his article explains Zero Based Budgeting (ZBB) in a practical way.

After reading you will understand the basics of this powerful financial

management tool.

What is Zero Based Budgeting (ZBB)?

Zero Based Budgeting is a reverse approach of traditional
planning and decision making with respect to budgeting. In traditional
budgeting, managers begin by reviewing the budget of the previous year
and make corrections (in revenue and expenditures) based
on performance expectations. The budget of the previous year is
consequently considered to be the baseline (starting point). In Zero Based
Budgeting all managers are required to justify all budgeted expenses, not
just the changes in the budget of the previous year. The baseline in Zero
Based Budgeting is not last year’s budget but “zero”.

Zero Based Budgeting requirements

This financial management approach requires much documentation and
justification. In addition to the total budget, the manager responsible
must identify all expected expenditures and rank all of the activities
according to their relevant importance and costs. The persons ultimately
responsible (high-level managers) can make decisions about investments
and budget cuts that can be justified at all times based on their
supporting information and no immediate pre-financing as is the case in
the traditional manner of budgeting.

Application
This type of budgeting usually occurs in the government and non-profit
sectors. The philosophy behind Zero Based Budgeting is good. However, it
should be noted that zero based budgeting requires frequent reviews.
In Zero Based Budgeting reviews are carried every year on account of the
fact that it is a time-consuming and costly process. Interim reviews can
be carried out but that is the organization’s choice with respect to time
and priority.
Zero Based Budgeting advantages
Zero Based Budgeting has the following advantages:

1. Efficient allocation of resources, as it is based on needs and

benefits.
2. This approach drives managers to find cost-effective ways to
improve activities.
3. This approach detects inflated budgets.
4. It is useful for service departments because criteria are not
always easy to identify.
5. It increases staff motivation because it gives them more initiative
and responsibility in the decision-making process.
6. This approach increases the communication and coordination
within the organization about certain decisions.
7. This approach identifies and eliminates wastage and out-of-date
operations.
8. This approach identifies opportunities for outsourcing.
9. This approach forces cost centres to link their mission to the
related organizational objectives.

Disadvantages
There are also disadvantages to the application of Zero Based Budgeting:

Time consuming
Sometimes the necessary expenditures are hard to define for managers
as a result of which it becomes too time-consuming and exhaustive a
process to arrive at a solid foundation with respect to the decision-making
about the investment.

Requires manpower
This approach forces staff (especially managers) to justify every detail
related to the expenditures. For instance, because the R&D department
cannot completely underpin their intended innovation, this could have
advantages for the budgeting of another department because they are
able to justify their expenditures in great detail.

Requires knowledge
In order to apply this approach appropriately, it is necessary to train
managers well. For Zero Based Budgeting to be successfully implemented,
managers at all levels of the organization must understand how zero
based budgeting works in the organization as they are ultimately
responsible for the management, decision-making and the communication
of entire process.

Awareness for details

As the volume of the required data and forms is very large in zero based
budgeting, no one is capable of knowing every detail of its content and
decisions. There is a risk to compressing information and details because
this might remove critically important data. This is a large risk.

Uniform
Honesty and consistency of the managers must be reliable and uniform.
Any manager that exaggerates affects the results negatively.

It’s Your Turn

What do you think? Is the Zero Based Budgeting costing method
applicable in today’s modern companies? Do you recognize the practical
explanation or do you have more suggestions? What are your success
factors for a good Zero Based Budgeting costing set up?

Share your experience and knowledge in the comments box below.

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What is Zero-Based Budgeting (ZBB)?
Zero-based budgeting (ZBB) is a budgeting technique that allocates
funding based on efficiency and necessity rather than budget history.
Management will start from scratch and develop a budget that only
includes operations and expenses critical to running the business; there are
no expenses that are automatically added to the budget.

All these expenses must be justified to remain in the budget. For example, if
a company expects to incur $100,000 in salaries and wages and believes
that the full $100,000 is absolutely necessary to run the business smoothly,
it will stay in the budget.

However, if instead of paying salaries, the company could substitute

technology to reduce these expenses, adjustments would be made
accordingly.

To learn more, check out our budgeting and forecasting course now!

Zero-Based Budgeting vs Traditional Budgeting

All businesses use budgets to keep track of expenses and improve ways to
minimize costs and maximize profit. Budget amendments are usually based
on budgets from previous years. In fact, traditional budgeting implements
incremental increases or decreases in the previous years’ budgets by a
certain percentage to meet new goals. These percentages usually range
anywhere from 1% to 10%.

Sometimes, budgets can get out of control or in some years, may show
significantly higher or lower costs depending on the overall market outlook
and other external factors. In these scenarios, it does not make sense to
look at last year’s budget. The entire budget needs to be redone from
scratch, hence, a zero-based budget.

In a zero-based budget, the company uses the current year’s information

and analyzes every expense/aspect of the business one by one. This is
referred to as starting from a “zero base.” While zero-based budgeting
examines all expenses, traditional budgeting only examines new expenses.
 

Advantages of Zero-based Budgeting

 The final output is well justified and is aligned with the overall
business strategy.
 Encourages more collaboration throughout the company
 Improves performance and operating efficiency by challenging
assumptions
 By avoiding traditional budgeting percentage increases, there is a
higher chance of overall cost reductions.

 
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Disadvantages of Zero-based Budgeting

 Implementing a zero-based budget requires qualified personnel and

specialized training, which can be time-consuming and costly.
 May harm the company’s overall culture or brand image
  May be cost-prohibitive for companies with minimal available
funding
 Costly, complex and tedious to start from a zero base. Traditional
budgeting is much simpler, faster, and easier to implement.

Final Thoughts

To sum up, although zero-based budgeting is an option for companies that

can create numerous benefits, they are also associated with some potential
drawbacks.

Implementing zero-based budgeting is not solely an accounting decision

and must be considered in conjunction with the company’s overall business
strategy and goals. While a zero-based budget may help companies better
reduce costs, they may completely change the value of the company and its
culture.

For example, if companies rely heavily on maintaining a positive, vibrant

and accessible environment for its employees but all the expenses to
maintain this environment were eliminated due to the zero based budget
process, the overall culture of the company may change. This change not
only leads to high turnover rates but results in different products and brand
perceptions.

According to a study by Accenture, only about 50% of companies can

sustain cost savings for one to two years, and in such cases, traditional
budgeting becomes ineffective.

Zero-based budgeting must be a collaborative, unanimous decision within

the company after careful consideration of all its advantages and
disadvantages.

To learn more, check out our budgeting and forecasting course now!

 Zero Based Vs. Incremental Budgeting
Table of Contents [hide]
 1 Base for Budgeting
 2 Allocation of Resources
 3 Wasteful Expenses
 4 Innovation
 5 Time Consuming
 6 Ease of Preparation
 7 Training
Zero-based budgeting and Incremental budgeting are the two most commonly used methods of budgeting
that are implemented by most of the companies. Both the methods are unique and are different from each
other in many ways. Before going through the differences, let us understand the meaning of zero-based
budgeting and incremental budgeting in brief.
Zero-based budgeting is a budgeting method where current year’s budget is prepared from the scratch i.e.
taking the base as zero. The old and the new activities of the business are ranked according to their
importance and based on that, resources are allocated to each activity without considering the past budgets
or achievements.

Incremental budgeting is a budgeting method where current year’s budget is prepared by making changes
in the past year’s budget. The changes are in the form of addition or reduction of expenses to last year’s
budget.

Following points will highlight the differences between zero-based budgeting and incremental budgeting.

BASE FOR BUDGETING

Zero-based budgeting is done considering the base as zero i.e. it is done without considering the budget of
the previous year. For every financial period, a fresh budget is prepared from the scratch and resources
allocated to each department are justified according to the expenses of that particular period. On the other
hand, incremental budgeting is different from zero-based budgeting. In case of incremental budgeting,
current year’s budget is prepared by making changes in the budget of the previous year. In Incremental
budgeting, the starting point for preparing budget is prior period’s budget. Taking this as base, current
period’s budget is prepared.
ALLOCATION OF RESOURCES
In zero-based budgeting, the budgets are prepared by allocating maximum resources to those activities
which benefit the organization. The activities which are revenue generating and critical to the survival of
the business, get the top most priority, Incremental budgeting is done without giving any priority to vital
activities of the business and last year’s budget is simply adjusted considering the inflation factor.

WASTEFUL EXPENSES
Since zero-based budgeting is prepared from the scratch, any resource to an activity would be allocated
only after considering the risk reward ratio and cost benefit analysis. This eliminates all sorts of
inefficiencies that are present in an activity. Thus it avoids any wasteful expense. In the case of
incremental budgeting, wasteful expenses become the part of the budget. The inefficiencies present in the
activities are mostly ignored and only the increase in cost forms the part of incremental budget.

INNOVATION
Zero-based budgeting promotes innovation in the business. As budgets are prepared right from start for
each period, it forces the management to come up with innovative ideas to lower their costs so that they
can justify the allocation of resources. On the other hand, incremental budgeting leads the company into a
conservative mindset. As the budgets are almost same over the years, it does not promote any innovation in
the business.  Therefore, zero-based budgeting is dynamic in nature whereas incremental budgeting is
conservative.

TIME CONSUMING
Zero-based budgeting is a time consuming process mainly because the budget is prepared right from the
start, which makes it a time consuming task. On the other hand, incremental budgeting is less time
consuming method because they are prepared by taking previous year’s budget as base and changes are
done in the previous year’s budget to meet the needs of current period.

EASE OF PREPARATION
Zero-based budgeting requires justification for allocation of available resources, which can be known only
after deep analysis and complex calculations. Thus, preparation of zero-based budgets is a complex task.
Whereas, incremental budgets are easier to prepare as it does not involve any complex calculations and can
be prepared by any department of the organization just by introducing the incremental changes.

TRAINING
Managers require special skills and knowledge to prepare zero-based budgets. Only a qualified and well
trained professional can prepare such budgets. On the other hand, incremental budgets are easy to prepare.
They do not require any specialized knowledge or training to prepare the budget. Any department can
make an incremental budget with ease.
Companies often shy away from the method because they fear it or believe it means
“budgeting from zero.” In reality, it’s a structured process that can build a culture of cost
management.

As many companies watch growth in sales, general, and administrative

(SG&A) costs outstrip increases in revenue, controlling expenses has become
an even greater priority. As a result, executives are under ever-increasing
pressure to deliver productivity improvements, and almost all companies have
sought to reduce costs, whether through traditional programs such as
outsourcing, offshoring, and strategic sourcing or other one-off cost-reduction
events. But in many cases, these are still not enough. Executives need bigger
savings that can be sustained over time.

Unfortunately, the typical approach to identifying cost-reduction opportunities

—examining operating expenses in the aggregate—is poorly suited to driving
realizable, lasting, and significant benefits. The findings are often too high level
to link clearly to the actions required to unlock the savings. Moreover,
managers can avoid action by refuting the underlying data or citing unique
business needs. Given such constraints, when savings are required, executives
often feel they have no choice but to slash and burn, making arbitrary budget
cuts without any changes to the underlying work, regardless of how prudent or
sustainable those choices may be.

Fortunately, there is a sustainable alternative to cost management appropriate

for many companies: zero-based budgeting (ZBB). We have heard of many
versions of ZBB, including the literal interpretation of the words: “a technique
for building a budget from zero.” While that is certainly a fundamental part of
ZBB, our experience has shown that effective ZBB is much more than that.

Five myths, five realities

Zero-based budgeting is a repeatable process that organizations use to
rigorously review every dollar in the annual budget, manage financial
performance on a monthly basis, and build a culture of cost management
among all employees. A world-class ZBB process is based on developing deep
visibility into cost drivers and using that visibility to set aggressive yet credible
budget targets. The annual budgeting process does in fact start from zero and
is very detailed, structured, and interactive in order to facilitate meaningful
financial debate among managers and executives. Throughout the year,
multiple owners are tasked with managing performance and continuing the
healthy debate on cost management. Through new system and process
controls, and aligned incentive programs, all employees make cost
management a part of their daily routine.

One company recently realized 11 percent savings in its operating budget

within the first four months of a new ZBB program. In this instance,
immediate savings came from increasing visibility into labor costs and
executing new approval thresholds to control demand for contract labor,
relaunching procurement initiatives to renegotiate prices, and changing “make
versus buy” decisions. More than 40 percent of the savings were strategically
reinvested in new teams and sales staff who spent all their time with
customers. While this company chose to reinvest those savings in the
customer-facing parts of the business, other companies use the savings to fund
and therefore amplify the next wave of productivity. And, of course, some let
the savings fall to the bottom line.

When properly implemented, ZBB can reduce SG&A costs by 10 to 25 percent,

often within as little as six months. Just how ZBB is capable of delivering and
sustaining these results remains a bit of a mystery for many executives. The
opaqueness of the term and the dire tone of the media stories can be
intimidating, sometimes causing ZBB to be avoided as an option for improving
productivity. What follows is an attempt to explore some common myths,
debunking them and highlighting how a well-run ZBB program can drive
sustainable impact in leading organizations.

Myth one: ZBB simply means building your

budget from zero
Reality: ZBB is a repeatable process to build a sustainable culture of cost
management

Zero-based budgeting is much more than building a budget from zero. World-
class ZBB efforts successfully build cultures of cost management throughout
the organization by using a structured approach to facilitate cost visibility, cost
governance, cost accountability, and aligned incentives. Fortunately the culture
shift isn’t left to chance. We believe that there is a proven, step-by-step
approach to implementing successful ZBB programs, and when this
implementation is done well, ZBB makes cost management a part of the way
every employee works on a daily basis.

Myth two: Implementing ZBB requires cutting

‘to the bone’
Reality: The degree of cost reduction is based on the company’s top-down
target

Although very little has been written recently about zero-based budgeting, the
published content that exists often associates it with cutting costs to the bone,
using any means necessary (for example, eliminating mini refrigerators in
office kitchens to save electricity). While this may sometimes occur, it is by no
means necessary. Simply put, the degree (and aggressiveness) of each
company’s cost cutting reflects the size of its top-down savings target. For
instance, in the most aggressive situations, we’ve seen 30 percent reduction
targets in year one versus other situations that aim for 10 percent reduction
targets with an agreement to reinvest half of that into more productive areas,
therefore only taking 5 percent to the bottom line.

Myth three: ZBB will overwhelm your business

and prevent it from doing anything else
Reality: Initial rollout of a new ZBB program can be led by a central team
and completed in four to ten months
Recently, one executive we met with said, “I simply cannot afford to ask the
entire company to stop what they’re doing for the year to implement ZBB.” The
idea that ZBB requires dedicated focus from every employee for a year or more
is simply not true. While it takes time to embed a new cost-management
culture into any organization, the setup and rollout of a new ZBB program has
much more limited requirements.

During the initial setup, a central coordination team develops deep visibility
into costs and sets detailed savings targets for the next budgeting cycle. That
team also ensures that the company’s systems and processes are in place for
the detailed reporting, governance, and performance management that a
world-class ZBB requires. In our experience, this setup period could take
anywhere from four to ten months and is primarily led by full-time support
from finance and IT, with part-time involvement from profit-and-loss owners
and cost-category owners across the company.

Organizations that are unsure about ZBB’s upside are well suited to pilot the
process. There are many ways to build these pilots, each of which can be
customized to meet the company’s objectives. One company, for instance, is
piloting a ZBB rollout across its global finance function. This approach builds
capabilities within the team that will help drive the program across the
enterprise while having the added benefit of helping team members achieve
their existing budget targets.

Myth four: ZBB only focuses on SG&A

Reality: ZBB can be applied to any type of cost: capital expenditures;
operating expenses; sales, general, and administrative costs; marketing
costs; variable distribution; or cost of goods sold

The fundamental elements of a ZBB program—governance, accountability,

visibility, aligned incentives, and a rigorous process—form a comprehensive
cost-management tool kit. However, certain adjustments need to be made
when using this tool kit in particular areas. For example, when ZBB is applied
to variable costs (such as cost of goods sold, variable distribution) the budget
needs to be volume adjusted in monthly performance reports. When ZBB is
applied to capital expenditures, costs are categorized by discrete investment
choices rather than types of expenses, as they are with operating expenses.

Myth five: ZBB is not designed for growth-

oriented companies
Reality: ZBB is successfully used by growing companies to redirect
unproductive costs to more productive areas that drive growth

Zero-based budgeting is a powerful tool for any company, whatever its

orientation. Even if the organization’s primary focus is on growth, profit, or
talent retention, cost management remains crucial to its success. Eliminating
unproductive costs allows the company to be redirected to more productive
areas. As we mentioned in the earlier example, back-office costs can be
redirected to customer-facing activities.

ZBB is not a slash-and-burn exercise that cuts costs without regard for the
expense. With deep visibility into costs, changes can be made to surgically cut
the fat and help build up organizational muscle.

Zero-based budgeting can drive significant and sustainable savings, but it is

much more than simply building a budget from zero. World-class ZBB
programs build a culture of cost management through unprecedented cost
visibility, a unique governance model, accountability at all levels of the
organization, aligned incentives, and a rigorous and routine process. ZBB frees
up unproductive costs and allows those savings to be taken to the bottom line
or redirected to more productive areas that will drive future growth.
https://efinancemanagement.com/budgeting/zero-based
Kris Timmermans takes a look at zero-based budgeting: now a long-term management
technique for success in the digital age

Today, companies are rapidly adopting Zero-Based Budgeting (ZBB) as a management

technique to help them achieve and sustain strategic cost reduction as they seek to redefine
how they compete and grow.

ZBB is relevant for businesses for a number of reasons. First, the economy remains volatile,
and in times of volatility, profitable companies with a strong competitive edge are best
positioned to innovate, grow and beat the competition.

ZBB also helps companies identify wasteful spending, redundant processes, bureaucracy
and unproductive products and services that are not generating an adequate return. They
are surgically removed via ZBB, and strategically redeployed to fuel innovation and growth.
In today’s era of digital disruption, many use those funds to invest in new technologies and
capabilities to help them out-compete traditional and non-traditional, digitally enabled
competitors.

Companies that adopt ZBB are now investing in the management technique for the long
haul. They look for sustainable ways to fuel their growth, change spending behaviours and
negotiate better pricing based on an enterprise-wide view of spending. Rather than just
whittling away at costs piecemeal and tackling overhead, they use ZBB to focus resources on
core goals, shifting funds from products or programs that aren’t productive to those
activities that will drive growth.

While there may be differences from industry to industry, our experience suggests that a
company may identify as much as a third of costs to reallocate as they work their way
through the ZBB process the first time.

Take, for example, global consumer goods company Mondelez International. Using ZBB, it
has freed up capacity to fuel growth. The company was able to save $350 million in selling,
general, and administrative (SG&A) expenses in fiscal year 2014, and projected three-year
savings of $1.1 billion. It now aims to increase operating margins from 12 per cent in 2013
to 14-16 per cent by 2016. It enjoyed three consecutive quarters of adjusted margin
expansion through the third quarter of 2014, with adjusted operating income (OI) margin up
140 basis points to 13.6 per cent in the third quarter. These improved margins are helping
Mondelez step up investment in production facilities, especially in emerging markets. In
2014, it announced new plants in Bahrain and India, and an expansion of factories in Turkey
and Hungary, as well as Ireland, the UK and the United States.

In the process, ZBB transforms what may have been a culture of spend to one of
accountability and stewardship. Cost management becomes a continuous process, as it
fosters teamwork around budgetary goals. People are held accountable for categories of
spend, and they are encouraged to treat the company’s money like their own. As such, they
question the value of each expense.

Useful in both profitable and difficult economic times, ZBB drives behavioural change at all
levels of an organisation, leading employees to regularly question the need to spend.
Achieving that result requires a deliberate approach that incorporates a massive change
management effort. Employee communication that explains the need for the new approach
to spending is paramount.

ZBB is not an easy process. It requires a focused effort and ambition. Well worth the effort,
this management technique can transform companies and create a structure for
sustainable, strategic cost management that frees up funds to invest in innovation as
companies redefine how they compete and achieve sustainable growth in today’s digital
world.

Understanding the Frequently Misunderstood: Zero-Based Budgeting

Increasingly, it seems that zero-based budgeting is a tack that companies are reportedly
taking to cut costs. Oftentimes, this approach is confused with the one-off practice of
decades past.

Naturally, sceptics who haven’t been able to leave the legacy behind are smirking at this
point. They recall the pain of deep indiscriminate cost cuts. And, they recall that the cuts
didn’t stick once the good times were rolling again.

But, that is not the way of the modern zero-based budgeting, and that is not what
companies today are buying into. So what is it?

Zero-based budgeting is a strategic approach to identify the costs that aren’t producing the
desired return. Zero-basing a cost base is a form of should-cost modelling as it builds a
budget based on what the cost should be on the back of detailed analytics. It also identifies
the duplicative costs that do nothing to help an organisation achieve its objectives today and
in the future on the back of a digital revolution that has dramatically changed the way
business is done. And, it changes the lines of demarcation between competitive industry
sets.

To make this approach work, an organisation begins with a clean sheet, and they build the
budget from the ground up, justifying each and every expense. Is it a necessary expense?
Does the return justify the cost? Is it possible to lower the cost for the same result all the
while respecting strict policies and meeting top-down budget targets?

This very detailed approach allows for useful internal and external benchmarking,
comparing the cost of a process, operation or item with other organisations to identify
reasonable targets as set by cost owners. It’s also a transparent and open way of creating a
budget that generates insight for management into the organisation’s consumption of
resources.

This continuous process year-on-year helps an organisation actively manage its costs. The
budget is reviewed for unnecessary costs; those that balloon up are reined back in and
funds are redirected into areas where investment is needed to execute on the business
strategy to realise future growth.

Kris Timmermans
Kris Timmermans is senior managing director of Accenture Strategy, Operations. He works
with companies to adopt ZBB and helps them to build operations strategies and digital
supply networks to increase efficiency and profitability.
The Business Case for Zero-Based
Budgeting in Manufacturing
 By Ron Giuntini
 Published: 8/24/2015

U.S.-based product manufacturers incur annual warranty management-

related expenditures, as a percentage of profit before tax, of as much as 20
percent. The warranty accrual incremental budgeting process faces
challenges when new products are introduced. Zero-based budgeting better
addresses new product introductions because budget inputs are completely reset
every budget cycle, with new inputs captured to reflect a changing business
environment.

Warranty driven expenditures, reported on financial statements, can include the

following, though the Securities and Exchange Commission (SEC) reporting
requirements are vague:

 Upgrade/modification programs employed when product performance guarantees are

not met.
 Voluntary/mandated recall programs.
 Goodwill initiatives (e.g. key customer’s product is warranted an additional six
months due to ongoing reliability problems).

The most popular budget technique employed for warranty claim accruals is the
incremental budget, which typically encompasses the following:
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 Engages readily available analytic tools like Excel.

 Applies inputs from historical data sets such as claim settlement expenses.
 Uses independent-demand forecasting techniques like weighted averaging and
trend.
 Does not consider that a black swan event may occur and assumes the existence of
a relatively stable business environment.
 Efficiently manages the budget process and minimizes levels of granularity to do so.
 Delivers a reasonable level of accuracy.
 Passes the muster of internal/external auditors.

But this budgeting process faces challenges when newly-designed products (NDPs)
are introduced as part of the mix of warranted products. NDPs are always defined as
being recently delivered for the first time to the marketplace. NDPs also contain a
combination of the following elements that differentiate them from warranty cost
drivers of previously designed products (PDPs):

 Product design (e.g. new capabilities, and more reliability, maintainability and
capacity).
 Different terms and conditions meeting product owner expectations (e.g. NDP
warranty duration of four years versus two years for PDPs).
 Volatility of warranty claim settlements, driven by the production learning curve slope
(e.g. warranty accruals are 8 percent of revenues for the first 50 units of NDPs
manufactured due to quality and engineering issues, and then will decline to 2
percent starting at unit 200, which then aligns with that of PDPs). If learning-curve
projections are wrong, warranty claim settlements may be dramatically affected.
 Relationship changes between the manufacturing organization of NDPs and its
suppliers.
The aforementioned may rule that the employment of the incremental budgeting
process is problematic for budgeting warranty claim accruals, but a product
manufacturer should first understand the financial materiality of those accruals. For
example, leadership and/or auditors may define the materiality threshold level as
being triggered when 20 percent of all warranted units are NDP units, and/or when
30 percent of all warranty expenditures are driven by NDP units. Note that a unit of
warranted NDP can incur warranty claim settlement costs that are 25 percent to 100
percent higher than that of a unit of warranted PDP. 

Once materiality levels are developed, the warranty budgeting technique chosen can
embrace one of the following four scenarios:

1. If warranted NDPs do not meet the financial materiality test, incremental budgeting
can be continued to be solely employed for both PDPs and NDPs, with an
understanding that the budgeting of accruals might be slightly inaccurate compared
to that of claim settlements.
2. If warranted NDPs do meet the financial materiality test, an alternative should be
chosen to replace incremental budgeting in order to be more adaptive to a variety of
cost drivers and a more volatile business environment.
3. A manufacturer can select to retain the incremental budgeting process for warranted
PDPs and employ an alternative budget technique exclusively for warranted NDPs.
4. If warranted NDPs do not meet the financial materiality test, leadership may
nonetheless seek an alternative budget technique for the combination of all
warranted products.

One alternative budget technique to that of incremental budgeting for warranted NDP
is zero-based budgeting (ZBB), a technique in which budget inputs are completely
reset every budget cycle, with new inputs captured to reflect a changing business
environment. Note that ZBB requires that a working business model, with simulation
capabilities, drives the selection of all its budget inputs. The abandonment of all
analytics that were performed in the last budget cycle and starting from scratch in the
next budget cycle is not the modus operandi of ZBB. 

There are several advantages to ZBB:

  Greater accuracy. Besides anecdotal experience, the use of a significant number of
budget inputs tangentially invokes the Law of Large Numbers of probability theory.
Also, operational personnel from the real world are involved and are accountable for
the validation of the inputted data sets.
 Greater adaptability. Easily enables changes to a variety of inputs during multiple
budget cycles and non-stable business environments.
 Greater granularity. Imparts a higher level of understanding as to the complexity of
a warranty program and its financial impact. Often an “awakening” for leadership to
dedicate greater resources in this area to improve the efficiency and effectiveness of
the processes.
 Greater action orientation. Increases the ability of an organization to identify
unfavorable warranty cost trends and engage in targeted changes, sooner rather
than later.

The business model driving zero-based warranty budgeting includes such inputs as:

 Products/models types that will be warranted during the forecasted period.

 Population size and value of warranted units.
 Customer solutions required to meet obligations of the warranty terms and
conditions.
 Processes and their activities required in delivering customer solutions.
 Direct and indirect resources employed in each of the solution-driven processes.
 Quantity requirements for each resource.
 Cost-estimating relationships.

The clarity and adaptability of a zero-based warranty budgeting initiative creates a

standard of excellence that is hard to surpass. But a ZBWB project is not an easy
endeavor to undertake. It can be extremely inefficient and even ineffective when the
following are lacking:

 A detailed business model driving the budget.

 Analytical software with simulation capabilities.
 Oversight by seasoned operational and financial professionals knowledgeable in
warranty management.
  Support from leadership.

Despite these challenges, ZBWB should be considered as the budgeting process of

choice for product warranty accruals, regardless of financial materiality.

Ron Giuntini is principal with Giuntini & Company Inc.

Editor's note: This "A Balancing Act" story is the seventh in a series for Food
Dive, where experts examine trends uncovered in earnings reports and discuss
strategies that impact the balance sheet. You can read the first piece  here , the
second  here, the third  here,  the fourth  here ,  the fifth  here  and the sixth  here .

A previous version of this story misstated how much cost savings Campbell is
expected to receive. This version has been corrected.

With quarterly revenue reports plunging for many major packaged food and
beverage manufacturers, executives are left scrambling to find a solution to
stagnant top-line growth.

Packaged food manufacturers are seeing sales decline for a variety of categories
as startups disrupt those categories  with innovative and better-for-you products.
Or declines occur as consumers turn away from a category en masse, such as
with soda and cereal .

In turn, manufacturers have launched aggressive cost-cutting initiatives that have

led to massive layoffs, factory shutdowns and the implementation of techniques
like zero-based budgeting. Harvard Business Review defines zero-based
budgeting as when employees must justify every expense for each new budget
period based on a demonstration of needs and costs rather than using last year’s
budget as an initial reference.

Story continues below

The question is: how sustainable is this approach? A financial limit guides just
how far zero-based budgeting and other cost-cutting strategies can go. And once
these companies hit their cost-cutting goals over the next few years, what's next?
If they haven't determined how to turn around their top-line performance in that
time, investors' appreciation of higher profit margins may not carry the company
forward forever.

Why are manufacturers embracing zero-based budgeting?

The short answer is slowing top-line growth rates. Without revenue growth,
manufacturers have to make cuts in costs elsewhere to retain profitability for
shareholders.

“The heightened strategic bent towards zero-based budgeting likely reflects the
slowing growth prospects the industry is facing,” Erin Lash, senior equity analyst
of consumer packaged goods at Morningstar, Inc., told Food Dive. “Several
packaged food firms have lowered their long-term top line targets from the 3%-
4% range down to 1%-3% over the last several quarters.”
Erin Lash

Credit:  Morningstar, Inc.

 
However, cost savings aren’t always about maintaining profitability alone, but
also about what manufacturers can do with those savings to grow their
businesses.

“We’ve long thought that these efforts don’t merely stand to bolster a firm’s
profitability, but rather stand to provide the fuel to reinvest behind brands,
including both investments in R&D as well as marketing support,” said Lash.

However, because zero-based budgeting often appears in conjunction with other

cost-saving efforts, the exact nature of the impact on a company’s bottom line or
reinvestment potential is not always as clear, she said.

“Several firms in the space are taking actions to rationalize their manufacturing
footprint and/or drive efficiencies within their supply chain, as well as implement
zero-based budgeting,” said Lash. “And as such, the financial benefits from zero-
based budgeting can be masked.”

Zero-based budgeting company spotlight: Campbell

At the Consumer Analyst Group of New York conference in February 2015,

Campbell detailed a new enterprise design and cost-reduction initiative that
aimed to align the company’s structure with its core growth strategies, Thomas
Hushen, senior manager of external communications at Campbell, told Food
Dive. The company expected the new organization, which created three new
divisions and implemented cost-saving strategies including zero-based budgeting
to generate at least $300 million  annually over a three-year period.

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Thanks to those efforts, Hushen said Campbell is now ahead of that schedule
and on track to deliver $300 million in annual savings by 2018. Zero-based
budgeting was one of three cost-reduction techniques Campbell implemented.
The other two included headcount reductions — “the bulk of which are behind
us,” Hushen said — and the formation of Integrated Global Services, which
Hushen described as “an organization that is a shared service group building
important capabilities while lowering cost.”

In fiscal 2015, Campbell had already achieved $85 million in savings. Since
officially implementing zero-based budgeting in fiscal 2016, Campbell
has delivered about $130 million in incremental savings, bringing the total to date
to over $200 million.
 

Credit:  Flickr; Kārlis Dambrāns

At Investor Day in July, Campbell CEO Denise Morrison told

shareholders, “Combined, these efforts are creating an ownership mindset at
Campbell where employees are treating every dollar as if it were their own. …
This approach is allowing us to invest back in the business for long-term growth.”

CFO Anthony DiSilvestro spoke at Investor Day about strategies for transforming
the way the company operated, such as expanding scope, re-engineering
processes and leveraging scale. DiSilvestro also discussed what Campbell
intends to do with those cost-savings: Continue adding to the business and
diversifying to stay competitive.

Those reinvestments include new product launches, capability building,

marketing support, the “real food” initiative , long-term innovation and geographic
expansion.

Should more manufacturers adopt a zero-based budgeting

strategy?

Though the food and beverage industry has seen many success stories with
zero-based budgeting—from Campbell and Mondelez  to Kraft Heinz and PepsiCo
—that doesn’t necessarily mean all manufacturers should adopt this cost-cutting
strategy.

“That is a decision that likely needs to be determined on a firm-by-firm basis,”

said Lash. “From our perspective, cost-reduction efforts have not always proved
beneficial.”

Lash said Kellogg is an example of how a company may successfully remove

costs, but then fail to invest those savings back into manufacturing and
distribution network to support growth. As a result, the company instituted
several recalls because quality control had deteriorated in the absence of those
costs, she said.

“However, in Kellogg’s case, we think management is more targeted in its plans

this time, using a scalpel rather than a hacksaw,” Lash said. 

Still, Lash warns any food or beverage manufacturer to weigh all options before
launching into this type of cost reduction.

“In this vein, when you pursue a zero-based budgeting program merely focused
on cost cutting, challenges could arise,” said Lash. “From our perspective, firms
in the highly competitive packaged food arena will be ill-served by trying to cut
their way to growth, but rather will need to fuel brand investments in order to
reignite top-line gains in the longer term.”

As more success stories arise among major manufacturers, other executives

could consider this approach for short-term bursts of cost savings that they can
then translate into long-term growth prospects going forward.

“Continued adoption will depend on the ultimate success or failure that ensues
over a longer time horizon,” said Lash.

The "A Balancing Act" series is brought to you by BMO Harris Bank, a leader in
commercial banking. To learn more about their Food & Beverage expertise, visit
their website  here . BMO Harris Bank has no influence over Food Dive's
coverage.
The venerable technique has vaulted back into the consciousness of corporate leaders—
for good reason. But getting it right is not easy and depends on five key elements.

“Zero-base budgeting” (ZBB) was first introduced to the public in a 1970

article by Peter A. Pyhrr in the Harvard Business Review1and soon gained a
following. However, over the last half century, the tool became dogged by
misperceptions and faded into obscurity.2Today, it is enjoying a renaissance.
The number of companies publicly referring to zero-base budgeting has
exploded over the past few years, including such disparate companies as Alcoa,
Boston Scientific, Jarden Corporation, and Quiksilver (exhibit). It’s not only
big companies that have taken to ZBB; businesses of all sizes are taking the
leap. For example, B&G Foods—a US-based multibrand company with $850
million in annual sales and less than $100 million in sales, general, and
administrative (SG&A) expenses—has recently adopted ZBB. It’s becoming
clear that ZBB can be effective across industries, in companies big and small,
and under both public and private ownership.
Exhibit

ZBB of the 1970s was fundamentally about ascribing each company activity to
a decision “package,” evaluating and ranking these packages for their costs and
benefits, and allocating resources accordingly.3Today’s ZBB is much more than
that—it’s a repeatable process to rigorously review every dollar in the annual
budget, manage monthly financial performance, and build a culture of cost
management. What makes ZBB unique is not the budgeting methodology; it is
the mind-set shift that upends managers’ default assumptions. Rather than
compare this year’s spending to last year’s, ZBB looks instead for the most
efficient return on spending, from the bottom up. As one executive who
recently made the transition to ZBB told us, “It was more effective to talk about
every dollar spent in terms of efficiency, and ask if it was really necessary,
rather than to compare it to last year. It resets the discussion.”

ZBB is especially useful for private-equity firms. It aligns well with the return-
on-capital approach that the industry favors. It can eliminate unproductive
costs (often as much as 10 to 25 percent of SG&A in six months), allowing
owners to reallocate capital to growth, through marketing, sales, and M&A.
And ZBB is a standardized and replicable playbook that can be rolled out
across a portfolio of companies, ensuring aligned processes, controls,
cadences, and incentives. For private-equity operating groups seeking
standardization (with a helpful degree of flexibility), ZBB is the perfect fit.

Five factors of success

Some executives ask us whether zero-base budgeting is the “secret sauce” for
cost reduction. It is an important tool, but just as important are the
organizational elements that must support it, such as management buy-in, the
organization’s willingness to challenge current thinking, and its tolerance of
the risks that arise when making changes to reduce costs. In our experience,
the following five factors are required to build the culture of cost management
that distinguishes superior ZBB from mediocre efforts:

 Deeper visibility into cost drivers. Companies need a granular

understanding of the drivers of costs so that managers can make better and
quicker decisions on how to control them. Tactically, that means grouping
costs into a matrix with two dimensions—the type of expense and the owner
—to make the drivers clearer. Without this visibility, it’s too easy to explain
away the way things are and why they cannot change.

 Dual-ownership governance model. Two people, the P&L owner and a

leader from a functional cost center (such as IT), should focus on driving
down the expenses in a given package. The addition of a second owner takes
away autonomy from the P&L owner and results in an ongoing and healthy
dialogue on cost management. This governance model helps spread best
practices across business units and geographies. It also ensures that
windfalls in one area do not get subconsciously reallocated somewhere else.
That’s the problem at the root of something we often hear CFOs say: “I don’t
understand—on paper we saved $100 million, but my EBIT is flat.”

 Rigorous processes for planning and monitoring. Budgeting from zero

is just one part of the planning process. Others include the setting of
 aggressive top-down targets by the C-suite (supported by detailed bottom-up
analysis) and structured budget negotiations across the company, with a
common fact base and analogous cost comparisons across operating units.
Monthly checkups on these plans ensure that savings don’t slip away and
unfavorable variances are quickly addressed by both cost owners.

 Aligned incentives. Adding an explicit metric to measure cost

performance (in addition to growth and profit) aligns compensation to cost-
management objectives. Metrics should consider only what is under each
manager’s control, to avoid penalizing managers in the field when, say,
intercompany charges and allocations from the corporate center rise.

 Mind-set. Perhaps the most critical change is in managers’ mind-set.

ZBB is most successful when managers stop trying to prove why something
is the way it is and start thinking actively about ways to make it better, the
same way they do at home when the money is coming out of their own
wallet. This includes a shift to “arguing things in” rather than “arguing things
out” and the realization that no spending is too small to be reviewed. One
hundred small changes that save $100,000 apiece still add up to $10 million.

A tool for all seasons

ZBB is an effective tool, but it is also a thorough process that takes time to
execute and requires management buy-in. Before budgeting begins,
management needs to build a highly detailed fact base, develop visibility into
cost drivers, and put in the effort needed to support aggressive top-down
targets with detailed bottom-up analysis. Given the high degree of change
required—the new financial-planning process, modified incentives, as well as
the execution of significant cost reductions—ZBB is most effective at
companies with willing and able management (often newly installed) and a
small and aligned investor group that has control of the company. ZBB is less
successful in growth-capital investments.
More companies are taking up ZBB every month, in every kind of
circumstance. In our experience, the following situations present an ideal time
to begin the transition in a portfolio company:

 at the start of the first annual budget cycle under private-equity

ownership

 at a change in management, with the opportunity it presents to reset the

company’s behaviors and practices

 when a company is underperforming and the need to exit is rising

 when a company’s performance culture resists continuous improvement

 when a company needs funding for growth initiatives

In a 2014 McKinsey survey of private-equity operating groups,4firms agreed

that a standardized playbook across their companies is highly desirable. While
some firms have made some headway in several core processes, budgeting is
often more ad hoc and company specific. ZBB gives private owners the
standard but flexible approach they want for perhaps the most essential
corporate process: the allocation of capital.

It is thus no surprise that, 45 years after its creation, ZBB is making a

comeback. Private-equity firms and others are finding it a useful frame-work
to reset a company’s default mode of operating and drive sustainable cost
efficiency. This time around, ZBB seems likely to stick: the new incarnation is
more likely to become a widespread norm than to fade into the ether. For ZBB
2.0, this may be just the beginning.
 https://youtu.be/84-RFiUT5wc

Creating value with zero-based budgeting at Kellogg

Company
July 24, 2017 Meredith Hobik No Comments Finance

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Sticking too long with commonly held assumptions and accepted ways of
doing things can put even the biggest businesses at risk. For instance,
during the 1980s, IBM stayed focused on mainframes while servers and
PCs took over. More recently, Blockbuster clung to its retail outlets while
new technologies were changing the ways people could access movies.
Looking back, we are collectively astounded that such companies stuck
with the status quo for so long. But that’s exactly what we do when we
produce an annual budget by taking last year’s actuals and adding a few
percentage points to account for wage rises and inflation.
Such incremental budgeting may appear harmless, but if it persists
indefinitely, it can lead to inefficiencies and missed opportunities for cost
savings. That is why an increasing number of global companies are
challenging the status quo by adopting zero-based budgeting (ZBB), where
everything in a budget must be justified as both relevant and cost effective.

Kellogg Company at the forefront of ZBB

Kellogg Co., the world’s largest cereal company, is on the front lines when
it comes to adopting ZBB. In 2016, the company publicly announced
an anticipated $150–$180 million in savings from zero-based budgeting , and noted
that these savings will build in 2017 and 2018 to a run rate of $450–$500
million. These savings will allow the company to invest in its existing
brands, acquire new ones, fund geographic expansion, and make
significant progress towards its stated target of increasing its margin by 350
basis points.
Despite the prospect of realizing savings of a similar magnitude, many
organizations still shy away from ZBB due to the misconception that it is
expensive, time consuming to implement, and will disrupt their business.
But Kellogg knows differently: Compared with the ERP system it replaced,
the planning platform that supports the company’s ZBB program around the
globe also saves the company $177,000 annually on support costs.
In a recent presentation, Kellogg discussed how organizations need top-
down sponsorship in order to make a ZBB initiative a success. These are
not empty words, as they know from personal experience just how
important executive support is. Kellogg also knows that without an effective
and easy-to-use planning platform in place, ZBB can be laborious and time-
consuming. Thankfully, Kellogg Company selected Anaplan.
Having completed its first full fiscal cycle using ZBB, Kellogg has a plethora
of best practices about ZBB and the type of platform needed to support it.
To learn more, watch the video, “Creating value through cost savings with zero-
based budgeting at Kellogg Company.”