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ZBB—Promise or illusion?
O M E G A The Int. JI of Mgmt Sci.. Vol. 9, No. 2, pp, 107 to 112, 1981 Printed in Great Britain. All rights reserved
0305-0483/81/030107-06502.00/0 Copyright © 1981 Pergamon Press Lid
EDITORIAL ZBB
Promise or Illusion?
BUDGET PLANNING and control in any organization is an explicit expression of the allocation of resources, since every single resource requires a financial outlay to acquire and/or to maintain it. In the private sector, decisions relating to the budget may be incorporated in the overall control of clearly defined profit centres and in the management of their cash flow, so that expenditure may be allowed to rise without fear of intervention from higher authority, provided certain predetermined profitability criteria are met without detrimental effect on the cash flow. As soon as the activities of a profit centre demand a financial outlay, either for capital expenditure or working capital, central procedures come into operation to justify the extra budgetary requirements. In the main, of course, these procedures are predominant in the management of cost centres, commonly found in public organizations or agencies, where expenditure must conform to budget appropriations approved by the relevant governing or statutory bodies, so that determination of these allocations is the primary means by which an overall direction and evaluation of the activities of the cost centres is usually carried out. Many of you have experienced the annual ritual of a budget review, either from the top, as legislators or directors concerned with the process of resource allocation, or at the receiving end, as executives for the operational side, having to ensure that budgetary limits are not violated. The review usually takes the form of incremental budgeting, where the previous year is regarded as an acceptable baseline and increments are then voted to allow for inflation and salary increases, in addition to any expansion of current activities and the introduction of new ones. Thus, incremental budgeting pre-supposes not only that past allocations of financial resources have been correct, but that they will continue to be valid and justified in the future, so that any arguments about future allocations do not focus on how to divide the total cake but on how to divide the incremental cake. Any changes in the distribution of resources can only come about by allocating increments to the various cost centres in different proportions to those prevailing hitherto, and clearly a significant shift must take a long time to materialize, unless the increment in the total budget is comparatively large. 107
108
Editorial
The shortcomings of incremental budgeting are obvious, in that it legitimizes past activities. It does not explicitly question their intrinsic value or efficiency. They continue to be desirable just because they have been accepted in the past. Like the election of members to a club, where the credentials of new candidates are scrutinized only prior to their admission but never thereafter, a given activity needs to be approved only once, after which its survival is not seriously threatened even when more deserving causes appear on the scene. Such a process can only harbour inefficiency and waste, and yet it is wide-spread, particularly in public organizations. What is the explanation for that? The answer is that budget allocations involve people, heads of units who jealously protect their empires, and members of their staff eager to maintain their jobs. To question the worth of their activities is to question their own legitimacy, and a consensus soon develops that it would be better for all concerned not to rock the boat. Thus, the past is tolerated, awkward questions and major upheavals are avoided, and attention is then focused on the allocation of increments which generally involve relatively minor adjustments. Many examples can be cited of commitments to employees that effectively rule out the sacking of permanent staff, and that--coupled with limits to staff mobility-enhances the preservation of the status quo. It is, therefore, understandable why incremental budgeting is an acceptable, though inherently a rather inefficient, process. The result is that budgets continue to grow and sooner or later political and financial pressures are mounted in a clamour to control expenditure. We have seen ample evidence of such pressures, particularly at the level of central and local government, though no cost centre (even in a profit-making organization) can be immune from such pressures for long. The question is: what can be done about traditional incremental budgeting to improve the outcome.'? One possible way of accelerating the rate of change in the distribution of resources is to widen the range of the annual budget increments by making some of them negative. Thus, as a result of central direction, some activities will expand while others contract and this means that ranking of all the activities as to their worth must take place. Such ranking is involved in traditional incremental budgeting as well, since unless all budgets are increased by equal proportions it is necessary to develop a rationale for determining differential increments. But a modification of the process that provides for negative increments obviously has more far-reaching consequences and therefore imposes further demands on the ranking exercise. A more fundamental approach is Zero-Base Budoetin9 (or, ZBB for short), which requires a manager to justify the whole of his budget and not just increments to it. He needs to evaluate several alternative missions that his cost centre is expected to perform and to state what resources he requires for each. The fundamental philosophy of this
Omega, 1Iol. 9, No. 2
109
approach is summarized by Sherlekar and Dean [2, p. 759]: "+Analysis of different levels of performance of decision packages forces the manager to examine, on the same basis, the relative efficiency of operation and the priorities of existing and new programs. ZBB provides top management with an absolute minimum level below which the unit will not function and the incremental levels above the minimum that will enhance the operations of the unit as well as the organization as a whole. As resources are related to performance and workload measures+ top management knows exactly what it is buying for the minimum and incremental commitments of resources within a decision unit".
ZBB aims at achieving a state of affairs whereby the whole of the budget needs to be annually justified from scratch, not only in order to combat waste and complacency, but also to ensure that the relative worths of missions remain under constant surveillance and that alternative levels of activities in each sector are reviewed periodically. Apart from the obvious potential savings and improved resource allocation envisaged by enthusiasts of ZBB, they point to its advantages as a management process, both in terms of its systematic approach in trying to resolve difficult problems in budget planning and in the way that managers of various echelons inevitably get involved in a series of consultations, in the development of a rationale for structuring the budget and hence in becoming an integral part of the decision making process per se. The question that arises is whether a manager can make this kind of objective contribution when he has an axe to grind. In spite of the logic behind the ZBB concept, the manager has his reputation and status to defend, the future of his staff may be at stake, his past decisions and recommendations may need to be justified, and the long term versus the short term operations of his unit have to be considered. In short, it is too much to expect from him a totally objective and detached view of what his unit can and should do, and what resources would be needed for this purpose. Two ways of overcoming some of these difficulties spring to mind: The first is to relieve the manager of the responsibility for determining what alternative levels of activity should be considered for his unit, while the second would also deny him the right to specify zero-based resource requirements for given alternatives. Both methods are designed to make the ZBB process more objective by shifting the onus of decision and verification of crucial data to top management and/or consensus of peers. Thus, in the first of these two methods the manager is presented with several alternative missions, each with its own terms of reference, range of activities and level of service. The manager is then asked what resources he would need in order to meet the requirements for each alternative, and this information--coupled with top management's own ranking of the values of the listed alternatives--provides a basis for determining tradeoff functions, so that the implications of the expected extra costs in upgrading, say, alternative A to alternative B, would be known and taken account of in the final budgetary allocation. The
110
Editorial
attraction of this method, so it may be argued, lies in the fact that the manager's views are solicited neither with respect to the alternatives that should be considered nor to their relative merit, so that his responses to the questions posed are less likely to be coloured by his attitudes to the more basic issues and would tend to rely more on his technical knowledge and managerial experience. However, the fact that he is not asked to express his preferences does not mean that he does not have any and bias may therefore be reflected in some alternatives being presented as particularly cost-effective. To eliminate such bias, the second alternative goes even further and precludes the manager's involvement both in the determination of possible alternatives and in the specification of resource requirements for each. The outcome may be defended on grounds of objectivity, but no use is then made of the manager's expertise in his own area of responsibility and the whole exercise loses any claim to being a participatory management process. For all these reasons it is not obvious how successful ZBB or any of its variants can be, and we therefore need to examine cases where ZBB has been implemented in practice in order to determine what problems have been encountered and what benefits have accrued. A study of this kind was initiated in 1977 to evaluate the first year of operation of ZBB in 16 Departments and Agencies in the US Federal Government by means of a detailed questionnaire [1], followed up by an attempt to evaluate quantitatively the responses and assess the strengths and weaknesses of ZBB on that basis. For the purpose of their evaluation, Sherlekar and Dean relied on eleven criteria, briefly summarized as follows [-2, p. 754]:
A. Agency objectives, goals and strategies A1. Formulation of objectives and goals A2. Quantification of or focus of objectives A3. Identification of major organizational strategies or issues
B. Resource allocation (effectiveness and efficiency) B1. B2. B3. B4.
Formulation of alternatives for improved operation Flexibility in resource allocation Tradeoffs within and across programs Setting priorities of efforts
C. Quality of budgets and budget preparation C1. C2. C3. C4.
Tangible cost saving Better allocation, justification and shifts in priorities Participation of management in decision-making Effectiveness of total time and effort spent
The responses of the agencies were analysed and awarded effectiveness scores with respect to each of these criteria (on a scale of 1 to 10),
Ome~ta, Vol. 9, No. 2
111
so that the average or weighted score for each criterion and for each agency could then be computed. The criteria were then ranked in terms of their effectiveness index and, similarly, the agencies were ranked for each group of the criteria listed as well as in terms of 'overall performance' in relation to the ZBB process. The results are supposed to tell us how successful ZBB was perceived by the respondents to have been, but there are certain fundamental difficulties in such an evaluation exercise, and I shall mention only two here. The first is the degree to which the responses may be considered objective, reliable and consistent. Objective they are unlikely to be, and the authors themselves point out "that federal agencies could be politically motivated to evaluate ZBB favorably as a planning and budgeting tool to appear cooperative, while under-rating it as an instrument for tangible cost saving in order to avoid paying a possible price in terms of budget costs" [2, p. 756]; in fact, cost-saving was ranked bottom among the eleven listed criteria, whereas in reality it is probably the prime reason for ZBB to be imposed on cost centres in the first place. The reliability aspect of the responses stems from the question of whether each reply represents the views of a single respondent or is a consensus of his colleagues, and whether it can be regarded as a true indication of what view the organization takes on the matter, whatever that means. And consistency reflects the fact that different respondents may well respond differently even when they are put in identical situations. The second difficulty in such an evaluation study stems from any attempt at weighting either criteria or agencies. The authors assigned equal weights to all, either because of the absence of any data and compelling reasons to proceed otherwise, or because they just wanted to evade this thorny issue. However, the choice of equal weights is itself a judgement of relative merit and any computed indices are obviously affected accordingly. Alas, the results are not startling or particularly illuminating. Following a detailed discussion on the criteria and their ranking, the authors note that while ZBB scored well on most criteria, its objectives "could be realized by alternative means which are not addressed in this study" [2, p. 757]. They also conclude that while ZBB involved a considerable increase in paperwork, "in general ZBB resulted in improved budget justification, greater awareness among managers, articulation of priorities, and greater focus on matters relating to policy and resource allocation with inputs from managers at different levels with different perspectives" [2, p. 758]. For me the most striking results from this investigation are those that I have already mentioned. The first is that ZBB was not regarded by the agencies as an effective tool for cost saving; that---coupled with the statement that it enhanced budget justification--highlights the respondents' bias and the human reaction of individuals, who tend to
112
Editorial
manipulate such a tool for their own purposes. The second result is that much of the benefit attributed to ZBB was intangible, in the sense that it is less quantifiable: better communication, better understanding, increased participation. Hence, the answer to the question "ZBB--promise or illusion?" is that it is probably a bit of both. In principle, it is a tool that allows a more searching examination of the budget than traditional incremental budgeting can ever hope to produce, and at the very least it can provide planners with some indication of the excess cost of a current operation compared with an idealized model, unencumbered with constraints and commitments that have accumulated with the passage of time. In reality, however, it can achieve much less than its promoters claim, largely because its success relies on the cooperation of human beings, whose first natural instinctive reaction is self-preservation and self-interest. REFERENCES 1. OffiCE Or MANAGEMENTAND BUDGET (1977) Assessment of Zero-Base Budoetin 0. Washington, DC, USA. 2. SHERLEKARVS & DEAN BV (1980) An evaluation of the initial year of Zero-Base Budgeting in the Federal Government. Momt Sci. 26, 750-772.
SAMUEL E I L O N
Chief Editor
0305-0483/81/030107-06502.00/0 Copyright © 1981 Pergamon Press Lid
EDITORIAL ZBB
Promise or Illusion?
BUDGET PLANNING and control in any organization is an explicit expression of the allocation of resources, since every single resource requires a financial outlay to acquire and/or to maintain it. In the private sector, decisions relating to the budget may be incorporated in the overall control of clearly defined profit centres and in the management of their cash flow, so that expenditure may be allowed to rise without fear of intervention from higher authority, provided certain predetermined profitability criteria are met without detrimental effect on the cash flow. As soon as the activities of a profit centre demand a financial outlay, either for capital expenditure or working capital, central procedures come into operation to justify the extra budgetary requirements. In the main, of course, these procedures are predominant in the management of cost centres, commonly found in public organizations or agencies, where expenditure must conform to budget appropriations approved by the relevant governing or statutory bodies, so that determination of these allocations is the primary means by which an overall direction and evaluation of the activities of the cost centres is usually carried out. Many of you have experienced the annual ritual of a budget review, either from the top, as legislators or directors concerned with the process of resource allocation, or at the receiving end, as executives for the operational side, having to ensure that budgetary limits are not violated. The review usually takes the form of incremental budgeting, where the previous year is regarded as an acceptable baseline and increments are then voted to allow for inflation and salary increases, in addition to any expansion of current activities and the introduction of new ones. Thus, incremental budgeting pre-supposes not only that past allocations of financial resources have been correct, but that they will continue to be valid and justified in the future, so that any arguments about future allocations do not focus on how to divide the total cake but on how to divide the incremental cake. Any changes in the distribution of resources can only come about by allocating increments to the various cost centres in different proportions to those prevailing hitherto, and clearly a significant shift must take a long time to materialize, unless the increment in the total budget is comparatively large. 107
108
Editorial
The shortcomings of incremental budgeting are obvious, in that it legitimizes past activities. It does not explicitly question their intrinsic value or efficiency. They continue to be desirable just because they have been accepted in the past. Like the election of members to a club, where the credentials of new candidates are scrutinized only prior to their admission but never thereafter, a given activity needs to be approved only once, after which its survival is not seriously threatened even when more deserving causes appear on the scene. Such a process can only harbour inefficiency and waste, and yet it is wide-spread, particularly in public organizations. What is the explanation for that? The answer is that budget allocations involve people, heads of units who jealously protect their empires, and members of their staff eager to maintain their jobs. To question the worth of their activities is to question their own legitimacy, and a consensus soon develops that it would be better for all concerned not to rock the boat. Thus, the past is tolerated, awkward questions and major upheavals are avoided, and attention is then focused on the allocation of increments which generally involve relatively minor adjustments. Many examples can be cited of commitments to employees that effectively rule out the sacking of permanent staff, and that--coupled with limits to staff mobility-enhances the preservation of the status quo. It is, therefore, understandable why incremental budgeting is an acceptable, though inherently a rather inefficient, process. The result is that budgets continue to grow and sooner or later political and financial pressures are mounted in a clamour to control expenditure. We have seen ample evidence of such pressures, particularly at the level of central and local government, though no cost centre (even in a profit-making organization) can be immune from such pressures for long. The question is: what can be done about traditional incremental budgeting to improve the outcome.'? One possible way of accelerating the rate of change in the distribution of resources is to widen the range of the annual budget increments by making some of them negative. Thus, as a result of central direction, some activities will expand while others contract and this means that ranking of all the activities as to their worth must take place. Such ranking is involved in traditional incremental budgeting as well, since unless all budgets are increased by equal proportions it is necessary to develop a rationale for determining differential increments. But a modification of the process that provides for negative increments obviously has more far-reaching consequences and therefore imposes further demands on the ranking exercise. A more fundamental approach is Zero-Base Budoetin9 (or, ZBB for short), which requires a manager to justify the whole of his budget and not just increments to it. He needs to evaluate several alternative missions that his cost centre is expected to perform and to state what resources he requires for each. The fundamental philosophy of this
Omega, 1Iol. 9, No. 2
109
approach is summarized by Sherlekar and Dean [2, p. 759]: "+Analysis of different levels of performance of decision packages forces the manager to examine, on the same basis, the relative efficiency of operation and the priorities of existing and new programs. ZBB provides top management with an absolute minimum level below which the unit will not function and the incremental levels above the minimum that will enhance the operations of the unit as well as the organization as a whole. As resources are related to performance and workload measures+ top management knows exactly what it is buying for the minimum and incremental commitments of resources within a decision unit".
ZBB aims at achieving a state of affairs whereby the whole of the budget needs to be annually justified from scratch, not only in order to combat waste and complacency, but also to ensure that the relative worths of missions remain under constant surveillance and that alternative levels of activities in each sector are reviewed periodically. Apart from the obvious potential savings and improved resource allocation envisaged by enthusiasts of ZBB, they point to its advantages as a management process, both in terms of its systematic approach in trying to resolve difficult problems in budget planning and in the way that managers of various echelons inevitably get involved in a series of consultations, in the development of a rationale for structuring the budget and hence in becoming an integral part of the decision making process per se. The question that arises is whether a manager can make this kind of objective contribution when he has an axe to grind. In spite of the logic behind the ZBB concept, the manager has his reputation and status to defend, the future of his staff may be at stake, his past decisions and recommendations may need to be justified, and the long term versus the short term operations of his unit have to be considered. In short, it is too much to expect from him a totally objective and detached view of what his unit can and should do, and what resources would be needed for this purpose. Two ways of overcoming some of these difficulties spring to mind: The first is to relieve the manager of the responsibility for determining what alternative levels of activity should be considered for his unit, while the second would also deny him the right to specify zero-based resource requirements for given alternatives. Both methods are designed to make the ZBB process more objective by shifting the onus of decision and verification of crucial data to top management and/or consensus of peers. Thus, in the first of these two methods the manager is presented with several alternative missions, each with its own terms of reference, range of activities and level of service. The manager is then asked what resources he would need in order to meet the requirements for each alternative, and this information--coupled with top management's own ranking of the values of the listed alternatives--provides a basis for determining tradeoff functions, so that the implications of the expected extra costs in upgrading, say, alternative A to alternative B, would be known and taken account of in the final budgetary allocation. The
110
Editorial
attraction of this method, so it may be argued, lies in the fact that the manager's views are solicited neither with respect to the alternatives that should be considered nor to their relative merit, so that his responses to the questions posed are less likely to be coloured by his attitudes to the more basic issues and would tend to rely more on his technical knowledge and managerial experience. However, the fact that he is not asked to express his preferences does not mean that he does not have any and bias may therefore be reflected in some alternatives being presented as particularly cost-effective. To eliminate such bias, the second alternative goes even further and precludes the manager's involvement both in the determination of possible alternatives and in the specification of resource requirements for each. The outcome may be defended on grounds of objectivity, but no use is then made of the manager's expertise in his own area of responsibility and the whole exercise loses any claim to being a participatory management process. For all these reasons it is not obvious how successful ZBB or any of its variants can be, and we therefore need to examine cases where ZBB has been implemented in practice in order to determine what problems have been encountered and what benefits have accrued. A study of this kind was initiated in 1977 to evaluate the first year of operation of ZBB in 16 Departments and Agencies in the US Federal Government by means of a detailed questionnaire [1], followed up by an attempt to evaluate quantitatively the responses and assess the strengths and weaknesses of ZBB on that basis. For the purpose of their evaluation, Sherlekar and Dean relied on eleven criteria, briefly summarized as follows [-2, p. 754]:
A. Agency objectives, goals and strategies A1. Formulation of objectives and goals A2. Quantification of or focus of objectives A3. Identification of major organizational strategies or issues
B. Resource allocation (effectiveness and efficiency) B1. B2. B3. B4.
Formulation of alternatives for improved operation Flexibility in resource allocation Tradeoffs within and across programs Setting priorities of efforts
C. Quality of budgets and budget preparation C1. C2. C3. C4.
Tangible cost saving Better allocation, justification and shifts in priorities Participation of management in decision-making Effectiveness of total time and effort spent
The responses of the agencies were analysed and awarded effectiveness scores with respect to each of these criteria (on a scale of 1 to 10),
Ome~ta, Vol. 9, No. 2
111
so that the average or weighted score for each criterion and for each agency could then be computed. The criteria were then ranked in terms of their effectiveness index and, similarly, the agencies were ranked for each group of the criteria listed as well as in terms of 'overall performance' in relation to the ZBB process. The results are supposed to tell us how successful ZBB was perceived by the respondents to have been, but there are certain fundamental difficulties in such an evaluation exercise, and I shall mention only two here. The first is the degree to which the responses may be considered objective, reliable and consistent. Objective they are unlikely to be, and the authors themselves point out "that federal agencies could be politically motivated to evaluate ZBB favorably as a planning and budgeting tool to appear cooperative, while under-rating it as an instrument for tangible cost saving in order to avoid paying a possible price in terms of budget costs" [2, p. 756]; in fact, cost-saving was ranked bottom among the eleven listed criteria, whereas in reality it is probably the prime reason for ZBB to be imposed on cost centres in the first place. The reliability aspect of the responses stems from the question of whether each reply represents the views of a single respondent or is a consensus of his colleagues, and whether it can be regarded as a true indication of what view the organization takes on the matter, whatever that means. And consistency reflects the fact that different respondents may well respond differently even when they are put in identical situations. The second difficulty in such an evaluation study stems from any attempt at weighting either criteria or agencies. The authors assigned equal weights to all, either because of the absence of any data and compelling reasons to proceed otherwise, or because they just wanted to evade this thorny issue. However, the choice of equal weights is itself a judgement of relative merit and any computed indices are obviously affected accordingly. Alas, the results are not startling or particularly illuminating. Following a detailed discussion on the criteria and their ranking, the authors note that while ZBB scored well on most criteria, its objectives "could be realized by alternative means which are not addressed in this study" [2, p. 757]. They also conclude that while ZBB involved a considerable increase in paperwork, "in general ZBB resulted in improved budget justification, greater awareness among managers, articulation of priorities, and greater focus on matters relating to policy and resource allocation with inputs from managers at different levels with different perspectives" [2, p. 758]. For me the most striking results from this investigation are those that I have already mentioned. The first is that ZBB was not regarded by the agencies as an effective tool for cost saving; that---coupled with the statement that it enhanced budget justification--highlights the respondents' bias and the human reaction of individuals, who tend to
112
Editorial
manipulate such a tool for their own purposes. The second result is that much of the benefit attributed to ZBB was intangible, in the sense that it is less quantifiable: better communication, better understanding, increased participation. Hence, the answer to the question "ZBB--promise or illusion?" is that it is probably a bit of both. In principle, it is a tool that allows a more searching examination of the budget than traditional incremental budgeting can ever hope to produce, and at the very least it can provide planners with some indication of the excess cost of a current operation compared with an idealized model, unencumbered with constraints and commitments that have accumulated with the passage of time. In reality, however, it can achieve much less than its promoters claim, largely because its success relies on the cooperation of human beings, whose first natural instinctive reaction is self-preservation and self-interest. REFERENCES 1. OffiCE Or MANAGEMENTAND BUDGET (1977) Assessment of Zero-Base Budoetin 0. Washington, DC, USA. 2. SHERLEKARVS & DEAN BV (1980) An evaluation of the initial year of Zero-Base Budgeting in the Federal Government. Momt Sci. 26, 750-772.
SAMUEL E I L O N
Chief Editor