – Beyond Budgeting 52 © BBTN – All rights reserved

To evaluate performance in an adaptive and dynamic way, the basis of Performance Measurement must shift Against plan Against time • Prior periods • Progress towards achievement of medium-term (2-3 years) targets Internal focus External focus • Internal peers • Competitors • Benchmarks/Stretch Annual focus Trends and “as needed” Financial measures Few key indicators Closed systems Open information systems for all Pure measurement Mixed approach meajuring/judging “Indicators only indicate“/there is no “truth“ in the numbers – living systems cannot be evaluated just by measuring! Seminar – Beyond Budgeting 54 © BBTN – All rights reserved

beyond Make it real! budgeting > transformation network. BBTN: www.bbtn.org Niels Pflaeging Gebhard Borck BBTN & MetaManagement Group BBTN & gberatung Al. Santos 1.991 Fritz-Neuert-Str. 13a 01419-002 São Paulo – SP, Brazil 75181 Pforzheim - Germany niels@bbtn.org gebhard@bbtn.org Skype: npflaeging Skype: gborck www.metamanagementgroup.com www.gberatung.de Xing forum: www.xing.com/net/beyondbudgeting Get in touch with us for more information about BBTN membership and about leading transformation, or ask us for a workshop proposal.

beyond Make it real! budgeting > transformation network. Beyond Budgeting: Leading with flexible targets. How to beat the competition – without fixed targets and with no annual planning whatsoever! Niels Pflaeging BBTN & MetaManagement Group Seminar with Uni Strategic, Kuala Lumpur 01./02.12.2008

Let´s leave compensation myths behind! “We found no systemic pattern linking executive compensation to the process of going from Good to Great.” Jim Collins, From Good to Great, 2001 “Individual incentive pay, in reality, undermines performance – of both the individual and the organization.” Jeffrey Pfeffer, Six Dangerous Myths about Pay, HBR 1998 “Spending time and energy trying to “motivate” people is a waste of effort... The key is not to de-motivate them.” Jim Collins, From Good to Great, 2001 Seminar – Beyond Budgeting 58 © BBTN – All rights reserved

Background stories we wouldn´t tell our clients: Real-life examples from companies The case of Marie Taylor This is what happened: Marie Taylor, a sales person from our organization, has generated income that goes against our company´s principle “Always act to the benefit of our customers“. The decision: Marie Taylor is transferred to the internal sales support department. All her bonuses rights are immediately cancelled. The background story: It is true – all sales people are obligued to act in the interest of customers. But it is also true that 40% of Marie Taylor´s salary depend on the amount of net sales she generates. Seminar – Beyond Budgeting 59 © BBTN – All rights reserved

Background stories we wouldn´t tell our clients: Real-life examples from companies The case of Frank Miller This is what happened: Frank Miller, a consultant, has overcharged during his work with clients, which means he has systematically inflated the amount of worked hours charged to his customers. The decision: Frank Miller has been fired and is leaving the company immediately. The background story: It is true – Frank Miller has acted against the law, by charging more than he has actually worked for customers. But it is also true, that 25% of Frank Miller´s income depend on the hours charged to clients… Seminar – Beyond Budgeting 60 © BBTN – All rights reserved

The problem with “incentives”: How traditional management systematically forces people to cheat Bonus Variable Bonus Common practice: hurdle area limit “Ceiling” „Pay for performance“ compensation Salary/ Reduction Maximization Reduction incentive: profile with fixed bonus incentive: Lower incentive: Anticipate postpone results to performance contract: result even more results next period Creates maniuplation incentive in any situation! Base salary 80% 100%: 120% Performance as % of target target of target of target realization Linear compensation curve without breaks: A better model: Result variable compensation becomes oriented compensation decoupled from targets profile with relative Salary/ Free from performance bonus incentive to manipulate contracts: No incentive to manipulation. Actual Actual Actual Performance in Source: Michael Jensen result #1 result #2 result #3 relative evaluation Seminar – Beyond Budgeting 61 © BBTN – All rights reserved

General principles for designing compensation systems in Beyond Budgeting organizations 1. Pay the person – not the position. Abolish salary bandwiths. 2. Reward results (ideally, relative to external benchmarks), not target realization or actuals compared to plans. Abolish all links between targets and money. 3. Apply group- or team-based variable compensation, e.g. participation in the overall financial result of the firm, not individual bonuses. 4. Design simple variable compensation systems – eliminate complexities, which will lead to manipulation. 5. Compensate long-term value creation – not short-term performance. 6. Only use financial performace indicators in compensation systems – not intermediate indicators which are often hard to quantify or measure (such as quality or customer satisfaction). 7. Include all people in the variable compensation system (turning the system fair and inclusive) – not only an “elite“. 8. Use the language of participation in results - not the philosophy of “incentives“. By freeing themselves from conven- tional forms of “pay for All employees should earn a performance”, organizations will share of the financial success. create simple and more transparent Restrain from the idea of compensation systems. “motivating them“! Seminar – Beyond Budgeting 62 © BBTN – All rights reserved

How often do the systems, especially the HR systems, get in the way of change, transformation, vision and strategy? Answer: Far too often. History often leaves HR people in highly bureaucratic personnel functions that discourage leadership and make altering human resource practices a big challenge. Source: J. Kotter, Leading Change, HBSP, p, 110-111 Seminar – Beyond Budgeting 63 © BBTN – All rights reserved

Employing resources dynamically: A typical way of doing it, as practiced by Sydney Water, Australia Resources Income as “total (expected) available resources over time“ - forecasted as “limiting factor“ Yet uncommited resources – work actively on available Already approved investments - “options for a better future“ actively handled as “dynamic portfolio“ Operational resources – controlled by Key Performance Indicators (KPIs) – activities are focused on continuous improvement! Projected period (e.g. 5 quarters) Source: Sydney Water Seminar – Beyond Budgeting 65 © BBTN – All rights reserved

Why isn’t everyone devolving decision-making power to the periphery? “We have known for nearly half a century that self-managed teams are far more productive than any other form of organizing… productivity gains in truly self-managed work environments are at minimum 35% higher than in traditionally managed organizations. … [People] are asking for more local “Through extensive field tests, the autonomy… There is both a desire to participate more [US] Army has discovered that when individuals have information [about and strong evidence that such participation leads to what’s occurring in the battlefield] the effectiveness and productivity we crave… With and know how to interpret it because so much evidence supporting participation, why isn't they know the ‘commander's intent’, everyone working in a self-managed environment right they can make decisions that lead to now?” greater success in battle.” Margaret Wheatley, Author of “Leadership and The New Science”, Margaret Wheatley, Leadership and the Goodbye, Command and Control, Leader to Leader, No. 5 Summer New Science, Berret-Koehler Publishers 1997 Do mangers not want to devolve power? … or do they not know how to do it? … or both? Seminar – Beyond Budgeting 67 © BBTN – All rights reserved

More about devolved leadership • Devolution: Like delegation, it is a form of decentralization. But there is a difference: Delegation occurs when a superior decides to pass a power, responsibility or task to a subordinate. Devolution occurs when a board (or equivalent) decides as a policy to empower a lower level in an organization. Devolution is therefore much more permanent than delegation. It involves structural changes that impart a greater degree of autonomy (Greek: self governance). • Devolved Leadership means decentralizing decision making authority to teams at as low a level in the organization as possible. The aim is to enable everyone to think and act like a leader. It is likely to require changes in organization, and for people to acquire new capabilities. It will usually involve decentralizing some activities in order to provide teams with greater autonomy, but it does not mean that all activities must be decentralized. • Centralize what? Under Devolved Leadership, activities may be centralized or decentralized. As a rule decentralization of activities is preferred because it leads to better customer service and reduces organizational complexity, but it does not preclude centralizing activities if doing so will make significant cost savings or enable more specialist expertise to be retained, and these benefits outweigh those of greater autonomy. • Relationships: However, what has to change under Devolved Leadership is the relationship between units. Power must be given to the customer, whether external or internal. Suppliers must respond to the needs of their customers, not be driven through a functional hierarchy. • Results of devolution: As an outcome, the organization becomes flatter. It can then act as a network of autonomous units, each unit adjusting continuously to the needs of its customers (internal and external), thereby enabling the whole organization to become more adaptive. Seminar – Beyond Budgeting 68 © BBTN – All rights reserved

Some questions that we need to respond, if we want to decentralize decision-making power in an organization How can we create oben dialogue and “How can we end “Centralized” “Devolved”/descentralized transparency between 100% of the the arrogance of people in the organization? the corporate center (HQ)?“ What will be those teams close to the customer (“cells“) like, in our organization? How do we link periphery and center of the organization – leading, not managing? People are divided by function and Leadership is devolved (within defined How do we create an environment in which the between ‘doers’ and ‘thinkers’. boundaries) to the frontline – Consequently, many decisions good people within our organization can customer 95% of have as close as possible to the to be taken centrally after as entrepreneurs, the way and to as many people act being they deserve? passed up the hierarchy. and with as much autonomy as possible. Seminar Beyond Budgeting - Niels Pflaeging Seminar – Beyond Budgeting 69 © BBTN – All rights reserved

The power of visionary leadership: dm-drogerie markt, transformed during the 1990s f( D x V x S )> R The results: • More successful than its competitors in all relevant performance indicators. • One of the most respected companies in Germany. Strong organic growth. • Almost without hierarchy, since the late 1990s. “Branches rule“, leadership happens “by dialogue“. • Doesn´t manage “cost” or “plans”, but shows employees how value creation flows through the organization, through internal value creation accounting system D = Dissatisfaction V = Vision S = Strategy/Steps R = Resistance Seminar – Beyond Budgeting 72 © BBTN – All rights reserved

The best-led technology firm in the world? Semco, from Brazil – transformed at the beginning of the 1980s • Consistent performance during the last decades, inspite of deep crisises in Brazilian economy • Transformed after deep crises in the early 80s, 3.000 employees today • “The fastest-growing company in Latin America” (strategy+business) • One of the most admired companies in Brazil. • “The most democratic company in the world” (HBR) • Lowest staff turnover among competitors • All people participate in their business unit results • Employees choose their own bosses and set their own salaries • No formality – minimum of meetings, memos and approvals. Everybody knows the numbers. What they don´t need at Semco! • Fixed work hours and time control • Org charts • “Strategic plans” • HR department • Mission statement • Rigid plans and fixed targets • Obligation to participate in meetings • Fixed work places • Job and budget cuts • Conflict with syndicates/unions • ... Source: e.g. Ricardo Semler, „The Seven-Day Weekend“, 2004 Seminar – Beyond Budgeting 73 © BBTN – All rights reserved

The case study: Transforming an organization, as suggested by John Kotter, HBS: A process model for organizational change References Organizational change process (John Kotter, “Leading Change” to “Our Iceberg is Melting”) 1. 2. 3. 4. 5. 6. 7. 8. Create a Pull Develop Communi- Empower Produce Don't Create a sense of together a change cate for all others short-term let up! new culture urgency guiding vision and understan- to act wins coalition strategy ding and buy-in Seminar – Beyond Budgeting 74 © BBTN – All rights reserved

The case study: What was done? „The week of truth“ Status of the project 1. 2. 3. 4. 5. 6. 7. Create a Pull together a Develop Communicate Empower all Produce Don´t Phase in % sense of guiding change vision for understan- others short-term let up urgency coalition and strategy ding and to act wins buy-in 1. There is a strong guiding coalition that sustains the transformation. 2. All over the organisation, “profound change“ is considered an issue. 3. Different groups in the organisation (task forces) already work on specific changes. Seminar – Beyond Budgeting 75 © BBTN – All rights reserved

A case study: What was done? „The week of truth“ Workshop preparation: Execution: • Participants: Approx. 20% of the firm´s employees • from all areas of the firm. Phase 1 – Speaking a • from all hierarchical levels. common language • Three groups were formed • Market Phase 2 - Recognize & describe • Product the current situation • Central Services Phase 3 – Think and describe the networked cell structure Seminar – Beyond Budgeting 76 © BBTN – All rights reserved

The case study – the organizational structure looked like this CEO Director Director Director Director CFO oes the International Production Technology Sales Germany here d Region Region Region Region Branch Branch Branch Branch And w 1&2 3&4 5&6 7&8 I II III IV Admini- HRSales Control- Marke- Production Sales Cont. Admini- Material Cont. Marke- Assistant IT Assistant ling Assistant Quality Engeneers, here? stration OEM education tingOEMSales stration Sales education ting/ CI Region Region Region Region Leader SalesPlanning Developers Sales t fit in 9 & 10 11 & 12 13 & 14 14 & 15 ma r k e Accoun- Work Sales After-Sales Customer Customer Central sales TelephonistsAssistant Internal sales Region Region Region Pro- Services ting Region Assembly planni Logistics office Services Services support services duction 23 16 & 17 18 & 19 20 & 21 22 & ng Sales large Region Region Region Sales large Technical Region Technical Projects & Projects & Process Toolings & Complaints Complaints Purchasing & systems 26 &Hotline 28 24 & 25 27optimization 29 equipments Hotline ProposalsDesign Offers Maintenance Disposition Seminar – Beyond Budgeting 77 © BBTN – All rights reserved

Our excercise: Develop a dentralized networked cell structure instead! • The market is the boss. (“Outside“ rules!) • There are three kinds of building blocks of a devolved organization: A sphere of activity, network cells, “strings“. • All “key tasks“ performed in the old structure have to be performed in the new structure as well. • A cell is not a department: It is functionally integrated, not functionally divided! • A cell has clients - external or internal – which it Seminar – Beyond Budgeting 78 © BBTN – All rights reserved

The case study: What was done? “The week of truth“ Central Market Services • Overall Region “Market” Marketing/CI Northeast Region • Training Region Clients: All R-Cells Center Southeast Equipment • Tooling construction P4 P5 • Facility Management Region Region Cells (“R-Cells”) Clients: all P-Cells Region Europe Key Roles of R-Cells P3 P6 • Planning & offers West Central Equipment • Sales Market • After-sales services Services Materials & Logistics P2 P7 Region • Logistics • Sales office Materials & • Hotline Org Logistics America • Purchasing Region Clients: All P-Cells • Complaints Shop North Product Info P8 “Own“ all customers in Cell 1 Shop Product cells (“P-cells”) their regions • Production • Info Shop work Process & Region “Sphere of • IT planning Org Shop Southwest •…• Financial accounting Quality • HR Activity” • Controlling • Maintenance • Executive board + assistance • Clients: all R- and P-cells Production logistics • Central office • Process optimization Clients: All R- and P-Cells • Material planning • Design/R&D Customers: All R-Cells Seminar – Beyond Budgeting 80 © BBTN – All rights reserved

“Cell structure“ as a foundation for sensible target definition in a “relative“ way - using league tables Strategic cascade Firm to Firm Firm to Firm ROCE ROCE Region to Region Region to Region 1. Firm D 31% Cost over income Cost over income 1. Firm D 31% P-Cell to P-Cell 2. Firm JJ 2. Firm 24%1. P-Cell to P-Cell 24%1. Region A 38% On-time-delivery etc. Region A 38% On-time-delivery etc. 3. Firm I I 3. Firm 20%2. 20%2. Region CC 27% Region 27% 4. Firm BB 4. Firm 18%3. Region H 20%1. P-Cell JJ 28% 18%3. Region H 20%1. P-Cell 28% 5. Firm EE 5. Firm 15%4. 15%4. Region B 17% 2. Region B 17% 2. P-Cell D 32% P-Cell D 32% 6. Firm FF 6. Firm 13%5. 13%5. Region FF 15% 3. Region 3. 15% P-Cell EE 37% P-Cell 37% 7. Firm CC 12%6. Region EE 12%4. 12%4. P-Cell A 39% P-Cell A 39% 7. Firm 12%6. Region 8. Firm H 10%7. 5. Region JJ 10% 5. P-Cell I I 41% P-Cell 41% 8. Firm H 10%7. Region 10% 9. Firm GG 8% 8. Region I I 7% 6. 7% 6. P-Cell FF 45% P-Cell 45% 9. Firm 8% 8. Region 10. Firm AA 10. Firm (2%)9. Region G 6% 7. Region G 6% 7. P-Cell CC 54% (2%)9. P-Cell 54% 10. Region D (5%) 8. 10. Region D (5%) 8. P-Cell G 65% P-Cell G 65% 9. 9. P-Cell H 72% P-Cell H 72% 10. P-Cell B 87% 10. P-Cell B 87% Contrib. to value creation Leads to lowest operational cost! Seminar – Beyond Budgeting 81 © BBTN – All rights reserved

are we “It’s not because it’s difficult that we don’t dare to do it: it seems difficult because we don’t dare to do it.” Seneca, Roman philosopher and statesman, 4BC – 65AD Seminar – Beyond Budgeting 83 83 © BBTN – All rights reserved

There are many pioneers of the new model, worldwide. But only very few of them have undergone transformation. All organizations with Selected pioneers of the model traditional models will eventually have to transform! In the 70s In the 50s In the 90s In the 90s In the 80s In the 90s Pioneers that went through transformation Seminar – Beyond Budgeting 85 © BBTN – All rights reserved

Part I of the “Double Helix” transformation framework: A process model for organizational change References Organizational change process (John Kotter, “Leading Change” to “Our Iceberg is Melting”) 1. 2. 3. 4. 5. 6. 7. 8. Create a Pull Develop Communi- Empower Produce Don't Create a sense of together a change cate for all others short-term let up! new culture urgency guiding vision and understan- to act wins coalition strategy ding and buy-in Seminar – Beyond Budgeting 87 © BBTN – All rights reserved

What to do when in the process? Two examples • Create array of larger Task Forces to change Organizational organizational structure, management change process processes and business processes (John Kotter, “Leading Change” • Align projects and decision processes to “Our Iceberg is Melting”) with 12 principles and the values defined in the case for change 1. 2. 3. 4. 5. 6. 7. 8. Create a Pull Develop Communi- Empower Produce Don't Create a sense of together a change cate for all others short-term let up! new culture urgency guiding vision and understan- to act wins coalition strategy ding and buy-in • Write the case for change • Build awareness through selective action (e.g. abolishing budgets) • Win hearts and minds, train for empowering leadership styles and more transparency Seminar – Beyond Budgeting 88 © BBTN – All rights reserved

Part II of the “Double Helix” transformation framework: a process model for personal change Reference 3. Beginning Individual change process (William Bridges, “Managing Transitions”) 2. Neutral Zone Individual 1. Ending change process (William Bridges, “Managing Transitions”) Seminar – Beyond Budgeting 90 © BBTN – All rights reserved

Putting the “Double Helix” together. 3. Beginning Organizational Individual change process change process 2. Neutral Zone 1. 2. 3. 4. 5. 6. 7. 8. Create a Pull Develop Communi- Empower Produce Don't Create a sense of together a change cate for all others short-term let up! new culture urgency guiding vision and understan- to act wins coalition strategy ding and buy-in 1. Ending Seminar – Beyond Budgeting 91 © BBTN – All rights reserved

Principles: Leading profound, transformational change 3. Beginning Organizational Individual change process change process 2. Neutral Zone 1. 2. 3. 4. 5. 6. 7. 8. Create a Pull Develop Communi- Empower Produce Don't Create a sense of together a change cate for all others short-term let up! new urgency guiding vision and understan- to act wins culture coalition strategy ding and buy-in References 1. Ending Seminar – Beyond Budgeting 92 © BBTN – All rights reserved

Underlying assumptions of our recent management model transformation projects 1. Organizations are “systems”. So they have to be transformed as such. Thus, finance people cannot do it alone. (And it's actually much more fun approaching change holistically.) 2. “It´s all about human nature”. Apply “Theory Y” rigidly! 3. Everyone's communication styles and behaviour patterns must change. Transformation thus requires “people” specialists, coaching and some training. 4. A systemic view of the change process: it is senseless to plan too far ahead. So we will not do it. We will instead “follow the energy”! 5. You have to do this yourself! We will give advice, and guarantee that you are aware of the consequences, beforehand. We will help you in applying the mental model in any situation. You will make the decisions for yourselves, our role is to make the consequences clear. We will also provice you with methods to solve problems, all the time. 6. “Mature” cases and the model itself are key to making the vision palpable. We will also use “emotional” techniques, metaphors, stories, scientific evidence, and our international network, wherever indicated. 7. Abolishing budgets is 0,5% of the project (and not the difficult bit). Creating an entrepreneurial devolved network is key to the “new” model. Which in case of PE means changing a hundred mindsets. Seminar – Beyond Budgeting 94 © BBTN – All rights reserved

beyond Make it real! budgeting > transformation network. BBTN: www.bbtn.org Niels Pflaeging Gebhard Borck BBTN & MetaManagement Group BBTN & gberatung Al. Santos 1.991 Fritz-Neuert-Str. 13a 01419-002 São Paulo – SP, Brazil 75181 Pforzheim - Germany niels@bbtn.org gebhard@bbtn.org Skype: npflaeging Skype: gborck www.metamanagementgroup.com www.gberatung.de Xing forum: www.xing.com/net/beyondbudgeting Get in touch with us for more information about BBTN membership and about leading transformation, or ask us for a workshop proposal.

Beyond Budgeting - Leading with Flexible Targets: 2-day seminar

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