What if there was a way to manage costs that emphasized funding growth as much as cost-cutting discipline? Take another look at zero-based budgeting (ZBB).
Many CFOs fear imposing austerity measures may hinder growth, hurt morale, and limit flexibility at a time when most organizations prize agility. Since the ZBB methodology of building annual budgets from scratch first became popular in the 1970s, it has often been regarded as a tactic for companies in dire financial straits.
But if correctly implemented, ZBB can help automate and simplify the budgeting process and align costs with future goals in a range of targeted scenarios, including growth stages.
In Ernst & Young LLP’s experience, when using ZBB, 45% of clients have achieved cost reductions of 10% to 20%, and a further 35% have cut costs by more than 20%. However, the real power of ZBB is not in achieving cost-cutting benchmarks; it lies in combining digital budgeting tools with greater cost accountability and a process that links budgeting discipline to future growth.
ZBB does this by using analytics to help prioritize competitive capabilities that require new investment over SG&A (sales, general & administrative) areas where overruns often occur. Those areas include non-strategic headcount, travel, unused technology, real estate, maintenance, and back-office expenses. When coupled with operating model improvements, ZBB can also prevent nonstrategic costs from creeping back into the budget.
In one example, a major retail chain developed detailed budgeting templates, deployed a cloud-based budgeting platform, and implemented change management that included training for more than 250 users. In the two years following the initiative, the company achieved 25% to 30% cost savings from non-strategic areas. It used the savings to enhance the in-store customer experience and improve its mobile app.
When to Use ZBB
Some organizations urgently need cost transformation, while others manage costs effectively but would benefit from reallocating resources. In the wake of the COVID-19 pandemic, companies seeking to jump-start growth may need greater budgeting discipline together with an investment focus. The following are four scenarios in which ZBB can be used.
ZBB is not just for companies in financial crisis, but can help restore liquidity, relieve pressure from apprehensive investors, or reestablish short-term profitability.
Companies undertake targeted restructuring when they may need to cut costs quickly. However, since targeted restructuring isn’t driven by severe financial distress, the organization can more selectively cut expenses.
Cost enhancement or management
Companies focusing on medium-term improvements can use ZBB to cut waste and manage increases in future spending. In established industries with low margins, even minor cost improvements can significantly benefit EBITDA (earnings before interest, taxes, depreciation, and amortization).
A company may have already completed a cost-takeout initiative but wishes to rebalance its investment portfolio. ZBB adds cost-cutting focus by providing visibility into price and quantity drivers, average prices paid for goods and services, and location-based spending data. It supports the investment process as a tool to gather the information needed to make strategic spending decisions.
We recommend an updated, five-stage approach to ZBB.
Strategy alignment and cost visibility. Digitally supported ZBB helps the organization establish cost baselines, use benchmarks to set targets, and align specific expenditures to corporate strategies.
Budgeting. Budgeting becomes an automated process of creating a balanced spending agenda, with justification required for each line-item entry.
Accountability and sustainability. The company deploys cost-category ownership and governance structures, supported by change management, to promote sustainable cost management and reinvestment across categories and functions.
Control and monitoring. Automation enables early detection of overruns and tracking of reinvestment through defined policies and controls, including quality key performance indicators and monitoring to enable cross-organizational visibility.
Operating model optimization. The operating model helps unlock value by aligning the organization’s structure to long-term objectives. ZBB can help fine-tune the operating model by re-prioritizing the processes that best serve strategic business goals.
Akshat Dubey is a partner and U.S. EY zero-based budgeting leader at Ernst & Young LLP.