In a strategy class the other evening, a student asked if I was familiar with the concept of Zero Based Budgeting. To his surprise, I said I was.
In a series of recent Wall Street Journal articles, mention was made of a 1970s-based cost-cutting managerial technique used by 3G, the Brazilian private equity group, who, along with Buffett’s Berkshire Hathaway financed the merger of Heinz and Kraft Foods. That technique, Zero Based Budgeting (ZBB), is a budgeting process that involves forcing managers every year to start at zero and explain each and every cost they need, as opposed to merely adding on the prior year’s budget. (http://blogs.wsj.com/moneybeat/2015/03/25/on-zero-based-budgeting-activists-at-knee-of-3g/?KEYWORDS=zero+based+budgeting)
In the 1970s, ZBB got a bad wrap due to the connection with the Federal Government implementation attempts. Such bad experiences were described by the Carter Administration and other government entities that the ZBB movement lost much of its luster. However, with the implementation by such stalwarts as Buffett’s co-investors, new interesting is being shown as a means to take costs out of an existing company.
Companies that implement the ZBB process hope to achieve significant cost savings by looking at every department, product/service, and activity on a value-added based seeking to determine whether the firm really needs that item or to perform that activity. This short paper will provide background on the ZBB process.
Zero Based Budgeting (ZBB)
ZBB is an approach to planning and decision-making that reverses the working process of traditional budgeting by examining every line item of the budget to ascertain its necessity. Each budgetary item must be approved, not just the change from prior periods. The ZBB process also refers to the identification of a task or tasks and then funding resources to complete the task independent of current resourcing.
Zero-based budgeting starts from a “zero base” and every function within an organization is analyzed for its needs and costs. Budgets are then built around what is needed for the upcoming period, regardless of whether the budget is higher or lower than the previous one.
For instance, an accounting department will examine its work flow process. Do certain activities like internally maintaining payroll need to be manually processed? Could it be automated? Could it be outsourced to a third party provider? Or, does a certain activity even need to be performed anymore?
Conceptually, ZBB complements and links to existing planning, budgeting and review processes. It allows top-level strategic goals to be implemented into the budgeting process by tying them to specific functional areas of the organization, where costs can be first grouped,
then measured against previous results and current expectations.
Many who implement ZBB only look at it as a cost-cutting process. Instead, if implemented properly, it may be determined that activities or processes may be added to a department or should be invested in to enhance the strategic performance of the organization.
There are numerous advantages and disadvantages to the ZBB process. Certain advantages or benefits include:
- Efficient allocation of resources, as it is based on needs and benefits rather than history.
- Detects inflated budgets.
- Identifies and eliminates wasteful and obsolete operations.
- Identifies opportunities for outsourcing.
- Forces cost centers to identify their mission and their relationship to overall goals.
Some of the disadvantages are:
- More time-consuming than incremental budgeting.
- Justifying every line item can be problematic.
- Requires specific training, due to increased complexity vs. incremental budgeting.
- The amount of information backing up the budgeting process may be overwhelming.
Firms who have implemented ZBB tend to adjust the process over time. Instead of conducting Zero Based Budgeting annually, they may perform the thorough implementation every four or five years. Also, they may implement it on only the most important, either strategically or resource-wise, instead of every single deparment.
ZBB and Startups
The interesting characteristic of ZBB is how it relates to the budget planning for startup companies. Or, more importantly, how startups perform ZBB processes without knowing it. Because young organizations are limited in resources at the beginning, they tend to spend lots of time ascertaining whether they really need to spend money on a particular activity or if they do without or at least bootstrap it. Only when they get older with greater resource levels and success, do they forget their original ZBB mentality.