Zero-based budgeting revisited

Is now the time to give it a second chance?

The Corona crisis is shaking up entire industries and pushing companies to the limits of their capabilities. Uncertainty about the duration and extent of the crisis and the need to cut costs is a significant challenge for many businesses. However, even without the Corona-crisis, digitalisation is turning existing business processes on their heads, especially in the financial departments. Besides, new competitors offer products and services that did not exist in this form before.  Despite this initial situation, many companies’ cost management is still based on the old “business as usual”. Budgets are determined based on the previous year, therefore representing existing structures and making it tough to reprioritize. Especially in such disruptive times, it is necessary to rethink cost structures to free up capital for activities that drive growth. This is where the “forgotten” zero-based budgeting (ZBB) comes into the equation. ZBB is a method of cost management in which the budget is planned from scratch. Thus, ZBB aims to ensure that every euro is spent in line with the company’s strategy and has the overall goal to reduce costs. In this objective, the focus is on a reallocation of available resources from tasks that are not essential to strategic projects that ensure the company’s growth.

In this article, we want to take a closer look if ZBB could be a suitable principle to react to the current situation and rethink planning and budgeting.

Zero-based budgeting makes you think about the company from the first principle

To make ZBB work in an organizational context, companies should follow a couple of rules. First, the management needs to understand the business and ask what activities and resources are essential to compete under future market conditions. An honest answer to this question can be uncomfortable but is the crucial starting point to making a real impact through ZBB. Second, after answering this key question, a clear strategic vision and cost targets need to be set to provide a frame for future budgeting decisions. Furthermore, a comprehensive fact base of current offerings, functions, and expenses must be established to assess the company’s whole cost situation.

Usually, it is an appropriate way to apply ZBB firstly in a project for some company areas before rolling it out to the entire organization. For the successful implementation of a zero-based budgeting project, the management forms a project team consisting of top-class employees of the company who represent the company-specific functions, such as R&D, production, logistics, finance, human resources, and materials management. Also, to gain the full advantages of ZBB, it can help to start with an unbiased and nonhierarchical view of the organization and the budget process. Managers can oftentimes achieve this by bringing in new (to the topic) employees or external project management. For maximum impact in its application, ZBB needs to be more than just a tool to reduce cost. Strategic cost reduction can only be successful if savings are reinvested in business areas that promote growth, innovation, productivity, or enhance customer experience.

 

Use zero-based budgeting to increase transparency and strategic alignment

ZBB confronts conventional thinking and resource allocations by challenging every line item and assumption, including those considered “sacred” in the organization. Hence, especially for complex and large companies, zero-based budgeting can be a helpful tool. In addition, key strategic imperatives can be created while removing high non-value-adding costs that burden the company’s bottom line. In conclusion, ZBB brings transparency of spending, encourages cost discipline, and pushes managers to reallocate budgets in an agile manner.

For example, a large European corporation in the travel industry launched a new venture to utilize the available data for new business models. The company’s initial direction was explorative and could not be defined precisely for the first years until a business model was clearly established. Hence, an approach was needed that did not create unnecessary cost structures in the early days of the venture. ZBB offered precisely that because it aligned the limited available resources with the strategic evolution status Also, it encouraged the management to continuously ask the “make-or-buy”-question to keep a maximum level of efficiency in the operation. At the core, the venture transferred budget definition responsibilities down the hierarchical order to a level where it could accurately evaluate operations from the first principle. Top-level management then received an aggregated view and trimmed it towards strategic fit. That rigor was crucial to keep the effort low and utilize the “agile advantage”.

Finally, it unleashes a culture of steady improvement. ZBB can be helpful if the cost basis cannot be sustained due to market circumstances and therefore be a valuable tool to lower the break-even point of a company in tough market conditions – like we are experiencing right now.

How digitisation brings zero-based budgeting back into focus and enables a truly agile approach to planning

The emergence of digital budgeting tools enables the further application of ZBB in today’s companies. In the past, ZBB was often seen as tedious and time-consuming. Budgeting can be an onerous duty, and especially the finance departments of large companies must collect, compile, review, and revise the budgets of many cost centers. This state can be frustrating both for the companies that rely on the allocated resources and for the employees who are forced to reconcile many differently formatted spending requests manually. The introduction of user-friendly spreadsheet software has increased this problem The versatility and flexibility of familiar desktop spreadsheet software simply do not scale well, allowing the creation of an almost infinite number of templates, making their merging an even more manual and error-prone torture. However, today, the real-time provisioning of financial and key-performance-indicators and currency conversions provides a fast track to meaningful budget reviews. Budget planners can now focus on understanding business requirements and can establish new business policies.

Second, in crisis situations like many industries are experiencing right now, ZBB can be a valuable tool because it allows to think from first principles and exemplary, brings enough urgency into the reaction of a steep demand decline, or an interruption of logistical chains.  Furthermore, in those areas, category savings are often challenging to realize immediately because of long-term contractual commitments, or the lead time required to make the change. Traditionally when applying ZBB, the lack of immediate value realization typically pushes these cost categories out of scope. Technology makes it easier to take these efforts on, enhancing transparency and enabling decisions today that may not produce savings until sometime in the future. Nevertheless, ZBB also has disadvantages which must be professionally evaluated before implementation. On the one hand, the successful and sustainable implementation can be a complex and lengthy process. Especially in the first year of implementation, it involves much effort. Besides, the employees affected need special training to ensure successful implementation. Lastly, ZBB is not a method that can always be applied in the same, standardised way but requires a specific adaptation to the respective company.

To sum up, zero-based budgeting is more than just short-term cost savings, which, in the worst case, could pose a threat to the company’s future competitiveness. Essentially, ZBB is about making companies more agile, more cost-efficient, and more competitive. Small-scale approaches, which mainly focus on fixed costs and cost of goods sold, are a common mistake when implementing cost-cutting measures. Besides cost savings, continuous improvements in cost management, optimization of processes, and employees’ motivation to act as owners of the company, are therefore goals of a zero-based budgeting approach.

Draxinger & Lentz helps you to rethink planning and budgeting. We enable our clients to exploit the full potential of ZBB, create an efficient and agile planning process, and avoid common pitfalls of ZBB. D&L always considers the current situation, strategic priorities, and transformation ambitions of our clients and provides a tailor-made approach for the application of ZBB or other planning approaches.

 

If you want to get more information on how to implement zero-based budgeting in your organization, feel free to contact Fabian Winckler (fabian.winckler@draxingerlentz.de) or Marco Lotz (marco.lotz@draxingerlentz.de).