Embracing Modern Zero-Based Budgeting
This blog was written in collaboration with Michael Huthwaite
Zero Based Budgeting (ZBB) is a great way to apply a higher level of scrutiny to the budgeting of your fixed costs (SG&A). This means eliminating rubber stamps and free passes.
The classic approach of budgeting SG&A based on last year’s spend plus a minimal growth rate will, if left unchecked, eventually lead to unnecessary bloating of OPEX over a period of several years. Not only does this approach lead to a ton of waste which drives down shareholder value, but it also creates a culture of overspending rooted in the “use it or lose it” mentality.
Organizations need to think smarter about their spend. This is where modern ZBB approaches can help.
Introduction to Modern ZBB: What is it about?
Modern ZBB is not a slash and burn exercise. It is about applying the optimal cost structure to the right parts of the business in the right stages of maturity. It is about maintaining and growing revenue while looking to cut out areas with excess spend.
For large businesses with multiple business models and significant SG&A spend across them, a single cost structure simply is not only suboptimal, it is unrealistic.
Modern ZBB is about embracing more agile approaches to spend management. This can be done by running experiments on what spend can be cut out and what spend needs to be retained to support the long-term health of the business. It is about leveraging analytics and modern tools to continuously screen and re-evaluate what expenses are necessary and what expenses are not.
In simple terms, modern ZBB is about ensuring that you are applying fuel in the right places, so your organization can continue to grow and evolve.
Three Questions to Consider When Implementing Modern ZBB
What Are You Measuring?
It is important to recognize that although ZBB is about spend management, the KPI used to measure performance should not be focused entirely on expenses only. Doing so would only promote the slash and burn mentality that modern ZBB tries to avoid. Rather, success needs to be measured using a more balanced measure such as SG&A divided by Sales.
Assuming Sales are growing over time, ZBB success can be achieved in one of three ways:
- by cutting costs
- by holding costs constant
- or by allowing expenses to grow, but at a slower rate than your Sales growth.
In the end of the day, ZBB is about putting the right cost structure in place and the only way to do that is to make sure that you are not eroding Sales at the same time.
How Should You Look at Your Data?
The simplest way to implement a Cost Transformation effort like ZBB is to start with better transparency of costs. This includes grouping expenses that have similar drivers, such as Travel and Events. Make sure to apply these “subaccounts” across the entire business so it becomes easier to compare spend across the organization. This is an obvious place to start, but most organizations could benefit from the clean-up and discipline that goes along with this effort.
Next, start to look for outliers. Why should one business unit have considerably more spend than another? Is it justified or is there a behavioral element there that needs to be reviewed? For example, why are all employees in one cost center staying at a high-priced hotel when the rest of the organization is staying at a preferred hotel vendor? Bringing outliers in line with the average is a great way to cut costs and apply spend controls.
“Name and shame” might sound like a harsh technique, but trust me, no one wants to be the cost center with the highest degree of excessive spend. Having the option to use both carrots and sticks when necessary is a technique made possible with better transparency.
Looking across the business for outliers is a great way to normalize expenses. But often this effort is not enough; the focus needs to shift to making trade-offs across the various SG&A account lines.
Establishing the optimal mix of SG&A can often be much harder than setting the overall spend target. In most cases, there just simply is not a one-size-fits-all template that will hold constant.
FP&A teams need to continuously test and play with their SG&A mix to optimize the outcome of their business units. Modern ZBB is an agile journey. What works today needs to be constantly monitored and reviewed for tomorrow. It is simply not a case of setting it and leaving it.
How Do You Build the Right Cost Culture?
Perhaps the hardest, but most important aspect of establishing a modern ZBB initiative is driving the cultural adoption among employees.
How do you get your employees to spot waste and want to do their part to cut it out?
How do you build a culture that embraces spend management as a new normal without feeling like they are going through austerity measures?
Regardless of what approach you take, the key is to be consistent in your messaging and your management approach.
When times are good, it is natural to want to loosen the belt and allow for more spending. However, this is not the ZBB way. When things are going well this is a critical opportunity to bank the savings.
Allowing the additional spend to occur will provide a message to your employees that unnecessary spend is ok. This needs to be squashed out. Organizations need to build a ZBB culture that awards people for doing the right thing all the time, not just when the boss is looking (for savings). Doing so tends to reign in the consumption component of spend, which normalizes spend over time in both good and bad times.
In the end of the day, establishing the right mix of SG&A spend is a continuous evolution. Setting the overall spend target is often much easier than tactically managing the optimal mix of expenses that go into making up your total SG&A.
In other words, trying to establish a one-size-fits-all template that will hold constant across the business, across the year or across the life cycle of the business for that matter is not going to be an optimal way to manage spend.
The best way to implement an optimal spend management strategy is to start with a balanced approach. Cutting expenses without considering how they impact your organizations ability to deliver revenue is a recipe for disaster.
Next, monitor spend across the organization so you can eliminate unwanted behaviors. Transparency is critical when you need to drive change.
Finally, build a business culture that recognizes that having a low-cost structure is a serious competitive advantage that will drive shareholder value and provide job security in both good and bad times.
These are the critical elements to implementing a modern ZBB process.
To learn more, have a look at the Ventana Research paper, sponsored by SAP, Achieve Agility in Planning and Execution: Contingency Planning Built with Predictive Analytics Delivers Better Results.