A Clean Slate

Many of Dollar General's newest growth investments aren't costing the company a dime.

Thanks partly to zero-based budgeting, executives at the publicly held company with 12,000 locations and $20.4 billion in 2015 sales have new funds available to reinvest in the business.

In fact, the company announced in March it expected its Selling, General & Administrative (SG&A) expense leverage point to be about 2.5 percent to 3 percent, down from 3.5 percent in 2015. The targeted lower point reverses what had been an upward trend for SG&A leverage.

"We recently adopted zero-based budgeting to proactively improve our efficiencies and reduce expenses over a multiyear timeframe, all while giving us the flexibility to reinvest savings to drive growth," CEO Todd Vasos said during a conference call with equities analysts March 10.

Dollar General is among a growing number of grocery retailers and CPG brands adopting zero-based budgeting as they encourage senior managers to rethink their departments' annual budget increases. The idea is to kick the habit of adding a percentage increase each year to existing line items without a hard look at productivity.

But others suggest zero-based budgeting poses a risk to businesses if it encourages managers to narrow their focus to such an extent they miss the larger opportunities emerging around them. Without the courage to devote resources to address long-term challenges to the industry or develop new ways of exciting consumers, they could over time give up considerable market share to competitors with more foresight.

WRONG FOCUS

A focus on cost-cutting could drive the wrong behavior, says Barry Clogan, senior vice president of business consulting services at MyWebGrocer, who formerly was head of Tesco's international grocery online.

"Grocers are becoming less relevant," Clogan says. "They are definitely less relevant to millennials who are using Blue Apron to get their groceries to their house." The challenge becomes, what is the unknown cost of not being online? And will zero-based budgeting encourage retailers and brands to address it if managers are being graded on how well they contain costs?

For zero-based budgeting to work well, many companies have to change their cultures, experts say. The process is more enticing when managers see the opportunities it can bring.

Dollar General's focus on costs has led it to eliminate less productive segments while expanding the departments most in demand with consumers. It has been accelerating its square footage growth this year, with plans to open about 900 new stores in fiscal 2016 along with 875 store remodels or relocations. It is trying a more customer-friendly format in its new store layout with faster checkout, and it's opening about 80 smaller format stores of less than 6,000 square feet of selling space, representing a 20 percent reduction from its 7,500-square-foot core format. At the same time, Dollar General plans to deliver total annual shareholder returns of 11 percent to 17 percent, through a combination of earnings per share growth and dividend yield.

DEFINED PROCESS

"Our 2016 budget was built through a zero-based budgeting perspective with a clear and defined process to address spending," Vasos said. "All of these actions are filtered through three lenses: One, is it customer-facing? Second, does it align with our strategic priorities? And finally, third, how does it impact our risk profile?"

But what one company considers risk, another might call innovation. Clogan uses the catchphrase "future-proofing your business" to describe the investment retailers and brands should consider for long term viability.

For many grocers, it requires changing the company's focus from channel marketing, such as Dollar General's in-store focus, to consumer marketing to serve consumers wherever they like to shop.

"Retailers need to move away from old-fashioned channel profitability to customer profitability," Clogan says. "The more channels we offer [and] the more opportunities we offer for consumers to shop with the brand, we are driving that lifetime value."

The real risk, some observers say, is that zero-based budgeting might discourage the type of lofty thinking that often brings disruptive innovation, or at least better margins over the long run. New growth ideas rarely come from accounting spreadsheets. Instead, retailers should pay attention to what consumers want and what's selling well, says James Bergeron, founder of Silicon Valley-based 108 Partners, a CEO coaching firm.

The focus on cost-cutting can be misguided. "I just fundamentally don't believe you can cut your way into creating something for your business. You have to figure out what is a good business model. You can only cut so long until you cut into muscle instead of fat," Bergeron says. "I think it's more about identifying higher margin opportunities within your shelf space."

ACCOUNTING FAD?

Some industry observers say zero-based budgeting is the latest accounting fad in the grocery retail and CPG industries, suggesting it won't have a long shelf life. But others say zero-based budgeting provides managers with more information to make intelligent decisions. Leaders who invest the time and resources to educate managers on zero-based budgeting's merits, and empower them to manage their department budgets as if they owned the business, are more likely to see the rewards.

"At its core, zero-based budgeting makes complete sense. It reboots a company's financials. It makes every cost be justified, as opposed to, 'I did it because we did it last year.' That kind of approach allows fat to build up inside the organizations," says Greg Portell, partner in A.T. Kearney's Consumer Products & Retail and Media Practices. Often, companies will add to a budget to support a new program, but when the program ends, they don't reduce the budget, Portell says.

But cost-cutting goals specifying a certain percentage of savings also can be detrimental if they stifle the growth of the company. Cost-cutting alone also won't fix an underlying problem, and the expected savings might not materialize.

"If you're really going to do zero-based budgeting, it needs to be linked to overall priorities," Portell says. "This can't be just a mass exercise done once a year."

Instead of focusing on cost-cutting for the sake of trimming expenses, companies can encourage a more thoughtful approach to prioritizing expenses and looking for savings that can be reinvested in more productive projects. Contrary to the slash-and-burn image some have associated with zero-based budgeting, it can support new costs if they can be justified.

"ZBB allows for more precise measurement. You're now linking costs to a business need," Portell says.

3G'S PLAYBOOK

3G Capital has the playbook on zero-based budgeting, Portell says. "They have an expected performance that they are expected to hit," he says. "If somebody is looking for an increase in the cost line, it will be hard to get it through."

A spokesman for Kraft Heinz, which is owned by 3G Capital, doesn't dispute it. "ZBB requires employees to justify every dollar we spend, which helps us make the right business decisions, even the hard ones," says Michael Mullen, senior vice president of corporate and government affairs for Kraft Heinz.

The company's integration program has targeted cost savings of $1.5 billion in 2017, Mullen says. Because of its emphasis on cost-cutting, some have speculated 3G will use its clout to try to reduce trade spending at retailers. But how successful the company might be is anybody's guess. It would mean "going against decades of industrywide behavioral patterns," Portell says. "I'm not aware of any one company that can change that," he says.

NO PANACEA

Zero-based budgeting isn't a panacea, he says, noting that many companies have tried it unsuccessfully by failing to understand how to incorporate it with strategic planning. "When you see ZBB just chase the numbers, that's how you can see it going astray," Portell says. "The ones who have done it poorly are retrenching and starting to learn and get into next-generation moves."

Retailers and brands shouldn't expect to operate at 10 percent less, Portell says. Nor should they necessarily compare themselves with the lowest performers. Instead, "create an expectation of accountability," he says. The transparency zero-based budgeting brings can allow a company to react and adjust to changes more quickly than the traditional budgeting approach.

But programs don't always go according to plan. At Tesco, Clogan says he led a program to establish the company's digital presence in eight different countries. In the beginning, the new businesses were losing money because of the licensing fees Tesco imposed for the use of its software.

"How do you align those [emerging] businesses with zero-based budgeting? That's arguably the contradiction and challenge for senior leaders," he says.

Whatever budgeting approach grocers use, they should look ahead more than one year. "You've got to get your house in order," Clogan says, then look to the future.