Since the boss knows all about sandbagging (the boss is, in fact, probably even better at it) the
response is: “How can you put forth this plan with a straight face? Where are all the growth
initiatives? Why do you expect prices to decline so much? Where is all this extra cost coming from?”
This goes back and forth as the parties attempt to narrow the gap toward a budget they both
accept. Discussions are anything but transparent, since both parties have an interest in holding the
information they have confidential to help their own side’s negotiation. The budget process creates
an incentive to withhold information from superiors and subordinates.
Some managers seem to be better than others at this budget negotiation game, and they wind up
getting easier budgets and often earn higher bonuses as a result. At many companies, a careful
analysis over time shows no correlation at all between pay and true performance, because the ease
or difficulty of budgets can end up mattering more than the results. Tying bonuses to budgets
reduces the emphasis on actually improving performance as long as targets can be negotiated.
The boss is put in a precarious position. Adopt an accommodating approach, and the manager won’t
set her sights high enough. But take too tough a stance, and the manager may no longer consider
the budget as his own. If the business underperforms, the manager will likely say “I told you that
budget was unrealistic.” Managers don’t take ownership of the budget when the bar is raised by the
These are some pretty serious problems, but what else can be done? How can we set targets any
other way? Don’t we need to address uncertainty by setting targets as close to when the year starts
as possible so we know what is reasonable? And how do we make sure rewards aren’t too high in
cases in which the manager is simply lucky that the industry is doing well?
Many companies focus on continuous improvement, always measuring performance against the prior
year. Thus the budget process can be the true planning process it was intended to be, one in which
managers and bosses sit on the same side of the table sharing insights and ideas and trying to find
ways to improve performance. If performance improves, both parties win.
Although many companies recognize the benefits of a continuous improvement focus, many don’t see
how to make this work in a dynamic business environment. Many companies face commodity cycles
and competitive volatility, making it hard to let go of the budget-based targets and look to
There are two requirements to make a continuous improvement incentive succeed. The first is a
“complete” measure of performance that takes into account revenue growth, margin improvement
and asset efficiency. Well-known measures of economic profit and others based on cash flow can be
used to make sure an improvement in the performance measure only happens when all aspects of
performance are collectively moving in the right direction.
The second requirement is to make sure the incentive plan is not too sensitive to the up-and-down
volatility of the business. The more volatile a business is, the less sensitive bonuses should be to the
swings above or below target. With the proper sensitivity, a good portion of performance cyclicality
can be dampened and the resulting reward program can be more effective.
To be sure, determining the right complete performance measure and properly calibrating incentives
for cyclical performance are difficult tasks. But the reward for embracing such ideas is a budgeting
process and management culture with more transparency, cooperation, innovation, initiative,
accountability and results.