The drive for Zero-Based Budgeting (ZBB) over the past few years has seen companies of all sizes attempt to implement the process, but the company often cited as patient zero for its resurgence is Heinz.
When Berkshire Hathaway and 3G Capital took Heinz private in 2013, they implemented a number of transformational changes at Heinz. One of the first was ZBB, a budgeting technique focused on cost reduction, the advantages of which we focused on in part 1 of this series. ZBB starts from zero-base, and every function is analyzed for its cost. Budgets are then prepared for the coming period by calculating a cost for each organizational function regardless of whether the budget is higher or lower than the previous cost.
Chris Winter, Financial Planning Controller, was responsible for ensuring that ZBB was implemented across Heinz’s European operations. He explained the main principles for ZBB and how to implement it at the recent CFO Rising West Summit in London.
Firstly, Winter noted all costs are divided into packages - simple packages and complex packages. Simple packages are those where you have an opportunity to reduce costs, whereas complex packages are the necessary areas that are more difficult to cut down. Each package is further broken down into sub packages to help further improve understanding as to what your costs are. Companies should target big reductions in their simple packages, and large reductions in complex packages.
Every cost has two owners. One is entity owners. They have vertical or organizational responsibility - these are traditional budget holders. In the past, they were previously set a budget of half a million dollars which they were then free to spend how and when they felt. In zero-based budgeting, a package owner is responsible for checking the spend on each package to ensure that the money they spend is not wasted. This is usually an additional responsibility on top of their other roles and they will require a fair amount of support. It’s also necessary to ensure that the right person is in place, as the role will often entail having to tell a more senior manager to restrain costs.
The next principle that Chris Winter notes is cost reduction targets. You start with a big reduction of your targets and then everything is built line by line, i.e. in the travel budget every detail must be accounted for, from taxi trips to hotel stays. By going through line by line and having regular meetings with senior management to ensure that costs are all accounted for and you do not get surprises.
When implementing ZBB, the first thing you need to do is define what’s in scope. This should include costs, overheads, marketing and so forth. but have nothing to do with variable costs and nothing used in the making of the product.
Packages and sub packages should also be clearly defined to ensure that no crossover in cost responsibility between package owners.
You should then build a baseline, going through the last year of actuals to understand where your costs are. You should check where costs are being coded against ledgers and map them into packages, then cross reference with accounts payable data to ensure nothing has been paid into the wrong account.
There are three things to remember when it comes to ZBB. First, global policies based on data are essential. For example, when it comes to travel, flights must be booked 14 days in advance as those booked after have been shown to cost more. Secondly, you need to build a good reporting system and make sure every region reports at the same time. Thirdly, standardize reports. They should be kept simple, and the same report used in all briefings with all levels of management so that everyone on the same page. ZBB is a time consuming process and everything possible should be done to cut down on the workload.
The main challenge - and the ultimate goal - of ZBB is to change employee behavior so that they are focused on costs. Implement qualifiers and KPIs and ensure that everyone shares objectives so there to help ferment a sense of teamwork. To encourage people to abide by ZBB at Heinz, they have adopted a system whereby you get a bonus for achieving your targets, however, you have to hit the qualifier or you’re not eligible. The qualifier, in every case, is to not exceed the ZBB budget. ZBB is not easily done. It requires a lot of hard work and a real adjustment in working practices. However, once it is drilled in with constant routine, and so long as you keep updating policies based on feedback, ZBB can be a valuable tool.