Should more health systems adopt zero-based budgeting?

Pete Pyhrr's concept of zero-based budgeting was adopted by his company, Texas Instruments, at the time of its inception in the early 1970s, and soon after by Jimmy Carter while he was governor of Georgia and then president. The budgeting technique has recently been revived by private equity firm 3G Capital Partners as part of the firm's strategy to slash costs, according to the Wall Street Journal.

Mr. Pyhrr developed zero-based budgeting between 1969 and 1971 when he was working as a controller for Dallas-based Texas Instruments. In a 1977 interview with People magazine, Mr. Pyhrr said, "We discovered to our horror that many programs [at Texas Instruments] were not analyzed every year, and that many were just funded as a matter of course — without a conscious decisions being made by anybody."

In zero-based budgeting, managers plan a department or company's annual budget as if starting from zero, as opposed to adjusting the budget according to the previous year's spending. Under this technique, every expense must be newly justified every year, not just new ones, and the goal is to bring it lower than the year before.

Zero-based budgeting requires managers to reduce programs or activities into discrete "decision packages" with all associated costs added in to determine how funds are used. Essentially, the system forces managers to justify the costs and assess the benefits of the budget every year to ensure funds are being allocated to the most profitable projects, according to WSJ.

Mr. Pyhrr, the zero-based pioneer, called it a "tremendous" tool, "especially in times of economic problems, when you need to make reductions, or when you have significant and rapid technological change," according to the report. Those two characteristics will ring a bell for any healthcare professional today.

Could healthcare organizations employ zero-based budgeting to ensure spending is going in the right direction and effectively control costs?

Hospitals and health systems must respond to numerous external challenges that affect their finances, such as public and private payers' efforts to reduce costs, fluctuating inpatient volumes, the increased adoption of bundled payments and other alternative payment systems, as well as increased co-pays and deductibles that incentivize a more conservative outlook among patients on healthcare utilization.

According to the Bain industry brief "Radical redesign through zero-based budgeting," healthcare organizations can benefit greatly from taking a comprehensive approach to lowering cost structures through zero-based budgeting.

"In our experience, zero-based budgeting provides a practical way for companies to radically redesign their cost structures, cutting as much as 25 percent of spending on overhead and support functions, while boosting efficiency and competitiveness," according to the report.

In contrast with targeted cost cutting, zero-based budgeting asks what activities and resources need to be kept under current and future market conditions, whereas the former seeks out what needs to be trimmed. In this sense, zero-based budgeting strengthens capabilities that lead to competitive differentiation, while simultaneously downgrading other areas that over-deliver nonessential functions, according to the report.

Additionally, zero-based budgeting is executed in one comprehensive effort, as opposed to successive periods of targeted cost-cutting, which can have profoundly negative impacts on employee morale. The comprehensive nature of this approach also ensures executives they are not cutting costs in one area of the organization only to later discover the cause of the issue was rooted somewhere else.

While zero-based budgeting may help morale in the long-run, it has also been characterized as cut-throat and can leave employees blindsided when their jobs are called into question or eliminated. For instance, 3G — which implements zero-based budgeting — operates in such a unique business sense that analysts now refer to it simply as "the 3G way." The company is fond of strict, old-school budgeting that falls under the advice of "treat the company's money as you would your own."

"There will always be people who don't like it, especially the ones who were just entitled to be there for historical reasons, the ones who were not performing," Luiz Edmond, Anheuser-Busch InBev's zone president in North America, told Fortune about the 3G culture. (3G led InBev's hostile takeover of Anheuser-Busch in 2008.) "Our processes, our systems, do not allow that. They do not allow you to hide in a nice room, stay for the whole day. No."

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