The major advantages of zero-based budgeting are flexible budgets, focused operations, lower costs and more disciplined execution, while the disadvantages are resource intensiveness, the possibility of being manipulated by savvy managers and a bias towards short-term planning. Pete Pyhrr developed zero-based budgeting in the 1970s while he was an account manager at Texas Instruments. In recent years, Fortune 500 and private equity companies have also adopted zero-based budgeting.
Zero-based budgeting deviates from traditional budgeting in that each year’s budget is created from scratch. In contrast, traditional budgeting takes the previous year’s budget as a template and then builds off it. Zero-based budgeting forces managers to think about how every dollar is spent, every year. This process also forces them to justify all operating expenses and consider which areas of the company are generating revenues.
In traditional budgeting, legacy costs may not be examined for years until there is some sort of economic shock that forces the company to take extreme actions. Expenses have a tendency to grow over time, with each department protecting its budget from cuts. This approach can be myopic; over time, it leads to significant misallocation of resources.
One of the major shortcomings of zero-based budgeting is that it can reward short-term thinking by shifting resources towards areas of the company that will generate revenues over the next calendar year. Some areas of the company are long-term investments, such as research and development or worker training. These won’t be generating revenue in the near term, but over the long term, they are the keys to remaining competitive.
Zero-based budgeting is also quite resource-intensive. It takes a lot more time and effort to draw up a budget from scratch rather than modify an existing budget. Many critics argue that the benefits of zero-based budgeting do not justify its time cost. Further, the process can be gamed by savvy managers to get more resources into their departments. It can lead to a change in culture where there is a decreased spirit of cooperation in the company, as workers feel expendable.