VSM and Financial Performance Management

1. VSM and Financial Performance Management Steve Morlidge

2. Who is talking to you? • Steve Morlidge • Unilever 1978 – 2006 roles include: • Controller Unilever Foods UK ($1 billion turnover) • Unilever – Bestfoods Integration Leader • 2002 – 2006 Leader Dynamic Performance Management Change Project (part of Finance Academy) • Outside Unilever • Chairman of Beyond Budgeting Round Table 2001 – • BBRT Associate 2007 - • 2007 - Founder Director Satori Partners Ltd, f (wis) Ltd • 2005 – PhD Hull University (Management Cybernetics)

3. Characteristics of a Budget • it estimates the profit potential of the business unit • it is stated in monetary terms • it generally covers a year • it is a management commitment. Managers accept responsibility for achieving budget objectives (responsibility centres) • the budget proposed is reviewed and approved by an authority higher than the budgetee • once approved the budget can only be changed under specified conditions • periodically actual financial performance is compared to budget and variances are analysed and explained Anthony 1995

4. Beer’s Perspective • ‘managers and ministers have become hopelessly entangled in immensely high variety estimations about performance in future epochs that are arbitrarily selected…[and] consists mainly in rationalising and updating plans which have been constantly falsified by unfolding history’. Sources: ‘Brain of the Firm’ ‘Heart of the Enterprise’

5. Ashby’s Law of Requisite Variety V(c) ≥ V(e)/V(g) V = the number of distinct states a system can be in (a measure of complexity) in a given period of time g = system goal(s) e = the environment ‘The smallest variety cannot be less than the quotient of the number of rows divided by the number of columns’ ‘Only variety can destroy variety’ W Ross Ashby c = the control system Generalisation of Shannon’s 10th Communication Theorum

6. The VSM and financial management • Focuses on: • Organisation – an effective system of constraints • Measurement - filtration • ‘Ignores’ • Goal setting • ‘Motivation’ • Acknowledges • Financial soundness as a prerequisite for viability • Financial resources as an engineer of variety • The importance of time – dynamics • ‘Budgets’

7. ‘Profit Potential of a unit’ • ‘financial soundness expresses no more than a constraint on the system’ • ‘ROI does not have requisite variety’ • ….’has elastic definitions that can easily be manipulated’ • ‘The control target of steady response, which entails steady profit making and steady growth, can be achieved only relatively. The important outcome of regulation, as we have learned from our study of homeostasis, is to hold critical variables within physiological limits’

8. Covering a period of a year • ‘orthodox management procedures appear to rely wholly on ‘snapshot’ accounts of the situation. It is strange and it is dangerous’ • ‘there are no crucial dates in the development of a firm except those provided by convention’ • ‘there may be sluggish response to certain types of fast varying input – because of the complexities of the systems which damp down oscillation. There might also be amplifiers in the system which increase the amplitude of dangerous oscillations which should be damped’

9. Representing a management commitment…only changed under specified conditions • ‘any rigid plan, however well conceived, will not produce the goods unless it is continuously modified…because the operation is subject to continuous perturbation as well as the perturbation of it’s own basic input’ • Plans should ‘continuously abort’

10. Subject to review and approval by an authority higher than the budgetee. • Power should be….’derived from concatenations of information not from the allocation of dependencies’ • Management should ‘make minimal use of the variety attenuators in the downward direction’

11. Periodically compared to actuals for analysis and explanation • Information: ‘that which changes us – when a fact is recognised and is susceptible to action’ and a manager is the ‘metasystemic administrator of Ashby’s Law’ • Traditionally we ‘insert amplifiers on the wrong side of the variety equation’ and have a ‘managerial emphasis on error correction rather than error exploitation’

12. Ashby’s Law explains regularities observed from the application of budgetary control • Cost/bureaucracy - reduction of control variety to a Target/Single Plan (Rewards attenuate Goal Variety) • Gaming behaviour - informal increase in control system variety/behaviour to cope with low variety targets, high variety environments • Inflexibility - inadequate control system variety, failure to deal with leads/lags Conclusion - ‘variety’ perspective explains many of the reasons for dissatisfaction with existing practices

13. Implications for the Design of Performance Management Systems… • Externally reference, limit to those salient to the purpose of the organisation, or sub systems, and be clear about (range of) acceptable states Targets Planning Measurement Regulation (Resource Allocation) Match environmental variety where salient to the goals of the organisation, reduce variety where impact is limited Identify variety relevant to goals (‘signals’) including ‘non financial’, eliminate variety (including noise) with limited impact. Decide at the right time (taking into account lead/lags) and differentiate between high (investment) and low (maintenance) variety interventions

14. ….and the Organisational Context • ‘Cells’ of self managed teams at all resolutions. Maximise empowerment consistent with the need to maintain cohesion and extract synergies Structure Governance Co-ordination Definition of Success Rewards Establish boundaries (constraints) based on Strategy, Purpose and clear definition of roles/responsibilities. Achieved through high variety interventions Externally defined – related to viability High variety, system wide, after the event.

15. The Chasm Model The visionaries – interested in the possibility of creating something new and wonderful. Listen to endorsements of innovators. The pragmatists – want to fix a broken mission critical process. Interested in effectiveness, reassured by endorsement of peers. The conservatives – interested in efficiency/cost equation The sceptics – see all the downsides. Will only change if there is no option The anoraks – interested in anything new – for its own sake. They will find you

16. Key messages • We are like fish who don’t know what water is: we are blind to, and blinded by our current performance management paradigm • It no longer works • There is an alternative - based on systems science/cybernetics • It ‘explains’ scientific findings/alternative management models • There is a once in a generation opportunity to engineer a paradigm shift