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As fall rolls around, finance departments everywhere gear up for their budgeting busy seasons. If part of your job includes managing a budget, now is a great time to refresh your memory about a couple of budgeting and operations difficulties.

 

SUB-OPTIMIZATION OF RESOURCES

 

Company leaders insist on the budget exercise not because they love working with numbers but because they know resources are scarce. There will only be X million dollars available for capital expenditures like furniture, equipment and computers; leaders have to decide who should get the money. There is also only so much available for headcount; they have to choose which department is allowed new hires and which one has to wait. Sub-optimization of resources like capital or headcount occurs when the budget masters put the money in a less productive/lucrative place and leave a more productive/lucrative place wanting. One reason this happens is managers who pad their budgets and request more than they actually need. A second reason is that some managers are more able to work the political system to ensure that their budgets are not cut. If you have suffered as a result of sub-optimization decisions in the past, this is the perfect time to promote how lucrative and productive your department is. Make your case publicly with data and examples. Even if you don’t enjoy schmoozing, you may need to do some of that to point out the value your department brings. In the long run, when resources are misapplied, no one wins.

 

CROSS-SUBSIDIZATION

 

A common result of the budgeting process is cross-subsidization. Cross-subsidization is allowing (or insisting) that a more profitable product or business unit bear more than its fair share of allocated costs. (The less profitable product or business unit is being subsidized by the more profitable one.) Sometimes cross-subsidization is part of a market penetration strategy; sometimes it is just a glitch.

 

INTENTIONAL CROSS-SUBSIDIZATION

Creating cross-subsidization can be an effective marketing strategy in some cases. For example, the retail price of a cell phone is far higher than the amount a customer actually pays . . . but only if he or she signs a monthly service agreement. The more lucrative product line (monthly service) is subsidizing the less lucrative product line (resale of phone equipment). This strategy allows providers to sell phones at less than cost and could be a winning strategy if enough people sign up and the phone provider is able to dominate the market.

UNINTENTIONAL CROSS-SUBSIDIZATION

 

If an organization does not realize that it is subsidizing a less profitable business at the expense of the more profitable one, strategy decisions are based on dangerously faulty assumptions. As a worst case example, a business could choose to expand the less lucrative product by shutting down the more lucrative one or give headcount to the less productive department rather than the more productive one. Even if you are not in charge of an entire division, understanding the concept of cross-subsidization will make you more budget-savvy. Insist that people explain to your satisfaction any allocations that are added to or subtracted from your results. Learn how these costs are driven and determine what you might do to reduce company overheads. (Keep in mind that you need to influence the reduction of costs overall, not just the movement of an allocation off of your reports and onto that of another department.)

 

PAY ATTENTION

 

Turning a blind eye to sub-optimization and/or cross-subsidization is risky. Especially at budgeting time, the successful manager is the one who recognizes the dynamics of budget decisions being made behind closed doors.