Find experts and specialist service providers.
One of the phrases I have heard a lot in the past six months is Zero Based Budgeting. Like many of the ‘new’ approaches that are sweeping the world at the moment, this is not a new idea.
It emerged in the early 1970s, although it was originally little more than a mechanism for re-setting the budget process whereas now it has garnered more support by evolving into a more mature process that can be used by organisations to not only set a more effective budget but to then track actual activity against that budget and re-set activities accordingly.
This is especially applicable to IT functions where the traditional approach to budgeting has been to examine last year’s spending, make adjustments for inflation and refresh cycles, add in new projects and remove any completed projects.
Whilst a useful ready reckoner, this approach results in very stagnant behaviour and is often the consequence of simply ‘doing the same again’. The trouble with doing the same again is either we end up doing precisely that, which is anathema to innovation or we end up so diverged from the original thinking that the budget is essentially useless.
The reality is that an effective budget should not only reflect the intentions of the business (or IT function) but should also be a fundamental element that drives those intentions in the right direction.
One of the keys to innovation is to be able to re-allocate funding into new or emerging markets, business units or brands but using the more traditional approach to budgeting often means that the majority of spending is trapped in the historical cycle and cannot easily be re-allocated so starving the innovation areas.
Truly innovative companies are those that more effectively re-allocate funds to where they are needed. This fluidity of financial movement is something that start-ups are more able to do, hence the continual emergence of disruptors into many markets.
To allow more mobile funding, zero based budgeting has become far more popular as it allows future funding to be aligned more effectively with the needs of organisations in the current fast-paced World.
Zero based budgeting is essentially a process of ignoring any previous budget and setting all expenditure items to zero. The owners of the various elements of the organisation must then, at a very granular level, justify their cost requests for the budget period.
These requests, when approved, then become the budget and they are not assessed with any comparison to previous periods but only in terms of need for the future. This approach allows for top-level strategic goals to be built into the budgeting process by tying the goals to specific functional areas within an organisation.
Traditional budgeting, which generally results in incremental increases over previous budgets, only properly analyses new costs as these are usually additions to the cost base. Zero based budgeting analyses all costs within the budget which means a justification is then required for old, recurring costs as well as net new costs.
This approach ensures that budget holders are required to justify all expenses and is intended to drive value for an organisation as well as creating more mobility in costs to allow a greater speed of change within an organisation.
For example, within an IT function, many traditional budgets contain requirements for the renewal of software licenses. These are often increased by the provider and the actual increase can become lost in the general uplift of licensing costs year on year.
If, however, all these items are set to zero, the budget holders are then encouraged to explore other software options or other delivery options with their current provider. Many software vendors will not actively switch their existing customer base from traditional licensing to a more cost-effective Software as a Service solution unless asked and the customers often do not ask as they simply accept annual increments to the budget as ‘normal’.
In a similar vein, as organisations adopt more cloud-based services and infrastructure, they often do not strip their usage to zero and examine the costs of their cloud environment in general.
Many cloud expenditure budgets are regularly increased with the increased being masked by the justification that more cloud is being used therefore costs are likely to increase.
Taking a zero based approach means that all usage is closely examined and has to be justified and this often results in a decrease in the cost base as straightforward efficiencies are identified.
There is an obvious downside to this approach, however. A traditional budget has the advantage of a starting point to which only new costs need to be added and more obvious savings removed.
Zero basing the budget means that every element of the cost base needs to be examined, reviewed and justified before it can be included in the budget and this creates a lot of work.
The volume of work may actually justify a line in the budget of its own but once a rhythm is established and the habit of all members of an organisation becomes one of cost guardian then the benefits are enormous.
The most obvious benefit is the ability to understand and, therefore, remove obvious waste in an organisation. However, perhaps the most important benefit in this age of disruption and the need for agility is that money can become more mobile and applied more effectively to the development of new solutions within organisations which can then be used to generate more revenues. None of this will work, though, without a fundamental change in approach across an organisation to how budgets are created and then managed.
Traditional budgets are notoriously inaccurate during times of change because they are predicated on what is often many years of historical inaccuracy that has become embedded within the budget system.
Line items may have existed for many years, often unchallenged as ‘the cost of doing business’ and will then have been incremented over the years by inflation or third-party price increases.
Now, under zero based budgeting, each of these items must be investigated and challenged and, when they are included in the budget, they must then be closely monitored.
Zero based budgeting requires far more stringent governance not only during the budgeting process but also throughout the year to monitor the activity and ensure that the budget remains validated.
Failing to maintain the initial energy levels that went into creating the budget on a zero basis will result in the poor habits engendered by traditional budgeting creeping back and the positive effects being diluted.
The more traditional approach with many organisations is to keep a very close eye on the top line, the revenue, and the bottom line, the profit on the assumption that if both of these are tracking properly then the costs element must be under control but this is to miss the point.
If we look, for example, at an IT function, the costs are still invariably seen as a ‘necessary evil’, something that has to be incurred as a consequence of doing business. IT has no associated revenue and nor does it have a profit associated with it and staff are continuously encouraged to reduce their costs.
However, they are rarely incentivised at a personal level to establish accurate costs and to monitor and manage these effectively and nor are they allowed to re-purpose their budgets to seek more effective solutions and create more fluid funding within their business.
The CIO should be incentivised to create a culture where spending can be re-invested where it benefits the business and to remove dead spending from their organisation. The CIO needs to be encouraged and empowered to identify wasted expenditure, isolate and remove it and then be allowed to re-invest this in much more productive ways.
Not all expenditure in IT is equal and the more successful organisations realise this and encourage their CIO to reduce the less useful spending to release funds for more effective spending. This latter element is critical because zero based budgeting must not ben seen as a simple cost-slashing exercise but rather about investing more wisely.
The CIO can then work more confidently with the business in developing new solutions knowing that these investment funds are available and won’t be removed from them.
Of course, a CIO cannot operate in isolation and it is imperative that the zero based approach is adopted across an entire organisation and that the Board fully supports the approach.
That said, implementing a new approach wholesale is a huge undertaking and beginning with functions such as IT and then adopting a rolling programme across the organisation over a period of time is a more effective approach.
This will only ever work if the Board is behind it and supports it not only in their words but in their actions. A simple example I encountered at a client recently was where the Board determined that no papers should be printed for any internal meetings.
The saving was negligible within the overall budget but the made the statement in tandem with the promise to invest the savings in new equipment for the end users which, in turn, improved staff morale. The actual cost of printing was only uncovered when a full zero based budget review was undertaken and it turned out that several thousands of pounds a month were being spent on printing.
The key to the initiative was threefold: the zero based review uncovered a largely hidden cost that had simply been accepted for years. The cost saving was identified and seen as valuable by the Board. The resulting saving from the stipulation on not printing was shared and re-invested towards the users so they were not only aware of the saving but beneficiaries as well. A simple previously unquestioned cost was identified, removed and the resulting saving converted into more mobile expenditure that could be easily re-purposed to distinct benefit.
Using a very simple example such as this clearly demonstrates the financial value of zero based budgeting but it also shows the cultural change necessary to maximise the benefit.
Cost slashing rarely creates a positive benefit but re-purposing can be used to effectively drive change within an organisation and this is one of the reasons for the renaissance of zero based budgeting.
Many organisations that have effectively applied this approach to their budgets are now moving into phase two of the approach which is to apply zero basing to their operational structure by questioning the cost and value of roles within their organisation.
The fundamental idea behind this approach is to shift organisations from thinking in a traditional organisational structure approach to looking at their organisation in terms of the way that work is accomplished with the result that organisations become more agile and responsive by taking time that is used unproductively and re-purposing it into more effective tasks that drive innovation and change.
Zero basing is predicated on gathering strong data, analysing the data in the context of the organisations wider strategic goal and then re-designing the various levers that can manipulate the finances or the staffing to maximise the impact of the assets within a business and create a more fluid approach to both finances and staff.
Adopting the zero based approach across the whole organisation allows a very clear view of budgets, staff costs, productivity, end-to-end processes and efficiency which can then be compared to peer organisations. These assessments often highlight opportunities for shared services, process re-designs and automation that create efficiency and effectiveness and create space for people to be released into other, more valuable tasks in the same way funds can be released through the zero based budget.
Over years, organisations become stuck with an organisational structure that is no longer aligned with their current strategy or market and a budget that is set based on previous behaviours.
The zero based approach is an effective mechanism for hitting the reset button and releasing organisations from these historical strictures. Releasing these bonds frees the organisation and creates a culture of more mobile assets which, in turn, creates a more agile culture that is able to realise the innovative ambitions of the Board.
Article by channel:
Everything you need to know about Digital Transformation
The best articles, news and events direct to your inbox