Without an assessment of baseline services for optimization opportunities and value generation, funding for business growth and innovation is limited and challenges business expectations of the CIO.


What is the Solution?

The solution is taking a deeper assessment of baseline activities and determining their value contribution to the business.  Low-value activities should be considered for elimination.  Service levels should be assessed, even if adding a degree of value to the business, to determine if it is an affordable level for the business to achieve enterprise bottom-line growth.   Related activities would then be evaluated for elimination or reduction.


A Zero Base Budget approach would provide the means to complete this assessment.  It is a method of budgeting in which all expenses must be justified for each new period.  Zero-based budgeting starts from a "zero base" and every function within an organization is analyzed for its value, needs and costs. Budgets are then built around what is needed for the upcoming period, regardless of whether the budget is higher or lower than the previous one.  


Bain & Company notes in its 2013 Management Tools report: “Zero-Based Budgeting forces managers to scrutinize all spending and requires justifying every expense item that should be kept. It allows companies to radically redesign their cost structures and boost competitiveness.  Zero-Based Budgeting analyzes which activities should be performed at what levels and frequency and examines how they could be better performed—potentially through streamlining, standardization, Outsourcing, offshoring or automation.” [2]


Origins of the Zero Based Approach

Looking at baseline costs this way is not necessarily a new concept, but the formal methodology and adoption of Zero Base Budgeting started at Texas Instruments in the late 1960’s by Peter Pyhrr.  His group was faced with a 10% budget reduction.  The initial exercise took a “peanut butter” approach to spreading where the reductions would be taken.  It became clear there were critical areas that would be reduced to the detriment of the contribution they were making to the business and some areas did not even have goals and objectives set.  He then developed the Zero Base approach to re-evaluate all programs and expenditures, hence the name zero-base.  It was later used in all areas of Texas Instruments because of its success.  He later wrote about the approach in the Harvard Business Review.  Jimmy Carter, then governor of Georgia, read the article and hired Peter to deploy the concept for the state budget.  It was successfully used to develop the entire executive budget recommendation for the State of Georgia.  Carter then carried forward the model at the federal level as President of the United States.  Since then, the approach has been applied within other government agencies and private business.  


Today, Activity-Based Costing is a similar concept mirroring the inception of Zero Base Budgeting.  For purposes of this article, however, I will only talk about Zero Base Budgeting.


How can the solution be implemented?

The following steps are recommended:

  • Obtain enterprise strategy and plan documents.  Identify key goals and objectives of the business as a starting point.  If these documents are not available, research any information available such as annual reports, investor summaries, etc.

  • Develop a strategy and plan for IT that outlines the goals and objectives for technology that aligns to the enterprise strategy and plan.  This does not need to be a detailed document at this point.  The essence is to be able to describe what IT goals and objectives are in enough detail for IT managers to understand.

  • Develop Level 1 (directs to the CIO) organization charters outlining the key functions and the business contribution and value of those functions based on the enterprise and IT strategy and plan.

  • Develop decision packages at the activity level that provide the right amount of information for management to determine if the activity should be eliminated, decreased, or increased.  A good outcome for managers that are short-staffed is it presents a case for additional staffing to support the business needs.  The decision package should include:

                  a. Description/Purpose Statement – Pertinent details of the activity including goals and objectives and value to the business.

                  b. Cost  Analysis – Include costs between current year and next year budget.  State whether cost behavior is fixed, variable or both.  If

                      both, elaborate on the fixed vs. variable components.  Identify significant non-staff components such as fees for outsider services,

                      hardware, software, etc.

                  c. Staffing Requirements – Scope should include current year and next budget year.  Include Total Full-time Equivalents (FTE’s) and

                      the consulting/temporary component vs. permanent staff.

                  d. Workload Drivers – Briefly describe key elements of the workload such as service levels (e.g., 24x7 coverage), volumes (e.g., # of

                      calls), etc.  Specifically define/quantify service/volume assumptions.

                  e. Workload Trends – Specify up, down or flat.  Highlight key elements of trends.  Specifically state and quantify service levels/

                      volumes that are expected to increase/decrease.

                   f. Define KPIs – Briefly explain each metric considered to answer the question,  “What defines success for this service/activity?”

                      Include external benchmarks if available.

                  g. Define Options – Outline key considerations and benefits, including:

                                   i.    Consequences of not performing the activity

                                   ii.   Opportunities to reduce incoming workload

                                  iii.  Productivity opportunities


A Decision Package example is included at the end of this article for reference.


  • Aggregate the packages and calculate the total baseline budget.
  • Schedule budget meetings with the organization head, Finance team and the CIO to review the decision packages.
  • Based on the reviews, the CIO, organization leads and Finance team collectively determine an assessment of activities to be fully budgeted, activities to reduce/increase and activities to eliminate.  The assessment should include the proposed budget cost and resources, implication of any changes to the business, and action plans to implement the changes.  In addition, if there are impactful variances from the original baseline, several scenarios should be completed.
  • The CIO should present the budget assessment to the C-level (including the CFO) and business unit heads, highlighting scenarios and specifically noting assumptions and changes to the baseline budget and business implications.
  • Based on guidance from the CFO, act on budget recommendations.


Other Considerations   

  • A Zero Base Budget exercise takes additional time and effort.  Its maximum value is within the first two years of assessing baseline activities.  It is not recommended to perform the assessment annually
  • This approach is a means to determine how mandatory budget reduction and contingency targets will be met without taking arbitrary reductions.     Gartner notes as one of its top 10 guidelines for IT budgeting, to use Zero Base Budgeting where it makes sense.  They recommend using it for personnel, hardware/software, telecom and external services cost categories [3]
  • Accountabilities for decisions reside both within the business and with IT.  The business will determine the risks to the business for proposed changes in baseline activities and service levels.  IT is accountable for maintaining the stability and security of the operations
  • It is necessary to have action plans developed as part of recommendations to change the baseline budget, including plans for asset retirements, staff adds and deletes, contract negotiations, etc.
  • A communication plan is crucial to communicating changes to service levels to business management, not just the leadership team.
  • Another part of the communication plan, now that you determined value around the baseline activities, is to communicate that value to the business.  It will build trust and appreciation for IT’s contribution to the business.
  • Completing a Zero Base Budget is a good prelude to deploying activity-based costing techniques.


Footnotes

[1] ITSpending and Staffing Outlook for 2014, Computer Economics IT Spending Series, October, 2013.

[2] Darrell K. Rigby, Management Tools 2013: An Executives Guide, Bain & Company.

[3] Jim McGittigan, Top Ten Guidelines for IT Budgeting, Gartner Research, June 27, 2012.

[4] Jamie K. Guevara, Linda Hall, Eric Stegman, IT Key Metrics Data 2014: Executive Summary, Gartner Research, December 16, 2013.


CIO's are challenged to balance IT’s focus between innovation and sustainment.  A first step is to assess current operations to determine value contributions and to manage baseline costs to optimized levels.  This not only contributes to bottom-line business goals, but also can enable self-funding for innovation.  This newsletter will provide an overview of an approach, Zero Base Budgeting, to complete such an assessment.


The Problem

Traditional budgeting methodologies assume baseline resources (people, technology and facilities) are a given going into the next year.  The focus of the budget exercise is to reflect inflation to baseline costs and add new business growth.  When the budget is analyzed, most of the baseline costs are considered fixed and non-discretionary and business growth as discretionary.  The focus of budget reductions is therefore on business growth, which is arguably the most critical contributor to future success as compared to baseline activities.


The fallacy of this approach is to consider baseline costs as non-discretionary.  A true fixed cost is a commitment to spend, either through contracts and deployment of fixed assets like facilities and equipment.  Cost of labor, either full-time employees or consultants, for the most part is variable.  Also add-ons to the fixed costs, like some hardware/software maintenance, are variable.  


In addition, CIOs are being pressured to spend more time on innovation and what the business considers value-add, yet total IT budget growth has slowed since the recession to accommodate these activities.  Computer Economics report on 2014 spending trends show moderate growth over the last four years.[1]   See the chart below.

ZERO BASE BUDGETING AND HOW IT CONTRIBUTES TO IMPROVING THE VALUE OF IT

Results that make a difference