Zero-based budgeting

14 March 2016 | Tim Phillips

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Tim Phillips

Blog Author | Freelance writer


Like lobsters in a kitchen who wonder what that big pan of boiling water is for, many service providers with large enterprise business contracts may have noticed recent news about more organisations adopting zero-based budgeting (ZBB).

Like lobsters in a kitchen who wonder what that big pan of boiling water is for, many service providers with large enterprise business contracts may have noticed recent news about more organisations adopting zero-based budgeting (ZBB).

ZBB is a management idea with a strong theoretical base and a patchy record in practice. It is based on the idea that budgets should not be justified by looking at what you did last year, and adding a bit or snipping a bit off. Instead, spending in each area should be justified by how much it contributes to the firm’s profitability. In the most radical version, every spending department has to make its case for everything it spends each year. Budgeting becomes the function through which a company continuously refreshes its priorities.

This idea made the national news in the US when Carly Fiorina, the former CEO of HP, argued that it would be the best way for the federal government to balance its $3.9 trillion budget. Like many political plans, this appears simultaneously attractive and delusional: the biggest objection to running ZBB across companies is that the time taken to collect the data and make the arguments over priorities paralyses the organisation rather than invigorates it. The US government employs 12 million people. I predict telecoms spending would be a much larger part of any US government zero-based budget, if only because of the number of conference calls it would take to agree it. This might be the organisational wall that Nigeria’s government has just hit. It has had to delay its own federal budget announcement, and blamed it on its first-time use of ZBB. Note that Nigeria’s government spends about 100 times less than the US government.

On one hand, Otive Igbuzor, executive director of the African Centre for Leadership, Strategy & Development points out that Nigeria’s zeal for ZBB is admirable, because the budget has previously been “a copy and paste job” that perpetuates corruption and waste. On the other hand, copy and paste is quick: “The amount of information required to back up zero-based budgeting is huge and can overwhelm public servants that are not used to this kind of budgeting. And it is difficult and problematic for departments with intangible outputs like education, health and value re-orientation to justify every line item,” Igbuzor adds.

Historically, an announcement that you’re going to be part of a ZBB effort usually means that you might become the lobster that gets cooked at the end of it. So it was when, for example, CFO Wayne H Pace announced a “relentless” ZBB cost-cutting effort to analysts. The business was AOL, and the year was 2003, shortly after an amazed Time Warner executive had complained to the Washington Post that: “They knew their ship was a piece of sh*t… But when we pulled the hood up, it was too late.”

But, in the second coming of ZBB, not all initiatives are born out of corruption or disaster, just a desire that budgets reflect the changing prices and opportunities that technology serves up, and that traditional budgeting (and the inflexible contracts that come out of it) is too slow to recognise. McKinsey, Bain Consulting and Accenture are recommending that their clients consider ZBB again.

Consultancies are also keen to point out that it doesn’t have to be a “scorched earth” process, in which every function re-evaluates every dollar, euro and yuan, every year. Instead, a ZBB review can target specific metrics: for example operating expenditure or admin costs, or focus on one part of the business. McKinsey recommends that a small central team can set up a ZBB operation to do this in four to 10 months.

Carriers are one of the major suppliers of the technology that will come under review. How do carriers avoid being part of a reverse auction every 12 months?

First, ZBB doesn’t mean that every contract is for one year only - but it does mean that a service contract will be reviewed regularly. So building binding annual rate reviews seems sensible - customers who are going to demand them anyway. Flexible contract terms on scaling up, scaling down and billing, especially for technologies for which flexibility is supposed to be a fundamental selling point, is also important.

The alternative is to hope that ZBB goes away again. But McKinsey notes that 90 companies mentioned ZBB in their quarterly earnings calls in 2015, compared to 14 two years earlier. Only an unusually dull person would claim that “budgeting just got interesting” but, when it makes national news, you have to take notice.