In this issue, interviewer Steve Player speaks to legendary costing professor Dr. Charles Horngren of Stanford University, whose market-leading textbook, Cost Accounting: A Managerial Emphasis (first issued in 1962 and now in its 13th edition from Prentice Hall), has been used to train more CFOs and other finance executives than any other. In this rapidly changing world, Dr. Horngren provides sage advice on what remains timeless and important in finance's quest to add value.

Player: Dr. Horngren, let's start with some quick background on your career ...

Horngren: My teaching began in 1948 while I worked on my undergraduate degree in accounting at Marquette University in Milwaukee. I was enrolled in the College of Business Administration. During my junior year, I began tutoring World War II disabled vets who were homebound and needed help. I also was tutoring basketball players. This was when I learned that teaching was the route I wanted to go.

Upon graduating, I went to work for Peat Marwick & Mitchell in my hometown of Milwaukee. After reconciling bank accounts for 12 hours one day, I looked at the want ads and saw a position for an accounting instructor. I decided to go for it, so I wrote a response. Three days later, I got a call and was hired for $50 more a month than I was making. I instructed for eight months and then went to Harvard to get my MBA. The summer after going to Harvard, I came back and taught in Milwaukee.

I was eventually hired by the University of Chicago as an instructor under the condition that I'd work on my doctorate at the same time. In those days, this was the requirement for a Ph.D. I did that, spending three years in Chicago. I then went back to teach at Marquette and back to Chicago to teach for seven more years (10 in total) before going to Stanford.

Player: What inspired you to go from Chicago to Stanford?

Horngren: I loved Chicago -- not specifically the city, but the university -- and my colleagues there. It was a stimulating place. But when Stanford offered me the job (1965--66), they first offered me a visiting professorship for a year. I thought, "What do I have to lose?" They had a new dean and were recruiting some very capable people. Initially, my wife was not that keen on Palo Alto, as she had lots of family in Chicago.

In February, the dean made me the offer to join Stanford on a full-time basis. The weather and the environment did have some influence, and the dean at the time, Ernie Arbuckle, was very persuasive. My wife quickly learned to love this area. We have been married 55 years.

I told my Chicago colleagues that if they could airlift the University of Chicago and transplant it to Santa Barbara or somewhere like that, I'd still be at Chicago.

Player: Your textbook, Cost Accounting: A Managerial Emphasis, has been used to train literally thousands of CFOs and other finance professionals. What caused you to write this book, and can you give us an overview of its evolution?

Horngren: I started the cost accounting book in Milwaukee just before going to the University of Chicago and did most of the writing while at Chicago. As I taught, I studied the students firsthand and their learning experience. I used this as I gathered information and research for the book.

Most teachers, when they first start teaching accounting, begin with teaching an introductory class. Often every teacher thinks that his or methovmethod is better than those of others, and of course I thought that about my introductory course. Like many instructors, I thought that I could write a book that would be better and that could compete in that area.

I presented the idea to an editor at Prentice Hall, Bill Eastman, who was also a wise marketing guy. He told me not to do an accounting intro book because there were already enough strong books in that area. Instead, he told me to write it on cost accounting. After thinking about it, I realized that there weren't really any solid texts in that area. A colleague and mentor of mine, Bill Vatter, had written one, but l felt that it still needed more work. The problem was, How could I discuss this with Bill?

I decided to address it directly. I spoke with Bill, asking if we could work together to take the book he had already written and build upon it. He replied, "Look, if you want to write that book, then do it yourself. I think that would be the most efficient and effective way to do it, and you have my blessing." So that's what I did. When it was published, I dedicated the book to Bill Vatter, giving him suitable recognition for his influence on me.

Player: How did you get the courage to ask him that?

Horngren: Bill had strong opinions, so I had some reservations about co-authoring with him. Asking him freed me up so that I didn't have to worry about offending him. And in return, I gave him the recognition he deserved.

Player: What were your expectations when you started writing?

Horngren: They were very low. I thought that I could bring a book into a classroom, have the students invest in the book since they had to have it for class, and hold my head high, knowing that I had produced something that was effective in the classroom. I didn't want fame; I just wanted to improve the educational mission.

The success of any product is dependent not only on its own characteristics and appeal, but also on that it's better than anything out there. You always want the "best," so I knew that I had to compete with other texts available. That was my standard when writing it.

Player: It certainly has expanded in size and comprehensiveness and is now in its 13th edition. What compelled you to continuously update it?

Horngren: When you're writing a book like this and you want to keep it up to or ahead of the competition, you have to work on it 24 hours a day. Basically, every time you read something, you compare it to your book. If I read The Wall Street Journal, BusinessWeek, etc., I'd constantly relate them to aspects of the book that could be improved.

Player: Your career spans over half a century. Did you ever dream that you would be doing this for as long and as successfully as you have?

Horngren: It may surprise you, but I never had any long-term objectives to do this so long in one place. I just try to enjoy what I'm doing and worry about where it unfolds as a matter of circumstance instead of ambition.

Player: I recall the first time we worked together. In that instance, you were gracious enough to accept our invitation to provide subject matter expertise for a consortium study of the leading practices in activity-based management. What amazed me was the energy and thirst that you showed in probing the companies providing site visits. Your thirst for knowledge set the tone of the study effort and the group. One example of that was your attendance at virtually all the site visits. I remember one in particular. You taught your class and then took a red-eye flight to be at a series of site visits. What keeps you going? How have you maintained this thirst for knowledge that I saw when we first worked together?

Horngren (chuckling): What keeps me going probably goes back to my upbringing. My father was a type A kind of person who was always busy even in his retirement years. I think that I got this gene. The other thing is, I truly enjoy learning, and if it's professional learning, I enjoy it even more. So even if it means taking a red-eye to learn what others are doing and teaching, I am willing to do that.

Player: Let me tap into your stores of knowledge to ask about finance transformation. In what ways have you seen finance transform?

Horngren: In terms of transforming, one thing that I've been impressed by through all these years is how markets work. Competition seems to sharpen everybody's minds to focus on the more essential things that spur change. For example, what is your response when you see a competitor coming out with a new aspect of a long-existing product or idea? I find that organizations are keen to respond and emulate productive behaviors. Competition becomes a great transforming agent.

When individuals come along with more creativity and enthusiasm and you put them together, you see changes made regardless of whether they are minor or major.

One example of something new is Beyond Budgeting. At its root is an approach that allows management teams to rethink their entire approach to the performance management process. Beyond Budgeting is an idea that is spoken of as a radical change, and in some ways it is.

Readers should understand that Beyond Budgeting in its extreme form is abandoning budgeting completely. Many well-known organizations such as American Express, Millipore, Guardian Industries, and Park Nicollet Health Systems have successfully eliminated their budgets, replacing them with continuous planning and adaptive controls. Seeing these results is truly exciting. [Editor's note: Dr. Horngren has served as the academic advisor to the Beyond Budgeting Round Table--North America.]

It is intriguing to see management teams running their organizations without the forms of budgeting that so often become a millstone around the neck of operating managers who think that they are unsuccessful if they don't make the budget. They are overcoming the traditional budgeting attitude that I think leads to dysfunctional decision-making.

Player: I recall your emphasis on decision-making. What is the role of finance in support of management decision-making?

Horngren: I used to tell my students about the importance in distinguishing between certain aspects of management. The example I used as an instructor describes a stranger who walks into a room of students and says to one of them, "I'd like to make a bet with you." The student who is approached shows interest, and the stranger explains, "I'm going to put down a $20 bill, and you put down a $1 bill. Then you ask any one of the others in this room to toss a coin. If it's heads, both bills ($21) are yours. If it's tails, you lose your $1."

After pondering the odds for a little while, the student takes the bet. An independent third person tosses a fair coin. It comes up tails, so the student loses. The stranger takes the $1 and the $20 and leaves.

The question is, "Did the student make the right decision?" I always say, "Think of it yourself -- was a good decision made?" Decision scientists will tell you immediately that it was a good decision. Yet the student lost his $1.
But you have to distinguish for yourself between decisions and outcomes. Yes, the decision was a good one because of the possible outcomes. But, the outcome was not good. You have to think of the risk between your odds and your possible outcomes.

The stranger actually made a horrible decision, but had a good outcome. He was very lucky, with what is sometimes referred to as "dumb luck." It is important to beware of decisions made in the face of risk and consider the outcomes. Your decisions aren't always going to have a good outcome, but your best protection against a bad decision is to get the most information and increase your likelihood of a good outcome.

Player: How do managers avoid being too afraid of risk to ever make a decision?

Horngren: Well, that happens with some people. A common complaint of management is that they don't have enough information to make a decision. Life is not always kind, and sometimes you have to go with a decision before you have all of the information you want. In many ways, failure to decide also has consequences. Your best bet is to think through the information that you have at hand.

Player: On the flipside of change, what are your views on the ways in which finance has remained the same? What things are timeless?

Horngren: One thing I've always stressed that is very important when you start thinking about accounting systems is to understand what they are there for -- their purpose -- which is to improve decision-making. Many people who design and operate systems lose sight of the reasons they are doing so.

Closely related to this is the need for information-gathering to pass the cost benefit test. You can always gather more data to try to improve decision-making. This usually takes the form of more detail. While this might be helpful, additional data cost more money -- more data to collect, more data to store, more complex reports. The question is whether these extra costs provide corresponding benefits that are greater. And those benefits come from making better decisions.

Another important aspect of financial systems is to ensure goal alignment. This is a process whereby you observe decisions and decision-makers to determine whether the decisions being made are aligned with the goals and desires of the organization. One of the first tests of a system is to ask the question, "Is this goal congruent with the organization or is someone in sales or marketing pushing a particular product or service because it's easy to sell, or his best friend is in the customer base, or some other self-guided reason?"

This forces people right from the start to think about the right things. The popular term these days is to "get your strategy in place," and all that is is basically goal alignment.

Player: Where else should CFOs focus?

Horngren: Well, it seems that they certainly haven't been playing enough of the role of risk manager. The current problems in the credit market illustrate this, but the need for risk evaluation and management crosses all industries.

They can help their teams continue to develop by making sure that individuals working in finance have enough training and understanding to make sure that they can do an adequate job. The person who is actively engaged is the one who keeps it going, not just the one on the side keeping score.

One other thing that I think will add value is something that's been pushed for years but not far enough: The CFO has a dual role in that he or she must hold CEO qualities. The more the CFO can also think like a CEO, the stronger the CFO will be. And, even further, there has to be a strong partnership that exists between the CFO and the CEO.

Player: What do you think someone has to do to be successful in finance today?

Horngren: They need a broad finance education. They need the knowledge and a grasp of where all of the aspects of running an organization fit. Some of the people I've met in my lifetime know a lot about everything -- marketing, people, etc. While other people have been very narrow and mostly playing the part of scorekeeper. There are too many "scorekeepers" in the business. When someone is too focused as scorekeeper, I assume that the education is not as strong as it should be.

Player: Let me ask about costing. Where do you see cost management in today's business, and how do you view the general comprehension of its role in finance?

Horngren: There are managers who really do think long-term and make decisions based on that. While there are others who don't think beyond what's going to show in the quarterly report. In terms of cost, you have to get a handle on what costs you are trying to manage, and this is the first step in what cost management is all about.

Cost is often associated with waste. This kind of thinking certainly plays a role, but it has to be viewed in both short-term and long-term aspects. Another aspect of cost is, "How much risk are you willing to take?" A new product or new process is not always going to have a great payoff. You don't always want to take too much risk, but you don't want to avoid it all together if you want to think long-term.

Player: What do you think about some of the latest waves of costing? Is any of it new, or is it just repackaging?

Horngren: I think that very little of it is new, but the repackaging and marketing of it has been superb. I am very hesitant to call anything "new." For example, balanced scorecards and activity-based costing have been around for a long time. They have contributed to better management in many places and continue to do so. In evaluating how to use them, it's the old test: Do the benefits match up to the costs? If it does, then they are making contributions, whether they are "new" or "repackaged." Just like products, repackaging can make things easier and more cost-effective to use. It can increase the benefits and lower the cost of use.

Player: What's next on your personal agenda? What plans do you have for continuing to improve finance?

Horngren: I think that this whole risk area needs much closer attention from people who have financial responsibilities, especially when you look at the current subprime disaster. Everyone is blaming everyone else, and I think that the whole shooting match is guilty in some respects. There is a lot that could have been avoided, whether through regulation or just smarter people. I am really trying to distinguish between whether it was greed or unwise decision-making that got us there. It seems that greed affects decision-making too often. The question is, "How are we going to disentangle the influence of greed and keep it from being destructive to decision-making?"

Player: Over your career, what key lessons have you learned that you would like to share?

Horngren: Professionally, decision-making is the ultimate reason why accountants and finance people exist. The way to judge the quality of an accounting or performance management system is to determine whether it is spurring quality decision-making. The second aspect is the goal alignment that exists in any organization. The third is to never forget the influence of decision-making on outcomes.

Listen to Steve Player's interview with Dr. Horngren here [1].