Use Zero-Based Budgeting to Rightsize Tight Budgets

In today’s cost-constrained operating environment, executive leaders need a budgeting approach that enables them to assess their spending in terms of the value it drives for the enterprise. By reverting the budget to zero, zero-based budgeting (ZBB) can more effectively assign costs to business priorities and outcomes. 

“ Clarifying what ZBB is and does is a critical first step to capturing its value”

This breaks with the traditional budgeting process, in which organizations base costs on whatever was spent in prior periods and then just add arbitrary allowances for growth or reduction. But in today’s volatile times, organizations must be more deliberate in how much they choose to spend on the business results and strategic outcomes being targeted.

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“Even when zero-based budgeting isn’t adopted by corporate finance, executive and functional leaders should consider it as a complement to more traditional budgeting processes,” says Galliopi Demetriou, Senior Director Analyst, Gartner. “Its principles give leaders a strong lever to defend budgeting priorities and spend allocation in terms of value.”

What is zero-based budgeting? 

The term “zero-based budgeting” is the source of much of the misunderstanding about ZBB. Clarifying what ZBB is and does is a critical first step to capturing its value and smoothing the way for successful implementation. 

The “zero” stems from the fact that ZBB starts with an empty spreadsheet, instead of just assuming that previous expenses will be maintained. In practice, of course, many costs can’t simply be wiped from the budget at the beginning of the next accounting period. But, the objective is to deliberately choose how and what to spend to fund the business results or strategic outcomes identified in the strategic plan.

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5-step process for ZBB implementation

The Gartner approach to ZBB incorporates five prerequisites and follow-on activities to ensure the principles of ZBB are implemented successfully — and operationalized on an ongoing basis.

1. Ensure financial transparency

You need visibility into: 

• The relationship between activity (cost driver) and cost, so you can see which levers of cost are adding value and which aren’t. 
• Whether costs are variable, fixed, discretionary or nondiscretionary 
• The impact on costs if spend changes, e.g., contract penalties, severance costs

Without this level of transparency, you can’t see inefficiencies hidden within services/projects/initiatives and can’t identify behaviors that need to be managed to change costs.

2. Identify strategic business priorities and KPIs 

Identify and cascade strategic business priorities into the budgeting process to ensure alignment and to identify key performance indicators (KPIs) by which to measure the success of investments.

Executive leaders must agree and communicate strategic priorities collaboratively and across functions. Without this consensus, zero-based budgeting can’t effectively prioritize spend in terms of business value and outcomes. The choice of metrics/KPIs should reinforce the strategic alignment.

Also make sure senior executives endorse the use of the zero-based budgeting approach vs. traditional budgeting methods, either across the enterprise or in the function(s) adopting it. Clearly communicate its purpose and principles to avoid pushback and gain buy-in from the budget holders who will need to examine their cost base. This smooths ZBB implementation.

3. Align, evaluate and optimize 

Conduct the process of zero-based budgeting as a rightsizing exercise to align functional area spending priorities with desired business outcomes. 

Especially amid the post-pandemic resetting of business strategy, this realignment ensures that approved budgets are focused on driving value, that is, enabling a business priority/outcome. 

Note that even though cost-cutting is not the primary objective of zero-based budgeting, cost reduction could be an outcome — although only if:

• There are no value-adding priorities to which spend could be shifted.
• The enterprise needs to return cash to the bottom-line for imminent survival.

4. Control and monitor the budget 

Maintain a comprehensive and regular review of budgets, spending and variances, at least quarterly and maybe monthly, to stay aligned with business priorities and to contain variances.

Monitor budgets to ensure that spending and forecasts remain closely aligned to the activities and outcomes that were the original intent of ZBB implementation.

Use the chosen metrics and KPIs to measure and assess the value and alignment of spending to the strategic/desired business outcomes. Just because spending stays within budget doesn’t automatically mean the objectives of the spend have been met.

5. Value-based spending 

Operationalize the concepts of zero-based budgeting through an ongoing process of value-based spending. If senior leaders focus too much on the procedural changes of ZBB implementation, functions may view it as just another budgeting method.

Instead, articulate and reinforce that budget holders don’t “own” approved budgets and value-based spending involves an active assessment of all spending — regardless of whether or not it has been previously agreed to in the budgeting process. 

Senior executives should actively demonstrate and reinforce behaviors that are at the core of zero-based budgeting, such as:

• Encouraging honest trade-off discussions, driven by alignment to business outcomes
• Making tough resource sacrifices.

How to decide what stays in the budget

ZBB is often seen as a time-consuming, resource-heavy process, but Gartner research shows that when implemented correctly, it takes, on average, five additional days relative to traditional budgeting approaches.

It is critical, though, to instill standard criteria to evaluate budget items. This helps to ensure that:

• Activities are evaluated fairly.
• Common biases in decision making are overcome. For example, the focus stays on the contribution the activity makes to business outcomes, and isn’t influenced by how well budget holders describe the urgency of their cost.

To evaluate whether items should be included in the zero-based budget, use a decision tree (see graphic below) and test budget items for: 

1. Strategic alignment: Does the activity, its scope and cost being proposed for the budget align to and enable a strategic objective?
2. Efficiency: Is the activity and cost included in the budget sourced in the most cost-efficient way? Have you achieved the best price?

Immediately cut budget items that fail the first test. Challenge any that survive initially to ensure those costs can’t be optimized before earning a permanent place in the budget. 

If adequate funds aren’t available for all qualifying activities and costs, you may have to conduct another round of prioritization to business outcomes. Any excess is reallocated.