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Why Retooling Requires a Zero-Based Cost Management System
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  • Inflation and slower economic growth are raising costs and eroding profits. Recession could add to the pain.
  • Zero-based cost management delivers savings that can help boost growth and expand operating margins.
  • Leaders in cost management sustain savings by redesigning the work, building new skills, and developing a different mindset.

For executives tasked with managing costs, there’s little relief in sight. Covid-19, a slowing global economy, geopolitical disruptions, and inflation have taken a toll on companies’ financial performance. Now, a looming recession risks tightening the squeeze on margins.  

A zero-based cost management system helps companies play offense in a recessionary environment (see the Bain Brief “The New Recession Playbook”). It enables leadership teams to rapidly shrink the firm’s cost base as much as 25% and redeploy savings to spur growth and expand operating margins. That boosts flexibility and competitiveness.

Top-performing companies act fast when signs point to a downturn. They work feverishly to get ahead of the risks by targeting costs and productivity. Bain research on 3,900 companies globally shows a sharp divergence in profit performance between winners and losers both during and after disruptions (see Figure 1).

Figure 1

Over 13 years, our research has shown a sharp divergence between winners and losers during and after disruptions

Over 13 years, our research has shown a sharp divergence between winners and losers during and after disruptions

Moreover, companies with consistent cost productivity gains—measured by subtracting revenue growth rates from earnings growth rates—realized higher growth in total shareholder return (TSR). The top 2% of performers—those companies with five years of cost productivity gains from 2016 to 2021—achieved a TSR of 22% on average, more than 2 ½ times that of the rest of the pack.

And cost productivity remains relevant at any point in the economic cycle. Top TSR performers far outpace bottom TSR performers in both revenue growth and productivity, in good times and bad.

Cost creep

Despite major efforts to streamline and simplify their cost structures, most companies acknowledge that over time, cost and complexities always seem to come back. Leaders embrace a cost management methodology that allows them to allocate resources with more agility and sustain the results. That helps fuel productivity gains, even in a turbulent economy.

Leadership teams can manage costs on three levels (see Figure 2). In our experience, the most effective cost managers operate on all three, building knowledge and insight from each effort.

Figure 2

Companies can tackle costs on three levels

Companies can tackle costs on three levels

Benchmarking and setting targets. This is what most companies do. They figure out where they can compress costs, set top-down targets, and require the business and functional leaders to fall in line. It’s a brute-force approach to cutting costs, but the underlying work and activities don’t go away. As a result, cost reductions typically last only one or two years before creeping back.

Redesigning the work. This is what some firms do. They take complexity and work out of the system by redesigning their operating model and deploying automation and digital technologies. Companies that do this well use zero-based redesign (ZBR), a clean-sheet approach that resets the way work is done. They use ZBR to strengthen capabilities that provide competitive differentiation, while streamlining functions that are less critical. ZBR starts with a “today forward, future back” view. Future back means envisioning customer needs, required capabilities, and cost structure three to five years from now to define a clear point of arrival. Today forward involves defining the pathway to move from where the company is today to that future state. The problem is, most companies fail to put in place new ways of working and performance processes to track and sustain the value creation. As a result, the improvement in performance typically lasts three to five years before the costs return.

Embedding a cost management capability. Leaders ensure long-term savings and flexibility by building the right cost-discipline skills (people, processes, and technology) and mindset (values, behaviors, and ways of working). This is what few firms do. Zero-based budgeting (ZBB) is a methodology that creates both the skills and the ownership mindset to take costs out for good and reallocate scarce resources to their most productive use. ZBB is more than just a budgeting process; it’s a set of tools that enables a fundamental shift in a company’s overall approach to cost management.

Companies in this group set top-down targets and redesign the work. But what separates them from the pack is rigorous performance management. They establish routines to identify new productivity initiatives, track the progress of those initiatives, and ensure that gains flow through to the P&L. When savings hit the bottom line, the managers in charge are rewarded. When they don’t, these managers are held accountable. The results stick because cost savings can be identified, tracked, and continually improved. Even companies that don’t deploy a full ZBB program can build cost discipline by improving spending visibility, understanding what demand fuels spending, and embedding behavioral change into the organization.

ZBB allows leadership teams to finally understand how much of the company’s cost base is fixed vs. variable. It provides visibility into who’s spending and what they’re purchasing. This enables companies to tie savings delivered and budgets met to incentives and establish accountability across the leadership team. It is not a matter of using one approach for analyzing efficiency opportunities and another approach for designing processes to sustain those efficiencies; it integrates the two. Spending visibility also helps companies create flexible cost structures that they can adapt to changing market conditions. That makes firms nimbler and more competitive, especially during a recession.

The most effective companies share a distinguishing feature when retooling costs: CEO and CFO engagement in a full change management effort. These leaders acknowledge at the outset that cost management requires new skills and a new mindset. They play a major role in shaping the goal and ambition, and design programs that address the potential barriers to change. Finally, they build the strategic case for change, instead of just implementing it. In doing so, they bring the organization with them.

Businesses face an increasingly unpredictable future as costs mount and risks multiply. Those that embrace all three levels of cost management will be able to navigate near-term market shifts, even as they gain a competitive edge for the long term.

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