Why it is unreasonable to manage with plans and budgets, or the problem with running in leg shackles

Why it is unreasonable to manage with plans and budgets, or the problem with running in leg shackles

If a budget is used to manage the costs of the organization, its costs are always higher than they might be without a budget.

An organization drafting sales plans always sells less than it might do.

"One of our leading company presidents tells the following story on himself. Fifteen years ago he bought for his company a small independent plant in Los Angeles. The plant had been making a profit of $250,000 a year; and it was purchased on that basis. When going through the plant with the owner — who stayed on as plant manager — the president asked,

"How do you determine your pricing?"

"That’s easy," the former owner answered: "we just quote ten cents per thousand less than your company does."

"And how do you control your costs?" was the next question.

"That’s easy," was the answer: "we know what we pay for raw materials and labor and what production we ought to get for the money."

"And how do you control your overhead?" was the final question.

"We don’t bother about it."

Well, thought the president, we can certainly save a lot of money here by introducing our thorough controls. But a year later the profit of the plant was down to $125,000; sales had remained the same and prices had remained the same; but the introduction of complex procedures had eaten up half the profit."

Peter Drucker.
Essential Writings on Management (2001)

  1. Planning as a competitive disadvantage
  2. Why planning is bad
  3. For some organizations planning is counterproductive, while for some others it's a must
  4. IEM: removing the old spell
  5. On uselessness of cost budgeting
  6. Cybernetics explains why it's so stupid to manage with plans

 

1. Planning as a competitive disadvantage

Let's take two relay running teams.

The first one is a traditional team. The members of the other team get their feet shackled.

Which team will win?

It's worth knowing that the competition rules say nothing about leg shackles.

You may wonder what idiots put shackles on for a running race?

Three quarters of the time to be dedicated to training the second team actively spends on arguing about what kind of shackles should be used, who deserves to wear an advanced model or everyone must be shackled impartially. And so on and so forth.

The lion's share of working time is taken for discussions about shackles to be used the next year.

After another race is lost, a learning the lesson session takes place.

"Should we get rid of shackles?"

"Are you serious?

We believe that we have to spend several millions on a specialized software solution to select shackles more wisely. We also need to order best-in-class consultancy services (another couple of millions) to get understanding of modern trends in shackle usage.

We can also learn how Big Data and other fancy techniques are applied to improve the process of shackles" selection".

That's enough sarcasm for now, let's see what's underneath.

 

2.Why planning is bad

It depends on how to apply it. Let's be clear with terms:

scenario planning and

managing the plan.

Scenario planning (simulation, to be precise) is a useful tool.

The bad thing is managing the plan.

It is when some random figures (based on "historical data" or "an analysis conducted by our analytical department"...) instead of being used in spreadsheets of possible scenarios are used to justify future activity.

Since long texts are difficult to read, you are welcome to see our Bad ideas regarding incentives. Its logic may be equally applied to any aspect of business.

Don't you want to say that you know how to plan it right? How to use advantages of planning and to eliminate its drawbacks. This is what advance forecast techniques are intended for and...

Don't be naive.

"The knowledge of certain principles easily supplies the knowledge of certain facts" (Helvétius is believed to say that).

There is an example of the USSR — it's quite an illustrative, historical and global experiment on managing with plans. Its result is well-known.

Or maybe the Soviet planning experts were not that expert?

They didn't have MBA degrees.

They didn't attend any out-of-the-box-thinking workshops. But hypothetically, if they had attended, they would have improved their planning system and the USSR would have won the cold war.

It would be useful to take a historical example of the famous Kosygin’s reform. It was possibly the most large-scale, universal and well prepared reform in in the humankind history.

The best academicians of the best of its time Soviet mathematical school worked on the reform.

It had being thoroughly prepared for several years.

Its results were so amazing that the authorities were scared and put an end to it.

The reform was so successful because it was aimed... at thoroughly concealed departure from the planned economy.

 

3. For some organizations planning is counterproductive, while for some others it's a must

Let's divide organizations into two general categories:

  1. "free market" organizations which buy marketed goods on the market. Suppliers of such goods are interchangeable.

  2. "dependent" organizations which buy mostly non-marketed goods. Suppliers of such goods if not being monopolies are hard to be replaced anyway.

The food supermarket is a good example of the free market organization. In its diary product category it's free to change an assortment and suppliers. What matters is the price, quality and terms of delivery.

The Apple company represents the other category. It obtains its phones already assembled from Foxconn factories. There are not any other suppliers of these phones on the market at the moment. It takes months at best to replace Foxconn with another OEM manufacturer.

Thus, free market organizations in their operations (investment projects are another case), do NOT require planning at all.

There is nothing to apply it to: you can stock the shop with whatever is sold, try different goods, negotiate with different suppliers. Milk is trendy today and yogurt is in demand the next day. The supermarket management should follow shifting preferences of customers.

For dependent organizations, planning is the only technique now available to arrange a supply chain: Apple plans to sell a million iPhones, so Foxconn needs time to buy a million cameras, cases and so on, Foxconn's suppliers need time to buy plastic, glass and so on. This is the very SCM — supply chain management.

It doesn't mean that planning is good for Apple. It's bad as for everyone else.

But the company will not be able to deliver iPhones to stores without planning its supply chain.

That is the dilemma: either to accept planning with all its drawbacks to supply retailers with iPhones, or to get neither of these.

Apple would readily abandon planning, if it had a better solution for arranging its supply chain.

 

4. IEM: removing the old spell

However, there is such a solution — it is that rare case when fancy IT initiatives can be applied for profit.

Smart contracts between Intellectual Enterprise Management systems of supply chain participants can ensure their coordination in real time.

It should be as follows:

  • you come to a store to buy an iPhone

  • the IEM System of the retail chain recalculates the required inventory amount for this store and for the entire chain (the main server of the retailer IEM System collects data from all stores)

  • then it notifies the distributor IEM System and updates the amount for the next delivery

  • the distributor IEM System instantly informs the Apple resource management system which collects data from all Apple distributors

  • Apple contacts the Foxconn system...

....

... This information ultimately reaches manufacturers of plastic, glass and copper for wires.

When you are still checking your newly bought phone, some robotic excavator in Chile extracting copper ore has already received the command to extract a bit more ore today.

This communication process now takes moths. It doesn't apply, except for severe force major situations, due to its sluggishness making it senseless. When data for March is processed and analyzed, October comes.

Direct loss: either inventory shortage (missed profit), or excessive inventory (loss from selling-off).

Indirect loss:  payroll for a crowd of marketers and analysts, investments into IT delusions under different names, and all that is for the sake of getting some planning figures a little more accurate than random.

The potential for productivity growth amounts to a half of the global GDP.

Moreover.

If take a closer look, one might notice that the approach described above eliminates dependent organizations as a category.

This is because dependency on suppliers (with some temporary patent exceptions) is solely results from overwhelming difficulty to rebalance a lengthy supply chain. It is difficult to make such arrangements initially and it's even more difficult to observe them. It's a tricky task.

Automatic reconfiguration of a supply chain by communication of participants' IEM systems using smart contracts can completely fix the problem: a bit more ore can be extracted as well in Australia or elsewhere.

With no additional cost, at any time in 24/7/365 mode.

A conclusion:

  • free market companies must not practicing planning at all. Just forget it

  • dependent organizations are better focus their efforts off initially meaningless activity and concentrate them on the approach described above. The first ones which accept and implement it will be able to strengthen their competitive positions.

But only for some time until others do the same.

Maybe you are puzzled about how to calculate financial incentives without plan targets?

Pay by results.

A half a year after consistent implementation, you'll be astonished with results.

 

5. On uselessness of cost budgeting

If a budget is used to manage the costs of an organizations, its costs are HIGHER than they might be without a budget, other things being equal. The budget is a plan, so everything said before equally applies to it.

Budgeting is just another form of managing with bureaucratic procedures in place.

Thus, the fundamental laws of bureaucratic initiative evolution can be applied:

  1. The firs law ensures that actual results are opposite to target ones: costs will increase.

  2. The second law explicitly points out the only beneficiary — people employed in budgeting.

Of course, they prosper at the cost of shareholders, customers and useful employees.

NB: this concerns MANAGING the budgeting process when such process is implemented.

There is a useful application for budgeting when it is used as a benchmark to assess actual results against targets set by the budget (model). It's useful, as it allows to find out in good time that something went wrong and to develop adjusting measures before it's too late.

 

6. Cybernetics explains why it's so stupid to manage with plans

This statement can be easily proved with a simple mental experiment. Let's imagine a free market organization working in a perfect competitive global market. It offers its convenience goods to all people on the Earth. The entire planet is a free trade zone.

Let's try to manage the organization using plans. According to the Law of Requisite Variety, the managing system must be of greater variety than the system being controlled. But how can we reach a greater variety?

The organization already serves the entire planet with all its inhabitants. In order to reach a greater variety by the managing system, it needs AT LEAST another planet with all its resources just to prepare and update plans for the organization.

That is actually it.

December 28, 2016 by John Galt