EPISODE 59: The retail industry has faced significant disruption due to the ongoing COVID-19 pandemic, which has put finance executives in a position to re-evaluate their expenditures to offset declining revenue. Ashley Farquharson, a Lead Consultant for DHG Advisory, discusses the Zero-Based Budgeting method and how it can help contribute to sustained savings for the retail industry.
[00:00:09] JL: Welcome to today's edition of DHG's GrowthCast. I'm your host, John Locke, and at DHG, our strength lies in our technical knowledge, our industry intelligence and our future focus. We understand business needs and are laser-focused on company goals. In this ever-changing world, DHG's GrowthCast provides insights and thought-provoking conversations on topics and trends that address growth opportunities and challenges in the current and future marketplace.
Thanks for joining us as we discuss tomorrow's need today.
[00:00:42] ANNOUNCER: Views and concepts expressed by today's panelists are their own and not those of Dickson Hughes Goodman LLP. Always consult the advice of your legal and financial professional before taking any action.
[00:00:58] JL: With us today is Ashley Farquharson, a lead consultant with DHG Advisory. We're going to discuss zero-based budgeting and how this can help contribute to sustain savings for the retail industry.
Ashley, thank you for being here today.
[00:01:12] AF: Thank you, John. I'm excited to be here.
[00:01:15] JL: So, Ashley, DGH released an article about this back in December talking about how the disruption that the industry faced in 2020 from the ongoing pandemic put finance executives in a position to reevaluate their expenditures to offset declining revenue, and the result is the method we're now referring to as zero-based budgeting. That essentially means you're starting from scratch. Is that correct?
[00:01:40] AF: That's right John. Zero-based budgeting, also called ZBB for short, is a budgeting method for expenses in which the budget is built completely from scratch, thus starting from a zero base hence the name. ZBB is very different and much more comprehensive than traditional budgeting approaches. Typically, when an organization is developing their annual budget for the upcoming year, they start with a prior year budget as the baseline. They then add on any top side adjustments for known items such as merit increases or new initiatives that they have planned for the upcoming year. They may also reduce the budget for items that were one-time events in the prior year that they don't expect to re-occur such as severance expense or a consulting project that happened in the prior year that they don't expect to reoccur. With ZBB, the prior year budgets are not used as a base. Rather you create the budget as if it were the first year the budget was being created. It really requires you to think through each individual expense that you need to have in your budget in the upcoming year rather than just carrying forward the prior year budget and assuming that expenses should be the same year over year.
Additionally, with ZBB, a business purpose is needed for each individual expense item in the budget. So as you're going through your budget spreadsheet and adding in each individual expense item, you would have a separate column where you would document what the business purpose is for that expense. So thinking through why is it necessary to have this expense? What value does it add to the organization? Thinking through those kinds of questions as you're populating your budget. Once this is all done and the budget is ready to be reviewed by management, management would then have to go through and review each expense and approve of its business purpose. So this is also very different from traditional budgeting because typically reviews are done at a much higher level focusing on changes year over year. With ZBB, management gains a lot more insight into the expense structure as they need to review it in much greater detail.
[00:03:41] JL: So, Ashley, actually this method can really help businesses evaluate where they can potentially eliminate unnecessary spending and some other benefits. Can you tell us more about those?
[00:03:52] AF: Yes. Definitely, John. So ZBB can be extremely helpful in identifying unnecessary spending, and I actually think that is the biggest benefit of implementing the ZBB approach. And the reason why it's so helpful for identifying and eliminating unnecessary spending in your budget is because with the traditional approach that I was describing before you typically carry forward prior year expenses year over year because you develop your annual budgets using the prior year as your baseline. But the issue is when you follow that traditional method for several years, what can often end up happening is that you carry forward expenses year over year that are really no longer adding value to the organization. But because a detailed review isn't really happening, no one's actually questioning those expenses. And so it's really important as business needs change to really think about implementing a ZBB approach and doing that deep dive into your expense structure and really going through each individual line item and asking yourself what is the business purpose? Do we actually need this for our upcoming year or is this more of just a nice to have in our budget? So that's really important with the ZBB approach. An organization may go through the ZBB process and find that it carried forward a lot of unnecessary expenses in certain departments over year, and they can decide to either drop those out of the budget or reallocate them elsewhere.
Some really common examples of these types of expenses that management should be questioning are travel expenses, subscription expenses and technology costs. There can be many other types of expenses, but I think these are some really common ones that management should definitely consider reviewing. So with travel expenses, for example, at least before the pandemic when we were still taking business trips, was management really thinking through the necessity of business travel? Were there certain trips that were being taken that needed to happen? Or was the type of work that was being performed on those trips work that could have been done remotely? So thinking through those types of questions.
And then with, say, technology costs, evaluating what are the technology platforms that your business is using. Are they actually being utilized? And it could even cause management to realize that technology systems and platforms are outdated and require reinvesting in upgrading those systems. And then since I mentioned subscription services, I'll touch on those, because those are things that especially when you have a large organization with several department budgets, subscription services may seem small across the individual budgets, but in aggregate across the organization really equal a lot of money that you're spending. And so it's important to look through those and see what kind of subscriptions do we have and are we actually utilizing them? Are we gaining any value internally or externally from having these subscription services?
Another benefit of ZBB that I want to touch upon is that it really provides greater assurance that the expenses in your budget are truly adding value. So as I mentioned before, part of ZBB requires you to add a business justification for each expense line item in the budget, and in doing so you're really ensuring that the budget is in line with the company's strategic vision and that the money that you're spending is truly adding value to your organization.
Another benefit that I'd like to point out is that ZBB provides a lot more transparency than traditional budgeting. This is because management must perform a much more in-depth review of all expenses rather than a high-level review.
[00:07:37] JL: So when we talk about why retail companies are having to deal with declining revenue, we're also really talking about why many have to think about a totally different business model for their operations due to trends in the industry. So, Ashley, can you speak to this about what these trends are and how zero-based budgeting fits into the picture in terms of a way to address these trends?
[00:08:00] AF: Absolutely. So retailers are having to take into consideration a lot of disrupters and impacts to their business model recently. So the first one that I'll touch on is related to physical store locations, and that means evaluating if they should keep their physical store locations or if they should be closed because the revenue from stores is not substantial enough to justify its costs, or it could be reducing the size of physical store locations.
Another trend that we've seen because of the pandemic is retailers offering curbside pickup and no contact delivery options. And for stores that are open during this time, there're capacity restrictions on in-store shopping in order to comply with social distancing guidelines. Additionally we've also seen increased reluctance from customers to shop in store even where in-store shopping is allowed. And lastly, and probably the most significant trend, is just an overall significant emphasis on digital channels. That includes shopping online, shopping through social media platforms, iPhone and android apps and utilizing virtual customer service options.
[00:09:13] JL: Well, there's no question the retail world has transformed in the last nine or ten months and I can't imagine the challenges that these retailers are facing trying to make good decisions. These trends seem to be here to stay, but let's talk about going beyond the COVID-19 pandemic. Do you see these being a little bit more of a permanent change in the business model especially after 2021?
[00:09:40] AF: Yes. I definitely think that some of these trends are here to stay and will continue beyond the pandemic. Some of these industry trends were already occurring, but were really accelerated by COVID-19 such as the trend of increased store closures as more customers were preferring to make purchases through digital channels. That was something that we were definitely seeing a lot of retailers go through even before the pandemic. The major trends that I believe will stay beyond the pandemic are reduced presence of physical stores. So either closing more physical stores or reducing the physical size of stores that are remaining especially if they want to continue offering curbside pickup no contact delivery, and additionally an increased focus on digital innovation. So this includes investing heavily in data and analytics as well as investing in improving the online shopping experience, phone applications and even social media presence as it's become a lot more common over the past year to make purchases through a retail social media platform.
And so ZBB can be really useful in helping address these trends for retailers because especially when we talk about digital innovation, that requires a really big financial investment. And so in order to help offset the costs of that investment, ZBB can help identify and eliminate unnecessary spend from other areas in the organization that are no longer adding value.
And then as we talk about physical store locations, if this is not already being done, retailers should really think about evaluating all of the physical store locations and looking at all of the expenses associated with those. So the rent expense, maintenance cost, utilities, etc., and comparing those expenses to the corresponding store revenue and make that decision of whether it justifies keeping the store, making some reductions or closures. I think that is the most useful way that ZBB can help address those trends.
[00:11:43] JL: Because of the nature of actually doing zero-based budgeting, I would imagine there are some challenges to proactively address beforehand certain with time in training, right?
[00:11:54] AF: Yes. So while the ZBB method can provide tremendous value to an organization, there are definitely some challenge and implementation that are really important to consider. So the first and probably biggest challenge is that it is time consuming. Building a budget from a zero-based takes more time than simply utilizing the prior year budget as a starting point. And along with that, the ZBB approach also requires a much more detailed and comprehensive review for management as they need to go through each expense line item in the budget versus a high-level review of top side adjustments.
In addition to the time consuming nature and detailed reviews that have to happen, another challenge to consider is training of employees. So for the first time implementation of ZBB, employees may need to be trained on how to build a budget from scratch and how to identify the business purpose for each expense item. And lastly there could also be additional cost if an organization decides to employ a consulting firm who is experienced with ZBB to assist in that process. And so if they go that route, there can just be additional challenges of the logistics and working with a third-party as well as the actual cost of paying for them.
[00:13:08] JL: Ashley, any other considerations that our listeners might want to think about before they jump in to the ZBB opportunity?
[00:13:19] AF: Yes. Definitely there are some additional considerations that they should think about. So as I just mentioned before third-party involvement, consider whether it's necessary to hire a consultant with ZBB experience to help reduce the manual effort. This can be really beneficial depending on the size and complexity of your organization and it can also help free up your existing employees to focus on their normal tasks.
Other considerations to have are to have a process in place to compare prior year actuals to your forecast. If this is something that's not already done, retailers should definitely think about implementing this. This helps to identify one-time non-recurring items that occurred in the prior year and it really gives you a more clear picture of what your expenses were in the last year.
Another important consideration is to identify areas to measure return on investment. And when I say this, I mean, some budget items can be reviewed to measure the utilization by the business and employees. So for an example, one item that I talked about in the article is some organizations offer employee perks, like tuition reimbursement. And so what they can actually do is look at the historical trends and see how many of our employees are actually utilizing this program. Does it makes sense to continue to allocate funds to this or the same level of funds depending on how much is being utilized? So that's just one example, but it's important to look for expense areas where you can really quantify how valuable it is to the organization.
And then another consideration I want to point out is that ZBB isn't just for SGNA expenses. It can also be used for payroll, and I really suggest that. And so that would just involve managements in conjunction with HR, reviewing payroll expenses, looking at the headcount across various departments and justifying the purpose of each job function. See if there are roles that are being duplicated across the organization and maybe can be centralized. That's definitely another important consideration.
[00:15:36] JL: Wow! Great information, Ashley. Thank you for sharing all these tips and spending some time just sharing your big picture view of zero-based budgeting with our listeners today.
[00:15:48] AF: Thank you so much.
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[00:15:51] JL: And thank you for joining us today on our discussion on zero-based budgeting with Ashley Farquharson, a lead consultant with DHG Advisory. We hope that as a result of today's discussion you can better analyze the ROI on implementing a zero-based budget for your retail business. I'm your host, John Locke, and I look forward to reconnecting with you zoon on an upcoming episode of DHG GrowthCast.
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