In Zero Based Budgeting you are given a
fixed period of time in the future - the next quarter or year, for example - and are asked to justify proposed expenditures
during that time period solely on their merits. Past expenditures may serve as guide to but not a justification
for future outlays.
You can also apply the principles of Zero Based Budgeting to any
proposed marketing, advertising or sales project. Often the desired outcomes are
well-defined, but reasonable costs and practical timelines appear difficult to ascertain. This
Example of Zero Based Budgeting walks you through the thinking we apply
to all marketing, media, or creative projects.
Step Zero. Define the Objective.
"We want to get
15% to 20% more customers.
What will it cost?
There is invariably a trade-off between the time and money required to attain any desired
result. You could spend several years adding 15% to 20% more
customers at next to no cost, or acquire them quickly with a massive
advertising, promotional, or sales blitz. The advantage of zero
based budgeting is that all three variables - Time, Money and Value start
at the same point. Zero.
Square One Is A Cube.
There are innumerable combinations of Time and Money that can produce
any given result. However, the Value of that result must be greater than or equal to its Price: V
> P. The value of acquiring 15% to 20% more customers must be equal to or greater than the price,
or there's no reason to do it. Even if you're a charity, a new
"customer" has some Value worth the effort to acquire him or her.
Time and money are measurable costs. The quotient of the
two defines Price. That is T ¤
M = P. The symbol [¤] suggests
multiplication, but the true relation between the two is not purely mathematical.
-
It costs roughly six times as much money to run
a double-truck spread ad in one issue of a magazine as it does to run
a square third in six issues.
The spread might produce more impact - measurable recall. The
square thirds might produce more inquiries. (This is why you TEST
THINGS!)
-
One $100,000 a year Sales
Director will not
necessarily produce exactly as much business as two $50,000 a year sales reps.
-
A $200,000 direct response TV spot
might not produce ten times the calls of a $20,000 commercial.
Still, the Value of obtaining your goal must be equal
to or greater than ANY combination of Time and Money: V > [T ¤ M]
Step One. Define Value.
In this example of zero based budgeting we'll
assume your average customer produces $150 a year in revenues and $25 in profits,
and you now have 20,000 customers. Therefore, adding 15% to 20% more customers should produce:
| # Customers |
Rev @ $150 |
Profit @
$25 |
| 3,000 |
$450,000 |
$75,000 |
| 4,000 |
$600,000 |
$100,000 |
A clearer statement of the original goal would be:
"What
would it cost and how long would it take to add 3,000 to 4,000 more
customers, increase sales by $450,000 to $600,000, and profits
by $75,000 to $100,000?"
The range of increased sales or profits is a reasonable definition of Value. Therefore: [$75...$100K] > T ¤ M.
Step Two. Set a
Deadline.
Once Value is set at a number or range of numbers
greater than zero, the next step is to define the TIME component of Price somewhere between Now and Never.
It's often better to set Specific Dates by which
one or more milestones must be
completed before you set the dollar budget.
"Starting May 1, we want to add 15% to 20% more customers in two months...."
Why set deadlines first? ZBB Corporate and Government planners must set start
and stop times for on-going activities. Our experience is that if marketers commit to accomplish a specific project by a certain
time, they are more likely to do it than if they wait to "see what it will cost". If you set the budget first,
you'll be more likely to give yourself an indefinite amount of time to spend it.
In reality based budgeting Indefinite Start = Never.
Will the deadlines change? That's possible, even likely.
But given a fixed VALUE and firm DEADLINES, it'll be
easier to deal with the MONEY variable, which is next.
Step Three. Set
a Budget.
The MONEY portion of Price must be greater than Zero but not
so high as to make
T ¤ M > V. Here's a practical Rule of Thumb:
A. Set your minimum budget as a firm percentage of your minimum Value.
B. Set your maximum budget as an acceptable percentage of your maximum Value.
Direct Marketers will recognize this rule immediately. An
acceptable Media Cost Per Order or "allowable" is a percentage range, usually 45% to 55%, of each DR TV or DR Radio order,
with some allowance for upsells and repeat orders.
So, what percentage of added profits are you willing to give up to
acquire 15% to 20% more customers? It could be 5%, 30%...50%. You can use past performance figures as a guide. Your
min/max ranges might be:
| Min/Max % |
Min/Max Profit |
Min/Max Budget |
| 33% |
$75,000 |
$24,750 |
| 40% |
$100,000 |
$40,000 |
With just a little arithmetic the project definition has become clear:
"Starting May 1, we want to add 15% to 20% more customers in
two months, and increase net profits between
$75,000 and
$100,000.
We are willing to commit at least $25,000but no more than $40,000 to
accomplish that goal."
Square One is now defined along all three axes. You've determined a Range of Values. You've set start and stop Deadlines.
You've set Minimum and Maximum Budgets.
V > [T ¤ M]
Both the TIME and MONEY components of Price may change in practice,
but setting limits to both makes it much easier
to price out the various subcomponents of the project.
For example, a direct response radio campaign will
require production (an overhead cost) and media (a variable cost).
You'd fund both from the minimum test budget ($25K) and apply the additional $15K to rollout media.
In practice you may end up spending 37% of $86,400 in
net profits gained from 3,165 more customers acquired in nine weeks. Without a firm zero based budgeting statement, though,
it's likely that nothing will happen during that time period.
Compare:
"We want to get
15% to 20% more customers. What will it cost?"
To:
"Starting May 1, we want to
add 15% to 20% more customers in
two months, and increase
net profits between $75,000 and $100,000.
We are willing to commit at least $25,000 but no more than $40,000 to
accomplish that goal."
The advantages of zero based budgeting are clear.
The only "fuzzy numbers"
you have to define are reasonable deadlines and an acceptable percentage
of Value. All the other hard numbers greater than zero compute themselves.
Once you realize Square One is really a Cube,
it's fairly easy to get off it.
