An uncertain future has motivated managers to take a closer look at costs. An old idea from the 1970s has re-emerged right on cue. Zero-based budgeting asks managers to question each line item in their budgets, and the related activity, from scratch. ZBB supporters dispute the merits of traditional budgeting, which involves increasing last year’s costs for volume and inflation.
As they struggle with the effects of the pandemic, companies need a control system that matches spending with their post-lockdown survival strategy and ignores historical spending levels.
Desperate shareholders with frozen cashflows may be tempted to slash and burn activities across the board, regardless of how sustainable their choices. The soft targets are always the first to go – advertising, travel, training, maintenance, consulting fees, communications.
Zero-based budgeting (ZBB) can provide a structured and rational approach to cost management. When done well, ZBB drives significant, sustainable savings and enables efficient resource allocation. But getting it right requires strong leadership to steer your people through their initial resistance.
The practice shot back into favour a few years ago when Brazilian private-equity firm 3G Capital used zero-based budgeting to squeeze billion-dollar savings from food processor Kraft Heinz. But more of that later.
Everything’s under the microscope
Easy to define in concept, difficult to apply in practice, in zero-based budgeting, all – and I mean all - expenditure for the next period must be justified anew. The planning stage always starts from zero and requires the cost and benefit of every activity to be placed under the microscope. There are no sacred cows.
Managers are required to justify their department’s existence, their activities, way of working, and their expenses, from scratch. Or come up with a better alternative. They must re-look at their staffing, activities, projects and costs through new eyes with no reference to the past. They need to ask “starting again in an ideal world, how would we go about this activity and to what would we give the highest priority”?
The objective is to review and justify and control all planned expenditure so that money will only be spent if and when it is needed. The hoped-for outcome: money will only be spent on the immediate needs of each department for the coming year and not based blindly on last year’s pre-COVID budget or expense level.
Zero Base is a tool for the control of everything a company spends money on, also works in government and “not-for-profit” organisations, and doesn’t remove the need for detailed cost budgets. Zero-base thinking can be applied everywhere - in direct manufacturing and sales operations, and to service and support departments.
The impact on people
Successful implementation of zero-based budgeting lies in convincing employees of the benefits. Companies with workers who place a lot of trust in upper management are more likely to succeed with ZBB. Sponsorship from the top is essential.
Leaders need to move the hearts and minds of people in their organizations in the right direction. ZBB can be challenging for managers who have spent years investing and growing their business units, when expected funds are diverted elsewhere. People will say that in effect, they are being asked to re-apply for their own restructured jobs. They need to be convinced that ZBB is not about cutting costs; that instead, it is about value creation since every Rand saved today will be reinvested in the survival of the business.
The process usually creates conflict. You can’t expect the organisation to let longstanding projects and colleagues go, or to live easily with restrictive budgets that constrain every move. After approval, even when everyone seems to be “on board”, the planned levels of expenditure need to be centrally enforced.
Zero based budgeting – in the first year at least – must be followed by centralised authoritarian control of actual expenditure combined with detailed reporting and key performance indicators. Without post-control, the whole process is a waste of time. Costs will creep up to previous levels and the credibility of the process will be lost. A research report from Deloitte found that “poorly designed tracking and reporting” was a key factor in the failure of ZBB in 43% of cases.
Long term and sustainable ZBB savings result not only from clamping down on discretionary costs like travel and telephones, but also from doing things in different innovative ways. There is often an overlap between zero base thinking, technology and business process engineering. Banks are slowly automating their loan approval process aiming to eliminate human intervention. The whole "work from home" movement is a changed business process, a new approach to a traditional way of working. Zoom and Skype are impacting travel costs and the way we hold meetings.
It’s important to recognise that starting entirely from scratch is simply not feasible for most organizations. There will be pre-existing suppliers’ contracts, labour and union arrangements, entrenched (but not necessarily efficient and effective) business processes, and distribution channels that may take some time to re-design. Trade-offs will have to be made.
Zero-based budgeting is about choices. Seems easy, but some decisions will be hard. With limited resources you must decide where to invest and where to constrict. Some things you just have to let go.
WHO SHOULD DO IT?
There is no one single prescription for managing ZBB. To achieve the benefit, the process must be professional, open and respectful. ZBB needs objectivity. In times of real crisis, a review of a company's spending processes and habits by external directors and consultants acting as benevolent dictators – the Kraft-Heinz approach - can create more immediate value than doing it internally.
In a more settled environment, it will be better to combine a central coordination team with full-time support from finance and IT, with part-time involvement from profit and cost centre owners across the company.
In the original US government version many years ago, the zero-base budget proposals were prepared by the department managers themselves, which took months and didn’t result in any cost reduction. Turkeys don’t vote for Christmas. Carter brought ZBB in, Reagan threw it out.