Zero-based budgeting is gaining in popularity as companies cut costs because of the pandemic, but it's not the slash-and-burn tactic it used to be.
Instead, businesses are having success applying the measure for strategic, targeted savings.
Katie Anderson, CFO of apparel company Guess, helped her business ride out the pandemic by using the budgeting method to make tens of millions of dollars in strategically targeted capital and operating expense cuts. GM and Signet Jewelers are said to have done the same thing.
"[Coronavirus] disruptions are causing people and companies to fundamentally rethink parts of their budget," Luke Pototschnik, Boston Consulting Group managing director, told the Wall Street Journal.
Consulting and research firm Gartner says most businesses have already had some quick wins with temporary zero-based budgeting (ZBB) approaches to belt-tightening during the pandemic, mainly by cutting spending on travel, entertainment and consultants.
But Gartner cautions against using COVID-19-inspired ZBB for long-term measures that could backfire when the crisis abates.
"Overhauling a major financial management process at an accelerated pace, or as a one-time effort when key performance indicators are in flux, can be more detrimental than helpful," Gartner said in an analysis.
Help from technology
Zero-based budgeting came to national prominence when the federal government employed it during the Carter Administration in the late 1970s.
Shortly after the start of the Reagan Administration, budget director David Stockman ended to the procedure, claiming it was cumbersome, and didn't reduce costs as much as its proponents claimed it would.
Today, cloud computing and AI is making zero-based budgeting easier, Oracle Senior Director of EPM Marketing Jennifer Toomey said.
In the past, the sheer volume of information required by a large organization was too overwhelming to justify it, she said.
"Prior to the cloud, ZBB entailed gathering finance and operational data from every corner of the business — usually on hundreds, if not thousands, of spreadsheets," she said. "Finance teams then had to spend days consolidating and reconciling these numbers."
But these days, the IT power of cloud computing has made the task easier, quicker and, at the same time, simpler to involve more people, plan at the granularity needed, connect across the business, and improve collaboration, Toomey says.
She pointed to one insurance specialist operating in the United States, the U.K. and Bermuda that was able to sit as an executive team to get a better grasp on their expenses and make decisions about strategic expenses to prioritize.
By taking a strategic approach to managing expenses with a modified zero-based budgeting approach, she said, they were able to reduce their expenses by 250 basis points.
COVID has accelerated changes that were already underway, and companies can operate differently, Bryan Lapidus, FP&A director at the Association of Financial Professionals, said.
"A ZBB-like review of expenses can lead to better analysis of the activities that support the customer," he said. "This could be a huge value-add to the business by helping to assess profitability of products and services accurately, and be more meaningful than simply reading down the list of contracts in a general ledger."
At the same time, though, companies considering ZBB will have to contend with its bad reputation, he added.
"We have one member at a large industrial company who said his CFO wanted to examine every expense in every general ledger line but not to call it ZBB, because that would scare executives and spark [job cuts] fear among employees."
The kind of businesses that can benefit most from zero-based budgeting are those with a large portion of fixed costs, says assistant accounting professor at Duke University Fuqua School of Business, Elia Ferracuti.
"For these firms, COVID-19 causes larger economic losses, which puts more pressure on their managers to cut expenses and increase efficiencies," Ferracuti said, adding ZBB may not be the way to go for liquid firms that could incur significant adjustment costs after the crisis.
Gartner recommends taking the following steps to increase the effectiveness of ZBB and reduce the burdens of putting it in place:
- Showcase quick wins from ZBB by initiating ZBB efforts with line items well-understood by the business, such as general and administrative spending.
- Identify duplicate spend or cost synergies by evaluating line items across the organization, rather than within functional silos.
- Rotate the ZBB schedule to zero-base all line items every few years.
- Use existing budgeting timelines for ZBB so deadlines to create zero-based budgets coincide with the normal budget submission deadlines.