Critical Literature Review
The correlation between uncertainty and the use of Traditional Budgets as a Planning & Performance Measurement tool
Rationale for research
Lately, in light of the ongoing Coronavirus pandemic, Senior Management at a multinational retailer has criticised internal Budgets for not being flexible enough to support Management decisions in times of uncertainty and unexpected economic changes. In the last months, the business experienced Retail store closures, rapid sales reductions and a strong shift towards the Online Distribution Channel, resulting from government restrictions and changed buying behaviour in the different markets, depending on the economic impact of the virus. However, the traditional Budgets that were set a year in advance didn’t reflect these changes and new priorities, leading to the inability of the Management to use Budgets for steering the company’s activities. As a result, Budgets lost their purpose as Planning and Controlling instruments.
Empirical studies and articles confirm that the increasing dissatisfaction with traditional Budgeting is not just a company-specific concern. Despite their widespread use in many contemporary organisations and their significant contribution to short-term planning, resource allocation and performance measurement, traditional annual Budgets are criticised in some academic research for being quickly outdated, inﬂexible and unable to provide reliable information in dynamic environments (Hansen et al., 2003; Ekholm and Wallin, 2011). Some researchers even articulate the view that traditional Budgets are becoming useless in times of increased uncertainty and propose to replace or abandon them completely (Hansen et al., 2003).
Acting in a dynamic international environment that is characterised by frequent changes in technology and government regulations as well as high competition and customer demands, the Retail industry is heavily exposed to the impact of uncertainty on the company’s Budgeting Control System, which will present the foundation for this literature review.
The objective of this paper is to synthesise available research and empirical studies on the association between uncertainty and the usefulness of the traditional Budget as well as its different functionalities. Furthermore, the aim is to critically examine conclusions that support or contradict the criticism about traditional Budgeting in times of uncertainty. This review should create the foundation for further research to discuss the need for alternative Budgeting systems and techniques, considering the findings of the use, preferences and concerns in different organisations.
Discussing the contextual variable of Uncertainty
The examined studies (Ezzamel, 1990; Hartmann, 2005, Hoque, 2005; Ekholm and Wallin, 2011) are analysing the impact of uncertainty on the role, the design or characteristics of Budgets in organisations by conducting surveys where respondents are asked to give an indication for both factors, Uncertainty and the use of Budgets.
The researchers agree on the wider definition of uncertainty as a lack of clarity and information originating internally from the organisation's processes (Task Uncertainty), or through the external environment, the organisation is surrounded by (Environmental Uncertainty) (Hartmann, 2005).
A commonly used way for researchers to measure environmental uncertainty is the Perceived Environmental Uncertainty (PEU), which focuses on the perception of uncertainty at a business unit level of a firm (Duncan, 1972; Ezzamel, 1990; Hartmann, 2005; Hoque, 2005; Ekholm and Wallin, 2011). To measure PEU, researchers use a range of items to be assessed in their predictability by the surveyed organisations or Business Units. Hartmann (2005) developed a model with four major sectors concerning customer demands and preferences, suppliers' actions, competitors' actions and regulatory groups like labour unions, which are enhanced by items related to interest or exchange rate changes in Financial Markets in Ezzamels study (1990). The model became even more advanced by taking new factors like production and information technologies, new products and developments in the raw material or labour market into account (Ekholm and Wallin, 2011; Hoque, 2005).
Against expectations, that more factors are included in more recent research to reflect important changes in the economic environment, Hartmann (2005) is using a comparably limited range of items when assessing uncertainty, not considering important market or product developments, which might lead to an incomplete and outdated picture of the PEU.
Although the introduction and further development of factors of the external environment in some studies help to make PEU more standardised, the presentation of a predefined selection limits the response possibilities for managers to capture their overall perceived uncertainty. Also, it remains unclear how the factors are communicated in detail in the surveys and whether there is room for misinterpretations that can lead to a different understanding of researchers and responsible members of the organisation. Additionally, all reviewed surveys are missing a clear explanation of how the factors are utilised and weighted to get to a Total PEU.
Besides, several limitations of the studies result from using individual perceptions instead of objective measurements. First, it needs to be noted that perceptions vary depending on other contextual factors and individual characteristics. As analysed by Hartmann (2005) and supported by findings from Duncan (1972) the measurement of uncertainty depends on an organisation's tolerance for ambiguity and uncertainty and its personnel and functional component. Taking these findings into consideration, generalised conclusions on the relationship between environmental uncertainty and the usefulness of Budgets should be treated very carefully, as they are disregarding the fact that perceived environmental uncertainty as a variable is not predefined and constant, but conditional on individual characteristics.
Related to this issue, one weakness of all examined studies is that they are using “Environmental Uncertainty” and PEU synonymously (Ezzamel, 1990; Ekholm and Wallin, 2011; Hoque, 2005; Hartmann 2005), which is misleading, as the subjective perception of individuals does not necessarily represent the “objective” reality. This degree of deviation depends heavily on the abilities of the responsible individuals to predict and assess the state of the environment. The assessment in turn is based on the availability of information and the individuals’ knowledge and understanding of relationships among different elements in the environment (Milliken, 1987).
Second, next to the cognitive abilities and the availability of information, Duncan (1972) reports that the perception also depends on the direct, close environment an individual or a Business Unit is surrounded by. Units in simple-static environments are likely to perceive less uncertainty, due to similar, unchanging factors than units with complex-dynamic environments, that are exposed to a large number of changing factors and do not have the required information to assess the outcome of a decision. Based on these findings, another limitation follows from the unit of analysis and the samples that have been selected. Ezzamel’s (1990) survey results collected from Financial Directors (FD) to analyse the organisation as a whole do not necessarily reflect the organisation's perceived uncertainty but rather the uncertainty of the Business Unit the FD is working in. Similar applies to the survey of Ekholm and Wallin (2011) who asked CEOs or CFOs of manufacturing companies to rate the external uncertainty. The article is missing an indication, of whether the perception of multiple Business Units is considered, or if the results are purely reflecting the CEO's individual perception. Generally, results from Ekholm and Wallin’s (2011) and Ezzamel’s (1990) study are limited in their applicability as they are only regarding perceptions from specific Business Units or individual members to reach a conclusion about organisations as a whole. Hartmann (2005) presents a better approach by including a large sample of managers, across different functional areas and positions in the organisation. Common findings from his study can be used to reflect the organisation's PEU.
Combining these insights, PEU is a commonly used variable but findings need to be treated carefully. Using the subjective perception of individuals, which depends on a range of factors, as a standardised measurement can be insufficient as it is questionable if and how Business Units or even organisations can be made comparable and how results from surveys can be used for general conclusions on the environmental uncertainty.
While the studies from Ekholm and Wallin (2011), Ezzamel (1990) and Hoque (2005) are disregarding the impact of task uncertainty, Hartmann (2005) takes a broader approach to explore the impact of both types of uncertainty. In his empirical study, he tested the Perceived Task Uncertainty (PTU) by applying a widely-used model developed by Withey et al. (1983) asking respondents about their perception of task analysability1 and variability2. Withey et al. (1983) state that an increase in the number of exceptions and fewer analysable tasks lead to an overall increase in Task uncertainty.
By referring to Withey et al (1983), Hartmann (2005) is building his research on a very advanced model, which was developed through testing and evaluating a range of other concepts to eliminate weaknesses in measurements. However, even though the questions to respondents are related to both dimensions, Task analysability and Task variability, Hartmann (2005) then combines them into a single composite variable (PTU) that is supposed to capture both effects. This approach might lead to limited validity of the results, as Withey et al (1983) suggested exploring both dimensions separately to capture ‘…unique theoretical and empirical relationships with other work unit characteristics’ (Withey et al., 1983:61). Additionally, he notes that there is still a weakness when measuring the analysability dimension because the scale is too elusive. Another limitation of this approach is, that the model has only been tested on a work unit level, using a small sample of 23 Units and therefore does not provide reliable results for organisations as a whole.
In conclusion, a lack of consistency in existing work on how they treat the variable of uncertainty can be identified. More specifically, the inconsistency is resulting mainly from a missing theoretical and empirical differentiation between two types of uncertainty, the task uncertainty and the environmental uncertainty. Readers need to keep in mind that when Ezzamel (1990), Hoque (2005) and Ekholm and Wallin (2011) are referring to ‘Uncertainty’ as a determining factor, they are focusing exclusively on environmental uncertainty and are not exploring the impact of both variables. This presents a general limitation of the three studies as Hartmann (2005) reports a correlation between task uncertainty and the appropriateness of budgeting control systems, which is showing the opposite effects of environmental uncertainty. Based on the impact both variables have on the overall uncertainty faced by an organisation it is critical to respect and examine them separately and in detail. Therefore, Hartmann’s methodology and approach present a great advantage in comparison to the other papers. Findings from studies that purely focus on one type of uncertainty can be considered but results should be scrutinized in their general acceptance and application.
1 describing the extent to which tasks can be displayed in mechanical steps
2 Variability referring to the amount and frequency of unexpected exceptions in the planning or production process