Zero-Based Budgeting has been in the news for all the wrong reasons lately. Kraft Heinz have reported a $15billion write-down after a focus on cost cutting, primarily using the Zero-Based Budgeting technique, resulted in the business taking its attention away from their customers.
Kraft Heinz investor, 3G Capital, is well-known for deploying Zero-Based Budgeting as a way of driving costs down. Their work at Burger King and HJ Heinz, pre-merger, encouraged them to try to repeat the same trick with Heinz Kraft.
This time they ended up writing off over $15billion.
Analysts believe too much energy within the business went towards reducing costs, leaving too little energy to focus on customer needs. That was unfortunate, to say the least, as the nature of Heinz Kraft’s traditional product lines meant that many of their products were precisely the products today’s more health-conscious, environmentally-minded customers were starting to move away from.
By the time Heinz Kraft caught on to the change in their marketplace, it was too late and $15.4 billion had to be written off the value of well-established brands like Oscar Mayer hot dogs and Kraft macaroni and cheese.
As a Finance Director and CFO, I always get concerned when businesses adopt a “paint by numbers” approach to anything. It’s a sure route to trouble.
At the very least, the business ends up falling short of its potential for transformation. At the very worst, it completely messes up a useful technique and ultimately puts the whole business at risk.
Now, I’ve no idea how Heinz Kraft approached their Zero-Based Budgeting exercise, and with deep-pocketed shareholders I don’t imagine their business is at risk any time soon.
But, from the outside, given their $15bn write-down and the accompanying analyst commentary, it’s at least possible that some of the common errors of a Zero-Based Budgeting programme were part of the experience at Heinz Kraft. Let’s explore where they might have gone adrift.
What is Zero-Based Budgeting?
Before we get into the details, perhaps first we need to explore what Zero-Based Budgeting really is, as it’s one of the most frequently misunderstood business models, in my experience.
I’m not sure if the term Zero-Based Budgeting was arrived at by an accountant trying to jazz something up with a bit of marketing hype, or by a marketer trying to over-dramatise what might have sounded to them like an otherwise fairly dull financial technique.
Either way, the biggest problem Zero-Based Budgeting has is that the term lends itself to an overly-simplistic interpretation, as this brilliant cartoon from Tom Fishburne illustrates…
That overly-simplistic interpretation is usually something along the lines of “every department has all their budgets taken away from them and they have to justify, line by line, every single item that gets put back in”.
Someone, usually the Finance Director or CFO (sorry…), is tasked with saying “no” to a lot of the budget lines that are requested with the net result that the business’s operating costs reduce substantially.
Expenses that look “optional” – pesky things like marketing, training and employee engagement – which perhaps lack the robust business cases which can be applied to, say, re-engineering a product to take a pound of aluminium out of each unit produced, tend to fall by the wayside.
Frankly any idiot can say “no” to a proposal for supporting customers better or training staff to be more effective, especially if the payoff is uncertain (in conventional business modelling terms, that is, they’re a nailed-on cert for anyone who has even a superficial knowledge of the role of human behaviour in decision-making).
So if this is what you think Zero-Based Budgeting is all about, the good news is that you don’t need to go to the expense of having a Finance Director or CFO go round saying “no” to people. Someone like Dilbert’s Pointy-Haired Boss is more than up to the task of making moronic short-term decisions.
But this interpretation of Zero-Based Budgeting is a gross over-simplification of quite a nuanced technique.
Zero-Based Budgeting was developed by Peter Pyhrr, at the time a manager at Texas Instruments. His objective was to break the historical way of compiling budgets which, back in the 1960s and 70s, generally involved taking the actual spend from the previous year and increasing it by some inflationary increment to arrive at the new year’s budget.
You don’t need to think about cost management for very long to realise that the “annual inflationary increase” method of budgeting was unlikely to be the most sensible way to run a business over anything other than the short term.
In the very short term in a stable business environment, it might be a reasonable enough approximation to reality. But at times of high inflation, as in the 1970s and 80s, or great technological change, such as the move to digital in the last 20 years, the likelihood is that “the way we’ve always done things around here”, supplemented by an annual inflationary increase is probably not going to cut it any more.
That’s why the original concept behind Zero-Based Budgeting was to re-imagine the best way to run a business on a reasonably regular basis to reflect changing economic and technological times.
Why Zero-Based Budgeting is a good thing, when applied properly
I’ve used Zero-Based Budgeting extensively throughout my career as a Finance Director and CFO, more often than not informally.
Of course, you can mobilise the entire workforce, employ gangs of consultants and spend millions of dollars to come up with some whizzy new plan if you want to, but that’s often unnecessary, especially in small-to-medium sized businesses.
For a Finance Director or CFO who knows what they are doing, a conversation, usually as part of the normal budget review process, with department heads, and an afternoon with a spreadsheet can usually get you the results you need without creating a ruckus within the organisation.
Whether you’re running a Zero-Based Budgeting project with teams of accountants, or just your CFO and departmental managers working together in a less formal way, any approach which doesn’t start with a thorough understanding of the results the business needs is doomed to failure.
And those results are much more than reducing costs just for the sake of reducing costs. In the short-term, earnings might mathematically increase as revenues hold constant against a background of reducing costs, but this is generally only true in the short-term.
That’s because of a significant assumption – one you rarely see in business plans, but it’s always there in the customers’ minds.
You see, businesses often think they “own” their customers. Many of the craziest decisions taken by large businesses were predicated on the belief that their customers were a constant and would never go elsewhere.
Thinking about that for just a second, of course every one of us would at least consider taking our business elsewhere sooner or later if we felt we were paying ever-higher prices for what we perceived as ever-poorer value. Yet this dynamic always seems to catch large companies like Heinz Kraft by surprise.
In the short term, businesses can be suckered into thinking they got away with it as revenues hold up after dramatic cost-cutting. What they’re forgetting is that brand loyalty is a lagging indicator, not a leading indicator.
In the short term, loyal customers will cut you some slack and hope you realise the folly of your decisions. Inertia means that hordes of customers won’t head for the exits the minute you make a change. And in markets like those Heinz Kraft serves, considerations such as how much shelf space you get in Walmart and what promotions you run might take the edge off a little for a while.
But in the end, you will be found out. And businesses whose customers don’t perceive them as offering good value will, sooner or later, start to decline.
In fairness to Heinz Kraft, the value they offered or didn’t offer was probably secondary to the fact they’d taken their eyes off a grocery market which was moving against the products they had traditionally sold while they focused on a massive internal project to reduce costs.
But the same principle applies – if you stop listening to your customers, whether that’s about the value you deliver or the products you supply and their position in your customers’ order of priorities, you’re putting your business at risk, sooner or later.
It doesn’t have to be this way. Here’s how to run a Zero-Based Budgeting process with a minimum of disruption, while keeping your eyes where they should be, on serving your customers.
A simple Zero-Based Budgeting approach that works
To run a sensible Zero-Based Budgeting project, here’s what you need to ask your budget-responsible managers: “Knowing what we know now, would we do things the way we’ve always done them…and if not, what would we do instead?”
This needs to work within the context of your business model, so if you don’t have a clear idea of how that works, make sure you develop a well thought-through business model first.
But assuming the business model is clear, those questions are all your Finance Director or CFO needs to ask at budget time (and perhaps, depending on how fast-moving your sector is, a couple of other times during the year too) to run a sensible, low-hassle Zero-Based Budgeting project.
Let’s make this into a practical example…
If your business needs 1,000 customer leads every year to generate the sales income the business requires, ask your marketing manager whether there is a better way (by, for example, accelerating the sales cycle), or a cheaper way, to deliver 1,000 suitably-qualified leads in the coming year.
To keep this simple, let’s assume the rest of the business model stays the same – your sales team converts leads into customers in the same ratio as before, customers spend the same amounts they did previously over the same customer lifetime, and so on.
In recent years, lead generation activity for most businesses is likely to have moved away from printed materials, outbound sales calls and personal visits from sales representatives to more digitally-based solutions. Perhaps Google Ads or LinkedIn sponsored posts play more of a role now, depending on your business.
The key point to remember, despite the name of the technique, is that the objective of a zero-based budgeting project isn’t to get the Marketing Manager’s budget to zero. It’s to determine how much of a budget he or she needs to generate 1,000 suitably-qualified leads, updated in this particular case, for the more digitally-based approach to lead generation.
What you’re doing is rethinking the business approach, without any preconditions or assumptions that things will continue into the future they way they’ve always worked in the past.
Done properly, a Zero-Based Budgeting project should also force you to consider the knock-on consequences of any changes. You’ve got to take these into account too before taking action.
Maybe you can halve the print advertising budget, but only if you invest in an upgrade to the website to enable a digital-only solution.
Maybe you can save a bit on the costs of the outbound telesales team that you need less of in the digital world. But you need to hire some digital marketing executives instead with the skills to fine tune your Google Ads campaigns and manage your social media presence.
And so on.
Business leaders who apply a “paint by numbers” approach to Zero-Based Budgeting, without really understanding the subtleties of the technique, tend not to think about the knock-on implications. And that’s usually the basis of their undoing.
Any idiot can suggest cutting out print advertising completely and using social media exclusively to generate leads because social media is “free”. (And, to be fair, plenty of idiots have done exactly that…)
But without the expertise and staffing the business needs, that strategy is the route to disaster. “Free” social media is actually quite expensive in terms of staffing requirement…those tweets and Facebook updates don’t write themselves, after all.
So any Finance Director or CFO worth the title should be considering the results in the round.
In addition, although “cheaper”, social media campaigns tend to have vastly poorer response rates compared to, say, traditional direct mail. You need to do the maths before deciding which approach is best, and perhaps selectively pilot some new strategies to make sure you’re on the right track before flipping the switch and doing things completely different.
That’s why, when used intelligently and holistically, Zero-Based Budgeting is a great system for continually reinventing your business, making sure you keep up with customer and market trends and giving you insights which allow you to service your customers better.
Problems with Zero-Based Budgeting
In my experience, the biggest problem with Zero-Based Budgeting is not the technique itself. All the problems come from those people who half-remember it from some management training programme and don’t take the time to understand it properly.
They inevitably end up applying Zero-Based Budgeting in a “painting by numbers” approach which is insufficiently customer-orientated.
This article from McKinsey highlights five common myths about Zero-Based Budgeting, and explains why those myths really don’t hold any water. But, in essence, the problems McKinsey highlights don’t come from the technique, or its underpinning philosophy, but in how people apply it when they don’t take the time to understand it properly.
Whilst Zero-Based Budgeting can realise substantial cost-savings – when done right – its more mindless proponents forget that one of the main reasons to make cost savings is to reinvest those savings, or at least a proportion of them, in making the business better.
As Accenture put it:
Strategic cost reduction [which includes Zero-Based Budgeting] can only be successful if the savings are reinvested in areas of the company to drive growth, innovation, improved productivity, better customer experiences and so on.(Source: https://www.accenture.com/gb-en/insight-getting-ahead-cutting-back)
Accenture’s own research shows that only 51% of businesses are able to sustain their cost savings for 1-2 years. That’s because:
Piecemeal approaches that focus on overhead and cost of goods sold is a common mistake that occurs during cost-cutting. These efforts only scratch the surface and risk causing the company to lose valuable, differentiating capabilities.(Source: https://www.accenture.com/gb-en/insight-getting-ahead-cutting-back)
But, for most people, their experience of Zero-Based Budgeting is exactly what Accenture say it shouldn’t be – a mindless cost-cutting approach which destroys the business’s operating model (if not in the short run, certainly in the long run) and doesn’t reinvest any of the savings to re-position the business for a more successful future.
Frankly there’s not a business technique in the world that will deliver something worthwhile in the face of that level of misunderstanding about what the process is supposed to be.
I’d also agree with Bain & Co that one of the primary reasons Zero-Based Budgeting, or ZBB, doesn’t work is this:
When ZBB fails, it’s usually because leadership is neither engaged nor aligned, cost-cutting is indiscriminate, cost control is the primary message, and execution is inadequate, prioritizing pace, tools and benchmarking over capability building.(Source: https://www.bain.com/insights/why-zero-based-budgeting-goes-wrong/)
People complain about Zero-Based Budgeting and say it doesn’t work. I’d respectfully suggest they only think it doesn’t work because they’ve never seen it applied properly.
If you want a high-level understanding of the potential of Zero-Based Budgeting, Bain & Co have produced a very helpful infographic which explains the underlying concepts succinctly.
Zero-Based Budgeting, in the right hands, can be a powerful technique to ensure your business is running in a cost effective way.
By getting your managers to consider periodically “knowing what we know now would we do this the way we always have done, and if not, what would we do instead?” you have the luxury of starting with a blank sheet of paper on a regular basis.
Zero-Based Budgeting put you in the fortunate position of being able to redesign your business as the world around you changes, at a time when most of your competitors won’t be.
Used by an astute leadership team, Zero-Based Budgeting is a wonderful tool for keeping at the forefront of your industry.
Used by a management team who don’t understand the subtleties of the concept and just use Zero-Based Budgeting to “slash and burn” their cost base without reinvesting the proceeds to position the business for the future, disaster isn’t usually far away.
For your sake, I hope your leadership team is an astute one.