1. Compare and contrast Borealis' old financial planning and control system with its new system — Throughout steering was place which abandons the traditional budget favour more
Business & ManagementGeneralCase Study
Throughout Borealis, a new financial and steering system was in place which abandons the traditional budget in favour of more purposeful tools such as key performance indicators, trend reporting and rolling financial forecasting.
—Borealis, 1996 annual report
Borealis, headquartered in Copenhagen, Denmark, was formed by a 1994 merger between the petrochemical divisions of two Scandinavian oil companies, Statoil of Norway and Neste Oy of Finland. The company, whose name means "of northern origin," was a fully integrated producer of two polyolefins, polyethylene (PE) and polypropylene (PP), commonly used to produce plastics. Borealis had production facilities in Austria, Belgium, Finland, France, Germany, Norway, Portugal, and Sweden. With a marketable capacity of 3,340 kilo-tons production per year, it was the largest producer of polyolefins in Europe and the fourth largest in the world.
Questions
1. Compare and contrast Borealis' old financial planning and control system with its new system.
2. Is Borealis' new system an improvement? If so, why do so few companies use systems that look like it?
SOLUTION
Purpose of Case
Companies have traditionally used budgets for planning, monitoring, and evaluation. Some companies, however, believe that budgets are inadequate in today’s competitive environments, that budget processes require too much time and resources, and that the budgets themselves are inflexible and get quickly out of date. A movement that encompasses these ideas has been popularized under the rubric “Beyond Budgeting.” A Beyond Budgeting Roundtable is a discussion group that meets with CAM-I
Borealis, which is a Beyond Budgeting company, abandoned its budgeting system and replaced it with four targeted management tools. The main question to be discussed is: Will these tools accomplish managerial objectives more effectively and efficiently than the budget they replaced?
Teaching Approach
1. Why do companies use budgets?
Students can be asked to assemble a list of purposes, which include the following:
to make strategy operational
to control spending (permission to spend)
to provide point estimates of spending by department (by what / by whom)
to facilitate better evaluation of decentralized managers by senior management
to communicate important information within the organization, both bottom-up and top-down
to enhance motivation and accountability
2. What is Borealis’ business strategy?
High quality provider.
More flexible plastic based on proprietary formula. Licenses Borstar technology in recent years. Research and development is important.
Note that Borealis was quite profitable (refer to the income statement).
3. What was wrong with Borealis’ budgeting process?
Its budgets served too many different purposes; e.g., both forecasting and target setting. Quote in case: “Forecasts should be realistic, targets should be challenging” (stretch).
Borealis used budgets to control spending, but Borealis did not flex the budget. Borealis had a broken MCS.
Quote in case: “Budgets not only set a ceiling on costs, but also a floor.” The floor means that managers will spend all they are allotted.
The budget constraints hindered decentralized decision-making.
Once established, the budget quickly became out-of-date because so many planning assumption variables changed quickly. They were also out of management’s control, so the variances were meaningless. (See quotes in the “Budgeting Process” part of the case)
It was a lot of work.
4. Why was Borealis having trouble with its budget, while other companies don’t?
Problem in the way that management used the system.
Design of system: fixed vs. flexed in highly volatile market where Borealis, despite its size was probably a “price-taker.”
“What if we didn’t do budgets at all?”
The Emperor’s New Clothes – individually, each manager expressed frustration and dislike of budgets and the budgeting process, but collectively they felt a need for budgets. Budgets provided a (false) sense of control since Borealis faced uncontrollable volatility in its feedstock costs and product prices. The board of directors gave approval as long as management could design a faster, simpler process.
5. What modifications would have made the existing system more useful?
Flex the budget to make it more useful and dynamic.
Beyond the need to flex for volume, Borealis needed to flex for changing input prices and changing product prices, which were uncontrollable by management.
Note how Borealis does a variance analysis to explain its YTY profitability (Exhibit 2C)
Develop new standards (e.g., compare actual to actuals to achieve continuous improvements or use external benchmarking, “best in class”).
6. What changes were instituted? And how did management expect the new measurement and control systems to help?
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Borealis managers set objectives to be achieved by the new measurement and control systems:
Improve financial management and performance measurement
Decentralize authority and decisions
Simplify the budgeting process
Reduce the resources used in the process
Several new tools were needed to replace the budgeting process and its two primary functions: financial planning and performance measurement (see Ex. 4):
Rolling Financial Forecasts
Balanced Scorecard
Key performance indicators
Relative Financial Performance
Activity Based Costing
External Benchmarking
Trend reporting
Decentralized Investment Management
7. What are the strengths and weaknesses of each of the new measurement and control system?
Rolling Forecasts
goal was to achieve a simple and accurate picture of expected financial performance.
similar to a flexible budget permits incorporation of dynamic states of the world.
used the most objective data available.
spent less time explaining deviations from budget.
This system could also be gamed, but Borealis did not tie compensation to achieving the forecasts, so there was little incentive to game.
If some resources are variable (flexible) with respect to volume and mix, when the company has updated and more accurate forecasts, it can do better short-term resource budgeting (authorize spending on direct, capacity, and support resources based on anticipated volume and mix of products and customers). This requires activity-based budgeting and would tie back to capacity planning (investment management).
Balanced Scorecard–communicate strategic objectives and measures to employees and encourage them to set personal objectives that would be linked to corporate strategy.
Relative Financial Performance (RFP) – to further distinguish between forecasting and performance measurement. The RFP was the correct flexible budget for Borealis. One that flexed for input prices and product prices as well as volume. Borealis’ financial performance was much more affected by external margin changes (changes in the spread between input and product prices) than by actual internal process performance.
important to achieve a balance and a focus on key performance indicators (KPI) without overwhelming managers with metrics galore.
Introduced small incentive plan between 3,000 and 8,000 Kronor ($500 to $1,000) based on 12 KPIs from the BSC.
ABC – to track and record costs by activities which create them, to develop cost information that was much more intuitive and understandable to plant employees.
External Benchmarking – used to set performance targets for VC, FC and operating margins by benchmarking against competitors (see Ex. 5). These targets were considered tougher, but the absence of budgets gave managers increased freedom for spending $$ to reach the targets.
Trends: measure and graph activity and process costs over time.
Removed gaming; Nobody wanted to be a ‘laggard.’
Spent less time negotiating targets.
Rates were determined using maximal usage of capacity. Variances arose because not all fixed costs were allocated to products. The cost of unused capacity was assigned to profit centers based on differences between capacity planned and used.
Decentralized Investment Management – to put decision-making and control with plant managers and employees who were closest to the marketplace and customers - collection of decision rights and specific knowledge needed for the best decision making, proximity to customer and markets.
8. Should compensation be tied to KPIs presented on the BSC?
How will this affect validity of data reported or aggressiveness of target setting? What other processes can management use to offset the information distortion when targets are established for performance measures?
The KPIs are not about strategic uncertainties. The KPIs are about measurement of outcomes from a well-defined process – the production of little plastic pellets. If so, then it seems OK to tie compensation to KPIs. In fact, without this reinforcement, the targets may have little motivational impact.
9. Is the Borealis new system for everyone? Why would it not be “universal medicine”?
Empirical evidence suggests that Borealis’ system is not for every company, as most companies continue to use budgets. Every company has tension in the design and use of MCS. These systems are used both to inform and to motivate. Using one system to do both is likely to result in the introduction of manipulation. There is no one way to address this tension. Some companies, for example, set top-down budgets or use tight supervision or truth-inducing incentive systems.
One problem with the Beyond Budgeting approach is feasibility. Every company must have performance standards. Borealis replaced its internally negotiated (budget) standards with benchmarked standards. This is not feasible for every business, as many companies guard their internal data on costs and margins very carefully.
Why do we observe the innovations suggested by the Beyond Budgeting Round Table (BBRT) being implemented primarily in Europe, and not in the US? In Scandinavia there are multiple examples of companies that have followed this strategy. Most notable is Svenska Handelsbanken, which has consistently been the most profitable Scandinavian bank over the last 20 years. Employees’ views seem to be different in different cultures. So what works for Borealis may not work in the US – as suggested by the quote by Bogsnes in the case.
In Borealis, decentralization seems to be a substitute for budgeting. This decentralization is motivated by the unpredictable price variability in Borealis’ environment (prices, costs).