Zero-Based Budgeting Case Studies

Zero-based budgeting (“ZBB”) is an old budgeting technique that came into vogue in the mid-1970’s, especially after Governor Jimmy Carter promised to use it to reign in the federal budget during the 1976 presidential campaign. (He didn’t follow-through, obviously.)

ZBB is still used by private equity and turn-around managers (e.g., like Lemann and Buffet) who have a broad and powerful mandate for overhauling companies.

Given the inherent resistance to change, and the sensitive corporate political challenges of ZBB, most legacy company managers who are looking at cost reduction today tend to use more conservative techniques for cost-cutting, such as across-the-board cost savings or Lean. A wise few management teams use ZBB every three to seven years as part of their regular budget process to cut “dead wood” from their budget, so that they realize the benefits of ZBB without the stark shakeup that occurs when it is first implemented after a long period of baseline budgeting.

As you likely already know, ZBB is radically different from traditional baseline budgeting, where prior operational experience is used to increase or decrease budgets.

Broadly speaking, ZBB requires budgeters to define mission-critical functions; then, to re-imagine how to achieve them “from scratch”. It opens every aspect of the company’s operations to critical examination, from procurement, to financing, to employees, to facilities, to inventory, to R&D, to administration, to distribution, to name only a few. Everything is on the table; no function is immune from scrutiny.

Overall, ZBB is a time-consuming, very challenging, almost cathartic exercise. Headcounts can be drastically reduced; entire functions can be combined or outsourced (or eliminated) and long-standing business relationships can be severed for more efficient or less costly competitors.

ZBB is also inherently risky. The “don’t fix what’s not broken” crowd will fight it at every turn; those who feel threatened will try to sabotage the process, and any failure – a new supplier who fails to deliver; a critical function that fails; a major customer that is lost – will all be laid at the feet of the agent of ZBB change. (See, later, about the critical need for executive and board support.)

But ZBB can result in staggeringly successful performance improvement if it is done well. (In the 1980’s and early 1990’s there was a wave of “right-sizing”, “process improvements” and “outsourcing” that improved US corporate profitability enormously. At their core, though, these processes were merely warmed-over ZBB by another name.)

ZBB requires the early and continued buy-in of key executive stakeholders in the company and the full support of the company’s outside directors and/or owners.

Since ZBB can sometimes result in senior executives eliminating their own jobs, some companies adopt generous contingent severance arrangements of all their executives so that the entire executive team buys entirely into the process, even if one or more of them are “voted off the island” in the ZBB process.

It’s also critical that ZBB be done quickly, although it is best done function-by-function after the mission-critical functions have been determined.

For example, it may be easy to determine that the in-house payroll department can be outsourced completely since its not mission-critical to have its function under the direct control of the company. But in-house procurement may be mission critical and require close examination. That examination should be done quickly, within 30 days or so; then, the cost-cutters should move on to the next function. (I am personally agnostic as to whether the cost cutting should be done piecemeal after each function is evaluated, or whether all departmental surveys are concluded and then cost-cutting implemented in a sharp change of a few days or weeks. Both ways have advantages and disadvantages. But either choice must have the full support of senior management and even the board.)

ZBB is based entirely on functions and processes, not on departments or products. Executives who have been outside auditors, particularly from the Big Four (I'm ex-"Big 8") are especially useful in the process because they have experience examining processes and functions from a macro perspective. They can assess the functions and contribute their thoughts as to how the functions can be improved, consolidated, outsourced, or eliminated.

If you're a legacy manager, you may wish to consider other alternative, such as across-the-board budget reductions, Lean (which segregates and eliminates no-value added processes), and other money-saving budget techniques before committing to ZBB as each of them is an easier and less risky process.

Should you determiine to go ahead with ZBB, these books (mostly out of print, but available on Amazon resellers) may be helpful. They are listed below:

Zero-Base Budgeting Comes of Age, by Logan M Cheek (1977)

Zero-Base Budgeting: A Practical Management Tool for Evaluating Expenses, Peter A. Pyhrr (1973)

Most budget hornbooks will have some discussion of the process, though not as detailed as these two. The Pyhrr book is the better of the two, but after you read it, you may find yourself saying “these techniques are so obvious…” (But if they were that obvious, companies would have already been doing them.)

Last, if you're a legacy manager, ZBB should be incorporated into your budget process every three to seven years. Having endured the radical change and disruption that is ZBB, it is easier to prune your company company, going forward, than to have to cut off whole branches of deadwood again 10 or 15 years from now.

Feel free to contact me here or through our website if I can be of further assistance.

Good luck and best wishes.

J.G. Collins

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I have implemented ZBB in conjunction with project portfolio management in R&D and IT environments which lend themselves to projectization of headcount, OPEX, and CAPEX. Incremental spending must be justified by strong business cases. Recurring spending is ripe for review in terms of value engineering, cost reductions and possible outsourcing. Managing budget decisions by projects rather than departments enables management to see how much is being spent on particular efforts at an enterprise level and ensures that strategic priorities are properly funded by all participating functions.

I ran across the following article which may be of help:

http://www.duncanwil.co.uk/zero.html

Best regards,

Jim Burtt

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In addition to the discipline and significant effort required to establish and implement a Zero-Based Budget, an organization must be able to quickly and effectively analyze their actual results vs. the established budget. Ideally, they should have the capability to forecast their' organization's Balance Sheet, driven by the ZBB data input.

I have personally seen at least one case of a failed ZBB initiative, as the organization was unable to properly track their actual results against the ZBB. This can be done and be successful, but it takes more than knowledge of the theory behind it.

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