We had an interesting discussion in one of my MBA classes last week. I asked the students to discuss the practice of padding estimates.
At first, most of the students said it was a wrong thing to do from an ethical perspective. One should tell the truth at all times and not play games trying to outwit the system.
On closer inspection, it became obvious that adding contingencies to estimates is not only ubiquitous, it is prudent business. Still, I believe there are some precautions to be followed, and this article is for the purpose of discussing these.
We are all familiar with the manager who is reaching the end of the fiscal year trying to encourage people to spend the budgeted money on anything, justified or not, just so the next year’s budget would have less chance of being cut.
It is a real trust buster for a frugal and careful boss to throw a lavish year-end party in an obvious attempt to somehow spend the full allotment. People see through the ploy, and it adds to the feeling that we are “playing games with upper management.”
Padding estimates for project work is so common that a project with no uplifts is suspect. The honest approach to reducing risk of overspending on projects is to allow a “contingency” line in the budget.
This practice recognizes that there will be several surprises during the course of a project, and although some surprises may be happy ones, my experience is that about 70% of them mean spending more than the original plan.
Some managers advocate no contingency line item, but I think that is a dangerous practice because it encourages covert padding.
As the conversation became deeper, one individual asked, what happens if you are the only person in the pack who is not padding and everybody else is including contingencies either overtly or not.
This is reminiscent of the “Prisoner’s Dilemma” experiment, where the optimal result occurs only when individuals elect to cooperate with each other and trust the other person will cooperate with them.
In this case, upper management needs to set the tone of no padding of budgets. Of course, since padding is by nature a secret event, it usually becomes a cat and mouse game.
Top managers unwittingly contribute to padding when they take a look at submitted budgets and demand a 30% cut before approval. Lower level managers quickly get the idea that in order to have adequate funding to do the job, they need to submit an initial budget that is inflated by at least 30%. That kind of escalation goes on in projects every day.
There are some mechanical systems invented to reduce the tendency of padding budgets. Zero-based Budgeting is one such technique.
This is where you start with a clean sheet each year regardless of the former pattern of spending. The technique sounds good on the surface, but it normally does not last longer than one cycle, just ask Jimmy Carter.
Reason: Even though a zero-based budget starts out with a clean sheet, managers have their historical files for comparison, so ultimately the good intention to start fresh breaks down.
The best antidote for padding is a culture of trust. If top leaders begin to stress that we are telling the truth here and not playing games with each other, then things may begin to change.
It may take several cycles, and top leaders need to be incredibly patient with people and consistent in their message, but it is possible to get to a real situation on budgeted funding.
Posted by trustambassador