Lessons and Pitfalls from Zero-Base Budgeting

October 20, 2016 Ryan Perrone No comments exist

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As we alluded to last week in our intro to zero-base budgeting, there are many other lessons and potential pitfalls to keep in mind as you go through this process.

 


What can you learn from this type of exercise?  The odds are, a tremendous amount regarding the organization in question.  Below are some of the most common themes I have witnessed:

 


Lessons:

  • Customers / Products that are a drain on the organization –  The initial reaction here might be to fire the customer or simply discontinue the product line.  Most likely, the correct course of action is more nuanced.  It is possible that a particular customer could be unprofitable at a given price or volume level.  The right answer might be to either adjust prices and or get the customer to commit to minimum volume levels, in order to reduce production runs. For products that are not contributing, there could be a host of options, including pricing, product re-design that might impact costing, and also assessing product cannibalization (discontinue one product and shift demand to a similar item).
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  • Missing the right personnel – At the end of the exercise, there should be a list of positions that are required with no names assigned.  The next step is to start matching up names on the existing organization chart against the positions required.  It is possible that there is a lack of alignment between the positions needed and the qualifications of existing personnel.  At this point, there are many options to be considered, including training existing personnel to take on new roles, or changing out personnel completely.
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  • A smaller business could be more profitable –  What type of business would you rather be associated with, one with $250 million in revenue, but losing $10 million per year, or one with $140 million in revenue and making $6 million per year. The answer should be obvious (barring different growth trajectories).  The most extreme example I have ever heard of was one where the 1st level of a zero base was a positive contributor, and the next dozen had a negative contribution.  See if you can guess which segment is still in business today?


Potential Pitfalls:


This type of exercise requires everyone to ask extremely critical questions of every part of the organization to make sure that the assumptions used are indeed correct.  The goal is not to produce a forecast on paper that looks good, but to get to something realistic and that is also economically viable.  At the end of the day, if this plan is adopted, the team has to deliver on it!

 

  • Too good to be true – For instance, if the company in question is a food processor, and at the end of the process, all segments of the business were contemplated, but only 4 of 6 food safety positions were included, this requires some critical evaluation.  Does this mean that there are truly two positions that are not contributing?  Or, could it mean that the duties and responsibilities by each position are not being adequately considered.
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  • Extra resources – On the flip side, if at the end of the process, the IT department says that 8 positions are needed, but there are only 7 current positions, this raises some questions.  It’s conceivable that with the 7 current positions, there are duties that are neglected.  However, absent a very compelling rationale, this could be evidence that the manager is not very knowledgeable of how their team is utilized throughout the organization (this could be an example of not having the right personnel!).  One thing to keep an eye on is managers who keep referencing their organization chart in an effort to shoe-horn their existing team back into the process.
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  • Balancing the desire to cut costs with reality –  If the entire team is focused on rooting out costs, this can be a blessing and a curse.  The goals is to get it right and have a realistic assessment, having a team suffer from groupthink can be fatal. Ideally, reviewing the results on day 2 (or 3), in detail with the team can allow them to digest all the initial assumptions and have a gut-check moment where they take an honest assessment of what has been proposed.


Understanding the Process:

  • So, why does it take zero-base budgeting to uncover issues?  Organizations evolve over time and the demands of customers shift the landscape.  While a new customer, division, or product line may have been a great idea when it was first started, many things could have changed over time.  This list of evolving items can include:  changes in commodity prices, lower prices due to competition, volume changes that impact absorption of fixed costs, shifting market demand, and increasing customer requirements.
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  • Why does it work?  This process ends up working because instead of trying to start at the top and cut things out from an aggregate viewpoint, the process allows you to identify your most valuable segments of the business and add the necessary resources for just that incremental portion.  As an organization evolves beyond a certain point, the complexity level begins to grow exponentially.  If the incremental customers / products at a certain level have below average margins, it turns out this is where losses can start to occur.
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  • Should your organization consider this?  It depends, but one of the most important questions to ask is, can it be done right?

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