A company’s budget shows what its strategy really is.
Imagine a world where you have full view of all budgets and resource allocations in every organization you could possibly want. You could read any company’s press releases, strategic statements, and marketing collateral—and then immediately assess whether that company is doing anything special with its resource allocations to reflect its “special-ness.” What do you think you’d find?
Let’s take a topic like share buybacks. What if a company told you its strategy was to accelerate share buybacks when prices are high, and to slow them when prices are low? Would you call that company crazy? Of course. Nobody says that. Yet FactSet publishes this:
Here’s the CliffsNotes version of this chart: S&P 500 executives and boards execute vastly more share buybacks (blue bars) when share prices are high (purple line) than when they’re low. Though there are many explanations for this seemingly nonsensical reality (most importantly the timing of capital availability in the cycle), the fact remains that corporate leaders exhibit the exact same pro-cyclical bias that any investor on the street does. It turns out that manias for tulips, dot-com stocks, real estate, and share buybacks have this in common.
Now, suppose an honest CFO were to slip up and say “We’re going to budget to buy back shares when everybody is really excited about our stock because that’s when we are excited about it, too!” Would you be impressed with the company’s strategic acumen? No. You’d just have the truth.
The practical insight
Because executives, managers, and employees would be crazy to admit their biases and lack of certainty publicly, a deft analyst or owner has to find other ways to unveil strategic intent. Here’s one to live by:
An organization’s budget is the honest expression of its strategy.
It’s Occam’s razor for discerning strategic intent. More than words. More than magnificent manifestations of PowerPoint prowess. More than organization charts and stated goals. The budget is the message. It’s the narrative applied. Follow the money.
Corporate finance practitioners are reading to this point, nodding vigorously, and probably wondering why such a concept merits a full article. Here’s why: The vast majority of stakeholders in and around an organization place a lot of weight on the words and fancy marketing messages that come with strategy. All the statements of intent to “be the best at” this and “compete the hardest on” that accompanying a typical organization’s vision get delivered liberally.
Those minor messages are extremely important to align and encourage the organization. They are the audio of the strategy. However, the video of a strategy is an organization’s resource allocation. And any stakeholder—employees, board members, executives, owners, and sometimes investors—needs to discern strategy from it as a sort of check on the words. Just like the old Russian proverb: Trust, but verify.
A side note on results
Note that I don’t confuse an organization’s budget or resource allocation with its “results.” A company’s prospective budget or resource allocation is the expression of strategy. Results, on the other hand, come from the confluence of position, potential, competitive actions, regulatory changes, customer idiosyncrasies, fluctuations in weather and commodity prices, luck, happenstance, and any number of noisy and ambiguous factors.
Results are measures of performance, but not of a healthy (or even discernible) strategy. They can be spun into a hindsight strategy, but aren’t necessarily the results of a prospective strategy. In other words, organizations with bad or nonexistent strategies can deliver good results, but not for long. The key is to find executives who recognize when they’re lucky.
Results are real and provide for the present. They are a must have. Strategy, however, aligns resources for the future. It’s a must have, too.
Unpacking the insight
On one level, a budget is simply numbers. It’s not strategy. Saying that you’re going to grow earnings or tamp down costs or grow the revenue line through a budget does exactly that. It shows those things mathematically. It doesn’t establish how you intend to use the resources.
More importantly, a budget shows what you expect to achieve, but it doesn’t show the opportunity cost of that achievement. Strategy is about choices. A budget isn’t a choice. It’s math. It’s the scoreboard, not the game, and certainly not the playbook. Math isn’t strategy. But on the other hand, the math is the simplest view of an organization’s aims. In this basic view, budget is, in fact, strategy.
Let me rephrase that: A budget, and the actions it enables, is the most honest expression of strategy. Show me a company’s three-year plan and budget, and I’ll be able to articulate the company’s strategy to an 80/20 approximation—though it may not match what’s printed on the marquee.
The really interesting part is when you put the strategy and the budget together. Your strategy says you want to grow. OK, what’s your investment in growth? The budget shows that. Your strategy says you expect to be a superior marketer. OK, what’s your allocation to marketing spend? The budget shows that.
A leader who truly expects growth but cuts productive growth spend is suffering from cognitive dissonance. He’s living two lives, but only one can survive. One side of the argument will win.
And these days, with incentive structures being what they are, what wins? It’s often the spreadsheet. It’s the budget—the accounting—that wins.
How to apply this knowledge
All of this is easy if you see the resource allocation and statements of strategic intent and can make the comparisons. If you’re on the outside looking in, it can be tougher. Here are a few practical points.
To test strategy and budget alignment, consider the following hot spots:
- Capital allocation: How is the company allocating its capital investment? Is the company in a mature market yet overspending on growth capital? Is the company pursuing a cost-driven strategy but starving assets of even minimal maintenance capital in order to drive earnings? These things can be discerned in most cases through even the highest-level financial reviews.
- Overhead allocation: Does the company allocate overhead to the right places within its strategy? Is overhead allocated to administrative and risk management activities more than growth and renewal of the franchise? Is that what is supposed to happen?
- Capability building/initiative spending: Can you find strong evidence of investment in capability building or renewal toward the stated strategic intent of an organization? If the organization is pursuing cost leadership, do you see evidence of investment in cost-leadership capabilities? Ditto for growth and innovation. Do you see it? Do they walk the talk?
Often, strategic discussions focus on the words of a strategy. Financial discussions frequently center on the math—forecast amounts of spend and investment vs. types.
In order to understand strategy applied, seek out the allocation of resources in the companies you own, serve, or work for.
Executives should use this sort of check on the strategies and budgets of their organizations. Avoid fooling others with and being fooled by clever narratives overlaying misaligned operations. Shoot for integrity.
Employees can use this as a test of whether the direction their organization is taking is actually the direction stated. That’s an important inkling when deciding where to ply one’s trade. They can vote with their feet. (Side note: Candidates can use this notion effectively as well. Does the company you’re interviewing with understand its resource allocations toward its aims vis-à-vis the competition? Does the audio match the video?)
Owners, board members, and investors simply need to ask the question and look for a satisfactory answer: What are the ways and means being applied to meet the ends being stated. They can also vote with their feet or, of course, with the stage hook.
The budget is an honest interpretation of strategy. It’s not the strategy, but it’s close. It’s Occam’s razor—the most direct path to strategic intent.
Follow the money.
What do you think?