Rethinking Cost Optimization in 2025 | ISG

2025 brings with it a witching hour of multiple macro-economic trends impacting every aspect of business. The rules of business in 2025 will be different.  Literally.  The combined effects of geopolitical and technological transformation and disruption are changing our supply chains, compliance requirements, risk calculations and ways of working. In other words, the fundamental cost basis of business is shifting, and this shift cannot be ignored.

It also can’t be addressed using outdated models, assumptions and techniques.

To thrive in the new year, organizations need to radically rethink their approach to cost optimization. This is not about hunkering down and retrenching. It is about adopting new cost optimization capabilities that didn’t previously exist and integrating them into the business transformation and growth agenda.

Geopolitical and Technological Change

Of all the macroeconomic trends, AI will undoubtedly have the most significant impact.  Done right, it will enable businesses to collect, analyze and apply data to tasks not previously possible – and to expedite many current administrative tasks. Companies that do not master AI will rapidly fall behind and become non-competitive in both cost and capability. The flip side of the AI revolution is the enormity of the risks it poses – most of which are still only partially understood – and managing the costs.

In addition to the opportunities presented by AI, regulatory changes present a large area of potential savings.  In the U.S., the National Association of Manufacturers estimated the per-employee cost of regulatory compliance in 2023 to be $12,800 and a total cost to the economy of $3.1 trillion. For a company of 50,000 employees, the current regulatory cost is about $64.4 million a year.

But the newly formed Department of Government Efficiency (DOGE) is proposing a dramatic reduction in regulations and bureaucracy. If the DOGE strategy is even partially successful, companies will have the opportunity for enormous cost reductions. Achieving them will mean tackling long-rooted incumbencies, bureaucracies and simplifying and eliminating many no-longer-necessary processes.

Meanwhile, the world is getting increasingly dynamic. The Russia/Ukraine war, conflict in the Middle East, state-sponsored hacking, industrial espionage and cyber-crimes, piracy and changing tariffs are among the many factors that will cause enterprises to rethink their supply chain and operational strategies. The risks of globalization are increasing, and, in some circumstances, the benefits of low-cost labor from a global workforce may decrease in importance, as more work can be done with AI. Undoubtedly, many companies will evaluate low-cost AI-enabled home-shore strategies as part of their portfolio. Cost-effective approaches to decentralization and redundancy for risk mitigation will also be important considerations. Optimizing costs in this highly dynamic environment will require much higher levels of sophistication than in the past.

The Need for Greater Enterprise Intelligence

Traditional cost management strategies were designed for a more stable and static environment than businesses face today. Cost optimization now requires a more intelligent and fluid organization than in the past, one with the capabilities to quickly understand and respond to rapidly changing variables and interdependencies. Solutions will make better use of internal and external data, improved decision models, higher levels of collaboration and frequent updates of market insights.

4 Challenges to Your Cost Optimization Program

Most organizations were designed to run in more stable environments than we now face. This presents a number of challenges:

1. Organizational inertia and complacency. Most companies have used tried-and-true belt-tightening techniques to address cost challenges. What is different now is that the key lever is no longer identifying waste or reducing the cost of the same things year over year but rather constantly rethinking the fundamentals. This is analogous to zero-based budgeting – but on steroids – and using tech. This change in thinking can be hard for employees and leaders because it challenges their security and stability and devalues many traditional skills. 

    

2. Uncoordinated and opaque systems of record and decision models. Typically, individual departments track the metrics and indicators that are most important to their roles. This can isolate a single element of cost. An obvious example is when contact centers keep their costs down in ways that inconvenience the internal and external customers they are supporting.  A less obvious example is procurement selection models that look only at the individual component being purchased and not the impact that selection will have on the total cost of a solution. The selection of a specific software configuration may focus on the price discount without taking into consideration how that decision will limit implementation, decommissioning, hosting and support options or create lock-in or require additional cost investments to manage data migration, training, process change, demand, compliance and performance. Traditional procurement “hard savings” models place higher value on reducing the price for like purchases rather than on collaborating with the business to identify a more modern solution that reduces the total cost of an operation. But many organizations do not have the time, talent or access to data siloes to fully understand and estimate the impact of interdependencies. Furthermore, individual performance measures and incentives are typically designed to isolate individual contributions, diminishing incentives to solve problems at a bigger-picture level. Organizations often have a much higher TCO for a given function than they might if they had better coordination across different sources of information and expertise.

    

3. Technical debt and write-downs. Technical debt – the cost of deferred technology modernization – often keeps organizations from migrating to lower-cost models. Business cases are typically built around multi-year scenarios, while the pace of innovation can render the solutions obsolete before they are fully depreciated. The result is that older assets often become less compatible with more advanced technology, resulting in costly workarounds, higher support costs or an inability to meet the needs of the business. The implications of a near-term write-off can be politically and reputationally untenable, calling into question the soundness of previous choices and forcing companies into a higher-cost model.

    

4. Having the right talent. AI and multi-disciplinary business skills needed to optimize costs are in short supply. There will be a time lag before these skills become mainstream and legacy employees can acquire and embed these skills into their ways of working. As a result, companies will pay a premium for the skills they need – but investments in talent need to be justified against the potential cost benefits. Given the speed of AI, a lack of hard historical data to justify these investments will be a challenge.

Setting a Winning Agenda for Cost Transformation

Traditional strategies for vendor renegotiations, headcount optimization and traditional outsourcing will always have their place, but they represent only the tip of the iceberg from a cost opportunity.  It’s critical that organizations adapt common metrics for cost savings and shift their focus to holistic cost optimization rather than departmental definitions.

Consider the SpaceX approach, which has radically reshaped the cost of space transport: 

• Make requirements less dumb: this involves questioning the necessity and efficiency of each requirement in a process.
• Delete the part or process step: If it’s not essential, remove it to streamline the process.
• Optimize: After removing unnecessary steps, refine what’s left to be as efficient as possible.
• Accelerate: Speed up the process where feasible without sacrificing quality.
• Automate: Use technology to handle repetitive or routine tasks to reduce human error and increase efficiency.

The Power of Partners in Saving Costs

Transformation is extremely difficult to accomplish on your own. Companies often achieve the fastest results through transformational and outcome-based sourcing, which aligns commercial incentives with advanced capabilities in process optimization, technical enablement, AI and automation.

The right partner ecosystem, constructed with well-balanced commercials, accountabilities and governance will help you achieve your cost and transformation goals faster and more effectively than undertaking the journey on your own.

ISG helps organizations create effective cost optimization strategies that are designed for today’s complex economic, regulatory and technological reality. Contact us to find out how we can help you.