6
Zero-Basing
Justify What to Keep, Not What to Kill

Zero-basing is an essential tool for any company pursuing a Fit for Growth transformation. More than a cost management lever, zero-basing is an overarching, holistic method of examining all business activities to distinguish the differentiating capabilities that create sustainable competitive advantage from the table-stakes capabilities needed to compete in the marketplace and the lights-on capabilities needed to operate any business. Zero-basing is a repeatable process for rigorously scrutinizing every dollar in a company's budget and instilling a culture of cost management across the organization. A well-executed zero-basing program yields sustainable cost reductions, fosters a mindset of questioning the need for every activity, and releases funds to invest in differentiating capabilities.

What Is Zero-Basing?

Zero-basing examines the costs of all activities, based on their strategic priority, value added, and business necessity, rather than budgetary precedent. Nothing is funded just because it was in last year's budget. Instead, zero-basing demands that a strong case be made for every expenditure. A decision-tree analysis based on five questions separates costs that support differentiating capabilities from those that support table-stakes and lights-on capabilities:

  1. What do we need to absolutely keep this business or function going? What is the bare minimum we need to do? Not all non-differentiating activities can be eliminated. Some are necessary to operate as a business or meet legal and regulatory requirements—to keep the lights on.
  2. Which non–lights-on capabilities drive true competitive differentiation and support our right to win? These are the activities that underpin your three to six truly differentiating capabilities.
  3. Of the capabilities that are not differentiating or lights-on, which ones do we think we can cut altogether? After scrutinizing various activities in light of budgetary limitations, you may decide your company can do without many things previously considered table stakes.
  4. Of the capabilities we want to preserve, is there a more economical way of deploying them? The performance and efficiency of many capabilities can be improved using the levers discussed elsewhere in this book.
  5. What risks would the business run if it made the cuts and changes we're considering? Evaluate the risk through the lens of a business case. Ensure risk-mitigation expenditures generate an acceptable return on investment in light of the likelihood and magnitude of the risks.

Answering these questions enables a company to realign spending priorities to reflect the importance of each capability to competitive differentiation, and to channel resources to critical capabilities while cutting back elsewhere. After assigning each activity to the three capability categories—differentiating, table stakes, and lights on—a company can realign its cost structure to reflect its strategic priorities (see Figure 6.1 ).

img

Figure 6.1

A comprehensive zero-basing can reset the cost structure drastically (assuming no similar recent pruning exercise). A large portion of the savings results from simply eliminating or dialing down spend in non–lights-on activities, through tough choices about where to spend the company's limited funds. In addition, across all capabilities, including lights-on, costs are optimized by applying the cost levers discussed elsewhere in this book, such as portfolio rationalization, outsourcing, business process optimization, and digitization.

For example, the information technology department of a large consumer packaged-goods company reduced internal costs by a total of 39 percent by combining a zero-basing approach with a segmented service model (which systematically restricted and prioritized demand and delivered much of the service through a low-cost outsourcing partner). The most important business units and business applications received the lion's share of dedicated discretionary resources, such as system enhancements and projects to build new features. Even service levels for activities that were previously considered lights-on, such as resolving application-user service tickets, were scrutinized and further segmented based on the criticality of an application to the business. Break-fix tickets for mission-critical applications were addressed right away, while low-priority tickets for applications that did not affect revenue were resolved days or weeks later. Such practices let the department spread demand and reduce the total amount of resources needed at any point in time. This move, in combination with a highly outsourced delivery model, allowed the organization to treat the number of resources as variable and to better match supply of IT resources with prioritized demand.

As a result, costs for differentiating capabilities were trimmed by a modest 10 percent—enabled by better-matched supply and demand, and access to a wide pool of talent through strategic suppliers. Table-stakes activities were cut by 30 percent by right-sizing service levels per application-segment and reducing the number of duplicate applications. Lights-on activities were slashed 60 percent, benefiting significantly from an investment in virtualization and an outsourced delivery model, as well as from offshoring routine applications and infrastructure maintenance services (see Figure 6.2 ).

img

Figure 6.2

A Versatile, Holistic Cost Lever

Zero-basing is a versatile tool that can be used narrowly to optimize a single function, or broadly across a group of functions, a business unit, or the entire organization simultaneously. This comprehensive approach maximizes efficiency throughout the company by putting the entire cost structure on the table and enabling trade-offs on where to dial down and where to invest. In addition, when departments collaborate, they break down the silo mentality and deliver cross-organizational savings that can far exceed the benefits of optimizing individual units.

Internal customers of IT, finance, or HR functions cause unnecessary spending when they ask for more services, or “higher-touch” services than they truly need. This may result from a lack of transparency into the cost to deliver a service, or from functional leaders' desire to pursue excellence initiatives that do not support a company's differentiating capabilities. In such scenarios there are opportunities to rationalize demand for high-touch services, such as superfluous financial reports, unnecessary training sessions, nice-to-have IT projects, and redundant market studies, and to generate significant savings by reducing service levels.

When Should You Zero-Base Your Capabilities?

Companies often turn to zero-basing at times of crisis or dramatic change—such as an imminent bankruptcy—when they need rapid and significant cost reduction. More recently, however, zero-basing has become a go-to method for executives under pressure from activist investors demanding rapid improvement in margins and shareholder returns.

While zero-basing works well as an emergency cost-reduction lever, it is also a powerful tool for companies that need to realign cost structures with a new business strategy. If any of the following statements describe your company, consider zero-basing your cost structure:

How to Zero-Base Your Capabilities

Zero-basing is a multistage process of evaluating cost structures throughout your organization, establishing spending targets based on your company's particular needs and strategy, and restructuring costs to meet those targets. In a zero-basing exercise, all capabilities and associated costs are categorized as lights on, table stakes, or differentiating, and their costs are challenged. For lights-on costs, a “clean-sheet” view of the lowest-cost model is created, along with associated risks. For table-stakes costs, capabilities are prioritized based on the value they create, with some capabilities cut back and all reviewed for opportunities to improve efficiency. Last, differentiating capabilities are also prioritized based on value, and the company considers possible investments and efficiency-improvement opportunities for each capability (see Figure 6.3 ).

Figure depicting zero-basing approach by an arrow pointing towards the right. From the left, define functional targets, segment activity and cost by capability category, assess value of table stakes and differentiating capabilities, zero-base all categories of costs, and plan and launch initiatives are represented at the bottom of the arrow.

Figure 6.3

Step 1: Define Functional Targets

Just as a Fit for Growth transformation starts by setting an enterprise savings target, a zero-basing exercise begins by establishing top-down savings goals for each capability, function, or business unit included in the exercise—much like the target-setting exercise for the overall transformation described in Chapter 4 . These top-down targets are critical to achieving savings goals, because they push the organization to question what activities are truly necessary versus merely “nice to have.” Without an aggressive top-down target, companies often fall into the trap of defending existing cost structures, preserving the current organization, and seeking only incremental improvements, instead of exploring ways to eliminate and/or reduce costs.

In addition to setting overall functional targets, set targets by capability category, too. We suggest setting low savings targets for capabilities identified as differentiating, while setting aggressive ones for table-stakes and lights-on capabilities. As a result, functions that deliver multiple differentiating capabilities will be asked to deliver far less savings than functions that provide only lights-on capabilities. When a single differentiating capability happens to be delivered by multiple functions, it is important to ensure that no function can decimate the differentiating capability in an attempt to meet its savings target.

Step 2: Segment Activity and Costs by Capability Category

Effective zero-basing requires a deep understanding of your processes, particularly the allocation of time and money across capabilities. Gather cost information with activity surveys in each function. Responses will reveal how people spend their time, enabling you to segment activities in each function that fall into the categories of lights on, table stakes, and differentiating. Your goal is to account for 100 percent of the time and cost associated with every capability and activity, including external expenditures and temporary resources. This will build your understanding of the work performed and its cost for eventual zero-basing. However, the mere allocation of functional resources across functional activities—while necessary—is insufficient. Also critical is the need to categorize the full suite of functional activities into lights-on, table-stakes, and differentiating capabilities to make transparent how much cost and effort is directed toward activities that enable you to win against competitors (differentiating) versus activities that are necessary to keep you in the game (table stakes and lights on). The best surveys leverage standard industry-process taxonomies that enable comparisons with external benchmarks, but are customized enough to reflect the terminology and processes used by the organization.

Step 3: Assess the Value of Each Capability Category

Once you have a baseline of activities and corresponding costs, determine the value of each cost category. First, set aside any costs and activities that support lights-on capabilities—activities that are necessary for operation or are legally required. These category of activities will be evaluated later to see how they can be performed more efficiently.

Once lights-on activities are filtered out, ask functional leaders responsible for providing a service to value the importance of activities supporting differentiating and table-stakes capabilities. To assess their contribution to strategic priorities and the bottom line, you might ask, “To what extent does this activity drive margin, cost control, or growth?” “To what extent does this activity drive differentiation by supporting a key capability pillar?” or “How does this process help the function effectively and successfully deliver service?”

At the same time, determine how much value internal customers get from various services. Ask them such questions as, “How does this activity help you deliver value to external customers?” or “How well does this activity enable your mission?” or, more to the point, “What are the risks to your business if this activity was discontinued?” Often, we see a big gap between what functional providers of services deem valuable and what the internal customers receiving those services actually find valuable. To make the discussions with internal customers most productive, table-stakes and differentiating activities are bundled into “decision packages”—clusters of table-stakes or differentiating activities that can be logically grouped to make a decision about the associated activities. For example, can the activities in the package be delivered more economically? Can the level of service be minimized? Or can an activity be entirely discontinued and, if so, what is the associated impact on costs, service levels, and business risks?

Aggregating the provider and customer scoring for each decision package enables you to identify the groups of activities that comprise each capability, prioritize those necessary to stay in business, and create a list ranking the importance of all other functional activities, along with associated costs from Step 1 (see Figure 6.4 ).

Figure depicting decision package analysis for table-stakes activities. Tables for reporting decision package and forecasting decision package are depicted at the and at the bottom, respectively.

Figure 6.4

Step 4: Zero-Base Current State

Actual decisions about what work to dial down or optimize happen in formal “challenge” sessions. These sessions are designed to help executive leaders understand the work being performed, why it's performed, who is generating the request, the resources consumed, and the value generated by the work, as well as the risks of eliminating it. Armed with such information, executives can make key decisions and trade-offs about which activities must be funded to remain competitive, while also ensuring such retained activities are optimally efficient. Challenge sessions work best when they are conducted on a single day and organized by function and/or process area. Participants should include the leader whose group is being analyzed, the overall transformation lead, business and functional subject-matter experts, and key customers of the function.

To kick off the challenge sessions, the leadership team should revisit corporate strategy and the differentiating capabilities required to support that strategy. This strategic review enables decision makers to generally assess the appropriate level of spending for each company function, based on the strategic importance of the capabilities it supports. After making these broader determinations, leaders should look across functions at a macro level to determine where they may want to be as lights on as possible to fund differentiating activities in revenue-generating functions. For example, this process led a consumer packaged goods manufacturer to decide to be lights on in IT and HR, dialing down capabilities in IT innovation, digital transformation, talent analytics, and high-touch HR business partnering to fund more investment in product innovation and brand-building capabilities.

Once the decision team has made macro-level resource allocation decisions by function, they move into individual functional discussions. They start with a blank sheet, assuming no spend in the function. To build the functional spend, they begin by reviewing the lights-on work and spending, to ensure that these activities are truly lights on and fully optimized. This involves challenging whether more commoditized lights-on costs such as IT infrastructure, accounting operations, HR administration, and back-office processing operations can be delivered more economically by embracing lower-cost models or outsourcing. It also means defining—in as clean-sheet a manner as possible—the “bare minimum” of expertise necessary to satisfy the company's legal, regulatory, and fiduciary obligations. Companies' risk-tolerance policies for such work is often needlessly overengineered.

Next, they compare the bare-minimum total lights-on costs with the functional affordability constraint, which is the new target functional budget. If there is room left in the functional budget after the lights-on work is funded, then select table-stakes and differentiating capabilities can be “added back” based on the relative return on investment each activity will provide, up to the top-down target set for the function. At this point the team should rank-order differentiating and table-stakes capabilities by decision package, and through an iterative process determine what to stop doing, do less of it, or do it cheaper by decision package, to make new cost structures and processes sustainable. All other activities that do not fit into the budget should be eliminated, and corresponding risks evaluated and acknowledged.

One of the most challenging issues we see in this phase is the tendency to overestimate what constitutes a lights-on activity. Highly regulated or expertise areas like tax, legal, quality assurance, risk management, or compliance often argue that everything they do is lights on. However, closer scrutiny may reveal that many activities aren't legally required, but reflect risk mitigation strategies that are business decisions.

Resolve sometimes weakens at this point, as executives shrink from the tough calls required to prioritize only the most essential activities. It can be hard to accept the painful reality that much of the lights-on work must be performed at very lean levels and that even some table-stakes capabilities may have to be cut back to fully support key strategic priorities. Executives confronting these decisions need to keep in mind that winning strategies aren't built on across-the-board excellence, but on deliberate choices to invest in distinctive capabilities in a few key areas while cutting back everywhere else.

Step 5: Plan and Launch Initiatives

After senior stakeholders make their decisions, teams develop implementation plans. These plans establish an overall structure for the implementation, establish a timetable for each step, and assemble teams to carry the initiative forward.

Implementation plans must address the behavior changes needed to achieve program goals, and establish mechanisms and governance structures for rejecting wasteful expenditures and for monitoring resource allocation. The teams must brace themselves for some fallout the first few times they decline to meet a request, and leaders must be there to support their teams and reinforce the value-trade-off decisions that were made. Remember that effective cost transformation requires changes in organizational behavior and long-term vigilance. An officially defunded activity will continue consuming resources if internal customers keep asking for it and providers keep saying yes.

Any company aiming to reduce costs without losing its competitive edge can benefit from zero-basing. This systematic approach illuminates the true drivers of cost, enabling organizations to root out unnecessary expenditures and enhance efficiency in all activities. Unlike traditional short-term cost-cutting tactics, zero-basing generates structural trade-offs and cost reductions that are sustainable over the long term. These fundamental improvements drive down overall spending while bolstering distinctive capabilities in line with a Fit for Growth cost transformation.

Zero-Basing Best Practices

  1. Commitment from the top and cross-functional cultural change. Senior leadership drives change by demonstrating a willingness to challenge the value of all work, explore new ways of working across all functions, and modeling a new attitude toward spending. This inspires cultural and behavioral changes that drive more value than short-term cost savings.
  2. Fit-for-purpose stretch goals. Zero-base your activities based on the cost structure needed to achieve your target profit margins, seeking best-in-class performance only where it's necessary to deliver on your way to play. Use zero-basing not as a bottom-up method of identifying savings opportunities, but as a tool to meet the top-down savings target established for the program.
  3. New ways of working. A successful zero-basing program changes the way a company works by prioritizing activities that drive competitive differentiation, cutting back or eliminating others, and optimizing efficiency everywhere.
  4. Ongoing discipline. To sustain the benefits of zero-basing, revise planning, resource allocation, and business-performance review processes. A full zero-basing exercise is too much work to do annually. Instead, put in place a process to look at new or incremental costs through the zero-basing lens every year, and do the full cost segmentation every three years or so.
  5. Do no harm. An effective zero-basing initiative drives efficiency and cultural change without impeding growth. It generates funds for investment in differentiating capabilities by targeting lights-on and table-stakes activities for greater savings, rather than butter-spreading cuts across all areas in equal amounts.
  6. Effective messaging and transparency. The right messaging tone intrigues and engages key audiences, while the wrong one merely annoys. Frequent, comprehensive progress reports—with the right level of transparency—build support by demonstrating concrete benefits from zero-basing, without sending unnecessary shock waves through the organization.
  7. The right people at the table. Input from the people directly responsible for processes and budgets under scrutiny improves decision making and fosters commitment to the zero-basing agenda. But don't delegate zero-basing decisions to lower-level managers; senior leaders of various functions should make the calls.

Pitfalls to Avoid

  1. Aiming low. Focusing on individual expenditures at too granular a level obscures opportunities to transform costs more dramatically through structural changes, such as exiting markets, discontinuing product lines, and eliminating capabilities.
  2. Stopping short. When companies eliminate only discretionary work, they miss the chance to save more by optimizing all their costs. Lights-on work should not receive “blanket amnesty” as it can be made more efficient as well.
  3. Waiting for perfection. A zero-basing program will never get out of the gate if leaders insist on having pristine data before making decisions. Most decisions can be based on “directionally correct” data.
  4. Deferring to providers. Those who perform an activity often consider it differentiating and essential to the business. Accepting their assessment without giving due weight to customer scoring will protect activities that should be tested rigorously.
  5. Avoiding tough calls. If the cost reductions and savings target are perceived as voluntary, decision makers will often forego savings because they can't bring themselves to take the difficult steps needed to rationalize cost structures.