The dramatic downturn resulting from the pandemic has caused havoc in our economy. Businesses are struggling to survive.Sweeping cost cuts to stem bleeding cashflows has been an immediate reaction as evidenced by mounting unemployment and shuttered stores.
A continuation of this volatility means that it is imperative for businesses to establish financial discipline. The fundamental aim is having effective oversight and control over the cashflows.
While there are a myriad of excellent software applications to effect this, there is a cost free methodology which can be applied irrespective of the system being utilised.
This is a methodology used by Amazon which I learnt as finance leader of their China business. Within a depressed economic environment, it has gained renown as an effective way of managing costs and is known as Zero Based Budgeting (ZBB). Whilst I call it a methodology, at Amazon it was more a mindset.
ZBB is a natural extension of two leadership principles that Amazon relentlessly drummed into me: ownership and frugality.
It is not a new idea. ZBB was developed in the 70s and mainly used by consumer goods companies.Since then, the methodology has spread across the economy given its universal applicability to those businesses wanting to be more lean. It has recently come back into vogue as pre-crisis, economic conditions were deteriorating. The pandemic has ramped up its appeal. Companies such as General Motors, Unilever, Guess? and Mondelez have brought the ZBB discipline into their budgeting process.
What exactly is ZBB? In summary, it is a holistic methodology that assumes all budgets start from zero. ZBB requires a granular scrutiny of all expenditures across the board inclusive of capex. A common practice of ZBB is to completely reset the annual budget to ensure resources are used efficiently. The mindset is to justify the inclusion of a cost rather than referring to past periods and debating its removal. There are growth oriented scenarios where ZBB can be applied though its essence is a bottom-up approach to budgeting. The main aim of ZBB is to drive productivity and efficiency during times of depressed economic growth.
Before embarking on any budgeting process, let alone ZBB, it is important is to strip out the associated behavioural problems commonly encountered.Three of the predominant behaviours to be wary of are: optimism, over reliance upon a sole expert and sandbagging.
We are all prone to be overconfident about projected results. Even CFOs are prone to being overconfident! A study conducted by Deloitte's showed that 80% of CFOs were confident of achieving their guidance whereas only one-third of results fell within the estimates. This can be overcome by reviewing actual results as compared to past projections as well as not placing sole reliance upon the narrative.
Over reliance upon an expert without scrutiny can also be an oversight leaving gaps in exploiting efficiency. Within a business, a decision made by an appropriate group rather than over reliance upon the best person can reduce this bias.
Sandbagging is a common strategy amongst seasoned managers in anticipation of horse trading during the budgeting process. Using the ZBB approach can mitigate this given the premise of starting with zero as a baseline.
ZBB can surgically target cost reductions instead of having a company instigate blanket cost cuts.Furthermore, the methodology provides transparency into hidden costs and installs accountability across the business. This is a result of ZBB reviewing costs by nature rather than by location. The improvement in transparency and the associated cost discipline enables better alignment of expenditures with strategic plans. In a way, ZBB challenges managers to be more innovative in conducting their operations. For example, it may spur the adoption of robotic process automation (RPA) for business processes to save costs.
The upshot of ZBB, if used properly, is the greater efficiency frees up capital which can be devoted to those projects which are better aligned with the company’s objectives.
An important caveat to be aware of when using ZBB is it has a reputation as an aggressive way of cutting costs. This can harm the company’s culture and staff morale.Hence, leaders of a business need to embrace ZBB as an ownership oriented program on a long term journey to enable sustainability.
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