The key to successful zero-based budgeting

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Have you ever wondered why we get hiccups?

In a fascinating book, Your inner fishNeil Shubin, a professor of anatomy at the University of Chicago, describes how we humans carry the very real remnants of our evolutionary past—hidden before our eyes—into the way our bodies function every day.

For example, hiccups. Shubin writes, “If the odd course of our nerves is a product of our shady past, the hiccups themselves are likely a product of our history as amphibians… Turns out the pattern generator [the nerve controller] responsible for hiccups is virtually identical to that of amphibians. And not in just any amphibians, in tadpoles, which use both their lungs and their gills to breathe.

Shubin continues, “Tadpoles use this pattern generator when they breathe with gills. In these circumstances, they want to pump water into their mouth and throat and through their gills, but they don’t want it to enter their lungs. To prevent it, they close the glottis, the flap that blocks the respiratory tube… They can breathe with their gills thanks to an extended form of hiccup.

In short, our hiccups are a vestige of our evolutionary past, when we shared an ancestor with tadpoles.

The evolutionary history of your business

If you really want to understand why a company does what it does, look at its business challenges and where it was five to ten years ago, or even more. Chances are that most of what the company does stems simply from how it met past needs, and that those business practices were passed down as part of the company’s culture – “the way we do business with” – over the years, without being reviewed and rebuilt.

I teach a very powerful case for this in my graduate course at MIT. This case presents a very complex optimization problem. Typically, students work hard on optimization and come to class prepared to discuss their quantitative approaches. I surprise them by starting the class discussion by asking them, “What is the problem we need to solve? »

After a long discussion, it turns out that in fact the company no longer needed the process that was being optimized. Not only that, but the process was actually hurting the business far more than it was helping it – and the more complex the optimization, the less likely students would be to question whether the underlying process was actually necessary.

The main lesson is that the most important things a company does are tacitly determined and never seen, never questioned and never examined. Within this tacit, historically determined framework, many adjustments take place, but the framework itself – “the way we do business” – is almost never examined.

What is most important is that the really a lot of money resides in the modification of the tacit frame, and not in its development. But hardly anyone operates at this more fundamental level.

What Margaret Mead Said

To emphasize the point about the pervasive invisible influence of the past, I tell the class the story of an anthropology course I took with the famous anthropologist, Margaret Mead. The course focused on the tacit transmission of culture across generations.

Near the end of the class, a student raised his hand and asked if Americans had any traditions passed down from generation to generation. When Professor Mead asked the class, she heard responses like “hot dogs” and “baseball.”

She then looked at the lecture hall with around 500 students present. She asked everyone born and raised in New England to raise their hands. I grew up in western Massachusetts and Connecticut, and my parents and grandparents were from Providence and Hartford, so I raised my hand. I looked around and saw that New Englanders were circled around the sides and back of the room like a horseshoe.

She explained that in the early days of town meeting government in small towns in New England, elected officials asked for volunteers to do town work. If there were not enough volunteers, the people seated in the front and in the middle were called upon to help.

So over the years, New Englanders began to sit around the sides and back of the room – and this unspoken behavior was passed down from generation to generation. without anyone knowing why, even long after people have stopped going to town meetings. My wife, who is from New York and likes to sit in front of the room, finds it both frustrating and fun.

The problem with zero-based budgeting

Zero-based budgeting is a very important management process. His logic, on the face of it, makes a lot of sense: all expenses should be assessed as if there were no pre-existing practices. I consider this the “if only I could wave a magic wand” business approach.

The problem with this seemingly obvious approach is that it’s nearly impossible for managers to get below the surface of business procedures to examine and question the more fundamental “way we do business”. Managers are almost always so stuck in their traditional way of doing things that they are unable to meet the goals of zero-based budgeting. Therefore, they fall back on adjusting existing practices for small additional gains.

Break the mold

Enterprise Profit Management (EPM) is the key to clearly seeing your company’s unspoken set of business practices in order to take a real look at your business. EPM creates a full, comprehensive P&L for every transaction (every product purchased by every customer every time) and uses a sophisticated data structure to combine and recombine these transactions to show the true overall profitability of every nook and cranny of a business .

Over years of experience with EPM, we have found that virtually every company has a characteristic profit segmentation pattern:

• Peak Profit Customers—typically about 20% of customers generate 150% of a company’s profits;

• Clients that drain profits — typically around 30% of clients erode around 50% of those profits; and

• Profit Desert Customers — Typically, the rest of the customers produce minimal profit but consume about 50% of a company’s resources.

EPM gives a clear picture of your business at a very granular level. It identifies the areas where it is most necessary to rethink and redefine the “way of doing business” of a company. This allows you to analyze exactly where your business is making money, where it is experiencing Profit Drains, why this is happening and what to do to accelerate Profit Peaks, reduce or reverse Profit Drains and increase the profitability of your Profit Deserts .

Every business is an “accidental business” in the sense that it is built to a surprising extent from old business practices. In our research and work with Profit Isle clients, we have seen in industry after industry that even in large companies, the zero aspect of Enterprise Profit Management allows managers to increase their profitability by 10 at 30% per year on a sustainable basis.

Why does this happen in so many companies?

This happens company after company, because in our previous era of mass markets, profitability was primarily a function of sales volume, which created economies of scale in everything from production to distribution to The advertisement. The prices were set by the manufacturers and the distribution costs were very homogeneous because the products were simply delivered to the receiving docks of the customers.

Over the past 30 years, we have entered what I call the era of diversified markets, during which everything changed. Prices are negotiated and often vary by account and product. Costs also vary widely, as vendors have very different relationships with their customers, ranging from an arm’s length relationship to a highly integrated relationship. Industry boundaries are blurring and capable new competitors are capturing market share.

In this new environment, markets are rapidly segmenting, and success or failure rests on a leader’s ability to deeply understand where their business derives all of its profits, to assess whether that segment is sufficiently differentiated and protected, and to channeling company resources into market segments with high sustainable profits. In short, the company must detach itself from the floating anchor of its history and build its future with a true zero process. Enterprise Profit Management is the only way to achieve this life or death goal.

Today, the traditional broad accounting categories of revenue and cost, which worked so well in earlier times and still work well for financial reporting, are utterly inadequate for understanding granular profitability. Yet we continue to manage as if we were still living in the previous era.

What you get is the familiar “islands of profit in a sea of ​​red ink” pattern that is a holdover from doing business in a way that worked years ago, but no longer fits – much like hiccups and sitting on the sides of an auditorium.

where is the real money

The power of Enterprise Profit Management is that it provides an extremely powerful view of the business as it really is today: where it works, where it doesn’t work, and why.

When you see this very granular picture of your company’s earnings landscape, you will immediately realize where your company’s activities – its “way of doing business” – fit today’s business needs, and where they fall short because that they essentially continue to apply the old working methods. doing business that is a holdover from the past and no longer appropriate.

With this detailed profit picture, you can’t help but take a real look at your business. You will be able to build a solid step-by-step plan to align your “way of doing business” with today’s business needs. This is where the really a lot of money is.

Enterprise Profit Management SaaS systems can be set up in weeks. They are extremely accurate and timely because the information is pulled directly from a company’s general ledger. Because the zero-based actions they enable are rooted in an intuitively clear and granular profit picture, you can be sure they will be accepted and work.

Without a hitch.

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