In recent years, there’s been a fresh buzz around zero-based budgeting or ZBB. According to the Boston Consulting Group (BCG), businesses who adopt this rigorous approach to cost-cutting have achieved savings of 12-30% on their absolute cost base.
But what exactly is zero-based budgeting? What are its pros and cons? And how can your business implement it? Here we take a look.
If your business is struggling and could potentially benefit from a zero-based budgeting reset, contact us today to arrange a confidential consultation.
What is zero-based budgeting?
Zero-based budgeting is a concept that originated in the consumer goods industry in the 1970s. Today, it’s seeing a resurgence due to digital disruption and the ever-increasing pressure to slash costs and stay competitive.
The idea behind it is simple. Instead of basing your annual budget on the expenditure of previous year’s and presuming you’ll operate at roughly the same cost – tacking on inflation and contingencies – you begin each year financially from scratch.
By resetting your budget to zero each time, you have the opportunity to review every single unit item expenditure afresh at the beginning of each budget cycle. Funds are then allocated based on justified need, leading to smarter spending.
Traditional cost-cutting vs. zero-based budgeting
Zero-based budgeting is different from traditional cost-cutting in several ways.
Traditional cost-cutting methods tend to be tactical, one-time exercises, carried out reactively in response to economic threats. They focus on blanket cost-cutting, personnel and non-personnel costs, and lay responsibility on specific business functions.
Zero-based budgeting, on the other hand, is a proactive, repeatable process that happens regardless of financial conditions. It considers your entire cost base with a broader view of budget drivers and sets targets and cost-accountability at a budget-owner level.
The growth or investor mindset
A crucial distinction between traditional approaches to cost-cutting and zero-based budgeting is that ZBB isn’t purely about cost-control.
Zero-based budgeting is also about adopting a growth or investor mindset (McKinsey) – one where your spending is always consciously aligned with your strategic goals and your focus is on shifting costs, realising savings and reinvesting.
In other words, it’s about squeezing money out of your business to fund your own growth through new or existing ventures.
The pros and cons of zero-based budgeting
Zero-based budgeting can be extremely effective. Many companies have reaped huge rewards from implementing this bottom-up, forward-focused approach to managing costs.
However, zero-based budgeting isn’t for everyone. Here are some important pluses and minuses to consider:
- It uncovers inefficient spend
- Can significantly reduce costs and improve efficiency and competitiveness
- Gives you the opportunity to reinvest for sustainable growth
- Instils a cost-conscious culture across the business
- Helps prevents insolvency and takeovers
- Identifies top cost-savvy performers
- More time consuming ‘from scratch’ process
- Difficult to measure annual needs
- It can be hard for some departments to justify spend
- Can negatively affect employee morale if cost-cutting is too aggressive
- Can inadvertently negatively impact the customer experience if cuts are made in the wrong areas
- Challenging to implement, especially in larger businesses
Implementing zero-based budgeting
The BCG argues that to implement ZBB effectively businesses need to strike a balance between cost reduction and growth – identifying nine steps for zero-based budgeting success: Vision, transparency, governance, target, zero-based budget, monitoring, execution, reinvestment and culture.
In practice, these steps mean:
- having a clear strategy
- properly disclosing financial information and value drivers
- giving people ownership of their budgets
- setting smart targets and milestones
- rigorously challenging the budget
- tracking costs
- setting milestones
- reinvesting in ways that best drive growth; and
- enabling a complete cultural shift
These are in line with the actions we take in turnaround.
Challenge the budget, but reward performers
When it comes to zero-based budgeting, focus should be on cutting costs that don’t deliver value to customers or affect the frontline, for example, supplies or facilities. Also, hone in on top-line drivers such as sales, marketing and advertising. Where can you rationalise budgets? How can you increase ROI?
Plus, take a close look at your expense categories. Use technology such as virtual conferencing, e-learning and social media to save on travel, automate processes where you can and go paperless to reduce printing and stationery costs.
However, you need to ensure your cost-cutting efforts aren’t negatively affecting employee morale. To avoid this, create a culture that understands the value in the method and sufficiently incentivise and reward people for hitting budget targets.
Zero-based budgeting is an aggressive but smart way to reset your business year-on-year, cut costs and operate your business more efficiently. By forcing you to regularly rethink your spend, it can slash the unnecessary, fund growth and increase nimbleness.
In an industry where we see businesses struggling, it’s a budgeting strategy that certainly makes sense – ideally in a proactive rather than a reactive way.