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Market Cap £7.63bn
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RPT-Back to zero: Companies use 1970s budget tool to cut costs as they hunt for growth

Mon 30th January, 2017 12:00pm
(Repeats without changes for wider distribution) 
    By Tim McLaughlin 
    BOSTON, Jan 30 (Reuters) - The number of U.S. companies 
using a budgeting tool made famous in the 1970s by former U.S. 
President Jimmy Carter is surging as they turn their spending 
habits upside down to boost profits and to re-invest in their 
businesses. 
    The upswing in zero-based budgeting (ZBB) signals that a 
broader cross-section of U.S. companies anticipate turbulence in 
their revenue growth. They face more pressure on profits, too, 
as wages and interest rates increase, and a stronger dollar 
makes their products more expensive overseas. 
    In consumer staples, where sales growth is often capped in 
the low-to-mid single digits, Campbell Soup Co  CPB.N , Kellogg 
Co  K.N , and Oreo cookie maker Mondelez International Ltd 
 MDLZ.O  have already rolled out ZBB programs that promise 
billions of dollars in savings.  
    Other industries, including finance, energy and 
manufacturing, are now following suit. Use of ZBB in 2017 is 
expected to increase dramatically in the United States and 
around the globe, according to consulting experts. Bain & 
Company reported last year in a survey of 406 North American 
companies that 38 percent of that group would use ZBB, up from 
just 10 percent in 2014.  
    "ZBB has taken on a life of its own," said Greg Portell, a 
partner at consulting firm A.T. Kearney. 
    A ZBB approach requires corporate managers to justify each 
line item of spending in their budgets, or even build their 
budgets from scratch. That is a departure from the typical 
process of using the previous year's budget as a starting point 
and adjusting it based on revenue and inflation projections, for 
example. 
    It often cracks down on the size of a company's real estate 
footprint, corporate travel, terms of international assignments, 
redundant technology and outside consultants. Employees get cut, 
too. 
    But there are risks. One is that companies focus too keenly 
on restraining spending and not on reinvestment that promotes 
new products and revenue growth. 
    "You continuously have to ask what are strategic costs and 
how can we invest behind the things that drive the highest 
volume," said Jason Heinrich, a partner in Bain & Company's 
Chicago office. 
    
    FEELING THREATENED 
    ZBB first gained widespread attention in the late 1970s, 
when Carter, as president, said he would apply the budgeting  
principles to federal spending. It never fully got off the 
ground, however, and Ronald Reagan abandoned it when he became 
president in 1981. 
    Its recent resurgence is due in part to Brazilian buyout 
firm 3G Capital, which used ZBB when it combined H.J. Heinz with 
Kraft Foods in 2015. 
    The combined Kraft Heinz  KHC.O  now has the best profit 
margins among its peers with an estimated year-over-year gross 
margin expansion of 258 basis points, better than twice the 
average among rivals, according to Morgan Stanley. Kraft Heinz's 
stock sports a 2.5-point price-to-earnings-multiple premium over 
its peers. 
    3G's success is one reason the highest adoption rate of ZBB 
is in the consumer staples sector, which has banked on cost 
cutting to offset weak sales growth. In the current fourth 
quarter reporting season, the consumer staples sector is on 
track to report profit of 6.3 percent off revenue growth of just 
3.2 percent, according to Thomson Reuters data. 
    Contrast that with the consumer discretionary sector where 
sales are seen rising 5 percent but profit just 1.1 percent. 
    Greg Kuczynski, a consumer staples analyst at asset manager 
Janus Capital, said ZBB is also being used by some to head off 
agitation from activist shareholders or even takeovers, like the 
Kraft Heinz deal. 
    "So many of them feel threatened," he said. "They're 
desperately implementing ZBB packages." 
    Now the approach is spreading to energy, finance, health 
care and manufacturing. Cheniere Energy Inc  LNG.A , Huntington 
Bancshares Inc  HBAN.O , Baxter International Inc  BAX.N  and 
Ford Motor Co  F.N  are some of the latest devotees. 
    "If a company uses zero-based budgeting, I have more 
confidence it can take out cost faster than peers who do not," 
said Marc Scott, who helps run the $1 billion American Century 
All-Cap Growth Fund  TWGTX.O .  
         
    TOUGHER THAN IT LOOKS 
    Not everyone is sold on it. It can be an uncomfortable 
adjustment for managers and companies have to be careful not to 
alienate customers and business partners, according to analysts. 
    The biggest risk is that companies concentrate only on 
cutting costs, and don't put some of that money back to work 
behind businesses with the potential for growth. One unintended 
consequence is cutting a product's marketing budget only to see 
a rival boost spending for their product and grab market share.  
    "It's not so simple as some of our other competitors out 
there make you believe, which has been roughly translated into, 
'Let's cut all the costs as long as we can get away with it to 
show you better margins for a short period of time. But I can't 
promise you any growth along the way,'" Unilever  ULVR.L  Chief 
Executive Paul Polman told investors in November. 
    Even Kraft Heinz has had trouble generating consistent 
growth. Its organic net sales, which excludes the impact of 
currency fluctuations and other items, declined by 1 percent in 
the three-month period that ended Oct 2. 
    Still, the cost cutting has caught the attention of 
investors, particularly when companies scrap product lines that 
add little value. 
    American Century's Scott said ZBB was a factor when he 
evaluated kidney dialysis provider Baxter International, which 
has used ZBB principles to cancel several programs that added 
little value. 
    He began building a position in late 2015 when Baxter traded 
below $35 a share, according to Thomson Reuters data. The fund 
now owns about 540,000 shares and the stock trades around $46. 
    "It was just another feather in their cap," Scott said about 
Baxter's use of ZBB. "It's not a huge growth play, but we expect 
their profit margins to nearly double in a couple of years." 
 
 (Reporting by Tim McLaughlin; Editing by Dan Burns and Paul 
Thomasch) 
 ((tim.mclaughlin@thomsonreuters.com; +1 617-856-4409; Reuters 
Messaging: Tim.McLaughlin.thomsonreuters.com@reuters.net)) 
 
Keywords: USA COMPANIES/BUDGET
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