Zero-Up: Rebuilding the Budget From Zero | EP7

Bill Canady: You're in a conference room with your CFO and eleven functional leaders, and on the screen is your next year's budget. And somebody, and it's never a bad person, it's usually your most conscientious VP, says the sentence. We took last year and we added five percent. Everybody nods. Hey, that's what we do. Meeting moves on. It's the least controversial moment in the entire quarter. Who doesn't like five percent growth a year? Low price, low market, it's gonna be fine. Well, I want you to think about what actually just happened in that room, because it's worth understanding precisely. Yeah, last year's cost structure was not designed. It was accumulated. It's the sum of every hiring decision made under pressure. Every headcount that got backfilled because it had always been there. Every function that grew because a customer complained loudly enough in 2019. Every process built to handle an exception that nobody has seen since. It is a sedimentary record of a decade of pressure and accommodation. And you just multiplied it by 1.05% and called it a plan. Hmm. Doesn't feel that good now, does it? Well, here's a line I'd like you to sit with a little bit. Last year plus 5% is how you lock in every bad decision you have ever made, plus all those who came before you. Because incremental budgeting is not a finance technique. It's a memory device, and it remembers your mistakes. Perfectly and your intentions, not at all. Okay, here's the proof. A $310 million industrial business that I ran, 32% of it gross margins, 8% EBITDA. Somewhere around day 60, we ran into the capacity diagnostic. We set every function leader down and asked him one question. What percentage of your team's time goes to the bottom quintile of customers? The lowest answer in the room was 18%. The highest was forty one. The average is twenty-seven. Twenty-seven percent of the functional capacity of a three hundred and ten million dollar company consumed by customers producing about five percent of the revenue. Now here's the part that matters for today. We did not run a zero up on day ninety. We ran the simplification work first, the minimum order value. The minimum order quantity at the SKU level, the discount freeze on quad four buck, the 187 accounts we moved to credit card on order over a single weekend. Order count came down to 38%. Gross margin per order went from 19 to 31. Now that's pretty good. We're starting to get somewhere. Then we ran to zero up. The plan was complete on day two hundred seventy and what it redeployed was at twenty seven percent, which by then was actually free instead of theoretically free. Big difference. Here's my promise. By the end of the next half hour, you will be able to hand your CFO a zero up build with a defined sequence and a date on it. You'll know the one question that runs the whole exercise, and you'll be able to tell the difference between capacity you have and capacity you only think you have. And here's the plan. Three moves. But before we move, I have to give you the mechanics and the sequence because zero up running the wrong order is worse than not running at all. So let's do it right. this is the thousand day CEO. I'm Bill Canady Let's get into it. Let's be precise about what incremental budgeting actually does to a business because the damage is specific. Every dollar in your cost structure was approved once by somebody for a reason, but it's only approved once, and after that first year it stops being a decision and becomes a baseline. Nobody has ever had to justify it again. The only thing ever has to justify is the change, the delta, what we're going to grow this thing by. So your budget conversation every October is a conversation about three or four percent of your entire cost structure. And 96% of it goes through an unexamined forever. Whew. Okay, think about what that means over a five-year period. The customer who justified that inside a sales team is gone. The product line that needed that engineer got discontinued. The reporting package that two people Took them to produce goes to a distribution list where nobody has opened it since the last CFO. None of that shows up because none of it is a delta. It's a baseline. Baselines are invisible. And here's the compounding part. Baselines get multiplied. 5% on top of a bloated base is a bigger dollar number than 5% on top of a clean one. So the businesses with the worst cost structure grow their cost structures fastest. Man, that's counterintuitive, but that's how it works. Incremental budgeting is regressive. It rewards accumulated mess. So zero up, ask a different question. Not what should we add? One question, and it's the whole exercise. If we rebuild this business today, what would we build it? And would we build it this way again? That's it. That's zero up. Everything else is just mechanics. If we rebuilt the business today, would we build it the same way again? And notice what that question does. That a cost reduction target doesn't do. A cost target asks people to defend their budget. This question asks them to design one. Those are completely different conversations and they produce predict completely different behavior. When you hand somebody a 15% reduction target, you get a negotiation. Why I need this? Why I don't need that. They bring you in three things you never'd cut, hoping you'll flinch. When you ask someone to build their function from zero for the business you actually have now. Most of them will hand you back something smaller than what you would have dared to ask for. I've watched it happen repeatedly and it still surprises me. Zero Up challenges an organization to stop defending historical complexity. That's the cultural work beneath the financial work. Because right now, in your company, at a significant number of very capable people are spending a significant portion of their week defending that decisions. That were made before they even got there. They're not even owned by them. They were made by people who are no longer with the company for customers that don't even exist anymore. Now let me name the cost of getting this wrong because there's a version of this that fails badly. The failure isn't running zero up, the failure is running it too early. And I want to give you the exact mechanism. You cannot reliably reallocate capacity until you first freed it. Run a zero-up exercise on a quad forward-laden organization, and you'll discover that you're redeployed people. Are still doing the old work. Here's what that looks like on the ground. You run the exercise. It says your customer service function should be nine people instead of fourteen. And the five freed up people should go to a new inside sales motion covering your quad two accounts. Well, that's great. You moved them. You announced it. There was a slide. And then the phone rings. It's the same tell of the small accounts, placing the same $400 order, needing the same expedite, asking the same questions because you never change the term. The minimums, the pricing, or the service model that generated those calls. The work did not go away just because you moved the person. So now two things happen. Either the five people quietly drift back to doing their old work, which is typically what happens because they know how to do it. And now you've got a new sales motion on paper that isn't happening. Or they don't service and they collapse that for the tell. You get that they blow up in the board meeting anyway, except that now it's a surprise instead of a decision. I don't like surprises. That's why zero upsets here in this season at day two fifty to day three sixty-five, and not earlier. Episode five was the simplification work, the dirty dozen, minimum order values, the discount freeze, retiring the tail. That app episode had to come first, not because it's more important, but because it's what makes this one true. Free the capacity, then reallocate it. It's that order every time. Alright, the framework we're going to work around. Let me give you the mechanics, and I'm going to give them to you as an actual sequence because zero up fails more often on sequence than on analysis. There's six simple steps. Step number one: split direct labor from indirect labor. That sounds like accounting housekeeping. I know, I know, I've said it myself. It is the foundation of everything that follows, though. Direct labor is the hours that attach to the unit of output. Part made, an ordership, a job installed. Indirect labor is everything else. It's the most middle market companies. These two are tangled together inside of COGS and inside of the departmental budgets in a way that makes it impossible to answer the only question that matters. How much labor does a given segment of my business actually consume? Pretty straightforward. Sometimes hard to tease out if you got it all wrapped together. Until you split them, every segment of P&L. You build is fiction with decimal places. Step two, apply the burden rate. Take your indirect labor and your facility and your equipment costs and turn them into a rate you can apply to direct labor hours. Very straightforward. Or whatever your true driver is. One rate, defensible, documented, fully burdened. You will get an argument here about precision. Somebody will want 12 burden pools. Don't. A single defensible rate that everyone understands beats an elegant model that three people can explain and nobody trusts. You are not doing this for the auditors. You're doing it to make a decision. This number's for you, not to prove to someone else. Step three, back direct labor cost out of COGS Now you see cost of goods sold as a material and true variable cost with labor setting where it belongs, as capacity you deploy rather than a cost that just happens to you. This is the step that changes how the leadership team thinks because the moment labor becomes capacity instead of cost, the question changes from how much does this cost to where is this going? And where is this going is a question a CEO can act on. Here's step forward: isolate quad one current state. Quad one, your fork. Those are your best customers buying your best products. Build as P&L as it exists today. Revenue, material, direct labor, burden. The specific SG&A that actually serves it. Do not build the aspiration. Build the current state. Warts include it. That's right. Include the bad stuff. This is your baseline. It is what it is, and it's the only baseline in this entire episode that you actually carry forward because it's the only one you verify. Step five: build quad one growth. Now and only now, you design. What does quad one growth need? What does it need to grow? What coverage? What service level? What inventory position? What engineering support? Build it from zero. Not from what Quad One has today, from what Quad One needs to grow at the rate your bridge says it has to grow. This is a step everybody wants to skip, and it's the one that creates the value because the output of step five is the demand signal for capacity. It tells you where the freed up people go before you free them up, which means what you do with them. It there's a destination. There's a place for them to go. So much better. Step six, layer in quad two, three, and four. Now the rest of the business gets added on top of a structure that was designed around the profitable core rather than the core being whatever's left over after everyone else took what it wanted. And quad four gets built last. Now this is deliberately because by the time you get there, you're asking a very clarifying question. Given everything I've now allocated to quads one, two, and three, what am I actually willing to spend to serve this? Usually the answer is a great deal less than what we currently do. That's a good thing. Finance owns this, not strategy, not you. Now, this is important. I want to be emphatic about it. That this is because it determines where zero up survives contact with next year. Your CFO owns zero up, not the strategy group, not a consultant, not the CEO's office. Three reasons and they're all practical. One, finance owns a general ledger. Zero up is a recut of your actual accounts. If the person building it doesn't control the source system, the numbers will not tie. And the first time a functional leader finds a variance between the zero up model and the monthly close, the entire exercise loses its authority and never gives it back. Two, finance owns the budgeting cycle. Who else? Zero up has become the budget, not a study that informs the budget. If it lives in a strategy deck, October arrives and somebody adds 5% to last year because that's the process. And the process wins every single time. The only way zero up sticks is if it is the process. Keep that in mind. Three, the CEO's office is the wrong owner because zero up owned by the CEO is a zero up that ends when the CEO's attention moves. And our attention moves all the time. We got a lot going on. And as your attention will move, you've got a bridge to turn, a team to build, and a board. Finance ownership is what makes it permanent instead of an initiative. Give your CFO the exercise and a date. That's the mechanism. That's what they're there for. And they're good at it. Occupied versus available. Now here's a distinction that determines whether any of these convert into dollars. And it's one of the most often I see missed. You run the capacity diagnostic. A functional manager tells you she spends 30% of her week on bottom quartile accounts. And the room hears 30% of that person is available for reallocation. Hmm, that would be a no. You'd like to, but they're already spoken for. She is not 30% available for reallocation. Instead, she is 30% occupied. Occupied means the work still exists and someone, something or whatever is still generates it. Available means the work is gone, retired, priced away, or moved to a channel that handles it, and the hours are genuinely open. Occupied capacity looks exactly like available capacity on a spreadsheet. They are indistinguishable in a model. They are completely different inside the building. So here's how you test which one you have. Take one specific block of work and ask three questions. One, what generates it? Name the mechanism. Small orders under a minimum, a discount structure that invites negotiation. A configuration option that requires an engineer to review. If you cannot name the generator, you have not found the work. You've only found the symptom. Two, has the generator been changed? Not scheduled to be changed, changed, actually changed. Is the minimum order value live? Did the discount freeze take effect? Are those hundred and eighty-seven accounts actually on credit card on order? Or is that on a slide? And let me tell you, they get on a slide a lot. Three. Has the volume of the work actually dropped in a number in the last 60 days? Order count, ticket count, expedite count, a real measurement, not an impression. Three yeses, it's available. Anything less, it's occupied, and you have to reallocate it if you will be able to move that person away from that work and it will follow them. So if they still got it, it's going to follow them no matter what you do, unless you march them out the door. Better to get rid of the work. That test takes about 10 minutes per work block, and it's the single highest return 10 minutes in this entire episode. One more thing before we get to the plan, and it's the thing that I want most to land. The purpose of zero up is not to cut, it's to reallocate, to move people, money, and attention out of the parts of the business that do not produce profit and into the parts that do. A zero up that only produces a cut number. was run by somebody who didn't understand it. And if the output of your exercise is we found $4 million, you got half of it. The output should be $4 million of capacity moved to these three specific places expected to produce this specific growth amount owned by these specific people. The redeployment then is a deliverable. This savings is just the intermediate step. You don't want just savings, you want to grow this baby. And in order to do that, got to have the resources available. I've seen a $400 million distributor redeploy $4 million of SGNA this way and put $12 million of EBADAL on the board in next six months. That's right. Those resources get converted to growth. The $4 million was not the win. It was where it went when we got the win. The plan that we're going to deliver. Here's the three moves. Move one, hand zero up to your CFO with a day. This week, a conversation, not an email. An email is necessary, not sufficient. The scope is a six-step build. Split direct from indirect, set the burden rate, back direct labor out of cogs, isolate quad one current state, and build quad one growth. Then layer in quads two, three, and four. Just do the same thing again. The date is the part people get wrong, so let me be specific. Give it a completion date that lands before your budget cycle starts. If you wait, it will get baked in, with enough room that it can become the budget rather than informative. If your budget process kicks off in October, zero up needs to be finished in August. And if you are running a thousand day clock the way I've laid it out, the zero up plan is complete by day 270, which is exactly what we did in that $310 million business. And it was complete by day 270 only because simplification moves were done by day 210. Write that date down. Say it out loud in a room with other people in it. Move number two run the questions on your three largest indirect costs. You don't have to wait for the full model to start the culture work. Take your three biggest indirect cost pools for most businesses, that same combination of customer service, engineering support, finance, and reporting, IT or planning. Bring each leader in one at a time and ask them a question. Not where you can cut 15%. The question is this. If we rebuilt this function today for the business we actually have now, would we build it the same way? Hmm. Then be quiet. Just sit there. Let them wrestle with that. This is the question that needs about eleven seconds of silence to work. When you get back from good people is a list that reports nobody reads, the approval step that was added after one incident in 2018, the three-week close process that exists because two systems didn't talk, the customer segment that generates 60% of the tickets and four percent of the revenue. Write it all down and do not act on any of it in that meeting. You gathering the map here. But you walk out of three conversations knowing more about your cost structure than the last three budget cycles told you. That's a big deal. Third move audit your own calendar against 70/30 for two weeks. Here's the personal level version of the same discipline, and I'd argue it's the one that most will change your next quarter. The rule is this schedule 70% of a normal executive week. The remaining 30% absorbs the unscheduled work. Hold the line on the 70% and the unscheduled fits. Lose the line and the rhythm breaks with a quarter. So for two weeks, pull down your own calendar and measure what percentage of your working hours were committed in advance. If you're at 95% book, you do not have a busy calendar. You have a calendar with no capacity. And every unplanned thing that arrives is going to displace something that was actually on your plan, which in practice means it deplaces the cadence because the cadence is the only thing on your calendar that doesn't complain when you move it. Same principle as the whole episode: a calendar at 95% booked is fully occupied and 0% available. And an occupied CEO cannot reallocate anything, including himself. Keep that in mind. If you're all jammed up, gotta find time. Gotta find time if you're going to get things done. One more piece of the mechanics because zero up generates dozens of proposed moves. And if you treat them all the same, you will either move too slowly on everything or too fast on the wrong things. Classify everything proposed, right, by reallocation by reversibility. Reversibility means that you can go fast and they do not need to be a consensus. Moving a person between teams, changing reports distribution, reassigning account coverage, consolidating a meeting. If you can put it back in 30 days, it needs near zero cost. The right process is decide it, do it, tell people. Do not build a business case for a decision you can undo easily. The cost of the analysis exceeds the cost of being wrong. Irreversible moves get a decision rule and a name decider. It's bigger because you can't get out of it easily. Eliminating a roll, exiting a facility, discontinuing a product line, changing a customer terms in a way that ends the relationships. You cannot cheaply put those back together. Humpty Dumpty falls off the wall. It's gonna be hard to put it back together again. A decision rule is written before the question and it states the condition. If quad four order volume in this category is below X, after two quarters of the new minimum order value, we discontinue the line. Right at first, so that when The moment arrives, you're executing a decision and instead of re-litigating one in a room where somebody is going to say, but that's still four million dollars of revenue. It's always going to happen. At the name decider is one person, not the committee. A committee gives input, one person signs their name. Two tiers, fast and quiet on the reversible, just do it and see if anyone complains and see what the outcome is. Slow and written and owned on the irreversible. That's it. Fast and quiet on reversible, slow and written on irreversible. Two things worth keeping from this one. One, last year's 5% is how you lock in every bad decision you ever made. Incremental budgeting is not a finance technique. It's a memory device, and it remembers your mistakes perfectly. And your intentions not at all. The replacement is one question. If we rebuilt the business today, would we build it in the same way again? Two, sequence the whole argument. You cannot reliably Reallocate capacity until you have first freed it. Run zero up on quad four laden organization, and your redeployed people will still be doing the old work because the work never left. The org chart did. Simplify first, then reallocate. Day 210, then day 270. Three, 30% of a manager's week spent on bottom quartile accounts is not 30% available. It's 30% occupied. Occupied and available look identical in your model and nothing alike when you actually sit in the chair. And the difference between them is whether you change the thing that generates the work. And the point is not to cut. Say that back to yourself before you walk into the first review. The point is not to cut. A zero up that produces only a savings number was run by someone who didn't understand it. The deliverable is a destination. Capacity move to where the profit lives, owned by a name with a number attached. 27% of a company's functional capacity was sitting at the bottom of a quartile of one of $310 million business. That's not a cost problem. That's an entire growth engine parked, running, and going nowhere. Go find yours. Next week, we're going to cross into phase three. That's day 366. That's the flywheel. That's where we start with the thing that decides whether any of it survives you. It's the rule of three, the visionary, operator, and profit. Three roles every company needs, and one of them is missing in about 90% of the businesses I walk into. I'll tell you which one and why its absence is the single most expensive problem in a middle market company, and how to know within one meeting whether you're the one filling a seat you shouldn't be sitting in. If you want these tools and others, you can always go to the 80/20 Institute. There is you can sign up and take a lot of these classes there. I think you'll find you'll like them. Hope you enjoy them. You can find me on billcanady.com. this is exciting work. It makes a huge difference in your business. I'm Bill Canady Now go do that work.