In Part 1 of this article, I showed how Amazon became Agile and conquered bureaucracy. In this article, I show how Amazon has tamed the annual budgeting process and turned it into something constructive.
In Think Like Amazon: 50 1/2 Ideas to Become a Digital Leader (McGrawHill Education, April 2019, John Rossman makes a strong case that Amazon has succeeded where most other firms have failed and tamed the budgeting process. Rossman’s book offers a clear and succinct account of the Amazon mindset and offers “50 ½ practical ideas” to enable others to learn how to think—and act—like Amazon.
In my earlier article, I showed how the problems of budgeting are linked to other issues of the firm—strategy, structure, HR, compensation, and accounting, as shown in Figure 1. It is difficult to fix the budgeting process without also fixing these other issues.
Internal Vs. External Orientation
In traditional management, the orientation of the budgeting process is typically internal. It focuses on costs and internal outputs and examines input-output relationships. Units often get recognition for outputs from their unit, regardless of the eventual outcomes for customers or the firm.
By contrast at Amazon, the principal focus of planning and budgeting is on costs and external customer outcomes of activities or capabilities. At Amazon, work isn’t seen as done when it is completed by an organizational silo: work is only done when metrics show that it is having value for customers or enabling Amazon to do its work better. In effect, the budget process at Amazon is imbued with customer obsession.
Building In Customer Metrics From The Beginning
Budgeting at Amazon is a subset of an exhaustive planning process known as OP1 in which every activity is reviewed in terms of its contribution to value for customers.
For in the months of July, August, and September, while also doing all the preholiday work before the retail peak season hits, you are spending your time meeting, debating, writing, and reviewing your next year’s operating plans and ideas for scaling and innovating.”
At Amazon, the reviews principally revolve around real-time customer-related metrics of individual activities, not about which unit gets how much money. That review is possible because each activity is evaluated at the very outset from the perspective of its eventual customer impact.
This is very different from traditional management, where activities and initiatives are often launched without any quantified idea of how the eventual impact on customers will be measured. As a result, many activities are launched that customers don’t eventually need or want or that do not constitute viable business opportunities.
By contrast at Amazon, external customer focus is built into activities' metrics from the outset. Thus, no significant new activity can be undertaken at Amazon unless and until there is an exhaustive management review of a six-page planning document supported by a PR/FAQ document and the customer metrics by which customer benefits of the activity will be measured in real time.
A PR/FAQ contains two elements:
- a future press release describing the benefits customers are getting
- the answers to “frequently asked questions” about how the activity was put together and
The package of planning documents is rigorously reviewed by a group of senior managers before it begins. If approved, it is funded and incorporated in the budget. As it proceeds, planning documents are steadily updated.
Budgeting Vs. Planning
These differences in approach reflect the fact that the amount of time spent in traditional management on planning and assessing the customer impact of individual activities is typically modest. By contrast, the budget process itself in traditional management can be costly, as there are disputes as to how to reconcile the conflicting claims on the budget, combined with little or no basis for making a determination. There are often months of in-fighting over not-much-change in unit budgets from the previous year.
By contrast, at Amazon, the balance between planning and budgeting is the opposite. The planning process for individual activities in terms of customer impact is grueling and exhaustive and can result in significant changes from the previous year. The budgeting process is simpler: it’s merely the consequence of planning decisions in respect of individual activities. Most of the hard choices have already been taken in the planning process. The question of which unit gets how much funding is not as important as, which activities are to be funded?
Budgeting Activities Vs Budgeting Organizational Units
At Amazon, the OP1 planning process and review of these planning documents and PR/FAQs are exhaustive and comprehensive; the ensuing reconciliation of all activities in the budgeting process is then relatively straightforward. That’s because there is already some agreement as to what activities are contributing to customer impact, along with the costs and risks involved. It’s not that the planning process itself at Amazon is quick or simple. It’s not. It’s rather that at Amazon, allocating funding (i.e. budgeting) flows from evaluations of customer-impact already made during the planning process.
What often makes traditional budgeting so frustrating is that everyone knows that substantive issues about purpose and priorities are not being addressed in the budget discussion: the budget battles are a proxy for unresolved power struggles between competing units and the divergent viewpoints of senior managers. The resulting budget is often an ugly compromise and resolves little or nothing about what’s important for the firm and what isn’t. Those issues remain to be fought over some other day.
Budget Game-Playing
In traditional budgeting discussions, there are often few reliable metrics about the impact of activities on customers. The most quantifiable thing under discussion is money and the budgeting process becomes a struggle to see who gets how much of it, and at what price in terms of promised outputs. Each unit tends to maximize its inputs by taking the level of inputs from last year’s budget as its “entitlement” or “floor” for the coming year.
By contrast, at Amazon, because there are reliable customer metrics for every activity, both actual and planned, the conversation revolves around how much benefit each activity will be generating and at what cost. There is no assumption that last year’s funding for any activity or unit is appropriate for the current year. The only question is whether the customer-driven metrics justify the activity in the future or not. The level of funding for any particular unit rarely enters the conversation; the discussion is about the funding of activities. The unit in which any particular activity may be located organizationally isn’t central.
Budget Ceilings And Floors
In traditional budgeting, each unit often seeks to minimize its commitment in terms of outputs; the level of outputs from the previous year is often presented as a ceiling for the coming year. At Amazon, there is no such presumption. In the planning process, each activity is evaluated from the perspective of the customer outcomes, not just internal outputs. If an activity is not contributing to customer impact at an appropriate level of cost and risk, it is obvious it must be cut. The conversation is not between units fighting for resources: it’s about the customer impact that each activity or capability is contributing and at what cost and risk.
In traditional budgeting, units often adopt an ethic of “spend it or lose it.” At Amazon, the issue is different because the budget discussion isn’t about levels of funding for units. It’s about funding for activities. In such a context, spending money for the sake of spending it in a fiscal year would be a very bad game plan: it would mean that the customer impact of each activity would be even more costly for the same level of customer benefit. In effect, it would jeopardize, rather than justify, the continuation of funding. In this way, Amazon’s budget dynamic discourages game-playing.
Updating The Budget
In traditional budgeting, the annual budget quickly gets out of sync with the external marketplace. In Amazon, with its reliance on real-time metrics for every activity, there is reliable information on every activity which is reviewed weekly, with alerts within 24 hours if something is amiss. The timeliness and speed of decision-making in response to the changes in the data are part of the Amazon culture.
In traditional budgeting, adjusting the budget can be an enormous task. given the interlocking nature of the overall system and the dynamic of unit managers fighting for and protecting “their” resources. Giving more money to one senior manager’s unit may mean taking it away from another senior manager’s unit. The budget may be updated on a quarterly basis, but major changes may be difficult to negotiate, even when they are obviously needed. By contrast at Amazon, there are weekly reviews of activities based on real-time customer metrics, and the phenomenon of units protecting their resources is much less prominent.
In traditional budgeting, top management has the ability to monitor the minute details of spending, something that often leads to top-down category-specific diktats, such as “freeze all travel expenditures.” Yet top management typically has little or no information on the consequences of such diktats on important operational plans or on customers. Levels of trust are often low.
At Amazon, weekly reviews are based on real-time customer metrics of individual activities, not units. Because top management can see the impact of any such counter-productive diktat, it is less likely to issue them.
Controlling Spending Vs Controlling Outcomes
In effect, traditional budgeting is predicated on careful monitoring of spending, often in the absence of reliable information about what is happening on the more important issue of customer outcomes. Any bad news is often kept from top management until it is too late to do anything about it. At Amazon, the availability of real-time customer-related metrics at all levels ensures radical transparency. There is nowhere to hide. Everyone knows everything.
In effect in traditional budgeting, the appearance of control that budgets offer to senior management in terms of neat tables of reconciled costs and outputs is often no more than an illusion of control, not the reality. By contrast at Amazon, the availability of real-time customer-related metrics for individual activities, not just costs, means that the management has reliable information and actual control of outcomes.
Relation To Organizational Structure
Traditional budgeting often reflects, reinforces and aggravates the siloed organizational structure, Siloes often get in the way of delivering value to customers. Rather than having truly cross-functional teams, with end-to-end responsibilities to deliver value to customers, supposedly “Agile” teams may work within their own silo and produce outputs, for which they may get credit in the budgeting process, but which lead to no immediate customer benefit. Inter-unit warfare in battles over the budget is common.
Amazon has a fairly conventional organizational structure, but the dynamic of the decision-making is dramatically different. It is based on an evaluation of the customer impact of activities and capabilities, not units. In effect, Amazon doesn’t let its organizational structure and titles get in the way of its customer obsession.
The OP1 process enables a holistic review of the value of each team’s business or service and its overall fit within the company’s strategy. It also forces every team to think through and outline the road map necessary to support the overall growth objectives of the company.
At Amazon, the budget process thus is not basically about how much money to give to each unit, but rather about which activities and capabilities are to be funded or de-funded. Each activity is led by a small self-managing team—a “two-pizza team”. Where the team is located is organizationally is much less relevant than what customer impact it offers.
Relation To Human Resources
The problems of traditional budgeting are often aggravated by the firm’s HR system, which may reflect and reinforce the siloed and hierarchical structure and budget, in which customer outcomes are not fully in the picture. Thus, individuals within each organizational silo tend to be evaluated and rewarded in terms of producing the budgeted level of outputs within the given budget envelope for their unit. As Rossman explains, things are different at Amazon:
Much has been written about about Amazon’s compensation structure. The commonly held belief is that the top salary in the organization is $165,000 per year. The only other compensation is stock grants. While that is not universally consistent across Amazon anymore, Amazon does avoid individual or team-based bonus structures and keeps salaries low relative to market. Why is that? People game the system. It’s human nature to optimize those functions for which we are measured and rewarded. It’s just human nature.
Amazon’s compensation structure is focused on incenting long-term enterprise value creation. The focus is on on achievement (big and small) with responsibility for getting to yes which is everyone’s job.
'What drives Amazon’s compensation strategy?... We pay very low cash compensation relative to most companies , ” says Bezos . ‘We also have no incentive compensation of any kind. And the reason we don’t is because it is detrimental to teamwork.’… If you lose some people over this, you’re likely better off having it happen early”.
Executive Compensation And Share Buybacks
In traditional management, an internal focus may be further accentuated in firms where senior managers are compensated with stock options: share buybacks become a convenient way to boost the share price, independently of any value delivered to customers. Given the lucrative nature and scale of this compensation in many public organizations, there are strong disincentives to change the internally oriented budget on which it is based.
At Amazon, there is little temptation to resort to share buybacks, because Amazon has so many new ideas on which it wants to invest its money. At Amazon, the disconnect between strategy and operations doesn’t happen because strategic thinking and customer focus are built into both the planning of individual activities and the overall planning process for the firm.
And read also:
The Seven Things A Highly Agile CEO Does: Jeff Bezos
Why Budgeting Kills Agile and Innovation
