Why the Best Businesses Adopt Zero-Based Budgeting
Posted by Sjoerd-Jaap Westra
Starting at zero doesn't sound like a great idea. But some of the best businesses have decided to do just that. Zero-based budgeting (ZBB) is a decades-old, controversial method of budgeting that's making a comeback, and companies are showing great gains because of it. See what zero-based budgeting is all about and why it makes more sense now than ever.
What Is Zero-Based Budgeting?
Zero-based budgeting (ZBB) was the brainchild of Peter A. Pyhrr and introduced by the Harvard Business Review in 1970. It wasn't an idea to cut costs or tighten the belt, but a strategy that helped organizations forget about the past so they could focus on the future. The method goes like this:
- Forget about last year's spend and reset budgets to zero.
- Each functional team researches and constructs their own plan based on current needs.
- Teams present a budget asking for a specific investment and promise a specific return for it.
- Senior management reviews the plan and either grants the amount or pushes it back for changes.
This results in senior managers betting their resources on:
- Better people
- Better plans
- Better strategic opportunities
In effect, this strategy reduces investment in the less effective people with ineffective plans and provides accountability through a promised return.
Why ZBB Works
In addition to moving the emphasis to future success rather than past failures, ZBB helps identify and eliminate unproductive costs so owners can reallocate capital to areas of growth and strategic objectives. Other benefits include:
- A standardized and replicable approach
- Ability to roll out across a portfolio of companies
- Aligned processes, controls, cadences and incentives.
According to McKinsey & Company, companies must rethink their success mindsets to make zero-based budgeting work. The five areas they identified are:
- Deep visibility into cost drivers
- Dual-ownership governance models
- Processes for planning and monitoring
- Aligned incentives
- The right mindset
Who Uses ZBB?
One-fifth of CEOs in a recent survey by CEB Global already have ZBB in place. Some of the more successful organizations include:
- Boston Scientific
- Jarden Corporation
- ConAgra Foods
Other companies also joined in after 2015 when 3G Capital combined H.J. Heinz with Kraft Foods and experienced a huge success. Reuters reported that 3G sported "an estimated year-over-year gross margin expansion of 258 basis points" with this move. Reuters also reported that Cheniere Energy Inc., Huntington Bancshares Inc., Baxter International Inc. and Ford Motor Co. are some of the latest corporations with ZBB strategies.
Is ZBB for Everyone?
Ironically, Harvard Business Review, the same venue that introduced ZBB so many years ago, has cautioned the decision to use ZBB. These cautions are based on aspects such as the inability to address operational excellence in core processes, inability to identify fundamental cost drivers like organizational complexity and customer complaints and a lack of challenge to existing process design.
While some may still doubt the effectiveness of the recent resurgence of ZBB practices, technological breakthroughs have made those worries obsolete. With real-time, cloud-based finance systems and integrated ERP, CRM and marketing solutions, companies are no longer relegated to the cumbersome manual analytics that were used decades ago when ZBB started.
Today, gathering the information needed to reset to zero and analyze the results is as easy as clicking a button to customize a report with the data you need. Even if that data comes from multiple departments or entities, it can be parsed within a matter of seconds rather than weeks or months.
Zero-based budgeting is an oldie but a goodie when combined with today's technology. This strategy may start with one zero, but it's the extra zeroes at the end that make this strategy the new go-to approach for businesses that want to add to their financial success.