Priority Based Budgeting (PBB) is the brainchild of Jon Johnson and Chris Fabian, two former county finance professionals who launched the Center for Priority Based Budgeting in Denver, Colo. several years ago. Since that time, PBB was identified by the International City and County Manager's Association (ICMA) as a "leading practice" and has also been endorsed by the Government Finance Officers Association (GFOA).

More than seventy cities and counties have adopted PBB as a means of better aligning available resources with local government priorities. In this time of increasing budgetary challenges, innovative approaches like PBB offer the hope of preserving vital local government services.

Gaston County began to consider PBB as an alternative approach to budgeting early in 2014 with the approval of the Board of County Commissioners. Fundamentally, PBB is designed to optimize the use of tax payer dollars and promote better alignment between programs and community values.

Unlike traditional approaches to budgeting which usually feature incremental changes to line item budgets, PBB allows for a more comprehensive review of all programs. Through the various stages of PBB, staff members and the governing body are able to engage in meaningful dialog concerning the numerous programs that comprise the activity of a typical local government and determine the degree to which those programs fulfill community priorities.

The goal of PBB is to identify those program areas that most closely align with Board established priorities and direct adequate resources to those areas. Conversely, programs determined to be less in alignment may receive less funding, be eliminated entirely if they prove to be duplicative or obsolete.

There is also the possibility that lower priority programs can be targeted for partnerships with other groups in the community that provide similar services. This process enables the local government to become more strategic in its approach to service delivery while conserving scarce resources.

PBB is an enlightening process for all those involved since it facilitates an objective prioritization process which provides better information on program efficacy. Unlike the private sector, local governments are mandated by the state and federal government to perform the majority of their programs. However, PBB also allows participants to determine just how much of a particular mandate they are obligated to fulfill.

In an effort to help foster business opportunities in the Greater Newtown area, the Newtown Chamber of Commerce continues to host free monthly networking events open to all local business professionals.

The next event will be at Sal e Pepe Contemporary Italian Bistro, 97 South Main Street, on Wednesday, November 12, from 8 to 9 am. The guest speaker is George Herring, vice president of Savings Bank of Danbury.

Mr Herrings presentation will include a discussion that highlights how local businesses, organizations, entrepreneurs, and residents of Newtown can better their budgeting and savings, while maintaining good credit.

The presentation promotes a free banking program offered by the Savings Bank of Danbury and The Financial Resource Center, through The United Way.

This breakfast networking session is sponsored by the Newtown Chamber of Commerce and is part of a series held on the second Wednesday of each month. Anyone interested in guest speaking can call 203-426-9193.

There is no charge to attend this event and reservations are not necessary; light refreshments will be served.

The TCC has recently decided two points of procedure which will be of interest to those involved in or considering proceedings in the court. The first is that no dedicated lsquo;window is to be built into the court timetable for alternative dispute resolution (ADR) procedures such as mediation. The second is that the court will have an unfettered discretion to order the filing and exchange of costs budgets in cases where the claim exceeds the monetary threshold for mandatory cost budgets.

A lsquo;window for ADR

When setting a timetable for proceedings, the TCC will aim to fix a trial date which is as soon as reasonably possible so as to ensure that costs do not get out of control. It will, however, also allow reasonable periods of time between each step in the process to give the parties time to reflect and consider ADR before incurring a further tranche of costs.

In a decision issued earlier this week, the TCC has refused to go further and build into the court timetable a dedicated lsquo;window for engaging in ADR. The court noted that:

  • Such a window would create undue delay and increased costs for purposes unrelated to preparation for trial.
  • ADR is a consensual process and it is inappropriate for the court to decide when ADR should occur.
  • It is wrong in principle to fix a time period for ADR especially when one of the parties actively does not want to pursue ADR.

The court noted that none of the above was intended to dissuade parties from engaging in ADR or to dilute the cost sanctions applicable where parties unreasonably refuse to do so. It was simply to emphasise that parties are to engage in ADR concurrently with their continued preparation for trial.

Cost budgeting for cases above the threshold

Cost budgets are presently only required in TCC proceedings for claims within certain monetary limits. For claims commenced before 22 April 2014 the limit is pound;2 million and for claims after this date the limit is pound;10 million. In the same decision mentioned above, the court has clarified that it retains an unfettered discretion to order the production of cost budgets in cases above these limits. Parties need not show special circumstances and there is no assumption against the production of cost budgets in such cases. Instead, the court will consider whether to make such an order taking into account all relevant material, without prejudging or making any specific assumptions one way or the other.

Click here for reference toCIP Properties (AIPT) Limited v Galliford Try Infrastructure Ltd amp; Others[2014] EWHC 3546 (TCC)

The findings are often too high level to link clearly to the actions required to unlock the savings. Moreover, managers can avoid action by refuting the underlying data or citing unique business needs. Given such constraints, when savings are required, executives often feel they have no choice but to slash and burn, making arbitrary budget cuts without any changes to the underlying work, regardless of how prudent or sustainable those choices may be.

Fortunately, there is a sustainable alternative to cost management appropriate for many companies: zero-based budgeting (ZBB). We have heard of many versions of ZBB, including the literal interpretation of the words: “a technique for building a budget from zero.” While that is certainly a fundamental part of ZBB, our experience has shown that effective ZBB is much more than that.

Five Myths, Five Realities

Zero-based budgeting is a repeatable process that organizations use to rigorously review every dollar in the annual budget, manage financial performance on a monthly basis and build a culture of cost management among all employees. A world-class ZBB process is based on developing deep visibility into cost drivers and using that visibility to set aggressive yet credible budget targets.

The annual budgeting process does in fact start from zero and is very detailed, structured and interactive in order to facilitate meaningful financial debate among managers and executives. Throughout the year, multiple owners are tasked with managing performance and continuing the healthy debate on cost management. Through new system and process controls, and aligned incentive programs, all employees make cost management a part of their daily routine.

One company recently realized 11% savings in its operating budget within the first four months of a new ZBB program. In this instance, immediate savings came from increasing visibility into labor costs and executing new approval thresholds to control demand for contract labor, relaunching procurement initiatives to renegotiate prices and changing “make versus buy” decisions.

More than 40 percent of the savings were strategically reinvested in new teams and sales staff who spent all their time with customers. While this company chose to reinvest those savings in the customer-facing parts of the business, other companies use the savings to fund and therefore amplify the next wave of productivity. And, of course, some let the savings fall to the bottom line.

When properly implemented, ZBB can reduce SGamp;A costs by 10 to 25%, often within as little as six months. Just how ZBB is capable of delivering and sustaining these results remains a bit of a mystery for many executives. The opaqueness of the term and the dire tone of the media stories can be intimidating, sometimes causing ZBB to be avoided as an option for improving productivity.

What follows is an attempt to explore some common myths, debunking them and highlighting how a well-run ZBB program can drive sustainable impact in leading organizations.

Myth one: ZBB simply means building your budget from zero. Reality: ZBB is a repeatable process to build a sustainable culture of cost management.

Zero-based budgeting is much more than building a budget from zero. World-class ZBB efforts successfully build cultures of cost management throughout the organization by using a structured approach to facilitate cost visibility, cost governance, cost accountability and aligned incentives. Fortunately the culture shift isn’t left to chance. We believe that there is a proven, step-by-step approach to implementing successful ZBB programs, and when this implementation is done well, ZBB makes cost management a part of the way every employee works on a daily basis.

Myth two: Implementing ZBB requires cutting “to the bone.” Reality: The degree of cost reduction is based on the company’s top-down target.

Although very little has been written recently about zero-based budgeting, the published content that exists often associates it with cutting costs to the bone, using any means necessary (for example, eliminating mini refrigerators in office kitchens to save electricity). While this may sometimes occur, it is by no means necessary. Simply put, the degree (and aggressiveness) of each company’s cost cutting reflects the size of its top-down savings target. For instance, in the most aggressive situations, we’ve seen 30% reduction targets in year one versus other situations that aim for 10% reduction targets with an agreement to reinvest half of that into more productive areas, therefore only taking 5% to the bottom line.

Myth three: ZBB will overwhelm your business and prevent it from doing anything else. Reality: Initial rollout of a new ZBB program can be led by a central team and completed in four to ten months.

Recently, one executive we met with said, “I simply cannot afford to ask the entire company to stop what they’re doing for the year to implement ZBB.” The idea that ZBB requires dedicated focus from every employee for a year or more is simply not true. While it takes time to embed a new cost-management culture into any organization, the setup and rollout of a new ZBB program has much more limited requirements.

During the initial setup, a central coordination team develops deep visibility into costs and sets detailed savings targets for the next budgeting cycle. That team also ensures that the company’s systems and processes are in place for the detailed reporting, governance and performance management that a world-class ZBB requires. In our experience, this setup period could take anywhere from four to ten months and is primarily led by full-time support from finance and IT, with part-time involvement from profit-and-loss owners and cost-category owners across the company.

Organizations that are unsure about ZBB’s upside are well suited to pilot the process. There are many ways to build these pilots, each of which can be customized to meet the company’s objectives. One company, for instance, is piloting a ZBB rollout across its global finance function. This approach builds capabilities within the team that will help drive the program across the enterprise while having the added benefit of helping team members achieve their existing budget targets.

Myth four: ZBB only focuses on SGamp;A. Reality: ZBB can be applied to any type of cost: capital expenditures; operating expenses; sales, general, and administrative costs; marketing costs; variable distribution; or cost of goods sold.

The fundamental elements of a ZBB program — governance, accountability, visibility, aligned incentives and a rigorous process — form a comprehensive cost-management tool kit. However, certain adjustments need to be made when using this tool kit in particular areas. For example, when ZBB is applied to variable costs (such as cost of goods sold, variable distribution) the budget needs to be volume adjusted in monthly performance reports. When ZBB is applied to capital expenditures, costs are categorized by discrete investment choices rather than types of expenses, as they are with operating expenses.

Myth five: ZBB is not designed for growth-oriented companies. Reality: ZBB is successfully used by growing companies to redirect unproductive costs to more productive areas that drive growth.

Zero-based budgeting is a powerful tool for any company, whatever its orientation. Even if the organization’s primary focus is on growth, profit, or talent retention, cost management remains crucial to its success. Eliminating unproductive costs allows the company to be redirected to more productive areas. As we mentioned in the earlier example, back-office costs can be redirected to customer-facing activities.

ZBB is not a slash-and-burn exercise that cuts costs without regard for the expense. With deep visibility into costs, changes can be made to surgically cut the fat and help build up organizational muscle.

Zero-based budgeting can drive significant and sustainable savings, but it is much more than simply building a budget from zero. World-class ZBB programs build a culture of cost management through unprecedented cost visibility, a unique governance model, accountability at all levels of the organization, aligned incentives and a rigorous and routine process. ZBB frees up unproductive costs and allows those savings to be taken to the bottom line or redirected to more productive areas that will drive future growth.

Shaun Callaghan is a consultant in McKinsey’s New Jersey office; Kyle Hawke is a consultant in the Atlanta office, where Carey Mignerey is an associate principal.The authors would like to acknowledge Greg Kelly’s contribution to this article.

This article was originally published by McKinsey Quartlery. Copyright  McKinsey amp; Company. All rights reserved. Reprinted by permission.

Image: Thinkstock