In the last post Jim Kennedy, Asset Management Council, looked at what it took to construct a ‘defensible budget’.  He argued that stakeholders (customers, community, government, employees) are everything but he wondered whether organisations really understood what they were promising. In other words were they really clear about the consequences of their decisions and promises made?

Capability to deliver

For example, had they turned these promises into the capability to deliver (technology, plans, people, facilities, information systems, logistics, support systems).

This has two aspects: there is an ‘enabling or inherent capability’ and an ‘organisational design, or organisational capability’. In other words, the equipment may be able to deliver, but has the organisation the right people in place?

Studies have shown that where someone was sent in to fix a problem who did not know what needed to be done, was not familiar with the asset or problem, or was not fully competent to do it, the level of competence was only 50% . This led to the job needing to be done 5 (!) times more often than if a competent knowledgeable person had done the job initially with 100% competence.

But what is the organisational implication of this?   To ensure that you have the right level of competence ready when needed, you have to have highly competent (and thus well rewarded) people under-occupied so as to be available when needed. As we cut back on training because it is expensive, and aim to have everyone fully engaged all the time in order to ‘achieve efficiencies’ – what is the real cost?   If  we cannot demonstrate the benefits of organisational capability in a ‘defensible budget’,  costs will increase and quality decline.

Comment?

We often take pride in our ability to ‘make do’ when the situation is not as we would have liked. This particularly applies to those occasions when we do not get the budget we requested. We grizzle – but we ‘make do’. But what message does this send? Jim Kennedy, speaking at an Asset Management Council Chapter Meeting in Adelaide warned of the dangers of this ‘make do – can do’ culture. When we ‘make do’ (usually by cutting corners, or deferring activity that results in larger costs later) we are telling the finance section that our budget request was overblown. When Finance subsequently provides less than requested (working on the basis that the initial request was ‘gold plated’) and the recipients subsequently ‘make do’, that does more than confirm the initial Finance suspicion, it creates a lack of trust on both sides. Budget proposals are now ‘boosted’ to allow for the inevitable cuts. Finance reduces the budget request and as it goes on, budgets lose their informational, decision-making, value.

Jim proposes that the value proposition for Asset Managers should be “How to protect your leader against political opposition” and his answer to this question is a ‘defensible budget’.

So what is a ‘defensible budget’?   Jim describes it as follows:

• Fact and Risk Based
• Fully traceable to the asset’s output requirements.

He reckons these two are really sufficient but could be bolstered by showing that the budget is

• demonstrably good practice and in accord with national standards; *compliant with statutory and regulatory imperatives;
• implemented by competent (certified) staff;
• supported by verified technology (information decision systems);
• transparently and verifiably costed (which builds up trust between the technicians and finance; and
• deliverable in the agreed time frame (don’t promise what you cannot deliver).

Good stuff! – but, and here’s the rub – developing good practice, ensuring competent (certified) staff, establishing sound information decision systems, demonstrating transparency and ensuring deliverability does not happen overnight. It takes years of consistent management attention and good leadership.

Question this week: Do you know where your organisation stands on each of these facilitators of sound and defensible budgets?  Is there a program to improve it?  Comment?

A hole in your budget needn’t be the end of the road!

In the previous post we looked at a city council’s response to a sudden $60m hole in its budget – and the consequent media storm.  Could this have been treated differently?

Put yourself in the City Council’s situation.   Faced with a sudden $60m hole in your budget through external circumstances, what are your options?

• You can cut back on services (but these are services that the community want and that you have already prioritised into your budget)
• You can borrow (and borrowing might be a short term option to maintain service continuation but only if there were expectations that the external cut would be reversed in the near future or that other revenue increases could be anticipated)
• OR, and this is the option that the City adopted, you could withdraw the funds from your fully owned subsidiary – in this case BC Hydro – in exchange for a city asset portfolio (city street lighting).

BC Hydro now needs to make a return on the assets it has bought and so it engages in a forward contract to maintain, operate and supply street lighting services to the council.

Bear in mind, that any profit made by BC Hydro reverts to its shareholder – the City Council.  If the costs of the contract are greater than the costs that would have been incurred by the City if it had retained ownership of the assets, then this will be reflected in a larger profit made by BC Hydro.  Conversely if the contract costs are less than the City would have otherwise paid, it saves on ratepayer funds but (unless BC Hydro can run the streetlighting more cost effectively) it will receive a lower return on its BC Hydro shareholder funds.

OK, so these are the financial facts.  The transaction enables the City to continue providing all the services that its ratepayers want and expect in the face of a sudden hole in its budget caused by the withdrawal of provincial funding. Out of one pocket into another but the same city coat!  This being the case, why did the question of how much that was paid for the contract become the major story?

I would suggest that there are a number of lessons to be learnt here:

1. The City could have sold this as a smart solution to the problem of continuing needed community service in the face of sudden withdrawal of funding by the Provincial Government. It could have promoted the idea of BC Hydro being in a better position to cost effectively manage street lighting given its expertise in lighting and power generally.  It could have used this problem to market the value of its ownership of BC Hydro.  In other words, on a PR basis, it could have got out in front of the story. But it didn’t. Instead it hid the contract details for 5 years before eventually acceding to Freedom of Information requests.  Whatever the facts of the case, this action itself makes the council guilty in the eyes of the public.
2. The public generally have very little understanding of the ratio of ongoing operations and maintenance costs to the initial capital costs.  If we don’t tell them – in ways that they can understand – their natural reaction is to see the annual payments in the light of (exhorbitant) interest payments.
3. The time to generate this greater understanding is BEFORE you need to use it to substantiate council decisions
4. In all likelihood, the councillors (and perhaps senior staff members) did not understand the full import of operations and maintenance costs either.   Their reaction in hiding the costs from public view suggests that they did not believe they were defencible.

Lesson 1 may not apply to you now, but Lessons 2-4 will always apply.

Comment:  What are you doing to ensure this level of understanding of O&M is generated in your council and staff (or in your senior management and board)

Should I jump?

In 1993 a very successful American bond trader gathered together a few of his disciples and a handful of super-economists and set up a new hedge fund company that promised to be different from anything that had gone before. The new company apparently genuinely believed that their ingenious computer models would allow them to bet on the future with near mathematical certainty. Because their team had some high powered players – including two who were to be future Nobel Prize winners – investors believed them. The company portfolio grew quickly to $100 billion when a default in Russia set in train a sequence of events that the models had not anticipated. This placed the whole financial system at risk and the Federal Reserve quickly called in Wall Street’s leading bankers to underwrite a bailout. Roger Lowenstein in “When Genius Failed” (Fourth Estate. 2002) tells the whole fascinating story.

How could anybody – let alone the super intellects in that hedge fund company – possibly believe that a computer model, no matter how finely tuned, could predict ‘with near mathematical certainty’ future stock markets (which, after all, reflect the volatility that Keynes referred to as ‘animal spirits’).   How could investors clever enough to have amassed the funds to invest, believe them!

Pondering these questions, I thought of the managers I have met who so passionately believe in their models that they brook no doubt, no exploration of better ways, no questioning – and I thought of the problems that this causes. Possibly it starts because to get financial backing in the first place, either from your organisation or from the market, you need to assume and project confidence.

However, confidence is one thing, blind confidence completely another.

So my question for you today is:  How do we transit from the confidence we need  to be persuasive before the project is adopted, to the level of confidence we need,  after the project is adopted,  that allows some room for doubt enabling resilience when the world changes (as it certainly will)?

Our post today responds to a comment by Ben Lawson  that the “Fit for the Future” program is leading councils to equate depreciation and renewal spending regardless of the age or need of their assets.

This issue came to the attention of one of our State Auditors-General who dismissed it, saying ‘I agree that a ratio of renewal: depreciation is too simplistic and that there are real risks to be managed, but ‘it is only an indicator’ ‘  He also suggested that since ‘bureaucrats avoid things that are too complex’, it was necessary for indicators to be as simple as possible.

It is not difficult to see how dangerous this approach is when you consider that an aircraft instrument panel is simply a set of indicators. But without many hours of flying instruction (and thus an understanding of what lies behind each of the indicators) would you expect to be able to correctly interpret the information provided by these indicators – and keep the plane from crashing?

Perhaps we can make it easier for you as the pilot if  we simplify the indicators!   What if were to just keep the altimeter, for example, or the speedometer?  Perhaps just the fuel gauge? Maybe we could do without the compass, or the airspeed indicator, or the directional gyro?   And is the turn indicator really necessary?  What about the vertical speed indicator?

Well, you don’t have to be a trained pilot to figure out that actually you DO need all the instruments on the panel – ALL the indicators, and enough understanding to be able to correctly interpret them in any particular circumstance.    Moreover, this is just for a simple two seater Cessna, not even a Boeing 707, and just for just one aircraft – not a fleet of aircraft.

Now consider that even a fleet of aircraft would present far less decision points than the far greater variety of assets and asset questions facing the average council. Can the task of managing an ever changing and wide range of public sector assets with all their attendant services and disparate user groups, possibly be managed by a few simple indicators?

Worse, can they be managed by a few rules that are applied blindly without understanding?