Zero Based Budgeting: the way forward
A company’s work culture is an intrinsic factor in determining its growth and adaptability. We are living in arduous times, making it imperative for managers to come up with efficient strategies for finance management. The pandemic’s obtrusive nature has not only caused billions in losses (the global GDP is predicted to lose about 346.98 billion U.S. dollars) but has also forced companies to change their work culture.
With cases increasing all over the world, the first response of the companies, ideally, should be to secure their cash base -the travel ban that has been implemented across countries has only added to their losses- making it imperative for them to ensure adequate liquidity for running operations during these adverse times.
Some even initiated vehement cost cuts to secure their cash position and redefined the rules for discretionary spending. However, with volatile projections related to recovery leaving current plans and budgets render obsolete, problems haven’t ended yet. The humanitarian and economic dislocations as a result of the pandemic has caused several companies to rethink their strategies for the “new normal.”
Zero Based Budgeting
Zero-based budgeting, a cost optimizing exercise, came in with a splash in the 1970s but soon lost its charm because of excessive and tedious procedures of cost- cutting and lack of digitalization during that period (especially in a large organization). ZBB is a bottom-up approach, with origins in the consumer goods industry, it focuses on building a culture of cost and performance management. It revolves around the simplest of economical concepts: optimal resource allocation.
Zero-based budgeting essentially means scrutinizing the budget for every new project. Contrary to blanket cost cutting procedures, this strategy calls for a more decentralized version of cost cutting. It enables the organization to make active, well-considered choices rather than merely revising its ongoing trajectory of prior spending. Focusing on four key areas: indirect spending, organization, supply chain, and marketing, this approach requires managers at all levels to look at every project with fresh eyes. ZBB stipulates a lean and optimized cost base–with “zero bad costs”–to free up funds and ensure flexibility so the company can pounce on opportunities when they emerge.
The economy has put survival skills and preparedness to the test. As the recession grows stronger , ZBB transformation could be instrumental in strengthening the company both offensively and defensively. A delayed response of companies to the crisis will lead to draining of savings to shore up the balance sheets. However, if an accelerated ZBB program is implemented now, it will help companies respond to the crisis immediately and generate liquidity relief via data-driven identification and prioritization.
This all boils down to how to make it work in practice? How to manage the cultural change without compromising on the morale of the employees? ZBB is more like the way of doing business rather than a technique itself, it requires a change in mindset.Let’s see what tricks and methods we have up our sleeves:-
- Companies need to alter their processes, layers, control mechanisms, roles, and decision rights and establish sound reporting relationships.
- Companies will have to incorporate this agenda, starting from the C-suite as a source of motivation. Rewarding, acknowledging and retaining employees who religiously follow these practices with hard and soft incentives is essential.
- Leaders can frame ZBB to neutralize the loss aversion bias by presenting ZBB as building up from zero base instead of a painful cost cut. In one case, a company started building this program by a cost reduction drive in new investment projects, since this was done on a project to project basis, it smoothened the process of transition, and making the employees habitual to the practice and leading to an open mind.
- The ingrained behaviour of status quo bias can be used in a way that there is no option given to the managers, but to follow this system, any exceptions would only be granted in very special circumstances with detailed requests and proposals
- People are likely to do a better and more careful job when they believe that they are being supervised, hence a simple exercise of just submission of pending requests to one’s manager serves to tamp budgets down. This is not because managers decline the spending requests, the perception of someone else notices your spending activities makes employees more self-conscious and efficient.
- A positive messaging framework is not only a way to establish ZBB, but it’s an excellent trick to nudge people. For example, “going paperless to save the planet” instead of “no more printing”. This increases the acceptance of even harsh and cumbersome policies.
Far from being just a tactic to save costs, ZBB forces companies to test their priorities regularly. It allows them to invest in long-term projects as it frees up funds. Research also confirms that companies that regularly and aggressively relocate their investments achieve higher returns to shareholders over the long term (McKinsey, 2019). The culture established makes the workforce outshine its competitors. It leads to increased transparency and often leads executives to focus on setting ambitious targets, making consumer-centric investments, responding to shifting market conditions, and improving resource allocation. Companies likeReckitt Benckiser (a UK-based multinational consumer goods company) used this approach during the height of the great recession (2007-2010) not only mitigated losses but also achieved an organic top-line growth of 10%.
The data shows a pre-emptive transformation renders greater and positive growth resulting in an ROI that is 50% higher than a reactive transformation. In downturns such as these, many activities are cheaper and out of reach of cash-strapped competitors. To stay primed for growth, companies must maintain strategic momentum, regardless of market conditions. They must keep up marketing support, carry out internal improvements, seize M&A opportunities, and pursue innovation. Owing to the digital advancements, this strategy might be a savior.
Source: Deloitte cost survey report
- (McKinsey and Company, 2018)
- (Fritzen, Hawke, & Open, 2018)
- (Basu & Amte, 2015)
- (Group, Boston Consulting, 2017)