Budgeting and Target-Setting have become a tradition in many companies, even though they can cause quite obvious negative side effects. Provocatively speaking, classical budgeting processes not only are very time-consuming and costly. They regularly force people to cheat.

A good friend approached me a few weeks ago, she was a bit weary. She is working as a sales coordinator for a company which is currently facing difficult market conditions. Her team was very frustrated, because they were about to miss their yearly bonuses even though it had been looking good almost through the whole year. Their numbers were now close to target, but not close enough. As some of the team members had already planned their bonus payments into their family budgets they were in a rather tense situation now.

But that was not the end of the story. A few days ago I met her again and she told me that they now had problems as some of her team seem to have made mistakes in order entry. Incorrect sales orders were captured, which would have caused customers to receive way more units than what they had ordered. Luckily the company found this problem before the parcels went out and they were able to correct the wrong orders … A coincidence? An entry error? Or dummy orders placed on purpose to boost numbers just in time for year end closing?

Linking Targets to Budgets can cause unwanted behavioral effects

One might complain now about the greedy and opportunistic employee trying to tweak numbers to get his bonus. But this behavior is just a symptom pointing to a deeper underlying problem. People typically will not cheat on their employer if corporate culture and corporate processes are working fine. Before an employee places a dummy order or opportunistically manipulates numbers something must have gone fundamentally wrong. The mutual trust relationship probably was damaged already beforehand.

A popular way to ruin trust is the way budgets and target-setting are applied in today’s companies. The way many companies link their targets to budget numbers almost forces people to lie. Variable salary components were originally meant to motivate people to concentrate on achieving challenging targets. But as soon as the individual employee loses belief that he or she can actually influence the target achievements, this system is considered unfair. If targets are automatically increased every year, raising the bar higher and higher, the employee considers the system as unfair. If individual bonuses are to a large degree depending on ones group or team to perform well and his individual influence is very limited, he considers the system as unfair.

As soon as a bonus system is considered unfair, the system not only will not motivate anymore, but in fact will trigger a downward spiral of mistrust. Employees will try to find a smart way to tweak numbers. If the system is unfair, why should they be fair? Being fair does not seem to pay off. Therefore orders might be entered even though they belong into the upcoming year. Dummy orders might be captured only to be canceled once the numbers are in. Or the odd mistake is input accidentially, leading to temporarily increased sales numbers. All these actions are fraud. And they will cause companies to react with an increasing level of control. Management will be looking for ways to prevent or punish this kind of behaviour. After a while, what started as a positive system to let employees benefit from a company’s success turns into a culture of mistrust.

Budget Poker – A clear indicator for mistrust and dysfunctional processes

Another more subtle indicator for a badly working budgeting process is the well-known budget-poker. Cost centers burn any left-over budgets to avoid budget cuts in the next year. In budget cycles any involved unit will always claim to require more money than in the preceding year, knowing that the negotiation process will cut down initial demands anyhow. Units that are honest in their initial budget requests will receive a cut-down in the same way as units that over-estimated their requirements. So being honest does not pay off. The regular Budgeting process again forces people to lie.

Is it worth the effort?

Given the explained problems: What do you think is the value of the planning data that are generated in such kinds of budgeting cycles? If the focus is more on a short term negotiation process than on thinking about the achievable numbers, on how to avoid the inherent risks and on how to achieve the long term strategic targets, then the question is: Is this worth the effort? Does budgeting, handled in this way, really fulfill its purpose?

One might ask: Ok, but what’s the alternative? Or even the solution to this problem? Sophisticated companies find innovative forms of fixing targets and defining plans for the next fiscal year. They question and re-engineer their traditional budgeting cycles, which cause a lot of effort but can hardly prove their effectiveness. They focus on individual value drivers instead of detailed budgets. They dismiss the 1:1 link between a unit’s budgets and an individuum’s targets. Instead they define individual and motivating targets that take aspects into account which go beyond pure budget numbers. This might cause additional efforts. But slim-lining budgeting processes weighs heavily on the savings-side of that calculation. Anyway, forcing people to cheat is clearly not what a planning process should do. So a change of mind is overdue here.