Unlocking operational evolution: The zero-basing philosophy

| Podcast

Zero-basing could be said to have an image problem, with a perceived sole focus on cost cutting. In this episode of McKinsey Talks Operations, host Daphne Luchtenberg talks with experts Denis Fomin, Steve Frazier, and Carey Mignerey. Together, they debunk some of the myths surrounding this approach and explore how it can become a dynamic philosophy that goes beyond the constraints of conventional cost reduction, providing leaders with newfound visibility into their operations, investments, and resources. Additionally, they discuss the transformative potential of zero-basing and its role in reshaping organizational growth strategies, as well as how start-ups and disruptor companies are leading the way by maintaining a zero-basing mentality throughout their evolution.

This conversation has been edited for clarity.

Daphne Luchtenberg: Your company’s future success demands agile, flexible, and resilient operations. I’m your host, Daphne Luchtenberg, and you’re listening to McKinsey Talks Operations, a podcast where the world’s C-suite leaders and McKinsey experts cut through the noise and uncover how to create a new operational reality.

Companies are looking for new ways to mitigate against what continues to be a fluctuating backdrop. For many, this is increasing the cost of operations and reducing revenue. And on the topic of cost management, perhaps you’ve heard a recent episode on digitizing sales, general, and administrative costs, also referred to as SG&A, which formed part of the reset and reimagine framework. Today, we’re going to go a bit further into this topic by looking at zero-basing. We hope to dispel some of the myths around the topic as we talk to Carey Mignerey, a partner in our Atlanta office; Denis Fomin, an expert associate partner in Vienna; and Steve Frazier, a senior adviser to McKinsey who spent 20 years working for Amazon.

Carey, welcome.

Carey Mignerey: Thank you. Excited to be here.

Daphne Luchtenberg: And Denis, thanks so much for being with us.

Denis Fomin: Hi, thank you. I’m excited about the conversation today.

Daphne Luchtenberg: And Steve, great to have your voice and your experience in this conversation.

Steve Frazier: Hi, thanks for having me.

Daphne Luchtenberg: Okay. Let’s kick off this conversation. Zero-basing is often associated with cost cutting. Is that correct or is there more to it than that? Carey, I’d like to throw this first one to you.

Carey Mignerey: Zero-basing is about much more than just cost cutting. In fact, I like to think about it with respect to a few different things that it enables. The first is visibility. It gives leaders of institutions visibility into cost, investment, and resourcing—that’s traditionally been the case but may not be the case going forward. And that also leads to zero-basing enabling evolution—where companies invest their dollars and invest in their growth. So it’s less about what you cut in terms of costs. It’s much more around where you spend and where you invest going forward.

Daphne Luchtenberg: Thanks, Carey. That’s really helpful and a great introduction for us. Could we move to saying a little bit more about what zero-basing isn’t? Let’s try to begin to address the image problem. Denis, can you help here?

Denis Fomin: Glad that you asked this question. That is something our clients ask quite a lot. The most common misconception I would say is, yes, it’s a zero-based thing that’s something where lots of people sit around and fill in some templates in a long and tedious process. Well, the way I usually see it, it’s not a process. And that’s a common misconception. It’s more of a philosophy or an idea. It’s the idea that the way things have always been doesn’t mean they need to stay that same way. Are the costs that were there last year, the resources, the way of doing things still the best way to proceed? Or if we were starting it from scratch, would we have done it differently? And that’s a philosophy, and how you implement this philosophy could be a number of different things. It could be related to a process, or it could be related to an organization. But the underlying idea to me is the philosophy.

Daphne Luchtenberg: Thanks, Denis. I like that way of thinking about this idea, that it’s more of a philosophy. And if we move the thinking forward in that direction, about how organizations can start, stop, and change work, what’s the impact on people, on the workforce when you apply this approach?

Carey Mignerey: I think the key to zero-basing is around this being a mindset. As we heard earlier from Denis, this is a mindset. If zero-basing is a mindset, rather than a one-time or episodic event, and it occurs on an ongoing basis, and particularly occurs on an annual basis, it allows for evolving the organization rather than requiring large resets of the organization. As a functional leader, and thinking every year or even more frequently than that, what resourcing do I need and where should it be deployed? That allows me to make changes on an ongoing basis and redeploy my talent, rescale my talent, and move my talent where I need it. The net result of that is it’s less likely that I would need a major reorganization or a major design reset every three or five years, as we often see in many of our clients’ situations.

Steve Frazier: I think that’s a really important point—there’s an appreciation for keeping track of those kinds of costs as one thing that enables growth. Because if you don’t wait for the downturn to reduce costs, but you harvest costs and look for efficiencies as you go, that helps you fund new growth.

Because in a growth mode, you’re always looking for ways to fund the next 20 great ideas you have, and being efficient about your cost base is a great way to do that. It also avoids the kind of pressure you’re under when growth slows down and then you have to cut costs.

Daphne Luchtenberg: That’s great and really does reframe the conversation. So now that we’ve got a better understanding about what zero-basing is and what it isn’t, I’d love to hear some stories from you about where this approach or this philosophy has made a positive difference with some organizations you’ve worked with. Steve, I’d love to get your take on that.

Steve Frazier: In my background, it’s an approach that is particularly relevant to launching new businesses. And when business leaders are asking for resources, asking for investment to go and launch a business, it’s great to show what’s going to be required to launch that business with the smallest possible numbers. It’s your ability to say, “We’re launching a new business, but we can look at what we’ve done before and do it with less, or we can share resources with earlier businesses. Here’s the budget I’m putting together, and the great thing about my budget is there are a bunch of empty rows. I don’t need new resources in every one of these, because I can share some existing resources.”

Carey Mignerey: In our research, one of the points of inspiration we’ve had in terms of zero-basing is from start-ups and new business builds. And what we’ve seen in our research is that they’re actually often more efficient with their resourcing, particularly with regards to G&A [general and administrative]. One of the reasons for that is new businesses and start-ups are, by definition, zero-basing—they’re building their business from scratch. So the inspiration for large corporations and institutions is to say, “Look, if I were actually starting this business tomorrow, where would I invest? Where would I spend resources?” Just as a start-up would have to do every day. That’s part of the inspiration we would draw from start-ups with regard to zero-basing.

Steve Frazier: Another opportunity to think hard about is the benefits of automation and making sure you’re automating everything that doesn’t require a human to be involved. Humans can set things up, they can design a process, and they can think about the decision. But as you scale a business, there’s a lot that can be automated, and you not only understand the process, you engineer it, you get the software working, and then you make sure that the humans take their hands off, and that you work on perfecting the automation, rather than adding more and more people to do the same thing over and over again. And there’s a real benefit to that, both in getting people excited to write great software that enables it to happen and pulling resources out that can be invested in the next new business.

Daphne Luchtenberg: That’s a really motivating way of thinking about it. Do you have any stories you can tell about working with organizations that have done that? Are there companies you’ve worked with where you can talk about how that’s really made a difference?

Denis Fomin: I think building on the points that were mentioned earlier when we were talking about start-ups and start-up-like companies, what we see quite often is that they implement this kind of thinking, the zero-based thinking, not only on the costs, like what are the costs that I need in my organization, but also on the value add. Let’s take an example about business support functions. Usually, business support functions are a fixed-cost structure in an organization. They are there to support businesses to deliver pay slips, accounting balances, or things like that.

And then the start-up organizations ask a question like, “Is that how we would develop this finance or HR organization that was starting from scratch?” And some of them come to the idea that, no, actually we want them to be an integral part of the business. We want them to engage in a corporate strategy and be part of it, such as in supporting the organization from the talent side and making sure we are the best talent organization in the world. Look at all the various start-ups in the automotive space: they essentially reinvented the way of doing things. Certain parts of this can be attributed to those support organizations that have really delivered something that would not have been expected from them in a traditional company.

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Daphne Luchtenberg: That’s a really nice example. And as we explore the idea of operational excellence more, we’re seeing increasing examples of the SG&A functions becoming an integral part of business and a new source of competitive advantage. Carey, do you have an example you can add here?

Carey Mignerey: Let me offer an example from the retail industry. A global retailer I worked with effectively zero-based their organization. They didn’t call it that, importantly, but what they did was effectively that. They first started with exploring the work that needed to be done in the enabling functions—in legal, HR, finance, communications, etcetera—and decided where to stop, start, or change that work. An important point there is where to stop work, because the demand lever is actually a very critical part of the tool kit that zero-basing enables.

After that, they basically said, “OK, in one business unit, what does the ideal organization look like for enabling functions?” And then they worked through the mechanics of how the processes would work in the future, etcetera, with that ideal cleansheet or zero-based organization. And once they had that right for one market unit, or one business unit, they were able then to deploy that to the other business units. That’s an example of how zero-basing works and an example of a company that was very effective in doing it.

The result, by the way, was a much more effective organization because they’d eliminated duplication of work, they’d eliminated unnecessary work, and they’d been able to deploy resources against new work they knew they needed going forward. For instance, in the finance function, they needed more support with analysis for their new digital functions. This is an example where zero-basing in the organization not only drove efficiencies, which was true, but more importantly, drove effectiveness.

Daphne Luchtenberg: Yes, exactly. So it’s a really good example of aligning your resources where they can actually add value. Denis, it would be great if you had another story of where you’ve seen this approach or this philosophy we’re talking about working well.

Denis Fomin: One example where a company has applied some zero-based principles to actually enable their strategy is a software developer. It’s a company that had a really successful business—a really successful piece of software; however, the segment of the software was actually on the decline, so they probably still had five or six years left in this. They had some initial promising start-up-like products, which were actually getting traction. However, the board of the company was looking at how to actually resource this in the organization—and how to make sure it gets up and running and actually compensates for, at some point, lost revenues from the incumbent business.

What they did was something very dynamic. They sat together in a board workshop, and they went through the legacy organization five years before it would have, let’s say, had to ramp down. And they thought about, “What is the ‘keep the lights on’ strategy for this business? What is it that we actually need zero-based?” And once they had this question answered, and once they had identified all the resources, they had the discussion on how to use these resources that have become available to make the new business a success.

Daphne Luchtenberg: That’s a clear example of established companies using the approach to reinvent themselves. We’ve touched a bit on the idea of start-ups and disruptor companies doing this, and I’d like to explore that a bit more, particularly the idea about having budget lines with zeros and getting to build up from that point. Steve, with your experience of launching a new business and new business lines, where have you seen this work well?

Steve Frazier: My experience was helping to build businesses over a couple of decades, starting with an experience where the original cost base was intentionally very low, and there was a corporate value around frugality. So as you’d launch new businesses, you were always trying to match that or, frankly, do better. One key principle was benchmarking—looking at the way things had been done before and then trying to launch a new business with the same or hopefully fewer resources as you go. So one step was always looking inside and using that as a model to lower costs.

Another thing was always being self-critical that what you launched in the early days as a start-up might have been a bit of a hack. And as you scale, you may not be leveraging automation and technology to their full potential. So you can revisit and automate what you did earlier, now having the ability to invest in automation and bring those costs down even more. That automation on top of ongoing frugality, I think, allows you to reduce costs even more.

And finally, there’s this notion that as you launch multiple businesses, you’re going to find new efficiencies and ways to centralize and ways to build efficiencies across businesses that didn’t exist when you were just a single line of business. There’s a lot going on all at the same time. Start with low costs, automate to make costs lower, and then consolidate and build efficiencies as you start to scale.

Denis Fomin: Let me give another—let’s say, very practical—example of where zero-basing works without it being a formalized process within the company, but rather implemented as a philosophy. If we take an automotive player in one of those electric-vehicle disruptor spaces, what they have is a very strong procurement organization, as you would have because you need to work with lots of new suppliers, you need to find new resources, you need to get things for your cars there, especially if you’re launching a car. And once they launched the vehicle, for example, and the workload on the procurement organization was smaller, then they redeployed part of the procurement resources to support the next capital project, which was actually a ramp-up of a big factory.

In doing so, for a traditional player, that would have been completely impossible, because these are two completely different organizations—buying the vehicle parts and negotiating with construction companies. But just by applying this mindset, it was, “Hey, we got this procurement resource, they are good procurement people that are capable, they have the capacity and capabilities, so let’s put them where it actually matters.” And by doing this, you really generate value for the company. And ultimately, what people also do is they ask, “What is it that you want to do? Do you want to keep doing the same thing all over again? Or do you want to do what matters?”

And you can find what matters yourself or you can talk to people and find out where you can make a change and then you go there. So not only does it help the company strategically, but it’s also something that people—once they’ve understood and bought into the zero-basing philosophy—start to appreciate quite a lot.

Daphne Luchtenberg: I love that. And that feels like it aligns very closely with conversations about how a shared strategy and a shared purpose really helps to drive an organization forward. I think that’s a really good, positive message about what can be achieved. As we move toward the end of the session, I’d like to wrap up the conversation today by talking about how you can get started. For those organizations that haven’t taken this approach before, that haven’t yet bought into this philosophy, what can they practically do today or in the next quarter that can help make a difference? Steve, I’d like to come to you first if I could.

Steve Frazier: From the perspective of large global companies that are well past the start-up phase, one of the things I saw work well was pretty intensive benchmarking of comparisons of different businesses in different parts of the world—trying to align them, to recognize that as you built them, you might not have done them all the same way. So you attempt to standardize and benchmark and really understand what you need in each business, in each part of the world, and where to find efficiencies. As part of that benchmarking, you’re measuring function by function, how different things get done in different places.

With that, I think there’s a strong awareness that the corporate center and the corporate headquarters in the home country may not have all the answers. You may have done things well and have new businesses or new countries that can actually do things better and more efficiently, and you may have expertise at something that doesn’t always exist at the corporate headquarters. An example I always like to think about, from my own experience, is dealing with complicated things like tax issues in new countries, and dealing with the need to be responsive to different tax requirements.

In one of my experiences, we discovered that the tax regime in Brazil can be very complex and hard to deal with. Our team in Brazil got good at that and ended up becoming a global center of competence for some of the more complicated tax issues that were started in other countries. We recognized that in corporate headquarters, we didn’t have all the answers. And as new legislations and new regulations were passed in other countries, we said, “Let’s go fund additional resources to do it in Brazil, because they could do it better and faster than retraining people in the corporate headquarters to do it.”

Daphne Luchtenberg: I love that. Denis, is there anything you’d add there?

Denis Fomin: Let me actually refer to a piece of research that we did recently. We tried to compare start-up-like companies that have this zero-based organization and zero-based mentality with more traditional companies from similar sectors, and we observed their SG&A cost performance over the past ten years. What we found out is that in the past five years, obviously, we had a significant growth in the market overall and both categories of companies grew in revenue.

But what actually happened in cost for the, let’s call them incumbent companies, is the percentage of SG&A costs actually hasn’t changed at all. And for the start-up companies, it actually went down by 2 percent over the revenue. What this shows is, even in a growth cycle, there are some companies that are thinking about being more agile using all the examples we were talking about today for how they achieve this; whereas some other companies just don’t have this focus or lose this focus and only think about costs when there is a downturn, when the top line is not going up.

If I would take one thing away from the start-up and disruptor companies is that continuity matters. Continuity in keeping focus on your strategic priorities, keeping focus on your costs, making sure you are consistent in your strategy, and not just reacting to when the market goes up or when the market goes down.

Daphne Luchtenberg: Carey, can I give you the last word here? What would be the advice you’d give to your clients about where to start?

Carey Mignerey: On this topic, I would advise my clients to really think about one very clear, no-regrets move, which is focused on the facts. How do we really dig into the visibility of what our current state looks like today? Where I have a legacy company, a large organization that’s already deployed, where are they spending their time? What is the work they’re doing at each level? And just start with the facts. What we’ve found is that just that visibility, just getting started on the journey and understanding where we’re investing time, resources, and effort today, as an organization, often leads to quick learnings around where we need to make changes and shifts.

I think the gist of all this thinking around zero-basing and zero-based organizations is around thinking beyond the status quo. That’s where learning from start-ups and disruptors can be very effective. Because by definition, a disruptor is challenging the status quo. They’ve zero-based their organization because they built it from zero.

So my advice to clients is to start with the facts, understand what the business is, be willing to challenge the status quo, and evolve your organization over time by constantly instilling this mindset and this philosophy of zero-basing so that when there’s an economic downturn or a change in business conditions, you don’t have to have a wholesale reset of your organization. Rather, you’ve adeptly and agilely deployed your resources already, because you’ve constantly zero-based how you deploy your team.

Daphne Luchtenberg: That sounds like a perfect place to end this conversation—with the emphasis on getting the clear fact base. Our focus today has been very much about dispelling some of the myths around zero-basing, and instead get a better understanding of the opportunities there are to reset and reimagine SG&A functions. Thank you, Carey.

Carey Mignerey: This is an exciting topic and I appreciate the opportunity.

Daphne Luchtenberg: Denis, thank you for your time.

Denis Fomin: Thank you so much.

Daphne Luchtenberg: And Steve, thank you so much for being part of this conversation today.

Steve Frazier: Thank you.

Daphne Luchtenberg: You’ve been listening to McKinsey Talks Operations with me, Daphne Luchtenberg. If you liked what you heard, make sure to subscribe and stay tuned. Another great episode starts now.

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