Outcome Based Funding

So last time I talked about large companies and some of the reasons why they make sub-optimal decisions. Not bad decisions, but ones that aren't as good as they could be. The main reason for sub-optimisation was centralisation of decision making and the main reason for centralisation was the need for control. In particular the control on spending money. With no central control of funding, anyone could spend a bunch of company money and the company would soon be broke.

If decentralised decisions are more optimal because the person making them has more information than someone further from the coal face, but centralisation is required for spend control, what are large companies to do? Are they doomed to make sub-optimal decisions forever? Fortunately, no. There are ways of maintaining centralised control of spend while allowing decentralised decision making about where to spend money. There are, in fact, many ways to do this and we will look at one of them now. I'm calling it outcome based funding; I'm sure the financial folks have a fancy, official name for it, but outcome based funding will do for now.

Outcome based funding starts with strategic decision making. This is done centrally at an organisation-wide level. Most large companies have some sort of strategic planning, but in many cases this is really just looking at a bunch of business cases and working out which ones to approve. That's tactical, not strategic, thinking. Real strategic thinking is at the heart of outcome based funding.

During strategic planning, the senior execs look at the long term strategy for the company - where do they want to be in 1, 2, 5 years time? What opportunities do they see for new and existing markets over those timeframes? What threats are there on the horizon? This would usually be done at the highest organisational level of the company - business units, vertical markets, regions, however they are organised. The important decision to make is - based on the opportunity and threat landscape for each of our organisational units, and on our long term strategic direction, how much funding are we willing to allocate to each business unit for the next funding period? That's it. That's the centralised decision making done. It's now up to those organisational units to determine how that bucket of money is spent.

Well...not quite. It's not as simple as just allocating a bucket of money and forgetting about it. We still need control. So each bucket of money comes with strings attached. Those are the outcomes. An outcome is, as the name implies, the result that the business wants from that money. It should be a hard, measurable business goal, not some fluffy statement about "capability uplift" or "engaged employees". Those things are good but they are how you reach your business goal, they aren't an end in themselves.

It may be a cost saving target - spend this money to achieve a cost saving of 10% over the next 12 months. Or it might be a revenue outcome - "spend this money to increase revenue by 5% over the next 12 months". Or it might be a market share outcome. Or it may be a combination of those. It's now up to each organisational unit to demonstrate to the exec team that their spending decisions are leading towards the set objectives. That's how the organisation retains control - a spending cap (the size of the allocated bucket of money) tied to clear business outcomes that are in turn tied to strategy.

Now, the process repeats at a smaller scale in the various organisational units as the leadership team sets the spend for the various sub-units and so on down the line until we have people working at the coalface, with money available to spend (that isn't tied to specific projects), clear strategic goals and outcomes to shoot for, and all the relevant information required to make optimal spending decisions in order to meet those objectives.

Outcome based funding allows control of spending and ensures strategic alignment while enabling optimal decentralised decision making. It's the best of both worlds.

The funding period is also worth discussing. Most organisations work on a yearly funding cycle. Mostly because the funding process is long and painful, so no one can face it more than once a year. Outcome based funding tends to involve less pain because it's about strategy, rather than fighting over which project will get funded, so it is possible to do it more often. Why would you want to?

Because the business landscape doesn't work on a yearly cycle. New threats or opportunities can spring up at any time. If the business makes its funding decisions yearly, that's how long it will take to respond at an organisational level to a change in conditions. The tactical response to the change in conditions can be much quicker, of course, because that's done at the local level, but if the response needs a change in priorities at a higher level - increase the size of the spending bucket to enable a faster response for example - that higher level response can be fairly slow and can limit the organisation's ability to respond. If the organisation's funding cycle moves faster, its ability to respond in a coordinated way to a change in conditions improves as well.

Imagine how fast an organisation could respond if it had a well-oiled outcome based funding model that ran monthly. Every month, the organisation could tweak funding allocations and desired outcomes based on changes to their competitive landscape. Imagine how much better it could meet its long term strategic objectives if it was continually adjusting what it did to ensure that it was still heading in the right direction, even if the landscape was changing around it. Imagine how much more competitive they would be.