Nilly Essiades, Director & Practice Lead, Financial Planning & Analysis, AFP
A June 30 Harvard Business Review article titled, “Zero-Based Budgeting is not a Wonder Diet for Companies,” by Daniel Mahler makes an important point. ZBB is making a comeback, but a lot of companies have been disappointed with its results and the fleeting savings it’s produced because they’ve approached it in a piecemeal fashion. Instead, companies should go big to achieve full benefits.
I agree with Mahler that ZBB is making a comeback. But I disagree with his conclusion that it requires a big-bang implementation. A new AFP FP&A Guide, ZBB 2.0: A New Take on an Old Method, proves many companies are getting great results by doing the exact opposite: they’re applying ZBB in an almost surgical manner instead of starting everything from scratch every year.
This new version of ZBB, or ZBB 2.0, “is fundamentally different,” according to Kris Timmermans, senior managing director at Accenture Strategy. While the same principals apply, there are several factors that set ZBB 2.0 apart.
It’s a hybrid. According to Brad McCreedy, partner at KPMG, “we typically find that clients apply ZBB as part of a more hybrid approach to their annual budgeting cycle.” In his experience, ZBB is best applied to operational expenses, and used in conjunction with other methods such as driver-based budgeting.
Partly that’s because today’s business environment has significantly changed. “ZBB cannot be allowed to keep companies back,” said Philip Peck, vice president, financial transformation at Peloton. “You have to keep up with market conditions and proactively anticipate issues and opportunities on the horizon.” At the same time, however, companies need to be most efficient in their allocation and usage of scarce resources.
Meredith Hobik, product marketing, finance at software vendor Anaplan, whose firm supplies the technological infrastructure necessary to implement ZBB, pointed out that many experts today recommend a hybrid approach that involves using a rolling forecast for recurring expenses and applying ZBB for certain non-recurring initiatives such as marketing expenditures, technology investments, professional services and litigation.
It’s not applied to everything every time. McCreedy adds that ZBB is typically not repeated every year, and if it is, the expenses that it is applied to are rotated from year to year. “We believe you should choose a portion of your expenses that have been identified that could lead to cost savings, and when these savings are realized move to the next subset of expenses,” he said.
Rick Ferraro, a senior manager at Deloitte, concurred. Deloitte doesn’t recommend companies redo the budget from scratch at each cycle. Rather, companies should deep-dive on a rotating basis and focus on areas of concern, or areas that experience volatility or change, where the cost structure might have been affected. Doing everything every time does not necessarily produce meaningful results, according to Ferraro. By choosing areas ripe for change, “you actually increase profitability and direct the budgeting and FP&A resources to the right areas,” he said. “More often than not, this allows you to more actively manage your resources.”
It ensures smart consumption. In addition, what sets apart today’s ZBB from the old “slash-and-burn” ZBB of the past is that successful strategic ZBB programs guarantee budget owners won’t spend the resulting savings as they wish. The savings are pooled into a separate account and the decisions on how to utilize them are managed within a strict governance structure at the most senior level, with the goal of reinvesting in growth, according to Timmermans
Case in point: Premera Blue Cross
At healthcare insurer Premera Blue Cross, ZBB was adopted three years ago primarily because a change in leadership, according to Melanie Jimmerson, director of finance. Premera did not apply ZBB to the entire organization on day one. It chose first one, then another division and now, in year three, it’s contemplating a third. Currently, the challenge is to look forward, i.e., using ZBB to figure out how management wants the business to look in 2020 and what cost structure will it need to support this vision.
According to Jimmerson, the idea is to prioritize what is most important to the business strategy first, before layering on the dollars. “The biggest benefit of implementing ZBB has been allowing leadership to understand the business and cutting through multiple layers to provide a clear line of sight,” she said. “Leaders need to understand how their resources support their strategy. Strategy equals budget. If you say something is important, you’ve got to look at the wallet. You can’t just tell people that something is important and ask them to do it. Management needs to back it up. ZBB compares where the money is spent to the business priorities.”