The following table shows the work that each department must now undertake as it seeks to win funding for its mainstream work and its additional work: we'll just illustrate Department A, though, since all departments will be similar in this example.

Budget to prepare	Comment
Decision Package A1
Department A budget, including
Mission, aims, objectives	This is a crucial aspect of the budget since the department has to submit THREE budgets. One budget at 100% of normal output and a budget at, say, 120% of normal output and another at, say, 80% of normal output. Roughly the equivalent of normal case, best case, worst case scenarios.
Levels of output
Materials
Labour
Overheads
Capital budgets
Decision Package A2
Department A new project budget
Mission, aims, objectives	Since the department is requesting brand new funding here, it will have to provide a decision package for this. We are assuming here that this project is not just part of the overall department but it’s essentially something new. For example, a new product that needs new machinery, people and facilities; or an extension of the product range needing new technology and skills. Again, the decision package will call for 100%, 120% and 80% level plans.
Levels of output
Materials
Labour
Overheads
Capital budgets
Decision Package A3
Department A new project budget
Mission, aims, objectives	The same approach applies here as to Decision Package A2
Levels of output
Materials
Labour
Overheads
Capital budgets

Notes to the table 1:

1. the concept of normal is crucial here: it is the level of output that the organisation can expect to achieve under normal conditions. That is, allowing for all meal breaks, planned maintenance, machine changeovers and so on.
2. senior management has to see the impact on every department of a decision that might cut their budget request by up to 20% of normal, or might grant an additional 20% of finance over and above normal. That is, it's assessing its margins of safety, flexibility and so on.
3. each of these budgets is called a decision package. The Department A overall budget is Decision package number 1, called A1 in the table. The requests for funding for new projects are separate decision packages, called Decision Packages A2 and A3 in the table. So, the organisation is split into areas that can be put in or taken out in a modular kind of way. Consequently, if the department can be operated as before OR replaced by a sub contractor or abandoned altogether then a decision package approach is appropriate. If the department is part of a more complex structure and cannot simply be got rid of or replaced by a sub contractor, then this department will be part of a larger decision package.
4. ZBB is a perfect example of the implementation of Flexible Budgeting.

Example budgets

Another simplified example will help to illustrate how ZBB budgets are put together. Department A's basic departmental budget, Decision Package A1 is at the level of 100% of output; and there are two decision packages in this department are: package A1 at the 80% and 120% levels respectively.

Firstly, the total, outline, budget is shown in figure 1.

Figure 1Decision Package A1

Secondly, figure 2 shows the formulae based version of this model, for interested spreadsheet fans! For reference, the title Department A: Decision Package A1 is in cell B2.

Figure 2 Decision Package A1: Spreadsheet Formulae Version

We can see here why we mentioned flexible budgeting: such packages are nothing more or less than flexible budgets.

Now that management has these alternative decision packages, it can see the output and financial impact of them. At the 80% of normal output level, we can see that total costs are ?36,450, of which fixed costs are ?11,250. Such information can then be set against previous years' plans, current assessment of the market, developments in other parts of the business … to see whether this is the level of output that is required. Indeed, who set 100% of output at 1,000 units and how did they arrive at this figure?

In fact, a great deal of analysis can be carried out at this first stage, bringing in the idea of the inter relationships of budgets and how that has an impact on the ZBB process. In this respect, we would look at the 80% of output level and then assess the impact of it on the overall production budget or plan; and the impact of the new decision packages on this decision package … and so on.

Selection of projects

With incremental budgeting, it is usually the case that only one version of one budget will be provided, albeit it may have to be revised once or twice before it is finally accepted. The ZBB approach calls for three versions of every decision package and we now need to resolve the issue of how to decide on which version of which package to implement?

ZBB proceeds from the budget preparation stage by way of a voting system. Each level of management has a say in which package is accepted: it then recommends to the next highest level of management the packages it then has to vote on and implement. At the top of the organisation, the Board of Directors ratifies the decisions of the lower levels of the organisation. The following chart illustrates the voting regime for our simplified example: starting from the bottom and working upwards.

Figure 3 Department A: Decision Package Voting Outcomes

Note: figure has been cropped so we can only see Department A's decision package progression. We can imagine the rest for Departments B and C.

Imagine that the final overall budget package for this organisation consists of the decision packages shown in table 2:

A1	1
A3	1.2
B1	1.2
C1	1
C2	1

Table 2 Final Decision Packages: All Departments

Huge amount of work involved

Even though we are dealing with a relatively simple example, the key single reason why ZBB has not been widely implemented is that it generates a huge amount of work. Just consider a medium sized business along the lines that we have suggested, with three departments … even they have to start by preparing 27 budgets, not just three. Then the various levels of management have to wade through all of them and decide on the combination of decision packages they finally recommend.

More than this, as the CIMA definition said, ZBB makes us go through this process every time we prepare our budgets. For this reason, some organisations implement ZBB on a partial basis. That is, for example, only Department A uses ZBB this year, only Department B uses it next year and only Department C uses it the year after that, then it's back to Department A. In the meantime, the other departments use, for example, incremental budgeting.

ZBB in the USA

Whilst not inventing the regime, among the best known exponents of ZBB was President Jimmy Carter of the United States of America. Carter had been the Governor of the State of Georgia which had successfully used ZBB. Shortly after he took office as President, Carter sent a memorandum to the Heads of Executive Departments and Agencies within the Federal US Government in which he said:

During the [Presidential election] campaign, I pledged that immediately after the inauguration I would issue an order establishing zero base budgeting throughout the Federal Government. This pledge was made because of the success of the zero base budget system adopted by the State of Georgia under my direction as Governor.

A zero base budgeting system permits a detailed analysis and justification of budget requests by an evaluation of the importance of each operation performed.

… I ask each of you to develop a zero base system within your agency in accordance with instructions to be issued by the Office of Management and Budget. The Fiscal Year 1979 budget will be prepared using this system.

By working together under a zero base budgeting system, we can reduce costs and make the Federal Government more efficient and effective.

Criticisms of ZBB

Whilst ZBB has many stated advantages, there are several journal papers and books around which categorically deny that ZBB is in any way effective. The following is an extract from a chapter in a book aimed almost solely at destroying ZBB as a useful alternative budgeting system.

... there has been a substantial reallocation of financial resources within state government during Governor Carter's administration - especially during his first year of office.

All the evidence suggests that ZBB played a negligible role ... there had been no apparent shifting of financial resources as a result of employing the ZBB system. This story is repeated across Texas, New Jersey and Delaware.
Hammond & Knott (1980) p61

The rest of the chapter, negatively, concentrates on quotations and evidence (much of it anecdotal) that proves that ZBB never works. It should be pointed out, however, that the book was written after only one year of ZBB being in operation in the Federal Government.

Florida Power and Light and ZBB

On a more optimistic note, comes a report from a US Electricity Utility where ZBB is reported as having been a success. Early benefits of having installed the system are reported to be

1. it can be used to control indirect labour and expenses
2. it can be used effectively to require supervisors to set priorities on proposed new work
3. it can be used as an effective communications tool to identify what was being done now that would not be done in the future and gain concurrence up the line that it was all right to stop it
4. by applying resource constraints in forcing setting of priorities, we could squeeze out the low payoff work rather than keep it forever, and thereby protect our ability to limit growth in staff areas

Dady also gives guidance to those who feel they would like to install a system of ZBB.

Splitting budget elements into decision packages allows management to look at their business from a micro point of view; and from the point of view of a detailed analysis of cost behaviour, production and productivity and so on.

In the end, ZBB has a lot to commend it; but there are few management teams brave enough to commit the resources year after year to keeping the system going: hence, the suggestion that a partial implementation of ZBB can be the optimum optimorum solution to an organisation's resource allocation problems.

© Duncan Williamson
3 March 2002 updated 20 May 2005