EMERSON: THE QUEST TO IMPROVE THE BUDGET SYSTEM
Introduction
Emerson can be considered as a cost-averse firm due to its historic reservation and cultural infusion of continuous cost-effectiveness activities in its operations. However, without an effective budget system, the culture could draw them into the pit of zero-innovation and sub-optimal value-adding activities. They perform industry scanning before budgeting so it is helpful to implement a certain method that can maximize the environmental information and its relative impacts to internal operations. Thus, the introduction of performance-based budgeting is suggested to this end. Presented in the paper is the description and evaluation of Emerson budget system and the beneficial contribution of performance budget not only to its financial but also business performance.
The Firm and its Budgeting System
Emerson Electric Company is a US-based manufacturer that produces electric motors and computer support systems. It gained prominence due to 30-years continuous growth in profit and stock value. The key exists in goal-orientation is when the business managers presented at least 40 divisions plans and executes independently, while the headquarters serve as the monitoring administrator of key result areas. In 1998, the B firm showed business simplicity is truly beauty in empirical sense primarily which attributed to its financial track-record. CEO believed that providing the environment for unit managers to plan their own group’s targets and its concurrent budget line will lead to responsibility and accountability that makes smooth implementation and result-based approach to execution.
Planning is decentralized to general managers of each division including strategy formulation and operations. They set their own targets together with other subordinates. They work for months initially determining SWOT in the external environment and capital expenditure required to exploit or mitigate them. Afterwards, the 50-year old ideology of cost-reduction goals, a way of life in the firm is formulated and gave managers the pro-active view of what activities should be done in the coming year to align in this firm culture.
Strategic guidelines in planning and budgeting are followed. First, employee involvement is aimed for managers to get useful information from different sources and at the same time create a mechanism wherein resistance to change could be minimized. Second, competitive position is protected through continuous improvement in the value chain, assessing their resources and capabilities with rivals and product innovation. Finally, prudence in capital expenditure would give the planners rationalized trade-offs between investments (improvement) and accompanying costs (departure to cost-reduction culture).
Crucial to the firm is to achieve the designed results through rigorous planning and tight control. With this, they can shape the future as they have intended while profitability is considered merely a state of mind and not a chance. Also, how they will determine the results is largely dependent on operational level where long-run performance is deemed to stem. While the firm does not have complex business papers to reflect their plans, simplicity would fill the gap as it will foster discipline to employees driving them to pre-determined objectives and work practicality.
System Evaluation
As observed, Emerson has been able to minimize complexity of planning and remain objective in installing goals. The most knowledgeable, proximate and concerned people relative to resource and capabilities are the one who will allocate resources. These results to less effort and time devoted to arrive at reasonable forecast of results. Whatever the information they would use (cash, accrual or modified accrual) and template or software to be utilized, operating budget emerged through the minds of those who experienced budget shortage/ surpluses and who applied certain contingencies on emergency situations. Thus, only objective matters rather subjective or gut-feel are inputted to determine financial results. With this, determining the reserve budget need not be outsourced to an engineering firm while future revenues/ expenses are easily deciphered from the past year. As a result, there will be optimal resolution to avoid revamping that could arise in special assessments.
However, there are also loopholes in simplicity and cost-reduction scheme of the firm. First, since their major concern is scanning the industry and competitive environment, decentralization may increase research and monitoring costs for detriment of consolidated efficiency. Second, cost-reduction culture and emphasis on short-term gains could impede innovation and value-adding activities that could result in imitable competitive advantage as cost-cutting and price based competition have lower switching costs than value based ones. Lastly, oversimplification of setting annual budget would shift the manager strategies towards practical approach to recognize contingency opportunities/ threats that is risky for the division’s contribution for the whole organization.
Of course, the headquarters (HQ) is there to signal and apprehend the concerned division about symptoms of departing to activities determined in budget planning to arrive at results so these loopholes can be easily resolved. However, it is questionable that they can always decode what is in each manager’s heads. As a result, the picture seen by the HQ could be myopic that instead of enhancing the focus of the division to its goals, it would rather annoy and confused managers. It is not disclosed how strict is the monitoring of HQ and what disciplinary actions would be resorted, but our concern is a definitive structure that would lessen incidence of failure notification from HQ to division managers. With short-term operational lens applied, increase reliance to financial assets would undermine intangible resources such as human capital, innovation and reputation.
Apparently, the CEO’s belief to natural efficiency across the firm’s divisions has its trade-offs. Without caution, competitive advantage can only be sub-optimal. It is also observable that some of its planning guidelines are in conflict like being competitive with financial prudence and decentralization initially, but party centralization in execution as HQ monitors the implementation of each division. As a result, there is a need to fill these gaps by providing a clearer border line between HQ oversight and managerial flexibility using budgeting techniques from academic sources and best practices.
The Technique and Tools for Analysis
Performance-based budgeting is mission-driven, result-oriented budgeting that can clearly explain how Emerson would achieve cost-effectiveness in a consistent and sustained way. This form of budgeting details the cost of each activity- a certain organizational unit will perform that is tied with specific goal or performance level. For Emerson, efficient allocation of resources is a culture so the analysis would involve the economic aim of budgeting which is to achieve the best use of resources wherein benefits from expenditures are worth of their costs in terms of the sacrificed or displaced alternatives. Using this lens at the fore requires measurement of activities according to their incremental values and relative effectiveness although we should not hesitate to suggest modification and enhancement in its view on making annual budget to maximize the discussion.
Emerson Annual Budget: From Bad to Good
It can be argued that Emerson would likely use the line item budget to adhere in its simplicity. However, it does not show what key activities or programs of the firm will undertake that makes the HQ monitoring of division operations more unpredictable since both units do not have the map to guide their actions (divisions) and reactions (HQ). Aggravatingly, performance evaluation would highly depend on the level of periodical expenses since results in the annual budget for a specific activity is not indicated. Uncertainty of number results would basically make the budget yardstick futile.
Performance budget can ease the pressure of HQ to invest in monitoring mechanisms and to safeguard division’s adherence to their determined budget and results. The system will highlight key activities or those with relatively higher investment and crucial results providing the HQ key areas to look at. This could finally infuse strategic planning to the firm in order for specific steps back-up the objectivity of a certain project. Day-to-day operations oversight will be minimized instead diverting monitoring endeavors to the long-range actions and responses of division managers including their contingency decisions. Also, indirect cost of follow-up by HQ will be prevented like managerial demoralization leading to decrease in productivity due to frequent inquiry of HQ officials when an activity is done (incurring cost) without its presence in the determined annual budget.
As divisions can overcome cost-reduction culture through research supported activities, innovation will not be neglected primarily because of supply-side cognition of making budget. They can also transfer the additional or increased financing of a major activity like product development against trade-off in minor activity like firm funded parties. Priority areas are highlighted due to the existence of target outputs and their costs. As a result, managers can easily evaluate possible manipulation of operational areas financing for firm to bear the value-adding and sustainable feature of strategic planning. In effect, cost-reduction would not limit growth of the firm, instead, it will provide the platform to efficiently use its resources and improve its capabilities in view of its valuable contribution in allowing them to manipulate the flexibility of internal activities in favor of exploiting opportunities from the environment.
Contingency decisions during the operational year of division managers could also be limited and rationalized by the system. The budget ceiling implored in contingency account and its desired results will possibly mitigate the effects of an abrupt competitive wide-scale advertisement, will give the HQ and division managers the objective benchmark in which to base their actions-reactions. Of course, the HQ wants to protect shareholders and long-term stability of the whole organization. On the other hand, divisions intend to show performance that can differentiate them from other division and possibly get a higher budget for the succeeding fiscal year. The system will enable HQ and divisions to lobby their oftentimes conflicting goals of agency relationship in financial terms, thus, preventing them to argue in objective terms in case one request departure to the original budget due to unforeseen events (failure to reach quarterly sales quota due to increase in imported raw material costs).
Emerson Annual Budget: From Good to Better
Although the firm is successful in bridging simplicity of operations to reduce complexity and objectivity of planning, it does not have the budget database for all divisions to figure-out possible integration of individually determined activities. Division 1 would implement a strategy which is partly or the same as Division 4. With measurable results opposite to investment needed in performance budget, the HQ can identify possible synergy between two or more division having the same level of significance tied to a certain project. This can enhance the lobbying power of divisions to demand higher annual budget since they exhibit similar decision and priority patterns.
In addition, it can promote harmony across the divisions including HQ relations. Decentralization somewhat bring competitive tendencies between divisions to prove their worth of the annual budget and other division benefits. When they are aware that their projects are compared with others especially those that require large amount of investment, it would suggest teamwork and platform to remind them that they are working for one company. Also, HQ would have better company-wide planning as inputs from divisions who examined and looked for a possible joint project or intensive sharing of resources. As a result, the supposedly determinant of strategic direction of the whole firm would have greater inclination to leverage individual division’s operations intended to reach corporate long-term goals.
Further, using the system will strengthen the firm’s SWOT analysis because it requires substantial data, in this case, both external and internal data. Each division would then give ample effort to study the general environment on top of competitor and internal analysis. Of course, major activities would delimit their research endeavors since it needs huge organizational resource than minor and regular activities. This will not only build a bounded budget that is within achievable and calculated risk framework, but also stimulates human resources reception to both internal and external updates. In effect, they can argue their ideas during planning that will be the source of confidence to discuss the matter in front of the managers. This will support employee participation in decision making.
Finally, the supply-side stance of the firm could appreciate the importance of result-based approach to planning. This will minimize the tendency of the firm to be cost-averse despite of strong value chain and determined opportunities. It will provide the backbone to believe that budgeting is the means to an end and not simply awarding a budget to the end skipping the value-adding capability of improving the execution of the means. With two lenses at hand, Emerson would simply use the one appropriate to a divisional activity balancing the long-term and short-term prospects including accompanying costs and benefits. This will support entrepreneurial tendencies and creativity that is crucial to a globalized firm’s survival and profitability.
Conclusion
As said, using cost-leadership strategy is ineffective when the firm is unable to meet the acceptable level of goods and services it offers to customers relative to competitors. As a result, performance based budgeting could drive the organization to maximize the purpose of competitor and internal analysis by inputting activities that will respond to the finding through exposing them in the annual budget. Supposed that the competitor decided to directly compete in the market of Emerson, a large and innovative firm could drive it away in the industry due to its capability to absorb looses due to liquidity. It can indicate clear distinction and functionality of several major activities while testing cost-reduction regimes employable to them and would be set-aside as to give way to full divisional accountability to meet results.
Even though the system has benefits, it should be cautioned that extensive research is required to arrive at objective activities. Also, minor activities or those that are done every year are impractical to provide neither varying results nor extensive research as this would depart to simplicity culture of Emerson. In aggregate, what the system aspires to the firm is to adhere to their begging-of-the-year promises (divisions) wherein HQ has invested scarce resources to finance. It is an effective tool to promote responsible and accountable decentralized divisions, supportive and firm HQ and efficient allocation of resource in case of meeting the intended result or extending it. It will also measure the credibility of managers and financial tolerance of HQ concretizing the learning curve in budgeting and testing effectiveness of cost-reduction culture at the same time.
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