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HOW INTERNAL MARKET ECONOMICS WORKS
The solution to most resource-governance challenges is rooted in a new way of thinking about organizations: the business-within-a-business paradigm.
Consider the contrast between the old, bureaucratic organization and this different way to manage an enterprise.
In a traditional organization:
- The organization chart is defined in vague terms of roles, responsibilities, functions, and processes.
- Financial governance focuses on controlling what managers spend. Budgets are based on past years' spending, staff on hand, and proposed expenditures. Managers are monitored based on actual spending against plan.
- Strategies are decided based on rough estimates of the obvious direct costs.
- Strategic alignment is accomplished through written plans, with the expectation that managers will read the plan and translate strategies into individual performance objectives.
- Results are measured subjectively in annual performance reviews.
- Teamwork is based on loose understandings of participants' individual contributions, interpersonal relationships, and good-will.
In the business-within-a-business paradigm:
- Every group in the enterprise is an entrepreneurship, with a clearly defined product line that it sells to customers within the enterprise or externally.
- Financial governance focuses on what the enterprise will "buy" from each group, providing budgets to fund well-defined products and services which are selected based on payoff and strategic alignment -- termed Investment-based Budgeting.
- The full cost of a strategy can be calculated by adding up the costs of all the individual products and services required from groups throughout the enterprise.
- Strategic alignment is accomplished by funding all the products and services enterprisewide that add up to successful execution.
- Individual accountabilities are crystal clear, and results are measured objectively based on whether managers deliver the products and services they promised at a competitive price.
- Teamwork is based on internal customer-supplier relationships; managers buy clearly defined deliverables from one another.
Shared Services View
The contrast is particularly poignant from the perspective of internal service provider executives.
The old paradigm goes something like this:
- You propose and defend your budget -- on your own. It's based on what you plan to spend (compensation, travel, training, vendor services, etc.).
- Executives micro-manage you by cutting specific items you know you need (travel, contractors, etc.).
- You are forced to accept less than you asked for -- less than you know you need -- because your budget is based on past years and politics rather than investment analysis.
- Clients see everything as free, and demand everything they want.
- Clients blame you when you can't produce unlimited products and services with finite resources.
Traditional solutions are ineffective, if not damaging, and often induce decentralization and outsourcing:
- A steering committee to rank-order major projects doesn't tell clients "where the line is drawn" -- that is which will and won't be feasible with current resources. They go on expecting it all, and the steering committee only serves as a forum for their discontent.
Why this happens....
- Bureaucratic hurdles (like demanding that clients justify to you why they should have the right to buy from you) may chase away demands that aren't important to clients. But you antagonize clients by becoming difficult to do business with, and undermine a partnership that's key to delivering strategic value.
- Taking it on yourself to decide what will and won't be approved sets you up as the hurdle -- the adversary, not a strategic partner to the business -- and undermines your culture of customer focus. Meanwhile, you're not as well equiped to decide strategic alignment as are clients.
- Studying enterprise strategies and generating projects you feel are strategic makes you the sponsor of your own work. Even if you're right, clients resist when you force your solutions on them.
The business-within-a-business paradigm suggests a different way of treating your budget:
- You submit a budget that describes the cost of the products and services you propose to deliver -- your outputs, not your inputs.
It includes not just what you think the enterprise can afford, but also all the requests clients have made and might make.
- The enterprise budget process decides your total budget by considering the payoff of proposed deliverables -- termed "Investment-based Budgeting."
Clients naturally defend the projects and services that benefit them. And you'll leave the budget process with a clear understanding of which projects and services it does (and does not) pay for.
- You separate out budget for investments in your organization such as infrastructure and major process improvements (venture funding), and for enterprise-good activities like policy coordination (subsidies).
That leaves the bulk of your budget for client deliverables.
This portion of your budget is treated as a pre-paid account, money put on deposit with you at the beginning of the year to buy your products and services throughout the year. It flows into a "checkbook" that clients use to buy your products and services throughout the year.
- If you get allocations (high-level formulas that drive transfers of money from clients to you), these too can be treated as pre-paid accounts.
Quite different from the common view of taxing clients to pay your costs, clients generally support allocations when they're in control of the resulting checkbook.
- A governance process (perhaps with a client executive committee) has a well defined purpose: to write checks from that pre-paid account.
You communicate the full cost of all your products and services, and clients decide what they'll buy.
- If a client wants something new, he/she may make a case to the steering committee which can adjust its priorities.
That failing, he/she can find other sources of funding, and pay you directly (fee for service). As long as he/she is willing to pay full cost, you can expand your capacity (eg, with contractors and vendors) and satisfy the incremental demand.
In this new paradigm, your relationship with clients becomes simple, businesslike, and not at all bureaucratic or political.
More on the change in the nature of budget dialog....
Because clients are limited to the checkbook created by your budget, expectations match resources.
And because clients decide what they will and won't buy, strategic alignment is automatic.
Know the Full Cost of Products/Services
The key to making this work is knowing the true, full cost of all your organization's products and services.
The full costs of products and services is used during the budget process, and for clients to make decisions about what they buy using their prepaid accounts.
The full unit costs (rates) of products and services is used to issue invoices, either for chargebacks or to decrement the prepaid accounts.
"Full cost" means not only direct costs, but a fair share of all indirect costs.
The FullCost software and method are a powerful first step in implementing this business-within-a-business paradigm.
FullCost produces the following:
- Defines every group's line of business, and its catalog of products and services.
- Develops budgets for proposed products and services -- an investment-based budget which forecasts what you propose to sell, not just what you propose to spend.
- Calculates rates, the best basis for chargebacks (if any), client control of the checkbook created by your budget, and fair competitive benchmarking.
- Cultivates a culture of internal customer focus, entrepreneurship, frugality, and teamwork; teaches business planning and develops the next generation of enterprise leaders.
- Calculates product-line profitability with a comprehensive view of costs, including fair share of all enterprise indirect costs.
Changes the Dialog
FullCost changes the nature of business and business planning. Discussions become businesslike, and not at all bureaucratic or political.
Managers propose their products and services, with costs. Senior executives make judicious decisions about what they will and won't buy with scarce enterprise resources, considering ROI and alignment as they evaluate managers proposals.
Anecdote that illustrates the change in the nature of budget dialog....
An investment-based budget becomes the basis for rational budget decision-making and enterprisewide strategic alignment. It may also be used to to determine fair cost allocations.
There's no need for micro-management. Managers at all levels can be empowered with no loss of control; they're managed by results -- outputs, not inputs.
That leaves senior executives free to focus on the important issues: strategies, relationships, talent, organization, vision, and inspiration.
Strategy execution improves because resources are aligned with strategies, and individual accountabilities are clearly defined.
Note that there's no place for the "do more with less" plea, which leads managers to commit to more than they have resources to deliver. This unproductive game ultimately leads to failures in delivery that undermine strategy. Instead, the enterprise fully funds the few things it chooses to do, and removes costs associated with everything else.
FullCost allows better-informed budget and strategy decisions, explicitly aligns resources with enterprise strategies, defines accountabilities for deliverables, installs a discipline of frugality, enhances cross-boundary teamwork, and gives you a realistic view of product-line profitability.
The bottom line: With FullCost, shareholder value is enhanced.
FullCost is more than a business and budget planning tool....
It's a visionary way to run an organization.
What problems can FullCost solve?....
White paper: Investment-based Budgeting
why CFOs should mandate a new corporate budgeting process
Case Study: We've Already Got Budget Spreadsheets, Don't We?
how Sonoco Products discovered the value of a fully developed budgeting and product/service costing solution
Case Study: From Adversaries to Advocates
how budgeting and product/service costing improved relationships between IT and its clients
Case Study: Can You Really Know Your Full Cost of Service?
Riverside County IT found the way
Case Study: Re-inventing the Budget Process
the cost of success: interviews with CIOs on the benefits of budgeting for products/services
Anecdote: No More Games!
how knowing the true cost of your products/services can change the nature of budget negotiations
Anecdote: Budgeting Is a Waste!
a short story on how standing up for the truth broke the cycle of misery and failure
Column: IT Financial Management and the Service Lifecycle
how the pieces of the puzzle come together
Book: The Business-within-a-business Paradigm
Report: Full-cost Maturity Model
Speech abstract: Investment-based Budgeting
Speech abstract: The Big Picture
how all the pieces of financial governance processes fit together
Speech abstract: The Full-cost Maturity Model
how to assess your organization's level of competence at business planning, budgeting, and costing