'Zero-based costing':

a new approach to cost

Nowadays, cost rationalization is a priority for any company.
But the traditional top-down approach seems to be
insufficient and often not effective

Managing a company in a active involvement of mid- rigid labor market like the Ital-
time of economic growth can dle management. In fact, top ian one, it is neither easy to
be easy. However, mistakes management and operative implement nor ensures lasting
made during periods of crisis resources must both correctly results.
may be fatal. During such pe- analyze potential opportuni- Besides, companies applying
riods executives often have to ties and define together the this strategy expose them-
make unprecedented drastic consequent course of action. selves to many risks. First of
decisions. Their decision-mak- This approach is successful in all, they lose a key asset that
ing skills can be pivotal in the practice. Thanks to the promi- could give them a competitive
company’s ability to underpin nence given to operative re- advantage once the economy
market competition in both the sources involvement, the time stabilizes. Moreover, wide-
short and long term. needed to achieve cost-re- spread layoffs expose the
duction goals is considerably company to high negotiation
What is the best reduced. Operative resources costs (i.e, with unions, etc.),
approach for cost are strongly disposed and mo- detracting from cost optimi-
optimization? tivated to achieve shared and zation. Finally, it causes a
During the current unstable realistic objectives, as occurs climate of resistance and mis-
economic environment many when a bottom-up approach trust between top executives
of the decisions companies applies. Consequently, this and operative resources.
must make concern cost approach has high success Given these considerations, is
optimization. rates, with tangible and long- relying on traditional top-down
Strict top-down processes lasting results. Even execution approaches the best strategy
seem to be the easiest times are faster compared for dealing with the current
solution to the problem: Top to traditional top-down ap- economic crisis? Further-
executives impose their deci- proaches. more, is undifferentiated
sions on operative resources A drastic personnel reduction cost-cutting, such as drastic
in an undifferentiated and is an example of a top-down layoffs, helpful in the short
mechanical way, giving them approach that is frequently and long term?
top-down targets. adopted. During times of eco-
A bottom-up approach, often nomic crisis this strategy has Zero-based costing
disregarded despite having a strong impact on the media approach
recognized effectiveness, is and it is well-appreciated by We believe that an alter-
an alternative way to address financial analysts. But taking native to the top-down

'Zero-bas
the problem. The bottom-up into account its execution approach does exist:
approach depends on the complexity, especially in a zero-based co­sting. This

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 The zero-based

optimization
approach
emphasizes cost
optimization
through an
analytical, creative,
and shared
approach
By Paolo Cervini and Marco Occhetta

method enables the weak- In addition, the zero-based

nesses of the traditional approach provides a “breaking
approach to be overcome by point” toward the reengineering
implementing bottom-up logic approach, the goal of which is Top management
that builds concrete, immedi- to simplify interdepartmental and operative
ate, and lasting results. and horizontal (across the
The zero-based costing company) processes. The
resources must
method evolved from the zero-based approach aims both correctly
zero-based budgeting to minimize inefficiencies analyze potential
theory and is practical and throughout every cost center. opportunities and
useful. Its ultimate goal is to It detects vertical inefficien-
implement cost-saving op- cies (inside a cost center) that
define together the
portunities that already exist would be neglected by a pro- consequent course
within the company. cess-reengineering approach. of action
Top-down Bottom-up
approach approach

Undif f erentiated and “one- Specif ic and analytic

way” approach. approach.

Executives set the

Targets given by
direction and def ine the A drastic personnel -
executives.
mission. reduction approach
Employers involvement in
causes a climate
Employers f ollow
instructions (push).
identif ying and delivering of resistance and
optimizations (share).
mistrust between
top executives and
Typically, long execution
time.
Typically, short execution
time. operative resources
Typically, short-term Strong impact on
company’s status quo in
impact on company’s

sed costing':
the long-term. Tangible
status quo.
and lasting results.

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 Goal cost structure and a grasp of
the “optimal” level regarding
attainable benefits (cost-ben-
Activity X Activity Y Activity Z efit analysis). Consequently,
internal resources are encour-
aged to identify alternative
Options on “how” to Options /
carry out the activity alternatives list ways to carry out different
with same or
Options on
“intensity”
different output activities, strengthening the
levels
foundations for a radical and
lasting change of the com-
Cost / Benefits Analysis pany’s “status quo.” Internal
resources will be motivated to
Best option / alternative execution
undertake a creative process
(organization, processes, technology, people, that is consistent with the
procurement, investments)
company’s goals.
Furthermore, the analytical
approach reduces the likeli-
In particular, cost reduction is teristics: a detailed analysis hood of selecting optimiza-
achieved by forcing managers of available alternatives and a tion actions that don’t fit the
to seek alternative ways of strong “action orientation.” company’s characteristics.
carrying out their responsibil-
ites. The zero-based approach Why should a zero- The bottom-up method of
requires the organization’s based approach be operative resources has many
involvement at all levels: Top adopted? advantages over the tradition-
executives are committed to The zero-based approach is al top-down approach. Indeed,
coordination and sponsor- based on a detailed analysis thanks to their deep knowl-
ship activities, and mid-level of various options for the edge about the company and
managers focus on operative cost structure. First of all, its cost structure, operative
tasks. a detailed analysis gives a resources are encouraged to
The innovative side of this ap- better understanding of real suggest tangible and easily
proach has two main charac- needs regarding the actual implemented ideas. “Forced”

Zero-based framework

Analysis and review of activities Execution and

Planning
and costs monitoring

‰ “Decision Unit” ‰ “Decision packages” identification ‰ Action plan effective

identification (i.e.: (activities / projects) execution monitoring
Cost Centers) ‰ Analysis of costs and potential alternatives ‰ Monitoring of sustained
‰ Approach presentation for each “decision package” costs towards expected
and organization ‰ Analysis of potential savings and related ones
involvement trade-off
‰ Presentation of results and submission of
the related optimization proposal / budget
adjustment

'Zero-bas
‰ Assessments and formalization of
optimizations / budget adjustments

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 to propose and carry out spe- Ultimately, the zero-based
cific optimization actions, inter- approach can be considered Thanks to their deep
nal resources develop a strong innovative from a consult-
sense of commitment toward ing point of view. Indeed, it is
knowledge about
the achievement of expected quite different from traditional the company and
goals. This active involvement approaches since it requires, its cost structure,
enables significant goals to be from the beginning of the operative resources
attained. Optimizations consist
of many small opportunities
project, hands-on and active
involvement of consultants
are encouraged
that only internal resources who, while interacting with to suggest
are able to discover. internal resources, are directly tangible and easily
Our zero-based approach involved in detecting optimiza- implemented ideas
could be defined as a “cata- tion opportunities and achiev-
lyzer” of easily achieved op- ing the company’s goals.
portunities.
To assume that the zero- The zero-based
based approach is only appro- approach in practice
priate for specific opportunities The zero-based approach,
would minimize its effective- due to its characteristics, is
ness. As a result of internal re- relevant for many kinds of
sources’ organic involvement, industrial businesses. It has
the zero-based approach also proved to be extremely effec-
enables the detection of tive where fixed costs play
otherwise neglected inter- a major role. Tefen Italy has
departmental optimization used this approach several
opportunities. Furthermore, times to develop strong skills,
by avoiding undifferentiated mainly in the oil and energy
cost-cutting imposed by top industry (large refineries and
executives, two benefits are
obtained: (1) the creation of
thermoelectric power station).
Working on one of our recent
The zero-based
efficient cost centers, and (2) projects, this approach approach, due to
the distancing of managers enabled us to identify more its characteristics, is
from operative resources. The than 30 specific opportunities relevant for many
zero-based approach, due in more than 20 cost cen- kinds of industrial
to the organic involvement of ters. The overall benefit was
operative resources, enables quantified to be greater than
businesses. It
the workload required of every 5 percent of the considered has proved to be
single resource to be con- baseline. extremely effective
trolled. Indeed, as experienced In such kinds of projects, where fixed costs
during projects developed by investments in consulting fees
Tefen with large energy com- are quickly paid back thanks
play a major role
panies, the internal resource to large and easily delivered
involvement has been adapted results.
(resulting in focused interviews
Paolo Cervini,
and workshops) according to Partner, Tefen Italy
availability. Consequently, the

sed costing':
impact on day-to-day activities Marco Occhetta,
is minimized. Project Manager, Tefen Italy

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