Zero-based budgeting is essentially a cost-control mechanism. By re-setting each line of the budget at zero, it focuses attention on expenses and challenges existing costs. There are, however, contradictory views about whether the adoption of this method is supportive of revenue growth while its risks and limitations mean that it is not necessarily a good fit for everyone. Katy Askew reports.
Detailing her decision to eschew zero-based budgeting, PepsiCo CEO Indra Nooyi explained: “When you embark on a zero-base budgeting program that cuts to the bone, and jeopardises your ability to grow the top line, I think that’s a formula for disaster. We believe in smart spending initiatives where we look across all of our cost structure, and say where we can selectively reduce costs, intelligently, not for the short term, but find a way to make sure it does not affect top line growth initiatives.”
Indeed, with a top-of-class net margin of 13.02%, PepsiCo’s success in keeping costs under control without the use of zero-based budgeting is evident.
Like many other large packaged food makers facing challenging economic conditions and rapidly evolving consumption patterns, PepsiCo has increased its focus on productivity in the face of sluggish revenue trends. At the same time, the company has remained focused on reinvesting in growth through efforts to modernise its portfolio and build its brands. As Nooyi recently noted, 45% of PepsiCo’s total net revenue now comes from “guilt-free” products, a level that is set to climb still further as the firm steps up innovation on healthier products.
According to Wells Fargo analyst Bonnie Herzog, PepsiCo’s brand investment has supported “solid” sales expansion. “Overall we believe management is doing a solid job of leveraging productivity savings and the benefit of the extra week in its fiscal 2016 to invest in key areas such as: (1) advertising to support solid top-line growth; (2) R&D to support a healthy innovation pipeline; (3) technology to improve execution; (4) sustainability initiatives which are driving cost savings and a shift in PepsiCo’s product portfolio towards healthier alternatives, consistent with consumer demand; and (5) further productivity savings initiatives,” she notes.
The Frito-Lay maker is not alone in using other ways of reducing costs to strengthen margins. Nestle, the world’s largest food maker, has also gone down a different path with the implementation of its own structural cost reduction initiative, dubbed Nestle Continuous Excellence.
How well do you really know your competitors?
Access the most comprehensive Company Profiles on the market, powered by GlobalData. Save hours of research. Gain competitive edge.
Your download email will arrive shortly
Not ready to buy yet? Download a free sample
We are confident about the unique quality of our Company Profiles. However, we want you to make the most beneficial decision for your business, so we offer a free sample that you can download by submitting the below formBy GlobalData
Examining the Swiss group’s cost reduction efforts, MainFirst analyst Alain Oberhuber observes: “Nestle is not taking the zero-based budgeting route as the current NCE and the structural cost-saving programme goes beyond that approach. Furthermore, with ZBB there is a risk that organic growth could slow down.”
While Nestle declined to comment specifically on the advantages of NCE versus zero-based budgeting, a spokesperson for the group was quick to stress the far-reaching outlook of the NCE programme. “NCE is a strong part of the Nestle DNA and the scope of the initiative goes beyond manufacturing and it is used across the whole organisation,” the spokesperson tells just-food.
Likewise, Bonduelle finance chief Grégory Sanson suggests zero-based budgeting is not an appropriate approach to cost control for the French vegetable giant.
“We do not use ZBB. We choose in 2013 to decentralise responsibilities in [our] business units. We manage through profit targets and not through resources and ZBB,” he tells just-food. “Our low-cost DNA prevents Bonduelle from inappropriate expenses. Using ZBB reflects a way to manage and allocate responsibilities we do not support at Bonduelle.”
Bonduelle’s margins are under pressure at a time when competition from private label and an intensifying price war in Europe are shaping the competitive landscape. It might seem an appropriate moment, then, for Bonduelle to step up its productivity efforts and – arguably – zero-based budgeting could support this.
Midcap Partners Florent Thy-Tine, however, suggests Bonduelle’s operating model means zero-based budgeting would not be an appropriate way to deliver cost savings. “The capex intensity and the seasonality of Bonduelle’s activity are not really compatible with a zero-based budgeting approach,” Thy-Tine tells just-food.
Bonduelle’s lagging margins are not a “problem of cost but a problem of demand”, the analyst suggests.
Many proponents of zero-based budgeting have shed less profitable sales volumes to intensify their investment behind higher margin lines. Thy-Tine does not believe this is a solution for Bonduelle, which has a business model reliant on processing volumes and capacity utilisation. “Bonduelle stopped a plant but it did not increase their profitability, just reduced their loss. The more volume you do, the more profitable you are. Currently, prices are under pressure by private labels and if you don’t accept the contract you lose volume so you lose profitability and if you accept the contract the prices are too low to be profitable,” Thy-Tine says.
Zero-based budgeting is not a one-size-fits-all solution that will deliver improved efficiency for everyone. It is, nevertheless, a useful tool that represents a good cultural fit for some organisations, in some circumstances.
Times of change in management have proven opportune moments to re-think the budget and zero-based budgeting is an effective method. An obvious example can be seen following the acquisition of Heinz by private-equity firms Berkshire Hathaway and 3G Capital.
3G is known for its adherence to zero-based budgeting. Upon completion of an acquisition, the investment vehicle follows a typical playbook that sees it install management from within its own ranks at the top of the portfolio company. In this instance, 3G partner Bernardo Hees took over as Heinz CEO. Aggressive cost-cutting followed and zero-based budgeting enabled Heinz to prioritise investment behind products that delivered greater growth or returns.
Zero-based budgeting can also be useful in the integration of large-scale acquisitions requiring reduced complexity. And, when Heinz acquired Kraft Foods Group to form Kraft Heinz in 2015, Hees was again quick to roll zero-based budgeting out to the enlarged business to build the group’s “competitive advantage”.
Speaking shortly after the formation of Kraft Heinz, in November last year, Hees stressed the importance 3G places on zero-based budgeting as a tool to “achieve and maintain best-in-class margins”. He explained: “Two of the main drivers here will be zero based budgeting and making our manufacturing and distribution footprint more efficient. And we have already made significant progress in each of those areas. Zero-based budgeting, or ZBB, is a systematic approach, not a one-time event. It’s all about ownership and doing more with less. It drives accountability and encourages our employees to treat company dollars as if they are their own.”
The merger of Kraft and Heinz and the introduction of zero-based budgeting and other aggressive cost-control measures undoubtedly moved the needle on margin expectations. Many US food manufacturers fell into line, adopting what has commonly become known as the “3G model”.
As Kellogg CEO John Bryant explained in 2015, shortly after the Kraft Heinz merger: “We have a new model with the 3G model and Kraft and Heinz, we’re going to watch that closely and learn and reapply what works.” And reapply Kellogg did.
Building upon the savings it delivered via its Project K initiative with the introduction of zero-based budgeting, Kellogg has set a target for the 2017/18 fiscal to increase operating margin by 15-17%. The company’s previous forecast was for margins of 11-13%. Kellogg believes it can achieve an improvement worth 350 basis points by the end of 2018 – a revision on a previous target of 2020.
Delivering its second-quarter results in August, Kellogg claimed it had already seen the benefit of zero-based budgeting in North America, citing the practice as a factor in an 110 basis point improvement in operating margin in the market in the period. The company revealed it plans to extend the roll-out of zero-based budgeting and CFO Ron Dissinger said Kellogg expects to eke out $150-180m in savings from zero-based budgeting alone in 2016. Between the start of 2016 and the end of 2018, the company forecast total savings of $450-500m from implementing zero-based budgeting across North America and internationally.
Reacting to the current low-growth environment and the adjustment of benchmark operating margins, other US food makers have also insisted they anticipate significant savings from the implementation of zero-based budgeting.
For example, General Mills has initiated the process of zero-based budgeting, which it says is delivering savings, as well as advancing its existing holistic margin management (HMM) model. The company is “confident” on delivering its goal of 20% adjusted operating profit margin by fiscal 2018. Meanwhile, Mondelez International believes zero-based budgeting will help support its goal of taking margins to 17-18% in the 2018 financial year. US poultry group Pilgrim’s Pride expects zero-based budgeting to generate savings of $185m during 2016. And ConAgra Foods has used zero-based budgeting as a plank in its turnaround drive ushered in by president and CEO Sean Connolly.
European food makers have on the whole been less enthusiastic to champion zero-based budgeting – with notable exceptions including consumer foods giant Unilever.
Earlier this year, Unilever started to adopt zero-based budgeting as part of a three-pronged approach to improve efficiency alongside measures to address new functional needs, such as the integration of R&D into category teams, and net revenue management. The company’s approach to zero-based budgeting will include functions such as brand and marketing investments but exclude payroll, Unilever revealed.
Discussing the move, Unilever CFO Graeme Pitkethly stressed that the adoption of zero-based budgeting was a good “cultural fit” for the Knorr maker that “will be welcomed and energise the company”.
He explained: “First of all, it’s very data-driven and analytical… We like that sort of thing. It’s about eliminating waste. Again a good fit, we don’t like waste, we like to be more effective in what we do. It moves away from incremental and moves to a more absolute assessment of where we spend our cost and by opening up brand and marketing investment in addition to overheads, I think that’s liberating especially when there are so many changes happening within the consumer level.”
Reducing costs provides Unilever with a degree of flexibility that could include reinvesting to support top line growth, Pitkethly said. “As we realise savings, as we make choices about where we invest those savings, it could be behind growth and increasing the competitive margins. It could be somewhere in the bottom line, it could be some invested in the investments we will have to make in order to give access to the savings.”
Could we see more Europe-based firms take up zero-based budgeting as a tool to cut costs? Certainly, the challenging consumer environment supports a highly disciplined approach to expenses. And, as in the case of Unilever, expected savings can be used to strengthen margins or re-invested to support growth.
European dairy co-operative Arla Foods is “not ruling out” utilising zero-based budgeting methods, Morten Holm Jensen, vice president of corporate finance at Arla, tells just-food. However, he continues, the application needs to be targeted at “specific areas” that are well-suited to its rigours.
“Clear examples are areas within capital resource allocation where a ZBB approach is very useful and normally leads to a clearly improved capital allocation viewed on a year on year basis. The same goes for marketing investments, however in this area, a quite large spend is used to maintain brand positions and hence the ZBB concept quickly becomes a ZBB on top of a based pre-allocation that covers 50-60% of total spend,” he notes.
The same can be said of Arla’s manufacturing budget, which is largely made up of reoccurring volumes. “In a big production company like Arla Foods 85-90% of the annually-produced volumes across the supply chain is recurring year over year i.e. they are produced at same factories/dairies in same types and volumes across years. Hence cost optimisation across the supply chain is closely linked to continuous improvements and hence application of LEAN and other operational excellence toolboxes – it is to a large extent a matter of driving out incremental cost improvements at times coupled with new technology and production footprints that then delivers step changes in cost development.”
In the final instalment of our series examining zero-based budgeting, to be published tomorrow, we take a look at the crucial issue of implementation.