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Operations Practice

Excellence in
Supply Chain Management


As the global business landscape continues to evolve, so do its challenges. New com-
petitors are entering the market. Product life cycles are getting shorter. Customers
are more demanding, and their expectations now extend beyond cost and service to
include ethical, environmental, and sustainability concerns. This complex and fast-
changing environment puts new demands on supply chains, as companies seek ways
not just to manage the change, but also to use their supply chains as a source of
competitive advantage. Those that succeed are thinking far beyond their organizational
boundaries. They are optimizing their supply chains from end to end, and are finding
new ways to collaborate with both suppliers and customers.

No longer can companies afford to focus only on their established markets. The
consuming class in emerging markets is expected to grow from 2.4 billion people
to 4.2 billion between 2010 and 2025, resulting in a 150 percent increase in consumption
to $18 trillion. Building efficient and effective supply chains to compete in these
markets will be critical for any player looking to win the global game. Global supply
chains are inherently risky, however, and managing risk and volatility in the supply
chain has become an everyday necessity. Our analysis suggests that dramatically
improved agility will be the next key driver for logistics and network design.

McKinsey & Companys mission is to be a thought partner to senior leaders around

the globe and to help them solve their most difficult and important challenges. By
continually bringing the latest research to our clients and maintaining a top manage-
ment perspective, we have become the leading advisor on supply-chain-related topics
to companies around the globe. Our fundamental belief is that supply chain strategy
must support an organizations overarching corporate strategy, and that improve-
ments in the end-to-end supply chain can help generate value and bottom-line impact.

We hope that the articles we have selected for this compendium will provide food
for thought as you seek to evolve your own supply chain to enhance competitive
advantage and accelerate your journey to global excellence. We welcome the
opportunity to discuss these and other relevant topics as you move forward.

Best regards,

Christoph Glatzel Alex Niemeyer

Principal Director


Supply chain as a source of competitive advantage 6

Supply chain management on the CEO agenda 7

Is your top team undermining your supply chain? 10

Building the supply chain of the future 15

Excellence in planning: From silos to collaboration 22

Bridging the procurement-supply chain divide 23

CPG-retail collaboration: The next generation 31

Capturing value from supply chain management IT 40

When a plan comes together 44

The next horizon for logistics and networks 50

Agility: A response to the volatile world 51

Next-shoring: A CEOs guide 61

An untapped gold mine in the supply chain: Logistics excellence 69

Five lessons for supply chains from the financial crisis 76

Pushing the supply chain further and faster 86

Building a winning supply chain in Latin America 87

Advantage Africa: Five ideas to win in Africa 95

Getting started 106

How well is your supply chain really working? 107


Supply chain as a source

of competitive advantage

Supply chain
management on the
CEO agenda
Christoph Glatzel and Johannes Rhren

In this battle for customers, our supply that has risen most in their attention over
chain and distribution network gives us the last years. Supply chain excellence is
a key advantage. getting harder, however. Production and
Meg Whitman, CEO of HP distribution networks are increasingly com-
plex and global, and their effective opera-
In recent decades, companies in sectors tion is vital for profitability and resilience.
from automotive and high tech to retail and At the same time, risks across the supply
consumer packaged goods (CPG) have chain have increased, and improved trans-
come to realize that their supply chain parency is critical to the coordination of
is much more than the cost of getting effective responses. Making those supply
products into customers hands. These chains work at their best requires tight
companies understand that it is the supply cross-functional coordination and the right
chain that translates corporate strategy decisions and trade-offs across the orga-
into day-to-day interactions both within and nization. More importantly, however, the
beyond the organization. Ultimately, it is the right supply chain capabilities are playing a
supply chain that satisfies or disappoints critical role in allowing companies to exploit
their customers. These companies also emerging opportunities to boost growth
use a broader definition of the supply chain, and improve profitability.
including planning, information sharing, and
value-adding activities, from raw material Three examples illustrate the difference
to final distribution, rather than just logistics. supply chain excellence can make:

Leading companies have made strategic One leading CPG company uses its supply
investments in their supply chain capabili- chain to manage input price volatility.
ties and set up efficient and effective orga- It has created multiple recipes and supply
nizations that overcome cross-functional chains for a core brand of cleaning pro-
silos. By outperforming the overall level of ducts. Depending on the current prices
maturity in their sectors, they have been of ingredients, it switches between these
able to disrupt them, as Amazon has done recipes and supply chains, allowing it to
in retail, for example. These companies hedge against increasingly volatile raw
have redefined their customers expecta- material prices.
tions of service and their ability to bring
innovation to the market, turning their A major cosmetics company has created
excellence in supply chain execution into a a dedicated high-speed supply chain for
powerful source of competitive advantage. new products. This supply chain, incentiv-
ized only on time to market and product
Critically, the very best companies con- launch excellence, allows it to get the latest
tinue to evolve and reinvent their supply trends into the hands of consumers before
chains, even if they have already achieved its competitors, while its conventional
a leading position in their industry. By supply chain segment controls costs for
doing so, they are able to manage risks, products with steadier demand.
respond to changes in the economic, tech-
nological, and competitive environment Or take the fast-growing online retail
and exploit new opportunities more effec- market that is transforming consumer
tively than their competitors. expectations of delivery time and product
availability. In China, the online retail mar-
ket for consumer electronics provides an
Supply chain as CEO priority example. Companies such as Suning and
Gome, the two leading players, deliver to
In a recent survey, leading global CEOs consumers in the larger cities within two
indicated that the supply chain is the topic or three hours. Such speed has become

a competitive necessity, since consumers 2. Create a modern, end-to-end

increasingly order the same item at several supply chain organization
retailers, take the one that is delivered first,
and reject the later arrivals. The times of managing the supply chain in
separated tiers is over. Sophisticated data
analysis enables companies to manage
Three powerful interventions supply chains end to end and, in industries
like retail, almost in real time. Appoint a
If these examples demonstrate anything, single leader with responsibility for end-
it is the variety of ways that supply chain to-end performance and for delivering
execution can drive business perfor- improvement projects across tiers and tra-
mance. In our work helping companies to ditional functions such as marketing, man-
transform their supply chain performance, ufacturing, and procurement. Make sure
however, we have identified three specific your supply chain organization combines
actions that senior leaders can take to operational excellence with strong ana-
maximize the potential of their own organi- lytical capabilities and data-driven, cross-
zations supply chains. functional decision making. Create analyti-
cal teams to support decision making and
1. Differentiate your supply chain to identify hidden risks and opportunities in
and corporate strategies unstructured data. Ensure your IT function
is supporting them with nimble applications
Whether the strategy of your business and platforms that enable collaboration and
is superior service, product innovation, analytical decision making.
or cost leadership, ensure your supply
chain is helping to deliver the key points 3. Set the performance standards
of that strategy. Bring together leaders for the entire organization
from across your business to define the
supply chain that will work for youand Incentivize your supply chain organization
ensure they provide the data your organi- to work in ways that deliver the most value
zation needs to deliver. Marketing needs for your business, while protecting against
to tell you what your customers value its biggest risks. That means using more
most from your service, how those needs than the traditional metrics of cost, service,
vary between customers, and what will and capital. The right KPIs depend strongly
differentiate you from your competitors. on the needs of the business, the product,
Your commercial functions have to iden- and the market segment: cost of produc-
tify which customers justify the cost of tion for value players; stability of supply
the highest service and which would be for staples and critical products like spare
better served using a more standardized parts or medical devices; agility in volatile
approach. Together, your supply chain markets with fluctuating demand; or launch
and product development functions can excellence for new products are key. If a
find ways to create innovative products metric doesnt matter in your business,
that suit the needs of all those different dont misdirect the organization by using it.
customer groups, while keeping overall
costs under control.

The best companies have transformed What are you doing to turn your supply
their supply chains with time, investment, chain into a powerful source of competi-
and sustained top management attention. tive advantage?

Questions a CEO should ask about the supply chain

Check your current understanding of your organizations supply chain needs and
capabilities. Can you answer these questions?

What is your customers experience of your supply chain? How does it stand out
from your competitors?

What is your supply chain strategy, and how does it support your business strategy?
For which customers, products, and segments does your supply chain target the
best performance? Where does it optimize for cost rather than for service?

Do you have clear supply chain performance and cost targets? Which KPIs do you
use to measure these?

Who is ultimately responsible to deliver against these performance targets? How do

you ensure every function in your business supports those efforts?

How quickly can you ramp up production of a new product or a new sales region?
Is your supply chain agile enough to flexibly respond to external changes?

Christoph Glatzel is a principal in McKinseys Cologne office and Johannes Rhren

is a consultant in the Berlin office.

Is your top team

undermining your
supply chain?
Christoph GlatzeL, Jochen Gropietsch, and Ildefonso Silva

Managing a global supply chain involves in a supply chain, it will be more difficult
tough organizational challenges that still when companies deal with multiple
promise only to intensify as operations interconnected supply chains, each pos-
expand and become increasingly inter- sibly requiring a different solution. And
connected. Key among those challenges: consider the short- and long-term supply
getting functional groups to understand chain trade-offs that executives must bal-
their impact on one another so that they ance in a world where one business unit
can collaborate. To bridge the organiza- might be asked to shift its manufacturing
tional gaps that often divide their senior lines to a more expensive nearshore loca-
managers, McKinsey research finds that tion today to build capacity as a hedge
companies need to successfully address against potential future spikes in labor or
three main areas of collaboration tension. transport costs.

Building a global supply chain to When the recent earthquake and tsunami
succeedindeed, to thrivein a world in Japan evidenced the fragility of many
of rising complexity and uncertainty sophisticated supply chains, it became
requires recognizing and tackling sig- clear that these trade-offs can have very
nificant organizational challenges. real consequences. Many companies in
Specifically, the top management team the automotive and high-tech industries
needs to understand that the decisions are still recovering from availability issues
and activities of their companys supply in Japan, along with missed sales and
chain group affect, and are affected by, high reaction costs that we believe could
the sales team, marketers, and product at least have been partially avoided by a
developers, among others. The result is a more systematic management of risk, as
host of thorny trade-offs. Should a com- well as the trade-offs between short-term
pany, say, move a product to a low-cost optimization and long-term stability.
manufacturing facility to save money if
that means lengthening delivery times? Finding mechanisms to solve these and
What if trimming the companys product other difficult supply chain questions will
portfolio to reduce manufacturing com- require hands-on attention from the CEO
plexity and costs could stifle marketing and other company leaders. The process
efforts to reach new customers? When begins when executives work together to
do the benefits of improved customer identify places where better information
service warrant the additional operating sharing and teamwork will generate the
expenses required to deliver it? Supply most impact. Lets look then at three of
chain, sales, and marketing managers the biggest collaboration tensions and
invariably view such trade-offs through see how companies are bridging these
the lenses of their own responsibili- organizational divides to create more flex-
tiesand those perspectives often lead ible and capable supply chains.
to disagreements or misunderstandings.
Indeed, a McKinsey survey of global
executives cited the inability of functional Tension 1: Supply chain vs. sales
groups to understand their impact on one
another as the most common barrier to Supply chain organizations wage a con-
collaboration for resolving the major sup- stant battle against volatile demand, and
ply chain trade-offs. for good reason. An unexpected spike in
orders, for example, has expensive con-
Ineffective collaboration has long been a sequences in labor and distribution costs.
supply chain sore spot, but its costs are Similarly, inaccurate sales forecasts can
set to rise drastically. If its hard today to lead to stockouts, lost sales, or excess
agree on the right response to a disruption inventory that must be sold at a discount.

Sales and supply chain groups therefore spiky demand, along with the expedited
devote significant energy to creating freight costs to meet customer service
sophisticated planning and forecasting expectations, and began eating at the
processes in an attempt to predict companys bottom line.
demand volatilityand blame each other
when things go awry. In order to address this issue, the compa-
nys vice president of sales and its head
At first blush, the reasons for the discon- of supply chain collaborated to shape
nect may not be obvious. For example, demand into a more manageable form.
the sales team at a luxury goods manu- One key step: substantially trimming end-
facturer we studied rightly claimed to of-quarter discounts and instead using
have correctly anticipated a a price and discount structure based
Ineffective collabo- significant customer order. on sales volumes, product loyalty, and
ration has long been Unfortunately, however, participation in promotional efforts. The
a supply chain sore the forecast did not specify company also created new incentives to
spot, but its costs are the product type in enough encourage sales teams to spread sales
set to rise drastically. detail. This frustrated the more evenly across the quarter. All these
production team, which actions together reduced overall demand
insisted it was not able to plan the order volatility, thereby substantially trimming
in a timely manner. the inefficiencies across the value chain.

However, when these groups work Our second example involves a global
together more closely, they can move CPG manufacturer. This company dis-
beyond the traditional planning cycle covered that promotional activity in just
blame game. In fact, they can discover five customer accounts drove most of
the root causes of volatility and ultimately its demand volatility. Although the com-
begin to influence it. This approach pany carefully planned the promotions
brings tangible business benefitsoften to maximize revenues, its marketers
quickly. Crucially, over the longer term, hadnt thought about the impact on the
the experience that groups gain from supply chain. When several promotions
flexing their collaborative muscles height- coincided, for example, the manufactur-
ens the ability to react quickly, and in a ing capacity for one product group was
concerted way, to unforeseen events. overbooked, resulting in stockouts and
That skill will be even more necessary significant overtime expenses to meet the
given the increasing uncertainty in the demand. As service levels on key prod-
supply chain environment. Here are two ucts dipped, the CEO became alarmed
examples that illustrate the potential. and asked his sales and supply chain
executives to form a joint team and iden-
The first involves an automotive supplier tify improvements. By staggering the pro-
whose sales teams often scrambled to motions over several months and aligning
meet quarterly targets that would guar- them carefully with baseline demand
antee them better performance bonuses. patterns, the team was able to reduce the
Customers recognized this behavior and, overall volatility of demand by 25 percent.
in some cases, were gaming the system
by withholding orders until the end of the When the company rolled out the new
quarter to secure deeper discounts. The promotions plan, its managers identified
result was a series of supply chain head- another problem: many customers lacked
aches that included inventory buildups the resources to manage their order lev-
at the end of each quarter, and higher els efficiently and therefore sporadically
warehousing costs. Worse, the additional placed unnecessarily large orders. The
labor costs needed to cope with the company responded by bringing together

its sales and supply chain personnel and This came much to the surprise of the
working with these customers to create sales team, which had not taken into
better ordering processes for them. In account the full operational implications
this way, it smoothed the flow of orders of the new service target.
a move that benefitted both parties.
Whats more, the moves boosted cus- While this trade-off might have been
tomer service levels by three percentage acceptable under the right circumstances,
points in the core categories. a closer examination by the leaders of the
supply chain and sales groups revealed
Situations like these are endemic in that most customers didnt mind if deliv-
many supply chains. By tackling these eries arrived in two, three, or even five
problems, companies often enjoy imme- days. The real break point when service
diate benefits while building collabora- was most highly valued was 24 hours. By
tive capabilities that will be crucial over extending the delivery window for normal
the long term in the more complex and orders back to three days, the company
uncertain supply chain environment of returned its distribution costs to their
the future. original levels. Meanwhile, it launched
a special 24-hour express service for
critical deliveries, for which it charged a
Tension 2: Supply chain vs. premium. The move ultimately raised the
customer service companys costs slightly, but this was
more than offset by the new business
A second important tension involves the it generated.
setting of customer service levels. This
issue has been around for a long time, As supply chains splinter and companies
and its one that is set to get worse as diversify production to hedge against
companies seek to create more resilient uncertainty, the importance of making
global supply chains. Contentious ques- smart trade-offs about service levels and
tions abound: How speedy should deliver- speed can only grow. Companies that
ies be? Should some customers receive want to do better in this area will have
orders faster than others? What levels of to strengthen partnerships between the
product availability should be guaranteed? leaders of their supply chain, sales, and
In our experience, companies tradition- service functions.
ally leave these decisions to the sales or
customer service functions, which often
make service-related decisions without Tension 3: Supply chain vs.
understanding the broader operational product proliferation
implications or costs involved.
Remedying some of the root causes of
When these groups work together to ana- growing supply chain complexity will be
lyze the full impact of a service decision, another important benefit of enhanced
they avoid this pitfall. That lesson was collaboration in the executive suite.
learned by a chemical company whose Consider the complexity associated with
sales personnel were pushing its logistics product portfolios. Sales and marketing
team to reduce delivery times from three organizations work hard to create new
to two days. The company achieved this products, explore new market opportuni-
goal, but only by using more warehouse ties, and respond to emerging customer
space and labor and by loading its deliv- needs. As they do, products and variants
ery trucks less efficiently than it otherwise tend to proliferate, creating portfolios with
would have. Together, these actions long tails of niche offerings. A consumer
increased distribution costs by 5 percent. goods maker we know, for example,

recently found that nearly one-third of the across functional boundaries can com-
6,400 stockkeeping units (SKUs) in its panies make these right decisions. Such
product portfolio together represented collaboration wont eliminate the need for
just 1 percent of total revenues. more carefully segmented supply chain
strategies, but it should help ensure that
This complexity comes at a cost; econo- such efforts are well targeted.
mies of scale dictate that low-volume
products cost more to make per unit than
high-volume ones. For the consumer What the CEO must ask
goods maker, for instance, the complexity
had reached such a degree that it started The top of the organization is the right
damaging overall profitability, prompting place for most companies to begin
the companys top team to investigate the negotiating the functional trade-offs weve
situation more thoroughly. Subsequent outlined. But many senior management
analysis revealed that production costs for teams give precious little attention to
low-volume products were 129 percent supply chain issues. Across the trade-offs
higher than those for its best sellers. our survey explored, for example, no more
than 26 percent of the respondents said
Low-volume products also require dispro- that their companies reach alignment
portionate effort in sales and administra- among functions as part of the supply
tive processes. And they drive up supply chain decision making process. Moreover,
chain costs: a company must hold higher 38 percent say that the CEO has no or
inventory levels to meet agreed service limited involvement in driving supply chain
levels across a broad range strategy.
The top of the orga- of low-volume products
nization is the right than it does over a narrow This is a mistake. CEOs set the agenda
place for most com- range of high-volume ones. for their leadership teams, and it is up to
panies to begin nego- When all these extra costs CEOs to encourage and facilitate mean-
tiating functional are taken into account, the ingful discussion of important cross-
trade-offs. impact can be eye opening. functional supply chain issues. They can
One company we studied do more than thatand some do. In some
found that 25 percent of its SKUs actually of the most impressive supply chains
lost money. weve seen, the chief executive promotes
collaboration and performance improve-
In the face of these numbers, companies ment with missionary zeal. The CEO of
might be tempted to take an ax to the long an apparel company, for example, would
tails of their product portfolios. Yet blind always make a point, during store visits, of
cutting based on sales figures alone often asking shop-floor staff how the companys
does more harm than good. Some low- recent commercial decisions had affected
volume products have benefits that out- store operations, including logistics. He
weigh their costs. Consider the chemicals would bring up this feedback in meetings
manufacturer that set out to slim down its with purchasing and supply chain teams
product portfolio. On closer examination, and continually encouraged his managers
the company found that some small prod- to follow up themselves and engage with
ucts (in terms of revenues) were of vital shop-floor staff on similar topics.
importance for some of their customers,
and taking them out would have risked Similarly, a global consumer goods
losing several big accounts. Instead, company undertook a major effort to
increasing prices turned out to be the understandand optimizecomplexity
strategically better and more profitable in its product portfolio. Within a couple of
strategy. Only through close collaboration months, the companys leadership group

observed that the subsidiaries where local 2. Is the sales group doing all it can to
CEOs had personally gotten involved in make demand smooth and predictable?
bridging the different marketing, sales,
and operations functions had achieved 3. Are customers offered the service
superior results relative to the others. In levels they really need?
one of the subsidiaries with the highest
levels of CEO involvement, 30 to 50 per- 4. Is my marketing department calling for
cent of SKUs had been eliminated with no too many niche products that may be
negative effects on sales. too costly to supply?

CEOs looking to get started can benefit 5. Are our purchasing and sourcing deci-
from asking themselves five questions. sions being made with their supply
Consideration of these questions, we have chain implications in mind?
found, can help leaders begin to ferret out
situations where faulty collaboration may Poor collaboration and silo thinking have
be preventing supply chains from reaching long thwarted the efforts of companies
their full potential: to get more from their supply chains. In a
future characterized by rising complexity
1. Is production capacity being developed and uncertainty, solutions to this perenni-
in the right locationsboth for today al problem wont just be nice to have
and the future? they will be competitive necessities.

Christoph Glatzel is a principal in McKinseys Cologne office, Jochen Gropietsch is

a principal in the Barcelona office, and Ildefonso Silva is a principal in the
So Paulo office.

This article was originally published by Supply Chain Management Review (
and is reprinted here with permission.

Building the supply chain

of the future

Yogesh Malik, Alex Niemeyer, and Brian Ruwadi

Getting there means ditching todays insights for other companies hoping to
monolithic model in favor of splintered get more from their supply chains in the
supply chains that dismantle complex- years to come.
ity, and using manufacturing networks to
hedge uncertainty.
Twin challenges
Many global supply chains are not
equipped to cope with the world we are The stakes couldnt be higher. In our
entering. Most were engineered, some industry, says Jim Owens, the former
brilliantly, to manage stable, high-volume chairman and CEO of construction-
production by capitalizing on labor equipment maker Caterpillar, the com-
arbitrage opportunities available in China petitor thats best at managing the sup-
and other low-cost countries. But in a ply chain is probably going be the most
future when the relative attractiveness successful competitor over time. Its a
ofmanufacturing locations changes condition of success.1 Yet the legacy
quicklyalong with the ability to produce supply chains of many global companies
large volumes economicallysuch stan- are ill-prepared for the new environments
dard approaches can leave companies growing uncertainty and complexity.
dangerously exposed.
A more uncertain world
That future, spurred by a rising tide of
global uncertainty and business com- Fully 68 percent of global executives
plexity, is coming sooner than many responding to a recent McKinsey survey
companies expect. Some of the chal- said that supply chain risk will increase in
lenges (turbulent trade and capital flows, the coming five years.2 And no wonder:
for example) represent perennial sup- the financial crisis of 2008 dramatically
ply chain worries turbocharged by the amplified perennial sources of supply
recent downturn. Yet other shifts, such chain uncertaintynotably the trajectory
as those associated with the developing of trade and capital flows, as well as cur-
worlds rising wealth and the emergence rency valueseven as the crisis sparked
of credible suppliers from these markets, broader worries about the stability of
will have supply chain implications for the financial system and the depth and
decades to come. The bottom line for duration of the resulting recession. While
would-be architects of manufacturing many of these sources of uncertainty per-
and supply chain strategies is a greater sist, its important to recognize that new,
risk of making key decisions that become long-term shifts in the global economy
uneconomic as a result of forces beyond will continue to pressure supply chains
your control. long after more robust growth returns.

Against this backdrop, a few pioneering The increasing importance of emerging

supply chain organizations are prepar- markets tops the list of these uncertain- 1 Jim Owens made this remark
ing themselves in two ways. First, they ties. Economic growth there will boost in an interview conducted
are splintering their traditional supply global energy consumption in the coming by Hans-Werner Kaas on
September 20, 2010. For
chains into smaller, nimbler ones bet- decade by about one-third. Meanwhile, more with Jim Owens, see
ter prepared to manage higher levels of the voracious appetite of China and other McKinsey conversations with
complexity. Second, they are treating developing countries for such resources global leaders: Jim Owens of
Caterpillar, November 2010,
their supply chains as hedges against as iron ore and agricultural commodities
uncertainty by reconfiguring their manu- is boosting global prices and making it 2 For more, see The challenges
facturing footprints to weather a range trickier to configure supply chain assets. ahead for supply chains:
McKinsey Global Survey
of potential outcomes. A look at how Worries about the environment are grow- results, November 2010,
the leaders are preparing today offers ing, too, along with uncertainty over the

scope and direction of environmental subscale mom-and-pop stores. In Brazil,

regulation. for example, Nestl is experimenting with
the use of supermarket barges to sell
These long-term trends have knock-on directly to low-income customers along
effects that reinforce still other sources of two tributaries of the Amazon River.4
uncertainty. Growth in developing coun-
tries contributes to volatility in global cur-
rency markets and to protectionist senti- Meeting the challenge
ment in the developed world, for example.
Whats more, different growth rates across In such a world, the idea that companies
various emerging markets mean that rising can optimize their supply chains once
labor costs can quickly change the relative and for all circumstances and customers
attractiveness of manufacturing locations. is a fantasy. Recognizing this, a few
This past summer in China, for example, forward-looking companies are prepar-
labor disputesand a spate of worker ing in two ways. First, they are splintering
suicidescontributed to overnight wage their traditional monolithic supply chains
increases of 20 percent or more in some into smaller and more flexible ones. While
Chinese cities. Bangladesh, Cambodia, these new supply chains may rely on the
and Vietnam experienced similar wage- same assets and network resources asthe
related strikes and walkouts.3 Finally, as old, they use information very differently
companies in developing markets increas- helping companies to embrace complexity
ingly become credible suppliers, deciding while better serving customers.
which low-cost market to source from
becomes more difficult. Second, leading companies treat their
supply chains as dynamic hedges
Rising complexity against uncertainty by actively and
regularly examiningeven reconfigur-
Manufacturing and supply chain planners ingtheir broader supply networks with
must also deal with rising complexity. an eye toward economic conditions five
For many companies, this need means or ten years ahead. In doing so, these
working harder to meet their customers companies are building diverse and more
increasingly diverse requirements. Mobile resilient portfolios of supply chain assets
phone makers, for example, introduced that will be better suited to thrive in a
900 more varieties of handsets in 2009 more uncertain world.
than they did in 2000. Proliferation also
affects mature product categories: the
number of variants in baked goods, bev- From one to many
erages, cereal, and confectionery, for
instance, all rose more than 25 percent Splintering monolithic supply chains
a year between 2004 and 2006, and the into smaller, nimbler ones can help tame
number of SKUs at some large North complexity, save money, and serve cus-
American grocers exceeded 100,000 tomers better. Lets look at an example.
in 2009.
Splintering supply chains:
3 Tim Johnston, Striking Meanwhile, globalization brings com- A case study
Cambodian workers reflect plexities as rising incomes in developing
Asia trend, Financial Times,
September 13, 2010.
countries make them extremely desirable A US-based consumer durables manu-
4 Tom Muiler and Iuri Dantas, as markets, not just manufacturing hubs. facturer was losing ground to competitors
Nestl to sail Amazon Rivers Efficient distribution in emerging markets because of problems with its legacy supply
to reach emerging-market
consumers, Bloomberg News,
requires creativity, since retail formats typi- chain. Years before, the companylike
June 17, 2010. cally range from modern hypermarkets to many global manufacturershad sent

the lions share of its production to China distinct splinters. For high-volume prod-
while maintaining a much smaller pres- ucts with relatively stable demand (less
ence in North America to stay close to than 10 percent of SKUs but representing
the majority of its customers. One legacy the majority of revenues), the company
of the move: all of its plants, relying on kept the sourcing and production in China.
a unified production planning process, Meanwhile, the facilities in North America
essentially manufactured the full range of became responsible for producing the rest
its thousands of products and their many of the companys SKUs, including high-
components. and low-volume ones with volatile demand
(assigned to the US) and low-volume,
Now, however, increasingly volatile patterns low-demand-volatility SKUs (divided
of customer demand, coupled with prod- between the US and Mexico). Ramping up
uct proliferation in the form of hundreds of production in a higher-cost country such
new SKUs each year, were straining the as the US made economic sense even
companys supply chain to the point where for the low-volume products because
forecasting- and service-related problems the company could get them to market
were dissatisfying key customers. much faster, minimize lost sales, and keep
inventories down for many low-volume
In response, the company examined its SKUs. Moreover, the products tended to
portfolio of products and components require more specialized manufacturing
along two dimensions: the volatility of processes (in which the highly skilled US
demand for each SKU it sold and the over- workforce excelled) and thus gave the
all volume of SKUs produced per week. company a chance to differentiate itself in
Armed with the resulting matrix (Exhibit 1), a crowded market.
the company began rethinking its supply
chain configuration. However, the company didnt just reallo-
cate production resources. In tandem, it
Ultimately, the company decided to split changed its information and planning pro-
its one-size-fits-all supply chain into four cesses significantly. For the portfolios

Grouping products by demand volatility and overall volume can shed light
on how to optimize the supply chain
Volume and demand volatility by finished-good SKU,
example of US-based consumer-durables company
High volume-low volatility High volume-high volatility
8% of SKUs, 55% of profits 2% of SKUs, 10% of profits
Volume produced,
year to date
Thousands of SKUs

Weekly demand volatility

Low volume-low volatility Low volume-high volatility
25% of SKUs, 25% of profits 65% of SKUs, 10% of profits

Exhibit 1

most volatile SKUs (the ones now pro- choices, let alone make network deci-
duced in the US), the company no longer sions based on those trade-offs.
tried to predict customer demand at all,
choosing instead to manufacture directly Oftentimes, a good place to start is to
to customer orders. Meanwhile, manag- analyze the volatility of customer demand
ers at these US plants created a radically for a given product line against histori-
simplified forecasting process to account cal production volumes and to compare
for the remaining productsthose with the results against the total landed cost
low production runs but more stable for different production locations. This
demand. information provides a rough sense of the
speed vs. cost trade-offs and can even
For overseas operations, the company suggest locations where supply chain
continued to have its Chinese plants pro- splinters might ultimately be located. A
duce finished goods on the basis of long- global CPG maker, for example, quickly
run forecasts, as they had done before. saw that two-thirds of the demand asso-
The forecasts were now better, though, ciated with a key product line (about 40
because planners were no longer trying percent of the companys product port-
to account in their models for the noise folio) could be moved from a higher-cost
caused by the products with highly vola- country to a lower-cost one without hurt-
tile demand. ing customer service.

Together, the changes helped the com- Of course, companies must care-
pany reduce its sourcing and manu- fully check these broad-brush analyses
facturing complexity and to lower its against customer needs. The consumer
cost of goods sold by about 15 percent. goods company, for instance, found that
Meanwhile, it improved its service levels packaging innovation was a differentiator
and shortened lead times to three days, for some of its products and thus config-
from an average of ten. Quality also ured a single production line in the new,
improved across the companys full range lower-cost location to make packaging
of products. for several markets quickly. By contrast,
in automotive and other assembly-based
How many splinters? industries, we find that the customers
responsiveness and the complexity of
The first question for organizations individual products are important inputs
exploring multiple supply chains is how that help determine where supply chains
many are needed. Answering it requires might be splintered.
a close look at the way the supply chain
assets that a company uses to manufac- Second-order benefits
ture and distribute its products matches
up against the strategic aspirations it has While dividing a supply chain into splin-
for those products and their customers. ters may seem complicated, in fact this
approach allows companies to reduce
This requirement seems obvious, but complexity and manage it better because
in practice most companies examine operational assets can be focused on
only the second half of the equation in a tasks theyre best equipped to handle. At
sophisticated way; they can, for example, the same time, the added visibility that a
readily identify which products they see splintered approach offers into the guts
as leaders on cost, service, innovation, or of a supply chain helps senior manag-
(most likely) some combination of these. ers more effectively employ traditional
Fewer companies seriously examine the improvement tools that would have
operational trade-offs implicit in such been too overwhelming to tackle before.

After the consumer durables maker chains confer are most valuable if com-
divided its supply chain into smaller panies view them dynamically, with an
ones, for example, it was able to use eye toward the resiliency of the overall
formerly impractical postponement supply chain under a variety of circum-
approaches (producing closer in time to stances. Will the various strands of a
demand to keep holding costs low). The particular global supply network, for
companys US plants now combined example, still make sense if Chinas cur-
various SKUs into semifinished compo- rency appreciates by 20 percent, oil costs
nents that could quickly be assembled $90 a barrel, and shipping lanes have
into products to meet customer orders 25 percent excess capacity? Its critical
(Exhibit 2). Indeed, the lower inventory for organizations to determine which of
costs this move generated partially the many questions like these are right to
offset the higher labor costs of the ask and to invest energy in understand-
US factories. ing the global trends underpinning them.
Some companies are already thinking in
Likewise, the global CPG maker found this way. Nike, for example, long a leader
that after splintering its supply chain, it in emerging market production, manu-
was more successful at applying lean factured more shoes in Vietnam than in
management techniques in its plants. China for the first time in 2010.6
Among the benefits: much faster change-
over times in higher-cost production In fact, we believe that the ability of supply
locations, enabling them to handle pro- chains to withstand a variety of different
duct-related complexity more effectively. scenarios could influence the profitability
and even the viability of organizations in
the not-too-distant future. In light of this,
Use your network as a hedge companies should design their portfolios
of manufacturing and supplier networks
The advantages that multiple supply to minimize the total landed-cost risk 6 Fiscal year.

With better visibility into supply chain operations, companies can achieve
bigger efficiency gains
Example: A consumer durables maker lowers its inventory costs
by moving production closer to customer demand

Before Order to forecast Order

Supply to forecast Ship to order
Finished goods Finished goods
supplier inventory

After Order to forecast Order

Work in process Assembly

Supply to Assemble
Component forecast Component
supplier inventory to order

Exhibit 2

under different scenarios. The goal supply disruptions, including fires, earth-
should be identifying a resilient manu- quakes, and labor-related strife.
facturing and sourcing footprinteven
when its not necessarily the lowest cost A North American industrial manufacturer
one today. This approach calls for a sig- chose to broaden its footprint in Brazil
nificant mindset shift not just from opera- and Mexico to hedge against swings in
tions leaders but also from CEOs and foreign exchange rates. In particular, the
executives across the C-suite. company invested in spare capacity to
make several innovative, high-end com-
At the consumer durables manufacturer, ponents that it had formerly produced
for example, senior executives worried only in Europe and the US because of the
that its reliance on China as a hub could advanced machining and engineering
become a liability if conditions changed required. The investment is helping the
quickly. Consequently, the companys company hedge against currency swings
senior team looked at its cost structure by quickly transferring production of the
and how that might change over the next components across its global network to
five to ten years under a range of global match economic conditions. Moreover,
wage and currency rate conditions. They the arrangement helps it better support its
also considered how the company could supply partners as they serve important
be affected by factors such as swinging growth markets.
commodity prices and logisticscosts.

The company determined that while
China remained the most attractive man- Making these kinds of moves isnt easy,
ufacturing option in the short term, the of course, since any alterations to a com-
risks associated with wage inflation and panys supply chain have far-ranging
currency rate changes were real enough implications throughout the organization.
to make Mexico a preferable alternative For starters, such changes require much
under several plausible scenarios. more cooperation and information sharing
Consequently, the company has begun across business units than many compa-
quietly building its supplier base there in nies are accustomed to. Indeed, the orga-
anticipation of ramping up nizational challenges are so significant that
While China remained its manufacturing presence for many companies, a hands-on effort by
the most attractive so that it can quickly flex the CEO and others across the C-suite is
manufacturing option production between China needed for success (for more, see Is your
in the short term, and Mexico should condi- top team undermining your supply chain?
Mexico was preferable tions so dictate. Similarly, on
under several the global CPG manu-
plausible scenarios. facturer is examining where Nonetheless, the rewards are worthwhile.
dormant capacity in alter- By creating more resilient and focused
native low-cost countries might help it supply chains that can thrive amid height-
hedge against a range of labor cost, tariff, ened uncertainty and complexity, compa-
tax, and exchange rate scenarios. The nies will gain significant advantages in the
company is also factoring in unexpected coming years.

Yogesh Malik is a principal in McKinseys Washington, DC office, Brian Ruwadi is a

director in the Cleveland office, and Alex Niemeyer is a director in the Miami office.

Excellence in planning:
From silos to collaboration

Bridging the
chain divide
Ashutosh Dekhne, Xin Huang, and Apratim Sarkar

Procurement teams are good neighbors ness requirements to drive cost reduction
with their counterparts in supply chain while the supply chain operations main
management. But they really need to goal is to deliver products and services
become family. If they can find ways to that satisfy end-customer demand, which
interact more closely, they may find they is dynamic by nature.
can cut total inventory levels across the
value chain by at least 15 percentand What is needed now is a cross-functional
lower overall supply chain costs in approach that embeds a total supply
the bargain. chain perspective in procurements opera-
tions. Given the continued worries over
Although many companies have been global economic recoveryand the par-
focusing on improving the effectiveness ticular concerns of business leaders about
of their procurement operations, relatively profitable growth amid signs of slowdown
few have had much success with prop- worldwidewe consider it imperative for
erly integrating suppliers into their supply business leaders to first recognize that
chain operations. Theres a mismatch: there is a mismatch between procure-
companies and their suppliers optimize ments static perspective of supply-side
their operations to suit their own environ- interactions and the supply chain opera-
ments. The consequences are far reach- tions very dynamic view, and then to act
ingeverything from significant supply promptly to close it. This article offers six
shortages and excess supply inventory ways to begin to do that.
to frequent write-downs and excessively
long shipment times.
A closer look at the mismatch
You dont need to look far for telltale signs
of this misalignment. We know of a food On the face of it, a companys supply
processing company that stored excess chain and procurement functions should
raw material inventory while its packaging have a lot in common. They both act as
supplier was also burdened with finished primary interfaces between an organiza-
goods inventory. There is a CPG pro- tion and its suppliers, for example. And
ducer that suffered from shortages of a they are both incentivized to ensure that
common raw material after it introduced a materials and components bought from
new product that shared the material elsewhere are available in the right qual-
with the companys old products. And ity, at the right time, and the right price.
we have come across a medical device
manufacturer that moved to a local Yet at many companies, procurement
production footprint to improve the and supply chain processes dont work
responsiveness of its supply chain, but hand in hand, but sequentially. At discrete
then found that it had to ship raw intervalsduring the development of a
materials around the world. new product line, for example, or every
few years after launchthe procurement
The misalignment is not the fault of one function will launch a project to identify
side or the other. Each has evolved suppliers that are capable of delivering
naturally toward efficiencies that make specific material requirements at the
sense for its immediate objectives, but forecast volume and the required quality.
not for the whole. But a root cause of It will then engage with qualifying suppli-
the supplier-customer mismatch is the ers to negotiate favorable terms and fix
disconnect between the customers pro- those terms in a robust contract. At that
curement and supply chain operations. point, procurement hands over much of
Procurement, the primary face to suppli- the management of the ongoing supplier
ers, usually takes a static view of busi- relationship to the supply chain function.

Procurement staff will continue to moni- supplier flexibility into account during the
tor the situation at arms length, checking qualification process or build appropri-
that suppliers are complying with con- ate measures into supply contracts and
tract terms, for example. But the detailed pricing. One consumer goods company
management of orders and logistics is left aimed to make itself more responsive to
to their supply chain colleagues. customer demand by shortening its plan-
ning cycle from a month to a week, for
Working this way not only creates sig- example. The companys manufacturing
nificant inefficiencies, but also ignores and distribution functions could accom-
important opportunities to reduce costs modate the change, but such short lead
and to add value for companies and times had not been foreseen when many
for their suppliers. Inefficiencies arise critical supply contracts were drawn up.
because, even if overall demand meets Some of the companys principal suppli-
forecast levels, the day-to-day detail ers were simply unable to operate with
of supply requirements can be highly lead times shorter than four weeks, and
dynamic. Seasonal demand variability, the the result was widespread raw materials
introduction of competitive products, or shortages.
promotional activity in retail channels can
drive big short-term fluctuations. On top Some companies are seeking to overcome
of this, any number of exceptional circum- these issues by improving the collabora-
stances, from floods to product quality tion between their supply chain and pro-
issues, can require rapid and significant curement functions. At its simplest, this
action by suppliers. approach involves procurement profes-
sionals gaining a full picture of supply chain
If procurement staff arent fully aware of requirements before negotiating supplier
the dynamics of their organizations sup- contracts. Such an understanding helps
ply chain requirementsusually because to ensure that potential suppliers are able
the supply chain function hasnt made to offer sufficient volume flexibility and
them clear up-frontthey may not take sufficiently short lead times, for example.

Transitioning to complete integrationfunctionally and with suppliers

Strategic integration
Operating as one
Strategy decisions on growth
are collaboratively made in
the best interest of all
Transactional integration stakeholders
Breaking organizational and Suppliers physically and
functional boundaries systemically integrated into
Joint planning for future the companys operations
Touch-point agreement requirements
Satisfying requirements Mutual agreement on
sharing benefits with
Information dissemination
Contracts management
Periodic reviews

Exhibit 1

Procurement and supply chain organiza- reduce supply risks, or allow the supplier
tions share the responsibility of integrating relationship to contribute additional value
between themselves and extending that to the business (Exhibit 2). We have seen
integration outward, strategically, to their that companies that strive for operational
suppliers (Exhibit 1). excellence not only embrace integration
across the supply chain, but also manage
The benefit of this collaboration goes it strategically. Lets look at each of the six
beyond preventing problems down the factors in turn.
line, however. By considering both their
own organizations supply chain require- 1. Demand planning
ments and supplier organizations supply
chain costs and capabilities during con- The objective of focusing on demand plan-
tract negotiation or renegotiation, pro- ning is to create end-customer demand
curement professionals also gain access transparency throughout the supply chain
to some important new levers they can and synchronize demand planning activi-
pull to reduce total cost of ownership and ties. Central to demand planning is the
improve the overall value of the supply need to share with suppliers the stream of
relationship. unfiltered demand data from end custom-
ers and to leverage the strengths of both
parties to jointly forecast demand.
Six ways to close the gap
Its also crucial to synchronize and opti-
Our experience, observations, and analy- mize the end-to-end demand planning
ses of several companies have helped processfor example, order and replen-
identify six specific ways beyond the basic ishment activities, seasonal promotions,
touch-point agreements in which con- and the processes for handling excep-
sideration of supply chain issues during tions, such as big spikes in demand,
the procurement process can identify whether they are expected or not.
opportunities for further cost savings, Demand planning also involves strict

Ways procurement and supply chain can work better together

Signi- Footprint
ficant design

Lead-time planning
Inventory management
Sales and

Low High
Integration across supply chains

Touch-point Transactional Strategic

agreements integration integration

Company Company Company

Supp Supp
Supp Supp Supp X
Supp A
Supp Supp A X B
A Supp X

Exhibit 2

controls on manual adjustments to fore- 4. Product lifecycle management

casts, production plans, and schedules.
And it requires that people be held account- The objective of this path is to ensure opti-
able for the accuracy of the data they key mal support from suppliers during product
into the planning system in the first place. introduction and phaseout. Done right,
product lifecycle management implies that
2. Inventory planning the supply chain partners can optimize
end-of-product-life purchases (for exam-
A renewed focus on collaborative inven- ple, last-time buys of components) using
tory management can help to ensure the analytical models instead of gut feel
best balance and distribution of inventory decisions. It means that companies have
stocking points across the supply chain to establish rigorous supply ramp-up and
for example, helping to eliminate redun- ramp-down processes with suppliers
dant inventory buffers between supplier communicating in detail about design
and customerand to create transpar- nuances, bills of materials, etc. There has
ency for all supply chain partners. It will to be close interaction with suppliers so
lead to alignment on inventory strategy they can increase capability flexibility to
on specific issues such as safety stock shift between new and old supply chains.
levels, inventory planning methodolo- And it is essential to leverage suppliers
gies, and supply chain parameters. The capability to drive product innovation and
use of multi-echelon inventory planning shorten the cycles for product develop-
techniques can help to set safety stock ment and commercialization.
requirements holistically, pinpointing the
trade-offs between supplier inventory, cli- A large industrial manufacturer that ad-
ents raw material inventory, and clients hered to these practices saw a 6percent
stocks of finished goods. pickup in EBIT because its end-to-end
product strategy and comanufacturing
At one large retailer we know of, the joint approaches with suppliers enabled it to
development of a demand sharing and get new products to market in half the
inventory planning strategy slashed the time of its competitors.
inventory of big-ticket items by about
60 percentequivalent to a months stock. 5. Footprint design

3. Lead-time optimization The intent is to align each suppliers

footprint with the customers supply
Lead-time optimization puts the spotlight chain strategy. Proper footprint design
on quick responses to changes in demand makes sense of the mix of offshore and
from end customers. It helps companies nearshore facilities, taking into account
determine their optimal supply lead-time the trade-offs between purchase prices
requirements holistically, using a seg- and supply chain benefitsfor instance,
mented approachfor example, by align- responsiveness and logistics costs.
ing lead times across all components to It also helps to fine-tune the vertical
support the supply chain strategy. It calls supply chain collaboration/integration
for trade-offs between logistics costs and strategyidentifying the circumstances
lead times, makes use of lean concepts in which it is appropriate to set up colo-
to identify bottlenecks at any point up cated facilities with suppliers to increase
and down the supply chain (and to devise supply chain flexibility. (The colocation
cost-effective ways to get around them), supply chain strategy of one large high-
and determines and enforces guidelines tech manufacturer helped it cut inventory
and processes for rush orders, based on by about 20 percent and boost EBIT by
cost and benefit trade-offs. roughly 6 percent.) At the same time,

footprint design helps the company to and lead-time optimization to do just that.
optimize the transportation network strat- The high-tech company wanted to dra-
egythe use of cross-dock locations, matically reduce its service delivery lead
pool points, and the best mix of third-par- times in order to improve the availability of
ty logistics service providers and internal its broad product range without the need
logistics capabilities. to carry cripplingly high levels of finished
goods inventory. The companys supply
6. Capacity planning chain group worked with its procure-
ment function to find a way of integrating
This factor is important in order to align the supply of critical components in the
long-term capacity plans between sup- new distribution regime. The cross-
pliers and customers, and to mitigate the functional group quickly recognized that
risks of supply shortages. The bedrock it risked simply pushing large amounts of
point is that there has to be joint planning inventory upstream to suppliers, which
of capacity with suppliers. That activity will would not ultimately deliver the impact
help to determine optimal excess network itwanted.
capacity based on the trade-off between
the costs and benefits of risk mitigation To avoid this, the team sought suppli-
approaches for handling demand spikes. ers that were willing to locate their own
Joint capacity planning will also help both parts inventories in the same distribution
sides to develop alternate sourcing strate- center as the companys, and to deliver
gies. The benefits can be rapid and imme- parts to its production and configuration
diate: we know of a CPG leader that real- lines on a just-in-time basis. This tight
ized a 2 to 3 percent uptick in EBIT after integration allowed the suppliers to keep
planning capacity in collaboration with its relatively low on-site inventories of parts,
suppliers, and thus optimizing the capac- which the company could pull as required
ity of its whole supply chain network. to assemble specific, highly configured
finished goods in response to demand
signals from its customers. (Although
Benefits for both sides this arrangement seems similar to a tra-
ditional vendor-managed inventory (VMI)
In practice, supply chain levers are par- approach, the differentiating factor was
ticularly useful for procurement functions that the setup was operated as a joint
because they typically offer genuine ben- venture, requiring adequate process and
efits for both buyer and supplier. Retailers management controls while ensuring a
can improve demand and inventory plan- mutually agreed sharing of benefits from
ning by giving suppliers access to point- the arrangement.)
of-sale data, for example. This can lead to
smoother demand profiles than the peri- Building on the typical levers of procure-
odic signals sent by store buyers. In turn, ment, the high-tech companys strategic
it allows suppliers to reduce their own capacity planning and footprint design
finished goods inventories, or to run their provided a construct to enable end-to-
production equipment more smoothly, end inventory planning and lead time
creating important cost savings they can optimization across the supply chain.
share with their customers. The results were eye opening: systemwide
inventory fell by 19 percent, the companys
In some cases, closer supply chain col- freight costs fell by 22 percent, and its sup-
laboration has allowed companies to pliers freight costs ended up 14 percent
build whole new kinds of relationships lower. Average lead times approached
with key suppliers. One company in the zero; customer service levels improved
high-tech sector used footprint design from 68 percent to 94 percent. Operating

as a joint venture meant that the com- handle products), and smoother financial
pany could take advantage of unified IT transactions with suppliers (as seen, for
systems, which led to reduction in the example, in the systemic generation and
headcounts of planners/buyers from 27 processing of invoice and related pay-
to 16. The company also experienced a ments between the transacting parties).
significant improvement in EBITa testa-
ment to the impact of the cohesive inte- Lastly, sustainable results will require a
gration of functional organizations. This rigorous companywide effort to ensure that
example was by no means confined to capability building and performance man-
the high-tech sector; it could just as eas- agement not only are institutionalized within
ily have occurred in any other industry. the organizations culture, but that they
include suppliers organizations aswell.

Real impact on EBIT In our experience, many companies launch

initiatives that rapidly achieve short-term
In our experience, the combined applica- value, but they fail to maintain momentum
tion of all six supply chain levers in pro- long-term because cross-functional sup-
curement has the potential to reduce total port drops off, core players are pulled into
inventory levels across the value chain by other initiatives, and new players are not
15 to 30 percent, while also producing trained in time (see sidebar on the follow-
overall EBIT improvement of 2 to 5 per- ing page, Why Procurement and Supply
cent, as shown in Exhibit 3. Companies Chain Dont Talk as Often as They Should).
that apply them well enjoy a host of oper- Companies that succeed over the long
ational benefits too: they gain improved term tend to focus on both performance
agilitysuch as greater responsive- and health, with heavy emphasis on up-
ness to changes in demand mixsim- front training in new tools, processes, and
pler logistics processes (for instance, approaches so they can build up a cadre
transfer of ownership from supplier to of experienced managers who can sustain
customer without the need to manually this effort far into the future.

Typical impact from deploying integration initiatives

Range of possible application Decision making and execution

Capacity planning

Footprint design

Product lifecycle management

Lead-time optimization

Inventory planning

Demand planning

Inventory savings 10-20 10-30 15-30 5-10 15-30 15-30+
EBIT savings 0.5-1 1.5-2.5 2-3 2-5
Exhibit 3

Next steps

We recommend three immediate actions collaboration. (In our experience, the

for companies that want to permanently diagnostic typically takes a few months
sync up the efforts of procurement and to complete.) The final step is to plan for
supply chain teams. Given that cross- execution in multiple waves, target-
functional collaboration is absolutely key ing different parts of the supply chain
in this process, the first step is to achieve and the vendor base. Depending on the
alignment between procurement and complexity of the procured goods port-
supply chain leaderships on the neces- folio and the supply chain, these waves
sity of such an initiativefollowed by can take several months to more than
unwavering sponsorship from those lead- a year to complete. It no longer
ers. While it may sometimes seem too makes business sense for the Procurement
prescriptive, it will be essential to obtain procurement and supply chain teams are good
clear direction from those senior execu- organizations to keep acting neighbors with
tives in order to achieve well-defined independently of one other. In their counterparts
targets within the mandated time frames. todays precarious and highly in supply chain
This will not only define a cross-functional volatile global economy, compa- management. But
objective, but also provide a framework nies need every edge they can they really need to
for alignment and engagement. get. Its clear that those that are become family.
The second step is to conduct a rapid finding ways to align their pro-
diagnostic, led jointly by procurement curement and supply chain objectives
and supply chain, in order to size the and that know how to make alignment
potential of cross-functional collabora- part of their organizational fabricare
tion, followed by vendor ideation ses- already several steps ahead of their
sions to underscore the benefits of that competitors.

Cross-functional trade-off discussions at wrong organizational levels

No discussions Limited to Cross-functional Cross-functional

take place operations at middle level at top level

Increase product portfolio complexity

vs. decrease supply chain costs

Volatile operations yet flexible process

vs. smooth operations with less flexible

Flexible production with idle capacity

vs. mass production without flexibility

Superior customer service vs. cost to

serve enforcement

Supplier consolidation vs. supplier


Centralized production vs. fragmented

manufacturing footprint

SOURCE: McKinsey quarterlyWeb site survey with over 400 executives

Exhibit 4

Why procurement and supply chain

dont talk as often as they should

Intuitively, leaders understand cross- wrong organizational levels (Exhibit 4).

functional issues, but there are three key There is too little recognition of the
reasons why they dont succeed when factors that really enable change,
attempting to address them. and inadequate means to implement
them even if they are recognized. Its
1. Inability to address cross-functional common for there to be too little trans-
trade-offs and maximize value. parency, inadequate performance
Often, senior managers lack the com- metrics, and too few incentives to drive
prehensive perspective and pragmatic true end-to-end integration. Worse:
approaches needed to tackle cross- when middle managers attempt to
functional challenges. Its rare for them resolve issues, they typically fight for
to have systematic methodologies whats best for the function and not for
with which to understand and arbitrate whats best for the company.
among inherent trade-offs. Too often,
their fact bases are incomplete (for 3. Incentives are often misaligned.
example, supply chain planners may Even if procurement and supply chain
order smaller batch sizes because managers do talk with each other,
they lack a clear understanding of their incentives dont often match the
the contracted volume discounts), objectives that they should share.
and they have too few tools to make Procurement may be measured on
an impactfor instance, the kinds of savings from applying traditional pro-
sophisticated tools that can analyze curement levers using a total cost of
total cost of ownership of products, ownership (TCO) approach, while supply
including inventory carrying and chain managers are usually incentivized
ordering costs. Moreover, there may based on service levels, logistics costs,
be only limited links between the and inventory levels. A perfect example
business and the supply chain of such conflict was evident at a large
strategy, and between the supply retailer, where procurement defined vol-
chain strategy and the quality of ume-based supplier contracts that were
supply chain implementation. executed early in a finite financial period
whereas supply chain operations only
2. Dealing with issues in the wrong ordered as needed in order to minimize
forums and without proper enabling inventory levels. This resulted not only
elements. A recent executive survey in increased procurement costs (higher
shows that top cross-functional trade- logistics costs) but also in the loss, later
off discussions still take place at the on, of substantial volume discounts.

Ashutosh Dekhne is a consultant in McKinseys Dallas office, Xin Huang is an associate

principal in the New Jersey office, and Apratim Sarkar is an alumnus.

This article was originally published by Supply Chain Management Review (
and is reprinted here with permission.

CPG-retail collaboration:
The next generation

Andreas Brinkhoff, Luis Benavides, Jochen Gropietsch, Cdric Losdat, and Daniel Swan

Consumer goods retailers and manufac- Based on data from a 2010 survey
turers have many good reasons to collab- conducted together with the Grocery
orate on supply chain topics, but to make Manufacturers Association (GMA) in the
progress, theyll have to improve the way US, more than 80 percent of compa-
such efforts are planned and managed nies are involved in collaboration efforts
and get better at sharing the benefits. today. In a 2012 survey with 140 compa-
nies conducted by Efficient Consumer
With disposable incomes and consumer Response (ECR) Europe and McKinsey,
confidence remaining low across Europe all respondents said they collaborate in
and the US, value-conscious consumers at least one area of their business, and
are continuing to put pressure on prices. more than half said they collaborate in
Meanwhile, costs of commodities and at least six areas. The survey brought
raw materials keep rising. In this environ- to light the collaboration practices of
ment, its no surprise that many consumer 97 manufacturers, 31 retailers, and 12
goods manufacturers and retailers are service providers from 13 European
seeking to collaborate tostimulate con- countries. The goal of the survey was to
sumer demand and control costs. identify the areas in which CPG players
are collaborating, their success in doing
Collaborationpartnering on joint initia- so, the areas in which they hope to col-
tives that extend beyond day-to-day busi- laborate in the future, and the factors that
ness and that aim to deliver significant hinder successful collaboration.
long-term improvement and value for both
partiesoffers a welcome alternative to In this article, we discuss findings on the
price-driven (and at times antagonistic) status of collaboration today and describe
supplier-retailer relationships. Indeed, six steps that CPG manufacturers and
collaboration efforts have grown in popu- retailers can take to boost the chances that
larity since the economic downturn. their collaboration efforts will succeed.

Impact of collaboration on both commercial and supply chain sides

is significant
Commercial areas Increased sales Increased profit

Strategy and calendar for promotions 6.2 3.0

In-store programs/promotions 7.3 4.2

In-store layout/visual merchandising 5.2 4.4

Category management and product
5.3 3.8
Joint innovation 5.8 4.2

Supply chain areas Decreased OOS Decreased cost

Supply chain flows and processes 4.7 5.1

Demand planning and fulfillment 4.1 5.6

Materials and products handling 2.1 3.1

Asset utilization in manufacturing 3.3 4.5

Joint purchasing of raw material n/a n/a

SOURCE: ECR Europe/McKinsey The next generation retailer and manufacturer collaboration survey 2012
Exhibit 1

Areas identified for improved collaboration by survey participants

X Supply chain X Commercial Top collaboration areas

Share of respondents
Collaboration areas Today Near future
1 Supply chain flows and processes 12.1 13.3

2 Demand planning and fulfillment 11.0 13.3

3 Category's product assortment 14.1 12.7

4 Strategy and calendar for promotions 14.8 12.6

5 In-store layout/visual merchandising 14.6 12.4

6 In-store programs/promotions 14.8 11.1

7 Materials and products handling 9.6 9.9

8 Joint innovations 6.7 8.4

9 Asset utilization in manufacturing 1.8 4.2

10 Joint purchasing of raw material 0.5 2.1

Exhibit 2
The rewards can be substantial: our experi- Retailers tend to gain more from sup-
ence shows that successful collaborations ply chain collaboration efforts than their
involving two or three initiatives in a cate- manufacturing partnersabout 8 percent
gory deliver a profit uplift of 5 to 11 percent in cost reduction for retailers versus 2 per-
in that category, through a combination of cent for manufacturers.
increased sales and reduced costs.
The fact that costs and benefits of supply
chain collaborations fall unevenly might not
All collaborations are not equal come as a surprise. A retailer often ben-
efits directly from processes that make it
The surveys underscore some important cheaper and easier to keep the shelves full,
trends that become apparent in our analy- while manufacturers may have to pay more
sis of collaboration in both commercial for such changes, for example, by reducing
areas (such as in-store programs and delivery lead times in the hope that this will
merchandising) and supply chain areas lead to improvements in customer satisfac-
(such as demand planning and materials tion and higher sales over the longer term.
handling). Survey respondents are more
likely to collaborateand see financial Some companies do manage to run suc-
impactin commercial areas: they report cessful collaborations even when the distri-
that successful commercial collaborations bution of benefits is skewed, however. They
boosted sales by approximately 6 percent do this by addressing the problem head
and profits by about 4 percent, and these on and taking a focused effort to identify
benefits were shared equally between the planned benefits and agree upon how
retailers and manufacturers (Exhibit 1). they will be shared. One approach is for
By contrast, although successful supply the winning partner to put a share of the
chain collaborations resulted in an almost achieved savings into a special fund that it
4 percent decrease in stockouts and a then uses to pay for additional joint efforts
cost reduction of nearly 5 percent, those to boost sales or improve performance
benefits were distributed less equitably. elsewhere in the relationship.

Supply chain issue offer opportunities for future collaboration

X Supply chain X Commercial

Collaboration areas of the future Share of respondents

1 Consumer and shopper journey 12.1

2 Advanced collaborative logistics networks 11.9

3 E-commerce/m-commerce 10.9

4 Leveraging digital/social media 9.7

5 Supply chain benchmarking 9.2

6 Waste management 9.0

7 Cross-border logistics 6.8

8 E-category management 6.4

9 RFID and innovative labeling 6.4

10 Innovative unit loads 5.6

11 Store as media 4.7

12 Endless aisle/multichannel inventory mgmt 4.1

Exhibit 3

Collaboration in the future others, the idea of broadening logistics

collaboration not just in the integration of
Turning a win-lose situation into win-win assets, data, and services but also in the
does take effort and persistence, but the number of possible partners both hori-
indications are that companies have an zontally and vertically.
increasing willingness to take on the task.
Our survey demonstrates a widespread Deeper supply chain collaborationon
recognition that improved supply chain optimizing processes, sharing data, and
performance will be critical in both con- building logistics networks togetheris
trolling costs and boosting service in the eagerly anticipated by all the participants
coming years. When asked to identify in our survey, whether they are retailers
the areas in which they were most keen or manufacturers. Now it is time to turn
to collaborate in the near future, survey desire into reality and make those col-
participants ranked supply chain flows laborations happen.
and processes and demand planning
and fulfillment as number one and two
(Exhibit 2). Why collaboration is hard

When we asked respondents to look While a majorityabout 60 percentof

even further into the future at topics that collaboration initiatives in Europe report
they have not collaborated on in the past, substantial financial benefits, the remain-
the continuing importance of supply ing 40 percent failed to deliver impact,
chain collaboration was clear. Although despite the cost and effort invested by
the number one topic was a commercial both parties. In earlier US analyses to
one (consumer and shopper journey), validate the impact of collaboration, only
a key supply chain issue came a very 20 percent have proven sustainable
close second (Exhibit 3). That topic was improvements. In our work helping retail-
advanced collaborative logistics net- ers and CPG manufacturers manage
works, a concept that embraces, among their collaboration efforts, we have seen a

handful of factors that make collaboration be enthusiastic about new promotional

problematic. Some of these will be famil- opportunities, while retailers operating
iar to any organization thats involved in a on thin profit margins may be much more
large-scale change process. Companies interested in taking cost out of product
may, for example, lack the commitment handling and storage. The relationship
they need from senior management to and power dynamics between collabo-
drive the collaborations, or the message rating partners can be dramatically differ-
that the collaboration is important may ent, too. Manufacturers typically will have
be lost in translation as it passes down relationships with a small number of key
through the organization, with the result retailers, while those same retail partners
that middle managers or frontline teams will have relationships with hundreds of
dont show the same enthusiasm and different suppliers.
commitment as their leadership does.
Sometimes companies fail to provide suf- The following case of a major food manu-
ficient resources to make collaborations facturer and a retail chain provides an
work, or they spread limited resources instructive example of how collabora-
too thin over too many initiatives. tion can go wrong when participants
dont trust each other enough. The two
These issues are difficult enough to over- companies agreed to collaborate on
come and are compounded by the fact a cobranded product line. The retailer
that collaboration initiatives must align hoped that the manufacturers brand
two separate organizations. To make the name would boost both the credibility
collaborations work, the players involved and the sales of its product, while the
must navigate differences in organizational manufacturer saw the partnership as a
design and culture. At the same time, a way of increasing its own market share
history of difficult relationships can make within the retailers network.
partners reluctant to share important
information, leading them to work on their The collaborative effort failed to play to
parts of the collaboration in separate either companys strengths, however.
silosa recipe for suboptimal solutions. The retailers rich point-of-sale and
consumer preferences data provided
Finally, the incentives of the different the information needed to develop an
parties involved in the collaboration may accurate profile of its customers require-
be fundamentally misaligned, making it ments, but concerns about sharing that
difficult even for enthusiastic, committed information led the retailer to analyze
staff to make the collaboration work while the data and develop the product speci-
still fulfilling their other targets. These fication itself without the benefit of the
misaligned incentives arise because dif- manufacturers category expertise. The
ferent players in the supply chain may see resulting product was expensive to make
the world in very different ways. A manu- and missed the mark on package size,
facturer, for instance, might want to grow product specifications, and shelf appeal.
its market share by improving its own Sales were disappointing, and within
offerings relative to competitors, whereas months, the partners were forced to re-
a retailer might be interested in increasing assess their relationship.
sales or margins across the category, not
in making changes to the product mix.
Making the right choices
This difference in outlook can mean that
retailers and manufacturers want very CPG companies can greatly improve
different things from the collaboration. their prospects for success by taking a
Growth-focused manufacturers may thoughtful approach to the areas they

6 key steps to successful collaborations

Where to collaborate 1 Collaborate in areas where you have a solid footing

2 Turn win-lose situations into win-win opportunities with the
right benefit sharing models
3 Select partners based on capability and strategic alignment,
not just size

How to collaborate 4 Invest in the right infrastructure and people

5 Jointly manage performance and measure impact
6 Collaborate for the long term

Exhibit 4

select for collaboration, their choice of Potential collaborators should also be

partners, and the way they implement sure they have the right supporting
their collaborations. Based on our expe- infrastructure in place in advance of any
rience, we have identified six essential collaborative effort. Is top management
steps (Exhibit 4) that can make the differ- committed to the collaboration process
ence between a productive collaboration and ready to offer support over the long
and a frustrating one. term? Are in-house IT systems robust
enough to facilitate real-time data sharing
1. Collaborate in areas where you if required?
have a solid footing
2. Turn win-lose situations into
Companies are often tempted to use win-win opportunities with the
collaboration as a way to fill gaps in right benefit sharing models
their own capabilities. In practice, the
most successful collaborations build on Some collaborations promise equal ben-
strengths rather than compensate for efits for both parties. If, for example, a
weaknesses. A manufacturer seeking manufacturer and a retailer collaborate to
to collaborate with a major retailer in optimize product mix, both could expect
order to improve its own forecasting to benefit from the resulting increase in
performance, for example, will have sales. In other cases, however, the col-
little to gain from access to the retailers laboration might create as much value
point-of-sale data unless it has the overall, but the benefit could fall more
in-house analytical capability to make to one partner than to the other. Heres
effective use of that data. Similarly, there one real-life example: a retailer and a
is little point in entering collaborations to manufacturer were able to reduce overall
boost sales if any increase in demand is logistics costs between factory and store
likely to run into manufacturing capacity by cutting out the manufacturers distri-
constraints. bution centers and treating the retailers

distribution network as one integrated 3. Select partners based on capa-

supply chain, from manufacturing plant bility and strategic alignment,
to store shelf. However, the retailers not just size.
supply chain executives struggled to
gain acceptance for the idea from their The biggest potential partner might not
leadership because it resulted in the be the best one. Many companies aim
retailer carrying a far larger fraction of to collaborate with their largest suppliers
the logistics cost. or customers because they assume that
the greatest value is to be found there. In
Rather than shying away from such many cases, however, this turns out not
asymmetric collaborations, smart com- to be true. Collaboration may be of more
panies can make them work by agreeing interest to a smaller partner, which might
on more sophisticated benefit sharing invest more time and effort in the pro-
models. These can come in the form of gram than a very large one that is already
discounts or price increases to more juggling dozens of similar initiatives.
fairly share increased margins or cost
reductions, or they can involve com- A better approach is one that assesses
pensation in other parts of the relation- current customers or suppliers across
ship. For example, when one retailer three key dimensions. First, is there
collaborated with a manufacturer on enough potential value in collaborating
a cobranded product line, the manu- with this partner to merit the effort? Both
facturer agreed to absorb the up-front partners in a prospective collaboration
product development costs in return need to be sure that it will deliver a suf-
for an expanded share of the retailers ficient return to justify the up-front invest-
product offerings across a wider set of ment. Second, do both partners have
categories. sufficiently common strategic interests
to support the collaboration? A retailer
Benefit sharing can help to overcome that has prioritized growth in a particular
differences in strategic priorities, too. region or segment will have more to gain
One growth-focused manufacturer was from collaborating with a manufacturer
persuaded to join a supply chain waste that has a strong offering in the same
reduction collaboration with a retailer by area. Third, does the partner have the
establishing an agreement to deposit right infrastructure and processes in
part of the savings both companies place to provide a basis for the collabora-
achieved into a joint pool, which would tion? Collaborating to improve forecast-
then be invested in efforts to generate ing and demand planning is likely to be
additional sales. frustrating if one partners existing plan-
ning processes, systems, or performance
Similarly, in the product flow improve- are inadequate.
ment case described in Making it work
in practice, the manufacturer provided 4. Invest in the right infrastructure
the up-front investment in new retail- and people
ready packaging, while its retail partner
reaped most of the benefits of increased Both manufacturers and retailers that
availability and reduced labor costs. The participated in our research cited a lack
two companies established a joint ben- of dedicated resources as one of the top
efits pool and agreed to use a percent- three reasons for the failure of collabora-
age of the savings to fund future cost tion efforts. Companies frequently under-
reduction efforts and a sales improve- estimate the resources required to make
ment program. collaborations work, assuming that staff in

various functions can do whats required retailer. This team will also be responsible
in addition to their other responsibilities. for the day-to-day monitoring of the effort
once it is up and running.
In practice, even relatively simple col-
laborative tasks will be more difficult than Execution of the collaboration should
equivalent activities conducted within the take place within the line organization and
walls of the organization. Thats because will ultimately form part of the everyday
staff must overcome differences in cul- responsibility of the staff assigned to it.
ture, organization, and terminology, not to The best companies avoid forcing their
mention the basic challenge of finding the frontline staff to reinvent the wheel by
right contact within the partner organiza- providing strong support when establish-
tion with whom to liaise. ing each new collaboration. They may,
for example, leverage experience gained
Disconnects within one organization can in previous collaborations by setting up
create problems, too. A grassroots col- teams to support their colleagues during
laboration started between two supply the initial phase of subsequent efforts.
chain managers can lead to rapid perfor-
mance improvements, only to be snuffed 5. Jointly manage performance
out when those higher in the organization and measure impact
fail to understand the initiatives poten-
tial. Alternatively, a collaboration agree- An effective performance management
ment made between two board-level system helps a company to ensure that
executives will fizzle out if the managers any long-term project is on track and
responsible for executing it think it is yet delivering the results it should. In supply
another short-lived senior management chain collaboration efforts, both partici-
whim, if they cant see how the collabo- pants should use the same performance
ration will help them achieve their own management system. By building com-
objectives, or if they lack the incentive to mon metrics targets and jointly monitor-
put additional effort into the project on ing progress, companies avoid the mis-
top of their existing day-to-day roles. aligned incentives that damage so many
collaboration efforts. Picking the right
To prevent both of these problems, best- metrics can be challenging, however,
practice companies devote extra resourc- and it will inevitably involve trade-offs. In
es to their collaborations, particularly in a collaboration to reduce logistics costs,
the early stages of a new relationship. for example, the partners may have to
Appropriate infrastructure for a success- choose between a pallet configura-
ful collaboration begins at the top of the tion thats optimized to suit a retailers
organization, with a steering committee restocking processes, which will reduce
of senior leaders who can set the defining in-store labor costs, and one that opti-
vision for the collaborative effort and allo- mizes truck fill, which will reduce trans-
cate resources to support it. The detailed portation costs from distribution center to
design of the collaboration program is retail store.
then completed by a team that comprises
members of all relevant functions from How to overcome these potential con-
both partners in the collaboration. The flicts? The trick is to keep things simple
team for a demand planning effort, for by picking the smallest possible number
example, should include members from of metrics required to give a picture of the
sales, finance, and supply chain for the collaborations overall performance, and
manufacturer, and from purchasing, mer- then to manage those metrics closely,
chandising, and store operations for the with regular joint reviews and problem

solving sessions to address trade-offs. term objectives and identify initiatives they
The real power of any performance can work on together over time. Such
management system comes from this planning helps companies to break out of
frequent, robust dialogue between part- the short-term-project mentality that can
ners, yet this is also the element most limit the beneficial impact of collaboration.
commonly ignored or underemphasized Nevertheless, partners must also ensure
by collaborating companies. that they are doing everything they can to
capture any available quick wins, so the
6. Collaborate for the long term collaboration starts delivering value as
quickly as possible.
The final vital ingredient of a successful
collaboration is stamina. It may take time When companies take a long-term
and effort to overcome the initial hurdles perspective, their collaborative efforts
and make a new collaboration work. Both can become a virtuous circle: a greater
parties need to recognize this and build understanding of each others capa-
an appropriate long-term perspective into bilities, knowledge, and costs will often
their goals and expectations. This means reveal new potential sources of value,
including metrics that review performance while the experience of working closely
beyond the first year, as well as conduct- together means that later initiatives will
ing joint, long-term planning so both part- take less time and be easier to execute
ners can understand each others longer- than early ones.

Making it work in practice

It should be clear by now that success- categories, the company established

ful supply chain collaboration is neither joint sourcing programs with manufac-
quick nor simple. But is it worthwhile? The turers to purchase key commodities for
answer has to be an emphatic yes. The both its own private label products and
following are some examples to this end: the manufacturers brand name items.
Collaborations have included the sourcing
A beverage manufacturer and a retailer of potatoes for chips manufactured in the
collaborated to improve demand planning US and sugar for soft drinks manufactured
and fulfillment. Prior to the collaboration, in the UK, with the latter effort securing a
the retailers ordering process did not 14 percent cost saving.
match changes in consumer demand,
with the result that shipments from the Finally, the case of a retailer and food man-
manufacturer fluctuated twice as much as ufacturer shows how collaboration can
did retail sales. To avoid stockouts under work to dramatically improve product flow
this regime, both the manufacturer and the efficiency. The manufacturer produced
retailer were forced to keep high levels of packaged foods in a large assortment of
inventory on hand. flavors, making it difficult for its retail part-
ner to manage inventories across the cat-
Working together, the manufacturer and egory. This required time-consuming and
retailer agreed on a joint forecasting and labor-intensive efforts to keep the shelves
demand-analysis system. They improved stocked.
their information sharing, toothe retailer
gave the manufacturer access to its on- The two companies tackled these issues
shelf availability data, which allowed the by developing retail-ready packaging that
two companies to modify product distri- made it easier to keep the shelves stocked
bution to maximize availability in individual while also optimizing the way delivery
stores, while the manufacturer informed trucks were loaded. The new packages
the retailer about supply constraints that were designed to fit into jointly developed
might limit its ability to meet high levels of in-store display units that held more prod-
demand at short notice. The partners also ucts and made items easier to find than
agreed to stagger promotional activities the conventional shelves they replaced.
among regions to reduce overall demand As a result, the average time it took con-
peaks. The introduction of the new system sumers to select an item dropped from
cut shipment volatility by one-third, allow- 58 seconds to just 8 seconds. The com-
ing both the retailer and the manufacturer panies then changed the replenishment
to achieve inventory reductions of more system to accommodate the new display
than 15 percent and increase profit mar- units. They segmented various retail sites
gins by three percentage points. by volume, velocity, and volatility, and then
optimized shipment sizes and replenish-
Another area for fruitful collaboration is ment frequency for each segment. For
sourcing. One large US retail chain has the highest-velocity stores, the partners
used collaborative sourcing to great effect introduced a rapid replenishment program
across a broad range of categories and in which deliveries were timed to coincide
geographies. In an effort to combat rising with peak selling days.
raw materials prices in key

Andreas Brinkhoff is a consultant in McKinseys Cologne office, Luis Benavides is a principal in

the Miami office, Jochen Gropietsch is a principal in the Barcelona office, Cdric Losdat is an
associate principal in the London office, and Daniel Swan is a principal in the Chicago office.

Capturing value
from supply chain
management IT
Per-Magnus Karlsson and Markus Leopoldseder

Leading fast-moving consumer goods make the best use of new tools and tech-
(FMCG) manufacturers have made signifi- nologies as they emerge.
cant investments in supply chain manage-
ment IT systems, but these investments
havent always delivered the expected Capturing value from supply chain
returns. To get the most from such sys- management IT solutions
tems, organizations have to adapt to new
ways of working and be prepared for con- For FMCG companies, one common posi-
siderable fine-tuning after they go live. A tive result of the money and time invested
host of new technologies is emerging too, in ERP and supply chain management IT
but companies need to think hard about projects is an unprecedented level of sup-
how these will fit with their current and ply chain transparency and data integration.
future supply chain strategies. Disappointingly, however, this technical
progress has not always resulted in tangible
The consumer goods industry is a fiercely operational performance improvements or
competitive environment strongly influ- bottom-line impact. There is plenty of evi-
enced by changing retailer and consumer dence among consumer goods companies
expectations. Over the past decade, many that supply chain management IT invest-
of those changes have had a direct effect ments have not yielded the expected return.
on supply chain practices. Retailers are Projects often take longer than expected
demanding lower prices, smaller and more to implement, cost more, and deliver less.
frequent deliveries, more frequent promo- Understandably, senior executives are
tions, and improved on-shelf availability. At pushing hard to capture greater returns
the same time, consumers ask for environ- from their investments. Our research and
mentally certified products, greater choice, client experience has revealed three suc-
frequent product updates, and better value cess factors shared by organizations that
for money. have managed to do this well.

The inherent conflict between these Organizational capabilities

demands and supply chain efficiency
means supply chain metrics such as work- The end-to-end optimization enabled by
ing capital, service levels, and overall sup- an integrated planning solution requires a
ply chain costs are under increasing pres- corresponding organization to implement
sure. More frequent deliveries imply smaller those plans. If decision making along the
trucks or lower fill rates. SKU proliferation supply chain is siloed in various sales,
implies increased planning complexity and production, and supply management func-
increased demand volatility. Increased tions, then execution on the ground rarely
promotional activity is also a strong driver succeeds in capturing the potential of the
of demand volatility. Unless other process original integrated plan.
improvements are found, stock quantities
will creep up to safeguard service levels. Capability requirements have also changed
significantly. Supply chain management
These circumstances call for a review of solutions can allow companies to free up to
supply chain strategies, and of the IT tools half their planning capacity. The planners
that make those strategies come alive. For they do use, however, must have a deep
FMCG companies, key questions include understanding of both their functional area
whether they are currently using the right and the supporting IT solution.
tools to support their evolving supply chain
processes, whether they are implementing Typical introductory training in key user
and running those tools in the most effec- concepts is not sufficient. Advanced supply
tive way, and whether they are prepared to chain mangement planners should not shy

away from becoming system expertsand more transparent and traceable for
they must get support from their manage the supply chain planner, which helps
ment to do so. Learning can also be accel- increase acceptance of the supply
erated through participation in groups that chain management software solution.
bring together advanced users from dif-
ferent industries to share experiences and Data accuracy. To deliver their full
best practices. This effort is rewarding: potential, integrated planning applica-
once a companys staff has seen a true tions require a high level of data qual-
expert seamlessly conduct the mighty ity. Too often, however, safety stock
supply chain orchestra from a planning parameters, planning lead times, or
application, they will be reluctant to return planned capacities deviate from real-
to their old ways. ity soon after system implementa-
tion. These parameters must be fully
System tuning understood in detail (and not only by the
implementation consultant),
While it is usually a significant effort to reach actual values must be monitored, and
the go-live day for a new IT system, the an appropriate organization needs to
mindset that the mission is accomplished be put in place to take care of planning
at that point leaves considerable value data. A good practice is to track the
on the table. In practice, much of the real accuracy of parameters through KPI
implementation work actually starts when style portals to create transparency and
the new system is used in real day-to-day to make individuals accountable for the
work. Many projects would benefit if more accuracy of those parameters.
of their budget were allocated to tuning
activities for the live system. Common Complementary solutions
improvement areas include:
No single IT solution off the shelf can offer
Planning stability. Many advanced best-practice processes or the best pos-
planning systems suffer from major sible results for every company in every
instability in the results they produce. industry sector. While extensive custom
Plans are optimized, but every planning development is not a replacement for the
run produces a new optimum, some- organizational changes, capability build-
times as a result of minimal changes ing, and system tuning described above, it
to input variables. Stakeholders along is our experience that a truly useful supply
the supply chain quickly come to dis- chain management IT backbone usu-
trust such volatile plans and will start ally requires smart, custom-developed
to ignore them. There are dozens of planning functions and selective use of
parameters that need to be understood best-of-breed software solutions, all tightly
and controlled in order to drive stabil- integrated into the main system. In this
ity, from consumption forecast rules to respect, supply chain planning differs from
averaging periods and supply freezing other, more transactional functions of ERP
horizons. systems, where rigorous standardization is
often key to success.
Differentiation. One-size-fits-all
planning approaches need further We have observed the greatest opportuni-
segmentation. Examples include dif- ties for complementary solutions in the
ferentiating between automatically and areas of demand planning, S&OP (Sales &
manually planned products/locations Operations Planning), and transportation
or replacing complex integrated plan- planning and execution. These areas all
ning logic with simpler pull loops where require functionalities that many ERP ven-
appropriate. Doing this makes results dors have been slow to develop,

leading to a comparable advantage to should watch out for synergies

smaller specialist vendors. between marketing and supply chain
forecasting analytics. In fact, similar
analytics, interests, and approaches
Three emerging technology may bring those historically separated
opportunities in supply chain IT worlds closer together than ever.
for consumer goods
Processes need to be redesigned
Even as companies struggle to get the best to become more collaborative in
performance out of existing IT solutions, nature. With perfect joint visibility,
new technologies are emerging fast. For should the retailer forecast, should the
FMCG supply chains, we see three areas consumer goods company forecast,
of particular importance: new tools to should both parties forecast separately,
structure, analyze, and extract value from or should there be as collaborative fore-
vast amounts of increasingly available data, casting process? Who has the stron-
advanced analytics to drive real improve- gest forecast accuracy historically?
ments in forecast accuracy, and real-time How should fulfillment be triggered?
S&OP processes to capture the full impact While companies have experimented
of those improved forecasts. with collaborative planning forecast-
ing and replenishment for the past 15
Using big data to drive collaboration yearswith mixed resultsbig data
availability gives the concept a powerful
Leading retailers increasingly share a new push. Creating the right joint busi-
wealth of data with their suppliersand ness process around joint information
expect them to use it to improve supply is what ultimately will create the value
chain efficiency. Walmart, for example, between the consumer goods com-
shares point-of-sale demand, warehouse, pany and the retailer.
and store level inventories, and expects
suppliers to improve their store-level prod- Advanced forecasting analytics
uct availability. Tesco and Coles started
sharing supplier shipment forecasts in While many consumer goods organiza-
addition to PoS demand forecasts. Several tions have made strategic choices for their
retailers are experimenting with electronic demand planning software, only a few have
stock-out detection in stores and will share already exploited the full analytical power
their results with suppliers. The resulting available. There is untapped opportunity
enormous volumes of data are commonly to enhance forecast accuracy by using the
referred to as big data. There are two criti- most advanced forecasting technology
cal steps to make use of them: available today. Key levers to look for more
advanced tools include:
Big data needs to be structured and
made transparent. To do this, retail- A rich library of algorithms. Different
ers and consumer goods firms need demand patterns require different sta-
to create a shared data layer that holds tistical forecasting models to deliver a
data relevant to both, such as granular good forecast. Forecasting tools need
POS data, stock levels, their respective a rich library of forecasting models, as
forecasts, and planned promotions. well as the capability to enhance cur-
A number of smaller software vendors rent models and build new ones.
already specialize in providing solutions
to make data available for supply chain Automated model selection capa-
planning, marketing, and bilities. With a library of roughly
commercial analyses. Companies 30 different and exotic forecasting

models, even forecasting specialists Data integration. The tool should

will need decision supportpreferably help ensure that everyone is working
automatedto select the right forecast- towards the same objectives. It should
ing model for the given demand pattern. be able to integrate plans from different
organizations (manufacturing, supply
Causal data streams. By providing the chain, financial budgets and forecasts,
model with more demand-correlated sales forecasts, market mix modeling,
data (e.g., weather, price, social data), etc.) into the S&OP consensus plan-
forecasting accuracy can be greatly ning framework, then push back the
improved. There are endless oppor- agreedupon plan into the planning
tunities to experiment with new data tools used by individual business units.
sources, like the data mining of social
media. Real-time demand/supply balanc-
ing. New in-memory planning tech-
Attribute-based forecasting. For nologies allow a radically new approach
new products with no demand history, to planning. Instead of having to wait for
statistical forecasting engines typi- planning results from nightly batch pro-
cally struggle. A way to overcome this cessing runs, new technologies allow
is through attribute-based forecast- interactive plan optimization and sce-
ing, where demand is forecast based nario evaluation. Leading companies
on a set of attributes associated with have already started transforming their
an item. In consumer electronics, for regular S&OP process cadence into
example, these might include screen real-time planning capabilities.
size, memory, and processor speed.
Companies use information on existing Process and decision management.
items that share some of these attri- Cross-functional planning processes
butes to build an artificial demand his- need a great deal of alignment. This is
tory and improve forecast accuracy for especially true for increasingly global
the new item. planning activities like S&OP. Beyond
pure analytics and data management,
Real-time business optimization process management and S&OP deci-
sion making have to be supported by
While most consumer goods companies work flow systems that are deeply inte-
have some sort of S&OP process in place, grated with planning applications.
few have considered how software can
improve that process. Frequently S&OP
processes are supported by spreadsheets,
e-mails and slide presentations, with all Advanced IT systems can help consumer
the associated limitations of such a data- goods companies meet many of their cur-
intensive and collaborative process. As a rent and emerging supply chain challenges,
result, consensus plans are not securely but getting full value from such systems
managed, stored and monitored for perfor- requires considerable care in selection,
mance, and S&OP processes start to lose implementation, and tuning. Companies
momentum. Appropriate S&OP software also need to integrate their organizations to
support can address these shortcomings match the end-to-end capabilities of their
by accelerating the process and increase systems. These challenges will only inten-
both its rigor and the degree of analysis sify as a new generation of advanced col-
used. The key aspects that companies laboration, analysis, and optimization tools
need to address with S&OP technology are: becomes available.

Per-Magnus Karlsson is an expert in McKinseys Stockholm office, and Markus Leopoldseder

is director of knowledge for supply chain management and is based in the Vienna office.

When a plan
comes together

Luis Benavides, Nitin Khanna, Hendrik Kohleick, Frank Snger, and Daniel Swan

Cooperation is a hot topic for manu- Smaller inventories. Demand-based

facturers and retailers today. ECR Europe production plans help avoid over-
(a European organization of retailers and stocking and write-offs of unsold
manufacturers that promotes collabora- merchandise without endangering
tion) gives further proof to that: 59 percent availability.
of the companies surveyed engage on
collaboration across a broad series of Fully stocked shelves. Supplying
topics. And partners teaming up from the goods to retailers faster and in line with
consumer goods industry and retail have demand minimizes both stockout
long since moved beyond their initial focus situations and administrative work.
on promotions or assortment optimiza-
tion. Instead, far more survey participants Fewer returns. Optimally coordi-
named a better coordinated supply chain nated logistics between the partners
as their number one priority to tap sales improves truck routing and utilization
and cost potential in the coming years. and lowers the number of returns.
They see working together to plan and
shape demand and improve product avail- Advances along a broad front. In
ability as their most important goal, and time, more intensive sharing and closer
also want to exchange planning, inventory, relationships between manufacturers
and sales dataideally in real time (see and retailers bring further progress in a
sidebar at end). range of areas (such as joint efforts to
further develop products, plan catego-
Just a few years ago, most industry play- ries, and design store layouts).
ers would have dismissed the idea that
retailers and manufacturers could share
data this intensively, arguing that such Retailers take the lead
a level of cooperation was technically
impossible, involved too much effort, or The ECR study shows where companies
simply cost too much. But in the mean- pursue collaboration, they can boost avail-
time, this vision has become a reality. ability by 3 percent on averagewhile low-
Thanks to rapid advances in information ering supply chain costs by 6 percent and
technology, companies can now collect increasing sales by the same share. And in
enormous amounts of data automatically many cases, the results are even better.
at almost every point along the value chain
and process it in seconds. For example, The prospect of such improvements has
a manufacturer can potentially check its spurred a number of companies to take
production volumes and delivery capacity action. Retailers in particular are asking
against a retailers real-time forecasts of suppliers to draw more heavily on their
customer demandproviding a far better data for joint planning. As a result, they
basis for planning. Capabilities like these are providing their suppliers with vast
make improvements possible along the amounts of information, including register
entire supply chain: records and demand forecasts updated
daily. In exchange, they expect to see
Fact-based decision making. Greater improvements on distribution and ser-
transparency when it comes to vice. Three examples illustrate this:
demand data, inventory, and priorities
enables better decisions when avail- 1. Back in the 1980s, Walmart tested
ability issues occur or inventory runs early cooperation approaches with
short. The advantages are especially Procter & Gamble that involved shar-
clear in exceptional circumstances or ing register and demand data. Today,
periods of increasing volatility. with its Retail Link system, Walmart

provides all suppliers worldwide with Fact-based planning for future

access to weekly forecasts of point- promotions
of-sale demand, store and warehouse
inventories, and service levels along Opportunities clearly exist for retailers, but
the supply chain for every article. As whats happening on the manufacturer
a result of this transparency, the focus side? Exhibit 1 shows how consumer
throughout supply chain management goods companies can put greater supply
shifts from the service level of manu- chain transparency to work for them. Many
facturer warehouses to availability are increasingly using IT tools to crunch
instores. the data more easily and quickly, so they
can identify causes of recurring availability
2. The UKs Tesco and the Australian problems throughout the entire supply
retailer Coles have been using online chain and eliminate them. In working with
portals since 2012 that not only provide retailer data this way, manufacturers are
forecasts of point-of-sale demand, but therefore less oriented toward meeting sta-
alsothanks to backward planning ble demand than toward anticipating devia-
show when manufacturer deliveries will tions due to promotions, product launches,
likely be necessary. Armed with this and the like. For example, these tools help
knowledge, suppliers can create bet- in situations such as estimating demand at
ter demand and production plans, and the store level to better plan future product
even get an advance view of the trans- rollouts. They also enable decision makers
port capacities they will need, lower- to quickly evaluate those that are under-
ing inventories and logistics costs. way, so they can swiftly adjust demand
Finally, a detailed view of the expected planning and marketing activities. Even the
increase in volumes through promo- impact of promotions on demand can be
tions and the amounts sold to date analyzed, with the results flowing into future
leads to significantly higher availability promotion planning. Furthermore, the tools
and fewer left-over promotional items. provide detailed tracking of the demand
and inventories along the full value chain,
3. C arrefour and other French retail minimizing outdated overstock.
companies, in turn, rely on VMI. In
France, more than half of the overall Other no less important tools analyze
volume of consumer goods is deliv- stockout situations and their causes, creat-
ered to retailers using this process. ing the fact basis required for availability
A more advanced version involves boosting initiatives. Analytical planning
joint VMI for several manufactur- software like demand-sensing solutions
ers, who transport their goods to forge an even closer link between manu-
their retail customers warehouses facturers and their customers supply chain
in shared trucks. In this approach, data. The benefits that result include better
the VMI system provides rough order forecasts of short-term demand.
volumes, which are later adjusted to
optimize truck utilization. Solutions with similar functions are also
currently being developed and deployed
Among German retailers, Metro and the in marketing managementalthough to
dm drugstore chain provide the most somewhat different ends. Since sharing
extensive supply chain data to their sup- data and tools can pave the way for an
pliers. However, far less use is made of integrated approach, companies in these
this data in Germany than in other coun- cases likewise face the organizational
tries, meaning theres plenty of improve- challenge of creating a closer connection
ment potential for German companies between planning on the marketing and
tocapture. supply chain sides.

Manufacturers can process retailers supply chain information by using

one of the following 3 approaches
Retailer Manufacturer

Manual analysis Manufacturer

of retailer data Retailer planning
portals systems

Analysis using Manufacturer

consolidation Retailer planning
software portals systems
Selected software providers
Retail solutions
Retail right
Accelerated analytics

Integrated Manufacturer
Planning planning
planning Retailer
solutions systems

Selected software providers

Terra demand sensing
Retail solutions
Exhibit 1

Next up, manufacturers: time, as well as joint planning of demand

how it works and promotions in a clearly defined pro-
cess involving mutually available data.
What exactly should makers of consumer In addition, they would need to optimize
goods do next, and how can they work inventory and ordering parameters and
with their customers to achieve joint investigate options for improving the entire
improvements as they do it? The real-life flow of goods. Then both companies ana-
story of one cooperative effort provides a lyzed existing capabilities and processes:
good example. A global food company and What data were they already sharing, how
a leading international retailer were both often did they share it, and what was its
dissatisfied by the lack of transparency level of quality and detail? To what extent
and rigor in their relationship. Established was this data actually used in planning
processes were lacking, a great deal of processes? What coordination and other
available data was not adequately con- contact takes place between the two
sidered during planning, and the service parties? At the end of this step, a highly
level as a whole was simply not up to par. detailed concept had already taken shape
In response, the food manufacturer initi- and could be discussed with the retailer,
ated a collaboration effort with a twofold who responded positively.
objective: to boost data transparency and
sharing, and to establish a standard pro- In the second step, the food company
cedure linking this shared data with a joint reached an agreement with the retailer
integrated planning process. The partners about the collaborations objectives,
achieved this goal in three steps. methods, and general framework, and
developed the idea in more concrete
First, they defined in detail what the joint terms. Then a rough collaboration plan
collaboration effort would require. was drawn up and refined in a series of
Essential elements included access to the workshops. During this phase, the focus
retailers supply chain data in close to real was to quickly reach a consensus on key

points and get both sides thinking about Win-win: Both partners profit
the project in terms of win-win solutions.
In this way, the two companies laid the The main reason that the work on the
foundation for a successful collaboration: new planning process went so well was
a project team with committed experts that all relevant functions and stakehold-
from every area, a collaborative mindset, ers from both sides were involved. People
and performance indicators that made it from throughout the food company con-
possible to measure how well they were tributed their expertise: the sales team
doing (in terms of service level at various contributed its market insights, contact
points of the supply chain, with inventory with the retailer, and long-term strategic
requirements and even penalties for miss- perspective; the planning team its techni-
ing targets). The success of this part of the cal know-how, modeling capability, and
process was largely due to the manufac- data on historic trends; and the customer
turers concept, which was detailed while service team its experience of both the
still leaving the retailer opportunities to retailers ordering behavior and its own
shape the program. companys supply chain performance.

Now the point had come to draft the new The new process has now been exten-
process, along with the tools and tem- sively tested and has proven its value for
plates it required. The most important both partners. The food manufacturer
end product of this design phase was was able to turn around an originally
a detailed planning process for the next tense customer relationship: thanks to
30, 60, and 90 days because the advan- the collaboration, each company now
tages of data transparency are only real- values and appreciates the other. The
ized through rolling plans based on these service level also jumped, with product
intervals. Throughout this process, an availability at stores reaching 98 per-
Excel-based tool brings all the critical data cent. Most importantly, both companies
together to provide a comprehensive view achieved ambitious growth targets in a
of the situation. The food company and generally slow-growing category.
retailer also agreed to regular meetings
with a fixed agenda. The information and
approach needed to reach the objective
were even specified for each agenda point. This example demonstrates three points.
First, even large international manufac-
The partners completed all this prepara- turers and retailers have only begun to
tion within just three months. Then they exhaust the tremendous potential that
piloted the new planning process to adjust closer collaboration offers. Second, tap-
or refine individual elements and instru- ping this potential takes less time and
ments before both companies codified effort than many companies assume. And
them into standard procedures and car- third, both sides profit enormously over
ried them over to other aspects of their the long term from the improvements that
collaboration. such a collaborative project brings.

ECR Europe: Survey on

partnerships in the consumer
goods sector

In a joint study, McKinsey and the con- At the same time, about 40 percent
sumer goods/retail network ECR asked of all initiatives fail to meet their goals
140 retailers and consumer-goods com- because the partners lack the willing-
panies in 13 European countries about ness, persistence, or skills to make
the status, impact, and outlook for man- cooperation work, or because they
ufacturer-retailer partnerships, as well as cant agree on how to share data or split
what makes them successful. The main up the profits.
findings: while many European retailers
and manufacturers are already working The study also shows that the focus of
together (59 percent), the level of coop- such partnerships is undergoing a shift.
eration still lags far behind that in America Most efforts until now have centered
(95 percent). Furthermore, successful on topics at the interface of sales and
efforts bring considerable sales growth purchasing. In the future, improving the
(6 percent on average for both parties), supply chain will play a greater role, as
reduce supply chain costs (7 percent for companies work together to plan and
retailers and 2 percent for manufacturers), meet demand and optimize supply
and boost availability (6 percent for retail- route processes.
ers and 3 percent for manufacturers).

Luis Benavides is a principal in McKinseys Miami office; Nitin Khanna and Hendrik
Kohleick are alumni; Frank Snger is a principal in the Cologne office; and Daniel Swan
is a principal in the Chicago office.

The next horizon for

logistics and networks

Agility: A response
to the volatile world

Raoul Dubeauclard, Kerstin Kubik, and Ulf Schrader

Agility has become a core operational skill ranging from political uprisings to natural
for pharmacos, one that will confer a signif- disasters are posing challenges to phar-
icant competitive advantage. Pharmacos macos increasingly globaland fragile
need to become agile so that they can supply chains. Indeed, in a recent survey
respond to increasing volatility and uncer- of manufacturing companies across
tainty in global supply chains and markets. industries, 80 percent of respondents
However, most companies say they arent said they believed the level of uncertainty
becoming as agile as they need to be. In is rising.1
fact, companies often struggle to decide
where to build agility and how to make the A wide range of trends can worsen the
right trade-offs between the costs and severity of uncertaintys impact on
benefits of agility. Pharmacos can become pharmacos. Complexity in operations
agile by understanding the effects that has increased as pharmacos have
uncertainties have on operations, by build- expanded their product ranges and lines
ing agility across functions, and by includ- and entered new markets. Local market
ing the abilities to detect and respond to requirements and global production
volatility among their core capabilities. strategies have added to the manage-
ment challenges. Pressure on working
capital is increasing the need to finance
The case for agility new drug pipelines and acquisitions.
Emerging markets are increasingly
Pharmacos have become all too familiar important to the business, but these
with the rising number of disruptions and markets have more volatile demand
increased uncertainty and volatility affect- (especially as tendering has increased)
ing supply chains. And it is not a matter and less mature distribution channels.
of concern for the supply chain function Pharmacos are managing more generic
alonein addition to impeding the delivery drug launches each year that have uncer-
of life-saving drugs, these issues threaten tain timing and demand. Furthermore,
the performance of the whole enterprise. Yet public health officials expect pharmacos
few companies are responding to this new to rapidly ramp up new supply chains in
reality by systematically implementing agile response to pandemics and epidemics
operations and enterprise risk management. so that they can provide millions of vac-
cine doses. And payers have pushed to
Its time for pharmacos to move agility from achieve cost savings through regular ten-
nice to have to the center of the opera- ders and rebate contracts for generics.
tions arenamaking it a core enterprise
capability that, in volatile times, will differ- Adding to these uncertainties and
entiate the champions from the laggards. potential shifts of market share, some
Doing this effectively requires specific regulators have imposed import bans.
processes and capabilities for detecting For example, in 2009, the FDA banned
uncertainty, the incorporation of agility into imports into the US of drugs produced by
operations functions and processes, and the Canadian manufacturer Apotex. The
strong leadership from top management. company estimated that it lost sales of
$520 million as a result. In 2013, the FDA
banned the import of products made by
Worrisome trends, but an the Indian generics manufacturer Ranbaxy
inadequate response so far at its new factory in the Punjab region of
India, causing a 30 percent drop in the
In recent years, the level of uncertainty companys share price overnight. This was 1 Survey of 42 global companies
during McKinsey Global Agile
has increased throughout the global the third time the companys imports had Manufacturing Conference,
business environment. Disruptive events been blocked in the US since 2008. Munich, June 5, 2013.

Fortunately, pharmacos can improve their with patient demand. It defined one owner
ability to respond to uncertainty. Leading for each planning loop and systematically
companies are rising to the challenge by challenged demand figures by flagging key
becoming agile. Companies with agile changes or inconsistencies and deploy-
operations have the ability to sense, ing scenario planning. By setting the right
assess, and respond to uncertainty planning frequency and alerts, it was able
allowing them to both mitigate downside to trigger appropriate action throughout the
risks and capture upside opportunities in a entire supply chain. A sales and operations
fast, flexible, and cost-effective manner. planning governance process facilitated
management decisions on critical issues
As an example of the innovative ap- and bottlenecks. This focus on end-to-
proaches to dealing with increasing end planning led to a 5 percent increase
uncertainty, one pharmaco recently set in revenues and a 30 percent reduction of
up a postponement operation in a central supply variability. It also put the company in
hub in Europe with unpacked blisters ready a better position to respond to any sudden
for final language and pack-size custom- increases in demand due to epidemics.
ization. This approach enabled the phar-
maco to dramatically reduce lead times Although many companies recognize
and achieve up to a 50 percent reduction the need for agility, most say they arent
in safety stock, which in turn allowed it to becoming as agile as they should. Only
nearly eliminate obsolete products. about a quarter of the executives we sur-
veyed told us that agility was a priority or
Another pharmaco increased revenues and an integral part of their operations agenda.
agility by implementing end-to-end supply And the vast majority85percentsaid
chain planning. The company defined three that their company was not improving the
clear planning loops to ensure that each agility of its operations enough (Exhibit 1).
part of the value chainmaterials, supplies, Indeed, in a recent assessment of supply
drug substance production, and finished chain agility in dimensions such as demand
product replenishmentsynchronized shaping, integrated planning, and inventory

Despite the need and impact, most companies say they arent improving
as much as they should

Most clients are working on agility but not to the extent they feel they should

Do you think your company is investing enough How much is your company improving the
in building agility? agility of its operations?
Percent of respondents; n = 33 Percent of respondents; n = 26

Not at all 0 Not at all 8

27 Some, but 85
Some, but it is minimal
not enough
We are improving our
About the
agility, but it is not a 45 8
right amount
Agility is an integral part Somewhat
18 0
of the operations agenda overinvesting
Agility is a priority
and we have dedicated 9 0
resources to it

SOURCE: McKinsey Agile Operations WebEx, July 19, 2012

Exhibit 1

Pharma shows a spike on postponement, Most important pharma levers

but lags behind in all other dimensions

of level in
Supply chain agility pharma 1 2 3 4 5 Top industry
Reduce Best-in-class forecasting High tech
and risk Demand shapping Machinery and industrial foods
Risk management Telco

Build Postponement and modularization Pharma

agility into Integrated planning and collaboration High tech
supply chain
Labor and asset flexibility Telco

Agile supply chain network Telco

Ensure Lean fulfilment/replenishment High tech

reactivity Launch excellence n/a

Inventory placement and felxibility High tech

Disruption response plans1 Machinery and industrial foods

1 Insufficient data for pharma

Exhibit 2

flexibility, we found that pharmacos lagged To simplify and focus agility building
behind other industries (Exhibit 2). efforts, it is critical to understand uncer-
tainties in terms of the effects they have on
operations. For example, the entry of new
A three-step approach competitors or launch of promotions can
each result in short-term demand variabil-
How can pharmacos succeed in increas- ity, which can be managed with the same
ing the agility of their operations, and supply chain tools.
where does building agility provide a pay-
off? We discuss a three-step approach: Once the uncertainties have been trans
understanding how uncertainties trans- lated into effects, companies can imple-
late into operational effects, building ment an agile strategy review (ASR) pro-
agility across all the core functions, and cess to quantify the magnitude, frequency,
developing capabilities to detect and and duration of the effects they face. For
respond to uncertainty. example, an automotive and assembly
company set up an ASR process for sup-
Step 1: Understanding how plier issues that takes place monthly and
uncertainties translate into involves key operations personnel such as
operational effects. the leaders of procurement, quality, manu-
facturing, R&D, and supply chain. An ana-
Each pharmaco encounters hundreds of lyst prepares a clear overview of current
uncertainties in planning its operations. uncertainties and quantifies the effects.
For example, a generics competitor might The reviews output allows the company
suddenly receive approval to enter a to prioritize the uncertainties that require
market, and another competitor might be reaction.
forced to remove products from the same
market. Identifying and preparing for each Uncertainty typically has the following
uncertainty can appear to be an expensive seven effects on operations. For each
and potentially impossible task. effect, we specify the questions pharmacos

should ask to determine the right actions Input cost volatility. How can opera-
for an agile response: tions go beyond financial mechanisms
to further insulate the supply chain from
Cyclic demand. How can operations input-cost volatility? A company might
preserve margin in down cycles while launch a supplier collaboration program
capturing disproportionate volume in in an effort to share the risk for a key API
up cycles? This is relevant for drugs that is also used by other manufactur-
used to treat flu or any other illness ers. This can help ensure preferred
that is seasonal or cyclical. treatment when the API is in short sup-
ply and thereby lessen cost increases.
Mix shifts. How can operations be set
up to increase the likelihood of devel- Safety and operational risk. How
oping blockbusters in a large portfolio can operations increase its ability
of drugs without overinvesting in to predict equipment and process
capacity for every drug? For example, failures? Pharmacos that apply best
can a facility make multiple products, practices in agile maintenance, for
allowing it to shift between them in instance, would use leading indica-
response to changes in the demand tors such as machine temperature
mix so that it can reduce the chances or operating hours to reliably predict
of idle or underutilized capacity? potential breakdowns.

Short-term demand volatility. How Based on the answers to these ques-

can operations maintain service without tions, a pharmaco can better understand
compressing margins through haphaz- how its operations can manage each
ard reactions? Among other options, effect and thus the key uncertainties.
this might entail asking a contract man-
ufacturing organization to contribute a Within the pharmaceutical industry, we
greater share of products to ensure an tend to see mix shifts, internal disruptions,
agile response to a demand surge. and supply disruptions as the biggest
Supply disruption. How can opera-
tions ensure that an external disruption A mix shift can occur when, for exam-
to supply affects the company to a ple, a tender selects one pharmacos
lesser extent than its peers, allowing drug over others. This can result in a
the company to capture share as a sudden and drastic increase in volume
result? The company should consider for the selected drug and a significant
issues such as whether it could insulate drop in volume for those drugs not
itself from disruption if a common sup- selected.
plier for the market loses three months
of capacity after failing an FDA audit. Significant internal disruptions can
result from an FDA warning letter stem-
Internal disruption. How can opera- ming from poor performance on an
tions quickly react to minimize the auditrecovery from such a disruption
impact on volume of an internal dis- can take many months.
ruption to supply? For example, a
company might have a rapid-response Supply disruptions are becoming more
team that goes to a plant whenever a frequent with the increasing length of
quality issue flares up. Their objective supply chains. For example, one phar-
would be to quickly put out the fire maco recently shut down its internal
and then design a sustainable solution vial-filling operations, only to find out
to address the root causes. that its outsourced provider had serious

quality issues and was suddenly very labor flexibility both improves service and
risky to rely on. The pharmaco needed reduces over- and idle time), thus making
to step in and develop the suppliers investments in agility a no-regret move.
capabilities in-house so that it could Other areas will require long-term strategic
avert a supply catastrophe for its billion investments that entail trade-offs between
dollar drug. agility and costs (Exhibit 3).

Step 2: Building agility across A typical trade-off entails adding redun-

functions, coherently. dant capacity to meet spikes in demand
or cover for a failure at a facility. Another
After a company identifies and prioritizes common agility investment relates to
uncertainties based on the effects, it must inventory placementpharmacos can
quickly move to embed agility in organiza- choose to store inventory closer to cus-
tional areas in which it will have the greatest tomers to react more quickly in case of
payoff. The company should conduct a urgent demand due to a disease outbreak.
review of regions and end-to-end product
supply chains to understand where the Exhibit 4 sets out the levers that com-
effects of uncertainty will require the most panies can apply to build agility in each
agility to best serve customers and drive function and indicates which levers can
profitability. This should be followed by a have the greatest impact for pharmacos.
review of the current state of the agility- Together, these levers constitute an
related capabilities of its core operational agility toolbox.
functions. The company can then apply
the appropriate levers to build agility in the One of these agility levers is having a
targeted areas. true multi-echelon philosophy. Instead of
managing stock levels at each loop of the
There are some areas for which agility supply chain separately, a multi-echelon
promotes cost improvements (for example, philosophy dictates a comprehensive

To succeed, a balanced agility strategy is needed which combines

no-regret moves with long-term strategic investments

No-regret moves agility levers Agility investments

Implementing can actually reduce costs Can yield significant return on investment
Can be quick wins Involve cost-benefit trade-off
Require an end-to-end view of business to Choices done at a strategic level
understand cost-benefit trade-off

Agile initiatives

Companies struggle to make big bets on

Companies can increase agility while agility, but can work through strategy, risk,
lowering cost and ROI for agility

Example Lean fulfillment (e.g., speeding up internal Diversified network (e.g., redundant capacity)
processes) Inventory placement (e.g., forfeit pooling effect
Labor flexibility (e.g., work time accounts) to be closer to customers)
There is no one-size-fits-all solution
each industry and company is different

Exhibit 3

Addressing volatility requires the use of levers across NOT EXHAUSTIVE

each operational function Low impact High impact

Building agility across functions, coherently

Function Lever Impact

Product development Create design to switch ability
Develop modular approach
Purchasing Active management of global capacities
Implement flexible supplier contracting strategy
Select and develop agile suppliers and ecosystems
Develop contingency supplier capacity plans
Monitor raw material price/supply markets, establishing triggers for switch ability
Transfer risks to third parties
Manufacturing Develop optimum flexibility in assets
Set up catastrophy response teams
Make cost structure variable
Optimize process design flexibility
Supply chain Factor key uncertainties into logistics network configuration decisions
Optimize level and location of inventory (e.g., postponement)
Reduce supply chain interfaces and lead times
Plan end-to-end collaboratively and transparently
Sales and marketing Shape customer demand
Forecast demand
Implement flexible customer contracting strategy

Exhibit 4

approach that covers suppliers for API, The sales and marketing organization
tablets, and blister packs, as well as should forecast demand by applying
finished goods inventory at internal ware- advanced market insights, directly linking
houses, distributors, wholesalers, hospi- operations with patient demand where
tals, and pharmacies. possible. For example, short-term fore-
casting of a newly launched weight control
Pharmacos can increase their agility by drug could include mining Facebook and
designing the optimal configuration for the Twitter posts to gather information about
supply chain to leverage the benefits of preferences and side effects. Just as man-
late-stage customization and postpone- ufacturers and retailers use weather fore-
ment. They can substantially reduce total casts to predict consumption of weather-
cost to serve, for example, by customizing sensitive foods (such as ice cream),
to orderthat is, using anonymous blisters pharmacos can use climate predictions to
for primary packaging, and customizing forecast expected volumes for cold and flu
on a postponement line based on country medicines for the upcoming season.
orders (Exhibit 5). This gives the company
additional flexibility to react to sudden Step 3: Making detection-and-
changes in mix (for example, packaging response core capabilities.
type or volume per country) and makes
it less vulnerable to obsolescence (as With key agility elements integrated into
could happen if, for example, a packaging its operations, a pharmaco can shift its
change rendered large quantities of pack- attention to building capabilities to detect
aged products obsolete, requiring expen- and respond to capacity plan to cope with
sive rework or disposal). This approach is volatility. The company faced shortages of a
especially attractive for products with low vaccine critical to public health as the result
packaging volume per SKU, high bulk vol- of significant volatility in vaccine demand
ume, high value, or high demand variability. coupled with poor capacity planning.

There are various technological solutions allowing

late-stage customization

Production of Decouple primary and secondary packaging to manage very small batch sizes and
anonymous avoid loss of efficiency in production
blisters Blister production into bulk containers or large packs

Logistics Logistics modules to decouple primary and secondary packaging

modules Blister into a box (BIB)/blister out of a box (BOB) modules also for transport to other sites

Blister printing Blister printing e.g., Hapa 230T1 color in Mediseal CP 200/400/600
Blister printing with 2 printers: one for blister identification and one for product
information printing

In-line pack Customization line cartoners e.g., Mediseal P1600 with up to 150 cartons per minute
printing and QC In-line QC e.g., Qualivision print and check
In-line carton printing
On-demand in-line printing of correct country leaflets and customized country packs
High-tech quality control systems with line cameras with up to 20 megapixels

SOURCE: Press search; company Web sites

Exhibit 5

A comprehensive analysis of uncertainty Organizations that dont fare well in this

gave the company greater transparency high-level assessment have room for
and improved decision making by allow- improvement in both managing the down-
ing it to distinguish between predictable side of uncertainty and capturing gains
and unpredictable demand. It also built a when opportunities present themselves.
quantitative model to clearly understand the events as they occur. As a role model,
impact of uncertainty in different scenarios. pharmacos can look to military organiza-
A cost-benefit analysis across a range of tions. Consider the high stakes (victory or
probability-weighted scenarios allowed the defeat, life or death) and the extraordinary
company to correct misconceptions regard- level of agility required when conducting a
ing the required capacity levels. The com- military operation in an unfamiliar territory
pany also identified capital and noncapital or a hostage rescue mission. Although
levers that would allow it to release capacity business is not war, what can pharmacos
with a clear understanding of operating pro- learn about agility from the military?
cedures under various demand scenarios.
Military organizations are conscious of
To achieve such improvements, pharma- how much and what kind of agility to
cos need to follow a disciplined approach build into each division within a branch.
to understand uncertainties, build cross- The regular army, peace keeping forces,
functional agility, and implement rapid and special forces fulfill different types of
detection-and-response capabilities. How missions, requiring dramatically different
do you know if you should be investing in degrees of agility:
agility? How agile is your company already?
An agile operator would be able to provide A regular army makes heavy invest-
positive answers to a series of pointed ments to develop standard work pro-
questions about its operations (see box, cesses and training given its emphasis
How agile are your operations?). on broad interventions in visible terrain.

A peace keeping force will require deployment is reserved for only the
a wide range of talent and skills to most critical situations.
agilely fulfill its mandate to restore
public order, safety, and economic Similarly, pharmacos need to decide
activity in an area. This includes where they need to make the most signifi-
responding to security risks, medical cant investments in agility. For example,
needs, and communication require- like a special forces unit, some factories
ments. For example, a peace keeping may need the highest level of agility, while
force needs negotiation skills to medi- others should be a basic unit that is able
ate disputes between local leaders as to execute its tasks with only modest
well as skills to defend itself or those it investments in agility. Or, as is common
is protecting if it comes under fire. in high tech and consumer electronics,
pharmacos can use war room teams
A special forces unit, such as the US staffed with a mix of young talent and
Navy SEALs, has highly targeted experienced practitioners drawn from
missions, focusing on specific tar- around the world to manage the most
get zones and a few individuals. A critical service crisis.
unit conducting a hostage rescue
operation, for example, would rely Based on examples from the military
completely on the agility skills of its and other types of organizations, Exhibit
team members. They would operate 6 sets out eight core tools that phar-
with a clear mission and some level macos should use to embed detection
of understanding of the situation, but and reaction capabilities deeply in their
would be expected to adapt to their organizations. It starts with a leadership
surroundings and do what it takes to philosophy that allows the organization to
get the job done. Achieving this level understand and more effectively imple-
of agility requires the best-trained, ment key decisions. For example, Navy
most highly skilled people, and their nuclear submarine commanders develop

Core mindsets and tools of agile leadership

Leadership philosophy Contingency planning

The articulation of an individuals leadership style, Scenarios with alternative COAs, based on
shared with their team anticipated deviations

Leaders intent1 Critical information requirements

A clear picture of the desired end state, developed KPIs and dashboards to measure if a contingency
and shared at the start of any campaign plan should be triggered

Landscape analysis2 Contingency thresholds

Structured approach to define timing, resources, Defined levels for KPIs at which contingency plans
and execution challenges should be enacted

Team-leading procedures3 After-action review

Course of action (COA) to achieve the leaders Thorough review of decisions and assessment of
intent, with clear roles for all, in simple language how to respond differently in future campaigns

1 Leaders intent adapted from US military commanders intent

2 Landscape analysis adapted form METT-T analysis (mission, enemy, terrain, troops, time)
3 Team-leading procedures adapted from troop-leading procedures approach

Exhibit 6

their personal leadership philosophy that have launched holistic efforts have
and explain it to their direct team achieved large, sustainable gains.
upon assuming command. Landscape
analysis includes the IT security simula- Among the successful ones is a pharmaco
tions used by financial institutions to that increased revenues by 16 percent over
anticipate unexpected deviations from five years by introducing a comprehensive
plans, such as intrusions by rogue oper- capacity plan to cope with volatility. The
ators. As an example of team-leading company faced shortages of a vaccine crit-
procedures, industrial and logistics oper- ical to public health as the result of signifi-
ators develop irregular ops playbooks cant volatility in vaccine demand coupled
based on different, frequently recurring with poor capacity planning. A comprehen-
conditions (such as the weather). After- sive analysis of uncertainty gave the com-
action reviews are exemplified by NASAs pany greater transparency and improved
midcourse pause-and-learn exercises decision making by allowing it to distinguish
during long programs; the agency uses between predictable and unpredictable
these to identify and immediately incor- demand. It also built a quantitative model
porate improvements. to clearly understand the impact of uncer-
tainty in different scenarios. A cost-benefit
analysis across a range of probability-
Getting started weighted scenarios allowed the company
to correct misconceptions regarding the
Becoming agile has significant benefits, required capacity levels. The company
but a structured approach is required to also identified capital and noncapital levers
capture them. Indeed, although we have that would allow it to release capacity with
seen many pharmacos begin targeted a clear understanding of operating proce-
efforts to increase agility, only those dures under various demand scenarios.

How agile are your operations? When uncertainty strikes, can all func-
tions respond with equal levels of agility?
Pharmacos can use the following ques- To what extent can they, for example, flex
tions for a high-level assessment of their capacity up and down without undue mar-
operations agility: gin pressure, or shift supply, formulation,
and conversion if a disruption occurs?
Understanding how uncertainties Are your suppliers and logistics provid-
translate into operational effects. ers contributing to your agility, or do they
Would each functional leader agree on slow you down?
the top uncertainties the company faces?
For each of the top uncertainties, what Making detection and response core
magnitude, frequency, and duration is capabilities.
the company prepared for (such as the For key uncertainties, do you have a
number of supplier failures or the intensity dashboard of leading indicators and clear
and duration of the next cyclical demand thresholds?
increase)? Who is responsible for identifying each
type of uncertainty to the organization as
Building agility across functions, they are gaining speed?
coherently. For key uncertainties, do you have a
What happens to the P&L, balance sheet, cross-functional response team (special
and customer service at the coverage forces) and clear decision rights?
level youve established? How do you build agility in your leaders?
How do you build uncertainty into your What level of the organization gets that
ROI calculations? training?

Raoul Dubeauclard is a senior expert in McKinseys Lyon office, Kerstin Kubik is an expert in
the Vienna office, and Ulf Schrader is a principal in the Hamburg office.

A CEOs guide

Katy George, Sree Ramaswamy, and Lou Rassey

Proximity to demand and innovative Something of equal moment is occurring

supply ecosystems will trump labor costs today. As we settle into a new normal
as technology transforms operations in catalyzed by the global financial crisis,
the years ahead. the ensuing recession, and an uneven
global recovery, traditional arbitrage
Demand for manufactured goods in models seem increasingly outmoded.1
emerging markets is surging and frag- For some products, low labor costs still
menting as factor costs shift; technologi- furnish a decisive competitive edge, of
cal advances, such as more powerful course. But as wages and purchasing
robotics and the Internet of Things, are power rise in emerging markets, their rel-
creating a range of new opportunities for ative importance as centers of demand,
manufacturers to digitize operations. not just supply, is growing.

Global energy dynamics too are evolv-

Why it matters and what to do ingnot just the now-familiar shale gas
about it revolution in the US, but also rising levels
of innovation in areassuch as battery stor-
Manufacturing strategies built on labor-cost age and renewablespotentially refram-
arbitrage are becoming outmoded; the ing manufacturers strategic options.
race is on to get ahead of what comes next. Simultaneously, advances stemming from
the expanding Internet of Things, the next
Place greater emphasis on proximity to wave of robotics, and other disruptive tech-
both demand and innovation while: nologies are enabling radical operational
innovations while boosting the importance
Making location decisions that bal- of new workforce skills.
ance economies of scale against the
growing diversity of tastes within and Rather than focus on offshoring or even
across global markets reshoringa term used to describe
the return of manufacturing to devel-
Building supplier ecosystems that oped markets as wages rise in emerging
combine technical expertise with onestodays manufacturing strategies
local domain and market knowledge need to concentrate on whats coming
next. A next-shoring perspective empha-
Developing the people and skills need- sizes proximity to demand and proximity
ed to make the most of technological to innovation. Both are crucial in a world
advances across the organization. where evolving demand from new mar-
kets places a premium on the ability to
When offshoring entered the popular lexi- adapt products to different regions and
con, in the 1990s, it became shorthand where emerging technologies that could
for efforts to arbitrage labor costs by using disrupt costs and processes are making
lower wage workers in developing nations. new supply ecosystems a differentiator.
But savvy manufacturing leaders saw it as Next shoring strategies encompass ele-
more: a decisive change in globalization, ments such as a diverse and agile set of
made possible by a wave of liberalization production locations, a rich network of
in countries such as China and India, a innovation-oriented partnerships, and a
steady improvement in the capabilities of strong focus on technical skills.
emerging market suppliers and workers,
a growing ability to transfer proven man- In this article, well describe the economic
agement processes to new locales, and forces sweeping across the manufacturing
1 See Ian Davis, The new
increasingly favorable transportation and landscape and examine technologies com- normal, McKinsey Quarterly,
communications economics. ing to the fore. Then well suggest some March 2009,

principles for executives operating in this markets, such as Chinasince demand

new world. The picture were painting is of bottomed out during the recession fol-
necessity impressionistic: next-shoring is lowing the financial crisis of 2008.
still taking shape and no doubt will evolve
in unexpected ways. Whats increasingly Regional demand looms large in sec-
clear, though, is that the assumptions tors such as automobiles, machinery,
2 See Manufacturing the future: underlying its predecessor, offshoring, are food and beverages, and fabricated
The next era of global growth giving way to something new. metals. In the US, about 85 percent
and innovation, McKinsey of the industrial rebound (half a mil-
Global Institute, November
2012, on, lion jobs since 2010) can be explained
for an in-depth analysis of Economic fundamentals just by output growth in automobiles,
the economics and trends machinery, and oil and gasalong with
surrounding five types of
manufacturing industries: The case for next-shoring starts with the linkages between these sectors and
global technologies (for the economic fundamentals of demand locally oriented suppliers of fabricated
instance, electronics) that (since the importance of local factors is metals, rubber, and plastics (Exhibit 1). 2
are R&D intensive and highly
traded; global innovation growing) and supply (as the dynamics of The automotive, machinery, and oil and
for local markets (autos, labor and energy costs evolve). gas industries consume nearly 80 per-
machinery) that are R&D cent of US metals output, for example.
intensive but tend to produce
adjacent to demand; labor- The importance of local demand
intensive regional processors factors In China too, locally oriented manufac-
(food, fabricated metals) that turers have contributed significantly to
are highly localized and locate
adjacent to demand; resource- More than two-thirds of global manufac- rising regional investment and employ-
intensive commodities (metals, turing activity takes place in industries ment. The country has, for example,
paper and pulp) that are that tend to locate close to demand. This emerged as the worlds largest market
energy intensive and locate
near demand or resources; simple fact helps explain why manu- and producer for the automotive indus-
and labor-intensive tradables facturing output and employment have try, and many rapidly growing manufac-
(apparel, footwear) that are recently risennot only in Europe and turing sectors there have deep ties to it.
highly traded and locate where
labor is cheap. North America, but also in emerging

In the recent US industrial rebound, about 85% of the job growth in

manufacturing occurred in automobiles, machinery, and regional
supplier industries
Gross job growth in US manufacturing during the recovery, Share of gross job growth in
Jan 2010 - Feb 2013 manufacturing 2010 - 121
Thousands of jobs Percent

Fabricated metals 174 27

Autos, other transport 162 25

Machinery 129 20 86%2

Primary metals 50 8

Rubber, plastics 38 6

Food, beverage 50 8

Other 43 7

Printing -38

Textiles, furniture -25

Other -32

1 Deviances due to rounding

2 Data reflect growth for local supplier industries to the oil and gas sector, in addition to those for automobiles and machinery

Exhibit 1 SOURCE: US Bureau of Labor Statistics; McKinsey Global Institute analysis


Emerging markets share of global demand is expected to

reach 66% by 2025
Emerging markets
Share (percent)
65 Consumption of
manufactured goods
55 Global GDP
1995 2000 05 10 15 20 2025

SOURCE: IHS global insight; McKinsey global institute analysis

Exhibit 2

As automotive OEMs expand their capac- The limits of labor-cost arbitrage

ity in emerging markets to serve regional
demand, their suppliers have followed; Surging local demand helps explain
the number of automotive supplier plants why rapid wage growth in China hasnt
in Asia has tripled in just the past decade. choked off manufacturing expansion
there. Wages have nearly doubled since
The emerging markets share of global 2008, partly as a result of domestic mini-
demand is steadily climbing, from roughly mum wage policies.3 (The countrys
40 percent in 2008 to an expected 2011 five-year plan called for 13 percent
66 percent by 2025 (Exhibit 2). As that average annual minimum wage increas-
share rises, it also is fragmenting into es, a rate some provinces have already
many product varieties, feature and qual- exceeded.) True, in a few labor-intensive,
ity levels, price points, service needs, and trade-oriented industries, such as
marketing channels. The regional, ethnic, apparel production and consumer
income, and cultural diversity of markets electronics, labor-cost changes do tend
such as Africa, Brazil, China, and India to tip the balance between different
(where some local segments exceed geographic regions; manufacturing
the size of entire markets in developed employment in Bangladesh and Vietnam,
nations) is raising the ante for meeting for instance, has benefited from Chinas
local demand. In the automobile indus- wage surge, even as Chinese manufac-
try, for example, fragmenting customer turers are seeking to raise productivity.
demand has led to a 30 to 50 percent
increase in the number of models. But these are far from the only implica-
90 percent of recent capital expenditures tions of rising wages. Just as Henry
in the automotive sector have involved Fords $5 a day helped create a new
product derivatives worldwide and consuming class, so higher wages in
capacity expansions in new markets. China are increasing local demand, thus 3 Measured in nominal dollars.

reinforcing the local investment choices Consider, for example, the potential
of OEMs and suppliers. At the same impact of energy storage technologies,
time, there is little evidence of a zero-sum especially lithium-ion batteries and fuel
game between China and advanced cells, which are becoming more capable
economies, such as the US. Rather, and less costly. At the same time, the
the narrowing labor-cost gap reinforces improving economics of renewable
the importance of local demand factors energy productionparticularly solar and
in driving manufacturing employment. wind poweroffers manufacturers an
Indeed, factor costs often have the great- expanding range of future supply options.
est impact on location decisions within In some developing regions where power
a regionfor example, Airbus moving grids are unreliable or nonexistent, factory
to Alabama instead of Texas or North complexes served by distributed solar
Carolina. These costs interact with policy power may be feasible. Distributed gen-
factors, such as infrastructure spending eration is also growing in combined heat-
and tax incentives, to shape a regions power (CHP) plants, which use
overall economic attractiveness. heat created in the production process
to run steam turbines and generate
The impact of energy costs electricity locally.

The price of natural gas in the US has fall- None of these are a silver bullet today.
en by two-thirds as gas production from But as advances continue over time,
shale deposits rose by 50 percent annu- more and more companies may
ally since 2007. A narrow range of sec- become able to ask themselves where
torsgas-intensive manufacturing, such they would place major strategic bets if
as the production of petrochemicals, the availability and price of energy were
fertilizer, and steelare benefiting most lesser concerns. That too will probably
directly. Some downstream players in the lead back to a focus on local demand
energy value chain have begun shifting patterns. Interestingly, the country
investments. Dow Chemical, BASF, and representing the greatest source of
Methanex, for example, have announced future demand growthChinais also
plans for new US manufacturing capacity actively stimulating the development
to take advantage of cheaper, abundant of a range of new energy sources and
energysupplies. storage technologies through a focus
on new strategic industries in its
These moves are important for such five-year plans.5
companies and subsectors; McKinsey
Global Institute (MGI) research suggests
that by 2020, lower-cost energy could Technology disruption ahead
boost US GDP by somewhere between
4 For more, see the full McKinsey $400 billion and $700 billion.4 But do Technology is affecting far more than
Global Institute report, Game
changers: Five opportunities they presage a dramatic rebalancing of energy dynamics. Advanced robotics,
for US growth and renewal, global manufacturing activity? Electricity 3-D printers, and the large-scale
July 2013, on costs were already lower in the US than in digitization of operations are poised to
5 See Guangyu Li and Jonathan
Woetzel, What Chinas five- many countries, including Chinawhich, alter fundamental assumptions about
year plan means for business, along with others, also has opportunities manufacturing costs and footprints.6
July 2011, to boost its own energy output through To derive value from these shifts, com-
6 For more, see Disruptive
technologies: Advances that hydraulic fracturing. And fossil fuels arent panies will have to make significant
will transform life, business, the only area where the energy supply investments and ensure access to hubs
and the global economy, picture is morphing. of innovation, capable suppliers, and
McKinsey Global Institute,
May 2013, on highly skilled workers.

Advanced robotics 3-D printing

Investments in industrial robots have The economics of 3-D printing are

increased by nearly 50 percent since improving rapidly, as well. While still only
2008even in emerging nations such as a sliver of value in the manufacturing sec-
Chinaas a new generation of advanced tor (0.02 percent), sales of 3-D printers
systems develops, with greater dexterity are set to double, to $4 billion, by 2015,
and ability to process information. These and prices for the equipment are declin-
robots can perform an expanding array of ing swiftly.7 Also, 3-D printers open up the
factory tasksfor instance, manipulating possibility of more distributed production
small electronic parts, and picking and networks and radical customization. In
packing individual products. They can early manufacturing applications, some
work side by side with humans and be companies are using the devices to
trained by factory floor operators rather accelerate product development, since
than programmed by teams of highly paid they eliminate wait times for prototyping
engineers. Improved economics and by faraway specialists. Companies will
capabilities eventually may yield produc- be able to consider new supply chain
tivity gains that are unforeseen today, as models and, in some cases, replace tra-
well as better products and faster speed ditional suppliers of parts with targeted
to market. As that happens, companies usage of in-house printers.
will be able to retool their manufacturing
systems to provide new roles for these These printers wont replace traditional
mechanical workers. high-volume modes of production, such
as die casting and stamping. For more
Cheaper, more proficient robots that can specialized goods, though, its easy
substitute for a wider variety of human to imagine the emergence of service
tasks are another reason companies may businessesthe equivalent of copy or
locate more manufacturing closer to major print shopsthat would manufacture
demand markets, even where wage rates items based on design specifications
are higher. In developing nations, robots provided by B2B or B2C customers.
could speed up rates of automation and Crowdsourcing networks for new pro
help bridge shortages of some production duct ideas could one day complement
skills. MGI research suggests that 15 to traditional R&D activities for some manu-
25 percent of the tasks of industrial work- facturers.
ers in developed countries and 5 to 15
percent of those in developing countries Digitized operations
could be automated by 2025.
Significant as advanced robotics and
Further out, highly robotized factories 3-D printers are, they represent just two
also equipped with other information plot lines in a much bigger story about
technologies might shift competition to the digitization of operations. Cloud
areas such as the ownership of customer computing, mobile communications,
networks, which should become increas- and the Internet of Things8 are begin-
ingly valuable as information embedded ning to combine with advanced analytics
in them starts guiding production priori- to create threads of intelligent data that 7 Wohlers Report 2013: Additive
ties and flows. Flexible, intelligent assem- link assets and stakeholders as never Manufacturing and 3-D
Printing State of the Industry,
bly robots also should enable contract before. Increasingly, products will com- Wohlers Associates, May 2013,
manufacturers to serve an increasingly municate with each other, with robots
diverse range of customers, creating and advanced machines inside factories, 8 The growing collection
of sensors and actuators
new opportunities for attackers to target and with customers and suppliers. Digital embedded in products and
attractive microsegments. DNA for parts (including the materials, equipment.

equipment, and time required to make innovation, particularly an innovative base

them) will also be increasingly available. of suppliers. In developed and emerging
markets alike, both ingredients will be crit-
The implication is that we are approach- ical. Next-shoring isnt about the shift of
ing a day when manufacturers will have manufacturing from one place to another
unprecedented global visibility into who but about adapting to, and preparing for,
makes what, where, and how well. Theyll the changing nature of manufacturing
be able to run virtual operations war everywhere.
rooms on their phones. Theyll have new
opportunities to solve plant-floor optimi- Optimizing location decisions
zation problems as intelligent machines
interface with each other and with people Being close to demand is particularly
on the line. In the near future, manufac- important at a time when consumption
turers also will exploit opportunities for in emerging markets is growing rapidly,
crowdsourced design and on-demand boosting with it the diversity of the re-
production. These opportunities will gional preferences that manufacturers
extend well beyond goods made by 3-D must contend with. In a 2012 inter-
printers; manufacturers will pursue the view with McKinsey, Timken CEO
buying and selling of previously underuti- James Griffith explained his companys
lized production lines by the hour and approach: Over the last ten years, weve
will rely on dynamic databases to deter- added a very strong Eastern European,
mine what every part should cost. And Indian, and Chinese manufacturing base,
new forms of technology-enabled col- not because wages are low there, but
laboration, such as the three-dimensional because those were the markets that
virtual assembly and testing of vehicles, were growing. This expansion has been
will redefine what it means to be proxi- accompanied by a strategic shift away
mate to innovationwhich may be locally from a focus on automotive partswe
generated or accessed via broadband. could make a car last for a million miles,
but nobody cares. The new emphasis
Digital operations arent a far-off fantasy. is on fast-growing mining, trucking, steel
GE already has a 400-person industrial making, and cement making customers
Internet software team and its employees in emerging markets. For them, Timkens
use iPads to run an advanced battery reliability is a decisive asset.9
factory in New York State. Amazon is
employing growing numbers of smart Locating manufacturing close to demand
warehouse robots. Fiat has reduced the makes it easier to identify and meet
number of physical prototypes needed local needs. Its a delicate balancing act,
to introduce a new product; Alcoa has though, to create an efficient global man-
compressed prototyping time and costs ufacturing footprint that embraces a wide
for some products; and an auto supplier range of local tastes, since economies
recently slashed an eight-month prototyp- of scale still matter in many industries.
ing process to one week. Volkswagen has coped by moving from
vehicle platforms to more modular archi-
tectures that provide greater flexibility for
Next-shoring manufacturing several product variants or
Although these forces are still gathering
9 See Manufacturings new era: strength, theyre already pointing toward New products, market segments, and
A conversation with Timken two defining priorities for manufactur- consumer preferences are combining
CEO James Griffith, interview
by Katy George, December
ing strategy in the era of next-shoring: with perennial risks (such as seasonal
2012, proximity to demand and proximity to variations in demand and fluctuations

in wages and currency rates) to boost more robust, they will usher in a range of
uncertainty in manufacturing and sup- improvements, from surer logistics to bet-
ply networks. That uncertainty places a ter payment systems. These will create a
premium on operational agilitythe ability virtuous cycle of collaborative benefits.
to adapt design, production, and supply The supply bases of many manufacturers
chains rapidly to fluctuating conditions.10 thus may soon need significant upgrades
This too may play into location decisions. and capital investments to create joint
competencies in areas such as robotics.
Take the experience of a consumer Collaboration and management invest-
products company that had relied on one ment in skill development programs could
plant to supply its major market. When be necessary as well. In some cases, it
the company began experiencing unac- may be valuable to collaborate with local
customed spikes in regional and seasonal or national governments to create the
purchasing patterns, shortages and lost conditions in which the manufacturing
sales ensued. To accommodate rising ecosystems of the future can flourish.
variations in demand, the company built a Tighter supply networks will also foster
second plant with similar cost character- production systems that reduce the need
istics in a different region. This additional for virgin natural resources.
capacity helped ensure supplies to the
prime market, where the problems were A failure to develop innovative supply
most acute, while also allowing the com- ecosystems will have growing competi-
pany to meet growing demand opportu- tive implications for countries as well as
nistically in several new markets close to companies. The competitive challenges
the new plant. Although the investment facing the US sometimes look more like
was considerable, it lowered the compa- a system failure than an economic one.
nys risk exposure, eliminated damaging US investment in advanced robotics, for
stockouts, and improved the bottom line. example, often lags behind that of other
developed economies, with trade deficits
Building supplier ecosystems prevailing even in sectors where wage
rate differentials arent a big influence on
New combinations of technical expertise location decisions.
and local domain knowledge will become
the basis for powerful new product strate- Developing people and skills
gies. Responsive, collaborative, and tech-
savvy supplier ecosystems will therefore All this will place a premium on manufac-
be increasingly important competitive turing talent, creating a range of regional
assets in a growing number of regional challenges. In Europe and the US,
markets. To keep up with the opportuni- educational institutions arent producing
ties afforded by technological change, for workers with the technical skills advanced
example, a major manufacturer that until manufacturers need. In developing
recently had relied on a low-cost supplier economies, such as China, the millions
in Mexico for parts has begun working of lower-cost production associates who
with a new supplier that has cutting-edge are well adapted to routine manufactur-
3-D printing capabilities. The new rela- ing may find it difficult to climb to the next
tionship has lowered stocking costs (since level. Line supervisorsoften fresh out of
parts are made on demand), while provid- regional universitiesstruggle to manage
ing avenues for developing prototypes baseline operations and to coordinate 10 For more on operational agility,
more quickly. teams. Organizations will need to invest see Mike Doheny, Venu Nagali,
more in formal training and on-the-job and Florian Weig, Agile
operations for volatile times,
Examples like this are just a start. As infor- coaching to bridge the gaps. They must McKinsey Quarterly, May
mation flows among partners become also cast a wider net, supporting local 2012,

community colleges and technical insti- Next-shoring will look different in differ-
tutes to shape curricula and gain access ent locales, of course. Europe and the
to new talent streams. US have impressive advantages in areas
such as biopharmaceuticals, automotive
A related challenge is the need for new engineering, and advanced materials.
management muscle. As it gets harder to China, meanwhile, is quickly climbing
hide behind labor-cost arbitrage, regional the expertise curve, with increasingly
manufacturing executives and medium- sophisticated corporate and university
level managers will need to become both research facilities and growing expe-
better at running a tight operational ship rience in advanced processes and
and more versatile. They should be able emerging industries.11 In the world were
to grasp the productivity potential of a entering, the question wont be whether
range of new technologies and have to produce in one market for another but
enough ground-level knowledge of local how to tailor product strategies for each
markets to influence product strategies and how to match local needs with the
and investment trade-offs. The ability to latest veins of manufacturing know-how
11 See Gordon Orr and Erik build external relationshipswith sup- and digital expertise. While the road map
Roth, The CEOs guide to
innovation in China, McKinsey pliers, education partners, and local for every company, industry, and loca-
Quarterly, February 2012; and government officials who can influence tion will be different, we believe that the
Chinas innovation engine the development of vibrant, sophisticated principles weve laid out here should be
picks up speed, McKinsey
Quarterly, June 2013, both supply ecosystemswill also be a source useful for all.
available on of competitive advantage.

The authors would like to thank Michael Chui, James Manyika, and Venu Nagali for their
contributions to this article.

Katy George is a director in McKinseys New Jersey office; Sree Ramaswamy is a fellow of
the McKinsey Global Institute and is based in the Washington, DC office; and Lou Rassey is a
principal in the Chicago office.

An untapped gold mine

in the supply chain:
Logistics excellence
Knut Alicke, Raoul Dubeauclard, and Michael Schmeink

Supply chains are becoming leaner and companies, confirms that these strate-
leaner, and companies are continuously gies generally fail to meet the companies
seeking out new sources of value to sustain goals. But the findings also confirm that
its business. One of the most promising is with the right application of well-tested
also among the least explored: the every- methodologies (many of them already in
day logistics of getting products from facto- use in manufacturing operations), trans-
ries to customers. port and warehousing are an untapped
gold mine that together offer savings
Accurate, timely logistics performance equivalent to 15 to 30 percent of a com-
is so essential in todays business that panys total distribution costs (Exhibit 1).
for many companies, it no longer serves
as a major strategic differentiator. That It will, however, require a deeper commit-
achievement can lull companies into pay- ment of time and effort. As an example,
ing little attention to their warehousing and one European pharmacos experience
transport capabilities until problems illustrates the potential. Through a com-
such as delayed orders, incorrect ship- bination of better management of trans-
ments, or damaged inventoryarise. portation, network consolidation, and
lean warehouse operations, it reduced its
A closer look, however, would show that logistics costs by 33 percent. At the same
complacency comes at a very high price: time, pick errorssending the wrong
most companies logistics costs are much productfell by 50 percent, while overall
higher than they could be, in mature mar- delivery performance actually improved.
kets andeven more dramaticallyin
emerging markets. Moreover, some of
the most popular short-term fixes that Slim prospects from existing
companies have pursued are pushing efforts
costs higher still. Heavy investments into
IT, such as for sophisticated transport or For many companies seeking addi-
warehouse management systems, fail tional logistics efficiencies, the promise
to pay off because they end up layering of reduced cost at greater precision has
flashier equipment on top of long-standing made automation the improvement invest-
operational weaknesses. And automation ment of choice. But too often the gains
projects, prone to cost overruns, prove too then fade quickly, if they arrive at all.
expensive to maintain and too inflexible to
respond to market changes. A regional distributor followed the standard
pattern when it pinned its cost reduction
Given those headaches, turning over logis- hopes on an expensive automated stor-
tics to third-party service providers, as has age and retrieval system (ASRS) to handle
been the case in most industries, might detailed picking at its warehouses. The
seem easier. But to manage providers belief was that the systems high up-front
effectively, companies still need to retain price would be balanced by the reduc-
their expertise in logistics or join peers ing operating expenses the system was
that find themselves at the mercy of rising expected to deliver. Once installed, how-
provider fees. The common practice of ever, the ASRS yielded no operating cost
aggregating transport and warehousing, savingsin fact, it was more expensive
for example, obscures costs in a way that to run than an optimized manual system,
further weakens a companys ability to win especially once less visible costs such
even minor savings from its contractors. as those for maintenance or specialized
labor were factored in. Yet reverting to the
Indeed, our research over the past decade old system proved to be impractical: the
into the logistics practices of dozens of company would not recover any of its sunk

Logistics optimization can yield savings of ~15-30% of distribution costs

Indexed costs, total supply chain costs

Percent Levers for improvement

Initial distribution costs 100

Consolidation of loads
Transport optimization
Route optimization
(inbound, outbound) Procurement approach/supplier selection

Lean warehousing
Economies of scale/leveling of workload
Warehouse optimization 10-20
Layout improvements
Process standardization

Outsourcing select Economies of scale

warehouse services Labor/salaries cost advantages
Reduced depreciation

Improved network

15 - 30

Exhibit 1

costs, and ripping out the ASRS would Given that LSPs are building a margin into
itself be so expensive as to swallow any their cost structures, this result is perhaps
benefit that the company might earn. not surprising. But it shows that in relying on
outsourcing, companies are often trading
Understandably, a lot of companies one set of problems for another. And it sug-
seek to wash their hands of the issue by gests a real opportunity for companies to
outsourcing as much of their transport achieve much more than the 2 to 3 percent
and warehousing responsibilities as they in savings that many have regarded as a sat-
can. Some aspects in some industries isfactory result of their cost reduction efforts.
virtually require outsourcing. The pharma
industry provides an example. With lim-
ited transport infrastructure of their own A gold mine of opportunity
and warehouses that may be too small
to run very efficiently, pharmacos can In fact, a broader, more integrated pers-
sometimes reduce costs and raise quality pective will show that reductions of 20, 30,
almost instantly by turning to third-party and even 40 percent are not only possible
logistics specialists. But unless compa- but achievable, so as long as the company
nies are exceptionally careful in select- raises its ambitions and sharpens its skills.
ing and managing their logistics service The question any company must ask is
providers (LSPs), the cost benefits can not How much savings could our vendors
fade. A recent analysis of European ware- give us?, but How would we build our
house performance, for example, found network today if we were starting again
that across industries, LSP-managed from the ground up?
warehouses showed the greatest cost
variation and the highest average savings The answer will let the company make
potentialmeaning that as a sector, their better-informed trade-offs and create
average cost performance was the low- value by improving vendor management,
est (Exhibit 2). revamping the logistics networks

Typical warehouse improvement potential
Percent of total warehouse costs

Potential savings
60 56
40 36
35 32 33 32
30 27 27
15 10 10 11
10 8 7
5 6 6
Industry sector A&A GEM Health- High tech PAC Pharma Retail LSP

Average savings 13 16 13 14 18 17 16 28

Exhibit 2

structure, and reexamining internal labor is required for picking? How much
practices, especially via lean manage- for packaging? For transport, how much
ment of the companys warehouses. does the typical round-trip cost? How
many shipments can be consolidated?
Building from a clean sheet Overhead costs must be included on a
function-by-function basis: an allocated
As a first step, any company must learn percentage of dispatching, HR, compli-
not only what its logistics costs are but ance, etc., as well as of senior-manage-
what drivers account for those costs. It ment time.
therefore must identify all of the compo-
nents of logistics to see which of them Certain costs, especially in transport,
are costing the company more than they may require adjustment for the synergies
should. The goal is a ground-up cost per- that third-party providers earn by serving
spective that starts from a clean sheet, several pharmacos at once. In warehous-
which will consist of the lowest possible ing, the impact is usually fairly small if
cost of each component, rather than the even noticeable: better space utilization
actual cost the company is now paying. and greater economies of scale for cer-
The component-by-component price dif- tain types of overhead. In transport, by
ferences reveal where the company must contrast, the benefits can be much larger.
focus its cost-cutting efforts. Putting two companies goods on the
same truck to the same destination could
The level of detail involved presents an cut the providers costs in half, seriously
initial hurdle, as the analysis must not throwing off estimates.
only cover the materials, equipment, and
people required, at the volumes that the Yet as daunting as the data demands may
logistics system must actually handle, but appear at first, even a company that relies
also provide estimates on an activity-by- heavily on third-party providers can
activity basis. For warehousing, how much create a reasonably accurate picture of

what logistics should costand by using est values is the hypothetical ideal: the low-
mainly internal resources. Companies est-cost warehouse, for example, and the
procurement and logistics specialists typi- lowest-cost transport options. The more
cally have enough local market knowledge data a company can gather, especially from
to estimate many of the most important outside benchmarks, the more robust that
external inputs, such as prevailing wage ideal will become.
rates for drivers or warehouse workers,
average rents, and utility costs. For many Finding the gap
other factors, such as volume figures or the
cost of individual functions, a company can The next step is to compare the actual
use its own history in the relevant markets cost of each separate component against
or visit existing logistics sites to assess con- the lowest cost that the analysis could
ditions on the ground. The one exception find. The details in the data will point the
will be for transport: with external market company towards the root causes of
research, a company can generate a rough major differences. For example, if receiv-
model of the volumes the provider is mov- ing activities show the largest variation
ing between the same places for different among labor costs, the reason may be
companiesand therefore get a picture of excess idle time from feast or famine
its cost structure. delivery schedules. High variation in
picking costs often result from poorly
For each of these logistics components, designed layouts that force staff to run
the data that the inquiry generates will pro- from one end of the warehouse to another
vide a range of values. The sum of the low- to complete orders.

Renewing the network

Even more savings can result from combin- The answers provided an initial filter on the
ing the clean-sheet data with strategic con- locations where the logistics network would
siderations as part of a reevaluation of the need more or less coverage.
entire logistics network. A European phar-
maco started with a network comprising The next considerations to incorporate
a minimum of one warehouse for virtually were largely operational, including the
every EU member country, with additional location of current vendors and the service-
locations in some countries for specialized level requirements of major customers
requirements, such as cold chain capabili- frequency and speed of shipment, priority
ties. The ensuing complexity and redun- for allocation of difficult-to-source products,
dancy made for an unsustainable cost etc. Finally, accounting and finance con-
base, particularly given the larger economic siderations played a role in deciding where
and regulatory burdens that pharmacos inventory should best be located in light of
operating in Europe now face. tax or regulatory requirements.

Managers therefore took a hard look at The ultimate conclusion was a recommen-
the logistical implications of the strategic dation to close about half of the warehouses
moves that the company might make, given in the current network for a savings of about
growth projects for the various EU markets, 20 percent. But the process of consolida-
competitive dynamics, and public policy tion would take at least three years in light
matters such as possible changes to payer of the companys existing contracts and a
relationships or manufacturing incentives. need to minimize disruption to its business.

With this deeper insight into the true costs wait. But both for this company and for
that third-party providers are experiencing, most other companies, faster results are
companies can use a combination of sticks also possible by revamping how current
and carrots to make significant improve- warehouses operate.
ments in managing their contracts. If rising
wages on Chinas coast are the chief factor For example, we have analyzed well over
pushing local warehousing fees skyward, 100 pharmaceutical warehouses across
a company can seek either to limit the Europe and this showed a broad range
vendors fee increases to actual labor infla- of performance, with an average gap of
tion rates, or, if cooperation seems more 39 percent between actual and potential
promising, to shift the whole operation to a warehouse costs (Exhibit 3). Even the top-
different vendor warehouse located further quartile warehouses showed costs that
inland. In a similar manner, a company may were an average of 15 percent higher than
find that its own practices are the cause of what they could be.
other inefficienciesincomplete address
information for shipment, or last-minute However, deeper analysis of the data
bookings for long-haul transportand it revealed that there is no simple formula
can eliminate those inefficiencies for further for reducing warehouse costs that a
savings. Finally, in exchange for lower fees, company could apply across the board.
companies may be able to identify best Instead, identifying the areas that a
practices that providers could follow, such particular warehouse must address will
as better management of back-haul loads rest on the clean-sheet analysis of that
so that trucks travel full in both directions. warehouses individual performance. But
even though the specific issues will vary,
the approach that companies can use
Quicker riches from lean in addressing those issues will share the
warehousing same principles, which are rooted in the
lean management principles that have
That delay is fairly typical, if well worth the renewed corporate performance across

In wide range of warehouse savings potential, average savings is 39%

Percent of Outliers (75+% and no sav-

warehouses (n = 151) ings) occur mainly because
34 at certain sites, model cannot
Average clean-sheet reflect full set of operations
savings is 39%
30 29




10 8

75+ 50-75 25-50 0-25 No savings
Savings potential

SOURCE: McKinsey Clean Sheet Pharma Database

Exhibit 3

Clean-sheet cost assessment reveals performance gap SANITIZED

EUR thousands

Gap analysis Actions to close gap

Clean-sheet cost1 1,519 431

Preliminary gap 2,811 558

Customer-driven On-site
220 -65% Efficiency 510
processes visit to
Structural actions Performance
Wage rate 430 180
constraints management

Rental rate 122 180
tional setup

Performance gap 2,039 External 180

Current cost 4,330 2,039
gap closed

Exhibit 4
settings ranging from auto factories to the world, have reinforced our view that
wholesale banking. these tactics alone are not enough. For
improvement to last, it must fundamen-
Clean to lean tally change the way people work across
the entire operationsomething that no
For an individual warehouse, the clean- picking system can do on its own.
sheet comparison will generate a large
preliminary gap that is simply the total Conversely, the companies that have truly
costs of the current facility against the transformed their warehouses not only
ideal, as shown at the left side of Exhibit 4. sustain the changes they have made but
But that ideal is necessarily artificial and continue improving well into the future.
must be adjusted for external conditions What these companies have in common
that the warehouse cannot control, such is that they redesigned their warehouse
as compliance with specific customer operations using lean management con-
labeling and documentation requirements, cepts, which incorporate deep insights
or local wages and land prices that are about the human side of change into
higher than average. The final tally is the a rigorous system for identifying and
warehouses total cost-performance gap, addressing waste.
which is somewhat smallerhere, 47 per-
cent instead of 65 percent. The basic ideas behind lean are decep-
tively simple and are listed at the right
The next step is to translate the clean- side of Exhibit 4. A lean organization
sheet findings into tangible actions that redesigns its layout and processes to
close the gap. This is the stage where provide exactly what its customers really
companies are often tempted by technical wantno more, no lessat the right
solutions, such as the automated picking quality and with only the resources (labor,
system described earlier. But the experi- time, capital) that are truly necessary. It
ences of dozens of companies, operat- makes performance transparent, with
ing hundreds of warehouses around visual management techniques to aid in

the uncovering (and resolution) of prob- The visible changes were simple: the
lems and the deployment of resources. company revamped its factories label-
Its organizational setup evolves with new ing practices so that everything arrived
leadership norms that emphasize coach- at the warehouse correctly labeled
ing and capability building at every level, drastically reducing time to receive
along with strategy and goals that provide product. Within the racks, products
a meaningful purpose for everyday work. were slotted according to their velocity
(that is, where they were fast- or slow-
The trick, of course, is to strengthen all moving). And new operating practices at
of these elements at once. Finding the the start and end of each shift (such as
right actions to take at a warehouse will standard locations for the picking carts
therefore require a pharmaco to under- and reduced time for receiving the next
stand more than the warehouses visible picking batch) raised picker productivity
mechanics and processes. A company by 20 percent.
must have a clear picture of the manage-
ment practices and organizational culture Some of the crucial changes were much
as well. less visible. The company clarified the
warehouses performance metrics, then
Striking gold: A case example used them to create a new system
of brief daily huddles to review results
One clients warehouse illustrates this and identify problems. Managers
diagnostic in action. The warehouse was started spending much more time on
one of the companys better performers, the work floor, coaching employees,
but its operating costs were too high. observing real work flows, and reallo-
Management sensed that it could reduce cating people to balance the workload.
the warehouses costs substantially while Unit leaders who previously had little
improving service still further. contact with one another now had
regular meetings to resolve problems
A walk-through revealed quite a few very that cut across boundaries.
basic process problems, such as inef-
ficient workstation layouts for hospital The combination of structural, manage-
products, time-consuming manual label- ment, and mindset changes together
ing of packages, and redundant data doubled the warehouses volume, and
checks. But even more important were the number of employees actually fell
several things that the walk-through (mainly because of attrition). Packaging
should have found, but did not. Day- usage reduced substantially. On-time, in-
to-day performance management was full performance rose to 99 percent, and
essentially nonexistent; workers and picking errors fell to almost zero.
managers had little way of knowing how
the warehouse was doing or what their
goals should be. Collaboration was poor,
particularly on critical quality issues. And True excellence in logistics cost perfor-
capability building was occasional and mance is still an opportunity for many
informal, giving workers few opportuni- companies. However, as with all gold
ties to build new skills. rushes, the highest profits will go to the
earliest movers. Those that seize the
Over the next year, the warehouse opportunity quickly can attain a difficult-
underwent a complete transformation. to-imitate competitive advantage.

Knut Alicke is a master expert in McKinseys Stuttgart office, Raoul Dubeauclard is a senior
expert in the Lyon office, and Michael Schmeink is a senior expert in the Dsseldorf office.

Five lessons for

supply chains from the
financial crisis
Knut Alicke and Kai Hoberg

For many supply chain executives, the consolidating suppliers, and freeing up
financial crisis has been one of the tough- cash by taking out inventory.
est challenges in their careers. Firms
across industries were required to deal Difficult times frequently relate to an
with huge demand-supply mismatches individual firms situation: these could
caused by collapsing demand. However, include poor top management decisions,
the supply chain community found inno- cost pressures from a new competitor,
vative ways to deal with the challenges or demand being hit by poor customer
of these tough times. Here are five action service. However, difficult times are also
areas supply chain managers should be frequently caused by changing economic
aware ofbefore the next crisis. climates.

Firms have always been challenged to During the financial crisis that started five
adapt their supply chains to their success years ago, an unforeseen contraction
in the market. During boom periods, in demand across numerous industries
firms are eager to avoid costly backlogs, challenged supply chains globally beyond
to align manufacturing capacities with anything observed in the past. As the
growing demand, and to ensure raw economy continued to drift downward,
materials from new suppliers. Meanwhile, a significant turning point occurred on
supply chains are accelerated, costly air September 15, 2008, when Lehman
freight is accepted, and large batches Brothers, the fourth largest US investment
are produced because goods will be sold bank at that time, declared bankruptcy.
at some stage. In contrast, during diffi The collapse of Lehman Brothers sent a
cult times, firms must address shrinking shock wave through the financial world
customer orders, face increasing com- and triggered an unprecedented decline in
petition, and see decreasing margins. the global economy.
Accordingly, priorities for supply chains
differ significantly. Firms must focus on In particular, the manufacturing sector suf-
cutting costs, reducing capacities, fered severe consequences as a result of

Change in annual orders in selected US manufacturing sectors,


Consumer and electronic products -18.6

Electrical equipment, appliances,

and components

Furniture and related products -24.9

Fabricated metal products -25.4

Durable goods industries -30.3

Machinery -31.9

Primary metals -40.3

Transportation equipment -42.3

SOURCE: US Census Bureau

Exhibit 1

the recession: industries such as machin- in volume. Unfortunately, the specific

ery, metals, and transportation equip- knowledge that was required to establish
ment observed drops in customer orders new production lines was not transferred.
by up to 42 percent within a single year Moreover, the company went through
(Exhibit1). Many companies struggled a lean manufacturing program, setting
to survive and entire supply chains were inventory holding cost at a high level of 40
threatened with collapse. Those firms that percent, which was excessive for its low- to
survived the financial crisis reacted swiftly medium-value-dense products. Although
and decisively. Often, they leveraged all of the crisis measures were appropriate,
innovative approaches to safeguard their applying the measures in parallel placed
internal and external supply chains amid the company under severe pressure, caus-
the challenging business climate. ing the firm to deplete its cash stores near
to the point of bankruptcy.
Today, many firms continue to deal with
individual challenges. Similarly, the eco- In a supply chain context, the five action
nomic situation in many parts of the world areas that are illustrated in Exhibit 2 are
has become unstable. For those reasons, essential to cope with any type of crisis
innovative approaches for managing sup- situationindividual as well as economic.
ply chains in a downturn could become as First, supply chain managers should
important now as they were just five years gain a clear understanding of potential
ago. Based on a series of interviews with demand scenarios, as demand should
executives from numerous firms affected be the basis of all supply chain planning.
in the financial crisis, we identified five Second, firms should safeguard their
action areas supply chain executives supplies to avoid any critical bottlenecks
should be familiar with (Exhibit 2). as suppliers go out of business. Third,
firms must accelerate all efforts to cre-
ate flexible and breathing supply chains
Supply chain actions in that can cope with all types of variability.
difficult times Fourth, managers should carefully reduce
inventories to free up cash that is essen-
Management actions in difficult times are tial for turnaround actions. Finally, firms
well known and are typically in line with should also consider the light at the end
classic turnaround approaches. These of the tunnel and should begin to position
actions include engaging in significant cost themselves for the inevitable upswing.
reduction (including overhead costs), intro-
ducing zero-based budgets, establishing Based on our experience, all five action
war rooms, and redefining footprints and areas must be considered in parallel,
networks. However, it is also crucial to which will cause exceptional challenges
understand the trade-offs between myopic for supply chain managers while also
and sustainable actions. In addition, it is dealing with all types of operational
key to plan for the inevitable and prepare glitches. Accordingly, we believe that
the supply chain to deal with tough times. firms should begin to prepare as early as
possible for difficult times ahead. In the
For example, when a medium-sized end, they will not only benefit in the crisis
third-tier automotive supplier in Southern but actions are also beneficial to the busi-
Germany was confronted with significant ness from a long-term perspective.
demand reductions, the company reacted
quickly. The supplier closed one produc- 1. Understanding true demand
tion site, shifted production volumes
to low-cost countries, and furloughed One key lesson from the financial crisis
employees to adjust to the decrease was that numerous firms underestimated

Action areas for supply chain management during periods of

economic crisis

Action area Key actions

Understanding true Identify reliable demand information

demand Communicate frequently with customers
Prepare multiple demand scenarios

Monitoring and safe- Identify supplier criticality

guarding supply Monitor supplier health and lead times
Ensure the survival of critical suppliers

Creating flexible, breathing Understand the effects of demand fluctuations

supply chains Convert fixed costs into variable costs
Define smart contracts

Aligning inventories to free Avoid surplus inventory intake

up cash
Align inventory policies
Streamline service offerings

Preparing for the upswing Retain and develop talent

Prepare long-term projects
Provide upside capacity

Exhibit 2
the severity of the declines in demand, orders from Russia because of limited
which reached 90 percent in some firms. credit availability of these customers. For
Because forecasting demand is the start- this reason, successful firms established
ing point of all planning (i.e., capacity a process to monitor the probability of
planning, supply planning, and produc- order cancellations that is similar to the
tion planning), it is crucial to understand processes for monitoring the probability
true demand. Indeed, any significant for winning orders. Frequently, compa-
over- or underreaction could trigger a nies began to realize that leveraging infor-
disaster. Accordingly, successful com- mation from the over-opportunistic sales
panies have pursued three key actions to force did not provide any transparency,
improve their understanding of demand: as sales personnel were still handcuffed
(i) identifying reliable demand information, to their budget thinking. When chal-
(ii) communicating with customers, and lenged to explain their sales forecasts,
(iii) developing demand scenarios. personnel often expressed concerns that
capacity could be reduced too sharply
Identify reliable demand information. and that longer lead times would alien-
For most firms, the visibility of true cus- ate customers. Successful firms rapidly
tomer demand was close to zero at the moved away from initial budgets and tar-
beginning of the crisis. Many found it gets by implementing a new zero-based
challenging to identify reliable demand budgeting process.
information. In addition to high levels
of economic uncertainty, opportunis- Communicate frequently with cus-
tic competitor actions to fill capacities tomers. Numerous companies also
induced additional uncertainty. Even established more frequent communica-
long-standing orders were subjectto tion with customers and placed more
cancellation as a result of collapsing emphasis on short-term forecasts.
customer demand. For example, a When the symptoms of recession began
Scandinavian heavy equipment manu- to emerge, one automotive supplier
facturer lost nearly all previously booked reduced the firms forecast horizon and

sales personnel increased chatter with How long can we employ our workers
customers. However, communication given the current order book and the
through established channels between lack of new demand?
sales and procurement departments
often did not provide sufficient visibility, Top companies have endeavored to
as the information flow was slow within answer these types of questions and
the customer organization. Procurement have typically aggregated them into a few
departments themselves frequently scenarios. Several companies have even
had no visibility regarding procurement developed more advanced economic
volumes in the upcoming weeks and models to analyze the effects of early
months. Accordingly, increased direct indicators on the world economy and
communication began to occur among to develop scenarios and action steps
planning departments while contract accordingly.
details were coordinated between sales
and procurement departments. Some 2. Monitoring and safeguarding
companies also began to further inte- supply
grate planning systems and established
EDI to obtain real-time updates on The suddenness and severity of the
planned volumes. recession forced many firms to the brink
of bankruptcy. While sales and demand
Another example of effective communi- reached all-time lows, sourcing depart-
cation is a vertically integrated chemical ments faced an entirely new challenge
company based in Germany that pro- the risk of losing suppliers and entire sup-
duces goods for all stages of the chemical ply chains due to bankruptcy.
value chain. By sharing demand informa-
tion on all types of fine and base chemi- Accordingly, successful firms exerted sig-
cals internally, managers established a nificant efforts to safeguard their supply.
reasonable picture of the market demand Typically, they implemented an advanced
for different products several months in supplier risk management system that
advance. included three actions: (i) identifying sup-
plier criticality; (ii) monitoring supplier
Prepare multiple demand scenarios. health and lead times; and (iii) ensuring
Because of limited visibility, a single fore- the survival of critical suppliers.
cast for a product line was often difficult
to obtain. Therefore, successful compa- Identify supplier criticality. Although
nies began to prepare multiple demand most firms have established a regular risk
scenarios and to plan their actions within assessment and management process,
these scenarios. Such scenarios included these processes typically focus on physi-
consideration of the following questions: cal supply chain disruptions such as nat-
ural disasters or strikes. The risk of losing
Is the worst case that demand suppliers next door is often neglected.
decreases by more than 80 percent? Therefore, supplier criticality needed to
be reevaluated based on the risk of sup-
What is the outcome if all of our cus- plier insolvency. Which critical parts and
tomers in France close their plants for how much volume do we obtain from a
three months? supplier? Which alternative suppliers are
certified? What volumes can these alter-
What are the aggregated inventories native suppliers provide?
of all European customers, and would
these customers need to divest all of Who owns the tools and forms? Often,
their stocks? second-tier suppliers and subcontractors

also contributed to the problem, particu- were (yet) available, firms supported
larly in the automotive industry. For this suppliers by pooling spending or taking
reason, firms that had prepared supply inventory ownership from suppliers to
chain mapping scenarios could now ease their financial burdens. Particularly
more easily identify the potential effects in small oligopoly supply markets, firms
of supplier defaults. have tended to prefer supporting a strug-
gling supplier rather than coping with an
Monitor supplier health and lead times. even more concentrated supply base
Once supplier criticality was identified, in the future. In extreme cases, firms
firms were required to monitor sup- also attempted to actively reshape their
plier health and lead times. To monitor supply base according to their strategic
supplier health, successful firms lever- objectives. For example, one automotive
aged all types of internal and external OEM defined its preferred supplier land-
sources, such as buyers information on scape for a certain category and actively
the speed at which suppliers were com- reallocated sourcing spending to the
mitting to orders or requesting earlier preferred suppliers, thereby destabilizing
payments, information from plant visits out-of-favor suppliers and rendering them
regarding utilization, and newspaper/ easy acquisition targets.
industry discussions on sell-and-lease-
back deals or the loss of key people to 3. Creating flexible, breathing
understand the real situation of the supply chains
supplier. Additionally, many firms carefully
reviewed the quarterly financial state- When demand plunged in the financial
ments of their suppliers. In any scenario, crisis, numerous firms grappled with
the monitoring of suppliers must be overcapacity and struggled to right size
carefully coordinated, including the iden- their operations in the short term. These
tification of lead persons who collect all challenges were often inevitable because
information. network design and footprint decisions
had been carefully planned and imple-
In addition to supplier health, success- mented over the course of several years
ful firms also carefully reviewed supplier for a very specific demand scenario.
lead times. Low order intake often had an For the future, we suggest managers
inverse effect on lead times because sup- proactively address demand uncertainty
pliers reduced their capacities to stretch and create supply chains that are flex-
their order books over longer periods. ible to a wider range of demand. We use
Therefore, firms needed to proactively the term breathing supply chains for
align with suppliers with respect to new setups that can efficiently provide output
delivery schedules. at different quantities. Breathing supply
chains are also a means to deal with fluc-
Ensure the survival of critical suppliers. tuations in more regular operations. We
Communicating frequently with suppli- find that successful companies pursued
ers and being a good customer is often three key actions to implement them: (i)
beneficial for firms during more com- understanding the effects of demand
fortable financial times. Paying invoices fluctuations; (ii) converting fixed costs
on time rather than stretching payment into variable costs; and (iii) defining smart
terms can ensure a preferred customer contracts.
rating that allows additional favors in the
future. Nevertheless, several companies Understand the effects of demand fluc-
have been forced to ensure the survival tuations. One key task in defining supply
of critical suppliers. In instances where chains is to match capacity with demand.
no alternative suppliers for critical goods Accordingly, it is crucial to obtain a fair

understanding of the effects of demand crucial role in creating breathing supply

fluctuations. Firms must identify which chains. Many firms closed long-term con-
actions should be selected based on the tracts with suppliers to benefit from dis-
prepared demand scenarios and must counts. However, once locked in, volume
embed the breathing supply chain think- or price reductions often depend entirely
ing into their supply chain strategies by on the good will of suppliers. Successful
asking questions such as: How do we companies have considered fluctuations
provide the most flexibility regarding any in demand when defining their contracts.
changes in demand? For each demand
scenario, a firm must identify preferable For example, one Dutch chemical com-
actions that holistically consider the pany had an annual contract with a
effects of selling, closing, or idling manu- provider of tank capacity beginning on
facturing assets as well as any potential January 1. The firm received a volume
insourcing or outsourcing effects. On a discount based on the tank capacity
more operational basis, situations are fre- signed for the year. However, company
quently complicated by increased MRP officials realized that the firm would need
complexity in low-demand situations as to pay for unused tanks or would fail to
a result of coupled production, minimum receive volume discounts if capacity
batch sizes, and order quantities. requirements deviated from the plan in
mid-year. Therefore, the firm opted for
Convert fixed costs into variable a smart contract design. Rather than
costs. Ultimately, it is crucial to convert renting all tank capacity on January 1,
fixed costs into variable costs to com- the firm now begins its annual rents on
pensate for lower production levels by a rolling basis throughout the year (e.g.,
diminishing marginal costs. Firms have certain capacity on January 1, certain
often closed or idled assets with lower capacity on February 1). Rather than
productivity while carefully considering receiving a volume discount on the
the incremental costs of moving produc- capacity signed at the same time, the
tion to other plants. One alternative for discount is now based on the capacity
reducing fixed costs involves increasing rented at a given time. The firm can easily
the utilization of fixed assets and labor discontinue the rent for the tank with the
by insourcing. Whereas outsourcing has next expiring contract to adjust capacity
become a common practice for address- while continuing to receive high-volume
ing bottlenecks and reducing costs in discounts for the remaining tanks rented.
normal economic conditions, many firms The example highlights the importance of
have focused on insourcing during the considering your options before any crisis
financial crisis. For example, for firms in arises to ensure flexibility in tough times.
the machinery sector, insourcing stan-
dard manufacturing processes, such as 4. Aligning inventories to free up cash
milling, welding, or assembly operations,
appears to be rather simple. Through Reducing inventories while meeting
insourcing, firms were able to increase service level requirements has always
worker and asset utilization even when been a key challenge for supply chain
internal productivity was lower. However, managers. However, the limited avail-
firms must minimize insourcing costs by ability of credit during the financial crisis
cross-training workers, maintaining the triggered a skyrocketing interest in opti-
required tools, and developing smart mizing inventories, as firms were required
contracts that avoid penalties. to free up significant amounts of cash on
short notice. The situation became even
Define smart contracts. The definition more challenging as a result of unfavor-
of smart contracts with suppliers plays a able inventory dynamics. A significant

Quarterly inventory in days of supply between 2007 and 2010 for

different industries
Metals Machinery
(Basis = 89.3 days) (Basis = 116.5 days)

Electronics and equipment Transportation equipment

(Basis = 109.8 days) (Basis = 82.4 days)
2007 08 09 2010 2007 08 09 2010
Note: Index with basis Q2/2008
SOURCE: KLU analysis; S&P Compustat
Exhibit 3

reduction in sales slowed the outflow of time to turn. We found that successful
goods to customers; customers were firms reacted firmly to the decrease in
consuming their usual inventories at a demand and implemented a moratorium
lower rate and additionally reduced their on material orders to avoid any intake of
safety stock levels to a lower level, thus surplus goods. Similar to a travel ban,
triggering a multiplier effect. Accordingly, firms reviewed all material orders against
supplier production plummeted, and their demand scenarios and scrutinized
firms could only gradually consume their their supplier contracts for cancellation
raw material stocks. As a result, many opportunities. Even if contracts did not
firms observed the characteristic inven- allow for order cancellations, firms often
tory hump (Exhibit 3). Inventories hit successfully negotiated with suppliers to
the roof across industries in 2009 and extend volume commitments over longer
increased by up to 70 percent within six periods of time. Several companies also
months until the trajectory reversed. managed to sell raw materials to other
manufacturers that in turn benefited from
Our interviews with successful inventory favorable prices.
managers highlight three practices that
enabled managers to avoid or at least Align inventory policies. The significant
to balance the inventory hump: (i) avoid- change in demand required numerous
ing surplus inventory intake; (ii) aligning firms to review and align their inventory
inventory policies; and (iii) managing ser- policies. Frequently, order quantities were
vice offerings. reviewed and reduced. For example, one
leading European automotive supplier
Avoid surplus inventory intake. Although changed the typical order size for a cer-
inventory managers have few options to tain category from full truckload to half
increase the sales that trigger the outflow truckload in an effort to minimize cycle
of goods, it is essential to halt the inflow inventory. Likewise, firms reduced their
of surplus goods that will require a long batch quantities in accordance with the

new demand reality, which required more years, demand bumped back to the pre-
frequent changeovers. However, surplus vious dizzying heights. Likewise, many
personnel were available at virtually no firms were still in the right sizing mode and
incremental cost. Further, an increasing realized the challenges of moving from full
number of firms implemented analytical reverse to full steam ahead as production
safety stock targets to avoid or reduce capacities had been reduced and talent
safety stocks and aligned their processes had been released. However, farsighted
based on the management of slow mov- firms were prepared for the upturn and
ing items. managed to gain significant market share
by meeting customer demand while
Streamline service offerings. Finally, competitors struggled. We have identified
successful firms streamlined their service three practices that enabled firms to suc-
offerings to customers based on their cessfully meet the increased demand at
value add. One well-known trade-off in the end of the crisis: (i) retaining and devel-
inventory management relates to the oping talent; (ii) preparing long-term proj-
service level that is offered to custom- ects; and (iii) providing upside capacity.
ers: higher service level targets require
greater safety stock inventory. During Retain and develop talent. Although
the crisis, successful firms reduced the length of the crisis was unclear to
their service levels to move from a full- most managers, many successful firms
service to a cost-efficient setup. In one realized the utmost importance of retain-
case, a supplier to the furniture industry ing and developing talent throughout the
reduced service levels from 98 percent recession. Because manufacturing pro-
to 90 percent unless products were in cesses in many countries have become
heavy competition, provided significant more complex in recent decades, the
value add, or customers were willing to importance of expertise has similarly
pay a premium for higher service level. skyrocketed. Although firms had to lay off
Furthermore, firms aligned their make workers while adjusting their capacity,
to stock/make to order (MTS/MTO) mix talent retention was crucial for the eventual
to eliminate inventories, particularly for upturn. Many firms reduced employee
SKUs that were sold to a single customer work hours to ensure that the given order
only. However, this approach required book provided sufficient cover to retain
careful communication with customers, key personnel. Another successful exam-
as they were required to plan and order ple is Germanys chemical and automotive
these now-MTO items further in advance. industry, in which many firms leveraged
After the crisis, many companies relaxed government-supported part-time work to
their strict standards on the service offer- avoid layoffs (1.47 million employees were
ing while successful firms introduced new operating under part-time government
processes to carefully evaluate which support in May 2009 compared to 0.05
items to really serve from stock. million in May 2008). The ability to retain
talent enabled the firms to rebound as the
5. Preparing for the upswing economy began to recover.

As the financial crisis began to ease in Prepare long-term initiatives. Many

2009, numerous managers were caught firms realized that the downturn could
by surprise by the sudden economic also be viewed as an opportunity to pre-
upturn. For example, the demand plan of pare long-term initiatives as long as no
one transportation equipment company significant investments were involved. In
suggested a slow return to precrisis the boom years before the financial crisis,
demand levels over the course of six many firms did not have the resources
years. Nevertheless, in less than two necessary to carefully review their supply

chains, as skilled experts were struggling Were these outcomes purely the result of
to maintain pace with business expan- misfortune? In some cases, misfortune
sion. However, the sudden downturn halt- was perhaps to blame; however, we
ed further expansions and provided firms believe that the financial crisis harshly
with breathing space to focus on long- revealed the weak points in many firms
term initiatives. For example, one CPG supply chains. Based on our experience,
manufacturer reevaluated its manufac- we highlighted five key areas that many
turing footprint using the newly available firms did not sufficiently address. These
project management capacities that were five key areas are not necessarily crisis
implemented as investments became related. In fact, successful companies do
available at the end of the downturn. not require significant changes because
these firms already address these topics.
Provide upside capacity. When plan- However, firms that do not consistently
ning for business in the financial crisis, consider these key areas are much more
many firms did not consider the need to vulnerable in downturns. What does this
provide upside capacity. Although sup- finding mean for the next crisiseco-
pliers were frequently required to retain nomic or on an individual firm level?
some capacity on standby to prepare for
sudden demand increases, many firms First, firms must always be carefully scan-
did not sufficiently prepare for this scenar- ning for major changes in its specific mar-
io and were surprised by labor and asset ket conditions or in the overall economic
shortages. One example of upside capac- climate. Managers must ensure demand
ity is provided by a chemical company transparency, establish early warning
that needed to employ temporary workers mechanisms using internal and external
during the upturn. By paying a temporary data, and reconcile with other functions
employment agency a small standby fee as well as suppliers and customers. To
for the preferred provision of personnel, accomplish these goals, managers must
the firm was able to select the temporary establish the relevant processes.
workers first when the economy began
to recover. Accordingly, the firm was able In addition, firms must constantly chal-
to take on the temporary workers who lenge and test their abilities to adapt to
had previously been working in the firm, major changes in demand and supply.
thus minimizing the ramp-up time. Other One valuable tool is an agility assessment
examples include firms that were able of the supply chain to determine whether
to secure capacity early at key suppli- a firm is truly prepared for an inevitable
ers because they sensed the upcoming downturn. Numerous firms have already
increase in demand rather quickly. embedded semiannual or annual agil-
ity assessments into their routine risk
management processes. In this context,
Being agile alternative demand scenarios are out-
lined and supply chain adaptations and
Many firms suffered seriously or closed contingency plans may be developed.
their business during the financial crisis:
they did not reduce capacity as rapidly Overall, we believe that firms should
as demand plummeted, they lost critical continuously improve their agility, which
suppliers and thus could not fill customer is a means of ensuring success in any
demand, they nearly went bankrupt economic situation. Fewer stockpiles
because of high inventory levels and are accumulated when state-of-the-
a lack of cash, and they did not have art inventory management policies are
the talent or the capacity to fill soaring implemented, capacity can be adjusted
demand and therefore lost market share. quickly when contracts with suppliers

are designed intelligently, and supplier sufficiently adaptable in this regard, now
bankruptcies can be handled easily when is the proper time to begin working on the
alternative sources are constantly identi- measures recommended herein other
fied. For firms that have not yet become words, before the next crisis.

Knut Alicke is a master expert in McKinseys Stuttgart office, and Kai Hoberg is
associate professor of supply chain and operations strategy at Khne Logistics University
in Hamburg, Germany.

This article was originally published by Supply Chain Management Review (
and is reprinted here with permission.

Pushing the supply chain

further and faster

Building a winning
supply chain
in Latin America
Joo Pedro Branco, Leonardo Cabral, Santiago Kraiselburd, Ildefonso Silva,
and Tricia Witty

Its size, strong growth, and relative companies must strengthen their cover-
wealth make Latin America increasingly age across the entire area. From a supply
appealing as an emerging marketbut chain perspective, this necessity forces
only for companies that can overcome them for the first time to think about Latin
the regions supply chain complexities. America as a whole as they seek to drive
up service levels while keeping costs
Many companies today consider Latin under control. To do that well, supply
America to be an intrinsic part of their chain managers must first understand
emerging market strategy. And no won- the region-specific challenges they will
der: with a total gross domestic product face, and then adopt strategies for miti-
(GDP) of $5.5 trillion, the region offers the gating or overcoming them.
potential to reach more than half a billion
consumers. Moreover, Latin Americas
GDP is projected to grow 4 percent annu- Challenges on a grand scale
ally until at least 2017, twice as fast as GDP
in the major developed economies. Look at a map, and the challenge pre-
sented by the regions sheer geographic
In the aggregate, people in Latin America size becomes clear. The flying distance
are relatively well-off compared to other between two important commercial cen-
developing markets. GDP per capita in ters in South America, So Paulo (Brazil)
Brazil, for example, is 45 percent higher and Santiago (Chile), for example, is 2,500
than that of China and three times that of kilometers, around the same as the dis-
India. But despite its degree of personal tance between London and Moscow. The
wealth, the region is still very much an flying distance between So Paulo and
emerging economy. Its total GDP is only Mexico City is 7,500 kilometers, the same
one-third the size of that for the US, and distance as from London to Kathmandu.
40 percent of Europes. Per capita GDP
is lower still: one-fifth that of the US and a This huge spread might not be much of
quarter that of the main EU countries. a problem if the spaces between major
population centers were occupied.
All of this means that companies operat- But that is not the case. The direct,
ing in Latin America transport smaller 2,500 kilometer route from So Paulo to
volumes and less value there than they Santiago passes within 100 kilometers of
do in more mature markets. Volumes can only two secondary cities (Mendoza and
vary significantly from country to coun- Crdoba in Argentina). In fact, the top
try and region to region, too, making it 10 cities in Latin America are 3,900kilo-
hard for companies to take advantage of meters apart on average. Thats
scale effects by consolidating regions, 2,500kilometers more than the same
or to design efficient transport networks. figure for Europe. If you exclude Brazils
Despite such challenges, and as the sta- relatively concentrated population, the
tistics above suggest, Latin America is a average rises to 4,200 kilometers.
promising market that merits time, atten-
tion, and investment. Covering these huge distances is dif-
ficult. According to the World Economic
Historically, many multinational com- Forum, most Latin American countries fall
panies have focused on one or two key behind world averages for infrastructure
markets in the region, such as Brazil availability and quality. These dispari-
and Mexico. These markets are indeed ties are shown in Exhibit 1. Moreover, rail
important to the success of any company coverage is poor compared to EU or US
doing business in Latin America. But in standards, and ports are running at many
order to access this regions full potential, times their designed capacity.

For most modes of transportation, Latin Americas infrastructure quality

is below OECD average
WEF infrastructure quality index1, 2012-13 Latin America and the Caribbean OECD2

Country Roads Railroads Air transport Ports Electric supply

Brazil 2.7 1.8 3.0 2.6 4.9

Mexico 4.5 2.8 4.8 4.3 4.6

Argentina 3.0 1.7 3.5 3.6 3.5

Colombia 2.6 1.6 3.8 3.2 5.1

Chile 5.6 2.6 5.5 5.2 5.4

Bolivia 3.1 3.0 3.5 3.3 3.8

Panama 4.5 4.0 6.4 6.4 5.5

China 4.4 4.6 4.5 4.4 5.2

India 3.5 4.4 4.7 4.0 3.2

3.6 5.2 1.9 4.5 4.4 5.6 3.9 5.2 4.2 6.1

1 Index based on surveys inquiring the infrastructure quality in each dimension (1 = extremely underdeveloped/poor, 7 = extensive and efficient by
international standards/excellent
2 Average index compounded of the OECD countries
SOURCE: WEF Global Competitiveness Report 2012-13; team analysis
Exhibit 1

Countries in the region rely heavily on to Brazil from China or Hong Kong,
road transportation. In Brazil, 60 percent although the transit time, at 20 to
of the total domestic tons-kilometers 23 days, is some 10 days shorter.
(metric tons times kilometers traveled) Transporting the same container from
transported per year moves over the Europe would be cheaper. And, as
road; in Colombia, its 77 percent, and in Exhibit 2 shows, local transportation
Mexico 90 percent. That is much higher can be very expensivein fact, it costs
than in many other economies. In China, more to move a container between major
for instance, that figure is 21 percent, and cities in Argentina than it would to ship
in the US 36 percent. This is significant that same container from Hong Kong to
because road transport is considerably BuenosAires.
more expensive than transportation by
rail or ship. Road transport can also be Although Latin America as a whole has the
slow: average road speeds across Latin characteristics of an emerging economy,
America can vary from 10 to 80 kilometers for many companies operating there it is
per hour, creating important implications not a true low-cost region. Labor costs,
for supply chain planning and product for example, are significantly higher than
shelf life. The regions natural barriers, like those of Chinaup to 3.5 times higher in
the Andes Mountains and the Amazon the case of Brazil. And while labor rates
River Basin, add further cost and com- are not rising as fast as Chinas, the gap is
plexity to the transport picture. likely to remain significant until at least the
end of the decade.

The challenge of high costs This is true not just for warehouse or fac-
tory workers but also for managers and
Great distances and poor infrastructure executives. Professional salaries in Latin
mean high costs. Shipping a 20 foot con- America have risen dramatically in recent
tainer from Mexico or Colombia to Brazil years as demand for key skills outstrips
costs about the same as shipping one supply. The cost to employ an experienced

Local transportation costs can be significant

Hong Kong
~18,500 km
~300 km Buenos Aires

In Argentina, in 2013, it cost 18% more to move a 20 foot

container from Rosario to Buenos Aires (~300 km away)
than from Hong Kong to Buenos Aires (~18,500 km away)
SOURCE: Comex, March 27th, 2013
Exhibit 2

supply chain manager in Brazil, for goods. In the past, such situations have
example, is now on a par with that for the arisen between Colombia and Venezuela,
equivalent role in the US. Venezuela and the US, and Bolivia and
Chile, to name three examples. Internal
instability can also lead to unsafe road con-
Challenges across borders ditions or closures, with activity by guerril-
las in Colombia and by coca producers in
Latin Americafor the purposes of this Bolivia being two notable recent examples.
article, the Spanish- and Portuguese-
speaking countries in Central and South To complicate matters even further, the
America, plus Mexicoincludes 17 coun- region has a tradition of government-con-
tries, each with its own customs and tax trolled exchange rates, with a tendency
laws, bilateral agreements, and tariffs. In to engage in local currency wars. As a
Brazil, tax regulations even vary signifi- consequence, sudden devaluations can
cantly from state to state. Many countries make one country more or less competi-
in the region are trying to protect their local tive in relative terms without any signifi-
industries through import duties, quotas, cant changes in productivity. For exam-
and tax regulations. The sheer complexity ple, after Argentina recently devaluated
of these rules makes it difficult for compa- its currency, Brazils currency also fell in
nies to simply keep up to date with current dollar termsbut not enough to compen-
charges and regulations, let alone account sate for Argentinas devaluation, which
for all the many variables affecting their made Argentine goods relatively more
supply chain optimization efforts. competitive in Brazil. Combined with the
often painful bureaucratic processes at
Political developments can exacer- ports and border crossings, these effects
bate supply chain challenges. Tensions can make managing manufacturing and
between countries in the region frequently distribution footprints, lead times, and
lead to the closure of border crossings inventories in Latin America more an art
or to limitations on the movement of than a science.

Supply chain strategies for America each manufacture or assemble

success locally more than 90 percent of the prod-
ucts they sell in the region. Argentinas
Taken together, these challenges make top automotive brands all produce signifi-
it difficult for companies to optimize the cant numbers of vehicles in the country,
performance of their Latin American sup- both for local consumption and for export
ply chains. They also have driven some to other regional markets, especially
supply chain decisions that seem illogical Brazil, thanks in part to special treaties
at face value. for bilateral automotive trade between
the two countries. Maintaining this local
For example, it is not uncommon for footprint, especially in expensive places
companies to maintain idle manufactur- such as Argentina and Brazil, can be
ing capacity in both Brazil and Argentina. significantly more expensive than con-
This strategy allows companies to quickly centrating production in one low-labor-
change the percentage of goods they are cost country. However, doing so allows
manufacturing in one country or the other companies to be faster and more agile in
in response to changes in exchange rates a volatile market.
or tax policies, or when there are border
issues. Another example: in Argentina, From operational expedience
tax policies have encouraged many
consumer electronics companies to set In many cases, these localized supply
up assembly plants in Rio Grande, a city chains have been specifically designed
in the extremely cold Tierra del Fuego to meet the requirements of local tax and
region that lies around 3,500 kilometers duty regimes or to overcome import quo-
south of Buenos Aires, Argentinas main tas. In the case of mobile handsets, for
market. Similarly, tax policies explain why example, this may entail sourcing 80 per-
many consumer goods and electron- cent of the component value in the hand-
ics manufacturers have large plants in set from within the country. The benefits
Manaus, Brazil, located in the Amazonian of this type of tax-efficient approach can
forest region some 4,000 kilometers from be highly significant, often far outweigh-
So Paulo, Brazils main market. ing the potentially higher costs of local
manufacture. One consumer products
Despite the challenges outlined above, company, for example, was able to
some multinational and local companies increase its contribution margin for a key
have built extremely successful Latin product category in Brazil by 30 percent
American businesses. An intrinsic part by shifting to local production, despite
of this success has, in many cases, been the fact that doing this also increased its
the adoption of a Latin-America-specific cost of production by 30 percent. The
approach to the design and execution of difference came entirely from savings on
their supply chains, together with a tar- import duties, internal tax benefits, and
geted investment in supply chain capa- other regulatory effects.
bilities in the region. Lets review some of
the key elements of these strategies. to competitive advantage

While regulatory conditions may have

A significant local footprint driven the development of local footprints,
the most successful companies take
A significant local footprint forms a deliberate steps to turn both of these fac-
core part of the most successful Latin tors into a source of competitive advan-
American supply chain strategies. The tage, typically by tailoring products to suit
top four mobile handset makers in Latin the needs and tastes of Latin American

consumers. For example, in the 1980s, the multiple labeling variants for adjacent
German carmaker Volkswagen designed regions, for example, while the existence
the subcompact Gol specifically for manu- of various free trade agreements can have
facture and sale in Brazil. The vehicle was significant implications for the movement
built to replace the popular but aging of goods between and within countries,
Beetle, catering to local tastes and taking sometimes even requiring companies to
advantage of tax breaks for local produc- change package sizes or the number of
tion. It was later introduced in neighboring products per case to meet local regulations.
Argentina under a similar strategy. The
Gol has been the best-selling car in both As a result of these complexities, most
Brazil and Argentina; counting all its vari- large companies operating in Latin America
ants, it has sold over 10 million units, and choose to segment their supply chain
Volkswagen has used its Brazilian facto- organizations into regional clusters. These
ries to make compact, low-cost city cars clusters are designed to balance market
for other international markets. size, cultural similarity, and the cost and
ease of moving goods across internal
In the apparel industry, fast fashion borders within the cluster. A typical
player Zara makes design adjustments approach uses four segments: Central
especially for Brazil, something that it America (including the Caribbean countries
does not do for most other countries. It and Mexico), Brazil (which is often large
has also cultivated a flexible local supply enough to justify a dedicated supply chain
base, which allows it to quickly change its organization), the Northern Andean region,
production plans in response to demand. and the rest of the Southern Cone. Exhibit3
Other apparel manufacturers have turned outlines these typical segments and the
their Latin American supply chains into main considerations that affect where com-
sources of product for export, increasing panies will decide to draw those lines.
scale and allowing them to accumulate
export tax credits, which help to increase The right organization within each
the profitability of the local operation. cluster

Within and across these supply chain

An appropriate organizational clusters, companies must then make the
split right decisions to ensure that research
and development, purchasing, manufac-
Few Latin American countries offer a turing, sales, warehousing, and distribu-
large-enough market to justify an entirely tion assets are located in a way that bal-
local supply chain. A strong supply chain ances cost, service, and local taxation.
design requires companies to define the Often this entails concentrating assets
right regional split, one that maximizes in the largest market in a cluster, but the
the benefits of scale while also reflecting best design depends very much on the
the individual needs of particular regions. details of each organizations products
and markets. Ideally, the organizational
structure should foster quick reaction at
The right supply chain clusters the appropriate level within and across
the established network cluster.
An efficient supply chain organizational
split must take into account the physical
(long distances, jungles, mountain ranges), Pragmatic, agile execution
cultural (different languages, incomes,
and tastes), and political barriers in Latin Leading companies modify their supply
America. Language differences may require chain execution strategies to suit the

The organizational structure should foster quick reaction at the

appropriate level within and across the established network clusters
Typical configuration of
Challenges for Latin America Latin American organization
Different time zones 5 different time
zones in Latin America provide 16 straight Northern Andean
hours of work coverage in the region countries
Multiple languages, cultures and politics
different languages/regulations in Central C
Mexico and
America lead to multiple labeling Central
Long distances transporting items with America
low-value add increases total costs Brazil

Geographical barriers mountain passes

between Argentina and Chile can close for A
heavy snow making lead times and
inventory management challenging
Although Latin B
Various freetrade agreements (from American structures
subregional to ones between 2 typically fall into South
countries) different counts of products these clusters, America
per case and different sizes per country variations may occur excl. Brazil
increase portfolio complexity

Exhibit 3

realities of operation in Latin America. The the best and earliest possible warning of
best of them do this with a hope for the situations that may affect their ability to
best, prepare for the worst approach, in cost-effectively deliver to customers, and
which they accept the higher levels of risk then dynamically adjusting supply chain
and volatility in the region and run their parameters in response.
supply chains accordingly. This requires
a high degree of agility and flexibility, both One consumer goods company with
on a day-to-day basis and in the face of manufacturing facilities in Argentina, for
changing, longer-term trends. This, in turn, example, found that consistent supply to
calls for significant investment in supply customers in Brazil was affected by varia-
chain capability and talent, something that tions in the time required for goods to
many companies struggle with today. clear customs at the border, which could
vary from a single day to several weeks.
Tactical responsiveness To minimize the effect of these delays,
the company monitored border transit
A common strategy used to meet the times and dynamically adjusted its safety
day-to-day challenges of operating in stocks in Brazil, increasing them when
Latin America includes the use of higher border congestion rose and cutting them
risk-adjusted safety stocks than would back to reduce costs as goods began to
be typical elsewhere in the world, in order move more freely.
to maintain continuity of supply if local
logistics activities are subject to delays or Strategic agility
disruptions. To keep the costs of higher
inventories under control, companies also Leading companies improve their abil-
take steps to improve the overall agility of ity to react to changing situations in two
their Latin American supply chains. They ways: by creating and rehearsing con-
do this by actively monitoring changing tingency plans to deal with a wide range
supply chain conditions in order to have of possible scenarios, and by improving

their ability to collaboratively plan for and However, our research has shown that
react to unpredicted events. These capa- these leading organizations are the excep-
bilities are critical in Latin America, where tion, rather than the rule. Since 2010, we
political and regulatory changesboth have evaluated the supply chain capa-
expected and unexpectedcan have a bilities and performance of more than
swift and significant impact on supply 600 companies worldwide, using the
chain costs and efficiency. maturity assessment diagnostic tool
included in the McKinsey Supply Chain
In 2012, for example, the Brazilian govern- 360 benchmarking suite. The maturity
ment announced a law with strict new assessment tool covers hundreds of
limits on the time and distance that truck practices, which are grouped into 20 topic
drivers could cover between mandatory categories. For each practice, the evalu-
rest stops. From one year to the next, ated companies received a 1 to 5 score
these requirements had the potential to that reflected the current implementation
increase the cost of road transportation in level at the company. The Latin American
the country by up to 30 percent and to lead consumer goods supply chain organiza-
to a shortage of both vehicles and drivers. tions in our survey had an average score
across all dimensions of 2.73 out of 5,
One leading food company quickly rec- compared with 3.1 for Europe and 3.13
ognized the potential impact the new law for North America. As shown in Exhibit4,
would have on its supply chain costs, and this research reveals that among Latin
it embarked on a wide-ranging response American companies (both locally owned
while the law was still being drafted. The and locally based multinationals), critical
company established communication maturity gaps exist in two aspects of sup-
with the government at the top level of ply chain management that are among the
the organization, with the aim of prevent- most important for success in the region:
ing certain unreasonable clauses from risk management and forecasting.
being written into the law. It redesigned
its distribution footprint to adjust for lon- Many companies operating in Latin
ger lead times and shorter feasible daily America need a systematic approach
distances. It also opened early negotia- to compensate for these critical gaps in
tions with suppliers and transport com- supply chain maturity. Above and beyond
panies to secure additional capacity. As gaps in institutional capabilities, the short-
a result of this quick and comprehensive age of supply chain talent in the region
response, the company helped to ensure makes it difficult to fill these skill gaps
some critical modifications were made to through recruitment alone. Instead, com-
the draft law before it was passed, and panies need to build their own individual
it was well positioned to minimize addi- and institutional capabilities from within.
tional costs and potential disruption by The best organizations do this through a
the time the law came into force. combination of actions, like facilitating the
exchange of knowledge and best prac-
A focus on capabilities tices from their global supply chain orga-
nizations, investing in capability building,
Design and execution of an effective sup- and transforming their local organizations
ply chain in the challenging conditions to better adapt to local conditions.
encountered in Latin America requires
considerable individual and institutional
capabilities. As the examples earlier in Unlock Latin Americas potential
this article show, some companies that
are operating in the region have devel- Latin America offers companies a differ-
oped these abilities to a high level. ent kind of emerging market, with faster

Gaps in Latin Americas supply chain maturity are largest in areas that are
critical to managing complexities of the region latin America Europe
Median SCM Maturity Assessment Tool results by region1 US/Canada
5 = highest, 1 = lowest
1 2 3 4 5
1 Supply chain strategy
2 Service level mgmt
3 Portfolio complexity mgmt
4 Segmentation
5 Network design Supply chain risk is higher in
6 Supply chain risk Latin America than in
7 S&OP developed markets, yet the
regions' ability to manage the
8 Order and demand mgmt risk is significantly lower
9 Inventory mgmt Forecasting is critical in Latin
10 Forecasting America given regional
complexity and market growth,
11 Production mgmt however, forecasting maturity
12 Supply mgmt significantly lags developed
13 Operational logistics markets

14 Supply chain organization

15 IT
16 Performance mgmt
17 Incentives
18 Staff capabilities
19 Training and development
20 Mindsets and behaviors

1 Median scores by region, McKinseys SC360 tool, CPG industry 2 Average of median scores by region, McKinseys SC360 tool, CPG industry, 3.

Exhibit 4

growth than most mature economies and well worth the effort and investment
a wealthier starting point than much of required to implement those strategies.
Asia. Unlocking this potential will require The financial payoff is substantial: our
strategies to overcome the regions politi- research has found that for companies
cal and geographical complexities, how- that successfully master this approach,
ever. The only way to do that is by deploy- the typical impact includes simultane-
ing smart, flexible, and pragmatic supply ous increases in order fill rates of about
chains that can respond to challenges 10percentage points (which would
like the ones outlined in this article. result in higher sales), and decreases in
inventory on the order of 30 percent and
For companies that want to be suc- in transportation costs of approximately
cessful in this part of the world, it is 15 percent.

Joo Pedro Branco and Leonardo Cabral are associate principals in McKinseys So Paulo
office, where Ildefonso Silva is a principal; Santiago Kraiselburd is a senior expert in the
Buenos Aires office; and Tricia Witty is a consultant in the Toronto office.

This article was originally published by Supply Chain Quarterly

( and is reprinted here with permission.

Advantage Africa:
Five ideas to win in Africa

Hassan Belkhayat and Johannes Rhren

Africa is the worlds third fastest growing other emerging economies. These EBIT
region, with promising and sometimes margins are also notably larger than
startling prospects for more sustainable in many developed markets, with the
developmentand with huge oppor- exception of the US.
tunities for pharmacos. However, on
many levels, the challenges involved in The potential is also visible in the conti-
capturing those opportunities constantly nents low per capita spending compared
threaten to undercut the lofty margins with that of other emerging markets
and double-digit market growth that just $17 on pharma products per year
some pharmacos have enjoyed for more compared with $39 in Chinaand in the
than a decade in Africa. Five key factors, big differences in per capita spending
drawn from other industries as well as between African nations. Whereas South
pharma, show that, increasingly, success Africans and Algerians already spend
across the continent will demand fresh roughly $90 per head on pharmaceuti-
approachesapproaches very different cals, other fast-growing economies, such
from those that have worked so well for as Ghana and Nigeria, with per capita
so long in Europe, the US, and the BRIC spending of just $19 and $8, respectively,
nations (Brazil, Russia, India, and China). offer significant growth potential.

A look at the underlying drivers of growth

A continents worth of growth creates further confidence. Four main
opportunities for pharma trends are propelling Africas pharma
ceutical market:
Let there be no doubt that the African
continent is a cornucopia of opportu- Increasing spending on healthcare
nity for pharmaceutical companies.
Since 2000, Africas pharma market has The burden of disease continues to rise,
expanded at a rapid clip: 15 percent, most markedly as a result of NCDs (non-
compounded annually. Today, leading communicable diseases such as cancer,
pharmacos generate more than $200 diabetes, as well as cardiovascular and
million in annual sales in Africa and one respiratory diseases) and maternal ill-
has even topped $1 billionequivalent nesses. At the same time, the continents
to about 2 to 4 percent of total company population is growing, and by 2020, more
revenue. than 50 percent of households will have
discretionary income. Also, increased
The future looks just as bright: there is urbanization improves access to health-
enormous potential to increase per capita care services. Already, 52 African cities
spending, and the factors driving growth are home to more than one million people
in pharma sales are very promising. The eachas many cities of that size in
latest estimates project that Africas Europe and the US togetherwhich pro-
pharma market will grow by an annual vides unprecedented opportunities for
average of between 10 and 14 percent targeted market penetration.
over the next few years. Those projec-
tions anticipate sales volumes of between Expanding provision of health care
$44 billion and $66 billion by 2020on
a par with current pharma sales in China The capacity of African health systems is
and outpacing those in either France or growing. Between 2006 and 2009 alone,
Germany today. Already, pharmacos 35 about 70,000 new hospital beds became
to 50 percent earnings before interest availablemore than the total of 55,000 in
and taxes (EBIT) profit margins in Africa Greece today. In that same period, roughly
are higher than those obtained in most 16,000 doctors and 60,000nurses were

added. Additionally, private hospital channels favor branded generics over

investments and public-private partner- INN generics. Product safety remains a
ships (PPPs) are growing, and health- key concern to African patients given the
care is becoming a strategic priority for prevalent issues with substandard prod-
governments, particularly in nations that ucts and counterfeit drugs. Here, branded
are subject to growing pressure from their generics serve the brand-conscious
own populations and from the global African consumers well and guarantee a
community. certain quality standard.

Maturing business environment Indeed, global influences may accelerate

the African nations embrace of gener-
Across much of Africa, the business envi- ics. Although most countries in sub-
ronment for pharmacos is becoming more Saharan Africa still use the globalized
stable and predictable. Lawmakers in patent regime, Indias raising of the bar
many countries are pushing the develop- for patent protection increasingly influ-
ment of local pharmaceutical sectors and ences the discussion in African countries.
bolstering efforts to harmonize regula- For instance, in South Africa, officials
tions. The African Union, together with are reviewing patent protection laws
major nongovernmental organizations together with the WHO and the World
(NGOs) such as the Bill & Melinda Gates Trade Organization (WTO), and patient
Foundation and international institutions advocacy groups are lobbying vocifer-
such as the World Health Organization ously to implement the WTO agreement
(WHO) and World Bank, is striving to on Trade-Related Aspects of Intellectual
harmonize the registration of medicines Property Rights (TRIPS)a move that
and accelerate product approval in four would offer compulsory licensing as an
regional economic communities: West option in order to make patented drugs
African Health Organization, South more affordable for citizens.
African Development Community, Organe
excutif de la CEMAC, and East African
Community. The progress of these efforts Facing up to Africas abundant
has been uneven over much of the last challenges
decade, however.
Pharmacos still confront tremendous chal-
Growing acceptance of generic lenges in many corners of Africachal-
(Gx) drugs lenges that range from political instability
to counterfeit drugs. Yes, in general, those
The push for lower drug prices will con- hurdles have been lowered somewhat in
tinue throughout the continent, open- recent years, but they are still substantially
ing doors wider for Gx drugs. However, higher than is typical in other markets.
two different trends are at work here. Lets examine five categories of difficulty:
First, public tenders, which are mainly
for essential drug list medicines, favor Political uncertainty and
low-cost nonbranded generics (INN) and regulatory burdens
often go to Gx drug manufacturers based
in Asia. For example, Indian manufactur- Recent uprisings in Maghreb countries
ers have a stronghold in the regulated as well as upcoming elections in Nigeria
markets of East Africa, selling both to and Mozambique create political uncer-
NGOs and public healthcare systems. In tainty for pharmacos. Beyond the political
2011, Indian manufacturers accounted uncertainty, regulatory burdens make
for 17.7 percent of African pharmaceuti- Africa a challenging place to operate
cal imports. Second, in contrast, private in. According to the World Bank Doing

Business Ranking 2012, about 60 per- Nigeria, which restricts imports of any
cent of Africas 54 countries are ranked drugs that are already produced in the
in the lowest quartile of 185 countries. country. Ghana employs a similar model
Only eight African countries are in the first and prohibits the import of 44 basic
or second quartile (for example, South medicines also supplied by domestic
Africa is in the first quartile and Tunisia is manufacturers. And in Egypt, foreign
in the second). Among the African nations companies must establish a local manu-
that are in the third or fourth quartile are facturing presence, enter a joint venture
large markets, such as Egypt, Kenya, with an Egyptian company, or use a local
and Nigeria, with large potential. In such distributor (Exhibit 1).
nations, key regulatory issues include poor
investor protection, corruption and limited Pharmacos are also confronted with mar-
enforcement of contracts, and barriers to kets that are poorly regulated overall and
cross-border trade. where registration timelines can be very
longup to five years in South Africa, for
High entry barriers and local instance. Although there are efforts by
content requirements NGOs such as The Clinton Foundation
and by organizations such as the World
Increasingly, African countries are striv- Bank to help African nations establish
ing to develop their own pharmaceutical regional regulatory regimes rather than
industries. For example, in 2011, Nigeria having each nation reinvent the wheel,
introduced investment incentives for local pharmacos cannot wait for these efforts
pharma manufacturing. In 2012, South to materialize. Rather, they must cope
Africa launched a $260 million program to with todays reality.
boost its pharma producers. One conse-
quence of such moves: many countries Poor local logistics infrastructure
require local manufacturing content as
a condition of granting market access. Africas roads and railways, as well as its
One of the most stringent examples is ports, are significantly underdeveloped

Countries are pushing for manufacturing development More than 300 companies
manufacturing pharma-
ceutical products in Africa

Tunisia Recent reforms are

Morocco promoting further growth
in local industries
Algeria Libya
Western Sahara Egypt
Investment incentives for
Cape Verde Mauritania
Mali Chad local pharma manufactures
Senegal Niger
Sudan Eritrea July 2011
The Gambia Faso Central
Nigeria Djibouti
Guinea-Bissau Guinea African Somalia South Africa
Sierra Leone Republic South Ethiopia
Ghana Cameroon Sudan R 2.5 billion to boost local
Cte D'Ivoire Benin
Togo pharmaceutical sector
Uganda Kenya
Equatorial Guinea Gabon Democratic Rwanda April 2012
Congo Republic Burundi
of Congo Tanzania

Zambia Mozambique
Saint Helena
Zimbabwe Mauritius
Botswana Madagascar
South Africa

SOURCE: OneSource; company Web sites; press searches; McKinsey analysis

Exhibit 1

compared with the BRIC average. The contraceptives) were out of stock at
challenge is particularly relevant in land- least half of the time in public facilities in
locked countries where distribution of Senegal and Nigeria, even though prod-
imports takes up to nine days longer than ucts were available at the national level.
it would take for equivalent distances National forecasts typically rely on actual
within seaport countries. Although there consumption and thus generally under-
have been, and continue to be, sizable estimate real demand.
public and private investments in logis-
tics infrastructure in Africa, especially There is another significant limitation: the
around major urban areas, the shipping paucity of talent and capital to manage
of goods within and across countries Africas pharma supply chains. Local dis-
remains challenging. Poor road infra- tributors often lack the money to finance
structure, port congestion, and delays inventory sufficient to ensure high service
in custom clearance are just the most levels. Many African nations public health
prominent of the factors that distort lead care systems have no centralized logis-
times, extending the need to keep local tics, with almost no resources dedicated
inventory on hand and making supply to supply chain activities; they rely on
chain planning extremely difficult and poorly trained staff and inadequate physi-
logistics quite costly. In addition to these cal facilities to pull products from central
well-known limitations, controlled cold or regional depots.
chains required by products such as
vaccines barely exist in many African Counterfeit drugs and informal
countries. Nigeria illustrates the extent of distribution channels
this challenge. One recent study found
that 90percent of the nations refrigera- In nations such as Kenya, counterfeit
tors were not working and 95 percent of products account for as much as half of
health workers had little or no knowledge all sales in many drug categories. (It can
of vaccine vial management. So, in many spike as high as 85 percent for antimalaria
states in Nigeria, less than 15 percent of drugs.) More than 100,000 deaths a year
drug distribution facilities are equipped across Africa are tied to fake medicines.
with cold-chain equipment. Stockouts of
vaccines can be as high as 90 percent. At the same time, informal distribution
channels present major difficulties. In
Limited supply chain management French-speaking West Africa, for exam-
capabilities and lack of local ple, relatives and friends of patients will,
resources as a matter of course, purchase phar-
maceutical products in other countries,
Commercial and public-sector distribu- particularly when they travel abroad,
tors alike are dogged by Africas supply and bring them home for patients use.
chain limitations. Arguably the most In these countries, one to three distribu-
pressing need is for better forecasting tors benefit from oligopolistic market
and planning. Inventories are often too structures and high, regulated margins.
low or do not have the right product mix, Hence, ordinary citizens are doing what
resulting in poor availability at the point of they can to circumvent the high prices.
sale. As a consequence, indirect supply
chain cost such as lost sales and high
levels of obsolescence have a negative How pharmacos operate in
impact on end-to-end cost and margins. Africa today
Studies led by the Gates Foundation
have shown that family planning products The current hurdles might make it seem
(particularly injectable and implantable impossible for pharmacos to do any

Today, pharmaceutical companies use 4 different supply chain

models in Africa

Public supply chains Commercial supply chains

Centralized supply Product level supply Wholesaler/
chain chain Local manufacturing distributor model

Products shipped to central warehouse location in Local manufacturing Shipment to local whole-
Africa or NGO warehouse outside Africa Local wholesalers and saler/distributor
Central pharmacy man- Multiple supply chains distributors manage Local wholesalers/distri-
aged by MoH1 undertakes within country split by supply chain, own invent- butors handle customs and
procurement and product groups ory, forecast, plan, and own inventory
Model distribution distribute the products Local distributors report
Each program respon-
Hospitals and clinics order sible for forecasting, forecasts and supply chain
from regional entity procurement, and management KPIs
(dependent of central distribution to pharmaco
pharmacy) Rely on local facilities
to pull the products

Frequent stockouts Cost advantage form low Margins squeezed by

Real demand underestimated as forecast based import duties wholesalers in regulated/
on real consumption Higher degree of control centralized countries (e.g.,
Result Low supply chain
management talent leads Low transparency and
to inaccurate forecasting influence leading to lower
and low availability market penetration and
frequent stockous

1 Ministry of health

Exhibit 2

meaningful business at all in Africa. But as hospitals and service delivery points then
noted earlier, there are many successful order products from that regional entity.
pharma ventures there already. So how do In the other case, there are multiple sup-
they do it? ply chains but no central pharmacy, with
each program (immunization, family plan-
In general, there are big differences in ning, etc.) responsible for forecasting and
distribution channels for public-sector procurement, and with its own warehous-
productsfor example, medicines for es and facilities for delivering products.
public hospitals, sometimes bought or
donated by NGOs or UN agenciesand In both cases, forecasting and planning
commercial pharma products, such as are deficient, which often leads to stock-
those sold in pharmacies and private outs. And when many forecasts are based
clinics, and through social marketing on actual consumption rather than real
(Exhibit 2). In the public distribution chan- demand, the full market potential for those
nel, pharmacos typically ship to a central drugs remains untapped.
warehousing location or, where NGOs or
agencies are the intermediaries, they hand In the commercial distribution channel,
over products at the production sites out- pharmacos must manage local distribu-
side of Africa or ship to central European tion. Their supply chains differ substan-
warehouses. Forecasting, planning, and tially by region, driven mainly by regulatory
distribution are then handled locally by the requirements and the availability of local
public institutions, NGOs, or agencies. contract manufacturers. Here, too, there
are two distinctly different supply models:
Within this model, there are two distinct one in which drugs are produced locally
supply chains. In one case, countries and distributed by local wholesalers and
such as Senegal and Kenya operate cen- distributors to pharmacies, private clin-
tral pharmacies that take care of procure- ics, etc., and another in which medicines
ment and distribution to the regional level are air-freighted from manufacturing sites
for all public-sector medications. Local outside Africa to local wholesalers and

distributors that distribute the products to According to the IFC, already today
pharmacies, private clinics, etc. approximately 30 percent of the final for-
mulation takes place in Africa. However,
The former supply model is more typical local production is limited to only a few
of the relatively mature markets of North markets, with South Africa accounting
Africa and the nation of South Africa. for 70 percent, and Nigeria, Kenya, and
Pharmacos are often required to have Ghana together accounting for 20 per-
local production sites or to use those cent of local production. But local pro-
countries existing contract manufactur- duction is growing as pharma companies
ers. Distributors and wholesalers then enforce their local footprint. According
assume ownership of the product inven- to the IFC, 40 percent of the incremental
tory; they also forecast demand, plan healthcare investment of the cumulative
and manage distribution to pharmacies $1.6 billion to $2.9 billion will go into local
and private clinics, and handle social final formulation manufacturing.
marketing. This model usually is the more
cost-efficient one because it entails lower
import duties, reduced transport costs, Needed next: Out-of-the-box
and greater control of distribution. Again, approaches
subpar capabilities in demand forecast-
ing and planning, limited capital to finance The routes to success in Africa that have
inventories, and lack of supply chain talent worked thus far for pharmacos are not
leave abundant room forgrowth. likely to serve them as they continue to
grow. Although companies can lever-
The latter modelin which drugs are age their experience in other marketsin
freighted in by air from Europe and else- particular, the BRIC marketsAfrica
wherecan be much more fragmented. requires an even more localized approach
Local wholesalers and distributors take and innovative solutions to distribution.
care of customs clearance and own the McKinsey & Company believes that phar-
goods from customs onward. Importantly, macos will be successful in Africa if they
there are big differences between African adapt their traditional models to the chal-
nations that are primarily English-speaking lenges on the ground. They must be will-
and those where French is a major lan- ing to look to other industries for innovative
guage. In French-speaking nations such ideas. At the end of the day, winning sup-
as Senegal, there is heavy regulation, ply chains in Africa are focused on local
and pharmacos typically are obliged to requirements. They link customers, distri-
use specific wholesalers that benefit bution, financing, regulation, as well as pri-
from high, regulated margins. In English- vate and public players. And they provide
speaking countries such as Ghana and or facilitate end-to-end solutions to the
Nigeria, regulation is lighter, resulting in very practical challenges on the ground.
a much more fragmented landscape of
wholesalers and distributors. Our research and client work with a vari-
ety of industries in Africa point to five key
One clear consequence of these com- success factors (Exhibit 3). Each merits a
mercial setups is that pharmacos have closer look:
little visibility into the supply chain and
thus little influence over pricing or other Make it simple: Focus on key
factors. Hence, pharmacos increasingly products and megacities in select
move toward local production and tighter markets
integration with wholesalers and distribu-
tors in order to be able to influence mar- Political uncertainty and regulatory
ket penetration, pricing, and quality. burdens mean that pharmacos must

Africa's optimal supply chain approach

Assess the operating con-

Define product port- ditions, such as regulation,
folio that matches availability of partners,
local patient needs logistics infrastructure
Select key markets Analyze risks
Focus on key products
starting with large
and megacities
Define supply chain seg-
urban areas Tailor ments based on common
supply requirements

Screen other sectors to Think Africa

innovative solutions for key outside supply chain
challenges, such as last-mile the box
distribution, transparency,
Define a
fighting counterfeit drugs
Develop, pilot, learn
Roll out innovative solutions Develop end-
to-end supply network
Identify end-to-end break points Understand demand centers
Identify key stakeholders across the Define inventory holding
supply chain points (warehouses)
Develop end-to-end solutions and engage with Model logistics cost
supply chain partners to shape the operating Define national/regional
environment solutions

Exhibit 3

pick their priorities carefully. Successful Realize that one size does not fit
companies share one common way to all: Tailor supply chains to local
do this, regardless of industry sector: requirements
they focus on a few main markets and
products when they start out and tar- Next, pharmacos need to understand
get megacities first. Pharmacos should each markets entry barriers and local-
define product portfolios that match local content requirements in order to define
patient requirements and local healthcare supply chain segments whose product
systems. Then they need to prioritize and market combinations share the same
markets. They will likely focus on a mix characteristics. In particular, this includes
of more mature markets (for example, distribution channels for specific prod-
those in South Africa, Algeria, Egypt, and ucts (public as distinct from commercial),
Tunisia) and high-potential markets (those regulatory requirements (for example,
in sub-Saharan Africa, such as Nigeria, those governing local content, the roles
Ghana, Kenya, and Senegal). McKinsey of wholesalers and distributors), and the
believes that winning in Africa means availability of potential partners for pro-
winning in megacities. One-third of total duction and distribution. In addition, it
growth in Africa will come from 50 mega- is crucial to assess the country-specific
cities with more than 1 million inhabit- riskspolitical stability and investment
ants each. In addition to their enormous security, for instancein order to evalu-
growth potential, these cities offer better ate the risks of allocating capital.
logistics infrastructure and healthcare
capabilities than rural areas. At the same On the basis of these tailoring steps,
time, city dwellers are usually more willing pharmacos should then define the con-
to adopt modern medication than those tours of solutions for any given product
in rural areas. Then and only then should and market combinationfor example,
pharmacos consider targeting midsize products for the commercial market with
markets and rural micromarkets in local-content requirements but no limita-
those shortlisted countries. tions on the selection of distributors and

Healthy urbanization large cities will drive more than one-third of total
economic growth

Per capita Share of popu-

Contribution to African GDP growth, 2011-25 GDP, indexed lation, 2011 Number of
Percent of total GDP growth 100 = all Africa Percent cities, 2011

3 370 1 1
>10 million inhabitants

Large middleweights
3 37% 110 2 2
5-10 million

Midsize middleweights
31 250 10 47
1-5 million

Small middleweights
20 205 7 156
200,000-1 million

Other cities and rural 43 68 80 204

African GDP growth 57 43 100% = $2.5 trillion

SOURCE: McKinsey global institute: cityscape 1.3; C-GIDD

Exhibit 3

wholesalers. As a result, supply chain regional distribution hubs as they push

segments can be defined and tailored into Africas smaller markets. While they
strategies developed. keep national distribution systems in
Nigeria, South Africa, and many of the
Consider regional distribution larger Northern African countries, they
hubs: Define a physical build regional distribution centers in
distribution network West and East Africa to serve neighbor-
ing countries by sea, road, or air (or all of
In Africa, poor logistics infrastructure and the above) and to optimize their logistics
high distribution costs require a careful costs. For example, many companies
design of physical distribution networks use Dakar or Senegal as a hub to serve
(warehousing, transport) for commercial francophone West Africa, Accra or
supply chains. Take road transportation Ghana, to serve English-speaking West
as an example: the cost per ton-kilometer Africa, and Tanzania or Kenya to serve
in Africa exceeds the cost in Western East Africa. These countries tend to have
Europe by as much as 20 to 120 percent more reliable inbound infrastructurethe
depending on the route. Hence, distribu- airport in Dakar and the port in Accra, for
tion cost becomes a major cost factor in instanceand their customs legislation
Africa, exceeding the approximately 2 to is less onerous for exporting goods. In
3 percent of sales that pharmacos spend Senegal, for example, companies can
on distribution in Europe. Examples leverage bonded warehouses for some
from other industries, such as consumer products. In this model, there is no need
goods and mining, illustrate best prac- to pay custom duties for products distrib-
tices that can help pharmacos optimize uted to other countries; all that applies
these direct logistics costs. are import duties to the final destination.
Such regional setups can have significant
Increasingly, companies from these other cost advantages and may serve as an
industries are moving from national to example for pharmacos in the future.

Develop end-to-end solutions: new capabilities and using private-sector

Strive to shape the operating vendors for the last step of distribution.
environment Likewise, in Morocco, Pfizer invests in
cold chain capabilities and assets such
A successful approach in Africa requires as cold storage to improve the quality and
an integrated view across commercial, coverage of cold chains.
operational, and regulatory schemes.
Pharmacos need to take an integrated Similarly, GlaxoSmithKline (GSK) is shap-
approach and shape the operating envi- ing a strategy to focus on the needs of
ronment. Here, the supply chain plays a emerging markets. Together with more
key role in developing end-to-end solu- than a dozen other pharmacos, and
tions that go beyond organizing logistics. with government agencies and other
Winning supply chains in Africa take on organizations, GSK is working toward
an integrator role, from production all the the goal of eliminating or controlling 10
way to customers, and develop solutions neglected tropical diseases by 2020. The
to a broad range of challengesfrom collaboration is also aimed at improving
financing of inventories at wholesalers, to the regulation associated with manage-
establishing cold chains in public distribu- ment of those diseases. This effort is
tion channels, to increasing planning and complemented with initiatives in selected
forecasting capabilities at distributors. countries to build local capabilities. These
efforts include the education of a nations
Pfizer in Nigeria provides an excellent or regions health professionals and con-
example of how engaging with local part- sumers as well as stimulation of demand
ners in a commercial distribution chan- through ancillary services. They can also
nel can provide an end-to-end solution. help African nations governments to fix or
Pfizer entered a partnership with a local improve their public-sector supply chains
distributor (Biofem Pharmaceuticals), with targeted support or local visible
hired a company (Sproxil) to provide tech- grants. Improving these operating condi-
nical assistance, and engaged national tions ultimately has an impact on the per-
authorities (NAFDAC). Collectively, this formance of supply chains on the ground,
Pfizer team implemented scratch- in terms of higher and more reliable
off technology along the supply chain demand, higher availability as public and
whereby codes can be automatically veri- private partners become more mature,
fied by mobile phone texting. The results and ultimately lower cost to serve patients.
speak for themselves: after suffering a
75 percent drop in sales in the previous Be innovative: think outside the
three years, Pfizer saw its sales in Nigeria box to solve challenges
soar by 10 percent in just three months.
Regional problemsfor example, coun- Finding cost-efficient and scalable solu-
terfeit drugswere identified immedi- tions to some of the challenges on the
ately, and Pfizer was able to develop ground requires innovative ideas. There
targeted promotions. are impressive examples of innovative
solutions that make a difference on both
Similar examples exist in public distri- a small and a large scalein particu-
bution channels. In Senegal, Merck, lar with regard to last-mile distribution,
through its foundation Merck for Mothers, supply chain transparency, and fighting
together with the Gates Foundation, is counterfeit drugs.
supporting the transformation of the pub-
lic distribution channel from a collection For final-mile distribution, the ColaLife
to a distribution system, helping public initiative is an excellent example of how
authorities and public distributors to build to learn from and leverage solutions that

proved to be successful in other indus- pilot program, health facilities sent SMS
tries (see the box ColaLife piggybacks messages showing their current stock
drugs to African villages). levels; the data were aggregated every
week at a district level in order to optimize
Another example of an innovative way to replenishment (Exhibit 5). All in all, the ini-
manage last-mile delivery is that of the tiative succeeded in reducing malaria drug
cosmetics company Avon in South Africa. stockouts by half.
Avon found a way to cost-efficiently dis-
tribute products to rural areas by hiring Another innovative example is mPedigree.
and training less-advantaged women as Together with a series of partnerstele-
door-to-door salespeople. The approach communications operators, leading tech-
changed the lives of many marginalized nology companies, and regulatory authori-
women in South Africaand made Avon ties in several countriesmPedigree
one of the most respected brands in provides a solution to solve the big chal-
that nation. lenge of counterfeit drugs. A basic phone,
a scratch-off code on the pack, and a
The SMS for Life program showed how toll-free SMS number enable customers to
thinking outside the box and engaging check the quality of a product at the point
partners outside of traditional supply of sale. Given the importance of quality
chains can add value and create end-to- to customers and the risk of counterfeit-
end solutions. Novartis, Vodafone, and the ing, this simple-to-use and highly scalable
Roll Back Malaria Partnership launched technology is a step change in managing
the project in 2009. The initiative involved secure supply chains in many countries
129 health facilities providing healthcare across Africa.
to 1.2 million people across rural Tanzania.
The objective was to overcome regular
stockouts of malaria medicine. During the

SMS for Life process

District medical

Stock take and

Stock inquiry Automatic
response at
text is sent from compilation of 7 central WH Novartis
local healthcare
SMS for Life information

reporting tool

Exhibit 5

Given the array of difficulties facing phar- of a brand and community and hence
macos that want to tap into African mar- sustain brand positioning over time.
kets, many executives could be excused
for asking whether the effort is worth it. Moreover, the market structure in many
The answer: yes, it is. Africas pharma African countries allows pharmacos to
opportunity can beand for many com- obtain significant market shares by form-
panies, will behighly rewarding. ing agreements with governments and
supplying a broad range of basic medica-
As growth opportunities from blockbuster tion (mainly through nonbranded generics)
drugs (those that earn $1 billion or more to national health systems. And a blend
per year) are becoming more and more of preferential deals, targeted technical
limited, more granular approaches to assistance for local partners, and innova-
growth are gaining importance. Africa is tive solutions to some of the most pressing
one of the growth clusters for pharma- challenges can boost market size and
cos, though it is still largely uncharted augment the quality of delivered solutions.
territory. Because many African markets Building relationships with local communi-
have yet to take off, competitive intensity ties and authorities can be the decisive
is rather low and there are significant advantage in these public tenders that
opportunities for early movers to achieve look beyond price.
a competitive advantage with branded
generics that address the quality con- Those wins will not materialize overnight,
cerns of patients for drugs that go through and they cannot be achieved without
private channels. Building a strong brand substantial commitment. But its our
early on can establish sturdy entry barri- belief that the efforts and the time spent
ers for followers and create a belonging will be more than worth it.

Hassan Belkhayat is a principal in McKinseys Casablanca office and Johannes Rhren is a

consultant in the Berlin office.

Getting started

How well is your supply

chain really working?

Knut Alicke, Christoph Glatzel, Kerstin Kubik, and Markus Leopoldseder

Multiple metrics, subtle trade-offs, and It was the need to answer exactly these
structural differences between industries kinds of questions for our clients that led
can make true supply chain performance us to search for a single, simple metric that
hard to evaluate, and even harder to bench- senior leaders could use to understand
mark. A new single performance indicator whether they are getting the best pos-
cuts through the complexity. sible return on their supply chain invest-
ment. After more than six months and
You know that your business depends the analysis of nearly 2,000 data points,
on a well-designed, efficiently executed the McKinsey Supply Chain Performance
supply chain to keep customers happy, Index (SCPI) achieves that elusive goal.
manage risks, and keep costs and com-
plexity under control, but do you really
understand if your current supply chain is One metric
performing as well as it should?
The SCPI aggregates more than 20 differ-
By their nature, supply chains are com- ent measures of supply chain performance
plex, and most companies today monitor in four key groups: service, measured by
supply chain performance with a portfo- on-time, in-full (OTIF) levels or case fill rates
lio of metrics, including inventory levels depending on the industry; the costs of
and turns, delivery performance, logis- transport and warehousing; the size of
tics costs, and many more. Each one inventories; and the maturity of a com-
of these metrics matters, but together panys supply chain organization (Exhibit 1).
these fistfuls of numbers can obscure as Critically, it compensates for the structural
much as they reveal. Are high inventory differences between industries by normal-
levels compensating for poor manufac- izing those metrics based on real-world
turing agility, or enabling vital service performance achieved by other compa-
responsiveness? Is costly expedited nies in the same sector, and gives them
transportation really needed to meet industry-specific weightings (depending on
volatile demand, or just a symptom of the relative impact of each) on real financial
poor planning? performance, as measured by return on
invested capital (ROIC).

SCPI calculated using industry-specific scales and weights for each KPI
Supply chain
Service level Logistics cost Inventory process maturity

Customer case fill Transport cost and Total inventory days Qualitative assess-
rate or orderline warehouse cost (in (finished goods, ment of 20 supply
OTIF percent of COGS) work in progress, chain dimensions on
raw materials) a scale from 1 - 10

1 Industry-specific, 10
nonlinear scales 9
to evaluate 8
performance on 7
each dimension 6
2 Industry-specific
weighting of
reflecting impact
Exhibit 1

For company leaders, the result is com- The SCPI provides much more than a
pelling: a robust, simple indicator that snapshot of supply chain performance,
reveals exactly how well the organiza- however. Disaggregating the data just
tions supply chain is performing against one step into its four constituent groups
its financial goals and how that perfor- of metrics reveals the fundamental driv-
mance compares with peers in the same ers of overall performance. In the case
and other industries. of the CPG companies shown above, for
example, this analysis shows that deliv-
ering superior service levels is the most
SCPI insights: CPG example important factor linking supply chain
performance to overall financial return.
The data in Exhibit 2 shows the SCPI In fact, among the companies in our data
plotted against return on invested capital set, an extra percentage point of service
for 20 large CPG companies with aggre- is worth a third of a percentage point
gated revenues of more than $500 billion. in ROIC.

This chart shows two key results. First, This finding matters. While the apprecia-
the spread of supply chain performance, tion of the importance of service is rela-
even among large, leading companies tively widespread, two-fifths of the CPG
in their respective sectors, is broad: managers we surveyed for the index said
SCPI indices range between 2.7 and 8.4. they currently prioritize cost over service in
Second, companies with higher-perform- their own supply chain decision making.
ing supply chains are reaping the benefits:
one extra point on the SCPI was worth Of course, companies cant afford simply
an extra 0.7 percentage points in ROIC, to buy service at the expense of cost
against an average ROIC of 11 percent in and inventory levels, but the SCPI shows
the sample as a whole. that the best organizations are remark-
ably successful at avoiding this kind of

The relationship between SCPI and commercial performance for a group of

large CPG players
13.5 Best
12.5 Correlation 0.5
12.0 R 0.3
8.0 performers
1 2 3 4 5 6 7 8 9 10
Supply Chain Performance Index
Scale 1 - 10
SOURCE: 360 Supply Chain Diagnostic database; CPAT; McKinsey SCPI team
Exhibit 2

compromise. The top 20 percent of com-

panies in the index (with an average score
of 8 out of 10 overall) score no lower than
6 out of 10 in any of the KPIs assessed.
The key message for CPG supply chain
leaders: maintain focus on improving sup-
ply chain metrics across the board, but
ensure that improvements elsewhere dont
come at the expense of servicelevels.

Driving improvements

A growing number of companies are

already integrating the SCPI into their
ongoing management processes. Their
senior leaders use the index to bench-
mark their own performance against
competitors, to assess how well their
current supply chain performance is
meeting corporate goals, and to monitor
the progress of ongoing supply chain
improvement efforts. For their supply
chain managers, meanwhile, the more
granular insights provided by the index
data are helping them to focus those
improvement efforts and to avoid the
risk of local optimization that can plague
supply chain improvement programs in
such a complex area.

Knut Alicke is a master expert in McKinseys

Stuttgart office, Christoph Glatzel is a
principal in the Cologne office, and Kerstin
Kubik is an expert in the Vienna office, where
Markus Leopoldseder is director of knowledge
for supply chain management.
Contacts for Americas Contacts for Europe Contacts for Asia

Paul Carbonneau Knut Alicke Sumit Dutta

Washington D.C. Stuttgart Mumbai
+1 (202) 662 3297 +49 (711) 255 3958 +91 (22) 6630 2069

Alex Niemeyer Christophe Franois Mads Lauritzen

Miami Lyon Bangkok
+1 (305) 961 8710 +33 (1) 4069 9303 +66 (2) 694 8513

Ildefonso Silva Christoph Glatzel Martin Lehnich

So Paulo Cologne Shanghai
+55 (11) 5189 1686 +49 (221) 208 7210 +86 (21) 6133 4527

Daniel Swan Jochen Gropietsch Kenji Nonaka

Chicago Barcelona Tokyo
+1 (312) 551 3541 +34 64913 8977 +81 (3) 5562 2194

Editorial team

Ashutosh Dekhne

Jochen Gropietsch

Christofer Kohn

Yogesh Malik

Erika Schroederus

Ron Stach

Operations Practice
June 2014
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