Today's business executive is surrounded by challenges. Pressures on costs and pricing make lean, efficient operations necessary for survival. The pace of globalization, technological advancement, and relentless competition continues to accelerate, and terrorism and political instability are raising new concerns. At the same time, faith in reported business results -- and the leaders who provide them -- has been shattered. The need for ethical behavior and transparent reporting has never been more obvious.

To respond to these forces, senior executives need to create organizations that are lean enough to answer customer demands both profitably and efficiently, adaptive enough to respond nimbly to shifting operating environments, and ethical so that investors trust their results. To begin moving in this direction, an organization should examine the fundamentals of how it is managed. Ironically, research has found that the traditional budgeting practice is the root cause of many organizations' current problems. These businesses need to replace their budgeting process with management tools that offer continuous planning and adaptive control. Budgets and the command-and-control structure that supports them should be replaced by lean, adaptive, and ethical processes operated by front-line workers.

Improving Efficiency

The goal of the lean enterprise is to create a system by which customers pull value from the organization through a stream of activities that has no waste. The heart of lean thinking is a customer focus; companies should decide how to efficiently provide the capability customers desire at the appropriate price. Most organizations' traditional budgeting processes are a major roadblock to efficiency.

The following example -- adapted from "Jack: Straight from the Gut" by Jack Welch (Warner Business Books, 2001) -- illustrates how a typical company arrives at divisional budgets: Divisional managers spend weeks preparing for their annual budget presentation. They try to determine the minimum number they can sell to corporate. The corporate staff also spends considerable time preparing for the meeting. The divisional managers' presentation explains the weak economy, stiff competition, and a multitude of other factors that make their business environment difficult. They argue for a number lower than what they think they can actually achieve. Corporate management paints a rosier picture and argues for a much higher number in order to leverage the division's plan. Over years of practice, both sides have gotten progressively better at negotiating, bluffing, and playing the budget game. Back and forth the discussion goes. At the end of the day, a compromise is selected somewhere in the middle. The divisional team returns home satisfied that it managed corporate management's expectations, while corporate management feels it added value by ratcheting up the division's objectives. The focus has clearly been on negotiating skills, not on adding value to stakeholders.

In addition to the obvious inefficiency of time wasted in plotting and negotiations, budgeting has a second efficiency problem: It is inherently a push system. Managers attempt to forecast which products and services customers will require. The budget numbers build up resource requirements in anticipation of these customer needs. Buffers are often planned to cushion against peaks and valleys, in effect systematizing waste rather than focusing on eliminating it. The budget becomes the goal, and resources are coordinated to push this plan rather than organizing around customer demand.

In a lean enterprise, the driver for spending should come from the customer, who pulls activities. Some argue that traditional budgets are necessary to keep costs in check because they are a company's primary tool for authorizing spending. However, practice shows that the budgeting process has the opposite effect. Although it may set a ceiling on expenses, a budget typically also sets a floor. Managers spend up to authorized levels to avoid having to go through the approval process a second time and to ensure that their budget for expenditures is not reduced the following year. Traditional budgets establish a hoarding mentality in operational units that works against attempts to become lean.

The CEO and owner of a Florida-based consumer-products company eliminated budgets because he felt they were "authorizations to spend money before it was made." Many consumer-products companies reach quarterly and annual goals by convincing customers -- through price discounts and volume deals -- to buy large quantities at period end. The budgetless company rejected this type of technique because its strategic objectives emphasize the freshness of its product, and channel stuffing leads to product staleness. The company does not provide extra commissions to salespeople to push high-margin products, either. Its owner believes he should listen to customer demand (pull) rather than try to push products that are not exactly what consumers want.

To achieve this, the company replaced negotiated budget goals with a simple expense-ratio formula that clearly communicates its business plan objectives: It expects to reach a minimum 20 percent top-line growth yielding 20 percent profit, supported by marketing spending of 20 percent or more. A unique feature of its forecasting process is that the company makes a quarterly request for innovative growth opportunities but authorizes only high-potential initiatives. This enables the company to continuously look for ways to grow. Revenues from new projects are plowed back into the business. As a result, the company's growth exceeds 30 percent each year. Nevertheless, a manager's mind-set is: "Thirty percent growth is great, but why didn't we grow 40 percent? What can take us higher?"