Organizations that have long relied on grants from federal and state governments now face funding cuts, forcing leaders to rethink how to continue providing essential services. Zero-Based Budgeting (ZBB), or developing a budget from the ground up, is one tool that can help ensure the most critical programs and projects are protected.
Budgets are an essential financial management tool for a well-run organization, providing a clear roadmap for managers and employees and ensuring consensus on how resources will be utilized. Budgets allow for closer tracking of expenditures and help leaders anticipate financial warning signs.
Traditional (incremental) budgeting is the most common method, widely used because it relies on a simple, fast, and straightforward process. Incremental budgeting begins with the previous cycle’s budget as a baseline. It creates a new budget by adding or subtracting a percentage to account for inflation, anticipated growth, and cost or policy changes.
What is ZBB?
The Zero-based budgeting method was developed in the 1960s by Peter Pyhrr, a manager at Texas Instruments, Inc. In this global semiconductor company, growth led to complex budgets that needed better discipline. An article Pyhrr published in the Harvard Business Review in 1970 brought the process to the mainstream, where it quickly moved from theory to practice in the private and public sectors. ZBB gained considerable traction when Pyhrr helped Georgia Gov. Jimmy Carter implement it for the state’s executive budget process in 1973.
ZBB differs from traditional budgeting in that it allows for more strategic, priority-driven allocation of limited resources, emphasizing management input and communication in budget development. With ZBB, no spending is automatically authorized; every expense must be justified each budget period to ensure strategic alignment with the organization’s goals.
By ignoring historic spending, ZBB promotes a culture of cost management and accountability. Each cycle, departments begin from a zero-dollar baseline, rather than the previous cycle’s number.
To implement zero-based budgeting, leadership must take a fresh perspective on each budget line item and conduct a detailed cost-benefit analysis. Managers must identify all projects and programs, with each activity considered a unit to be evaluated. They must then prepare a “decision package” for each activity that spells out what the program or project is, why it exists, the costs associated with it, its benefits or outcomes, and the consequences of not funding the activity or of funding it at different levels. These packages are then ranked by importance, effectiveness, and alignment with the organization’s goals. Managers must decide whether to rank entire programs or tasks within programs. Once the activities are ranked, managers begin funding from the highest-ranked decision package downward until the available funding runs out. Rankings and decision packages are adjusted each cycle based on performance and changing priorities. This ensures essential services are protected while allowing lower-value or redundant programs to be reduced or eliminated.
Why choose ZBB over traditional budgeting?
Incremental budgeting, while fast and simple, can be imprecise and wasteful, ignoring alternatives, workloads, and tradeoffs among programs. Relying heavily on past spending to determine annual budgets can perpetuate past priorities, leading to continued spending without a critical evaluation of current needs. This traditional approach to budgeting can also encourage “use-it-or-lose-it” behavior, pushing managers to spend their entire budgets to ensure they receive the same amount the next cycle. It can also cause managers to feel compelled to compete against other departments, units, and programs to maintain or increase their share of resources.
ZBB is highly effective at helping organizations control spending by identifying and eliminating unnecessary costs and focusing on high-value initiatives. When every dollar is scrutinized, the highest-revenue-generating (or highest impact) programs and projects are prioritized.
At Texas Instruments, ZBB reduced waste through improved cost transparency, leading to more effective prioritization of research and development. In Georgia, where Carter pushed to overhaul opaque, traditional state budgets, ZBB helped eliminate redundant spending and led to a significant reallocation of funds toward high-impact programs such as education and public safety.
To be sure, transitioning from traditional budgeting to ZBB requires strong governance and change management to support morale and ensure continued investment in innovation. It is essential to ensure that short-term cost savings are not prioritized over long-term benefits, such as vital strategic projects. As with any budgeting approach, senior management must support and understand the process for it to be effective. The organization’s mission and goals must be clearly defined from the start, as must the program ranking criteria. Digital tools and analytics, including cloud-based planning solutions that use artificial intelligence and machine learning, can help support the process and reduce the administrative burden of implementing ZBB.
Organizations may also consider a hybrid approach using traditional budgeting for core functions and using zero-based reviews every few years for specific departments or high-spend categories to reexamine priorities and eliminate unnecessary costs.
The Takeaway: ZBB may be a valuable tool in an environment of increasing scarcity, as governmental and nongovernmental organizations face funding uncertainty and rising inflation concerns. ZBB is designed to leverage all the benefits of budgeting while avoiding the pitfalls of ineffective planning and budgeting processes. It exposes and justifies every dollar, reducing costs and promoting fiscal responsibility. This rigorous, disciplined approach to budgeting is more complex than traditional budgeting. It may be more time-consuming, but it pays off by increasing efficiency and encouraging frequent examination of resource allocation and strategy, helping organizations make the most of every dollar.