Zero Based Budgeting

Report: 5
Date: 21 May 2009
By: Director of Resources on behalf of the Commissioner

Summary

This report sets out the MPS’s approach to zero based and incremental budgeting to ensure effective cost challenge within an integrated performance management framework

A. Recommendation

That Members note:

1. The Service’s approach to zero based and incremental budgeting as part of an integrated performance management framework.
2. A further report will be submitted in July outlining the cost challenge approach used on three case studies, ie:
   • Forensics
   • THR
   • F&R Modernisation

B. Supporting information

Background

1. The Productivity and Performance Sub-Committee has asked the Service to identify possible pilots for zero based budgeting as a means of challenging costs.

2. There are two principal methods of developing budgets, i.e.:

• Zero Based Budgets (ZBB)
• Incremental Budgets (IB)

ZBB

3. In its pure form, ZBB involves the preparation of budgets on the assumption that the organisation is starting out afresh in the new planning period – it is as if the life of the organisation exists as a series of fixed term contracts and can start from a zero base at the start of each planning period. It is indifferent as to whether the total budget is increasing or decreasing. It is very resource-intensive and is usually most effectively used where the activities involved are wholly or mainly discretionary in nature.

4. The advantages and disadvantages of ZBB can be summarised as follows:

Advantages

• Questions accepted beliefs
• Focuses on value for money
• Clear links between budgets and objectives
• Involves operational managers actively and may lead to better communication and consensus.
• Is an adaptive approach to changing circumstances.
• May lead to better resources allocation.

Disadvantages

• Adds to the time and effort involved in budgeting.
• May be difficulties in identifying suitable performance measures and decision criteria.
• Questioning current practice can be seen as threatening – careful management of the ‘people’ element is essential.
• May be uncertain about costs and resources of options other than current practice.
• May not facilitate the identification and development of big hitting value for money projects.
• Outside consultants may be needed to facilitate the process, thereby increasing the cost.

Since its introduction practical experience has shown that, in its original form ZBB has proved unwieldy. Organisations using the approach have tended to modify it to suit their particular circumstances and/or focus on specific areas of potential saving.

Incremental Budgets

5. Incremental budgeting uses a previous period’s budget or actual performance as a base, with incremental amounts added for a new budget period. In its pure form, this model has its disadvantages in that the focus can be on growth and reductions, which are inevitably marginal to the total value of the budget, which is potentially rolled forward without much scrutiny or linkage to business objectives.

6. The advantages and disadvantages of IB can be summarised as follows:

Advantages

• Overall resource constraints are recognised.
• Budget is stable and change is gradual.
• System relatively simple to operate and understand.
• Managers can operate their departments on a consistent basis.
• The impact of change can be seen quickly.

Disadvantages

• Assumes activities and working methods remain unchanged.
• No incentive to reduce costs and encourages spending up to budget.
• May not recognise changing circumstances and priorities.
• May not identify inflated budgets.

The MPS Approach

7. In their pure form, neither ZBB nor IB is used by, or would be appropriate for, the MPS budgeting process. Instead the Service has preferred to modify and combine these approaches in order to derive many of the benefits afforded by both systems in terms of:

• IB:
  • challenging growth and reductions;
  • identifying and managing cost drivers across the business;
  • recognising the realities of resource constraints.
• ZBB:
  • determining and clearly stating organisational objectives
  • identifying major areas of Service change;
  • reviewing different ways of delivering how these services meet the organisational objectives so that the resources associated with the preferred option can be actively justified.

8. The MPS continues to develop its approach to budgeting as part of an integrated performance management framework which will deliver a legally balanced budget for the Authority within the financial constraints set by the Mayor. That approach recognises changes in demand and Service priorities and aims to balance:

• targets applied to individual Business Groups;
• additional smart targets for corporate and cross-cutting exercises which will eventually be applied to individual Business Groups.

This approach aims to ensure Business Groups’ existing budgets are challenged whilst proper regard is given to how services are delivered at a more strategic level.

9. All the proposals are judged against the Service’s six budget principles:

• priority to public facing services;
• alignment of resources to MPS corporate objectives;
• improve outcomes and minimise unit cost of delivery;
• achievability;
• identification of medium term saving proposals, not just Year One;
• understanding the impact of cost reductions elsewhere in the organisation.

10. At a Business Group level, base budgets, together with bids for growth and reductions, are challenged as part of the budget process.

11. The two areas of corporate activity included in the Service’s budget approach are:

• progressing the Service Improvement Plan (SIP);
• understanding cost drivers for the highest areas of spend and identifying options for reducing these costs.

12. Work on SIP projects involves questioning accepted beliefs and considering the possibilities for fundamental change, thus borrowing from a ZBB approach. In order to demonstrate the current approach is robust, it is proposed that a further report is submitted providing details of three SIP reviews at different stages of implementation, i.e.:

• Forensics
• THR
• F&R Modernisation

This would avoid disruption to reviews currently in progress. If agreed, the report providing details of these case studies will be submitted to Sub-Committee in July.

C. Race and equality impact

There are no race and diversity implications arising directly from this report.

D. Financial implications

There are no financial implications arising directly from this proposal. The approach proposed, however, aims to minimise the resource impact of meeting the Sub-Committee’s requirements.

E. Background papers

None

F. Contact details

Report author(s): Anne McMeel, Director of Resources

For more information contact:

MPA general: 020 7202 0202
Media enquiries: 020 7202 0217/18

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