Five myths (and realities) about zero-based budgeting
Companies often shy away from the method because they fear it or believe it means “budgeting from zero.” In reality, it’s a structured process that can build a culture of cost management.
As
many companies watch growth in
sales, general, and administrative (SG&A) costs outstrip
increases in revenue, controlling expenses has become an even greater
priority. As a result, executives are under ever-increasing pressure
to deliver productivity improvements, and almost all companies have
sought to reduce costs, whether through traditional programs such as
outsourcing, offshoring, and strategic sourcing or other one-off
cost-reduction events. But in many cases, these are still not enough.
Executives need bigger savings that can be sustained over time.
Unfortunately,
the typical approach to identifying cost-reduction
opportunities—examining operating expenses in the aggregate—is
poorly suited to driving realizable, lasting, and significant
benefits. The findings are often too high level to link clearly to
the actions required to unlock the savings. Moreover, managers can
avoid action by refuting the underlying data or citing unique
business needs. Given such constraints, when savings are required,
executives often feel they have no choice but to slash and burn,
making arbitrary budget cuts without any changes to the underlying
work, regardless of how prudent or sustainable those choices may be.
Fortunately,
there is a sustainable alternative to cost management appropriate for
many companies: zero-based budgeting (ZBB). We have heard of many
versions of ZBB, including the literal interpretation of the words:
“a technique for building a budget from zero.” While that is
certainly a fundamental part of ZBB, our experience has shown that
effective ZBB is much more than that.
Five myths, five realities
Zero-based
budgeting is a repeatable process that organizations use to
rigorously review every dollar in the annual budget, manage financial
performance on a monthly basis, and build a culture of cost
management among all employees. A world-class ZBB process is based on
developing deep visibility into cost drivers and using that
visibility to set aggressive yet credible budget targets.
The annual
budgeting process does in fact start from zero and is very detailed,
structured, and interactive in order to facilitate meaningful
financial debate among managers and executives. Throughout the year,
multiple owners are tasked with managing performance and continuing
the healthy debate on cost management. Through new system and process
controls, and aligned incentive programs, all employees make cost
management a part of their daily routine.
One
company recently realized 11 percent savings in its operating budget
within the first four months of a new ZBB program. In this instance,
immediate savings came from increasing visibility into labor costs
and executing new approval thresholds to control demand for contract
labor, relaunching procurement initiatives to renegotiate prices, and
changing “make versus buy” decisions.
More than 40 percent of the
savings were strategically reinvested in new teams and sales staff
who spent all their time with customers. While this company chose to
reinvest those savings in the customer-facing parts of the business,
other companies use the savings to fund and therefore amplify the
next wave of productivity. And, of course, some let the savings fall
to the bottom line.
When
properly implemented, ZBB can reduce SG&A costs by 10 to 25
percent, often within as little as six months. Just how ZBB is
capable of delivering and sustaining these results remains a bit of a
mystery for many executives. The opaqueness of the term and the dire
tone of the media stories can be intimidating, sometimes causing ZBB
to be avoided as an option for improving productivity. What follows
is an attempt to explore some common myths, debunking them and
highlighting how a well-run ZBB program can drive sustainable impact
in leading organizations.
Myth one: ZBB simply means building your budget from zero
Reality:
ZBB is a repeatable process to build a sustainable culture of cost
management
Zero-based
budgeting is much more than building a budget from zero. World-class
ZBB efforts successfully build cultures of cost management throughout
the organization by using a structured approach to facilitate cost
visibility, cost governance, cost accountability, and aligned
incentives. Fortunately the culture shift isn’t left to chance. We
believe that there is a proven, step-by-step approach to implementing
successful ZBB programs, and when this implementation is done well,
ZBB makes cost management a part of the way every employee works on a
daily basis.
Myth two: Implementing ZBB requires cutting ‘to the bone’
Reality:
The degree of cost reduction is based on the company’s top-down
target
Although
very little has been written recently about zero-based budgeting, the
published content that exists often associates it with cutting costs
to the bone, using any means necessary (for example, eliminating mini
refrigerators in office kitchens to save electricity). While this may
sometimes occur, it is by no means necessary. Simply put, the degree
(and aggressiveness) of each company’s cost cutting reflects the
size of its top-down savings target. For instance, in the most
aggressive situations, we’ve seen 30 percent reduction targets in
year one versus other situations that aim for 10 percent reduction
targets with an agreement to reinvest half of that into more
productive areas, therefore only taking 5 percent to the bottom line.
Myth three: ZBB will overwhelm your business and prevent it from doing anything else
Reality:
Initial rollout of a new ZBB program can be led by a central team and
completed in four to ten months
Recently,
one executive we met with said, “I simply cannot afford to ask the
entire company to stop what they’re doing for the year to implement
ZBB.” The idea that ZBB requires dedicated focus from every
employee for a year or more is simply not true. While it takes time
to embed a new cost-management culture into any organization, the
setup and rollout of a new ZBB program has much more limited
requirements.
During
the initial setup, a central coordination team develops deep
visibility into costs and sets detailed savings targets for the next
budgeting cycle. That team also ensures that the company’s systems
and processes are in place for the detailed reporting, governance,
and performance management that a world-class ZBB requires. In our
experience, this setup period could take anywhere from four to ten
months and is primarily led by full-time support from finance and IT,
with part-time involvement from profit-and-loss owners and
cost-category owners across the company.
Organizations
that are unsure about ZBB’s upside are well suited to pilot the
process. There are many ways to build these pilots, each of which can
be customized to meet the company’s objectives. One company, for
instance, is piloting a ZBB rollout across its global finance
function. This approach builds capabilities within the team that will
help drive the program across the enterprise while having the added
benefit of helping team members achieve their existing budget
targets.
Myth four: ZBB only focuses on SG&A
Reality:
ZBB can be applied to any type of cost: capital expenditures;
operating expenses; sales, general, and administrative costs;
marketing costs; variable distribution; or cost of goods sold
The
fundamental elements of a ZBB program—governance, accountability,
visibility, aligned incentives, and a rigorous process—form a
comprehensive cost-management tool kit. However, certain adjustments
need to be made when using this tool kit in particular areas. For
example, when ZBB is applied to variable costs (such as cost of goods
sold, variable distribution) the budget needs to be volume adjusted
in monthly performance reports. When ZBB is applied to capital
expenditures, costs are categorized by discrete investment choices
rather than types of expenses, as they are with operating expenses.
Myth five: ZBB is not designed for growth-oriented companies
Reality:
ZBB is successfully used by growing companies to redirect
unproductive costs to more productive areas that drive growth
Zero-based
budgeting is a powerful tool for any company, whatever its
orientation. Even if the organization’s primary focus is on growth,
profit, or talent retention, cost management remains crucial to its
success. Eliminating unproductive costs allows the company to be
redirected to more productive areas. As we mentioned in the earlier
example, back-office costs can be redirected to customer-facing
activities.
ZBB
is not a slash-and-burn exercise that cuts costs without regard for
the expense. With deep visibility into costs, changes can be made to
surgically cut the fat and help build up organizational muscle.
Zero-based
budgeting can drive significant and sustainable savings, but it is
much more than simply building a budget from zero. World-class ZBB
programs build a culture of cost management through unprecedented
cost visibility, a unique governance model, accountability at all
levels of the organization, aligned incentives, and a rigorous and
routine process. ZBB frees up unproductive costs and allows those
savings to be taken to the bottom line or redirected to more
productive areas that will drive future growth.
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