Is it time to stop using budgets to measure performance?

Recently, a physician colleague approached the administration of his hospital to request an additional nurse practitioner for his hospital-based clinical service. The service was caring for a larger than anticipated number of patients. He felt an additional provider would allow the service to maintain an excellent level of quality, while accommodating the increased volume of patients.

When he made his case to the hospital's chief nursing and chief financial officers, he was told they appreciated the hard work and the excellent quality his clinical service provided and understood and agreed with his need for additional clinical support.

However, since they were midway through the current budget cycle, and the additional position was not budgeted, there was no way to accommodate his request. They would certainly consider it a priority for next year's budget, however.

He left the meeting feeling very frustrated since he knew the short-term expense of the additional nurse practitioner, would result in sustained long-term ability to maintain increased patient volumes.

Why is it that many hospital administrators and managers are unwilling to deviate from their budgets, even when the initiative makes good financial sense in the long-term?

Budgets were designed as an internal accounting tool. They provide a means for forecasting anticipated revenues and expenses. Yet somehow, over time, the budget has taken on a much broader role, becoming both a strategic and performance management tool.

The allocations of resources, bonus money and promotions have all been tied to how well an administrator can manage his or her budget. Just think of how often you may have witnessed managers arguing over whose budget an unexpected cost should come out of for fear of reprisals.

Many a great idea has died at the hands of these budget wars. However, given the rapidly changing technology of the health care market, the increasing competition and the uncertainties of clinical demands, has the traditional "budget" outlived its usefulness? Is there an alternative means to provide the ability to measure performance, while allowing the flexibility and adaptability to changing needs?

Abolish the budget?

Jeremy Hope and Robin Fraser (1) argue traditional budgeting should be abolished. This is because the traditional budget and the command and control culture it supports prevent organizations from transforming into the decentralized structures they claim to be. They argue the fixed nature of yearly budgets results in several problems.

Centralized decision making ignores market feedback from frontline employees and managers. The preset allocation of resources in budgeting encourages hoarding. The rigid nature of the budget focuses people on compliance with the budget, rather than encouraging independent thinking and innovation.

Fixed incentives tied to budgetary performance instill a fear of failure in managers, and may add to fraudulent behavior, as was seen with WorldCom and Enron. Finally, fixed targets outlined in budgets usually lead to only incremental improvement in organizational performance. (1)

So how do we move away from traditional budgets? The first step is to redefine our performance expectations. Rather than set the expectation as "meeting or exceeding the budget," we should define expectations on multiple dimensions, which focus on improving both individual managers' and aggregate organizational performance.

These dimensions must not be based solely on financial metrics, such as achieving an acceptable operating margin. They should focus on metrics that are equally important and necessary for an organization's success, including quality, stakeholder satisfaction and innovation.

By defining, gaining buy-in and communicating these performance expectations throughout the organization, you create a platform from which key performance indicators can be developed.

For example, when setting key performance indicators (KPI's) for a surgical service line, rather than having performance mandates handed to them, the managers, nursing staff, ancillary personnel and physicians create the performance indicators and targets for themselves, based on the expectations they measure performance in the key areas of finance, quality, patient and stakeholder satisfaction, and innovation and growth.

This makes sense, since they are intimately involved in this line of business, have direct access to and can make use of continuous market feedback, and as such, have the best understanding of which performance indicators drive their business, as well as reasonable targets to aim for across the performance expectations.

Once determined, the KPIs and targets are presented to the administration for feedback and approval. Yet, how do you keep the services from setting unrealistically low or high targets?

The answer lies in setting more than one level of performance target for the KPIs. When only one level of target is created, performance is either "good" or "bad," and no one wants to be labeled as "bad."

Excellent, acceptable and unacceptable

However, if two targets are created, such as one for acceptable performance and one for excellent performance, three levels of performance are created--excellent, acceptable, and unacceptable.

With three levels of performance, the fear of failure is diminished. Managers are more willing to stretch their targets for excellence and push themselves and ultimately their performance, knowing they won't be reprimanded if they succeed at hitting acceptable target levels only.

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Once the performance indicators and targets are established, the next step is to measure performance and provide feedback. Yet, rather than set yearly targets, Hope and Fraser suggest the use of quarterly rolling forecasts. (1)

Rolling forecasts differ from budgets in several ways. First, rolling forecasts don't attempt to predict a "finish line" at the end of each fiscal year, based on what are usually outdated targets predicted some 12 to 15 months earlier.

Second, by looking at key performance indicators and not the vast array of detail seen in most budgets, they can be analyzed and adjusted more readily. In addition, rolling forecasts usually are more accurate since they are continuously updated with the latest estimates of customer demand, changes in quality requirements, and recent financial data from the most recent quarter.

Finally, unlike yearly budgets, where the forecast period becomes shorter and shorter as the end of the fiscal year approaches, rolling forecasts always project the same distance into the future. (1)

This prevents the "use it or lose it" mentality that often plagues budgets, where managers will find a way to spend any excess in their budget before the fiscal year ends to support their case for additional resources or to prevent the elimination of resources in the next budget.

By involving front-line managers and personnel in setting expectations, key performance indicators based on those expectations, and using three performance level targets, organizations can move from the fixed performance contract of the traditional yearly budget to the relative performance contract of the rolling forecast.

The result is decision making, innovation, and flexibility are encouraged. Continuous planning based on the rolling forecasts focuses everyone on creating value, rather than "staying within budget." Rewards based on relative performance of excellent and acceptable targets give managers the confidence to take risks, and motivate themselves to outdo merely acceptable levels of performance, without the fear of reprisal.

The result is a flexible, adaptable organization constantly looking into the future and making the necessary adjustments to meet its goals.

David P. Tarantino, MD, MBA, is executive medical director of Shock Trauma Associates, P.A., a 50+ physician, multispecialty practice associated with the University of Maryland School of Medicine. In addition, he is the chief executive officer of The MD Consulting Group, LLC, a health care management consulting firm in Baltimore. He can be reached by phone at 410-328-2036 or by e-mail at [e-mail].

Reference

1. Hope J and Fraser R. "Who Needs Budgets?" Harvard Business Review, February 2003.

By David P. Tarantino, MD, MBA

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