Zero-Based Budgeting Can Reduce Total Spend
Sourcing managers frequently re-evaluate indirect spend to deliver bottom line results. While conducting spend analysis and re-sourcing spend categories is very valuable to drive cost reductions, people seem to rely on a baseline assumption of organizational need. Companies that aggressively source but do not aggressively evaluate the needs of their organization can become extremely efficient — at spending money that doesn’t need to be spent. Organizations should periodically build bottom-up budgets through zero-based budgeting to continually challenge spend that occurs using traditional budgeting.
Zero-based budgeting is an aggressive budgeting process that forces evaluation of organizational need to allocate funds for expenditures on a line-by-line basis. Business operators must justify each dollar of spend in the upcoming year. This bottom-up approach forces business operators to think strategically about spending and simultaneously builds strong budget ownership. Budgeting is thus not owned by finance, but rather by the entire organization.
The process does not assume incremental increases for year-over-year budgeting, and it does not assume organizational need remains constant over time. This paradigm shift in budgeting forces a re-tooling of common sourcing practices. Rather than concurrently focusing on “what we spend” and “how to reduce this amount,” the organization first focuses on “what do we need” and then focuses on “how do we obtain what we need at the best value?” Through this re-evaluation, business operators make tough decisions regarding which expenses are truly needed and which can be eliminated to help achieve firm-wide goals.
Companies are hesitant to implement bottoms-up budgeting for several reasons. A primary concern is that the process is lengthy and requires significant participation from many levels of management. While this may be true, the process can be implemented at any cadence. Benefits of a review every year, other year, or on some other schedule far outweigh the costs. Companies that do not at least periodically implement bottoms-up budgeting should ask themselves:
- Do all expenses increase or decrease universally by the same amount? If not, what is the appropriate incremental annual adjustment to make?
- What justifies budget increases year over year?
- Do business operators feel they have ownership of the budget?
- Have organizational goals changed between budget cycles?
- Is the current spend the best use of funds?
ZBB can help address the questions above and drive deeper understanding of needs and costs. The average company spends 120 days from budget process initiation to final budget approval. Is an incremental budget, year-over-year, the best use of company time? Increasing or decreasing budgets by a set percentages is simple and relatively painless when compared to ZBB. Unfortunately, it does not reflect the dynamic nature of costs and changes in organizational needs over time. Not all departments grow equally, and not all line items grow equally. Gas costs and computer storage costs do not change at the same rate or in the same direction — why should their budgets? Simple and painless traditional budgeting assumptions are an inefficient use of company time.
Organizations that implement ZBB are forced to think strategically about spend. Sourcing strategies layered with bottom-up reviews truly contribute to the bottom line. Through ZBB, companies can recover dollars lost in incremental budget processes and develop true understanding of need. Once this is accomplished, sourcing efforts will minimize the spend that truly matters.
1 Source: Hackett Finance Benchmark 2011