Internal Controls Design Website by Matthew Leitch
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Internal Controls Design website by Matthew Leitch (consultant, author,educator, and researcher)
Related articles -All articles - The author- Services
Risk Management and BeyondBudgeting
by Matthew Leitch, 6 March 2003
Introduction: a sense of protection
Definitions
- Budgetary control- Risk management
- The Beyond Budgeting model
Why budgetary control blocks risk management but Beyond Budgeting doesn't
- Technical problems with current risk management processes
- Uncertainty suppression
- Competition between budgetary control and risk management
Reforming risk management
- A new purpose
- Acceleration
- Explicit quantitive modeling of uncertainty
Where risk management fits in the Beyond Budgeting model- Empowerment: what should we talk about?
- Action planning
- Forecasting: distributions not single points
The value of risk management within the Beyond Budgeting model
Summary of recommendations for Beyond Budgeting implementations
Introduction: a sense of protection
Business leaders want a sense of protection from the dangers of an uncertain future. Investors
want to feel that Directors of companies they invest in know what is going on and what willhappen. They want to feel that management are in control.
Budgetary control and similar systems of target setting and rewards have tried to provide that
sense of comfort. However, if budgetary control really provided control in today's fast
moving, complex, and turbulent world then companies whose budgetary control systems have
been operated rigorously would not get nasty surprises, but they do.
On 3 December 2002 the Daily Telegraph reported on an embarrassment for BP, one of the
world's most powerful and respected companies. Earlier that year BP had been forced to cut
its growth targets on more than one occasion. The paper reported that Lord Browne had said
he personally felt humiliated when the company scaled back its growth targets from 5.5pc forthe year to 3pc. This humiliation was not just because the targets had been dropped.
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According to a spokesman "He was taken aback that we did not have a clear idea at the
beginning of the [downgrading] process." BP had pledged to investigate fully why the
directors did not have adequate information about the company's operations at hand earlier in
the year when the sequence of production target downgrades forced the share price to a four-
year low. Lord Browne said that middle-ranking executives had been asked to "step aside for
a moment" (not literally as was later explained) while the company tried to assess what wasgoing on at grass-roots level. The results of this review were expected along with the group's
full-year results in February 2003 but in fact no explanation was given. Instead, Lord Browne
explained that BP would be stating estimated ranges in future and that announcing single-
point targets "...can distort the implementation of strategy."
BP is a much admired company and generally well run. It operates a conventional budgetary
control system rigorously and in theory such surprises should not happen. Outsiders can only
speculate as to what really happened. However, it is likely that they lost sight of their future
because of their budgetary control system, rather than despite it.
This paper discusses the true contribution of budgetary control and the potential role of areformed style of risk management within the Beyond Budgeting model.
The Beyond Budgeting model is a complete alternative to budgetary control, and its like,
whose superior effectiveness has been demonstrated in practice. It was developed out of
extensive case study research by Jeremy Hope, Robin Fraser, and Dr Peter Bunce of the
Beyond Budgeting Round Table (sponsored over the last 5 years by some 60 leading
companies).
Definitions
But first some definitions to explain terms and introduce the key concepts that distinguish
alternative approaches to management control.
Budgetary control
In this paper budgetary control refers to any management approach that involves setting some
kind of targets, regularly measuring variances between the original targets and actual
outcomes, and motivating people to reduce those variances. This kind of control usually uses
budgets, but these days the targets could be a mixture of financial and non-financial targets.
Companies are thought of as being controlled by a set of control loops, each one like the
thermostat of a central heating system. In control theory these are called negative feedback
control loops. (This is not because the feedback has a negative effect on people involved but
because the feedback is used to reduce the variance. A positive feedback loop is one where
the feedback increases the variance.)
Budgetary control attempts to deal with future uncertainties by reacting when the unexpected
becomes evident through variances. The system always tries to get back to the original
desired outcome.
This style of control has invaded almost every major company in the developed world andover-run many potentially interesting developments in management thinking. For example,
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the balanced scorecard was initially an interesting expansion of management information, but
very soon the thermostat philosophy was added in an attempt to provide a more complete
management system.
In many management textbooks, "management" and "management control" are defined in
terms of setting targets and monitoring and managing variances. It's almost as if there are noalternatives.
In fact there are alternatives. Budgetary control is a 20th century invention linked to
cybernetics and control theory. Its growth is probably the result of fascination with cybernetic
ideas at a time when corporations were growing to astounding sizes.
Risk Management
Risk management is an activity where people anticipate and proactively manage potential
future outcomes other than some benchmark outcome. The benchmark outcome is typically
the planned outcome or most likely outcome. (The planned and most likely outcomes are not
the same though they are often treated as such in budgetary control.)
For example, consider a loan made to a customer by a bank. There is a possibility that the
customer will not pay back the loan. This is called the risk of default. This risk is a "downside
risk" because the usual benchmark outcome is that the most likely thing will happen, and that
the customer will pay back all the money.
Another example will illustrate the idea of "upside risk" and show what happens when there
are many potential outcomes. Imagine a company runs a series of advertisements to boost
sales. It has forecast the most likely amount by which sales will increase as a result, but theactual level could be more or less than this. There is a set of upside risks representing various
levels of increase above the benchmark, and a set of risks representing various levels of
increase below the benchmark.
The future is uncertain, but one thing we can be very nearly certain of is that the most likely
outcome of a situation is not going to be the actual outcome. It's almost certain that the actual
outcome will be something else. This being so it makes sense to think about, and try to
manage, more than just the most likely outcome by:
doing research and monitoring sources of information for further indications about the
future; making plans that reflect potential alternative outcomes;
doing things in advance to modify the impact of alternative outcomes, should they
occur; and
doing things to change the likelihoods of alternative outcomes.
Most companies have a formal risk management process to comply with corporate
governance regulations, but also manage risk outside that formal process, informally and
formally within other management systems.
Formal risk management is usually done in workshops or meetings and typically involves
drawing up matrices of uncertainties, risks, and actions. Typically there is some form of
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rating to help prioritise actions and judge whether actions are sufficient. It is usual to start
with an action plan then use risk management to modify it and add mitigation actions.
Risk management deals with future uncertainty by anticipation and action in advance.
The Beyond Budgeting model
The Beyond Budgeting model is an exciting initiative based on a number of case studies of
large organisations that stopped using budgetary control. No such organisation has ever lost
control of itself. Instead, these organisations have benefited immediately from saving time on
budget arguments and reallocating it to more proactive and frequent adaptive planning.
Measurement and reward is based on performance compared to similar organisations or
business units, and on performance under the conditions that actually transpired, rather than
on absolute targets agreed at the start of a financial year. For more on the Beyond Budgeting
model visit www.bbrt.org. Beyond Budgeting is also one of the examples of Dynamic
Management cited in my paper"A new approach to management control:Dynamic
Management".
Why budgetary control blocks risk management but
Beyond Budgeting doesn't
Risk management has become increasingly important over the last couple of decades,
particularly in financial services organisations. However, its full potential has not been
reached. Budgetary control is one of the main reasons for that. Budgetary control has blocked
risk management in the following ways:
Risk management methods have been designed to support budgetary control, so
nearly all focus exclusively on bad things that might happen, creating a management
process that is negative and can be demotivating. This in turn has limited risk
management's appeal.
Budgetary control stimulates people to suppress uncertainty. They don't talk about it,
don't think about it, and so don't manage it as well as they could. This discourages
people from participating in risk management.
Both activities offer a means of dealing with an uncertain future, but budgetary
control is the entrenched competitor despite its limitations.
By understanding these blocks in more detail we can begin to see how risk management
could and should be reformed within the Beyond Budgeting model.
Technical problems with current risk management processes
The risk management processes in many companies are riddled with technical flaws,
undermining their credibility and value. (For more information read my paper "The crisis in
management control and corporate governance" which also contains a questionnaire to search
for the most common flaws.)
http://www.bbrt.org/http://www.internalcontrolsdesign.co.uk/dynamic/index.htmlhttp://www.internalcontrolsdesign.co.uk/dynamic/index.htmlhttp://www.internalcontrolsdesign.co.uk/dynamic/index.htmlhttp://www.internalcontrolsdesign.co.uk/dynamic/index.htmlhttp://www.internalcontrolsdesign.co.uk/dynamic/index.htmlhttp://www.internalcontrolsdesign.co.uk/crisis/index.htmlhttp://www.internalcontrolsdesign.co.uk/crisis/index.htmlhttp://www.bbrt.org/http://www.internalcontrolsdesign.co.uk/dynamic/index.htmlhttp://www.internalcontrolsdesign.co.uk/dynamic/index.htmlhttp://www.internalcontrolsdesign.co.uk/crisis/index.htmlhttp://www.internalcontrolsdesign.co.uk/crisis/index.html -
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However, the greatest flaw is the result of trying to make risk management support budgetary
control by providing a means of achieving the original business objectives no matter what
happens.
Most descriptions of risk management emphasise its role in helping organisations achieve
their business objectives and of course this means their original objectives. Since the action ifresults turn out better than expected is simply to ease off, the entire focus of risk management
is on outcomes worse than expected.
This in turn has made risk management negative and unpopular. A risk management
workshop is typically a session where people sit round a conference table and talk about what
could go wrong and what they're doing about it. This is not something people usually enjoy
doing or do without special permission. If your boss proposes a plan and you reply with a list
of things that could go wrong that could be taken badly. Risk managers are thought of as
inherently cautious people who prefer to say "No".
In the last few years risk managers have begun to talk about the "upside" of risk, and aboutmanaging "risks and opportunities". Some have suggested calling risk management
"uncertainty management" instead to show it refers to all alternative outcomes and not just
the bad ones.
This is the future direction for risk management, but budgetary control stands in the way. It is
hard enough to get people to discuss unexpectedly poor outcomes. It can be even harder to
get them to talk about unexpectedly favourable outcomes within a budgetary control culture.
People keep quiet rather than tempt their boss to raise the targets.
The Beyond Budgeting model sets risk management free from all this. It promotes a culture
in which uncertainty is accepted and results can go up as well as down. Risk management - or
uncertainty management to give it the new name - can become a balanced, popular process in
which uncertainties are openly discussed and managed.
Uncertainty suppression
The unwillingness to discuss outcomes other than that planned is part of the wider
phenomenon of uncertainty suppression. When leaders make it clear that they expect to see
delivery of originally committed results according to original budgets and deadlines, and that
they expect managers to be certain in their minds and actions, people generally respond by
pretending to be more certain than they are, and by not talking about, thinking about, ormanaging uncertainty. They can be pushed into making premature commitments to overly
specific targets, and when things go badly they keep it secret, hoping to recover. If this
doesn't happen then eventually the bad news will come out - often too late for anything to be
done.
Leaders should make it clear that they are looking for excellent risk management and
planning, and should encourage people to be open about uncertainties, discuss them
realistically, and manage them.
Budgetary control sends the wrong messages and causes uncertainty suppression. This is the
most likely explanation for BP's problems, though the full details will probably never be
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There often is no action that will get the project/business back "on track".
Negative feedback loops seem like a perfect control mechanism until you remember
that they assume an action exists that can get you back on track. In practice, there
often isn't such an action. Business managers are normally constrained on resources,
elapsed time, and quality so there's nothing they can trade off. The fact that no action
is taken until results have already been damaged is another reason why a recoveryaction often does not exist. Bad news is more likely to mean more bad news in future
because it usually shows that conditions are less favourable than was expected.
The reaction to outcomes better than expected is to ease off. It seems absurd that a
business that is doing better than expected should ease up, but that is precisely what
happens under negative feedback control. Imagine a company with several new
products that applies budgetary control to them. Sensible product portfolio
management calls for detecting the products that are doing well and pouring it on,
while investigating products that are struggling and being prepared to cut losses by
killing the product. Budgetary control drives precisely the opposite behaviour as
people perform heroics trying to rescue the failures at the expense of the potentialrunaway successes.
It drives uncertainty suppression. This is the point discussed at length in the
previous sub-section.
Although budgetary control is not very effective, it was adopted first and its position is
entrenched. In most companies budgetary control influences status, pay, and promotions. In
some companies budgetary control meetings are among the most highly charged and
stressful. These are the meetings where business leaders assert their dominance. By
comparison, formal risk management tends to be an exercise done to comply with corporate
governance regulations, while informal risk management is too often haphazard.
The Beyond Budgeting model emphasises proactive, adaptive planning, frequently repeated.
It accepts that the future is uncertain and flexes with conditions. It provides incentives to keep
pouring on the effort even if you are having great success. This is like driving a car with your
eyes looking forward at the road ahead. Risk management naturally fits into this as the
process whereby potential openings in the traffic and potential dangers are anticipated,
searched for, prepared for, and dealt with.
Reforming risk management
If an organisation's formal risk management processes are to support the Beyond Budgeting
model instead of undermining it, they will almost certainly need to be revised. Reforms will
probably fall into three types:
1. A new purpose for risk management.
2. Quicker, easier techniques for more widespread use.
3. More sophisticated quantification of risks in big decisions.
A new purpose
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Instead of being a way to achieve original objectives, no matter what, risk management must
become a way to get people to think about the full range of potential future outcomes, and
manage them by advance action where appropriate.
This also means that instead of just considering things that could go "wrong", people should
be considering outcomes both better and worse than expected.
It would help to rename the process "Risk and opportunity management" or just "uncertainty
management", though the phrase "risk management" would have to be retained for external
statements about corporate governance.
Having removed the negativity of conventional risk management the process will be more
attractive and there will be less resistance to doing more of it.
Acceleration
Risk/uncertainty management should be a normal part of most management deliberations so
it must be possible to do it quickly and conveniently. If the top team has to spend half a day
off site with flipcharts every time to get it done that is not going to be practical. There are a
number of techniques for accelerating the process but the most important is to be able to work
at a higher level.
The usual style of risk management tries to work at the level of individual risks. Each risk is
identified and then rated to help with prioritisation. Typically there are two separate ratings:
likelihood and impact. Actions listed are usually described as "mitigation" or as "controls".
Working at this level is often useful but it can be laborious and there are certain risks thatpeople often want to consider that cannot be dealt with like this. We need to be able to work
at the level of sets of risks, otherwise known as "areas of uncertainty", or just as
"uncertainties".
Examples
Area of uncertainty/set of risks Individual risks
Impact of litigation this year. We lose our case against Grumpy plc.
Fire damage this year. Our data centre is destroyed by fire this year.
Market growth in the next two years.
Market growth in the next two years is exactly 1.0%
less than expected.
Market growth in the next two years is exactly 1.1%
less than expected.
Market growth in the next two years is exactly 1.2%
less than expected.
etc
Demand for our new product in the first
6 months.
Demand is 5% above our best estimate.
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Demand is 10% above our best estimate.
Demand is 15% above our best estimate.
Demand is 20% above our best estimate.
etc
The most common technical flaw in today's risk registers is that the "risk" column is almost
always used for sets of risks, but the ratings are framed for individual risks. For example, you
might be able to estimate the likelihood of "Loss of market share" but what is the impact?
Obviously, it depends on how much market share is lost. The risk "Loss of market share" is
really an infinite set of risks, one for each possible level of loss.
Correctly rating such sets of risks requires a probability distribution (or probability densitydistribution for continuous variation) of impact. This can be done by, for example, gathering a
sequence of ratings for the likelihood of impact levels being in various ranges.
A rough approximation to this which can be done quickly and easily is to ask for ratings in
two stages:
1. What is the likely range for this variable? (Perhaps defined as the smallest range
for which you are x% certain the value will be in the range.)
2. What is the variation in impact over that range?
For example, "What is the likely range for total market growth over the next year?" then"What is the difference in impact for us between the best and the worst?"
The mitigation assumed must be carefully defined. This can be done by assuming a particular
set of mitigation actions, or by assuming a range of mitigation actions so that you can see the
best and worst results that might be achievable under all identified possible mitigation
strategies.
Working at the level of areas of uncertainty it is often not necessary to make ratings at all. If
an uncertainty is obviously important there is no need for ratings unless acting on it is also
costly and a difficult judgment is needed.
Very often, the first and most important actions in uncertainty management are to find out
more, or at least put in place monitoring so that more can be learned over time. This again
does not have to be at the level of individual risks.
Here is an illustration of a simple table design that accommodates high level reasoning about
uncertainty:
Table for fast and easy uncertainty management
Area of
uncertainty/set of risks
Impact Monitoring/research actions Mitigation/exploitation
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Impact of
litigation this
year.
Huge. Three cases
outstanding. Uncertain
outcomes with range
of impact around
100m.
Weekly briefings with
legal team.
Get second opinion on
Grumpy plc case
urgently.
Health and Safety
compliance audit.
Investigate insurance cover
options.
Fire damage this
year.
Fire precautions well
established. Slight
possibility of terrorist
attack and that would
be serious as it is
outside current
provisions.
Check progress on
BCP project.
Get risk team to give
us a briefing on
terrorism risks.
We are moving from
Docklands to Baskingstoke -
should be lower risk.
Review of fire precautions in
new offices.
Market growth
in the next two
years.
70% sure it will be
between -7% and
+13%. Impact huge.
Improve analysis of
sales figures to find
highest growth areasmore quickly.
Commission new
analysis of economic
indicators and update
monthly.
Revise activity model
to show warnings of
demand outside
existing capability.
Look for a more flexible
warehousing approach.
Demand for our
new product in
the first 6
months.
Very uncertain and
impact huge because
this is our big new
hope.
Pilot launch.
Conjoint analysis
study.
Buy market survey
from research
company.
Introduce portfolio
management of products and
ditch budgets urgently.
With simple techniques like this it is possible for everyone to practice managing uncertaintybetter, all the time.
Explicit quantitive modeling of uncertainty
Just about every major company says it considers risks when making major business
decisions. In the UK, the wording that appears in their corporate governance report usually
says their procedures include something like this:
"...the consideration of risks and the appropriate action plans, when appraising and approving
all major capital and revenue projects and change programmes."
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At present that consideration does not usually extend to quantifying uncertainty in the
financial models that underlie these major decisions. As a result, the financial models can be
highly misleading. Not only do they suggest greater certainty than they should, but even the
"best estimate" is likely to be incorrect due to the Flaw of Averages and other effects.
This Flaw is the tendency to assume that average (or "best estimate") inputs will lead toaverage outputs, so it is not necessary to consider other possible inputs in working out the
output result. In fact this is only the case if the model is linear, which most such models are
not.
For example, imagine a company that organises conferences. Before deciding to go ahead
with advertising a conference and booking a venue it estimates the attendance at the
conference and puts its best guess into a financial model to decide if the conference is
worthwhile. There is a chance that too few people will be interested in a conference and that
it will have to be cancelled, saving most costs but not the non-refundable deposit on the
venue, which is usually quite large. However, in most cases the impact of cancellation,
including the non-refundable deposit, is not considered at all in the model because the mostlikely attendance is enough to avoid cancellation. This is clearly incorrect. The correct
valuation should be lower to reflect the impact of potential cancellation.
Another reason that best guess models tend to be wrong is that they assume all decisions are
made by the company at the outset. There is no opportunity to respond to events so the value
of these options is not considered. New techniques now becoming popular combine
discounted cash flow models with decision trees to give a more realistic valuation.
Where risk management fits in the Beyond Budgeting
model
Risk management can contribute to the Beyond Budgeting model in three places:
empowerment, action planning, and forecasting.
Empowerment: what should we talk about?
Even under radical decentralisation the top management team in a company still has a
legitimate interest in the decisions and action plans of the business units to whom they have
given power. When they meet the business unit managers what should they talk about?
This is a dangerous encounter. Here is where central control could try to reassert itself as
Directors follow their natural instinct to dominate and direct. A discussion of performance to
date against targets would be wrong and crush empowerment, so it is vital to be clear about
the rules of these conversations and avoid allowing old habits to insinuate themselves.
In the June 2002 version of the "Beyond Budgeting White Paper" there is a section on
empowerment that says of companies who have gone Beyond Budgeting that:
"They have challenged local strategies and action plans to ensure they are sufficiently
ambitious but at the same time that they are robust and that risks are appropriate."
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The budgetary control interpretation of these words is that senior management have
challenged targets to ensure they are ambitious yet achievable. This is not the correct
interpretation.
The risk/uncertainty management interpretation is that senior management have challenged to
see that local management have thought properly about the full range of possible outcomes,and that their plans include steps towards very good outcomes as well as steps designed to cut
the risk of poor outcomes.
This can be broken into two elements:
Are we comfortable with their thought process? Have local management followed
a good process and thought things through effectively? Do they seem to know what
they are doing? Do they have a command of the facts? Clear thoughts? Adequate
information to hand?
Are we comfortable with their current conclusions? Can their current conclusions
be improved on? Sometimes the senior team may be able to offer the benefit ofexperience and a different perspective to improve risk assessments and inject new
ideas into action planning. Clearly the senior team cannot expect the local team to
take their suggestions as instructions to be followed until the next meeting.
This element of challenge might be missing altogether where decentralisation is very
effective and local management highly competent.
The format of an effective risk management workshop could be adapted to this purpose,
providing a form that clearly discourages target setting behaviour. Risk management concepts
can provide a common language to keep these conversations honest.
Furthermore, these meetings can be described to investors as a demonstration of good
corporate governance and to reassure them that their investment is safe.
Action planning
Risk management can also be added to action planning to improve plans. Ideally, it should be
an integrated part of action planning so that plans are shaped from the first by risk
assessments and risk management heuristics.
There are already hints of this in some Beyond Budgeting publications. For example, in"Beyond Budgeting", an article for Strategic Finance October 2000, by Jeremy Hope and
Robin Fraser, the section on performance management includes the recommendation for:
"An investment management process that forces managers to build flexibility and "exit
routes" into their forecasts and in which execution is made at the latest possible time."
In "Beyond Budgeting ... building a new management model for the information age" in
Management Accounting January 1999 Jeremy and Robin wrote:
"The new emphasis is on looking ahead and being in a position to take advantage of new
opportunities and counter potential threats by using an advanced information system to makedecisions early."
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And also:
"By monitoring the key business value drivers and especially the leading indicators that tell
us something about future performance, we are in a much stronger position to take action
before potential problems translate into negative numbers."
They quoted Ole Johannesson, VP finance of Volvo Cars, as saying:
"Today we need a process that enables us to react not only immediately but even
beforehand."
Both these comments show that Beyond Budgeting aims to go beyond even instant responses
to events. How can this be achieved if not by anticipating potential outcomes and acting in
advance to modify their likelihood and impact?
The hints are there but, based on publications to January 2003, there is scope for adding a lot
more to the risk management element of the Beyond Budgeting model.
Forecasting: distributions not single points
References to rolling forecasts are too numerous to mention in Beyond Budgeting
publications. What form should those forecasts take?
The most common form for forecasts is one that states the most likely outcome only. e.g. "the
NPV of this project is x", or "free cash of y", or "operating profit of z on turnover of x".
This is not very helpful to action planning and does not help people to appreciate the full
range of potential outcomes and their relative likelihoods. Uncertainty is suppressed.
A much more useful forecast is one that states the probability distribution of whatever is
being forecast. Uncertainty is explicitly represented, discouraging uncertainty suppression.
This is more helpful for action planning. One can ask questions like "What is the likelihood
that the NPV of this project is negative?", "On current funding plans, what is the probability
that our free cash flow will be less than the amount we need to maintain dividends at last
year's level?", "What is the likelihood that demand for this product will require warehouse
capacity greater than our current planned levels?"
This is not as difficult to do as most people think.
It is not necessary to gather a lot of data in order to provide useful distributions.
Even a complete guess as to the distribution would be better than ignoring uncertainty
as it discourages uncertainty suppression and encourages planning for a range of
outcomes. Getting more data and better models to support the distribution simply
increases its value. Most distributions are supported by a model that combines a
mixture of purely subjective and data-supported estimates. Done correctly this is more
reliable than unaided human judgment.
Techniques and software are readily available to do this to a level of sophistication
far greater than any company could reasonably require. Even using the most common
spreadsheet software, Microsoft's Excel, it is easy to set up Monte Carlo simulations
to explore how events could play out, and run the simulation thousands of time in lessthan a minute. @risk is an example of a spreadsheet-like program that has built-in
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Monte Carlo simulation and the whole model is in terms of probability distributions
rather than single numbers. It is cheap and easily available, as are its competitors.
It is not necessary to be a brilliant statistician to build or use these models. Professor
Sam Savage has pointed out that software tools for working with probabilities are
becoming easier to use and more powerful, leading to what he calls an era of"consumer stochastics" where many people will use statistical models and tools
whose operation they don't understand, just as they would use a car or computer
despite having little understanding of its inner workings. Professor Savage's work is
fascinating and his papers entertaining as well as useful.
It is common to offer a single-point best estimate and an optimistic and pessimistic range. If
"optimistic" and "pessimistic" are defined in probability terms this is a form of probability
distribution. (If you can do this you are very close to being able to show the whole
distribution in a graph too.) If these terms are not defined then the range is still helpful as a
reminder that uncertainty exists, but is not as useful.
Even so, forecasting outcomes as probability distributions is more difficult than single-point
forecasting and certainly less familiar for most accountants and business analysts. There are
many alternative techniques, some of which are hard to understand and implement.
Though forecasting with probability distributions may seem unfamiliar and complex now, in
years to come it will be as familiar as discounted cash flow models are today. Forecasting
distributions is a tangible expression of commitment to keep uncertainty in mind and not
make the mistake of assuming one future. It also puts business leaders in a position to say
something specific to analysts and investors without actual stating a single-point forecast or
target.
The value of risk management within the Beyond
Budgeting model
The sense of control, and protection against future uncertainties, that business leaders and
investors want does not have to be provided by "command and control" leadership, where
decisions are made centrally, and where original objectives are the yardstick of success.
Beyond Budgeting offers a welcome alternative based on:
Giving people a direction to move in.
Relative measures of performance that flex with conditions, so staying relevant.
Superior forward looking information.
Adding Risk/Uncertainty management to that list would further strengthen the sense of
comfort. It would also allow business leaders to make more detailed statements about the
future to analysts, if they wanted to, without stating targets.
Summary of recommendations for Beyond Budgeting
implementations
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Companies planning to manage their performance better by moving to the Beyond Budgeting
model should:
Review existing procedures for formal risk management and around major business
decisions such as capital and revenue projects and decide what reforms are needed if
risk management is to support rather than undermine the Beyond Budgeting initiative. Manage the uncertainty and risks of the Beyond Budgeting implementation itself.