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When spending goes wrong, frontline managers should step in

July 18, 2007

When 20-20 hindsight shows a sizeable fraction of a company's investment decisions to be wrong, maybe it's time to change the way those decisions are being made.

A recent survey conducted by the McKinsey Quarterly asked more than 2,500 executives from around the world about their companies' decision-making process for resource allocation.¹

The survey focused on four general categories of capital investment:

1. Acquisitions;
2. "Maintenance" investments to sustain the business at its current level;
3. Projects to stimulate growth in existing lines of business;
4. Innovation.

As many as one-third of investments considered "mistakes"

The researchers sought to learn "how frequently – and why – a company's resource allocation decisions go wrong." The results were "decidedly mixed."

Respondents said that one-fifth to one-third of their companies' investment decisions over the last three years were, in retrospect, mistakes.

In some cases, promising opportunities were missed. In others, investments were made that shouldn't have been made, and projects that should have been terminated continued to consume valuable resources.

Aversion to risk, internal politics the most common causes

Aversion to risk and unrealistic optimism about the likely success of projects were identified as important factors driving those faulty decisions.

Internal politics also played a significant role. And, unfortunately, more than a third of respondents said that managers "hide, restrict, or misrepresent information at least 'somewhat' frequently when submitting capital-investment proposals."

Firsthand knowledge from frontline managers

Is there a way to overcome these hazards and make better choices on a consistent basis?

No one has a crystal ball that can predict the outcome of business projects with 100 percent certainty. And risk is unavoidable if businesses are to enter new markets or launch new products.

But even a modest improvement in the success rate of resource allocations could produce substantial benefits in revenues and profits.

An answer might be found in one factor that was common to companies of all sizes and all industries in the McKinsey survey.

At a majority of companies, frontline managers had only a minor or secondary role in evaluating investment choices.

Frontline managers have firsthand knowledge of products, customers and markets, but in most companies that knowledge is underutilized, if not wasted.

A planning regime that encourages and facilitates broad participation from the front lines puts that knowledge to use.

More input from those in a position to know the "real" numbers brings greater accuracy and transparency to the decision-making process, and offers less opportunity to "hide, restrict, or misrepresent information."

As CFO magazine observed in its January 2007 issue, "Business-process consultants have long noted that when line managers have a hand in planning ... budgets get better."²

Politics, both good and bad

Internal politics, of course, are always with us. But when there is agreement on the numbers, it allows for more useful debate on the genuine merits of resource allocation choices.

Planning expert David Axson distinguishes between what we might call "good politics" and "bad politics" in business planning.

In his book, Best Practices in Planning and Management Reporting: From Data to Decisions, Axson writes, "...effective politics in planning is about communication and education, not influence and patronage.

"The planning process needs to be open and candid. Making sure that good proposals are heard or that wise expenditures are approved regardless of the source of the idea is a valuable part of the overall process."³

A better process leads to better decisions

The McKinsey survey concluded with the gloomy observation that "As executives maneuver for position behind the scenes and sometimes even deceive one another, constructive debate and dissent appear to suffer."

That describes a decision-making environment with little hope of success.

But when the process is open and inclusive, healthy debate and dissent can inform a company's investment decisions, and optimism about resource allocations can have a solid foundation.

Summary

Resource allocation decisions suffer from the influence of risk aversion, unjustified optimism about the likely success of proposed projects, and internal politics.

Better results would follow if investment decisions were founded on objective information drawn from the front lines of the business.

A budgeting process that draws information from frontline managers in a timely fashion can provide the insights necessary to produce better decision making and more successful resource allocations.

Find Out More Learn more about broad-based budgeting with IBM Cognos 8 Planning Discover planning best practices at the Cognos Innovation Center for Performance Management™ Download the related article, Are Your Best Practices Really the Best?" by The Hackett Group [PDF - 136 KB]

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Sources

¹ How companies spend their money: A McKinsey Global Survey, The McKinsey Quarterly, June 2007

² Don Durfee, The Last Mile: Why is it still so hard to engage line managers in budgeting? CFO, January 2007

³ David A.J. Axson, Best Practices in Planning and Management Reporting: From Data to Decisions, John Wiley & Sons, 2003, p. 149