- Be familiar with your company’s procedures and criteria for approving and managing capital expenditures. Your management will require a compelling return-on-investment (ROI) study (net present value, payback, breakeven, or internal rate of return estimates) vis-à-vis explicit or implicit hurdle rates.
- Establish clear links between your budget and corporate strategy. If your management can see the real benefits to the business, they’ll find the costs easier to absorb. Amazon’s customer-oriented culture requires every proposal for a new feature, product, or service to be pitched by means of a “Mock Press Release” arguing how a hypothetical Amazon customer would first learn about the feature and its utility.
- Don’t just roll your budget over from the previous year adding a certain percentage “and then some.” Many companies have adapted a cost-management tool called “Zero-Base Budgeting” that requires you to justify each line item in your budget as if it were an entirely new claim for an entirely new project.
- State your assumptions explicitly. Prepare worst-case and best-case scenarios to augment realistic forecasting of the future and help prudent decision-making. Keep your budgets ambitious but realistic.
- Allow room for contingencies. Avoid rigidities that could inhibit the quick and effective response to an unexpected event. Bring your contingency planning into the open for a careful review.
- Add some fat, but not too much. Keep this in your back pocket, but be ready to make some cuts by knowing what their impact can be. Be clear and confident when questioned about any of the numbers in your budget.
- Explain how true you were to the previous year’s budget. Make a distinction between controllable and uncontrollable budget variances. This will build your management’s confidence in your pitch for the year ahead.
- Put your budget proposal to test with your team and supportive peers. Encourage them to ask all the difficult questions they can imagine. They may not only know where the skeletons are hidden and help you with the answers you’ll need, but also become indispensable allies in getting your budget approved.
- To persuade each member of management, know what matters to him/her and link your budget to his/her objectives. Discuss your budget with the key decision-makers separately before a group discussion. (Management consulting firm McKinsey calls this technique “pre-wiring.”) By getting each participant’s buy-in, you can count on his/her support and avoid surprise reactions and disagreements.
Budgeting
3G Capital and the Fringes of Cost Management // Summary of Bob Fifer’s ‘How to Double Your Profits in 6 Months or Less’
3G Capital’s Playbook: Look at EVERYTHING—There are No Sacred Cows in Cost-Cutting
During the past decade, the achievements of the Brazil-based private equity group 3G Capital have drawn attention to the aggressive cost cutting methods outlined in management consultant Bob Fifer’s How to Double Your Profits in 6 Months or Less (1995.)
3G has raised the profitability of its acquired businesses by sacking thousands of workers, shutting down factories, simplifying operations—even using cheaper ingredients. In Israel, the 3G-controlled Heinz was forced to rebrand its iconic ketchup as “tomato seasoning” after a cost cutting-inspired shift to GMO-derived constituents. 3G’s playbook, however, encourages increasing budgets for strategically important business functions—for instance, Kraft Heinz has increasingly expanded spending on advertising and product improvement.
At every 3G-run company—Anheuser-Busch InBev, SABMiller, Heinz, Kraft Foods, Burger King, Tim Hortons, Popeyes,—the “zero-based budgeting” accounting tool forces managers to justify all claims on their organizations’ financial resources. As I noted in a previous article, this method forces managers to justify every line item on a team’s budget as if it were new a claim for an entirely new project, instead of merely being carried over from the prior year:
Zero-base budgeting advocates say that it detects inflated budgets and unearths cost savings by focusing on priorities rather than simply relying on the precedent. Managers secure a tighter focus on operations by justifying each line-item in their budgets, thereby reducing the money they allocate to the lowest level possible. Managers can also contrast competing claims on their ever-scarce financial resources and therefore shift funds to more impactful projects.
How to Double Your Profits has become a must-read for all managers affected by any 3G deal. This obscure book, purportedly written in just 15 hours, was also a favorite of such business luminaries as Sanford Weill (of Citigroup,) Bob Lipp (Travelers Insurance,) and Jack Welch (General Electric.)
3G’s methods have upended an entire industry known for characteristically lower profit margins. The specter of being acquired by 3G has forced Unilever, General Mills, J.M. Smucker, Nestle, Pilgrim’s Pride, Phillip Morris, and other consumer staples companies to implement sweeping cost cutting programs.
Every Expense is Evaluated to Be Cutback Unless It Contributes Directly to the Bottom Line
.jpg "'Double your profits' by Robert M Fifer (ISBN 0963688804)")
How to Double Your Profits obsesses about cutting costs by any and all means possible. Every corporate resource is a cost-center that must be pared down to the bone—unless it’s a strategic function. When it comes to marketing, for example, the author recommends outspending the competition in both good and bad times.
Seventy-eight brief chapters (“steps”) deal with every possible drain on time, money, and people in the modern corporation: reducing layers of management, cutting the amount of time managers spend in meetings, shrinking corporate expense accounts, eliminating first-class air tickets, getting rid of pointless reports, and so on.
- Focus on profits. “We’re here to make a profit. In fact, we’re here to make as much profit as we possibly can. Profit is the most accurate, most all-encompassing measure of whether we truly are the best. … Profits benefit all of us … when the profits slow down, we all suffer.”
- Run a true meritocracy. Set expectations about how performance will be measured and what rewards will accrue to what levels of performance. “Within any level or group of employees, there must be wide disparities in salary, tied to demonstrable differences in performance and contribution to the bottom line.”
- Avoid paralysis by analysis, make decisions faster. “Superb managers are instinctual, making the right decision most of the time based on limited data. The quantification that less-skilled managers insist upon is in fact illusory: They wind up making decisions based upon that which can be quantified rather than that which is important. Most of the critical variables in any business decision can only be judged and evaluated based on experience and instinct, not quantified.”
Much of the advice is effective, if predictable, but some suggestions are clearly crooked:
- Step 24 / Declare Freezes and Cuts: “Send a letter declaring an across-the board 3% reduction to suppliers. Make sure the letter is from someone high up and intimidating….(after getting the bill) deduct 3% from the bill and say, ‘Didn’t you read my CEO’s letter? Are you trying to get me fired? “
- Step 37 / Accounts Payable: “Never pay a bill until the supplier asks for it at least twice. You’ll be surprised: A few suppliers will take as much as two years before they finally get around to asking for their money.”
But Then Again, There is only so Much Fat to Cut out: The Crisis at Kraft Heinz
When discharged without due forethought, elements of Fifer’s cost-cutting mindset could lead to corporate myopia and an utter disregard for such intangible assets as human capital, brand value, and corporate philanthropy.
Certainly, in businesses with substantial cost inefficiencies and bloat, cost-cutting can produce considerable gains in profits, but even with these firms, gains will be time-limited, because there is only so much fat to cut out.
Aggressive cost-cutting has been blamed for the recent travails at Kraft Heinz. Over the last three years, Kraft Heinz’s fading return on invested capital and decreasing sales point toward a leadership team that has been giving precedence to near-term cash flows to the detriment of its long-term competitive position (“moat.”)
With the expansion of cut-price private-label brands, consumers are no longer remaining devoted to brands like they once did. Kraft Heinz’s roster of products is less appealing to customers than it used to be, and cost cutting hasn’t helped—Kraft Heinz has invested just 2%–3% of its sales on brand spending, as against 7%–9% at comparable consumer goods companies.
Recommendation: Fast Read ‘How to Double Your Profits’
Bob Fifer’s How to Double Your Profits in 6 Months or Less, even if out-of-date and brash in style, could help drive systematic cost-consciousness in large firms that have bloated cost structures in the hypercompetitive business environments.
Entrepreneurs, managers, and employees will find in How to Double Your Profits many ideas for establishing a culture where every employee feels liable for adding value to the organization’s bottom line. The key takeaway lessons are:
- Determine which costs are strategic (costs that bring in business and improve the bottom line) and over-invest in those processes as long as they are effective, i.e. producing better results. “Place the burden of proof on justifying costs, not on eliminating them.”
- Avoid over-quantifying and over-analyzing processes and results, particularly when the extra precision will not have any bearing on business decision-making.
- Consider business processes as a means to an end—a focus on business results should trump a focus on business processes. In other words, focus single-mindedly on business results.
Complement with Francisco Souza Homem de Mello’s The 3G Way (2014) and Cristiane Correa’s Dream Big (2014)—informative books on 3G written by Brazilian business journalists who’ve covered 3G and its founders over the years. Warren Buffett, who regularly teams up with 3G Capital, recommends these books.
Use Zero-Base Budgeting to Build a Culture of Cost Management
Traditional Incremental Budgeting
As part of the traditional budgeting process, managers tend to roll their budget over from one year to the next. In addition to accounting for any strategic initiatives or headcount changes, they simply add to every line-item in the previous year’s budget a certain percentage “and then some” to account for cost inflation. They assume that the ‘baseline’ is automatically approved, so they justify just the variances versus prior years.
The drawback of this budgeting process is that nobody questions the underlying ‘baseline’ costs. Further, these cost increases are carried from year to year.
Zero-Base Budgeting
.jpg "'Zero-base Budgeting' by Peter A Pyhrr (ISBN 047170234X)")
In the 1970s, Peter Pyhrr, a Texas Instruments accountant, formally developed zero-base budgeting. In his influential Harvard Business Review article and a book titled Zero-base Budgeting, Pyhrr advocated that a prior year’s budget should not be used as a benchmark for the next year’s budgeted costs.
With zero-base budgeting, managers prepare a fresh budget every year without reference to the past. Consequently, they start every line-item in the budget from a zero-base even if the amount didn’t increase from the previous year. They are thus forced to justify all claims on their organization’s financial resources as if they were entirely new claims for entirely new projects.
Advantages and Disadvantages of Zero-Base Budgeting
Zero-base budgeting advocates say that it detects inflated budgets and unearths cost savings by focusing on priorities rather than simply relying on the precedent. Managers secure a tighter focus on operations by justifying each line-item in their budgets, thereby reducing the money they allocate to the lowest level possible. Managers can also contrast competing claims on their ever-scarce financial resources and therefore shift funds to more impactful projects.
Zero-base budgeting critics call attention to the many practical difficulties of implementing this time-consuming tool. More importantly, since zero-base involves give-and-take, the budgeting process is susceptible to favoritism, cronyism, and political influence.
3G Capital’s Success with Zero-Base Budgeting
.jpg "'The 3G Way: An introduction to the management style of the trio' by Francisco S. Homem de Mello (ISBN B00MKKWZME)")
Zero-base budgeting has garnered much attention in the last few years as the centerpiece of an aggressive cost-cutting recipe used by 3G Capital, a thriving Brazilian buyout firm that’s renowned for its parsimonious operations. 3G’s predominant investment strategy is to acquire and then squeeze value out of companies, particularly in the food and restaurant industries.
At Anheuser-Busch, InBev, Tim Hortons, Burger King, Heinz, Kraft, and other acquired companies, 3G’s hard-nosed managers have used zero-base budgeting to initiate sweeping cost cuts. They’ve shut down factories, laid off thousands of factory workers, eliminated hundreds of management jobs, sold off corporate jets, forced executives to fly coach, restricted employees’ office supplies to $15 a month, and even asked employees to seek permission to take color printouts.
.jpg "'Dream Big' by Cristiane Correa (ISBN 8543100836)")
Inspired by 3G, many other companies have adapted zero-base budgeting to root out bloat. Some have even gotten carried away—for example, Pilgrim’s Pride (an American meat-processing company) used zero-base budgeting to measure how much soap employees use to wash their hands and how much Gatorade hourly employees consume during breaks.
Idea for Impact: Zero-Base Budgeting Is an Effective Cost-Management Tool
Cutting operating costs is an ever-bigger priority at many organizations. For each line-item in your budget, ask “Should this be done at all?” and “Is this the most efficient and effective use of our resources?”
Consider zero-base budgeting to rigorously find cost-effective ways to improve your operations. It can bring about cost discipline, force your operations to become lean, and ultimately boost your bottom line.
Suggested Reading
- For more on zero-base budgeting, read Peter Pyhrr’s Zero-base Budgeting.
- For more on 3G Capital and their management principles, read Cristiane Correa’s Dream Big and Francisco de Mello’s The 3G Way. These books are recommended by Warren Buffett, who likes to partner with 3G.