What are the risks and rewards of zero-based budgeting?
Can zero-based budgeting limit business growth?
A growing body of food makers are adopting zero-based budgeting as a tool to reduce costs and improve resource allocation. The method has also proven popular with investors with a focus on return on invested capital, while companies from Kraft Heinz, to Brazil-based meat giant BRF, to Kellogg are using the practice. However, it is not a one-size-fits-all answer to the challenges facing CPG companies today. In the second part of our series examining zero-based budgeting, Katy Askew takes a look at the pros and cons associated with the method.
What zero-based budgeting can deliver
- Zero-based budgeting requires each expense in the budget period to be justified, as opposed to more traditional budgetary methods that are usually based on costs for the prior period. By building your budget from the ground up, it is possible to ensure it is rationally justified and aligned to strategic priorities.
- Zero-based budgeting supports cost reduction by challenging budgetary assumptions and averting somewhat arbitrary year-on-year budgetary increases. This affords the opportunity to cut historical spending and reassess costs based on current conditions.
- It offers the opportunity to release capital by reducing costs and delivering improved operational efficiency. This cash can be reinvested in growth opportunities or passed to the bottom line.
- The implementation of zero-based budgeting requires management to actively assess and prioritise activities. This can increase organisational efficiency and place resources behind areas of the business most aligned with strategy or delivering the greatest return.
- Starting from a theoretical zero for each budget period encourages businesses to be nimble in the face of rapidly evolving circumstances.
- Zero-based budgeting is an analytical, data-based and repeatable process. This means the method can continue to deliver ongoing savings beyond initial implementation. It can keep a business lean over an extended timeframe.
The pitfalls of zero-based budgeting
- Traditional approaches to zero-based budgeting can focus on easily measurable and identifiable expenses such as SG&A costs. However, that fails to address operational efficiency in core processes such as marketing, procurement or manufacturing. It also fails to consider issues such as portfolio complexity. For zero-based budgeting to be a comprehensive efficiency exercise, these areas of focus must be factored in.
- The process is highly complex, time-consuming and therefore costly in itself to implement. Building the entire budget from scratch is significantly more work than simpler and faster methods that only require justification of incremental spending.
- The complex nature of zero-based budgeting means there is a risk managers will be distracted from their daily tasks or demotivated by a perceived need to count paper clips or restrict travel expenses etc.
- At its heart, zero-based budgeting is about limiting costs. While every company wants to be as efficient as possible and 'do more with less' there is a risk that a cost-restrictive approach could result in an unintentional culture-shift.
- Difficulties associated with ranking functions that are qualitative in nature mean there is a risk of cutting non-core costs that support a customer's or consumer's experience. This ultimately puts into jeopardy brand value in the long-term.
- An approach based on zero-based budgeting can limit investment in growth because short-term benefits may be allotted precedence over long-term planning.
- Savings are not guaranteed. It can be risky to invest in the adoption of zero-based budgeting when cost savings are uncertain.
Zero-based budgeting can yield meaningful rewards. By challenging existing assumptions and practices, zero-based budgeting can sharpen the focus of an organisation on delivering the best results using minimum resources. However, as with all things, there is no assurance of success. The chief risk of implementation is that time will be wasted on a budgetary exercise that can demotivate employees, devalue brands and limit growth.
In such a high stakes game, there is considerable debate about whether zero-based budgeting is a sound strategy for food corporations to adopt. It has largely won the backing of the investment community, which is focused on shorter-term returns. However, a significant number of executives feel it threatens long-term growth while cost-savings can be delivered in less intrusive ways.
In the next article in our series on zero-based budgeting, just-food examines who is adopting zero-based budgeting and whether it is a good fit for growth companies.
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