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Zero Based Budgeting (ZBB) is a great way to apply a higher level of scrutiny to the budgeting of your fixed costs (SG&A). This means eliminating rubber stamps and free passes.  

The classic approach of budgeting SG&A based on last year’s spend plus a minimal growth rate will, if left unchecked, eventually lead to unnecessary OPEX bloating over several years. Not only does this approach lead to a ton of waste which drives down shareholder value, but it also creates a culture of overspending rooted in the “use it or lose it” mentality. 

Organisations need to think smarter about their spending. This is where modern ZBB approaches can help.  

Introduction to Modern ZBB: What Is It about?

Modern ZBB is not a slash-and-burn exercise. It is about applying the optimal cost structure to the right parts of the business in the right stages of maturity. It is about maintaining and growing revenue while cutting out areas with excess spending.

For large businesses with multiple business models and significant SG&A spending across them, a single cost structure is not only suboptimal but also unrealistic.  

Modern ZBB is about embracing more agile approaches to spend management. This can be done by running experiments on what spending can be cut out and what needs to be retained to support the business’s long-term health. It is about leveraging analytics and modern tools to continuously screen and re-evaluate what expenses are necessary and what expenses are not.

In simple terms, modern ZBB is about ensuring that you apply fuel in the right places, so your organisation can continue growing and evolving.  

Three Questions to Consider When Implementing Modern ZBB

• What Are You Measuring?

It is important to recognise that although ZBB is about spend management, the KPI used to measure performance should not be focused entirely on expenses only. Doing so would only promote the slash-and-burn mentality that modern ZBB tries to avoid. Rather, success needs to be measured using a more balanced measure, such as SG&A divided by Sales.

Assuming Sales are growing over time, ZBB success can be achieved in one of three ways: 

1. by cutting costs
    
2. by holding costs constant
    
3. or by allowing expenses to grow but at a slower rate than your Sales growth. 

At the end of the day, ZBB is about putting the right cost structure in place, and the only way to do that is to ensure that you are not eroding Sales simultaneously.  

How Should You Look at Your Data?

The simplest way to implement a Cost Transformation effort like ZBB is to start with better transparency of costs. This includes grouping expenses with similar drivers, such as Travel and Events. Make sure to apply these “subaccounts” across the entire business, making it easier to compare spending across the organisation. This is an obvious place to start, but most organisations could benefit from the clean-up and discipline accompanying this effort.  

Next, start to look for outliers. Why should one business unit have considerably more spending than another? Is it justified, or does a behavioural element need to be reviewed? For example, why are all employees in one cost centre staying at a high-priced hotel when the rest of the organisation is staying at a preferred hotel vendor? Bringing outliers in line with the average is a great way to cut costs and apply spending controls.

“Name and shame” might sound like a harsh technique, but trust me, no one wants to be the cost centre with the highest excessive spending. Using both carrots and sticks when necessary is a technique made possible with better transparency.  

Looking across the business for outliers is a great way to normalise expenses. But often, this effort is not enough; the focus needs to shift to making trade-offs across the various SG&A account lines.

Establishing the optimal mix of SG&A can often be much harder than setting the overall spending target. In most cases, there simply is no one-size-fits-all template that will hold constant.

FP&A teams need to continuously test and play with their SG&A mix to optimise the outcome of their business units. Modern ZBB is an agile journey. What works today needs to be constantly monitored and reviewed for tomorrow. It is simply not a case of setting it and leaving it.  

How Do You Build the Right Cost Culture?

Perhaps the hardest but most important aspect of establishing a modern ZBB initiative is driving cultural adoption among employees.

How do you get your employees to spot waste and want to do their part to cut it out? How do you build a culture that embraces spend management as a new normal without feeling like they are going through austerity measures?

Regardless of what approach you take, the key is to be consistent in your messaging and your management approach.

When times are good, it is natural to want to loosen the belt and allow for more spending. However, this is not the ZBB way. This is a critical opportunity to bank the savings when things are going well.  

Allowing the additional spending to occur will tell your employees that unnecessary spending is ok. This needs to be squashed out. Organisations need to build a ZBB culture that awards people for always doing the right thing, not just when the boss is looking (for savings). Doing so tends to reign in the consumption component of spend, which normalises spending over time in both good and bad times.  

Conclusion

At the end of the day, establishing the right mix of SG&A spend is a continuous evolution. Setting the overall spending target is often much easier than tactically managing the optimal mix of expenses that go into making up your total SG&A.  

In other words, trying to establish a one-size-fits-all template that will hold constant across the business, across the year or across the life cycle of the business, for that matter, is not going to be an optimal way to manage spend.

The best way to implement an optimal spending management strategy is to start with a balanced approach. Cutting expenses without considering how they impact your organisation’s ability to deliver revenue is a recipe for disaster. 

Next, monitor spending across the organisation so you can eliminate unwanted behaviours. Transparency is critical when you need to drive change. 

Finally, build a business culture recognising that having a low-cost structure is a serious competitive advantage that will drive shareholder value and provide job security in both good and bad times. 

These are the critical elements to implementing a modern ZBB process.

This article was first published in the SAP Blog.