It’s no secret that half of a company’s costs lie in the supply chain or costs of goods sold (COGS). As a result, supply chain leaders are under constant pressure to reduce costs—but most are coming up short.
Take one personal care company, for example—even though the company was driving 4-5% improvement in COGS for existing products, costs for e-commerce and new products were on the rise, and other new product costs were popping up across the operations. As a result, the actual decrease to the bottom line was only 1%.
Another global food company had a continuous improvement program that was lauded for reducing logistics costs by 4% year over year. But the program barely kept overall logistics-to-revenue ratios flat over the same period, and leadership soon demanded more bottom-line impact.
Single Digit Category Savings Here, Ballooning Costs Over There
We could name similar examples across all industries—in fact, this scenario plays out more often than not. Even if supply chain leaders can deliver single-digit category savings in one area, costs end up ballooning in another area. That means no noticeable or sustainable change to the bottom line. And companies end up with a sense of “savings fatigue” across the supply chain organization.
Moreover, all of this is happening at a time when supply chain executives are under pressure to reinvent the supply chain by driving new efficiencies and meeting increasing consumer demands for speed and new products. But those new products and efficiencies also require funding. It’s a vicious cycle that must be broken—but how? Turns out, a new take on a decades-old budgeting technique is the answer.
The Solution Is Rooted in an Old Budgeting Technique
Zero-based budgeting is a profitability concept invented back in the 1960s that is centered around resetting budgets every year to zero, as opposed to basing them on the year prior. Generally thought of as a complex, arduous top-down process best suited for large consumer goods and industrial companies, supply chain executives have not historically considered zero-based budgeting. But a renewed approach to this technique called a zero-based mindset has emerged and is being widely adopted across functions within leading organizations—from the front office to organizational design to the supply chain.
What is a zero-based mindset? In a nutshell, it’s about building from the bottom up. A zero-based mindset is more than hunting down old costs in new ways. It requires a major shift in thinking about spending and cross-organizational commitment, and it’s enabled by digital technologies. Budgets are built by every entity owner, but they also have a horizontal owner, i.e., someone that has a view of the performance of every cost package across all the entities. This structure creates a healthy tension across the organization that ensures tracking and execution—and a culture where everyone is accountable.
The adaptive nature of a zero-based supply chain means it does not rely solely on past costs or performance—it continues to set and stretch performance targets, identifying “should costs” for costs of goods sold based on how the organization will look and operate in the future. And the savings uncovered are redirected into growth initiatives that drive efficiencies and new products and services. Essentially, the organization shifts from having a focus on savings to one that’s centered on impact to the profit and loss statement (P&L). And in doing so, it remains constantly focused on uncovering inefficiencies in costs that can be captured and redirected for new growth and bottom-line impact.
Backed by Digital Technology
At the backbone of a zero-based supply chain are digital technologies that help companies move beyond best practices to “next” practices—driving new capabilities and mindsets that account for the future over the past.
For example, artificial intelligence (AI) is helping one industrial company better assess variances in operating conditions with “digital twins,” or virtual models of processes, products or services. The digital representations are enabling automatic “tuning” of operating conditions to improve efficiency and reduce errors. As a result, the company improved quality by more than 20% from what was considered best performance only a few years ago. Other digital initiatives like the digital factory, intelligent automation, 3-D printing, advanced analytics and mobility solutions are improving operating expenses. What a zero-based mindset does is put a true value on these shiny objects—and ensures no false promises are being made on the implementation of digital technologies.
Another global products company adopted a zero-based mindset to break down barriers across business units and regions, creating increased visibility into costs and operational performance across its transport and warehouse operations. By applying advanced analytics and digital technology across the supply chain—including automation for picking and packing and warehousing, and predictive analytics for optimizing movement and modes of raw materials and finished product—the company was able to reset targets. And ultimately, it identified a more than 20% cost reduction opportunity across the network, capturing as much as 12% in the first year. That’s a significant difference from the companies that are just focused on traditional cost reduction initiatives. How can other companies find this same success?
Four Steps to Adopting a Zero-Based Mindset Across the Supply Chain
1. Leverage financial and operational data to achieve complete visibility into costs at a granular level and understand the current state of spend against internal and external practices. This is key to defining “should costs” and prioritizing focus to unleash value. For example, instead of just looking at high-level maintenance costs across the organization, companies can create visibility down to the sub-components of maintenance financially and operationally, compare across internal and external networks, and understand how digital tools could further change the cost curve. One company has done that by identifying key lines for improvement and applying predictive maintenance technologies, which has yielded more than 40% cost reduction on a per unit basis.
2. Develop organizational incentives that encourage collaboration across geographies and functions to identify best practices and emerging trends. But incentives must be tied to the bottom line to be effective. One company, for instance, built incentives for reducing COGS at the plant level that had an unintentional adverse impact because aged inventory costs were not included in this metric until they were completely written off. As a result, plant managers kept building aged inventory and running their assets harder to reduce per unit costs, which created more complexity and warehouse costs for the logistics organization. Aligning incentives to overall EBITDA and cascading these incentives down the organization removed these issues.
3. Embrace digital technology and analytics opportunities to set zero quartile goals and future-proof the supply chain. We have seen AI capabilities improve forecasting by 10-30%, reducing manufacturing, inventory and supply chain losses across the network. Additionally, new mobile tools are improving routing of workers in warehouses and on the shop floor, increasing productivity by 10-20% by reducing wasted movements and trips.
4. Drive support from the top all the way through the organization. Establish the right communications, incentives, tools and role modeling to make efforts part of the future fabric of the company—a closed loop rather than a one-time event. Identify cost segment owners that push and stretch the organization, challenge historical beliefs around costs, and enable the organization to set and exceed tough budget and performance goals.
With advances in digital technologies and analytics, adopting a zero-based mindset is not about slashing costs in whatever way possible. It’s about finding the resources that are not being used efficiently and reallocating them to improve capabilities, fund growth initiatives and increase competitive agility in a rapidly changing and complex environment.