Self-organization makes for smart managing: a few pioneers like American Express and Southwest Airlines have adopted a new system of budgeting and decision-making that eschews top-down finance controls. Instead, it recognizes the efficacy of empowering the rank-and-file and stressing flexibility.

The insights of Friedrich Engels, co-author with Karl Marx of The Communist Manifesto, might seem an unlikely inspiration for corporate strategy. The foraging and nest repair behavior of ants might seem, if anything, even less likely. Of course, anyone who has been on a picnic knows how quickly ants converge on an opportunity; fewer know that the same worker ants spontaneously redeploy from foraging to nest repair or other jobs when necessary, and solve challenging problems in optimization even though no ant has studied mathematics.

Ants manage to do this with no centralized direction, no headquarters and no command-and-control mechanisms. There are no ant CEOs, generals or CFOs. Each ant merely follows a few simple rules, and otherwise acts more or less freely. The result of thousands of ant "decisions" is a phenomenon known as self-organization, so powerful that even the Biblical Book of Proverbs commands, "Go to the ant; consider her ways and be wise."

A similar phenomenon was at work in Manchester, England, the city where the young Friedrich Engels helped manage a textile factory owned by his father. Manchester was an unplanned industrial area that had grown up more or less spontaneously and didn't have the usual administrative structure of a city. Yet, Engels observed that, without any zoning, centralized direction or city planning, residents spontaneously organized a commercial district and distinct residential areas for various classes. The urbanist Jane Jacobs, who campaigned to save New York's Greenwich Village from developers, would underscore the importance of free, individual, random encounters and decisions in the vitality of cities a century after Engels.

Now, self-organization has come to corporations, too, and a few have found it to be a powerful tool. The fact that the free decisions of individuals are a source of competitive advantage is a fundamental principle of management at some leading companies. "When there is a challenge out there, our employees rise to the occasion," says Laura Wright, CFO of Southwest Airlines and an FEI member. "That's when they shine the most--if you educate them and explain what's going on, you get the buy-in."

Southwest is among a growing chorus of business practitioners and business advisors that in the past few years have sounded the refrain that conventional budgets, targets, performance metrics and many of the managerial impedimenta that we take for granted not only fail to help companies achieve success but may actually help make success unachievable. In place of such traditional management tools, they advocate something approaching managerial minimalism.

What these companies are responding to is managing unpredictability. In a world of rapid and continuous change, the assumptions that go into conventional planning are obsolete within weeks. The traditional approach offers the impression of knowledge, control and accountability. But, says David Martin, CFO of Dimensional Fund Advisors, "Conditions change too fast. In fact, people aren't going to be accountable--they literally can't be accountable. You're going to be throwing out the plan by January, and then you start relying on variance explanations. It's a false sense of security."

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Mark Millemann, a consultant who has worked with BP plc, Borg-Warner Inc. and Sears, Roebuck & Co., is co-author of Surfing at the Edge of Chaos, a book that recounted the experience of several companies with self-organization. He says, "Most organizations have sufficient internal intelligence to solve complex problems. In contrast to deploying the intelligence of a few at the top, the benefit of tapping collective intelligence is the possibility for superior strategy informed by what's happening in the market."

For most companies, this is certainly not business as usual. "Past practice was very much a mandated, hierarchical structure, down to a very granular level--even what you spend on travel, top-down and mandated," says Brian F. McCarthy, executive partner of the Finance and Performance Management service line at consulting firm Accenture. "I would say it's prevalent in 80 percent of companies today, even though everyone recognizes it as being flawed fundamentally."

Accenture's research into high-performance businesses found that top performers gained competitive advantage by making decisions faster and at a lower level in the organization than their competitors--even when competitors ended up making the same decisions. McCarthy explains, "Give the right information to the right people, enable them with the right training, processes and tools, and they will make the right decisions."

Loosening the Budget Straitjacket 

The budget, planning and performance management processes at most companies depends on the assumption that the future is more or less predictable. The problem with their traditional command-and-control approach is that the future may now be less predictable than ever.

"I've always had a view that the plan is no better than a forecast," says Gary Crittenden, who recently moved from the CFO job at American Express to become CFO of Citi, the global banking giant. "It's only accurate for one second--the second it's finished, it's accurate, but then you spend the next year explaining your meeting or not meeting a plan that was only relevant at one moment."

When Crittenden, an FEI member, joined American Express in 2000, a top priority was to make the finance function more forward-looking and strategic. "I often use the metaphor that if a train wreck happens, it's useful to diagnose why it happened, why this signal didn't work, but [it would be] a lot more useful to be able to avoid the train wreck in the first place. Our job is to anticipate the future and look around corners."

So, at American Express, Crittenden replaced detailed budgets and plans with rolling forecasts updated monthly. The forecasts look ahead 12 months and focus on critical business drivers. For example, the number of Amex cards and the average spent by each cardholder drove billings, which in turn drove most of the company's business results. So, these key drivers were the focal point of the forecasts. The emphasis was not on explaining why plan targets were or were not met, but rather on flexible response to change.

Crittenden says the new approach "allows you to move a lot faster, because you're not wedded to a plan. If the rolling forecast tells us we will do better than anticipated, we know what to do next and we know how that will impact the business. Alternatively, if things are performing poorly, we know what investments we can cut with a minimum impact on our business."

Thus, the system reduced the amount of time needed to react when circumstances changed. However, it depended on redirecting managers' attention. "We're trying to manage to business outcomes--not to a budget number," Crittenden says.

What matters in business is how well the business seizes opportunities and counters threats. However, says Martin, the Dimensional Fund Advisors CFO, traditional budget and planning processes put the emphasis on negotiating targets and explaining variances, rather then on responding to a changing business environment. "I'm a firm believer in planning, and I've never seen a detailed budget that was worth the effort put into it," he says. "I think the greatest misuse of resources that finance inflicts on an organization is to put the business through a detailed budget. I think it's unconscionable."

Like Crittenden, Martin relies on rolling forecasts of factors that drive the business. Plans, therefore, are more like guidelines than rigid requirements. "Hopefully, people see the firm as being more flexible and intelligent. If you have an idea, you bring it out. You say, 'I know it's not in the budget, but I know I have a chance of being funded because the firm is flexible and creative (versus the notion that the budget is done and if you have any ideas, they have to go into next year's budget process).'"

At Dallas-Fort Worth Airport, Executive Vice President and CFO Chris Poinsatte found that the traditional, static budget approach prevented people from doing things that needed to be done, even when the airport could well afford to do them. "Even though we might be $10 million under budget in other departments, the department where something needed to be done wouldn't come and ask for funds because it did not want to spend more than its budget."

In his first months at the airport, noting that there was enough money to undertake these projects, Poinsatte insisted that the departments get the work done. "They used to do budget transfers to move money from one department to another. To prove my point that the budget was not sacrosanct, I said we won't do a budget transfer. They objected that they did not want to go over budget, but I said that's okay. So, they had a negative budget variance and nobody got fired. That's happened in a couple of years now."

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The airport has an unusual business model. At the beginning of the year, it estimates how much money it will need to cover expenses, subtracts revenues earned from parking and concessions, and essentially charges airlines to cover the balance. If it charges too little, airlines write a check to settle accounts at the end of the year; if it charges too much, it writes a check to the airlines.

Poinsatte's objective has been to make the forecasts so accurate that the airport settlement checks to airlines amount to no more than 1 percent of the budget. Rolling forecasts help. Instead of focusing the organization on budget dollars, Poinsatte puts the emphasis on what drives the dollars. So, instead of tracking dollar revenues, the parking manager watches parking days.

"Putting the budget in operational instead of financial terms helps get power in the hands of the managers, and gives them the flexibility to do creative things even in the middle of the budget year," he says. In 2006, when airlines made cutbacks in response to spiking oil prices, the airport adjusted its forecast, slowed investment in some programs and refinanced some debt.

Then, unexpectedly, conditions improved enough that the airport was on track to write a substantial settlement check to airlines by the end of the budget year. Instead of waiting, the airport reduced landing fees. "Airlines are our business partners, and they need the cash more than we do," says Poinsatte.

The New CFO Approach

This new approach requires a change not only in how CFOs work, but in how they define their jobs. Jeremy Hope, co-author of Beyond Budgeting and author more recently of Reinventing the CFO, notes that CFOs define their jobs as enforcing top-down decisions through detailed budgets, negotiated targets and a host of controls.

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"Most CFOs are steeped in command-and-control management. They see the organization chart, the boxes, the functions, departments, business units--and that's what they manage," says Hope. "The illusion is that it gives you control. The mindset says that if the CFO doesn't commit all these managers to 15 percent growth, then we won't achieve it. Yet it's the biggest illusion there is in business, because there's nothing more guaranteed to undermine performance than that process."

Not only is command and control counterproductive, Hope says--it is overwhelming CFOs with too much detail and too many metrics, preventing them from focusing on what really drives cost and revenues. At the average company, analysts can spend half of their time just looking for the information needed to fill out reports, and the finance operation is so bogged down with administrative detail that only 11 percent of its time goes to decision support. "The CFO needs to call a halt to this insane, data-induced micro-management," Hope says.

Some already have. At Southwest Airlines, CFO Wright says, "I spend very little time doing the green eyeshades stuff. The vantage point you have as CFO is probably the one position in the company where you can see how all the pieces fit together, what your drivers are, where you make money, how you stay in business. You have a fiduciary obligation to shareholders to make decisions that ultimately provide them the best value."

She estimates that she spends three-quarters of her time on strategy and decision support, and only a quarter wearing the figurative green eyeshades. Southwest educates employees on the important cost drivers, the ones where they can make a difference, and on the company's broad financial targets. "Our employees are very educated on the business and understand where we need to be," she says. Employees can request capital whether or not it's in the budget. "If it passes the hurdle rate and achieves savings, it's easy [to justify]," Wright says.

Indeed, the rapid pace of change in Southwest's business makes a more traditional approach all but unworkable. "We'd had 9/11, the invasion of Iraq, lots of changes in security, a new government agency that wasn't even around five years ago, bird flu, SARS--a lot of unpredictable items," she explains.

"We adapt our budget and plan every single quarter to new expectations. That gives us the opportunity to look at new initiatives, and be adaptive. We've had initiatives to counter security lines, to encourage customers to use the Internet. We've completely changed the way our passengers board airplanes and get boarding passes, and we've become more active in the fuel-hedging program in order to be less subject to volatility."

By contrast, the budget, planning and performance management process at many companies is rife with negotiating gamesmanship. Managers have an incentive to negotiate low targets, and little incentive to perform much better than budget. The conventional approach encourages people to protect their budget allocations by spending them somehow, even when the money might be better used elsewhere.

When circumstances change, making the original plan assumptions obsolete, much time is wasted by managers attempting to explain and justify the variances. Says Millemann, "To some extent, you're treating the top of the organization as though they were blue-collar workers. In fact, blue-collar workers in many organizations have more degrees of freedom than middle management." It's up to the CFO, he says, to ensure that the organization does not merely grudgingly accept or reluctantly comply with targets, but actually commits to achieving them.

At one organization, the CFO led an anonymous survey to determine the degree of confidence people had in the numbers, and opened a dialogue so that people could frankly address their misgivings. By contrast, another CFO claimed to have complete leadership alignment with a policy because "we had a meeting and they all had to demonstrate commitment by signing it."

The CFOs who have gone farthest with a more flexible approach, and have done the most to empower the rank-and-file, seem to define the job of finance in terms of service, not control. Crittenden says, "We are thought of as a facilitator. Our role is to make sure financial results are accurate and timely, but we are also a facilitator of the best in the business.

"Our job is to make sure we're pitching as many balls in the strike zone as we can so the business leaders have a choice of which to hit. Our job is not to select what they should hit, but to say, 'you have this option, or this option,' and let the business leaders choose."

Managing finance on these principles require CFOs to strike a delicate balance between centralization and decentralization, empowerment and discipline. For example, Dimensional's David Martin says, "It's easy to come up with an academic argument that we should be like Toyota and everyone can shut down the line, but there are businesses where you don't want employees to be that empowered. We are in a heavily regulated industry, and an employee taking the initiative, even a well-intentioned employee, could result in you being fined or banned. If everyone knew all the intricacies of compliance, you would not need compliance officers."

Although detailed budgets and rigid plans have clear downsides, companies are not jazz trios that can improvise everything as they go along. Yet, they can improve flexibility and market responsiveness by shifting the focus from the plans to the business reality.

Says Martin, "You spend more time on the forecast and what the key drivers of the business are, and less time negotiating whether a 3 percent or 4 percent growth rate is the right one. You take a guess at the beginning of the year and say, 'We want you to grow 1 percent faster than the market, and here is our market assumption.' We're going to assume that we know we are going to be wrong, but you don't argue assumption by assumption with each unit, and hopefully you spend more time on how to improve the future."

This approach to management has implications for how CFOs communicate with investors. In recent years, several major companies have announced that they will no longer give earnings guidance. Says Crittenden, "You preserve credibility if you don't provide guidance. The way accounting is involved, there's no flexibility in how you report the facts, so it's impossible for a company to hit a point estimate over a long period of time."

What investors really care about, he says, is not how companies are performing versus their plan, but how they are performing in comparison with prior years. "Have you ever seen a press release that says, 'Here's how we perform versus our plan!'?"

On a Path to New Methods?

Steve Player, program director of Beyond Budgeting North America, says, "In North America, many companies are on an evolutionary path to improve the way they plan and control, and ultimately they may eliminate the budget--but nobody sets out to do that. They quit doing budgets because they're a waste of time."

The real surprise may not be that companies are focusing on a few key business drivers and empowering members of the organization to make decisions flexibly as circumstances change. On the contrary, the real surprise may be that companies ever believed that top-down, command-and-control, centralized planning could work. After all, the free market economy itself depends on the independent, unplanned, undirected decisions of millions of buyers and sellers, doing what seems best to them moment to moment.

The alternative, centrally planned economies, resides in the dustbin of history. Perhaps companies are at last learning the right lesson from Engels--self-organization works better than top-down planning. As companies move in the direction of self-organization, they are reflecting in their internal processes the powerful logic of the global economy itself.

TAKEAWAYS

* "Self-organization," now being practiced by some leading companies, has long been practiced in the natural world by creatures such as ants.

* A key notion is that conventional budgets, targets, performance metrics and many of the managerial concepts that we take for granted don't contribute to success.

* Accenture's research into high-performance businesses found that top performers gained competitive advantage by making decisions faster and at a lower level in the organization than their competitors.

* These top companies are focusing on a few key business drivers and empowering members of the organization to make decisions flexibly as circumstances change.

GREGORY J. MILLMAN ([e-mail]) is a freelance writer in New Jersey and a frequent contributor to Financial Executive.