Why zero-based budgeting makes sense again
Advanced digitization,
enhanced behavioral understanding, and smarter organizational and governance
models spark a renaissance for a decades-old methodology.
After first making a
splash in the 1970s and
then fading in popularity over the ensuing decades, zero-based budgeting (ZBB)
is making a comeback. At its best, ZBB
brings remarkable spending visibility, helps achieve relentless cost
discipline, encourages managers to reallocate resources in an agile fashion,
and unleashes a culture of continuous improvement. Those benefits apply to
organizations in all stages of the corporate cycle, from mature (and often
profitable) companies still budgeting under “same old, same old” methodologies
to more nimble, posttransformation firms trying not to slide back to their
former “business as usual.”
To have maximal impact,
ZBB needs to be more than just a rote implementation of the process’s textbook definition; namely, to build a completely new
budget each year, function by function and project by project, by starting from
a zero base (rather than by starting from the prior year’s expenses).
Fortunately, advances in understanding the psychology behind ZBB; the
availability of newer, digital-based tools; and the power of singular purpose
within an organization—including the right messaging from senior leaders and
appropriate incentives to walk the talk—are making it easier than ever to bring
ZBB back to the fore, and to sustain its improvements for the long term.
ZBB: Why now?
ZBB is designed to
scrutinize every dollar. In a low-growth environment, it’s easy to see why
keeping costs down would be especially attractive. But the fundamentals of P’s
& L’s have largely been ever thus, and today’s ZBB renaissance comes from
more than just typical margin forces at work. In fact, the current climate of
disruption is unique because it has brought a heightened scrutiny about which
business models make the most sense (even when that means a dramatic shift from
the company’s traditional focus) and how resources should be allocated to best
effect. Decisions must be made faster, results are expected more rapidly, and
performance details are laid bare to a broader audience than ever before.
Fortunately, today’s
challenges have brought new advances to meet them. That, too, represents a
change from the “same old, same old.” For many years, ZBB was tedious and
time-consuming—certainly, more difficult than rules of thumb such as “last
year’s budget plus or minus” some percent. Let’s face it: budgeting
can be a chore, and finance departments at large corporations must collect,
collate, review, and revise budgets from hundreds—if not thousands—of cost
centers. That can be frustrating both to the businesses, which rely on the
allocated capital, and, even more, for the workers forced to align by hand a
vast array of differently formatted spend requests. Ironically, the
introduction of user-friendly spreadsheet software actually exacerbated the
problem. Familiar desktop-spreadsheet software’s versatility and flexibility
simply does not scale well and enables different managers to produce an almost
infinite variety of templates, which make aggregating them an even more manual
and error-prone ordeal.
New digital tools,
however, now readily available commercially, virtually eliminate this pain
point. Effective cloud-based digital-budgeting products, while no less
intuitive than offline spreadsheets, are programmed to compel disciplined data
entry. This forces managers to align their inputs to formats that synthesize
instantly. The result is a budgeting godsend. At one consumer-packaged-goods
(CPG) company, for example, one globally deployed cloud-based tool replaced
more than 10,000 offline spreadsheets, vastly freeing up the time and capacity
of the finance function. The tools—fast, scalable, and easy to deploy and
configure—also helped the company integrate business rules and data validation
into the budget-planning process, and enabled different cuts of financial data
suitable for different purposes. Perhaps most important, the advances made
finance assumptions more clear, fostering a consistent approach throughout the
organization. That helped everybody to work from the same ZBB playbook.
Turning ‘why’ into ‘how to’
It’s important to
recognize why ZBB is significant again, and it’s encouraging to know that
digital advances are opening new possibilities. But actually pulling off a
transition to ZBB—and better yet, sustaining the shift—requires a deeper understanding
of how ZBB can gain acceptance, and what leaders must do to keep it the new
normal.
ZBB and how our brains work
ZBB is at its core
about building a culture of cost and performance management. As such, it works
best when it accords with how people think and behave. In our experience,
managers of effective ZBB implementations often succeed because they harness
and channel employees’ own hardwired behavior. Sometimes, the secret of success
may seem a mystery—but if we understand the will behind the way, it doesn’t
have to be.
One normal human bias
is loss aversion, also known as “the endowment effect.” This phenomenon—our
ingrained preference to avoid losses more than to acquire equivalent gains—is
deeply rooted in human evolution. For example, losing one’s daily food ration
could lead to illness or death, but gaining one additional ration will have
only limited benefits. Our default psychological setting thus is to guard what
we need, rather than to gamble on acquiring something we may not.
Leaders can frame ZBB
to neutralize loss aversion by presenting it as building up from a zero base;
that is, as a no-risk spending gain instead of a painful cost cut. Case in
point: one company kicked off its cost-reduction drive with a line-by-line review
of its upcoming investment projects. Management’s introductions were to cancel,
defer, or decrease spending wherever it could. The executives tasked with
identifying potential cost cuts initially came up with a reduction of less than
5 percent. But when they blanked out the reductions and challenged the team to
justify adding to the corporate base budget project by project—thus avoiding
the appearance of loss—the same executives were able to achieve more than 40
percent savings. The same business leaders approached the problem with an open
mind to fundamentally changing how business was being done. After a few rounds
of back and forth to resolve cross-dependencies, leadership successfully
shifted mind-sets away from the psychological framework of loss aversion and
toward a sense of coming out ahead.
A second ingrained
behavior is status quo bias, otherwise known as the “path of least resistance.”
One illustration is the organ-donation rate in Germany and Austria. Germany
requires organ donors to actively “opt in,” while Austria assumes all drivers
automatically consent to organ donation, but permits them to affirmatively “opt
out.” Despite an extensive (and expensive) awareness campaign in Germany, the
country achieved a mere 12 percent organ-donor rate. In Austria, by contrast,
the organ-donor rate is 99 percent. That’s because people tend to stick with
the status quo.
To encourage a
zero-based approach in your organization, plan for ZBB to be the default
outcome. For example, consider making underperforming products or business
lines “sunset” automatically, subject to an accountability exception, such as
renewing spending only if a manager actively stumps for it. Designating a new
status quo helps unleash previously untapped creativity and frees managers to invest
more time and attention in exploring alternative, digital options—and makes
cost discipline the path of least resistance.
A third demonstrable
trait is that people behave more accountably when they perceive—consciously or
subconsciously—that someone else is watching. One of many examples is an
experiment conducted by psychologist Melissa Bateson, who placed an “honesty
box” along with a price list for tea and coffee in a university commissary.
Next to the price list, depending on the week, she placed either a picture of
flowers or a picture of eyes. Average payments were about three times higher
during the weeks when pictures of eyes were displayed. There were no
supervising personnel and no security cameras, yet the mere suggestion of being
“watched” caused the commissary users to adjust their behavior.
People being people,
this dynamic plays out in corporate settings as well. We have found that the
simple exercise of submitting spending requests to one’s manager serves to tamp
budgets down—not because managers are predisposed to reject the increases, but
because the perception that someone else is paying attention induces employees
to exercise self-restraint. To take another example, one company we know
eliminated 20 percent of its printing costs merely by posting the previous
month’s costs next to the stationery area. Another openly discussed in
leadership meetings the cost of the printing for that specific meeting—very
quickly, presenters declined to bring printed documents knowing that their audience
would know the cost (and environmental impact) they incurred. This visibility
makes employees take note of the amounts being spent and helped foster a “Do I
really need this?” mind-set.
Aligning personal with process
For all of the
personal, psychological reasons why ZBB should gain acceptance, we’ve found
that the greatest obstacles often arise from the institutional workings of
individual companies themselves. Too frequently, ZBB’s detailed budgets can
come off as one more burdensome to-do—even more so when the budgets are
implemented as a series of rote directives according to a prescribed script.
And when companies fail to come out of the gate quickly, budget misses tend to
compound, becoming progressively more difficult to overcome. Who wouldn’t resist
under those circumstances?
Rather than try to ram
ZBB through organizational inertia, leaders should, as we’ve discussed, turn
human biases into a force for positive change: present ZBB not as a loss but as
a gain; make ZBB the path of least resistance; and tap the power of
transparency. Add to that, as well, the very human preference for order above
chaos—now addressable through powerful, intuitive digital tools that simplify,
expedite, and put everyone on the same budgetary page—and the likelihood for success
is even greater.
But to really drive the
changes home, organizations must build a cost culture—which means, in turn,
that additional measures are critical. A crucial step is to align compensation
with ZBB conviction. We’ve found that rewarding high-performing business
leaders—with both hard and soft incentives aligned to controllable performance
elements—is essential. At one multinational corporation, for instance, senior
executive compensation was changed so that, in order for an executive to receive
the maximum variable portion, he or she would first have to meet a specific
threshold for performance on the management of operational expenditures.
Thoughtfully controlling costs went from being a “side job” to one of the core
focus areas for the senior-leadership team.
By Hanspeter Hueter, Carey Mignerey, and Tao
Tan January 2018
https://www.mckinsey.com/business-functions/operations/our-insights/why-zero-based-budgeting-makes-sense-again?cid=other-eml-alt-mip-mck-oth-1801&hlkid=4a9f5656e9174c98b1dace9ae3d1a5db&hctky=1627601&hdpid=68a48036-a3fc-4b45-b91c-af9893d2faf7
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