OBLITERATE TRADITIONAL BUDGETING.

The annual budgeting -- or, in some environments, "planning" -- process is an ordeal that would make Machiavelli proud. Every year a call goes out to each budget center to start preparing next year's budget. A bunch of financial guys, anointed by general management to keep everything moving, usually facilitates the process.

They do this by providing each unit manager with a "workbook" that shows all the expenditures of the past period down to three decimal places. Then, the ordeal starts. The unit managers agonize over their plans for the next period: Do I add staff? How much of a salary increase? Any new programs? Finally, after much soul-searching and number-crunching, the budget is submitted, only to be turned back with insightful commentary such as "it's too much" or "we can't afford it."

The cycle is repeated and repeated until the manager, debilitated by exhaustion, accepts the final version, which chops out training programs, systems upgrades and other "non-essential" items. Why is this process so painful and unfair? Let's examine some of the critical shortcomings.

For one thing, traditional budgeting is incremental -- that is, next year's budget represents incremental additions and deletions to all the budgets that preceded it. Rarely do you see zero-based budgets, which wipe the slate clean and start all over. Even those who profess to use zero-based budgeting clear the slate and then add back large components of past work. Is it any wonder that some elements of an organizational resource pool get hard-wired into budgets, and the entire budget grows bigger each succeeding year?

The incremental changes (mostly additions) invariably lead to higher operating budgets, which leaves management in a very bad mood. When the order to "cut" comes down, only programs not yet started can be removed without disruption. So, reluctantly, unit after unit pares or eliminates many new initiatives, some showing real promise.

Tolerating overlap and duplication

If and when new programs are approved, new work begins while work originally intended to produce the same result continues. Take, for example, the case made for outsourcing maintenance. What happens to those employees who originally performed the work? Will they be redirected, with new tasks and job descriptions? Chances are they will use their newly found free time to "monitor" the contractor, or spend more time on current tasks. Incremental planning tends to build new programs on old ones, resulting in overlapping responsibilities and duplicated activity. The answer to the dilemma is to move away from planning expenditures to planning activities.

Work is fundamental to any enterprise. Employees are trained, supervised and incented to do work, which can be identified by "activities" such as "manufacturing a product," "recording transactions," "servicing a customer" and so on. So, if activities are the manifestation of work, activities should be our focus. It makes sense to plan activities, not simply the expenditures necessary to generate them.

Activities are measurable

Activities are amenable to planning, and people can relate to activities. If a case is made to hire a new customer service representative and the required compensation is added to the budget, management still may have a difficult time making a judgment. It is much easier to comprehend if a plan claims to add 0.5 full-time equivalents (FTEs) for "troubleshooting customer problems by telephone" or 0.25 FTE for "liaison with field reps." (1 FTE can represent the work of one employee or 10% of the cumulative work of 10 employees.) Management needs to know what these new resources will be doing; they need to know activities.

Activities can be valued in terms of their contribution to the enterprise mission. They can also be segmented into a hierarchy depending on their degree of variability and role in supporting that mission. Such activity analysis has not gone unnoticed in the business world, spurring interest in Activity-Based Costing (ABC) as a way to recognize the true cost of a product or service. ABC has spawned Activity-Based Management, a way of eliminating an organization's unnecessary activities.

A fundamental tenet of these activity-based methodologies is to classify activities in terms of "value" and "non-value." This is far too simplistic. No employee sees his or her activities as being of no value. Conversely, if an activity adds value, why not do twice as much, or three times? A better way is to assess the consequences of not doing this work, by employing risk analysis. An enhanced variation of these methodologies comes in the planning process itself. This is Activity-Based Planning (ABP) -- an ongoing process that is repeated each year.

To get started in Activity-Based Planning, you must start at the top. Senior management must initiate the transformation from expenditure budgeting to activity planning. True sponsorship from senior management involves their visibility, enthusiasm and participation at every step in the process. Developing a value model may be one of the most difficult aspects of ABP and must involve senior management. It is here where the organization decides what value to place on all its activities. The model can be based on how much an activity contributes value or how much "risk" there is in eliminating it.

Adopt a process focus

Business processes are collections of activities intended to provide an intended result. Processes cut across the entire organization, so no one functional unit "owns" a process. It will be necessary to identify the dozen or so processes that define the entire business. The resource-consuming activities of compiling financial records, processing data and producing reports, for instance, can be wrapped into a process called "performance reporting." This process involves much of the finance and accounting of departments, almost all the information technology unit and parts of those groups that provide input or receive reports.

Selecting the right team to implement ABP is critical. This team needs to be made up of individuals who are truly "change agents," capable of understanding what needs to be done to fulfill the mission.

The following principles should be followed:

1. The team must be cross-functional. It should represent the major organizational functions such as operations, finance and marketing. A cross-functional team assures that the process focus is upheld, and there is less of a chance that parts of the organization will feel left Out.

2. The team must represent the right levels in the organization. Too high a level can be as bad as too low a level, in terms of both experience and authority.

3. The team must have the same vision. All members should share the same sense of urgency, and should understand the need for change and articulate a credible case for change to every employee they work with.

Conduct activity workshops

ABP is facilitated by activity workshops, one-day exercises in which representatives from each planning unit detail how his or her work unit is organized, what activities are involved, how much time is devoted to them and what processes are being supported. This becomes a profile of the "as is," or current state of affairs. The ABP team facilitates these workshops, usually spread over a week's time in a large organization.

It is important that this effort be very productive. There should be no more than 25 to 30 activities that represent each budgetary unit's collective efforts. These activities should be an honest representation of what's actually going on. Rules need to be set in advance to handle overtime, temporary employees, vacancies and other issues that could distort the results. An additional profile is created, listing all the unit's controllable expenses. Items such as travel expenses, office supplies, etc. should be coded in a similar way to activities to complete the picture.

Employees cannot be left alone to attempt to enumerate their organizational unit's activities; the process must be facilitated. One essential tool is an "activity dictionary," a compilation of all the generic activities that conceivably go on in this environment. As workshop participants describe an activity such as "giving work direction to subordinates" or "monitoring employee progress," the team can interpret this as generically "supervising staff." Doing so enables the team to compare similar work and its processes across the organization.

Activities are statements of work and must be clear. People still insist on defining work in vague terms such as "decision-making." Accepting such vague terms for the organization's activities, however, makes it next to impossible to place a value on them or analyze ways to improve them.

Implementing Activity-Based Planning in any environment can yield significant and even dramatic results, but it is not without risk. Failure to deal with behavioral changes during and after a program can render the entire effort useless, if not damaging. Careful consideration must be given to the intervention effort by engaging senior management, forming the best team, focusing on removing or adding work in accordance with a value model, and communicating effectively at every step along the way.

George R. Marcino is a retired partner in the Management Consulting business unit of PricewaterhouseCoopers who planned and directed dozens of transformation efforts in both large and small companies across a wide spectrum of industries. He is affiliated with the Cornerstone Group, a consortium of senior consultants and executives, and can be reached at [e-mail].

PREPARING AN ABP PLAN

1. Each budgetary unit participates in process meetings with other key "players" in the pro-cess. "As is" activity and expense profiles are presented, and the group views the resource consumption of each component.

2. Unit representatives present their activity value analysis and describe how their various initiatives impact their activity profiles, both adding and deducting FTEs of work effort.

3. The group arrives at a consensus on the right resource composition of each process and presents its recommendations to management.

4. Once approved, the units use their budgeted activity profiles to construct unit organization charts and position descriptions. Employees and/or outside contractors are chosen to fill the organizational positions.