Friday Business Feature: Corporate Budgeting Should Be a Tool for Strategic Focus

As companies begin the annual budgeting process, they should step back and focus on the capabilities that make them different and better — then double down on those

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New York — August 26, 2010 — The annual budgeting process offers a critical opportunity to focus on what matters most, but too many companies fail to take advantage of it.

That's the message from Booz & Company Partner Paul Leinwand and Managing Director Cesare Mainardi, co-authors of the recent Harvard Business Review article "The Coherence Premium," and the forthcoming book The Essential Advantage: How to Win with a Capabilities-Driven Strategy.

"Inevitably, there's a long line of people and departments looking for funding, but rarely is anyone considering which functional endeavors are most essential to the company's advantage. And that's just as true for the people reviewing and approving the budgets as it is for the people actually making the budgets," said Leinwand.

"Budgeting should lead to better performance. Unfortunately, at most companies it's a time-consuming, frustrating, painful process that has no impact at all on performance. And it happens the same way every year. People dread it. But no one seems to know how to fix it," added Mainardi.

Mainardi continued that the first task of budgeting should be to decide which capabilities are most important to supporting the company's chosen market position. "Then double down on those. It's an especially important task in an economy like this, when resources are stretched and competition is fierce."

Mainardi and Leinwand say that budgeting must support a company's "coherence." The key to strategic advantage is figuring out what the company is good at — how it adds value in a differentiated way — and focusing on those capabilities. The authors describe such companies as being "coherent," and they cite three key steps in building coherence:

  • "Way to Play": Make a clear choice about how the company creates value in the market — i.e., a considered strategy for attracting and holding chosen customers. The company's way to play forms the basis of its core value proposition and organizational mission: the ways in which what it does, and delivers, are different from others.
  • "Capabilities System": Identify the differentiating capabilities, those three to six things that the company does uniquely better than anyone else and that support the way to play — and how these capabilities fit together into a mutually reinforcing system that can be leveraged over and over again to build scale and pursue new opportunities.
  • "Product & Service Portfolio": Make a clear decision about the "sweet spot" in the market, and choose a product and service portfolio that provides an optimal fit between the company's unique capabilities and the demands of its chosen customers.

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Mainardi and Leinwand also explain that capabilities-driven budgeting:

  • Reinforces strategic advantage. Line managers know how and where to budget in order to reinforce the company's strategic advantage: they support the way to play instead of veering away from it; they strengthen differentiating capabilities to be even more efficient and effective; and they drive product development toward closer alignment with the first two.
  • Drives investment, not just cost-cutting. With a clear idea of coherence — i.e., how the company is positioned in the market, which capabilities are critical to supporting it, and what products and services are best suited to it — budgeting becomes a strategic investment exercise, one that's focused on growth and naturally eliminates irrelevant and wasted expense.
  • Is faster and leaner. Because line managers know what's important, they also know what to ask for — and what not to ask for. They are more likely to come up with realistic budget requests that need less guidance from senior management, and less pruning and juggling in the review and approval stages.
  • Is more transparent. When people have a clear framework for setting priorities, they are more likely to understand why something gets cut from the budget. Decisions feel less arbitrary, less personal, and budgeting can be used to model "coherence" up and down the line.

In terms of practical guidance on effective budgeting, Leinwand and Mainardi suggest that no budgeting exercise is complete without looking at strategy, or without a clear look at its impact on the company's capabilities system. In addition, all budgeting must be seen as a way to direct investment toward specific capabilities that the company needs to compete, and the products and services that best fit with its capabilities and way to play.

They also say that all budgeting should start with a conversation focused on coherence. The people putting together departmental and divisional budgets need to understand more than just what the numbers are; they need to know how to manage the numbers to help the company sharpen its competitive edge and achieve a right to win in the marketplace.

"Frugality, productivity and efficiency — the need to do more with less — are on every business agenda, and more intensely than ever since the economic crisis of 2008/09. But far fewer companies are having the more important conversation, about what makes them different and better, and how to take that advantage to the next level," said Mainardi. "In a tough year like this one, executives must tackle that core strategic question first, and ensure that the budgeting process delivers on its potential to enhance the company's advantage."

"Many companies don't have an adequate understanding of their differentiated capabilities, which are what add value and attract customers. They don't have a capabilities-driven strategy, one that aligns their way to play with their capabilities and products and services and thus increases their coherence. So in the end, there is no overarching framework or clear list of priorities for people to budget against," added Leinwand. "First you have to know what you're good at. Then you need to develop a capabilities-driven strategy that outlines your way to coherence. Let coherence drive your budgeting. If you can't find that coherent center, then you're lost, and the budgeting process will just be an exercise in running in place."