Zero-based budgeting can help balance cost management and strategic investments.

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What if there was a way to manage costs that placed as much emphasis on funding growth as on the discipline of cost reduction? Take another look at zero-based budgeting (ZBB).

Many CFOs worry that imposing austerity measures will stifle growth, hurt morale and limit flexibility at a time when most organizations value agility. Ever since the ZBB methodology of building annual budgets from scratch first became popular in the 1970s, it has often been seen as a tactic for companies in financial difficulty.

But if implemented correctly, ZBB can help automate and simplify the budgeting process and align costs with future goals in a range of targeted scenarios, including growth phases.

Advantages

In Ernst & Young LLP’s experience, by using ZBB, 45% of clients have achieved cost reductions of 10% to 20%, and an additional 35% have reduced costs by more than 20%. However, the real power of ZBB does not lie in achieving cost reduction benchmarks; it is about combining digital budgeting tools with greater cost accountability and a process that links budget discipline to future growth.

To do this, ZBB uses analytics to help prioritize competitive capabilities that require new investment versus SG&A (sales, general, and administrative) areas where overruns often occur. These areas include non-strategic headcount, travel, idle technology, real estate, maintenance, and back office expenses. When combined with operating model improvements, ZBB can also prevent non-strategic costs from reappearing in the budget.

In one example, a large retail chain developed detailed budgeting models, deployed a cloud-based budgeting platform, and implemented change management that included training for over 250 users. In the two years since the initiative, the company has achieved cost savings of 25-30% in non-strategic areas. She used the savings to improve the in-store customer experience and improve her mobile app.

When to use ZBB

Some organizations urgently need cost transformation, while others are managing costs effectively but would benefit from a reallocation of resources. In the wake of the COVID-19 pandemic, companies looking to revive growth may need greater fiscal discipline as well as a focus on investments. Here are four scenarios in which ZBB can be used.

Urgent intervention

ZBB is not just for companies in financial crisis, but can help restore liquidity, relieve pressure from worried investors, or restore short-term profitability.

Targeted restructuring

Companies undertake targeted restructuring when they may need to cut costs quickly. However, since the targeted restructuring is not motivated by serious financial difficulties, the organization can reduce its expenses more selectively.

Improvement or cost management

Businesses that focus on medium-term improvements can use ZBB to reduce waste and manage increases in future expenses. In established industries with low margins, even minor cost improvements can significantly benefit EBITDA (earnings before interest, taxes, depreciation and amortization).

Growth

A company may have already carried out a cost reduction initiative but wishes to rebalance its investment portfolio. ZBB focuses on cost reduction by providing visibility into price and quantity drivers, average prices paid for goods and services, and location-based spend data. It supports the investment process as a tool for gathering the information needed to make strategic spending decisions.

The approach

We recommend an updated five-step ZBB approach.

Strategy alignment and cost visibility. The digitally supported ZBB helps the organization establish baseline costs, use benchmarks to set goals, and align specific expenses with business strategies.

Budgeting. Budgeting becomes an automated process of creating a balanced spending plan, with justification required for each line item entry.

Responsibility and sustainability. The company deploys cost category ownership and governance structures, supported by change management, to promote sustainable cost management and reinvestment across all categories and functions.

Control and monitoring. Automation enables early detection of overruns and tracking of reinvestments through defined policies and controls, including quality KPIs and monitoring to enable cross-organizational visibility.

Optimization of the operating model. The operating model helps create value by aligning the structure of the organization with long-term goals. ZBB can help refine the operating model by reprioritizing the processes that best serve strategic business goals.

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Akshat Dubey is Partner and Head of US EY Zero-Based Budgeting at Ernst & Young LLP.

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