George would like to thank Philip Peck from Palladium Group, Inc. for his helpful input to this column.

After covering strategy management and key process management in previous months, today's column begins a two-part series on the third leg of the strategy execution model, resource management. The primary purpose of resource management, or the operational and financial planning processes, is to ensure that financial and other resources are available, integrated and sufficient to deliver against the company's core operational activities and strategic initiatives. This month, I will provide a perspective on the characteristics of effective resource allocation and introduce the concept of causal models for driver-based planning.

What constitutes good resource allocation, and how do these characteristics support successful strategy execution? As illustrated in my August column, portfolios of strategic initiatives defined by the strategy management process should be explicitly funded ("stratex"). This ensures that appropriate financial resources are dedicated to the key strategic themes and objectives of the company. Equally important, however, are the operational and financial planning processes that both govern the allocation of resources to operations and that provide the link to guarantee that operations are aligned to strategy.

Effective resource allocation is based on a forward-looking, continuously updated projection of expected future performance. A deep understanding and command of the underlying business model and knowledge of the critical business drivers provide the basis for this allocation. Via the planning process, companies make in-the-moment resource allocation decisions, and the most successful organizations are nimble, responsive and quick to move resources toward underfunded tactical needs and new strategic imperatives.

In most organizations, the traditional annual budget is the mechanism that governs the allocation of resources to support both strategy and operations. The budget, however, is not usually well suited for the type of resource allocation that supports successful strategy execution. The typical budget process is a painful, distracting, months-long exercise that consumes a tremendous amount of resources and quickly becomes outdated and irrelevant for decision-making. Because most organizations do not explicitly link their operational plans to strategy, the financial plan, operations and strategy often remain disconnected. Once the budget is approved, managers spend the next year attempting to analyze and explain results compared to a set of flawed and misunderstood targets contained within the budget.

Driver-Based Planning

As opposed to the traditional budget, driver-based planning, built upon causal models, provides a mechanism to overcome many of these limitations. Driver-based planning uses operational driver models to predict future financial results. These models are essentially equations that represent the mathematical relationships between key operational drivers or business activities and financial outcomes. These models are created by determining the cause-and-effect relationships between drivers, business activities, resource requirements and financial outcomes. While such relationships have always been the basis for budgeting, they are typically not represented in a formal, systematic and transparent way.

Figure 1: Driver-Based Causal Model for a Corporate Call Center


Figure 1 illustrates the elements of a driver-based causal model for a corporate call center. The marketing group of this company produces a series of advertisements (a driver) that results in a volume of inbound inquiry calls (an activity).1 To answer these calls, phone agents must be staffed accordingly (resource requirements), which generates call center labor expenses (financial outcomes). This is the backdrop for modeling and projecting the financial plan for the call center's labor expenses. In contrast to the causal model, the traditional budget provides only a financial expense estimate while the detailed assumptions behind the projected labor expense remain invisible.

Figure 2: Traditional Budget versus Driver Model


Figure 2 compares the output of a traditional budget with the explicit assumptions and causal relationships of a driver model. In the former, labor expenses for call center operations appear as one number.2 None of the assumptions underlying the final expense figure are visible or tracked systemically. Consequently, they are not available for review, discussion or subsequent analysis. In contrast, the driver model on the right consists of a series of equations that derive the final labor expense figure and expose the business assumptions behind the numbers.

Using driver-based models as the starting point for operational planning and financial forecasting provides numerous benefits. By focusing on the underlying drivers of performance, the business model is deconstructed and made transparent. In fact, the act of developing a driver-based model actually helps to establish a common language for talking about and analyzing the business. Leaders are forced to achieve consensus on which drivers are important, how financial-statement line items are derived from these drivers and the scope of their individual accountabilities. With the underlying assumptions visible, managers can't hide behind the numbers.

In my next column, I will refer back to the call center driver-model example and introduce the leading practices of rolling forecasts and cause-and-effect performance analysis. 

References:

  1. David Norton and Philip Peck. "Linking Operations to Strategy and Budgeting." Balanced Scorecard Report. Balanced Scorecard Collaborative and Harvard Business School Publishing, September/October 2006.
  2. Norton and Peck.

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