Business Policy, MBA 698

Wednesday, 16 May 2007

Professor Benain

Beyond Budgeting at UBS, a Strategic Choice

By Dekin O’Sullivan

Table of contents

Table of contents ....................................................................................................................... Executive summary ................................................................................................................... Introduction ............................................................................................................................... I. Positioning......................................................................................................................... a) The UBS-SBC merger...................................................................................................

II.

b)

The industry...................................................................................................................

c)

The “Beyond Budgeting” book .....................................................................................

Options ........................................................................................................................... a) How to theoretically drop budgets ............................................................................. b)

How dropping budgets works in practice for a bank: the Svenska Handelsbanken

case.. ................................................................................................................................... c)

Strategic objectives ....................................................................................................

III. a)

Implementation........................................................................................................... Managing change .......................................................................................................

b)

Organization and resources ........................................................................................

c)

Performance ...............................................................................................................

d)

A perfect system? .......................................................................................................

IV. a.

Evaluating the strategy and its execution ................................................................... The bank as a whole ...................................................................................................

b.

The International wealth management and Swiss retail and corporate businesses

division ............................................................................................................................... c.

Non-financial indicators .............................................................................................

Conclusion.............................................................................................................................. References .............................................................................................................................. Exhibits...................................................................................................................................

Executive summary




In 2004 – as part of a program to foster a more entrepreneurial culture – UBS decided to do away with the annual budgeting process in its International Wealth Management and Swiss Retail and Corporate Businesses division. In this paper our aim shall be twofold: first to assess the execution of the strategy, second to come up with a recommendation on the basis of what conclusions can be drawn from the assessment.




There are mainly three reasons why the division chose to do away with budgets: first, the increase in market volatility due to the recent surge of derivatives; second, the shortening life cycle of financial products (new products are coming out every day, increasing trend towards customization); third, the publishing of a book in 2003, “Beyond Budgeting”, which gave UBS’s executives the idea of abandoning budgeting as a ways of gaining a competitive edge in these new conditions.




The strategic issues are clear: need for a more flexible, agile and adaptive organization which can take on more risk and adapt quickly to the market whilst being able to take on difficult economic times without collapsing. This leads to the formulation of strategic objectives by UBS which it is pursuing with this strategy: growth, cost reduction and the implementation of a new entrepreneurial spirit within the organization.




The assessment of the execution of the strategy is clear: it is a success both on the financial measures side (growth and cost reduction) and the non-financial ones (culture change). In view of this success, we think that the organization as a hole can benefit from this strategy. We therefore strongly recommend that UBS extend the “Beyond Budgeting” strategy beyond the single Wealth Management and Swiss Retail and Corporate Businesses to its other divisions (Asset Management, Investment Banking, etc.).

Introduction

UBS AG is a diversified global financial services company, headquartered in Basel and Zürich, Switzerland. It is the world's largest manager of Private Wealth assets, and is also the second largest bank in Europe, by both market capitalisation and profitability. UBS has a major presence in the U.S., with its American

headquarters

located

in

Manhattan

(Investment

Banking);

Weehawken, New Jersey (Private Wealth); and Stamford, Connecticut (Capital Markets). UBS's retail offices are located throughout the United States, and in over fifty other countries. UBS's global business groups are Private Banking, Investment Banking, and Asset Management. Additionally, UBS is one of the leading providers of retail banking and commercial banking services in Switzerland. It currently employees some 78,140 people.

In 2004 – as part of a program to foster a more entrepreneurial culture – UBS decided to do away with the annual budgeting process in its international wealth management and Swiss retail and corporate businesses division. In this paper our aim shall be twofold: first to assess the execution of the strategy, second to come up with a recommendation on the basis of what conclusions can be drawn from the assessment.

In order to assess the strategy, we first need to understand what objectives UBS was aiming for when it decided to implement its strategy. To do this we therefore start with a positioning analysis where we will try to show that the causes which motivated the decision to “drop budgets” were mainly the enhanced risks of today’s financial markets and the shortening life cycles of financial products. It is important to note that the point we are here trying to make is not that there was a problem with UBS’s budgeting system as such (it

was just as good as any other’s) but that it is certain key issues relating to changes in the financial industry which led UBS to consider dropping budgets as a means to overcome these issues. Once the strategic issues discovered, we then, in a second part, try to show how the option to drop budgets can be considered as, in the present state of things, the only option allowing UBS to achieve a competitive advantage. This second part will end with the statement of the strategic objectives UBS was pursuing, which is to say cost reduction, growth and an enterprise culture change to foster a more entrepreneurial spirit within the organization. We then, in a third part, go on to analyze the actual way UBS implemented and executed the chosen strategy. We finally, in a fourth part, attempt to assess the strategy execution by analyzing its impact on financial and non-financial measures.

In the conclusion, we shall finish with the second aim of this paper, to come up with a recommendation for the future. The reader should always keep in mind that it is not all of UBS’s departments which dropped budgeting budgeting but only one of them, the International Wealth Management and Swiss Retail and Corporate Businesses Division. This is the bank’s largest division (it accounts for roughly half of its profits) and most successful (world leader in wealth management). One could wonder why then is it that we don’t only focus our analysis on this branch but, for example, analyze trends which affect the banking sector as a whole. It is that, the aim of our recommendation will be to either suggest that UBS stop the strategy, continue as is, or extend it to other sectors of its operations or even to the bank as a whole. What is at stake here is therefore not only one branch of UBS but the company’s future as a whole.

I.

Positioning

a) The UBS-SBC merger

Positioning is an analysis which usually contains an external and internal analysis. Such tools as PESTEL, Porter analysis and SWOT are used. However, we feel that these tools are best suited for acquiring general knowledge about an industry, an economy, and how a given company fits into its environment. This type of knowledge is useful when one either doesn’t have a strategy yet and needs the necessary information to come up with one or when one wants to see whether a given strategy idea could be viable given the conditions. Our case is quite different however. Indeed, we are dealing with a strategy which has already been put into place. Our aim is to understand not the general but the specific issues and reasons which led to its implementation so as to be able to assess the implementation and results to, finally, deliver a recommendation whether or not to continue with the strategy, expand it or drop it. We can therefore directly go to the reasons which motivated the strategic move. In this regard, we must first wonder why is it that UBS decided to implement its new strategy in 2004 and not before (or later for that matter) when other banks have abandoned budgeting as early as the 1970s?

A first answer lies in UBS’s recent history. One reason could indeed be that, in 1998, UBS merged with SBC. One of the key success factors was then cost discipline, as UBS itself admits to on its web site: “During that time, traditional

targets helped management and staff to achieve the efficiency objectives defined for the post-merger integration.”1 However, this explanation fails to explain why UBS had to switch its whole budgeting system, the necessity of the change once the turmoil caused by the merger had passed.

According to the UBS web site, traditional targets “rarely provided guidance on how to capture revenue opportunities – a feature that became important in the following cycle of Global Wealth Management & Business Banking’s development – the phase of growth and market expansion.” Therefore, according to this view, there was first a phase of consolidation were traditional budgets were required, and then a phase of expansion were a new approach was necessary. The problem is that the new budgeting system is known to reduce costs compared to the old system, so why not adopt it straight away? The reason could be that in the post merger turmoil, the new budgeting system was too demanding and the organization not ready to implement it. But why then not have implemented it before the merger? And what was the urgency driving such a big decision? To answer this question we are now going to look at the changes that have affected the financial industry in recent years.

b) The industry

In the last decade, the trend in the financial sector has been the explosion of the derivatives market. Increasingly, multinationals to hedge their risks and 1

http://www.ubs.com/1/e/handbook/0019.html

hedge funds and banks for speculative purposes, have been investing and trading in ever more complex and volatile derivative products. The complexity, volatility and novelty of these products have made it increasingly hard for the financial sector to predict stable earnings or patterns. Big multinationals have lost a lot of money on the derivatives market and some banks have even gone bust as in the case of the Barings bank in 1995. A good example of these derivative products are credit derivatives which are financial instruments that “derive” their value from the bond market. Credit-default swaps (a type of credit derivative) reached $20 trillion by June last year. With volumes almost doubling every year since 2000, some reckon the credit derivative market will be worth more than $30 trillion2. Their risk comes from the fact that they can cover any bonds that are not issued by governments – that is, where investors face the risk that the borrower may not repay. As Warren Buffet puts it, they are “financial weapons of mass destruction”3.

Parallel to this development, banks have been getting ever more creative with the investment products they offer their clients. There use to be a very small variety to choose from (stocks, bonds, funds). Now, several new products are coming out every day, some could be custom made to suit the needs of just one client. An example of these new “financial vehicles” are for example exchange traded funds (ETFs). Created in 1990, ETFs are part fund, part stock. Like an index mutual fund, they track baskets of assets, such as stockmarket indexes or commodities. But unlike standard funds they can be bought and sold throughout the trading day, so investors can make, or

2 3

st

Cf. “Credit Derivatives, At the Risky End of Finance”, in The Economist, April 21 2007 Ibid.

reverse, broad bets quickly, without having to buy dozens of stock separately. Assets held by American-listed ETFs rose about 40% last year4. Private equity and hedge funds are some more examples of these financial instruments which have recently taken on immense importance in the markets. Not all of these instruments are new but what is is that, thanks to the computerization and deregulation of the world’s financial markets, they are much easier to manipulate and can be offered to a much wider range of investors. For instance, the swap market grew by 1,800 percent between 1991 and 20015. These new products are not just new versions or mixes of old services but are entirely new classes of products which offer infinite possibilities of variation (de-correlation from market cycles (ex. : weather derivatives), absolute returns which is to say increasing returns regardless of whether the market is going up or down (hedge funds), etc.).

These two developments have therefore forced the industry to move towards ever greater flexibility as strategic cycles have become ever faster and shorter and uncertainty has increased. However, this is a situation which is faced by all banks, but all banks (actually none except for UBS and another we shall discuss) have dropped budgeting. It is therefore still not sufficient to help us understand why UBS dropped budgeting. There is indeed a third reason which is the publishing of a new book in 2003, which we shall now discuss.

c) The “Beyond Budgeting” book

4 5

st

“ETFs, Revolution or Pollution?”, in The Economist, April 21 2007 International Financial Management, by Eun and Resnick, McGraw-Hill, 2004, p. 228.

UBS’s executives read a book published in 2003, Beyond Budgeting by two Harvard professors, Jeremy Hope and Robin Fraser. In this book, the authors try to demonstrate that budgeting is, in itself, an obstacle to achieving superior performances. As Peter Thurneysen, Head Group Controlling & Accounting at UBS, puts it: “"Beyond Budgeting has inspired UBS not only to shift its focus away from traditional, detailed budgets but also to take the next steps and implement plans with adequate levels of detail; and further redirect its focus toward trend analysis, scenario planning, and rolling forecasts."6

Why are budgets so bad according to Beyond Budgeting? It’s that they represent a fixed performance contract. Rigid adherance to annual fixed plans and budgets stifle innovation, hindering the corporate response to the earnings and cost pressures, foreign manufacturers’ entry into domestic markets, and growing level of competition. Business units become preoccupied with meeting sales targets rather than satisfying customers. Salespeople eager to try new tactics are thwarted by rules requiring multiple signatures authorizing any changes in plan. And above all, the budgeting process is time consuming and expensive, taking valuable time away from activities that add greater value. Indeed, for most participants, the traditional budgeting process starts at least four months before the beginning of the fiscal year. Operating divisions, business units, and departments receive “budget packs” that include forms asking for forecasts of sales, profits, and capital expenditures. The forecasts are reviewed at a high level, and after several rounds of give-and-take, the budget document is finalized. The budget is a vast compendium of details. It lists the capital and operational resources that 6

http://www.bbrt.org/bbbook.htm

the corporate center is to make available to operating units, the obligation made by each unit for the coming year, and the commitments that business or operating units have made to one another, such as a production unit’s pledge to meet the sales plan. It also states what will happen to individuals’ compensation if targets are missed or surpassed. Over the course of the fiscal year, each unit is expected to file regular reports on its progress toward meeting the targets. Despite the number-crunching abilities of powerful computers, budgeting remains a protracted and expensive process, absorbing up to 30% of management’s time. A 1998 study of global companies showed that on average they invested more than 25,000 person-days per $1 billion of revenue in planning and performance-measurement processes.

As far as strategy is concerned, the final word is that budgets are divorced from strategy. According to a recent cover article in Fortune magazine, around 70 percent of companies surveyed were poor at executing strategy-a massive indictment of the performance management capabilities of budgets7. The ‘Fixed Performance Contract’ is a coherent part of the ‘Command and Control’ management model, widely used today but now outmoded. In a fast changing economy and under high competitive pressures, managers are driving the traditional approach well beyond its design limits, and the cracks are becoming evident.

II. 7

Options

“Who needs Budgets?”, in Harvard Business Review, Feb. 2003

a) How to theoretically drop budgets

Where does UBS go from here once their external analysis has revealed the need to become a more agile organization and the internal analysis that a great part of the problem could be coming from the way they manage budgets? What options are available? One could ask whether there were no other options than abandoning budgeting. The answer is obviously yes. One can hire and train more derivative and risk management experts, expose themselves less to risk by reducing their exposure to risky markets, hire more researchers to come up with new products (new financial investment tools, etc.). However, like all banks, UBS has done this. But, unlike all other banks, one of its divisions has abandoned budgets. This is thus clearly a strategy aimed at giving them a competitive advantage. This reason alone justifies that we now focus on the budgeting strategy to see whether it has, or not, achieved the desired results.

So again, back to our question, what do you do once you have recognized that budgeting is a problem? How do you drop budgets? Again, the answer comes from Beyond Budgeting. Its authors argue that, in the absence of budgets, alternative goals and measures – some financial, such as cost-to-income ratios, and some non-financial, such as time-to-market – move to the foreground. And business units and personnel, now responsible for producing results, are no longer expected to meet predetermined, internally selected financial targets. Rather, every part of the company is judged on how well its performance compares with its peers’ and against world-class benchmarks.

Some project leaders estimate that they have saved 95% of the time that used to be spent on budgeting and forecasting. In companies using these standards of performance, business units become smaller, more numerous, and more entrepreneurial. Strategy becomes a grassroots endeavour. The aggregate result of many small teams exploiting local opportunities is a much more adaptive organization. In other words, exactly what UBS needs to cope with an ever faster market and strategic cycle. In many companies who have abandoned traditional budgets, rolling forecasts that look five to eight quarters into the future play an important role in the strategic process. The forecasts, typically generated each quarter, help managers to continually reassess current action plans as market and economic conditions change. Without budget expectations to worry about, staff members can do something with the nonconforming customer and market information they collect – other than hide it. The reporting of unusual patterns and trends as they unfold helps the business avoid shortages or overages and formulate changes in direction. Instead of being imposed from above, strategy seeps up from below.

b) How dropping budgets works in practice for a bank: the Svenska Handelsbanken case

All of this isn’t just nice theory. Many companies have actually abandoned budgeting in practice. But how can UBS know it is a workable solution for a bank? The answer is by looking at how it worked for the only bank who had adopted it at the time, the Svenska Handelsbanken. Actually, the Svenska Handelsbanken is a perfect case study because, having abandoned budgeting

as early as the early 1970s, one can see the long term viability of such a move, or in other words, its real value as a strategy. Since it abandoned budgeting, the bank has outperformed its Scandinavian rivals on just about every measure, including return on equity, total shareholder return, earnings per share, cost-to-income ratio, and customer satisfaction. It produced an annual total shareholder return of 24% between 1979 and 2001 – a rate 33% higher than its nearest rival. Annual earnings per share grew at a rate of 10.9% from 1990 to 2000. Handelsbanken is also one of the world’s most cost-efficient banks, achieving a cost-to-income ratio of 45% in 2001; at most international banks, the ratio is over 60%. Few of its loans go bad, largely because the bank has a policy of giving frontline people responsibility for authorizing loans.

c) Strategic objectives

Now that UBS has identified their strategic problem (shortening strategic life cycles due to higher market volatility and shortening product life cycles), have found an option to pursue (abandon budgets) and received proof of the option’s viability (through the Handelsbanken case study), we can understand the strategic aims set by UBS executives which they hope to achieve by abandoning budgeting. In an interview given to Zfo, Anton Stadelmann, Chief Financial Officer of the Wealth Management and Business unit of UBS and member of the Group Managing Board, gives three strategic objectives pursued by the division by abandoning budgeting. The two first ones are financial: “We are pursuing the aims of cost reduction at the same time as

growth.”8 The third is non-financial and relates to enterprise culture: “Whether you can stand by this model depends on your view of human nature. We trust our employees to be able to live this culture, that they want to be better every day, and that they want to help others to be better too. That is our view of human nature. If we succeed in persuading the majority of our employees to live

this

consistently,

then

we

will

be

an

attractive

employer for

entrepreneurially-oriented employees. We will be attractive to people who are committed to this view of human nature. This would be a great competitive advantage in the longer term... We would like to be seen as the bank of choice by people on the job market who want to take entrepreneurial action. Perhaps UBS can also make a modest contribution to increasing understanding that people can actively create their own future.” How are these objectives related to the issues we previously discussed? Obviously, by pursuing them, the Wealth Management branch of UBS will be able to become leaner (cost reduction), meaner (growth strategy), both of which will help it to at the same time take advantage of new opportunities in the markets (risk) and overcome the downturns in rough times (quick response time, financial cushions). It will also be able to better cope with increasing customization demands and shortening life cycles of products (the entrepreneurial spirit which allows employees to take on responsibility for dealing with these situations). However, we can see that the strategic objectives go beyond the only issues of market volatility and product life cycles. Whilst permitting to cope with thises issues, they are much broader and general. This is because the move to go “Beyond Budgeting” was not only motivated by an analysis of industry trends

8

“Leadership statt Budgetierung”, in zfo, April 2005

and UBS’s position in the market, but also by the publishing of a book. UBS can therefore also pursue the other benefits which come with abandoning budgets. Indeed, the move to go “beyond budgeting” frees the company to adjust much better and quicker to any new issues and situations. In this sense it is kind of a meta-strategy, meaning that it is a strategy which enables other strategies and their creation. It is also from this perspective that going beyond budgeting can help UBS achieve more growth, cost reduction and an entrepreneurial culture.

We can see here that the main issue is not how to achieve greater predictability in the face of ever more volatile markets and changing customer demands. On the contrary, the move aims at achieving more flexibility as to better respond to an unpredictable environment. We shall now look at how UBS implemented (executed) the strategy. This will then bring us to our last part which deals with assessing the strategy’s execution.

III.

Implementation

a) Managing change

The most crucial part in the implementation phase of a strategy is first convincing the executive board to give strong financial or moral support, second to convince the rest of the organization to endorse it and change their old ways of doing things. This is why UBS put into place a three step communication plan at the beginning of the project. Indeed, according to

Anton Stadelmann, before deciding to go ahead with the project, the company’s top executives all met in a room for three days to discuss the viability of the strategy and its implementation9. Once all executives were convinced of the need for change, that the new strategy was the right thing to do and consensus was reached, UBS then moved on to communicate with its key stakeholders. Finally, it communicated its new strategy to all its employees, mainly through seminars. The main sort of resistance UBS encountered at the beginning was that people had a hard time getting used to working without fixed guidelines, so the emphasis in the seminars was not put so much on training than on informing, getting the employees to feel the need to change and feel secure about taking on more initiative.

b) Organization and resources

Entrepreneurial leadership involves decision-making, taking a commercial approach that balances income, cost and risk. This had a direct implication on the role of managers – and on the scope of their authorities. They decide on staffing levels for their units, on the skills required by their teams and on local marketing activities – and they are held accountable for them and, ultimately, for the unit’s performance10. In other words, additional investments are expected to yield additional revenues. Employees also have more responsibility. Client advisors now formulate their own business goals, and decide how best to achieve them. In traditional budgeting systems, inflexible cost targets can have the perverse effect of limiting the amount of business a unit takes on. At UBS, branches have the authority to decide whether the 9

Cf. “Leadership statt Budgetierung”, in zfo, April 2005 http://www.ubs.com/1/e/handbook/0019.html

10

income generated by, say, opening many new accounts is worth the higher costs those accounts will entail11.

c) Performance

How does UBS set and manage performance targets in the absence of budgets? As Stadelmann puts it: “We are replacing the budget with internal benchmarks as our reference points for performance appraisal.”12 The new process ensures clear strategic direction by a simplified top-level five-year business plan13. It focuses on strategic projects and initiatives that support the priorities of the business. Operational leadership is supported by a five-quarter rolling forecast which allows senior management to react quickly to changes in the market environment and initiate corrective measures immediately, if required.

This type of decision-making requires enhanced transparency and granularity in management information. As budget figures – the traditional point of reference – are no longer available, current performance is measured against actual results achieved in the previous periods and benchmarked to the performance of a defined group of peers14. This encourages managers, client advisors and other employees to identify best practices and, through an active exchange of ideas, ways to learn from each other. In this context, managers

11

Ibid. “Leadership statt Budgetierung”, in zfo, April 2005 13 http://www.ubs.com/1/e/handbook/0019.html 14 Ibid. 12

increasingly take the role of coaches who encourage and support their employees to exploit their full potential and fulfil their own ambitions.

Some might argue that putting each part of the organization in competition with the others might be destructive to the company as a whole, leading to such behaviours as not wanting to share information and the like. Anton Stadelmann’s answer to that is that such behaviour is not compatible with the company’s new culture and that UBS is, more and more, institutionalizing the information collection (making it compulsory for teams to store and report what they learnt from their projects) so as to turn UBS into a knowledge center that feeds on its experience15. Moreover, departments don’t just compete on internal benchmarks but on external ones as well (the performance of competitors with respect to the same measure), which forces the different teams to work in cooperation so that the organization doesn’t lag behind as a whole.

It is thus fair for the wealth management division of UBS to claim: “We have not partially abolished budgets, we have abolished them altogether. We only budget at management board level, and that in the sense of strategic considerations, without breaking these down further.”16 But, one could argue, doesn’t the system introduce a risk of chaos, every department and team going its own way, rendering any overall strategy impossible? Stadelmann says no: “ “beyond budgeting” does not mean, “beyond planning.” In fact, there

15 16

“Leadership statt Budgetierung”, in zfo, April 2005 Ibid.

is more planning than before: “We have probably never planned as intensively as we are doing today. However we are planning something quite different now. We are not planning more budget figures, but instead, actual market activities, and are finding out where we can create value and where we can tap potential. This planning is being done much more seriously. But it has nothing to do with bureaucracy.”17

d) A perfect system?

Even though all of these measures are steps in the right direction, does UBS stand the comparison in this operational level with competitors who have gone the same way? Here we realize that there are certain areas which can be improved upon.

Firstly, the idea to drop budgets completely is not applied to all of UBS’s departments but only to one, its international wealth management and Swiss retail and corporate businesses, which is itself a sub-division of the global wealth management and business banking unit. Even though this is UBS’s largest division, which inevitably has an impact on the company’s culture as a whole, this seems to indicate a certain reticence in the administration of the strategy which is made apparent when one compares UBS to a bank like the Svenska Handelsbanken which has been using such a system since the seventies and is considered best-in-class for its use of the system in the industry. 17

Ibid.

Indeed, a comparison first shows that UBS did not go the full way in its pursuit of a flexible, open organization. Handelsbanken seems to have taken the issue a step further by doing away with organizational charts all together18. The spans of control at Handelsbanken are therefore very wide, precluding micromanagement. “The few decisions that require high-level approval are kicked upstairs almost immediately. An answer usually arrives within 24 hours.”19

Another part of the organization which seems weak when compared with Handelsbanken is the compensation scheme. UBS still has the traditional team bonus for performance system which, when coupled with the inherent competition amongst the company’s teams brought about by the new organization, can lead to disruptive behaviour (not sharing of information, stealing each others’ customers, etc.) which destroys the cohesiveness of the company as a whole. We saw that UBS had answers to such concerns (institutionalization of information, company culture, etc.), but Handelsbanken, again, went a step further. Indeed, two policies at Handelsbanken keep competition and cooperation in balance20. One requires every customer to be attached to a particular branch; this avoids disputes over who gets the benefit of a customer order that has been handled by two branches. The other puts a portion of the company’s profits in a companywide pool from which every employee derives an equal share, irrespective of seniority or individual

18

Cf. “Who needs Budgets?”, in Harvard Business Review, Feb. 2003 Cf. “Who needs Budgets?”, in Harvard Business Review, Feb. 2003 20 Ibid. 19

performance. Thus, apart from securities traders, no one at the bank is rewarded for reaching a predetermined target-nor are branches even rewarded for doing well in a performance-league table. Individual and unit rewards consist of peer recognition and praise. Consequently, branches feel safe sharing information about customers. Some might argue that such a reward structure gives a free ride to managers who produce little in the way of results; On the contrary, a team-based and open organization like Handelsbanken that is governed by peer pressure exposes free riders very quickly.

So the question is why did UBS not go all the way in implementing its strategy? One answer can be that this probably constitutes a big pilot project. Instead of going full on with such a complex and daring project, management preferred to use the company’s division which was most fit to experiment with such a system. Expansion to the rest of the divisions would then be conditioned on the success of this “pilot” project (we put brackets here because pilots are usually small projects). If this is the case, it is a wise decision, but this answer only tells us why UBS didn’t apply the strategy to all of its divisions not why it didn’t apply the strategy fully in its pilot division (the international wealth management and Swiss retail and corporate businesses division). To explain this we could probably argue that UBS is a too big of a bank to do away with things like organizational charts and traditional compensation schemes. Handelsbanken is, indeed, a midget compared to UBS (2.8 bn Swiss Francs of profit for Handelsbanken in 2006 and 10,000 employees against over 11 bn for UBS and 80,000 employees), probably

making it easier to cope with such a flexible and open organization. There is also a cultural aspect to be considered. Indeed, Handelsbanken has been experimenting and implementing this strategy for decades, UBS for barely two years, the corporate culture thus had the time to adapt. Also, the Nordic countries are much more collectivist, so a collective reward system is probably more natural to them than it would be in a bank that operates all around the world. Here we see that the implementation of a strategy is in itself a strategic issue.

Only time will tell which one of these theories is the right ones and if UBS used the right method to implement its strategy. We can, however, try to assess the impact and the success of the strategy execution up till now. IV.

Evaluating the strategy and its execution

The question now becomes: how do you assess the execution of a strategy when you don’t have a budget? Budgets give financial targets against which one can easily compare the actual figures to measure the degree of success of strategy execution. These are precisely the kind of tools we don’t have any more. Another issue is that UBS has only carried out its new strategy for about two years whereas such an ambitious move can only really be assessed in the long run, giving time for the whole company culture to change. In the absence of budgets we shall see if we can infer, from some key financial indicators, that UBS has been moving towards the stated strategic financial targets: cost reduction and growth21. Due to the fact that the strategy has only been put into 21

Cf. “Leadership statt Budgetierung”, in zfo, April 2005

execution for a short time, we shall try to identify trends which suggest future directions the business is going. We shall then finish with an assessment of the non-financial objectives.

a.

The bank as a whole

The bank as a whole saw its operating income grow by 35% since it abandoned budgets in 200422 (against 10% from 2002-4). Though operating income stayed at the same level of growth from 2004 to 2005 than from 2003 to 2004 (11%), growth nearly doubled from 2005 to 2006 (18.23%). On the other hand, even though 2006 profits reached a record high (SF. 11.249 billion), they only represented a 19% increase compared to 2005, whereas 2005 and 2004 profits represented 28% and 27% increases respectively compared with previous years. However the cost over income ratio has been steadily declining from 2003 to 2006 (73.2%, 70.1% and 69.7%), suggesting that costs are being controlled and even curbed.

One can argue that these excellent results could be only due to the fact that 2006 was simply an excellent year for Switzerland as a whole, every major Swiss company beating expectations and breaking profit records. To test whether this hypothesis is true, we can compare UBS’s results with Switzerland’s second biggest bank, Credit Suisse. 2006 was also a record year for Credit Suisse with SF.11,3 billion in net profit (even though 1.3 bn come from the sale of Winterthur, an insurance company). However, Credit

22

Refer to exhibit 1 for this analysis.

Suisse’s cost trends tell a whole different story. In 2003, the cost over revenue ratio was a whopping 94.49%. Things normalized after this exceptionally bad year in 2004 with the ratio going down to 81% only to go up to 85% the next year and back down to 78% in 2006 (however, if we exclude the Winterthur sale which came a little as a last minute surprise the ratio would have probably stagnated around the 80% mark). In any case, the Credit Swiss cost over income ratio follow an erratic trend, to say the least. This simply reflects the industry’s high cost ratio and unpredictable nature as we discussed in the beginning of our paper. What is here remarkable is that, even though in the same industry and country, of comparable size and competing on the same markets, UBS has a 10% lower cost to income ratio than Credit Suisse and it is declining on top of that. The difference must therefore be in the management strategy of the bank. What is for sure is that the bank is achieving its aim of managing growth whilst curbing costs. But how much can be attributed to dropping budgets? Since it is the

International Wealth

Management and Swiss Retail and Corporate Businesses division which fully implemented this strategy, we can only answer this question by analysing the division’s financial data and how it relates to the business as a whole. b.

The International wealth management and Swiss retail and

corporate businesses division

The division is itself a sub-division of UBS’s global wealth management and business banking unit. The division’s total income for 2006 was SF. 10,798 bn, its total operating expenses were SF. 5,595 bn and total profit before taxes

was SF. 5,203 bn23, that is 23%, 17% and 46% respectively of the bank’s total income, operating expenses and profits. The division’s performances thus have a great and fundamental impact on the group as a whole. How, precisely, do the division’s performances relate to the bank’s?

Income from the division rose by 17% and 20% through 2004 to 2006. However, expenses only rose 13% and 15% through the same period (as a comparison, the bank’s expenses rose by 6% and 18% respectively. The division thus has much more stable and controlled cost curb). This allowed the profits of the division to keep an amazing 22.5% and 25% growth in 2005 and 2006 (remember that the same figures for the bank gave 28.3% and 19.14% respectively). This is after experiencing negative growth in 2002 after the dotbubble burst. Income before taxes only begins to really going up again in 2004, when the strategy was implemented24.

The most impressive remains the cost over income ratio which dropped by 6.3 percentage points (from 61.6% to 55.3%, a 45 percent drop) in 2004, the year the division implemented the strategy25. The ratio was, from 2004 to 2006, 55.8%, 53.7% and 51.7% respectively26 (a 4 percentage point decrease in 3 years). Recall that the bank’s cost over income ratio was 73.2%, 70.1% and 69.7% over the same period. The division’s cost over income ratio is thus 18 percentage points below the bank’s in 2006 and 11 percentage points

23

Refer to exhibit 4. Cf. exhibit 3 25 Cf. exhibit 7 26 Cf. exhibit 6. 24

below the global wealth management and business banking unit27. How does the division explain such a good performance? “The cost / income ratio improved to 51.7% in 2006 from 53.7% a year earlier. The cost / income ratio has improved for the fourth consecutive year despite the rise in costs in pursuit of our global expansion strategy. This improvement reflects the strong rise in income due to a higher asset base and higher volumes in Lombard lending, which more than offset the increase in personnel expenses (mainly headcount increase and performance-related compensation) and higher general and administrative costs.”28 This statement seems to show that the division’s performances are indeed at least partly coming from the implementation of the new strategy since it seems to have encouraged the division to take on more risks to take advantage of a bullish market (increase in Lombard lending) whilst curbing costs (probably due to management’s new found ability to directly decide their level of staffing and resource needs). In a traditional budgeting environment, the level of new business the unit could take on would have been limited a priori by the imposed budget envelop at the beginning of the year (they couldn’t have taken on more business because this would have obliged them to go over their budget allocated for expenses). Given the division’s extremely heavy weight in the company, we can thus conclude that it’s strategy helps the bank as a whole to improve profitability by generating more income (through more aggressive and creative tactics to gain market share), lowering the cost and cost over income ratio curbs and thus finally greatly contributing to profits (nearly 50% of UBS’s total profits).

27 28

Refer to exhibits 1, 4 and 5 for this analysis. Cf. 2006 Financial Report.

c. Non-financial indicators

But financial performances are not the only objectives of the bank. Going beyond budgets has also brought the company other advantages. First of all, in the way it communicates to markets: “We provide very few financialperformance commitments,” says Mark Branson, the company’s chief communications officer29. “Our experience shows they are counterproductive, building pressure for short-term action to save the credibility of forecasts. In effect, we show analysts and investors how the business works. This shifts the emphasis from meeting short-term promises to improving our competitive position year after year. The result is much more accurate interpretation of our results and news flow, meaning less volatility in our shares. Analysts like and respect our approach. They no longer ask for numbers-based forecasts.”

There is another non-financial objective the company had in mind when implementing its strategy: “ “Whether you can stand by this model depends on your view of human nature. We trust our employees to be able to live this culture, that they want to be better every day, and that they want to help others to be better too. That is our view of human nature. If we succeed in persuading the majority of our employees to live this consistently, then we will be an attractive employer for entrepreneurially-oriented employees. We will be attractive to people who are committed to this view of human nature. This would be a great competitive advantage in the longer term... We would like to be seen as the bank of choice by people on the job market who want to take

29

Cf. “Who needs Budgets?”, in Harvard Business Review, Feb. 2003

entrepreneurial action. Perhaps UBS can also make a modest contribution to increasing understanding that people can actively create their own future. This could be an approach that has an impact and encourages people.” It is obvious that such an objective is impossible to measure on a two year time span as implies a complete change of culture. There is, however, one way of assessing what the bank’s future employees might look like. Indeed, the type of people the bank wants to attract are often seeking for companies that not only display strong financial results but that also stand out from a management point of view and for the prestige their name carries with it. One of the most commonly used ways of assessing these two types of factors are awards. In 2004 (the year UBS’s wealth management and Swiss retail and corporate businesses division launched its beyond budgeting strategy), BusinessWeek named UBS the world’s 45th most valuable brand in the Global Scoreboard. In 2005, Business upgraded UBS to 44th spot. Since 2004, UBS won twice in a row Euromoney’s “Best Global Private Bank” award (an award which directly relates to the wealth management division…). But UBS doesn’t just receive awards for its performances. Indeed, the company was named one of the 100 Best Companies for Working Mothers living in the U.S. in 2006 for the fourth consecutive year by U.S. based Working Mothers magazine. In the light of these awards and of the many more that it will probably receive, it is of little doubt that the bank will encounter little trouble in attracting the kind of people it wants. As for the employees whom are already part of UBS, only time will tell if they will be able to change.

Conclusion

Our aim at the beginning of this paper was twofold: first assess the execution of the “going beyond budgeting” strategy. As far as this point is concerned, one thing is for sure: given the company’s incredible success these last few years, the strategy to go “beyond budgeting” has not broken the tremendous winning machine UBS has become in its 95 years of existence. This means that, at the least, it is not a harmful strategy. Only time will tell just how much this new strategic inflexion will bring more to the company. The strategy’s ultimate test will probably be to see if it is capable of keeping UBS above competition in times of turmoil and not just in times of strong economics, as was the case till now. As UBS is the only bank to have undertaken this strategic move and that it is precisely a branch which is world leader in its sector (wealth management), there are strong reasons to believe that this new strategy is a competitive advantage. Indeed, from what we have seen and tried to show, the implementation of the strategy has been a great success, both on financial and non-financial grounds. The second aim of this paper was to come up with a recommendation for UBS concerning its strategy: should it drop it, keep it or extend it? In view of the evidence our analysis has discovered, we can only encourage UBS to now extend the implementation of the strategy beyond the Global Wealth Management and Swiss Retail and Business Banking division to other parts of its business and, why not one day, to all of it. One could question whether it could work as well in divisions which serve different functions and aims (investment banking, asset management, …). Our answer is that, first, the

issues

encountered

by

the

private

banking

division

(global

wealth

management) affect the banking and financial sectors as a whole. Second, dropping budgets is not simply a strategy, it is also a meta-strategy, meaning that it normally allows an organization to become more flexible and enables it to better implement and change any other past, present or future strategies. The hole of UBS could thus drop budgets and still have its different units pursue various sub-strategies whilst unifying the hole company as regards to key strategic aims: cost reduction, growth and an entrepreneurial culture.

References

Publications:


“Who needs Budgets?”, in Harvard Business Review, Feb. 2003




Beyond Budgeting, by Jeremy Hope and Robin Fraser, Harvard University Press, 2003




“Leadership statt Budgetierung”, in zfo, April 2005




“Credit Derivatives, At the Risky End of Finance”, in The Economist, April 21st 2007.




“ETFs, Revolution or Pollution?”, in The Economist, April 21st 2007




International Financial Management, by Eun and Resnick, McGrawHill, 2004.

Internet resources


UBS financial report 2003, 2004 and 2006 at : http://www.ubs.com/1/e/investors/annualreporting.html




The beyond budgeting approach explained on UBS’s website: http://www.ubs.com/1/e/investors/annual_reporting2005/handbook/0019.htm l




The website of the Beyond Budgeting book: www.bbrst.org

Exhibits

1. UBS Income statement, 2006

Source: http://www.ubs.com/1/e/about/keyfigures.html

2. Wealth Management International & Switzerland compared to other units.

Source: 2006 Financial Report, p. 29.

Exhibit 3

Wealth Management International performances before tax 6000

CHF million

5000 4000 3000

Series1

2000 1000 0 2001

2002

2003

2004

2005

2006

Sources: 2003 and 2006 Financial Reports.

5. Wealth Management International and Switzerland Income Statement, 2006

Source: 2006 Financial Statement, p. 33.

6. 2006 Cost/income ratio for UBS’s Wealth Management International and Switzerland

Source: 2006 Financial Report, p. 33.

7. Cost / income ratio 2002-2004

Source: 2004 Financial Report