Trending in corporate finance: McKinsey discovers that companies actively reallocating resources deliver 30% higher shareholder returns
Research by McKinsey found that, on average, companies allocate 90 percent or more of their resources to the same projects and activities year after year. This happens regardless of market changes, what competitors are doing, or how corporate strategies are evolving. This common allocation approach is a classic example of planning short-sightedness, which is best summed up by carmaker Henry Ford : “If you always do what you’ve always done, you’ll always get what you’ve always got.”
Active resource allocation delivers better returns
McKinsey’s report found that dynamic companies—aka those reallocating resources more actively than their peers—deliver better and less volatile returns to shareholders. The results are impressive: The top third of McKinsey’s sample shifted an average of 56 percent of capital across business units over the 15-year period reviewed, and earned on average 30 percent higher total shareholder returns than companies in the bottom third. So how do you stop budget contributors from doing what they’ve always done?
Deliver cost savings and make resource allocation more dynamic with zero-based budgeting
Some of the world’s largest companies have spoken publicly about how zero-based budgeting (ZBB), in which managers must justify every element in budget submissions, has delivered cost savings between 10 and 25 percent. Adopting the ZBB approach prevents sandbagging and enables resources to be more dynamically allocated, as the McKinsey report suggests.
Not surprisingly, a lot of myths have grown around ZBB. However, two myths are readily dismissed: 1) costs do not necessarily need to be cut to the bone or cut across all departments, and 2) ZBB’s benefits can be quickly realized, particularly when the right tool is used. Anaplan’s new white paper, 5 best practices to zero-based budgeting, discusses how companies adopted a pragmatic approach to ZBB and highlights the best practices they followed:
- Integrate ZBB with core FP&A processes as an auxiliary procedure implemented every couple of years to refocus spending on strategically important initiatives.
- Focus ZBB initiatives for maximum return, perhaps limiting use to overheads, where large amounts of cost that are less well understood often reside.
- Unify operational and financial data on a single platform, making it easier to manipulate the data and resulting in quicker implementation.
- Make modeling easy so managers can understand the causal relationships among activity volumes, resource needs, and costs.
- Reuse ZBB models for routine FP&A processes such annual budgeting cycles and rolling reforecasts.
ZBB is being increasingly adopted by manufacturing, advertising, and hospitality companies, as well as government agencies. These organizations see it as a valuable methodology for breaking the business-as-usual mindset for planning and budgeting. To discover how they are being more flexible in how they implement ZBB and find out more about the best practices they use, download the complete white paper.