AFP GUIDE: Addressing the FP&A Talent Gap. AFP GUIDE TO Zero-based Budgeting 2.0: A New Take on an Old Method. FP&A Guide Series.

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1 AFP GUIDE: Addressing the FP&A Talent Gap AFP GUIDE TO Zero-based Budgeting 2.0: A New Take on an Old Method FP&A Guide Series Issue 13

2 AFP GUIDE TO Zero-based Budgeting 2.0: A New Take on an Old Method FP&A Guide Series Contents Why the new interest 1 So, what is ZBB 2.0? 2 Practitioner Voice: Finance Director of a Food Company 4 How ZBB and agile planning coexist 5 Practitioner Voice: Bryan Williams, Director of Strategic Planning and Analysis, LaJolla Pharmaceutical Company 6 Sidebar: How the process works 7 What are the risks and benefits of ZBB? 7 Potential ZBB drawbacks 7 Practitioner Voice: Peter Hinrichs, Vice President of FP&A and ZBB, Dollar General 8 What are the technology requirements of ZBB? 9 20 ways to get started 10 Conclusion 12

3 Executive Summary There s a new brand of zero-based budgeting (ZBB) out there. This new version is founded on the same principles: strip the budget down and start from scratch. It s at once more strategic and more targeted. It s about more than just budgeting. And it s applied on a less overarching basis. Instead of running a zero-based budget for everything with every cycle, companies rotate cost areas on a periodic basis and make it ZBB light by applying less rigor with every passing year. And while it may seem counterintuitive, ZBB these days can and does coexist with agile planning concepts like driver-based forecasting. In fact, according to some practitioners and experts, the two complement each other. Unlike traditional budgeting, where next year s budget is often based on some version of last year s, zero-based budgeting requires managers to justify every cost at the start of each cycle. It can be applied to any type of cost, such as T&E and CapEx. According to Kris Timmermans, senior managing director at Accenture Strategy, his firm has definitely seen a lot more requests around ZBB. Brussels-based Timmermans says that instead of looking at, for example, T&E spend last year, It [ZBB] is a fundamentally different approach, [which is] based on the drivers of cost rather than historical spend. Cost is then monitored monthly and rolls up to the senior cost-package leader, who has the authority to intervene if necessary. Today s ZBB is part of a new management effort to look at cost in a more strategic light. Instead of waiting for a burning platform, CEOs and CFOs are embarking on ZBB projects to change the management culture. Management wants to empower teams to become owners of the budget and take accountability for the numbers, according to Rick Ferraro, director in Deloitte s Cost Transformation Practice. According to Ferraro, it s about managers becoming more self-leading with respect to cost structure rather than being dependent on input from above. Added his colleague, Mark Hopkins, principal: The objective of the ZBB project is to place emphasis on what s important and make sure managers take control and own the budget. The big success stories are where ZBB was integrated into the business management process and culture and became an opportunity to rationalize activities throughout the entire value chain, said Philip Peck, vice president of Finance Transformation at professional advisory firm Peloton. ZBB needs to be viewed through a process-focused lens.

4 Why the new interest? There are seven key reasons why there s greater interest in the application of ZBB principles. 1. Extreme cost consciousness. A Deloitte report found that a sharp focus on cost in particular post 2008 has sparked a renewed interest in ZBB s tenants. According to a recent report from Deloitte: Faced with an economic recession, both public and private corporations began to turn towards [this] extreme method of budgeting. And it s no wonder considering that the resulting savings can be substantial. According to Deloitte, in the best-case scenario, ZBB can cut costs by 15-25% within six months. Further, ZBB has been shown to allow companies to sustain cost savings over time by embedding a cost-management culture into the organization. 2. Competitive pressures. According to Brad McCreedy, partner at KPMG, ZBB is becoming more popular because of pressure from the outside environment brought on by macro-economic challenges, competition and margin pressures. Many organizations are trying to find ways to remain competitive in an ever-changing landscape. Added Hopkins: A number of clients have shown concern about the disruption of their business by new entrants driven by mobile technology and the internet. Those companies are motivated by the need to free up capital in order to make their businesses more flexible and to enable them to react more quickly to new, competitive threats. 3. The economic climate. According to Meredith Hobik, Product Marketing, Finance at software vendor Anaplan, companies are slowing down their investments. IPOs are not as quick to come to market, and everyone is focusing on achieving profitable growth in many cases, by tightening their belts. ZBB is like pressing CTRL/ALT/DEL on your computer every year, she said. In her experience, Hobik sees ZBB most frequently applied at companies inside industries with razor-thin margins such as consumer goods, the public sector, or manufacturing organizations that are trying to find ways to save costs in order to reinvest in new growth initiatives. The Great Recession and economic slowdown that followed raised the expectations of the Board and stakeholders on CFOs to improve margins and profitability, said Peck. In many cases, that kind of improvement cannot come from topline growth and more traditional expense management techniques and discipline. According to Peck, CFOs and their teams have been forced to put a magnifying glass around the company s cost structure in order to find a way to align costs with the company s strategic objectives and the external marketplace. Companies want to make sure they re efficiently using the resources they have, whether it s through ZBB or another cost-management methodology. With ZBB specifically, FP&A is relentlessly looking to streamline, simplify, and improve core business processes so that the organization can do the right things with the right amount of resources. 4. M&A integration. According to Peck, another element that s putting a spotlight on rapid cost reduction is the recent M&A boom. Companies that either acquire or merge often have a definitive timeframe within which they ve promised results, often by eliminating duplicative structures, streamlining operational processes, and reducing expenses. They have to rationalize their activities and demonstrate to shareholders that they ve achieved promised results. Prior to completing the acquisition, you can do so much due diligence. At some point you need to ask: What is my detailed tactical action plan to deliver the promised synergies and financial returns substantiating the economics of the acquisition? In this case, no cost is sacrosanct. You have to look at everything with an objective, critical eye. 5. The changing role of finance. Another reason ZBB is making a comeback is that FP&As specifically, and finance departments as a whole, are focusing on doing things better and continuing to deliver value in different ways. Faced with globalization, the accelerating pace of change, and the increased complexity of the business environment, Association for Financial Professionals, Inc. All Rights Reserved 1

5 FP&A is looking to overhaul traditional planning processes and create a more dynamic, flexible, and adaptive planning and analytics environment that drives optimal usage of organizational assets and resources, said Peck. ZBB provides a proven framework, tools, and templates to assist with evaluating organizational efficiency and identifying areas where resources can be reduced and/or redeployed. 6. Published success stories. It doesn t hurt that some ZBB case studies have become success stories, such as those of GE, Intel and Mondelez. These stories have generated more interest in the ZBB world. According to Ferraro, board members hear about the practice from other board members, and that interest filters down. 7. Technological advances. Finally, there s the advent of new technologies that enable companies to dig down to the necessary level of detail and manage the process of planning, budgeting and forecasting, according to KPMG s McCreedy. Where ZBB plays a role, companies should build in some guidelines, principles, checks and balances to ensure that proposed activities and expenditures be considered and justified. An example of this could be the automatic incorporation of benchmarks or guidelines, according to McCreedy. So, what is ZBB 2.0? ZBB 2.0 is fundamentally different, Accenture s Timmermans said. The same principles apply; however, ZBB 2.0: 1. Doesn t apply to every aspect of the budget every year. 2. Relies on ongoing budget focus to make every year s cycle a little shorter. 3. Places a big emphasis on making smart use of the resulting savings. Timmermans thinks ZBB has evolved into a technique that is most often applied to the overhead cost line, or the supply chain. It could sit in SG&A or COGS. The approach still requires a forensic level of visibility. It s a level of detail most companies do not currently have. It means creating a common nomenclature about every segment of cost, such as IT, travel, or sales. Like before, it entails taking what s often a highly fragmented responsibility that s spread across thousands of budget owners and making it the responsibility of senior cost-package leaders, creating a healthy tension with budget owners. What s different, according to Timmermans, is that the approach leads to what he calls smart consumption policy. It changes behavior by leveraging best practices, he said. For example, a company might require anyone who organizes a meeting to pay for the travel and expenses (T&E) of everyone invited. Traditionally, each budget owner had his or her own T&E budget. The fact that the meeting organizer has to absorb the travel cost means he or she will now think twice about who to invite. It s a smart way to avoid unnecessary cost. According to McCreedy, ZBB has evolved from 1960s, when the U.S. government started using it. It is often misunderstood as merely a methodology that starts from a zero base every year to avoid budgets being sandbagged. This may have been ZBB s starting point at its inception, but it has grown into something more structured. We typically find that clients apply ZBB as part of a more hybrid approach to their annual budgeting cycle, McCreedy said. In his experience, ZBB is best applied to operational expenses, and used in conjunction with other budget methods such as driver-based budgeting. ZBB is typically not repeated every year, and if it is, the expenses that it is applied to are rotated from year to year, said McCreedy. We believe you should choose a portion of your expenses that have been identified as potential cost savings, and when these savings are realized, move to the next subset of expenses. There is a debate among consultants, according to Hobik, whose firm supplies the technological infrastructure necessary to implement ZBB. While some experts preach a full-blown, zero-based approach to the annual budget across each planning cycle, many recommend a hybrid that involves using a rolling forecast for recurring expenses and applying ZBB for certain non-recurring initiatives, such as marketing expenditures, technology investments, professional services and litigation. A lot of people don t ZBB the entire organization every cycle, Hobik said. That s what ZBB 2.0 is all about. Hopkins added that part of the initial effort in ZBB is getting one s house in order and getting the cost Association for Financial Professionals, Inc. All Rights Reserved

6 centers aligned with authority, responsibility and accountability. Once companies fix that and have a good process and incentive program in place, it creates an environment where you can move faster and more efficiently, Hopkins said. You have a line of sight into how things are controlled, so you can really look at the cost of new revenue. It ultimately allows for more flexible budgeting and forecasting. According Ferraro, ZBB is about establishing a solid foundation of understanding that cuts through the fog and directs attention to underlying cost versus use of historical data. Indeed, Deloitte doesn t recommend that companies redo the budget from scratch every year. Rather, companies should deep-dive on a rotating basis and focus on areas of concern, or areas that experience volatility or change where the cost structure might have been affected. Ferraro recommends that companies choose particular areas and use their findings to reallocate resources dynamically to other areas that are essential to accomplishing the company s strategic objectives. This way, you actually increase profitability and direct the budgeting and FP&A resources to the right areas, he said. More often than not, this allows you to more actively manage your resources. While it s important to remember that companies practicing this new version of ZBB aren t reinventing the budget from scratch every time, Timmermans cautions that it s also important that FP&A cast a broad enough net to capture any hidden, allocated costs from other departments. In many companies, there s a mechanism of allocation that s almost perverse, he said. There is a central function allocating budget to the business unit, and if they don t use it all they lose the budget the next time. That creates the wrong incentives. It s also essential for companies that want to sustain the savings to reinvest in growth. This is a more volatile world, said Timmermans. If a company wants to get its money working, it needs a sustainable mechanism. People tried cost interventions in the past, but so few have been sustainable. A recent Accenture survey of 700 C-level executives found that only 36% of them reported being able to sustain cost savings. ZBB promotes a continuous change in behavior and accountability that is becoming recognized as a proven way to sustain the savings, Timmermans said. Smart Consumption What sets today s strategic ZBB apart from the old slash and burn ZBB of the past is that successful ZBB programs ensure budget owners cannot spend the savings as they please. The decision about how to spend the savings has to be done within a stricter governance structure, with the goal of reinvesting in growth. Otherwise, the savings will disappear in the budget. It is important to have governance that isolates the savings and reinvests it based on priorities identified to foster growth, said Timmermans. 1. At the budget level. Traditionally, managers have played around with their budgets. For instance, if they didn t use up all of their legal budget, they might have moved some of it to cover facilities costs. ZBB creates a different structure where different senior executives look after specific budget areas, whether it s legal, facilities, travel, marketing or another budget category. This prevents a manager from moving excess funds from one line item to another based on their department s priorities, as opposed to those of the enterprise. This governance structure puts the light on, Timmermans said. With the light now on, you can t just move the savings around. It s clear that there s a target for everyone for facilities, for legal, etc. and you can t play with it. 2. At the regional and global level. Once savings is generated at the budget level, it is pulled on a regional or even global basis into a fund, which is governed by a top-level growth committee made up of the most senior executives of the organization. It is the committee s job to decide how to deploy the savings captured as a result of ZBB, whether they want to invest in digital disruption, new products, innovation, or acquisition. They ask the truly strategic questions, said Timmermans Association for Financial Professionals, Inc. All Rights Reserved 3

7 Practitioner Voice: A Food Company Zero-based budgeting became much more popular as companies such as the Brazilian private-equity firm 3G and activist shareholders at organizations like Mondelēz International publicly endorsed it and instituted it throughout their organizations. You get the press, and that s a big piece, said the finance director of a food company. According to this executive with extensive ZBB experience the practice has become most popular among industries suffering from margin pressure, such as consumer goods companies. At the same time, consulting firms like Accenture have been touting it as part of their toolkit. This is the trend of the moment, he said. While ZBB is very different from flexible budgeting and forecasting, it is not necessarily mutually exclusive. ZBB is not just a budgeting concept, said the finance director. It s a culture and a lifestyle. It s how you manage the organization: setting targets, building budgets, establishing financial incentives, managing costs on a daily basis, and forecasting future spending. It can coexist with concepts like driver-based planning and forecasting; it just involves a deeper level of cost details. However, he pointed out, It s a detailed process. You can t do a quick top-down forecast, and it tends to focus more on the cost side than on revenue. The challenge with ZBB, as opposed other cost-cutting exercises, is sustaining and maintaining it. For it to be successful, you have to have the tools that sustain it, this veteran ZBB implementer said. ZBB can be done at any type of company. It s about whether you willing to spend time and resources. It can also be applied to growth companies, but you need the people and the right culture and leadership at the top, he cautioned. For most growth companies, it s difficult to maintain a simultaneous focus on growth and cost. You have to make a choice on how and where your senior leadership focuses their time. According to this practitioner, ZBB starts with how you set targets and run the budget. It s extraordinarily detailed, down to every trip you take, budgeting every position and each line item for marketing and sales. And the targets are always aggressive. Targets are linked to compensation for budget owners. They must hit them to qualify for a bonus. That drives behavior, he said. Successful implementation requires a matrix organizational approach: there are budget owners and package owners for each type of expense. Package owners become specialists in a line items such as travel, consulting fees, or utilities, and they work with procurement leaders to identify savings. Most expenditures require approval from a package owner, a procurement leader, and then the budget owner. The review of each expense from three different perspectives ensures that all spending is business critical and reflects the lowest possible cost. Another success factor is senior management focus. Results are reviewed monthly, monthly forecasts through year-end are updated based on the results from the prior month, and quarterly reviews with the CEO ensure that all parties are driving toward their budget commitments. ZBB is one of our company s core management philosophies, said the finance director. While the benefits are clear active cost management and savings the drawback is the time and technology it takes to support it Association for Financial Professionals, Inc. All Rights Reserved

8 How ZBB and agile planning coexist ZBB takes finance into the weeds, but can it do that and also allow FP&A to remain agile? One clue is that ZBB doesn t get hung up on the past. Like other newer approaches to forecasting and planning, it seeks a forward-looking view. The other clue is that it eliminates reliance on managers gut feelings and is based on data-driven decisions. ZBB cannot be allowed to keep companies back. Things change on a dime, said Peloton s Peck. You have to keep up with market conditions and proactively anticipate issues and opportunities on the horizon. At the same time, companies need to be most efficient in their allocation and usage of scarce resources. Peck thinks ZBB and agile planning complement one another. ZBB is all about active expense management and accountability. You can apply ZBB principles and the overall philosophy and not necessarily do a budget from a zero base every time, he said. Similar to the initial implementation of a driver-based rolling forecast framework, the initial application of ZBB principles will likely involve the examination of all activities and related expenses. But, after the initial cycle, the level of effort is less where the balance of attention can be focused on the most strategic areas of significant spend. You can still have ownership and accountability for cost at the lowest relevant level, said Peck. That s the power of the ZBB mindset. The key is to think about your business value chain and make sure that the functions and their activities optimally support the company s strategic objectives. Do it well the first time, and you don t need to recreate the wheel every year. Ultimately, establishing a process that works is going to be faster than a negotiation-based budget, no matter what process it is. To keep that agility, companies need to have a mechanism that sorts through their investment options using a quick governance structure, so they can reallocate resources to keep up with a fast-changing market, added Timmermans. ZBB plays a bigger role during the annual budget process and can be used as a means of evaluating the link between deployment of resources and value generation. For this reason, it can clearly assist with the identification of drivers. Rolling forecasts can then make use of the drivers by applying them to expenses and costs for I believe the benefit is sitting in the first stage when you identify the costs that could lead to savings, as this normally involves the organization, and they then start thinking about the cost and its potential benefit and related cost. the rolling forecast, thereby allowing for quick and agile reforecasts. By being selective, ZBB can keep the organization agile. McCreedy says that ZBB is better suited to operational expenses and not the entire budget. In fact, we suggest going through a process before starting the budget cycle that identifies the costs that could benefit from using ZBB and apply it to those costs only. It is pointless to apply it to non-material costs, or even costs that are already effectively being spent, because of the time it consumes. He added, I believe the benefit is sitting in the first stage when you identify the costs that could lead to savings, as this normally involves the organization, and they then start thinking about the cost and its potential benefit and related cost. It actually makes a lot of sense that ZBB and driverbased modeling (on the cost side) go hand in hand. A lot of ZBB is about looking at what drives cost and trying to change those drivers, instead of arbitrarily cutting costs say by 5%, said Hopkins. By doing so, companies that slash cost arbitrarily punish the efficient cost centers and make it easier on the inefficient to absorb the tightening of the belt. By looking at what s driving the cost, you can take a more thoughtful approach, he said. According to Peck, with driver-based models, the company looks first to break down its expenses in the P&L as typically represented by GL accounts or groupings of accounts (dependent variables) into the individual operational and business drivers (in Association for Financial Professionals, Inc. All Rights Reserved 5

9 dependent variables) to determine the generation of these costs. The resultant driver-model equations are the framework for translating operational activity into anticipated financial results. As part of this exercise, finance may determine that 85% or more of total cost comes from three specific domain areas and is propelled by approximately 12 key business drivers. Whether it s called ZBB, proactive cost management or advanced driver-based planning, management can then apply ZBB principles to the largest cost opportunities and make those cost items high-priority areas for improvement analysis and action plans. Then, depending on the ownership of, and accountability for, those costs it can establish new targets for improvement based on process-improvement initiatives and ultimately rationalize and optimize the cost structure. Practitioner Voice: La Jolla Pharmaceutical Company Bryan Williams, associate director of strategic planning and analysis at La Jolla Pharmaceutical Company, noted that, throughout his career, he s worked for companies that practiced ZBB. Now running planning and analysis at a fast-growing biotech firm, the subject of ZBB has become relevant for his company following the most recent planning cycle. I noticed that people don t think about the future in as much detail, he said. Instead, they re taking about what s already there and just making some tweaks to it rather than doing a deep dive and comparing results to what has actually happened. According to Williams, in the 2016 planning cycle, he did not see as much rigor as he used to see with previous employers using zerobased budgeting. While the company uses a 24-month rolling forecast, it doesn t help FP&A come up with a concrete 12-month budget. Just how complicated ZBB implementation is depends on the size and maturity of the organization, according to Williams. Right now, his organization does not have a large finance and accounting team. His take is that ZBB is more successful at companies that have a large standalone finance organization as opposed to those that rely on operations to input and collect the data. We re in a weird hybrid phase, he noted. But going forward, ZBB may be the best path for us to ensure we have a solid base. He doesn t think ZBB and a rolling forecast are mutually exclusive and sees the two coexisting at his organization. One will provide a detailed, bottoms-up by account picture of the next year, while the other will look at the next 24 months at a higher level (major accounts only). They can go hand in hand, Williams said. The starting point is the budget. The key benefit of ZBB is that it gives companies a more solid understanding of where they should be in the next 12 months. It also weeds out issues with different groups, which may not be as good at providing budget assumptions. It s based on solid data instead of putting a stick in the sand, he said. To make it happen, companies need to have a financial planning tool. It s difficult to keep the data, update it, and generate new reports in a timely manner, Williams said. His company uses Adaptive Insight. You re constantly changing things as you go through the planning cycle, he said. You need to be able to produce reports on how things would look as a result quickly, he said. There are so many moving parts. A planning tool helps facilitate that. What are the risks and benefits of ZBB? Zero-based budgeting is not without risk. It can be time-consuming and require an atomic level of detail. If you do it right, the budget is aligned with corporate initiatives, such as launching new product lines, said Hobik at Anaplan. It forces you to have collaboration and alignment and there s the potential for cost reduction in order to find capital to invest in the business. But that does not come without drawbacks. The risk is that it can be extremely costly and time-consuming to implement. It can also be very disruptive to the organization, especially if you do it every year Association for Financial Professionals, Inc. All Rights Reserved

10 How the process works According to McCreedy at KPMG, the ZBB process has four key steps. 1. Baseline. During this step, the company gains an overall understanding of the current situation, identifies the expenses/costs, and analyzes the organization and its environment. 2. Performance levels. During this step, the organization seeks to gain an understanding of the activities and key processes of each performance level, including internal and external forces. It then analyzes costs, and their associated drivers, to get a thorough understanding of the costs and their composition. This step assists in the identification of possible improvement areas with their associated levers. 3. Optimization. Here, the goal is to identify cost saving scenarios and to obtain formal validation of levers and associated savings quantification. 4. Prioritization, implementation and monitoring. In the final step, the objective is to translate levers into action plans and compute and formalize targeted savings. This allows for principles and guidelines to be implemented in the budgeting process, which then need to be monitored to ensure the associated savings. Potential ZBB Advantages Leads to a budget that is well-justified and aligned to the company s strategy. Can generate substantial savings quickly. Delivers sustainable cost savings. Frees up capital to invest in growth initiatives. Catalyzes broader collaboration across the organization. Supports cost reduction by avoiding automatic budget increases. Improves operational efficiency by rigorous challenging of assumptions. Spending levels are based on what is necessary now versus what was necessary historically. Spending targets are better aligned with required activity. Replaces do with less with do the right things with the right amount. Eliminates common sandbagging. Potential ZBB drawbacks It s costly, complex, and time and resource as budget is rebuilt from scratch annually. May be cost prohibitive for organizations with limited funding. Risky when potential savings are uncertain. Execution challenged by budget-cycle timing constraints. Typically requires specialized training or personnel to accomplish. May be disruptive to the organization s operations. Could harm organizational culture or brand. Demands deeper understanding of departmental activities. Demands management and organizational commitment to stop inefficient activities. Requires a sometimes painful prioritization process. Can trigger pushback against a more detailed level of accountability. Can spur fear within the organization. Can lead to companies focusing on trivial data that s not necessarily worth the effort Association for Financial Professionals, Inc. All Rights Reserved 7

11 Practitioner Voice: Dollar General The renewed interest in zero-based budgeting, in large part, grew from success stories in cost cutting, which sparked the interest of investors and CFOs. It became clear that something needed to happen now with regard to cost cutting, said Peter Hinrichs, vice president of FP&A and ZBB at Dollar General previously senior director of Global ZBB Cost Management at Mondelēz International. The practice was quickly supported by offerings from large consulting firms like Accenture, which brought new tools to the party, and has grown in popularity over the last couple of years. It s not that FP&A was previously silent on cost reduction. Cost reduction has been a big issue for CFOs for some time; however, it needed to be more than a one-time, shortterm and relatively arbitrary effort. To do it differently, you needed to make it a sustainable effort, said Hinrichs. The problem in many organizations is that the cost packages (i.e., travel expense, IS, business events, legal services, facilities, contractors and consultants) aren t transparent. The biggest challenge in getting ZBB going is to really know what and where they spend, he said. For many companies, particularly large ones, there are multiple instances of ERP installations lacking fully standardized processes to record expenses in the G/L, which make it harder to get at the data. Getting the right information by cost packages is a major effort that many people underestimate. Next, companies need to look at ZBB as a process that s on a continuous loop. First, you gain visibility into the cost, Hinrichs said. Then you benchmark your costs against best in class using KPIs; set your cost targets; do bottomsup budgeting that meets the cost targets; and finally, monitor your actual performance against the budget. You have to decide where you want to go as a company with a good understanding of price and consumption levers, he said. And you have to do that well in the beginning, or it becomes very challenging. Companies can t simply decide to cut T&E by 30%. ZBB done right gives the organization the tools and processes to drive desired behaviors, like allowing a traveler to use only company-preferred hotels booked through the travel booking system, said Hinrichs. It also helps pinpoint what needs to change. It may be something simple, like switching to VOIP. It may be a decision on when to engage external legal counsel or the revision or creation of policies to support desired behaviors. From a system perspective, you usually need to invest in new functionality to your existing financial planning and reporting solution to support an efficient bottoms-up package planning and ease of reporting and visibility into cost, which is critical component to a successful ZBB adoption. The other hurdle is change management. In many cases, ZBB requires a lot of change management, said Hinrichs. For example, if T&E is targeted, employees may be expected to book early, or get approval in advance. These are the types of things that impact people. Everyone needs to understand the change, including why it needs to happen. It s very easy to not pay attention to change management when you re focused on just cutting cost. But companies that do soon find that it isn t sustainable. One way to get around that is to show that cost-cutting is not the sole objective, said Hinrichs. [At Dollar General,] we were able to demonstrate that savings helped fund investments (e.g., new product launches or incremental advertising). People could understand the connection between their personal cost reduction efforts and the overall impact on the business. It s important to understand, too, that implementing ZBB takes time and effort. It s really not a flavor of the month. It must be incorporated into the way you do business, said Hinrichs. You have to invest the time Association for Financial Professionals, Inc. All Rights Reserved

12 and train the organization. Everyone needs to understand what s expected of them. And you need to continuously re-educate the organization as new employees join the team. The drawback of ZBB is that it requires the investment of resources in regard to time, technology and tools. People should not underestimate the organizational investment, time and process changes, Hinrichs said. The trick is to very quickly integrate that into a business process, and tie the process to business reviews so it s not a discrete piece. Hinrichs acknowledged that may not be possible in the first year. Over time, you re trying to reduce the heavy workload to free up more time for strategic thinking, to spotlighting big issues, he said. The technology requirements of ZBB Zero-based budgeting requires a sharp focus on granular details and a collaborative effort that breaks down departmental and functional barriers. That s hard to do without the right tools. According to Ferraro, companies must have the ability to consolidate the budget, which may require an upgrade to their systems, or else they begin to use unfamiliar capabilities in their budgeting tools. Added McCreedy: If you want to use ZBB effectively, technology is a very important factor. Spreadsheets alone can t do the trick. It will make the management and process very difficult and time-consuming. We feel that ZBB cannot be successfully implemented and managed without enabling technology, he said. According to McCreedy, ZBB requires a scalable, multiuser environment with strong security, workflow and process control that allows for a collaborative review and approval process. The technology needs to have a strong calculation engine with a central database, maintain version control, and allow for what-if analysis. In addition, it requires an environment that makes it easy to plan and to analyze. It also needs to enable FP&A to capture snapshots of the past and drill-down to the driver level of any cost center or account and lay out how that driver impacts KPIs and strategic initiatives for the next year. For ZBB to be sustainable, it needs to be scalable and fast to deploy, according to Hobik. That may mean focusing on overhead and marketing in the first year of implementation, then moving to another area, such as supply chain, in the second year. For ZBB to work, you have to be tracking how you re investing the savings in new initiatives and hold people accountable throughout the year for redeploying that extra capital, Hobik stressed. ZBB 1.0 was popular 20 years ago. What s different about ZBB 2.0 is that technology is enabling FP&A to gather, process and analyze information so much faster. Information is flowing more quickly and the world is smaller. People need methods like ZBB 2.0 to shake up the organization, Hobik said. ZBB 2.0 is still a lot like pressing CTRL/ALT/DEL, she added. But companies today expect the soft reboot to be much quicker. Organizations have to be agile and they can do that with the right people and technology in place. You need the technology to allow you to be both disruptive and agile, she said. It must allow the organization to reconcile both top-down and bottom-up. It must enable FP&A to run multiple what-if scenarios. It should have predictive forecasting capabilities so the company can see how each scenario will affect the financials going forward. Finally, it needs to enable collaboration with the business. You don t want this to be a finance-only project, Hobik said. You want the marketing team to buy into that new budget number. The business has to be part of the technology so they have a better understanding of how it works that while it may slash their brandawareness budget this year in order to launch a new product, next year their budget will grow. According to Timmermans, most clients don t have the budgeting tools that allow them to go as deep as ZBB requires. The technology requirements are twofold: companies need a tool that allows them to put in that level of detail in terms of their new parameters and they need a calculation agent that can use those inputs. We also see changes that need to be made to procurement technology to better govern spending, he said. Plus, there s quite an investment required in analytics to maintain visibility, control and monitoring Association for Financial Professionals, Inc. All Rights Reserved 9

13 20 ways to get started ZBB is not for everyone. But because it s morphing into a less draconian effort, it s growing in popularity and becoming more manageable for more organizations even smaller ones. Here are 20 lessons experts and practitioners offer companies interested in adopting ZBB Assess organizational readiness. According to Hopkins, one of the first steps is to figure out whether your company is ready for the methodology. It may be that some parts of the company are and some aren t, he said. Embarking on a ZBB program if your company is not ready is simply going to create frustration among management and the rank and file. Assessing your organization s readiness means assessing both the technology and the people and process components. Do you have the necessary data? Are people in control of their cost centers? The key is to get that technology/data and cost ownership in place before embarking on the process. Otherwise, it just frustrates everybody, said Hopkins. 2. Assemble a visibility team. This team s role is to create forensic visibility into how a company s money is being spent, according to Timmermans. They need to work with finance, procurement and others and call on IT expertise to gain access to the transactional data. The management team also needs to define a common taxonomy for the entire company, create a handbook that defines the language the company will use, and then cleanse the data to be able to identify and allocate spending data in a matrix format, including budget and cost category and owners across all cost categories. 3. Get executive sponsorship. It s important to assign a senior leader to each cost category, such as professional services, office supplies, and T&A. Then engage the organization in analyzing the spending for each cost using benchmarking and other approaches and in identifying the opportunity for savings in each category, said Timmermans. Added Hinrichs: Putting the executive team in charge of cost packages sends a clear signal that gets the attention of the organization, he said. This is important, and it convinces managers to get on board. In his experience, the tension between package owners and budget owners at the executive level helped speed up alignment on what critical business activities needed to be prioritized. 4. Get top-level buy-in. ZBB is not just a finance or procurement initiative, said Timmermans. It s a business initiative that requires strong support from the CEO and senior management. The idea is to create a culture where people start to behave like they re spending their own money. 5. Educate the organization. Another success factor is the education of the organization and acknowledgement that full implementation and cultural change will take time, much of which depends on the type of the organization. Global organizations will require a communication effort that reaches people all over the world and that accommodates cultural differences. That takes longer and may require some regional or countrylevel adjustments, according to Hinrichs. 6. Match timing to overarching goals. Companies can use pilot programs or a slower, phased roll-out. However, if performance has deteriorated significantly (or in some cases, if a private-equity owner takes over), the program timeline is typically accelerated, Peck said. Figure out which part of the business and the related financial statement areas will be your first area of focus. It could be a particular program, function, or specific financial statement line item (e.g., office supplies, T&E, or outside consulting). 7. Clearly define your objectives. According to Peck, the project goals could be as simple as a cost-reduction target or as strategic as an FP&A-driven transformation program instituted to encourage the active management of cost. Be explicit about the endgame, Peck said. If it s about a continuous culture of better cost management, be clear on that Association for Financial Professionals, Inc. All Rights Reserved

14 8. Don t use culture as a barrier. Many organizations counter that their culture won t allow it. By now, ZBB has been implemented in so many cultures and geographies that it rings hollow, said Timmermans. What really matters is not so much the culture as the level of ambition. 9. Do your homework. Peck recommends that before starting the project, companies conduct some forensic analysis of historical cost activities. Look into the previous patterns of spend by cost center, business unit, segment or function, he said. Identify what the spend was generally, for example, to acquire customers, service customers, manufacturing, procurement, marketing, brand developments, before setting new targets. 10. Ask the why questions. Once the company gets the forensic analysis done, FP&A can begin to ask all the why questions, i.e., is there a better way of doing things, for example, outsourcing some activities or finding other suppliers? 11. Align compensation. To make people accountable, and drive the right behavior, Timmermans recommends that ZBB implementers consider how to change the management reward system to align cost savings with compensation. One approach entails adding some of the savings to budget owners compensation. 12. Don t take shortcuts. Timmermans also points out that ZBB is forensic in nature. Don t reduce cost arbitrarily by 10% or impose a travel freeze, he said. Go to the lowest level detail. If you take shortcuts, you ll get shortcut results. 13. Create a positive brand. A key aspect to success is creating a positive brand so that people don t get a misguided perception of what FP&A is trying to achieve. It s not a draconian slash and burn strategy. Brand it in a positive light that s consistent with the mission and goals of the organization, for example, the ability to invest in a higher growth area, Timmermans said. Other experts agreed. ZBB can conjure up scary images of layoffs and painful restructurings. It has to be communicated in the right way to the organization even rebranded. One possible rebranding term is value-based budgeting (VBB). Another organization called it advanced budgeting. The idea is not to scare people to the point where they don t want to participate. ZBB 2.0 does not necessarily mean layoffs or painful restructuring. 14. Know the business. To be able to track cost down to its activity and task levels, finance has to have a deep fundamental knowledge of the operational value chain. You ll need to decompose cost down to its elements and understand how the function and activity contribute to the value-creating and sustaining elements of the business, said Peck. According to Peck. The big success stories are where ZBB was integrated into the business management process and culture, and became an opportunity to rationalize activities throughout the entire value chain. 15. Have the right infrastructure. According to Deloitte s Ferraro, the company has to have the right back-office infrastructure to support the implementation. That means a disciplined budget culture and the technological platform necessary to provide a line of sight into the cost centers and the ability to consolidate. 16. Make sure it s targeted. ZBB should not be repeated in its entirety at every budget cycle, every year, according to McCreedy. Given the considerable time and effort that can add, he recommends applying the razor-sharp focus to a different cost area every year. 17. Keep the lights on throughout the year. Don t make ZBB a once-a-year event. McCreedy advises that ZBB works best in companies that maintain a continuous and rigorous focus on cost management and that apply continuous improvement throughout the year Association for Financial Professionals, Inc. All Rights Reserved 11

15 18. Benchmark with others. Assessing cost requirements in isolation is not helpful. To set up specific cost targets, companies should benchmark targets against best in class and their competitors to identify areas ripe for improvement. 19. Partner up. Anaplan s Hobik recommends not going it alone. Don t consider doing it on your own. To execute ZBB 2.0, you need an objective or experienced third party. That may mean hiring a consultant. Budgets can get personal. It s good to have a third party to help negotiate the compromises. 20. Prepare to measure and assign accountability. Don t start without preparing the metrics to measure the project s success and be sure to hold teams accountable once the program is running. According to Hobik, that includes monitoring how much time went into the program compared to the savings it produced. Hinrichs says that, at least initially, there s no question ZBB creates more work for the organization as a whole and finance in particular. The strain of doing a true bottomsup budget requires more time, he said. But very soon, you are shifting the discussion about the process and enabling business and package owners to have a better conversation about the tradeoffs, to make better-informed spending decisions aligned with the company s strategy, and ultimately create the ownership and accountability to deliver the budget. Conclusion Zero-based budgeting is not always the right answer. There s a spectrum of possibilities, Ferraro said. In general, whether the approach is ZBB or another cost-management methodology, what people value is that you can take a step back and evaluate the existing situation and what makes sense. At the front end, that s what is important. At the same time, FP&A has to focus on how strong budget owners have to behave on the back end, e.g., looking at budget variances and taking corrective action; that s the other half of what makes this process so successful, along with adjusting the reward system, said Ferraro. If you have 1,500 budget owners with a dedicated bonus, it really gets everyone s attention and is a massive influence on their behavior. The other piece is that s important, particularly during first time you go through it, is taking a hard look at who owns the cost center and whether they actually have control over that cost compared to how much of it is allocated to them, said Hopkins. The first step in the process is to fix those allocations so budget owners have authority, control and the right financial incentives. In many companies, cost center owners do not actually control the costs. This often adversely affects behavior for two reasons: first, they can t be held accountable for costs they cannot control; and second, the people creating the cost don t have the right incentives to control it. They just spread it around. ZBB exposes the free riders, said Ferraro. ZBB cannot be merely a side project. I strongly advocate that ZBB needs to be embedded directly into the core DNA of the planning, reporting and analysis, and management decision-making processes, said Peck. This helps institutionalize ZBB principles into the fabric of the organization, even to the extent of aligning incentives to support these goals. Also, it s critical to provide the necessary visibility into detailed cost center variance reports and related analysis so everybody can understand what they re responsible for. Some organizations do not necessarily provide that kind of transparency, said Peck. Further, Peck added, like any transformational effort, like rolling out a balanced scorecard or a six sigma program, there has to be an ongoing commitment from management and a repetitive and positive communication cadence around how ZBB helps the company improve how it allocates resources as opposed to the perception that it just reduces headcount. There s a big role for management in internal support and advocacy to ensure ZBB is not viewed as a grim reaper exercise but as part of a holistic performance management platform for the organization at large to help grow, prosper, and deliver sustainable success, said Peck Association for Financial Professionals, Inc. All Rights Reserved

16 About the Author Nilly Essaides is Director of the Financial Planning & Analysis (FP&A) Practices at the Association for Financial Professionals. Nilly has nearly 30 years of experience in research, writing and meeting facilitation in the global finance arena. She is a thought leader and the author of multiple in-depth AFP Guides on FP&A topics as well as monthly articles in AFP Exchange, the AFP s flagship publication. Nilly is a frequent contributor to numerous external blogs and a speaker at industry gatherings. She also co-authored a book about knowledge management and how to transfer best practices with the American Productivity and Quality Center (APQC). About the Association for Financial Professionals Headquartered outside Washington, D.C., the Association for Financial Professionals (AFP) is the professional society that represents finance executives globally. AFP established and administers the Certified Treasury Professional TM and Certified Corporate FP&A Professional TM credentials, which set standards of excellence in finance. The quarterly AFP Corporate Cash Indicators serve as a bellwether of economic growth. The AFP Annual Conference is the largest networking event for corporate finance professionals in the world. AFP, Association for Financial Professionals, Certified Treasury Professional, and Certified Corporate Financial Planning & Analysis Professional are registered trademarks of the Association for Financial Professionals Association for Financial Professionals, Inc. All Rights Reserved. General Inquiries Web Site AFP@AFPonline.org Phone