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Why Zero-Based Budgeting Makes Sense in Unpredictable Times

As companies look for ways to reduce spending during this economic crisis and uncertain times, zero-based budgeting, and its subset, category management, are back in use. Due to the global pandemic, the ability to accurately forecast customer demand and revenues is hindered in an unprecedented manner.

Together, they mean a company takes every line item in every category and justifies its existence. It's "building from the bottom up, the true category demand and specifications as opposed to relying on historical patterns," McKinsey partner Samir Khushalani said.

This is especially relevant now, when historical metrics don't necessarily apply. The pandemic is "causing us to totally rethink our category strategies both in terms of what we are buying and how much of it do we need," Khushalani said. "Everything's changed."

Companies can go beyond cutting just discretionary spending, if they put in the work to completely rethink how they spend money.

Zero-based category management isn't new”, Tradeshift chief procurement officer Roy Anderson, said. Early in his career, Anderson worked at defense contractor Raytheon, when the U.S. government cut military spending through zero-based budgeting.

"You go into an area and say, 'You have no budget. Prove to me you need one.' For every item, you have to build up as if you were starting the company from scratch," he said. "It's horribly painful and amazingly impactful."

Starting from zero and proving every cost in every category takes an enormous amount of time, effort and energy”, said Kent Mahoney, senior vice president of Proxima.

The process also must have buy-in from management. And it must include training on how to zero-base, along with dedication to stick to the process, even when cutting corners — such as using historical forecasts to determine costs — might be tempting.

"There's an ongoing investment of time to ensure people don't lose the mindset of zero-based budgeting as they go," Mahoney said. Otherwise, costs will start creeping back in and employees will "revert to using last year's budget as a zero baseline."

Most enterprises are doing some form of zero-based budgeting if they are cutting discretionary spending, Mahoney said. Due to the global pandemic, “It's like everyone's become a zero-based budget organization overnight whether they know it or not," he said. "A lot of organizations have organically found their way to their minimum operating cost right now. They've done so not necessarily with the rigor and level of process that actually implementing zero-based budgeting would entail."

Just as it's easy to cut too little, it's also easy to cut too much, or not take the full picture into view.

For private companies today, it means seeing how all costs hook together. It also entails strategic spending so growth opportunities are not missed out on once we emerge from the current crisis.

Consolidating or cutting spend too quickly can lead to hiccups. If companies consolidate their IT implementation with one firm, they may eliminate smaller, niche providers needed to keep things rolling, Mahoney said.

Applying zero-based category management can also help firms map out their costs, even if that means additional spend in some areas.

Companies that have consolidated their real estate portfolios during the pandemic may assume they're saving costs in workspace overall, however, their facilities management needs don't also scale down.

Instead, costs for cleaning and personal protective equipment (PPE) have risen. Also, if the company is providing things like printers, desks, VPN connections and better Wi-Fi for workers working remotely, and has a bigger software and cloud spend to keep operations going, real estate lease savings may be much smaller than initially thought.

Zero-base category management also means rethinking vendors, Khushalani said, especially if the nature of the company's business has changed at the hands of the pandemic. "When it comes to something like marketing, if you're not using the right agency, it could be an existential threat," he said. Every piece of the puzzle needs to be considered.

When asked about risks of doing zero-based category management and zero-based budget right now, Khushalani said, "I see a financial risk in not doing it," adding, "If you don't, what you come up with is an inaccurate estimate of demand and an inaccurate estimate of your requirements. It creates a lot of havoc down the road. This is time well spent."

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