Zero-based budgeting revisited: Why this time
is different
This
budgeting concept allows senior-leadership teams to put their money where their
strategy is, aligning resources with business priorities and setting the
example from the top.
In this episode of the McKinsey Podcast, McKinsey partner Kyle Hawke
and senior McKinsey external adviser Jan Perkins speak to Simon London about
why zero-based budgeting (ZBB)—an idea that’s nearly 50 years old—is having a
bit of a renaissance in companies looking to reset their resource-allocation
methods.
Podcast transcript
Simon London:Hello, and welcome to this edition
of the McKinsey Podcastwith
me, Simon London. Today, we’re delving into the world of finance and
budgeting—specifically, the set of practices known as zero-based budgeting.
Now, zero-based budgeting is making something of a comeback. There are a few reasons for this,
but probably the biggest is companies are realizing that, when done well,
zero-based budgeting can be a very effective way to free up cash for reinvestment.
In other words, it can
underpin a more dynamic approach to reallocating resources across the company.
However, as we’ll hear, zero-based budgeting is not for the faint hearted. To discuss the issues, we’re
joined today by Jan Perkins. Jan is a senior adviser to McKinsey and a former
senior executive in the consumer sector. We’re also joined by Kyle Hawke, who’s
a McKinsey partner based in Washington, DC. Jan and Kyle, thanks so much for
joining today.
Kyle Hawke:Thanks for having us, Simon.
Jan Perkins:Good to be here.
Simon London:Zero-based budgeting is definitely
one of the more quasi-technical topics that we’ve tackled on this podcast.
Kyle, if you don’t mind, maybe start by giving us a quick overview of what
zero-based budgeting is.
Kyle Hawke:The concept of zero-based budgeting
is not a new concept. It was actually introduced in 1970 but is experiencing a
bit of a renaissance in recent years. If you go back and you look at the
definition of it in 1970, it was purely about the budgeting process and
breaking down the budget into small pieces so that management can make
decisions on where to invest. But it was purely a budgeting technique.
In the last five years,
it has experienced a bit of a renaissance because it’s become much more than that. It’s
really a new way of working that allows companies to put their money where it matters most, align resources with their business priorities, and do
that on a repeatable basis.
It’s a process that’s
embedded in the normal financial-planning and management routines. It’s a set
of systems that, first, give you visibility to where you’re spending money and
where your resources are today and allows you to compare that to where they
should be. Then it provides better visibility to where you’re spending, so that
you can have better dialogues with the management team.
It’s a [form of] governance
that makes cost management and resource allocation really part of everyone’s
job rather than just finance.
Simon London:The obvious follow-up there is why
the renaissance? Like you say, as a concept this has been around for quite a
long time. What makes it especially relevant today?
Kyle Hawke:Resources get stuck where they have
always been, and we’ve done a lot of research on this. We studied the resource
reallocation of 1,500 companies over a 20-year period, and what we found is
that 90 percent of the dollars stay where they were the year before. So only 10
percent was actually reallocated across business units, geographies,
or brands.
However, some companies
are moving dollars more fluidly. If you look at those companies with [a] more
dynamic resource reallocation, they actually grow their total returns to
shareholders by 10 percent, whereas the more dormant reallocators grow at only
6 percent. What that means, over that same 20-year period, is that the market
cap of the more dynamic resource reallocators is actually twice that of the
dormant reallocators. It sounds good, right? But the question is how do you
unlock that tight grip that managers have over their budgets? We believe a
large part of that lies in zero-based budgeting.
Jan Perkins:I would add to the rationale behind
the renaissance: companies have years of productivity initiatives trying to
unlock those resources. And I believe there’s a portion of companies that
became quite successful at zero-based budgeting, making it more than just a
cost-reduction or a budgeting exercise and getting some pretty outstanding
results. That caught the attention of your external financial analysts, in
addition to some of the other competitive companies. People became more excited
about what is the magic to zero-based budgeting and can we use it? Will it
work for us?
Simon London:And the criticism was that to do
this well, you need a level of granularity—where costs fall, who the “owners”
are, where the possible efficiencies are, and so on in a more manual finance
world. That was a huge level of effort. But in a world where we’ve got very
good cloud-based finance systems, a lot of that infrastructure is there to
track all this. Is that, broadly, the way to think about it?
Kyle Hawke:If you look at some of the
criticisms of zero-based budgeting, one of them is that it’s not a repeatable
process and is something that you can only do on a periodic basis. What we’ve
seen is that digital tools actually facilitate the process end to end and make
it easier for companies to make it part of the way that they work rather than
this one-time or periodic event.
Historically, budgeting
from zero is very manually intensive and required thousands of spreadsheets
from across the organization, both to build the budget and then to monitor
performance at the required level of granularity. But now there are cloud-based
solutions that—off the shelf, for the most part—can support the majority of the
process and be ingrained in the normal way that you work and replace those
thousands of spreadsheets that existed before.
Jan Perkins:And they enable more than just the
budgeting. They’re also enabling the ability to govern it, and governance, I
think, is a key piece of the sustainability of this sort of initiative.
Simon London:Just say a little bit more about
that, Jan. What do we mean when we talk about governance in this context?
Jan Perkins:Governance is the opportunity to
really maintain that level of visibility and ensure that you are spending
according to the transformational targets and the policy revisions that have been put in
place. [The failure to do] that, I think, would be, in my experience, one of
the key faults of some of the prior initiatives. You make the changes. You post
them. You communicate them. You put it in the budget, and then over the months,
the quarters, and the years to follow, you lose visibility as to whether people
are adhering to the policies, and the spending starts to creep back up.
The governance, when
you’re using the tools to lock into the budgeting, can also connect to other
tools that help you report against what you’re spending. Are you adhering to
policies? And are there other opportunities to look at?
Simon London:Can we put some numbers around
what’s the upside? And what sort of results have we seen for companies
putting in zero-based-budgeting processes and doing it well?
Jan Perkins:So companies have achieved between
10 and 25 percent reductions in aggregate. As you drill down into certain cost
categories—and depending on how aggressive and transformational you want to
be—you can certainly see 50 to 60 to 75 percent cost reductions in particular
cost categories.
But these results are
pretty immediate. You can see them hit the P&L [profit-and-loss statement]
in four to six months. Some of them that are transformational can take longer.
It can take a couple of years. And you can see the savings on any type of
costs. Overhead, of course, organizational supply-chain manufacturing costs,
marketing, distribution, within cost of goods sold, capital expenditures. You
can apply this approach to any type of cost category.
Most importantly—beyond
unlocking these resources, though—a key contributing factor is a new way of
working. And it’s going to build a culture of cost management and an ownership mind-set so people are thinking very
much along the lines of “why should I spend this dollar?” versus historically
saying, “where can I cut?”
Simon London:You talked at the top, Kyle, about incentives.
What’s the role of incentives in this, and what do we mean? Is that giving
department managers incentives to really take this seriously and building that
into compensation?
Kyle Hawke:Every company has a few metrics in
the incentive calculations for executives. And there’s always something around
growth, and there’s always something around profit. But there’s rarely
something around cost as an explicit metric. The assumption is that if we have
growth and we have profits, then cost is in the middle of those two, and it
takes care of itself. In zero-based budgeting, the mind-set or the approach is
that cost is the one thing that managers have complete control over—especially
fixed costs. And therefore we should incentivize managers, or measure the
performance of managers, based on that as an explicit metric rather than an
implicit metric by measuring the other two.
The clarity of ‘what we
report and what we measure, we deliver’ is an aspect of accountability that you
cannot do this without.
Jan Perkins:Kyle, your comments on the
operating profit are exactly right. Most P &L owners would
say, “If I hit my operating-profit target, clearly I have met my cost targets
also in overhead costs.” To hold us accountable to how much we’re spending, and
the assessment of “is this dollar spend necessary,” you need to have cost built
in as a separate metric.
The incentives can be
tied to the operating profit or to the annual bonus. There are several ways to
do it. But the clarity of “what we report and what we measure, we deliver” is a
message and an aspect of accountability that you cannot do this without.
Simon London:What are the other success factors,
do you think, Kyle? When you look at the key things you have to get right here
to do this well, what would you pick out?
Kyle Hawke:I can think of five success
factors. One is that you need to align the approach to the organization’s
culture and objectives. This is not a one-size-fits-all approach, and there are
many dimensions on how to customize it. For example, the level of focus that
you have on reinvestment versus target setting or the degree of granularity in
the budgeting are all choices that a company can make to make it fit for
purpose.
A second success factor
would be to have an intelligent approach to target setting. Not every dollar is
created equal, and there are areas that you want to protect and invest in,
which are aligned with the value drivers of the business. There are others that
you want to eliminate completely or cut to the bone. And you need to be able to
distinguish good dollars from bad dollars, or productive costs from
unproductive costs, so that you can address them intelligently.
The third would be to
have an equal focus on where to invest as there is on where to reduce. If you
overemphasize the cost-reduction or the target-setting aspect, you have the
risk of losing the organization along the way and having them believe that
you’ve gone too far and you’ve swung the pendulum and you’ve forgotten about
growth.
You need to have a
serious and visible commitment from top management as you’re embedding the new
ways of working.
But if you can engage
the organization in identifying where to reinvest those dollars, it’s an
incredibly inspiring moment for them to say, “That was hard, but it was worth
it because we are able to do these things that we weren’t able to do before.” A
fourth would be to focus on changing the mind-sets and behaviors in the frontline operators and not making it just
a financial exercise or a productivity initiative. And then, finally, you need
to have a serious and visible commitment from top management, especially during
the activation phase as you’re embedding the new ways of working.
Simon London:Say a little bit more about
senior-leadership commitment. It’s something that we hear is necessary, of
course, in any big transformational change. But for zero-based budgeting, what
does it mean in practice?
Jan Perkins:My experience was that the
leadership commitment and role modeling were a critical success factor. You
lead by example. Where that became very visible and impactful to the
organization to start the cultural shift and the realization that things would
be different, there would be a new way of working—it begins in the
target-setting. Having a leadership team that’s committed to being decisive and
aligned on where you’re going. Transformational on where they want to see
things differently. Being committed to the idea that if it’s one policy, it fits
and applies to all of us. So that’s walking the walk or leading by example.
We didn’t write
policies where you had the haves and the have-nots—if you were this level or
above, you could still retain this benefit or this service, and if you’re this
level and below, you could not. If we really are going to be serious about the
idea that every dollar matters, it matters no matter what level you’re at in
the organization. It could be something as simple as the commitment, as with
[one company’s] ZBB initiative, to use fewer printers and go paperless as much
as possible. I would see executives come into the meetings and say, “Make sure
you bring your laptop or put a projector in the room because we’re not printing
out copies.” And as soon as you had an executive once or twice say, “No, thank
you, I don’t want that copy,” it didn’t take long at all before everybody
got that message. Just small examples like those would contribute to showing
that we’re serious in a new way of working. And it’s going to take some of the
monies we used to spend and redirect them or allow us to redirect them and grow
the business.
Communication also was
critical. Leaders needed to continually communicate to employees, talking to
them along the way. “Here’s what we’re looking at. Here’s what we’re changing.
Here’s what it means.” Having the leadership be seen as the ones committed to
that and sharing the message. People would hear that message being shared by
the leadership and say, “Wow, they are serious about this, and this is going to
be a new way of working. If they’re going to adhere to the policy, I guess I
shouldn’t ask for an exception to the policy.”
That was not an easy
thing for them to swallow and say, “Yeah, OK, we’re going to give up all of
these benefits also because we’re on the team.” If there was a particular cost
category that we were going after really aggressively, there was the ability to
say, “Let’s collect data. Let’s stay fact based. Let’s accumulate information
on whether we think this is inhibiting us to be successful. So if after nine
months, 12 months, this policy is punitive or it’s not supportive of where
we’re going, let’s agree that we can change it.” Once we did that, you had more
leaders saying, “OK, I can get on board with that. Let’s try it. Let’s do it.
Let’s collect the data.”
Kyle Hawke:It sounds like there was a
willingness to test and learn that may not have existed in other programs.
Jan Perkins:Yes, and to be fact based about it.
It wasn’t hearsay and sound bites; the willingness to do it was based on
“collect the data. Let’s see the real facts. And then let’s continue to be
decisive moving forward.” That was a significant cultural shift and very eye
opening, on several cost categories, to get us to where we needed to be.
Kyle Hawke:Are there other ways that leaders
can role-model—just in terms of the questions that they ask, for example?
Jan Perkins:Part of the success of the total
zero-based-budgeting transformation is to help them be strong leaders so that
they can learn how to approach things differently and then teach their teams
and their managers how to approach things differently. How do you handle all
these constant confrontations and conflicts in negotiations? When you go about
assessing a cost category or looking at it, what are the right questions to
ask? How do you assess whether this spend is necessary? What do I do with a
very strong-willed manager who says, you know, “Life will end if we can’t have
this spend”?
And sometimes just
giving the managers the words, or even the sales reps. “How do I talk to my
clients and my customers now when I have this new meal allowance I have to
adhere to?” You can say to them, “Let’s role-play a little” and talk about how
do you explain to them that “this is where the company’s going. And here’s why.
It’s because we will now have this money to invest in these things that will
grow both our businesses.” Openness and willingness to have those dialogues
were huge learning opportunities and gave us the foundation to build on to
shift the culture.
Simon London:Something I read about in the
literature is around having dual cost ownership or dual category ownership. I
think that’s a really interesting idea. So, Jan, what does that mean in
practice? And how does it help?
Jan Perkins:The dual ownership of cost
categories is extremely interesting, and it’s hard, initially, to get your head
around how that’s going to work. As you talk to the leadership that owns a P &L, not only are you now, from a ZBB standpoint,
analyzing all of the dollars being spent, you’re also introducing another layer
of governance looking over leaders’ shoulders, making sure that they are
adhering to the targets and the spend.
My experience was that
dual ownership was met with some resistance initially, and it didn’t work as
well as we had hoped. Trying to understand the culture of the company and where
the leadership was in the acceptance and acknowledgment of it, we stepped
back and redesigned it. The leadership team needed to step right in and be the
ones who did the cross-category ownership.
You would have a
president of a business unit who had a complete P&L that they were
accountable for but also oversaw the spending in a certain category. Inventory
write-off is a cost category and something that, transformationally, you were
looking to make some significant headway in the processes to, over time, reduce
it dramatically.
That particular
business-unit president would oversee that across the organization. They would
have conversations with other business-unit owners, other supply-chain leaders,
and anybody who was contributing to that overall spend as to how they were
progressing, why they were off target, what things were being done to address
getting back on target, and what help they might need to get there. Once we got
to the point where the leaders were the ones accountable for help in
overseeing, by cost category, it was much more impactful. Plus, they knew they
had the resources under them to support that from a visibility and a governance
standpoint.
Kyle Hawke:I talked earlier about this idea of
adapting the approach to the company’s culture and objectives. One of the ways
to adapt the approach is to design this cost category on a role to be fit for
purpose. So there’s a spectrum of ownership that we see with our clients that can
vary over time, and it can also vary by area of the business or cost category.
On the far left, you
have this individual playing the role of a coach. And on the far right, you
have this individual playing the role of a co-owner. A coach is there to inform
or guide and help share best practices. A co-owner is designed to do all that
but also to have joint accountability for, and a say in, the spend decisions in
that area.
Simon London:This whole part of the conversation
has brought home to me again that zero-based budgeting is not for the faint
hearted. It does involve quite significant changes in the way that people work,
including the executive team. So, Kyle, you must talk to a lot of companies
about zero-based budgeting. How do you know, and how do they know, that they’re
ready to commit to something like this?
Kyle Hawke:So I definitely talk to a lot of
clients on this topic. And I would say that, for every client I have the
opportunity to serve, there are probably ten where we have the conversation and
we explore it, and then we mutually agree that a ZBB approach is not for them.
And this can be for many reasons, but oftentimes it is because there is just
not the leadership commitment at the moment to drive it. That’s OK because
there are other approaches that you can take that are probably more fit for
purpose, and they don’t need to go all-in to really focus on changing the ways
of working.
You have to engage not
just the senior leadership but also these influencers who are not necessarily
at the top levels of the organization.
Simon London:For the one in ten where you do
decide jointly to move forward with a commitment to zero-based budgeting, what
can you do? And what can the executives do themselves to get ready to get this
off the ground successfully?
Kyle Hawke:The first is to help senior leaders
write their own personal change stories. This is their own interpretation or
words of why the company is embarking on this journey and what it means for
them personally. They can then use this change story to communicate and cascade
with their team in a much more personal way rather than taking a script that
somebody else gave to them.
The second is
identifying other influencers across the organization. So you have to engage
not just the senior leadership but also these influencers who are not
necessarily at the top levels of the organization.
The third thing is
something we’ve talked quite a bit about today, which is helping leaders role-model the new, very visible behaviors. Whether that’s dropping the
gold-plated IT service desk that was previously exclusive to the leadership
team or just simply asking the right questions to the organization around what
would it take to get there, it’s helping them role-model those behaviors
because we have seen that to be so critical.
Then, fourth would be
cocreating the answer with employees rather than simply handing it down as a
mandate. And this is incredibly important to drive conviction in the targets
and that, yes, there is a way to get there. So that when you go start to build
up from zero, you actually have a path on how you’re going to achieve it rather
than a bunch of plugs in the budget that you need to figure out throughout the
year.
Simon London:Anything you would add to that
list, Jan?
Jan Perkins:The other piece, once you do agree
to go into this journey—and as Kyle mentioned, giving each senior leader a
personal message—is incorporating in that a knowledge and a foundation on where
the organization has been. There’s no organization out there that hasn’t
already been through some productivity initiative and isn’t going to be
skeptical coming into this right off the bat.
So helping them relate
to that, why would this initiative be different? Also, taking into
consideration the company’s culture and what is it that’s going to help make
this successful? And how you can get them to that point of being fact based and
addressing some of the emotional reactions are really key.
Simon London:So I think that’s all we have time
for today. But, Kyle and Jan, thank you so much. That was really interesting.
Jan Perkins:Absolutely. Thank you for the
opportunity.
Kyle Hawke:Thanks, Simon.
https://www.mckinsey.com/business-functions/operations/our-insights/zero-based-budgeting-revisited-why-this-time-is-different?cid=podcast-eml-alt-mip-mck-oth-1808&hlkid=524e5de268714282a562b6e2a15de21f&hctky=1627601&hdpid=1b940523-f1c1-44c5-9289-051616017869
No comments:
Post a Comment