Zero-Based Budgeting: A Contemporary Method for Resource Allocation

Key Takeaways

• Starting from “zero”: With zero-based budgeting, the overall budget is built up from scratch every year. Using this method, each expenditure must be justified in a comprehensible manner, without relying on values or results from the past. 

• Prioritization and efficiency: After examining each expenditure, it is evaluated whether it contributes to achieving the strategic corporate goals. Only activities that offer direct added value are prioritized, while inefficiencies are eliminated. 

• Accountability and transparency: By requiring all expenditure to be justified in detail by the relevant departmental management, this process promotes greater accountability and enables more transparent decision-making at all levels of the organization. 

• Adaptability and flexibility: Due to an annual re-evaluation of the budget, ZBB offers a quick way to react to changes in company strategy or market conditions. 

Introduction to Zero-Based Budgeting (ZBB) 

The method originated in the 1970s and was developed by Peter Pyhrr, an account manager at Texas Instruments, to provide effective methodological support for dynamic cost management or cost-down management. The aim was to explicitly avoid a possibly excessive historical budget framework as a possible basis for discussions. The first step is to focus on externally orientated expenditure and service provider budgets. The reduction can therefore generally be implemented quickly and relatively easily because no internal processes need to be addressed and adapted. 

What is zero-based budgeting? 

Zero-based budgeting is a budgeting method in which the budget starts from zero each year or in each planning period. Unlike traditional budgeting approaches, which build on and adjust the previous year’s expenditure, ZBB justifies every expenditure from scratch. Each expenditure must be specifically justified, regardless of the amount of the previous year’s expenditure. 

In the ZBB process, all of the company’s programs, departments and activities are subjected to a critical analysis. The decision on the allocation of resources is not based on historical data, but on current priorities and the expected return on the respective activity. 

Differentiation: Traditional budgeting vs. zero-based budgeting

In traditional budgeting, the previous year’s budget serves as the starting point for calculating the following year. In these models, forecasts are made specifically based on historical data and assumed growth rates. Changes such as price increases or additional services are taken into account, but no comprehensive reassessment of the entire expenditure is carried out.  

Other useful methods in budgeting are: 

• Bottom-up budgeting: In this approach, planning is done ‘from the bottom up’. Departments create their own budget estimates and send them to the management. 
• Lean budgeting: Lean budgeting is particularly effective due to its flexibility and continuous adjustment, rather than focusing on fixed, annual budget targets. 
• Strategic cost management: Through careful cost control, strategic cost management can strengthen an organization’s strategic position and its overall objectives. 
• Activity-Based Costing: The ‘ABC’ method aims to accurately record those costs that cannot be clearly and directly allocated to the product. 
• Forecasting and budgeting: Forecasting is the process of forecasting future financial results based on current data and trends, while budgeting describes the creation of a financial plan that expresses all income and expenditure for a specific period. 

 Advantages of ZBB for companies 

• Stricter cost control and increased efficiency: ZBB enables companies to critically scrutinize and eliminate expenditure, leading to more efficient use of resources. As every expenditure must be justified, the focus is on the maximum benefit per resource invested (cost optimization). 
• Better alignment with strategic goals: ZBB ensures that resource allocation is targeted to areas in order to be able to achieve long-term corporate goals (corporate priorities and strategic focus). 
• High flexibility: Through annual / continuous reassessment, ZBB enables greater flexibility, which in turn can be very advantageous in dynamic markets or in times of economic uncertainty. 
• Promotion of innovation and change: As expenditure is not automatically continued, existing processes and programs are re-evaluated. This can lead to innovative solutions and a continuous improvement process within the company. 

Challenges and risks in the implementation of ZBB 

Despite the many advantages, ZBB also presents some challenges and risks that should be taken into account during implementation: 

• Effort and complexity: a detailed review and justification of individual expenses can be very time-consuming and complex, especially in large organizations. The evaluation of extensive data collections and their analyses can ultimately lead to an increased workload. 
• Resistance from employees: As ZBB requires justification and justification of expenditure in a department, this can lead to resistance and some fear of budget cuts among employees. 
• Focus on short-term savings:  If the focus is on the efficiency of a current period, long-term investments or strategic projects could be neglected in favor of short-term savings. 
• Prioritization difficulties: To implement ZBB effectively in large organizations with many departments, you need a clear method for evaluating and weighting the different items. Without a clear structure, it can be difficult to prioritize expenditure correctly in such a complex environment. 

The ZBB process in detail  

In preparation for the ZBB process, expenditure that is necessary to ensure ongoing business operations is separated from investments and costs that do not affect the course of business in the short term. The result is a prioritization of which expenses should be examined first. This cost block is discussed – usually in cross-functional teams – with a view to reducing the level of expenditure. It is possible to think in all directions to find a solution: 

• Is the product or service still needed at all, or can it be completely cancelled? 
• If the product or service is needed, then the focus should be on: 
• Opportunities to reduce quantities – can we also manage with a smaller number of units? 
• How can the specification or the service level agreement be thinned out in order to achieve price improvements? As a premise, the basic benefit should not be lost. 

These consecutive steps ensure that no product or service is purchased that is either not absolutely necessary or is over-specified. 

Practical examples of successful cost reduction through ZBB 

The starting point for a successful cost reduction are often specifications that are not updated with every tender. The potential can be realized here if ‘simplifications’ for the supplier are also communicated. For example, the delivery window is a decisive factor in the route planning of logistics companies: if it is specified that deliveries must be made between 07:00 and 08:00 in the morning on the city center route, this is a decisive calculation factor. If there is no urgent reason (e.g. a notice from the point of sale stipulating the time window), extending the time window forwards and backwards is a great lever for improving prices. 

An example from the field of marketing would be the grammage of the paper used for brochures and flyers. A reduction in paper grammage has a cost effect in the purchase of raw materials. In the next step, the costs for distribution can be renegotiated, as the weight of the distributed advertising material is also a relevant factor for the calculation. 

Typical potential savings and successes 

A ZBB program often starts with a target that specifies how much the budget should be reduced at the end of the process. The process can be iterated until sufficient measures have been found to achieve the ‘bottom up’ target. The discussions take place in cross-functional teams, which creates a cross-departmental discussion that promotes joint approaches to solutions and also generates a certain motivation to contribute and make savings. If one department makes concessions, it is increasingly difficult for colleagues not to contribute to cost optimization. 

Zero-based budgeting: Is it right for your company? 

ZBB is an attractive way to reduce costs because it can be implemented quickly and has an immediate positive impact on the company’s results. It is also a very effective means of reducing overheads/indirect costs. Compared to ‘direct’ costs, there is often little focus on this cost block because there are often no specialized departments, and the requirements are procured by the specialist departments themselves. 

Conclusion 

Zero-based budgeting is an effective method for optimizing the allocation of resources, reducing unnecessary costs and focusing more precisely on strategic corporate goals. The challenges, considerable effort and even resistance from staff associated with this approach must be carefully weighed up by the company. However, if implemented appropriately, ZBB can lead to a sustainable improvement in a company’s financial planning and long-term competitiveness. 

At EFS Consulting, the most effective and fastest way to reduce costs is determined for each analysis. ZBB is therefore always an approach that is evaluated in the initial phase of a project. In addition, many other methodologies such as should costing, benchmarking, increasing competition, policy and catalogue systems also add value.