How Compas supports driver-based budgeting

A driver-based budgeting/planning approach allows companies to respond rapidly to changes in their competitive environment, whilst improving overall forecast accuracy. Using Compas's sophisticated planning tools, it is possible to build a complete budget and set of operational forecasts from the underlying business drivers, so that when those drivers change, the associated elements of the forecasts update automatically. But what exactly is driver-based budgeting and why is it the approach recommended by so many consultancies and management gurus?

What is driver-based budgeting?

Driver-based budgeting is an approach that ties all aspects of the budget to the underlying business drivers. Rather than just putting a monthly revenue figure in the budget, for example, the revenue would be broken down into its constituent components (e.g. number of orders, average order value), and those components would themselves form part of the business plan. Assumptions driving those elements form part of the model and changing them requires justification - reducing gaming of the system.

Under such a model, revenues and costs would not be inputs, but would be outputs, calculated from the underlying drivers. The actual drivers chosen depend on the nature of the business, and the level of granularity that is appropriate for management. It is almost always possible to break down any one driver into smaller elements, but at some point, this results in such a proliferation of elements that it is impossible to manage them all, or they can lead to a loss of focus on what really matters.

For example, at its simplest level, a revenue forecast can be broken down into the number of orders/sales and average order value or basket size. Even this one simple step immediately lets the forecast support the business in a way that a basic revenue forecast does not. For example, if the revenue target has been missed, it is possible to see whether it is primarily down to fewer sales or people spending less per sale. This is important information for future forecasting, and for deciding how to respond, as well as having different cost implications.

Each of those numbers can be broken down further to provide more detail. Depending on the nature of the business, sales might be broken down into sales from existing customers and sales from new customers, or, they might be broken down into steady-state 'baseline' sales and promoted sales - with the latter tied to specific promotional activities which themselves form part of the business plan. In either case, different classes of sales can have different price and cost characteristics, allowing for more granular 'what-if' modelling of the effects of certain changes.

Selecting the appropriate drivers requires analysis and a good understanding of the business. Typically, the drivers used for planning will align fairly closely with the KPIs tracked by the organisation, as these should reflect what really matter to the business.

What are the advantages of driver-based budgeting?

Driver-based planning brings huge advantages of simplicity and clarity to the budgeting process. Whilst it might appear superficially simple to copy last year's figures and apply a multiplier for growth and inflation, in reality, as soon as the board starts to want changes, or to know the effect of, say, dropping a particular marketing activity, any simplicity is lost. Because the drivers for the costs and revenues are unknown, it is far from trivial to calculate the impact of changing them.

By contrast, if the budget has been built from drivers that have been well chosen, making changes becomes a relatively straightforward affair, as the drivers should already reflect the sorts of changes that the board is likely to want to make. Increasing the amount of promotional activity, changing the marketing mix, increasing prices across the board, if these are what matters to the business, they should feature in the drivers that underpin the budget. Yes, it will still be necessary to make judgement calls - about the impact of certain changes such as a price rise, for example - but at least the necessary levers should be there in the budgeting process.

Moreover, in many cases, key business drivers do not just drive one side of the revenue/cost equation. Most revenue drivers have cost implications, and it can be highly significant whether a change in revenue is driven by a change in the number of orders or the average order value (or something else, such as increased returns), as the impact on fulfilment costs is very different. Furthermore, if the budget contains a forecast for the number of orders, not only will this drive revenues and costs, it will also help to ensure that the necessary operational resources are available at the right time to service the demand. If the plan then changes, whether at budget time or later, the operational resource requirements will be updated automatically. This tying of operational resource requirements with financial planning and analysis is typically described as Enterprise Performance Management (EPM), a branch of business software which describes Compas very well. We will cover how Compas fits into the landscape of EPM software in more detail in a later post.

This excellent article by Professor Mike Bourne of Cranfield University identifies a number of benefits of driver-based budgeting, including, for one company, a massive 12-week saving in the time taken for each budget round. In general, he identifies many benefits of driver-based budgeting, including:

  • It considerably speeds up the budgeting process
  • The process of budgeting adds value and clarity to the business by illuminating areas of greatest impact and allowing what-if/scenario analysis
  • It reduces 'gaming' of targets by tying them to observable deliverables and resources
  • It makes reforecasting much simpler and quicker and allows organisations to respond quickly to changes in their environment

How does Compas support driver-based budgeting?

Having the right technology is a pre-requisite for driver-based budgeting. Creating a proof of concept in Excel is fine, but the technique inherently requires more dimensions and more detail than are supported by spreadsheets. Building an integrated plan is core to the Compas philosophy. A number of features particularly support this type of approach:

  1. Compas is built on an industrial-strength multi-dimensional database, which means that it can hold all the detail needed for a driver-based approach, but also deliver the top-level analysis required by senior management.
  2. Tailoring is an important element of the Compas platform. Different businesses operate very differently, and modelling the impact of different business drivers is not something that can easily be done off the shelf. The platform has been designed to allow bespoke models to be incorporated very easily.
  3. Compas has always applied a rigorous financial perspective to everything. It can build mini Profit and Loss accounts for individual activities (to allow their evaluation) and then consolidate these to calculate an overall P&L for the business.
  4. Compas maintains its own data warehouse, which means that it can draw on data coming from many different parts of the organisation (and outside sources).

A paper by the Association for Finance Professionals in the US identified a number of obstacles to adoption of driver-based planning, which can be grouped into the following headings:

  • Tools/data - inadequate, incomplete or dirty data and a lack of the correct technology
  • Model design - incorrectly specifying the drivers, or trying to do too much. Over-complicating things in a way that is not sustainable
  • Organisational - getting the necessary buy-in from senior management and people on the ground. Getting over the inevitable inertia and discomfort with a new approach
  • Cost/resources - a concern that moving to driver-based budgeting will be very expensive, or will take a lot of time and effort

Whilst Compas cannot in itself overcome a deep-grained aversion to change, it can at least address the other problems, in the hope that by demonstrating its value to the business, it can then start to win over the sceptics. Our approach combines many decades of experience in the management consultancy industry with a highly capable, yet inexpensive platform. During the scoping and implementation phase, our consultants work with the client to identify data requirements and sources, and help them to build the necessary feeds, reducing the impact on the IT department. We can also provide hands-on assistance with specifying and designing the appropriate models and provide other assistance to smooth the process of adoption. By tailoring the screens and incorporating the client's metrics and terminology, we ensure that the end product is easy to operate and feels familiar to the end users.

The result has the feel and tailored functionality of a bespoke system, but the cost is that of an off-the-shelf product. Clients typically start to see a return on their investment in the first year.

Driver-based budgeting is a sophisticated approach, which saves time and resources, both at budget time and at subsequent reforecasting rounds. It improves a company's speed of response and efficiency of operations, allowing costs (inventory, personnel etc.) to be matched more accurately with requirements. However, it requires good data and the right technology.

Compas is a low-cost, high-performance platform that is designed from the bottom up to support driver-based budgeting. Contact us now to arrange a demonstration.