Despite their serious flaws, traditional planning methods (such as annual budgeting or annual strategic planning) have one major advantage over any other approach, no matter how much more effective: ‘this is how we’ve always done it.’
While that may be the worst reason to do anything, it does offer one very real practical advantage: no change required.
This means no time or effort is needed, and there’s no risk of failure. These are significant benefits, especially in the context of changing a company’s planning practices, as making meaningful changes is always a major transformation.
Achieving significant benefits from changes in planning requires significant changes in decision-making, which, in turn, demand significant changes in behaviors.
Such behavioral shifts are often impossible without corresponding changes in incentives and organizational structure. And attempting such changes inevitably triggers political and social power struggles at the highest levels of the organization.
This is because the scope of these changes will inevitably be wide, both horizontally and vertically, for two reasons.
First, annual budgeting and its associated bonus and performance targets typically largely determine incentives and behaviors throughout the company. Changing these processes will have profound impacts across functions, business units, and all reporting lines.
Second, from a first-principles point of view, all major decisions have cross-functional and cross-business unit interdependencies, tied together through financials if nothing else. These decisions cut across all reporting layers, as the biggest decisions are made at the very top, inevitably impacting decisions made elsewhere.
The only way to avoid these challenges is to implement something that doesn’t have a major impact on decisions. That, however, also won’t have a major impact on performance, which is essentially the same as sticking to the status quo.
Therefore, any serious attempt to change a company’s planning processes is always a major transformation. According to McKinsey, the probability of failure for such endeavors is about 70% (although the validity of this common estimation has been questioned by several authors). Put differently, if you attempt three major transformations, the odds are that two of them will fail.
Now, regardless of the potential benefits, that failure rate alone is too high a risk for many—and rightfully so. Such transformations take years to complete and realize benefits, so it’s not something you can attempt every year.
At best, a CEO may get only a few chances over their entire career, and after a first failure, there might not even be a second or third time.
Moreover, the benefits grow incrementally and skew toward the long term. They don’t double profits overnight but instead deliver for example 7% annual growth compared to 5%, with major advantages arising from compounding over time.
In a $1 billion company, that’s $70 million in growth instead of $50 million in year one. A solid increase, but is it worth 1-to-3 odds when failure could cost you your job?
And the expected value is even lower. Considering the high likelihood of failure, in our example, the expected additional growth would be closer to 0.7% than 2%.
Is it worth the risk?
It depends—both on the CEO’s risk tolerance and on alternative uses of the time and effort required, as well as the time horizon in question. Since the transformation will consume a significant portion of key stakeholders’ time and entail considerable costs, it’s essential to consider how those resources might be used elsewhere.
For many companies, other less risky options may exist—especially in the short term, before the cumulative effects of compound interest take hold—that could exceed the expected benefits of a planning transformation.
For instance, two projects with an expected sales increase of $5 million each and an 70% to 80% probability of success might prove to be a better bet.
The specific numbers are not the point. They obviously differ case by case. For some companies, the benefits are much higher; for others, they’re lower. The probability of success varies, as does the abundance of alternative opportunities.
The point is that all serious attempts to change a company’s planning practices are inherently ‘high-risk, high-reward bets.’ This may not suit every organization, and the attractiveness of the business case varies, regardless of how much ‘better’ the alternatives appear on average.
In addition, the appeal of the business case depends on the time horizon. An additional $20 million per year for a billion-dollar company is a nice boost, but it’s neither existential nor career-defining. It might even go unnoticed, drowned out by standard variation.
The differences become undeniable and hard to ignore only in the long term. In five years (the average tenure of an S&P 500 CEO), our example shows a 10% or $130 million difference in revenue. In 10 years, this grows to 21% or $340 million, and in 20 years, it reaches 46% or $1.2 billion (see Figure 1).
Figure 1.
While these differences can become transformational and even existential over the long term, the practical challenge for most major companies is that no one is accountable for performance five years into the future, let alone 10 or 20 years.
Even if someone did passionately care about the long term, most executives’ largest incentives remain tied to short-term goals. Furthermore, implementing ‘better’ alternatives often makes hitting short-term objectives more difficult—not because it hinders short-term performance, but because the alternatives prevent ‘cheating’ to hit short-term objectives at the expense of long-term.
While it’s a myth that the stock market cares (in the long term) about companies hitting their guidance (it cares far more about real performance), a company operating this way attracts short-term investors, likely causing the stock to take a temporary hit when it adopts a more long-term view.
Even if the CEO and executive team would be willing to absorb that impact, convincing the board may be far from trivial. And without the board’s commitment, the chances of the CEO and executives searching for new jobs increase significantly.
A common ‘practical solution’ is to attempt changes to planning processes without altering the fundamental focus on hitting arbitrary short-term targets—quarters and years—under all circumstances, which is essentially the same as not changing much at all.
Put differently, this is when planning ‘transformations’ become more about perfecting the rain dance than influencing the weather that follows.
Better alternatives also reduce the suboptimization of arbitrary silos (like functions or business units) at the expense of the whole.
That means, objectively, not all stakeholders, executives, and employees benefit from implementing such practices. This, at the very latest, ensures that making such a change becomes a major transformation with a high chance of failure, as political and social games will inevitably shift into high gear.
So, although it is not hard—and in many cases even trivial—to identify major issues with traditional planning practices, and despite ample evidence of more effective approaches, it may not be wise for all executives even to attempt to implement them.
It’s the same as how, although there is ample evidence that a free-market system is more effective than a communist system, it may not be in the interest of someone who has done well under a communist system to try implementing free-market practices.
Yes, if such change would succeed, the entire country and most stakeholders would almost certainly do better. However, the chances of success are small, benefits are long-term, and the likelihood that the person driving the change will do worse is considerable.
Furthermore, even if the endeavor succeeds, not all stakeholders—including the CEO (or the person running the country)—will necessarily do better.
The advantage of ‘better’ alternatives to planning is their focus on real performance and improving the performance of the whole in the long term. The disadvantage of ‘better’ alternatives to planning is their focus on real performance and improving the performance of the whole in the long term.
In other words, the tradeoff is fewer opportunities and incentives for individuals to cheat or suboptimize at the expense of the whole in the long-term. While genuine high performers would thrive also under such conditions, not all who seem to be high performers under traditional planning practices would.
And even those who would perform well can’t know for sure, which is why there’s likely more objection than enthusiasm for implementing such practices.
The simple reason is that, for most companies, no one is accountable for maximizing the performance of the whole organization over the long term. In practice, over 99% of business roles, including C-level executives, are accountable for the performance of a silo of some sort in the short term.
Even CEOs, who may have accountability for the whole, are biased to care more about the quarter and the year than about what happens longer-term.
Moreover, it’s probably fair to say that, when it comes to planning practices, more than 80% of people have most, if not all, of their experience in ‘communistic systems’—with annual and five-year plans—that have dominated the business world over the last 100 years, rather than in emerging ‘free market alternatives.’
Therefore, sticking to severely flawed, short-sighted, and siloed traditional planning practices that hinder the company’s long-term performance may, for many, remain the best—or at least the most practical—option, given the high risks of alternatives and the lack of personal incentives to pursue them.
Practical insights
- Traditional planning has one major advantage: it requires no change.
- Meaningful changes to planning practices represent a major transformation.
- The benefits of planning transformations are for the whole over the long term.
- What’s better for the company often conflicts with what is better for individuals.
- From a career view, executives may be better off sticking to the status quo.
