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Zero-Based Budgeting: How to Do It Right

Basing ZBB on cost-cutting is the wrong approach.

As margins tighten in industry after industry, more companies are talking about zero-based budgeting (ZBB)—the deceptively simple idea that each year’s budget should start from a zero base, rather than from the prior year’s spending.

The trouble is that too often, companies see ZBB as just about cost control. In fact, when done right, ZBB changes a company’s entire culture, instilling a return-on-investment mentality where people throughout the company think about value, not just cost.

But to get there, companies need to shift their focus with ZBB from cost-cutting—which for most people isn’t a very inspiring goal, especially over time—to helping people at every level get the best returns they can on what they’re investing through their budgets.

In short, ZBB isn’t about pinching pennies. It’s about putting your money where it matters most.

Keeping up the Momentum

There’s little question that many organizations find that their initial push into ZBB yields significant opportunities for cutting wasteful spend. But what happens after the first big round of cuts? Too often, it’s like the pre-reunion crash diet that’s abandoned the minute the “welcome back” cocktails are poured. In researching 238 companies that announced cost-reduction programs between 2003 and 2014, we found that barely one-quarter were able to sustain the reductions for four years.

Even worse, only 41 of the 238 companies, or 17%, were able to grow at the same time. For the rest, the experience was all pain, with no lasting gain in return.

What makes the successful exceptions different? In our work with organizations across industries, we see a crucial difference in those that sustain ZBB over time. These companies recognize that the goal of setting budgets to zero every year isn’t to keep people from spending. It’s to help them see their spending through a new lens, making choices with complete transparency, rather than through a fog of last year’s numbers.

With the right approach, ZBB can make spending intentional. Too often, the first question people ask in considering a budget is, “Where can you cut?” Under ZBB, the question becomes, “Why should I spend?”

That’s the real value that ZBB can unlock, creating an environment in which everyone starts to “think like an investor”—turning a business-bestseller cliché into a lived reality. And they can react like an investor as well: new technologies automate much of the data-gathering and analysis that once required thousands of spreadsheets to crunch, yielding detailed insights at the touch of a keystroke.

Flexibility and Transparency

Importantly, annual budgets can still allow for agile spending. What previously was an annual budget line item reading “Brand X—Argentina—promotions” becomes “15 campaigns for Brand X in Argentina at $250,000 each.” If a movie star in Rio tweets a surprise shout-out hyping Brand X, the regional manager can catch the moment by reassigning a couple of promotions from Argentina to Brazil.

ZBB thus breaks bad habits and creates better ones. One industrial-goods maker, for example, discovered through its ZBB processes that much of its marketing spend was hidden in other budget lines, many of them pet projects like $10,000 sponsorships for obscure charity-golf tournaments. Pooling these penny-ante expenses together made it much easier to place bigger, more thoughtful, and more effective marketing bets.

With money flowing more quickly to where it can achieve the greatest impact, the entire enterprise becomes more agile. At that point, the challenge is to keep momentum going. That’s where the other enablers really matter:

Go granular. Visibility as to where money is going today must be available down to the level of individual cost drivers. When planned and actual spending amounts are shown in detail, managers and leaders can have better dialogues on the tradeoffs being made. These conversations force a healthy tension in the organization, and enable the rapid resource allocation that separates leaders from laggards.

Link resources to value. Getting money out of a business isn’t much help if you don’t know where to put it to better use. That’s why growth drivers must also be understood in detail to uncover what’s really driving value for the business: Is it new products, emerging markets, M&A? These insights inform where leaders should reinvest and where they should pull back.

Separate savings from reinvestment. When savings and reinvestment aren’t tracked carefully, individual units may hide the savings they generate in left-pocket-to-right-pocket “reinvestments” that don’t benefit the whole business. Instead, we recommend separating savings and reinvestment into two steps by pulling savings into a pool for deliberate reallocation. That helps ensure resources go where they matter most, and makes it easier to hold managers accountable for delivering returns on the reinvestments they take on. If initial investments don’t pay off, subsequent dollars can be clawed back to the pool for the next big bet.

When ZBB is only about cost, cutting is all that it can achieve. But when ZBB is about value and changing mindsets, the resulting faster reinvestment makes it easier to meet not only existing sales targets, but higher ones as well. Year after year, the organization can keep feeding growth by putting money where it matters most.

Kyle Hawke is a partner in the Washington DC office of global management consulting firm McKinsey & Co. Søren Fritzen, a senior partner in McKinsey’s Copenhagen office, and Matt Jochim, a partner in the London office, also contributed to this article.


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