2. Traditional Budgeting Issues
2
A traditional approach to budgeting does not ensure spend is focused on
the activities most critical to achieving enterprise strategy and objectives.
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Budgeting is viewed by many as one of the least effective
management practices.
• Requires significant time and effort for limited/uncertain benefit
• Premises are often obsolete before the budget is finalized
• Static – built off of history; difficult to adapt to rapid changes in business
conditions and competitive requirements
• Often drives counter-productive management behavior (spend to budget;
poor collaboration; internal competition)
• Bottom-up budgets are often inconsistent with top-down plans
• Can result in sub-optimal resource allocation
3. Kill the Budget?
3
A better question, “Is there a different approach to budgeting that will
provide even more benefit?”
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Budgets and the process of creating them are core to effective
business management.
• Key control in managing costs
• Structured process for reviewing priorities, evaluating cost structures,
considering tactical options and allocating resources
• Important element in managerial development and performance evaluation
So, budgeting is important but should you expect better
results simply by working harder following the same
approach?
4. Alternative Budgeting Approaches
4
There are merits to each approach, however we believe VBB strikes the
right balance between effort and results for many organizations.
• Rolling 12 month budget – budget is continually updated as each budget
period (month/quarter) is completed
• Zero-based budgeting (ZBB) – start at zero across the enterprise
• Selective ZBB – only some departments use ZBB (often G&A focused)
• Rotating ZBB – departments rotate between ZBB and traditional budgeting
on annual basis
• Value-based budgeting (VBB) – establish threshold budget level and add
budget increments based on relative value generation
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Leading companies have embraced alternative budgeting approaches
to drive more effective business management.
5. VBB – Budgeting for High Performance
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• Value Optimization – the overall budget reflects the best combination of options as
measured by net value generation (enterprise first)
• Strategic Connection – incremental activities are aligned with strategic priorities
• Leadership Alignment – shared understanding of cost and value of optional activities
as well as regrets for activities that didn’t make the cut
• Innovation – new thinking about how to achieve objectives at lower cost
• Improved Decision Making – value-centric, enterprise-wide
• Collaboration – working across organizational boundaries to build the optimized
budget
• Cost management – enables more effective cost visibility, understanding,
governance and accountability
• Effort – less effort than full ZBB
VBB is designed to deliver much more than basic budgeting
6. VBB Process Overview (1)
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1. Develop a threshold budget by department of
50 to 60% of the current budgeted spend and
headcount. This is generally a good starting
point for the core activities reflecting the
minimum acceptable level of service and
performance.1
2. Define the activities2 that can’t be performed
within the threshold budget at current cost
levels and calculate the expected net value of
those activities.
3. Consider alternative approaches to performing
those activities - outsourcing, consolidating,
automating, process simplification, etc. -
comparing cost to benchmarks where
available.
Objective: a budget prioritized basis relative value generation
Best Practice Tip
Cost categories such as T&E, advertising
and IT projects are often looked to as
prime areas for discretionary cost
reduction. However, some of those
expenditures may generate much greater
value than others in cost categories
considered non-discretionary.
If you aren’t clear on the activities that
are core to the business’ success it is
crucial that you work through that first to
avoid making cuts to activities that might
prove to have significant unexpected
consequences.
1) Threshold budgets could be set basis benchmark
standards where available
2) Combination of ongoing activities and project-
type activities
7. VBB Process Overview (2)
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4. Define increments (cost and headcount) of
optional activities (notionally 10-15% of
original budget per increment) up to the
current budget level.
5. Rank order incremental activities by value to
build to the targeted overall budget limit.
6. Increase departmental budgets to fund the
most valuable composite set of incremental
activities.
7. Establish reporting and management
processes to achieve budget compliance and
to modify budgets as business conditions
change.
Best Practice Tips
Sound estimates of the cost and value of each
activity are required for proper comparison.
The rationale behind cost and value must be
robust enough to withstand challenge.
However, while the estimates should be fact
based to the maximum extent possible, some
estimates will be necessary to avoid investing
excessive time in the VBB process.
The Finance organization should provide
guidelines and standard factors for use in
estimating cost and value.
Beware of bias in the selection and evaluation
of activities. Many activities may be viewed as
critical and/or highly valuable simply because
they have been performed for a long time.
8. Case Study
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Caseco revenue is expected to decline in the next fiscal year as they
respond to aggressive competitor pricing. The Caseco CFO has
determined fixed cost must be reduced by 10% to met target profitability.
Approach A – Cut and Cope
Each department reduces their current budget by 10% without consideration
of potential impact on sales, quality and workforce.
Approach B - Modified Zero Base Budgeting
The organization builds their 90% budget to fund the best combination of
activities based on enterprise value.
Start with a threshold level (minimum acceptable spend) at ~50% of total
budget and then build up to 90% with increments of 10% to 15%.
The CFO believes VBB will allow Caseco to meet the target without
destroying value.
9. Threshold Budgets
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Original
Budget
Threshold
Budget
Threshold as %
of Original
Finance $1,250 $ 700 56.0%
Logistics 1,850 1,100 59.5
Sales 2,175 1,300 59.8
HR 1,750 1,000 57.1
Manufacturing 975 525 53.8
Total 8,000 4,625 57.8
Caseco establishes departmental threshold budgets to cover critical,
core activities (generally 50-60% of current budget/spend.)
Each department then defines the set of activities that can’t be
performed at the threshold budget level and calculates the cost and
benefits for each of those activities.
10. Proprietary and Confidential
Building Out the VBB Budget
Selecting Incremental Activities with Greatest Net Value
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Activities
ranked from
highest to
lowest value
Add activities
with positive
value up to
budget limit
Org and
Increment
Proposed Activity Cost Net Value Cumulative
Budget
Total Threshold Budget 4,625.0
Finance 1 Maintain billing and collection staffing to maintain/improve DSO 100.0 400.0 4,725.0
Mfg. 1 Upgrade vibration sensors 100.0 375.0 4,825.0
Finance 2 Maintain staff for business performance reporting 150.0 350.0 4,975.0
Logistics 1 Maintain overtime level to maintain on-time delivery rate 250.0 350.0 5,225.0
HR 1 Retain staff required to support performance management process 175.0 325.0 5,400.0
Sales 1 Maintain full sales staffing levels 200.0 325.0 5,600.0
Sales 2 Upgrade portal for customer self-serve 100.0 300.0 5,700.0
HR 2 Upgrade portal for employee self-serve 300.0 250.0 6,000.0
Finance 3 Upgrade invoice scanning software to reduce contract invoice processing 200.0 200.0 6,200.0
Logistics 2 Maintain plant and equipment at current level of spend 300.0 250.0 6,500.0
Mfg. 2 Maintain rotating equipment at current level of spend 100.0 175.0 6,600.0
Logistics 3 Upgrade routing software 200.0 150.0 6,800.0
Mfg. 3 Maintain tanks at current level of spend 100.0 150.0 6,900.0
Sales 3 Add sales support staff 200.0 100.0 7,100.0
Finance 4 Retain staff required to maintain account reconciliation 100.0 70.0 7,200.0
Sales 4 Continue in-store promotions for low-growth products 200.0 55.0 7,400.0
Sales 5 Maintain annual sales recognition program 175.0 50.0 7,575.0
Mfg. 4 Retain contract electrical inspector 50.0 25.0 7,625.0
Mfg. 5 Upgrade blend analyzer 50.0 20.0 7,675.0
Mfg. 6 Continue use of roaming operator during off hours 50.0 -10.0 7,725.0
HR 3 Retain in-house physician for on-site medical services 275.0 -25.0 8,000.0
11. Comparing the Resulting Budgets
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Cut and Cope Budget VBB Budget
Initial
Budget
10%
Cut
Revised
Budget
Initial
Budget
VBB
Cut
Revised
Budget
%
Change
Change
vs C&C
Finance 1,250 125 1,125 1,250 - 1,250 - 125
Logistics 1,850 185 1,665 1,850 - 1,850 - 185
Sales 2,175 218 1,957 2,175 375 1,800 17% -157
HR 1,750 175 1,575 1,750 275 1,475 16% -100
MFG 975 97 878 975 150 825 15% -53
Total 8,000 800 7,200 8,000 800 7,200 10% -
Value Reduction 1,158* 115
* Cut and cope value reduction reflects best case scenario with some partial activity reductions. Worse case
scenario would result in nearly 1,600 in value reduction.
The two approaches result in dramatically different budget allocations
12. Key Considerations in Implementing VBB
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• Don’t wait until you need to cut the budget to implement VBB. Start well in
advance of the next budget cycle to build an understanding of cost and value
drivers.
Consider a pilot involving one or two departments to build understanding and
validate the benefits. Finance is often a good starting point as the pilot helps
them develop expertise to support others in a broader implementation.
• Management reporting should be modified to periodically update the cost and
value of the incremental activities. This may require some form of activity based
costing however we don’t recommend ABC without activity based management.
• Finance should ensure cost and value are calculated correctly and consistently so
options can be properly compared. This may mean Finance must be more
involved in working with the business in building the budget.
• Reward and recognition systems may need to be updated to drive behavior
consistent with optimizing enterprise value.
13. VBB Concerns
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There are several potential issues that must be considered and
addressed as appropriate before launching into VBB
• VBB may require significantly more managerial effort than the current
budgeting approach, particularly in defining incremental spend alternatives
and determining their associated value
• It may be difficult to assign economic value to “intangible” activities such as
R&D, advertising and community relations
• Strong leadership is required to deal with significant reallocations of funding
and staffing and to prevent gaming
• Requires additional support from Finance for valuation of alternative
activities and budget integration
If done well, improvements in enterprise performance and organizational
alignment more than justify the additional effort involved in VBB.
14. For More Information
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Steve Finkelstein
Senior Partner
314-409-6869
Steve.Finkelstein@experience-on-demand.com
Doug Groves
Finance Practice Lead
832-523-9570
Doug.Groves@experience-on-demand.com
To learn more about Modified Zero-Based Budgeting please contact:
