Starting from Scratch: How to Build a Billion Dollar BudgetOctober 19th, 2015 | Posted by in Manufacturing
The number of companies referencing zero-based budgeting during quarterly earnings calls increased from 14 companies in 2013 to roughly 90 companies in 2015. With the rise of zero-based budgeting in the CPG industry, how can managers effectively and efficiently make the best budgeting decisions?
Rather than building from the previous year’s budget, zero-based budgeting requires managers to build their budgets each year from the ground up. This approach forces managers to justify the value of each budget line for the upcoming year.
Proving the value of dozens or even hundreds of initiatives, however, can be difficult and time-consuming. Running tests in a small subset of stores or markets can enhance the zero-based budgeting process by helping managers quickly and precisely identify the incremental impact of each initiative across functional areas:
Marketing: The rise of digital media is increasingly important to managers determining marketing budgets. Research indicates that CPGs will increase digital media spend from $4.2B in 2014 to $7B by 2018. This trend forces managers to make tough decisions about how much to budget for each channel. Testing different varieties of media strategies can generate insights about which ideas are most effective in driving sales. For example, a manager can conduct a media test by running a new ad in some markets but not others to determine how much the ad increased sales. These insights can help managers justify their budgets for the upcoming year.
Merchandising: Within merchandising, managers must decide how to allocate their budgets between existing products and new innovations. For example, Fruit of the Loom recently introduced its “Stay-Tucked Crew” undershirts. Testing the product in a small subset of stores prior to broad rollout and comparing performance to very similar stores where the product is not introduced can reveal the new product’s true impact, net of any cannibalization or halo effects. Determining the incremental value of the “Stay-Tucked Crew” undershirts would help inform Fruit of the Loom how much to budget for similar innovations in the future. Testing may also lead to future hypotheses that can inform decisions about the focus for future initiatives. For example, Fruit of the Loom might learn that the “Stay-Tucked Crew” undershirts sell best in certain types of stores, like densely populated areas.
Sampling: Many CPGs, like Keurig Green Mountain, offer product samplings to increase sales. Sampling can be very costly, however, so managers first need to quantify the effectiveness of samplings before broad rollout. In addition to knowing the true ROI, it is valuable to understand where sampling works best and its long-term impact on customer purchasing behavior. A manager might learn that executing in-store samples for Product X only in certain types of stores would generate 90% of the incremental sales with only 50% of the cost. These insights will allow managers to allocate costs differently and justify the custom budget they need. If executed correctly, managers can taste some profits along with the product on display.
The zero-based budgeting approach has proved effective in helping CPGs cut costs. Leveraging testing when using the zero-based budgeting process can help companies even further increase profitability.
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