by Jack Welch
Now fast-forward to the Big Budget Meeting itself.
The two sides meet in a windowless room with a whole day set aside for what everyone knows will be an unpleasant wrestling match.
The field makes its presentation with a fat deck of PowerPoint slides, and the story is invariably dire. Despite reports of a pretty good economy, there are reasons to believe this particular business environment is going to be very difficult. “The competition has just brought a new plant online, and with its excess supply, there will be enormous pricing pressure,” they might say. Later in the meeting, you get: “Raw material costs and inflation pressures are severe. In order to meet these challenges, we need new cost-reduction programs that require $10 million in additional resources.”
The final pronouncement from the business managers usually goes something like this: “To be optimistic—very optimistic—earnings will likely grow only 6 percent.”
Headquarters, needless to say, has its own view of the situation, and it is decidedly not dire. The economy is strong. GDP is estimated to rise steadily all year. Orders are up everywhere else in the company. The main competition has a big asbestos lawsuit against it that will distract management. The business can get the cost reductions with $5 million in new programs, and earnings should grow 12 percent.
You know what goes on during this marathon—the grumbling and groaning, the probing and data quoting, the back and forth and back and forth again. On occasion, it can get contentious, especially if a senior person has worked within the business earlier in his career. He’ll throw out anecdotes about how they used to do it in the old days and accuse the field of lowballing. “I know where you’re hiding it. I used to park reserves in there too,” he might insist. “Now give it up.”
The grappling concludes—finally and inevitably—when the sides split the difference. The field gets $7.5 million in resources and a budget with a commitment for 9 percent earnings growth.
Before the field packs up to leave, everyone somberly shakes hands. The mood is resigned. For all involved, the unspoken vibe in the room is: we didn’t get what we wanted or what was right.
That pall lasts right up until the moment the field team pulls out of the driveway. Then the high-fiving begins.
“Those stiffs wanted us to deliver 12 percent, and we only have to hand them 9!” the people in the field exclaim. “Thank God we dodged that bullet!”
The headquarters team is also feeling pretty good about themselves. “Those sandbaggers only wanted to give us 6 percent,” they crow. “Did you see where they were hiding earnings? We let them off with 9 percent. They’ll deliver that, and probably more, but with their 9 and what we’ve got from the other businesses, we’ll have enough.”
Soon thereafter, the Negotiated Settlement gets officially approved, and the field and headquarters make their peace over its targets. They tell each other, “Well, we can live with the numbers this year. We guess they’re OK.”
When the end of the year rolls around, the awful ritual completes itself. Most often, the field hits or beats their targets and gets their bonuses, and of course headquarters congratulates them. Job well done!
Everyone is happy, but they shouldn’t be. In this minimalization exercise, there has been little or no discussion about what could have been.
EVERYONE MAKE NICE
The second budgeting dynamic that saps value is the Phony Smile.
Again, people in the field spend a couple of weeks coming up with a detailed budget plan. Compared to the Negotiated Settlement approach to budgeting, the sadder part of this dynamic is that often, Phony Smile plans are filled with good ideas and exciting opportunities. The people in the field have bold dreams about what they can do—make an acquisition, for example, or develop new products—given the right amount of investment. They’re eager to expand their business’s horizons, but they need help from the mother ship.
To make their case, the managers in the field prepare the usual stacks of slides. Since retiring from GE, I’ve seen such presentations with as many as 150 pages! Every competitive angle is covered, and usually overly so. Typically, these presentations are evidence of painstaking labor, wrought with angst over minutiae and born of long nights of building spreadsheets that contain precision to the last dollar. It’s likely that nobody actually enjoys putting together these slide packs, but when they’re done, along with exhaustion, the team understandably feels an enormous sense of pride and ownership.
On the anointed day, the team, led by a leader we’ll call Sara, travels to headquarters. And there, again in a darkened room, they present their case, slide by slide, to the senior group.
When the show is over, the lights come up, and for a few minutes, the managers and the field people engage in rather pleasant chitchat. It goes like this:
“I see you expect Acme Corp. to build another plant. That’s very interesting. They almost went bankrupt in ’88,” one senior manager musters the energy to say.
“Well, they were bought two years ago, and they’ve come back strong,” Sara quickly answers.
“Very interesting. Very interesting,” comes the vague reply from a headquarters heavy.
“And I see that you’re expecting the cost of natural gas to hold steady for the first six months,” another headquarters person might offer up as evidence he was listening.
“Absolutely!” Sara responds. “We don’t see any change in that pricing.”
“Hmm…interesting.…Yes, interesting….”
Finally, after a few more perfunctory exchanges, it’s over. The top team smiles brightly and says, “Nice job! Thanks for coming in! Have a safe trip home!” And pretty convinced that they did OK, the field people smile back brightly and go away.
Then there’s the meeting after the meeting.
That’s when the members of the top team sit around talking about how much they are really going to get from this business. The reality is, headquarters already knows how they are allocating the company’s investment dollars, and they know exactly what revenue and earnings numbers they expect in return from each business. Those decisions, they believe, belong at headquarters, where managers can see the whole picture, pick priorities, and divvy up the goods appropriately.
A few days later, Sara gets a call from a lower-level staff person at headquarters telling her that her business will get about 50 percent of what was asked for at the Phony Smile meeting, and the earnings budget number will be 20 percent higher than the one they submitted.
What a kick in the stomach! Instantly, Sara is enraged for a slew of reasons at once: Headquarters just didn’t listen! All that work for nothing! No one explains anything around here! And worst of all, now there won’t be enough money for all the things we should be doing.
The next day, Sara goes back to her people for their meeting after the meeting. Together, they all rail against the injustice and mystery of the corporate edict.
And then, without meaning to, Sara makes matters worse. To appease her team, she takes the money from corporate, now much less than they had asked for, and she evenly parcels it out, a bit to manufacturing, a bit to marketing, a bit to sales, and so on. Of course, Sara would be smarter to place her bets on one or two programs, but that rarely happens in these situations. People stuck in the Phony Smile budget game get bitter. Too often, they lose their sense of commitment to the company and forget how excited they were about their original proposals. They just take the money from corporate and spread it like crumbs.
My argument here is not with a senior team allocating resources. That’s their job because they have a strong, informed understanding of what each business can realistically deliver. The trouble arises when headquarters is secretive about the process, when they don’t explain the rationale behind their decisions.
But like the Negotiated Settlement dynamic, the Phony Smile usually concludes with everyone shrugging off the whole enervating event—it’s just business, right? And the next year, they start it all over again.
A BETTER WAY
Now, you may be wondering, “If companies manage to hit their numbers and pay bonuses with either the Negotiated Settlement or Phony Smile approaches to budgeting—as flawed as they are—why mess with them? At least they deliver.”
The problem is: they often deliver only a fraction of what they could, and they take all the fun out of setting financial goals. Yes, this annual event can be fun—and it should be.
Imagine a system of budgeting where both the field and headquarters have a shared goal: to use the budgeting process to ferret out every possible opportunity for growth, identify real obstacles in the environment, and come up with a plan for stretching dreams to the sky. Imagine a system of budgeting that is not internally focused and based on hitting fabricated targets, but one that throws open the shutters and looks outside.
The budgeting system that I’m talking about is linked to the strategic planning process described in the last chapter, in that it is focused on two questions:
How can we beat last year’s performance?
What is our competition doing, and how can we beat them?
If you focus on these two questions, the budgeting process becomes a wide-ranging, anything-goes dialogue between the field and headquarters about opportunities and obstacles in the real world. Through these discussions, both sides of the table jointly come up with a growth scenario that is not negotiated or imposed and cannot really be called a budget at all. It is an operating plan for the next year, filled with aspiration, primarily directional, and containing numbers that are mutually understood to be targets, or put another way, numbers that could be called “best efforts.”
Unlike a conventional budget, with its numbers cast in concrete, an operating plan can change as conditions change. A division or business can have two or three operating plans over the course of a year, adjusted as needed through realistic dialogue about business challenges. Such flexibility frees an organization from the shackles of a budget document that has become irrelevant—or even downright dead—because of changing market circumstances.
At this point, you might be thinking, “Yeah, yeah, this approach sounds great, but what about my bonus?”
That’s a good question. It’s the key question, in fact. And the answer is that this operating plan process can occur under only one condition:
Compensation for individuals and businesses is not linked to performance against budget. It is linked primarily to performance against the prior year and against the competition, and takes real strategic opportunities and obstacles into account.
For many companies, this condition would involve a radical change. People have been trained for years and years to hit their budget numbers no matter what, and managers have rigidly rewarded those who did and punished those who didn’t, no matter what.
That was the company I grew up in for twenty years, and largely the company that I inherited when I became CEO. Over the years, I was at the receiving end of plenty of Phony Smile meetings, and participated in dozens if not hundreds of Negotiated Settlement meetings on both sides of the table.
But as GE’s culture became more infused with candor, transforming its budgeting process became more realistic. Eventually, we were able to move our businesses away from budgets with rock-hard targets and toward operating plans filled with stretch goals.*
That transformation took time—several years, at least. Along the way, I promoted the change as often as I could.
In 1995, for instance, Appliances was having a brutal go of it. Competitors were churning out high-quality products at very low prices, and our team was struggling like crazy to catch up. They were innovating with several new product introductions of their own and improving manufacturing processes, getting more productive by the day. Still, at the end of the year, their earnings were 10 percent below internal expectations and about flat with the previous year.
At the same time, Plastics was having a great year. Their market took off, and shortages of material quickly developed, making it a seller’s market when it came to pricing. Their earnings jumped 25 percent, about ten points higher than the operating plan called for.
Back in the old budgeting days, Plastics would have gotten the big bonuses and Appliances would have gotten a lump of coal. But with the new approach, both businesses got increased payouts that were about equal in amount.
At our annual management meeting that year with five hundred of the company’s top people, I went out of my way to make this story widely known. In fact, I made a point of telling it in my keynote speech to the group.
Yes, I said, Appliances’ earnings were below plan and showed no rise over the previous year. But the business’s performance—in a brutal environment—was really impressive compared to its closest competitors, Whirlpool and Maytag, who had done worse than we had.
As for Plastics, yes, their earnings had beaten the plan, but it had been a layup. We cared more that one of their competitors had earnings growth of 30 percent and another had a 35 percent rise. We could have done better and we didn’t. In fact, we hadn’t been aggressive enough on price—a mistake, pure and simple.
You might expect that people in Plastics resented the bonuses paid out to Appliances, or that they wanted and expected more from headquarters for their results. But by that time, the reinvented approach to budgeting had permeated the organization. People understood how it worked, and how it made all of us better by looking outside the company to judge our performance. After all, what good is beating targets you set in a windowless room? The real world has its own numbers, and they’re all that matters.
GETTING IT GOING
As I said, it took years for this approach to financial planning to take hold at GE, but I know a case where it was up and running within two—and in China to boot, where modern management techniques in general are just taking hold.
It happened at 3M, the industrial conglomerate, which has been doing business in China for some twenty years.
To an outside observer, 3M’s track record in China has always been solid. In fact, when Jim McNerney became CEO in January 2001, the company’s Chinese businesses were posting 15 percent annual growth, about three times the company’s average. For years at budget time, the Chinese team had been congratulated for this level of performance and sent on its way.
But after his years of experience with the impact of stretch goals and operating plans at GE—where his last job was CEO of Aircraft Engines—Jim decided to transform budgeting at 3M, including its foreign operations.*
His first step, however, was not to install the stretch approach. “You can’t go to stretch directly,” he told me recently. “You have to get a culture of accountability first.” In other words, people have to mean what they say, deliver their operational and strategic commitments, and take responsibility if that doesn’t happen.
In the past, 3M had something of the Negotiated Settlement approach to budgeting, but with an added twist of benign neglect. The company called budgets “improvement plans,” which, as Jim notes, “had little commitment attached to them.” Headquarters and each business unit would come up with agreed-upon numbers during the budgeting ritual, and then amicably part ways until the same event the next year. In the meantime, goals would routinely be missed, and people at headquarters might have gotten angry, but nothing happened.
Over the past four years, as Jim and his team have changed the 3M culture, the “improvement plan” approach to budgeting has all but ended. There is new candor and trust—and accountability—throughout the organization. Enough, in fact, that Jim felt it was possible to introduce the stretch approach.
One of its earliest believers was Kenneth Yu, managing director of 3M China and a 3M employee for more than thirty years, first in Hong Kong, then in Taiwan, and now in Shanghai. In his early fifties and a veteran of good results under the old budgeting system, Kenneth was an unlikely candidate to embrace such a major change. But he had, as Jim describes it, “a total reawakening” as to how business could
be done.
“Once Kenneth realized that the stretch approach had a safety net, he really bought into the idea that stretching, even without getting there, could be a whole lot better than the old game,” Jim recalls.
Rather than come to Jim with the usual conservative growth plan and then beating it, Kenneth presented an operating plan to catapult the China operation to 40 percent annual growth. It involved bold, wide-open thinking about possibilities. For 2002, Kenneth proposed increasing 3M’s R & D investment in China in order to introduce many local product adaptations, and promoted new plant investment to support rapid growth.
In three years, 3M’s business in Greater China has grown from $520 million to $1.3 billion, with ambitious plans for the future.
This does not mean, of course, that stretch has totally taken hold at 3M. Jim says people are still getting used to the change, but they have definitely come to see that the company now celebrates and rewards people who think big. Today, “budgeting” at 3M is not about delivering good-enough plans and beating them. It’s about having the courage and zeal to reach for what can be done.
Doesn’t that sound like more fun than budgeting? And it works better too.
A WORD OF CAUTION
Before we finish up this chapter, I just want to make sure that I am not making this change sound too easy. Experience has shown me that while most people take to reinvented budgeting with enthusiasm, there are always a few diehards who do not and with their actions try to undermine it. Usually, these people are too steeped in tradition to let go of the old link between targets and bonuses. Sometimes they are just jerks. But whatever the reason, I would be a Pollyanna if I did not acknowledge that these types of managers haunt every company that switches over to the stretch approach. At GE, we never found or converted them all, but we never stopped trying.*