Operations Practice

Excellence in
Supply Chain Management
 3

Foreword

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
 5

Content

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

6

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
chain and distribution network gives us
a key advantage.
Meg Whitman, CEO of HP
In recent decades, companies in sectors
from automotive and high tech to retail and
consumer packaged goods (CPG) have
come to realize that their supply chain
is much more than the cost of getting
products into customers hands. These
companies understand that it is the supply
chain that translates corporate strategy
into day-to-day interactions both within and
beyond the organization. Ultimately, it is the
supply chain that satisfies or disappoints
their customers. These companies also
use a broader definition of the supply chain,
including planning, information sharing, and
value-adding activities, from raw material
to final distribution, rather than just logistics.
Leading companies have made strategic
investments in their supply chain capabili-
ties and set up efficient and effective orga-
nizations that overcome cross-functional
silos. By outperforming the overall level of
maturity in their sectors, they have been
able to disrupt them, as Amazon has done
in retail, for example. These companies
have redefined their customers expecta-
tions of service and their ability to bring
innovation to the market, turning their
excellence in supply chain execution into a
powerful source of competitive advantage.
Critically, the very best companies con-
tinue to evolve and reinvent their supply
chains, even if they have already achieved
a leading position in their industry. By
doing so, they are able to manage risks,
respond to changes in the economic, tech-
nological, and competitive environment
and exploit new opportunities more effec-
tively than their competitors.
Supply chain as CEO priority
In a recent survey, leading global CEOs
indicated that the supply chain is the topic
7
that has risen most in their attention over
the last years. Supply chain excellence is
getting harder, however. Production and
distribution networks are increasingly com-
plex and global, and their effective opera-
tion is vital for profitability and resilience.
At the same time, risks across the supply
chain have increased, and improved trans-
parency is critical to the coordination of
effective responses. Making those supply
chains work at their best requires tight
cross-functional coordination and the right
decisions and trade-offs across the orga-
nization. More importantly, however, the
right supply chain capabilities are playing a
critical role in allowing companies to exploit
emerging opportunities to boost growth
and improve profitability.
Three examples illustrate the difference
supply chain excellence can make:
One leading CPG company uses its supply
chain to manage input price volatility.
It has created multiple recipes and supply
chains for a core brand of cleaning pro-
ducts. Depending on the current prices
of ingredients, it switches between these
recipes and supply chains, allowing it to
hedge against increasingly volatile raw
material prices.
A major cosmetics company has created
a dedicated high-speed supply chain for
new products. This supply chain, incentiv-
ized only on time to market and product
launch excellence, allows it to get the latest
trends into the hands of consumers before
its competitors, while its conventional
supply chain segment controls costs for
products with steadier demand.
Or take the fast-growing online retail
market that is transforming consumer
expectations of delivery time and product
availability. In China, the online retail mar-
ket for consumer electronics provides an
example. Companies such as Suning and
Gome, the two leading players, deliver to
consumers in the larger cities within two
or three hours. Such speed has become
8
a competitive necessity, since consumers
increasingly order the same item at several
retailers, take the one that is delivered first,
and reject the later arrivals.
Three powerful interventions
If these examples demonstrate anything,
it is the variety of ways that supply chain
execution can drive business perfor-
mance. In our work helping companies to
transform their supply chain performance,
however, we have identified three specific
actions that senior leaders can take to
maximize the potential of their own organi-
zations supply chains.
1. Differentiate your supply chain
and corporate strategies
Whether the strategy of your business
is superior service, product innovation,
or cost leadership, ensure your supply
chain is helping to deliver the key points
of that strategy. Bring together leaders
from across your business to define the
supply chain that will work for youand
ensure they provide the data your organi-
zation needs to deliver. Marketing needs
to tell you what your customers value
most from your service, how those needs
vary between customers, and what will
differentiate you from your competitors.
Your commercial functions have to iden-
tify which customers justify the cost of
the highest service and which would be
better served using a more standardized
approach. Together, your supply chain
and product development functions can
find ways to create innovative products
that suit the needs of all those different
customer groups, while keeping overall
costs under control.
2. Create a modern, end-to-end
supply chain organization
The times of managing the supply chain in
separated tiers is over. Sophisticated data
analysis enables companies to manage
supply chains end to end and, in industries
like retail, almost in real time. Appoint a
single leader with responsibility for end-
to-end performance and for delivering
improvement projects across tiers and tra-
ditional functions such as marketing, man-
ufacturing, and procurement. Make sure
your supply chain organization combines
operational excellence with strong ana-
lytical capabilities and data-driven, cross-
functional decision making. Create analyti-
cal teams to support decision making and
to identify hidden risks and opportunities in
unstructured data. Ensure your IT function
is supporting them with nimble applications
and platforms that enable collaboration and
analytical decision making.
3. Set the performance standards
for the entire organization
Incentivize your supply chain organization
to work in ways that deliver the most value
for your business, while protecting against
its biggest risks. That means using more
than the traditional metrics of cost, service,
and capital. The right KPIs depend strongly
on the needs of the business, the product,
and the market segment: cost of produc-
tion for value players; stability of supply
for staples and critical products like spare
parts or medical devices; agility in volatile
markets with fluctuating demand; or launch
excellence for new products are key. If a
metric doesnt matter in your business,
dont misdirect the organization by using it.
 9

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.
10
Is your top team
undermining your
supply chain?
Christoph GlatzeL, Jochen Gropietsch, and Ildefonso Silva
Managing a global supply chain involves
tough organizational challenges that
promise only to intensify as operations
expand and become increasingly inter-
connected. Key among those challenges:
getting functional groups to understand
their impact on one another so that they
can collaborate. To bridge the organiza-
tional gaps that often divide their senior
managers, McKinsey research finds that
companies need to successfully address
three main areas of collaboration tension.
Building a global supply chain to
succeedindeed, to thrivein a world
of rising complexity and uncertainty
requires recognizing and tackling sig-
nificant organizational challenges.
Specifically, the top management team
needs to understand that the decisions
and activities of their companys supply
chain group affect, and are affected by,
the sales team, marketers, and product
developers, among others. The result is a
host of thorny trade-offs. Should a com-
pany, say, move a product to a low-cost
manufacturing facility to save money if
that means lengthening delivery times?
What if trimming the companys product
portfolio to reduce manufacturing com-
plexity and costs could stifle marketing
efforts to reach new customers? When
do the benefits of improved customer
service warrant the additional operating
expenses required to deliver it? Supply
chain, sales, and marketing managers
invariably view such trade-offs through
the lenses of their own responsibili-
tiesand those perspectives often lead
to disagreements or misunderstandings.
Indeed, a McKinsey survey of global
executives cited the inability of functional
groups to understand their impact on one
another as the most common barrier to
collaboration for resolving the major sup-
ply chain trade-offs.
Ineffective collaboration has long been a
supply chain sore spot, but its costs are
set to rise drastically. If its hard today to
agree on the right response to a disruption
in a supply chain, it will be more difficult
still when companies deal with multiple
interconnected supply chains, each pos-
sibly requiring a different solution. And
consider the short- and long-term supply
chain trade-offs that executives must bal-
ance in a world where one business unit
might be asked to shift its manufacturing
lines to a more expensive nearshore loca-
tion today to build capacity as a hedge
against potential future spikes in labor or
transport costs.
When the recent earthquake and tsunami
in Japan evidenced the fragility of many
sophisticated supply chains, it became
clear that these trade-offs can have very
real consequences. Many companies in
the automotive and high-tech industries
are still recovering from availability issues
in Japan, along with missed sales and
high reaction costs that we believe could
at least have been partially avoided by a
more systematic management of risk, as
well as the trade-offs between short-term
optimization and long-term stability.
Finding mechanisms to solve these and
other difficult supply chain questions will
require hands-on attention from the CEO
and other company leaders. The process
begins when executives work together to
identify places where better information
sharing and teamwork will generate the
most impact. Lets look then at three of
the biggest collaboration tensions and
see how companies are bridging these
organizational divides to create more flex-
ible and capable supply chains.
Tension 1: Supply chain vs. sales
Supply chain organizations wage a con-
stant battle against volatile demand, and
for good reason. An unexpected spike in
orders, for example, has expensive con-
sequences in labor and distribution costs.
Similarly, inaccurate sales forecasts can
lead to stockouts, lost sales, or excess
inventory that must be sold at a discount.

Sales and supply chain groups therefore
devote significant energy to creating
sophisticated planning and forecasting
processes in an attempt to predict
demand volatilityand blame each other
when things go awry.
At first blush, the reasons for the discon-
nect may not be obvious. For example,
the sales team at a luxury goods manu-
facturer we studied rightly claimed to
have correctly anticipated a
Ineffective collabo- significant customer order.
ration has long been Unfortunately, however,
a supply chain sore the forecast did not specify
spot, but its costs are the product type in enough
set to rise drastically. detail. This frustrated the
production team, which
insisted it was not able to plan the order
in a timely manner.
However, when these groups work
together more closely, they can move
beyond the traditional planning cycle
blame game. In fact, they can discover
the root causes of volatility and ultimately
begin to influence it. This approach
brings tangible business benefitsoften
quickly. Crucially, over the longer term,
the experience that groups gain from
flexing their collaborative muscles height-
ens the ability to react quickly, and in a
concerted way, to unforeseen events.
That skill will be even more necessary
given the increasing uncertainty in the
supply chain environment. Here are two
examples that illustrate the potential.
The first involves an automotive supplier
whose sales teams often scrambled to
meet quarterly targets that would guar-
antee them better performance bonuses.
Customers recognized this behavior and,
in some cases, were gaming the system
by withholding orders until the end of the
quarter to secure deeper discounts. The
result was a series of supply chain head-
aches that included inventory buildups
at the end of each quarter, and higher
warehousing costs. Worse, the additional
labor costs needed to cope with the
11
spiky demand, along with the expedited
freight costs to meet customer service
expectations, and began eating at the
companys bottom line.
In order to address this issue, the compa-
nys vice president of sales and its head
of supply chain collaborated to shape
demand into a more manageable form.
One key step: substantially trimming end-
of-quarter discounts and instead using
a price and discount structure based
on sales volumes, product loyalty, and
participation in promotional efforts. The
company also created new incentives to
encourage sales teams to spread sales
more evenly across the quarter. All these
actions together reduced overall demand
volatility, thereby substantially trimming
the inefficiencies across the value chain.
Our second example involves a global
CPG manufacturer. This company dis-
covered that promotional activity in just
five customer accounts drove most of
its demand volatility. Although the com-
pany carefully planned the promotions
to maximize revenues, its marketers
hadnt thought about the impact on the
supply chain. When several promotions
coincided, for example, the manufactur-
ing capacity for one product group was
overbooked, resulting in stockouts and
significant overtime expenses to meet the
demand. As service levels on key prod-
ucts dipped, the CEO became alarmed
and asked his sales and supply chain
executives to form a joint team and iden-
tify improvements. By staggering the pro-
motions over several months and aligning
them carefully with baseline demand
patterns, the team was able to reduce the
overall volatility of demand by 25 percent.
When the company rolled out the new
promotions plan, its managers identified
another problem: many customers lacked
the resources to manage their order lev-
els efficiently and therefore sporadically
placed unnecessarily large orders. The
company responded by bringing together
12
its sales and supply chain personnel and
working with these customers to create
better ordering processes for them. In
this way, it smoothed the flow of orders
a move that benefitted both parties.
Whats more, the moves boosted cus-
tomer service levels by three percentage
points in the core categories.
Situations like these are endemic in
many supply chains. By tackling these
problems, companies often enjoy imme-
diate benefits while building collabora-
tive capabilities that will be crucial over
the long term in the more complex and
uncertain supply chain environment of
the future.
Tension 2: Supply chain vs.
customer service
A second important tension involves the
setting of customer service levels. This
issue has been around for a long time,
and its one that is set to get worse as
companies seek to create more resilient
global supply chains. Contentious ques-
tions abound: How speedy should deliver-
ies be? Should some customers receive
orders faster than others? What levels of
product availability should be guaranteed?
In our experience, companies tradition-
ally leave these decisions to the sales or
customer service functions, which often
make service-related decisions without
understanding the broader operational
implications or costs involved.
When these groups work together to ana-
lyze the full impact of a service decision,
they avoid this pitfall. That lesson was
learned by a chemical company whose
sales personnel were pushing its logistics
team to reduce delivery times from three
to two days. The company achieved this
goal, but only by using more warehouse
space and labor and by loading its deliv-
ery trucks less efficiently than it otherwise
would have. Together, these actions
increased distribution costs by 5 percent.
This came much to the surprise of the
sales team, which had not taken into
account the full operational implications
of the new service target.
While this trade-off might have been
acceptable under the right circumstances,
a closer examination by the leaders of the
supply chain and sales groups revealed
that most customers didnt mind if deliv-
eries arrived in two, three, or even five
days. The real break point when service
was most highly valued was 24 hours. By
extending the delivery window for normal
orders back to three days, the company
returned its distribution costs to their
original levels. Meanwhile, it launched
a special 24-hour express service for
critical deliveries, for which it charged a
premium. The move ultimately raised the
companys costs slightly, but this was
more than offset by the new business
it generated.
As supply chains splinter and companies
diversify production to hedge against
uncertainty, the importance of making
smart trade-offs about service levels and
speed can only grow. Companies that
want to do better in this area will have
to strengthen partnerships between the
leaders of their supply chain, sales, and
service functions.
Tension 3: Supply chain vs.
product proliferation
Remedying some of the root causes of
growing supply chain complexity will be
another important benefit of enhanced
collaboration in the executive suite.
Consider the complexity associated with
product portfolios. Sales and marketing
organizations work hard to create new
products, explore new market opportuni-
ties, and respond to emerging customer
needs. As they do, products and variants
tend to proliferate, creating portfolios with
long tails of niche offerings. A consumer
goods maker we know, for example,

recently found that nearly one-third of the
6,400 stockkeeping units (SKUs) in its
product portfolio together represented
just 1 percent of total revenues.
This complexity comes at a cost; econo-
mies of scale dictate that low-volume
products cost more to make per unit than
high-volume ones. For the consumer
goods maker, for instance, the complexity
had reached such a degree that it started
damaging overall profitability, prompting
the companys top team to investigate the
situation more thoroughly. Subsequent
analysis revealed that production costs for
low-volume products were 129 percent
higher than those for its best sellers.
Low-volume products also require dispro-
portionate effort in sales and administra-
tive processes. And they drive up supply
chain costs: a company must hold higher
inventory levels to meet agreed service
levels across a broad range
The top of the orga- of low-volume products
nization is the right than it does over a narrow
place for most com- range of high-volume ones.
panies to begin nego- When all these extra costs
tiating functional are taken into account, the
trade-offs. impact can be eye opening.
One company we studied
found that 25 percent of its SKUs actually
lost money.
In the face of these numbers, companies
might be tempted to take an ax to the long
tails of their product portfolios. Yet blind
cutting based on sales figures alone often
does more harm than good. Some low-
volume products have benefits that out-
weigh their costs. Consider the chemicals
manufacturer that set out to slim down its
product portfolio. On closer examination,
the company found that some small prod-
ucts (in terms of revenues) were of vital
importance for some of their customers,
and taking them out would have risked
losing several big accounts. Instead,
increasing prices turned out to be the
strategically better and more profitable
strategy. Only through close collaboration
13
across functional boundaries can com-
panies make these right decisions. Such
collaboration wont eliminate the need for
more carefully segmented supply chain
strategies, but it should help ensure that
such efforts are well targeted.
What the CEO must ask
The top of the organization is the right
place for most companies to begin
negotiating the functional trade-offs weve
outlined. But many senior management
teams give precious little attention to
supply chain issues. Across the trade-offs
our survey explored, for example, no more
than 26 percent of the respondents said
that their companies reach alignment
among functions as part of the supply
chain decision making process. Moreover,
38 percent say that the CEO has no or
limited involvement in driving supply chain
strategy.
This is a mistake. CEOs set the agenda
for their leadership teams, and it is up to
CEOs to encourage and facilitate mean-
ingful discussion of important cross-
functional supply chain issues. They can
do more than thatand some do. In some
of the most impressive supply chains
weve seen, the chief executive promotes
collaboration and performance improve-
ment with missionary zeal. The CEO of
an apparel company, for example, would
always make a point, during store visits, of
asking shop-floor staff how the companys
recent commercial decisions had affected
store operations, including logistics. He
would bring up this feedback in meetings
with purchasing and supply chain teams
and continually encouraged his managers
to follow up themselves and engage with
shop-floor staff on similar topics.
Similarly, a global consumer goods
company undertook a major effort to
understandand optimizecomplexity
in its product portfolio. Within a couple of
months, the companys leadership group
14

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

CEOs looking to get started can benefit
from asking themselves five questions.
Consideration of these questions, we have
found, can help leaders begin to ferret out
situations where faulty collaboration may
be preventing supply chains from reaching
their full potential:
1. Is production capacity being developed
in the right locationsboth for today
and the future?
5. Are our purchasing and sourcing deci-
sions being made with their supply
chain implications in mind?
Poor collaboration and silo thinking have
long thwarted the efforts of companies
to get more from their supply chains. In a
future characterized by rising complexity
and uncertainty, solutions to this perenni-
al problem wont just be nice to have
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 (www.scmr.com)
and is reprinted here with permission.
 15

Building the supply chain

of the future

Yogesh Malik, Alex Niemeyer, and Brian Ruwadi

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

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

supply chain organizations are prepar-
ing themselves in two ways. First, they
are splintering their traditional supply
chains into smaller, nimbler ones bet-
ter prepared to manage higher levels of
complexity. Second, they are treating
their supply chains as hedges against
uncertainty by reconfiguring their manu-
facturing footprints to weather a range
of potential outcomes. A look at how
the leaders are preparing today offers
markets tops the list of these uncertain-
ties. Economic growth there will boost
global energy consumption in the coming
decade by about one-third. Meanwhile,
the voracious appetite of China and other
developing countries for such resources
as iron ore and agricultural commodities
is boosting global prices and making it
trickier to configure supply chain assets.
Worries about the environment are grow-
ing, too, along with uncertainty over the
1 Jim Owens made this remark
in an interview conducted
by Hans-Werner Kaas on
September 20, 2010. For
more with Jim Owens, see
McKinsey conversations with
global leaders: Jim Owens of
Caterpillar, November 2010,
mckinsey.com.
2 For more, see The challenges
ahead for supply chains:
McKinsey Global Survey
results, November 2010,
mckinsey.com.
16
3 Tim Johnston, Striking
Cambodian workers reflect
Asia trend, Financial Times,
September 13, 2010.
4 Tom Muiler and Iuri Dantas,
Nestl to sail Amazon Rivers
to reach emerging-market
consumers, Bloomberg News,
June 17, 2010.
scope and direction of environmental
regulation.
These long-term trends have knock-on
effects that reinforce still other sources of
uncertainty. Growth in developing coun-
tries contributes to volatility in global cur-
rency markets and to protectionist senti-
ment in the developed world, for example.
Whats more, different growth rates across
various emerging markets mean that rising
labor costs can quickly change the relative
attractiveness of manufacturing locations.
This past summer in China, for example,
labor disputesand a spate of worker
suicidescontributed to overnight wage
increases of 20 percent or more in some
Chinese cities. Bangladesh, Cambodia,
and Vietnam experienced similar wage-
related strikes and walkouts.3 Finally, as
companies in developing markets increas-
ingly become credible suppliers, deciding
which low-cost market to source from
becomes more difficult.
Rising complexity
Manufacturing and supply chain planners
must also deal with rising complexity.
For many companies, this need means
working harder to meet their customers
increasingly diverse requirements. Mobile
phone makers, for example, introduced
900 more varieties of handsets in 2009
than they did in 2000. Proliferation also
affects mature product categories: the
number of variants in baked goods, bev-
erages, cereal, and confectionery, for
instance, all rose more than 25 percent
a year between 2004 and 2006, and the
number of SKUs at some large North
American grocers exceeded 100,000
in 2009.
Meanwhile, globalization brings com-
plexities as rising incomes in developing
countries make them extremely desirable
as markets, not just manufacturing hubs.
Efficient distribution in emerging markets
requires creativity, since retail formats typi-
cally range from modern hypermarkets to
subscale mom-and-pop stores. In Brazil,
for example, Nestl is experimenting with
the use of supermarket barges to sell
directly to low-income customers along
two tributaries of the Amazon River.4
Meeting the challenge
In such a world, the idea that companies
can optimize their supply chains once
and for all circumstances and customers
is a fantasy. Recognizing this, a few
forward-looking companies are prepar-
ing in two ways. First, they are splintering
their traditional monolithic supply chains
into smaller and more flexible ones. While
these new supply chains may rely on the
same assets and network resources asthe
old, they use information very differently
helping companies to embrace complexity
while better serving customers.
Second, leading companies treat their
supply chains as dynamic hedges
against uncertainty by actively and
regularly examiningeven reconfigur-
ingtheir broader supply networks with
an eye toward economic conditions five
or ten years ahead. In doing so, these
companies are building diverse and more
resilient portfolios of supply chain assets
that will be better suited to thrive in a
more uncertain world.
From one to many
Splintering monolithic supply chains
into smaller, nimbler ones can help tame
complexity, save money, and serve cus-
tomers better. Lets look at an example.
Splintering supply chains:
A case study
A US-based consumer durables manu-
facturer was losing ground to competitors
because of problems with its legacy supply
chain. Years before, the companylike
many global manufacturershad sent

the lions share of its production to China
while maintaining a much smaller pres-
ence in North America to stay close to
the majority of its customers. One legacy
of the move: all of its plants, relying on
a unified production planning process,
essentially manufactured the full range of
its thousands of products and their many
components.
Now, however, increasingly volatile patterns
of customer demand, coupled with prod-
uct proliferation in the form of hundreds of
new SKUs each year, were straining the
companys supply chain to the point where
forecasting- and service-related problems
were dissatisfying key customers.
In response, the company examined its
portfolio of products and components
along two dimensions: the volatility of
demand for each SKU it sold and the over-
all volume of SKUs produced per week.
Armed with the resulting matrix (Exhibit 1),
the company began rethinking its supply
chain configuration.
Ultimately, the company decided to split
its one-size-fits-all supply chain into four
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
8% of SKUs, 55% of profits
Volume produced,
year to date
Thousands of SKUs
Low volume-low volatility
25% of SKUs, 25% of profits
17
distinct splinters. For high-volume prod-
ucts with relatively stable demand (less
than 10 percent of SKUs but representing
the majority of revenues), the company
kept the sourcing and production in China.
Meanwhile, the facilities in North America
became responsible for producing the rest
of the companys SKUs, including high-
and low-volume ones with volatile demand
(assigned to the US) and low-volume,
low-demand-volatility SKUs (divided
between the US and Mexico). Ramping up
production in a higher-cost country such
as the US made economic sense even
for the low-volume products because
the company could get them to market
much faster, minimize lost sales, and keep
inventories down for many low-volume
SKUs. Moreover, the products tended to
require more specialized manufacturing
processes (in which the highly skilled US
workforce excelled) and thus gave the
company a chance to differentiate itself in
a crowded market.
However, the company didnt just reallo-
cate production resources. In tandem, it
changed its information and planning pro-
cesses significantly. For the portfolios
High volume-high volatility
2% of SKUs, 10% of profits
Weekly demand volatility
Percent
Low volume-high volatility
65% of SKUs, 10% of profits
Exhibit 1
18
most volatile SKUs (the ones now pro-
duced in the US), the company no longer
tried to predict customer demand at all,
choosing instead to manufacture directly
to customer orders. Meanwhile, manag-
ers at these US plants created a radically
simplified forecasting process to account
for the remaining productsthose with
low production runs but more stable
demand.
For overseas operations, the company
continued to have its Chinese plants pro-
duce finished goods on the basis of long-
run forecasts, as they had done before.
The forecasts were now better, though,
because planners were no longer trying
to account in their models for the noise
caused by the products with highly vola-
tile demand.
Together, the changes helped the com-
pany reduce its sourcing and manu-
facturing complexity and to lower its
cost of goods sold by about 15 percent.
Meanwhile, it improved its service levels
and shortened lead times to three days,
from an average of ten. Quality also
improved across the companys full range
of products.
How many splinters?
The first question for organizations
exploring multiple supply chains is how
many are needed. Answering it requires
a close look at the way the supply chain
assets that a company uses to manufac-
ture and distribute its products matches
up against the strategic aspirations it has
for those products and their customers.
This requirement seems obvious, but
in practice most companies examine
only the second half of the equation in a
sophisticated way; they can, for example,
readily identify which products they see
as leaders on cost, service, innovation, or
(most likely) some combination of these.
Fewer companies seriously examine the
operational trade-offs implicit in such
choices, let alone make network deci-
sions based on those trade-offs.
Oftentimes, a good place to start is to
analyze the volatility of customer demand
for a given product line against histori-
cal production volumes and to compare
the results against the total landed cost
for different production locations. This
information provides a rough sense of the
speed vs. cost trade-offs and can even
suggest locations where supply chain
splinters might ultimately be located. A
global CPG maker, for example, quickly
saw that two-thirds of the demand asso-
ciated with a key product line (about 40
percent of the companys product port-
folio) could be moved from a higher-cost
country to a lower-cost one without hurt-
ing customer service.
Of course, companies must care-
fully check these broad-brush analyses
against customer needs. The consumer
goods company, for instance, found that
packaging innovation was a differentiator
for some of its products and thus config-
ured a single production line in the new,
lower-cost location to make packaging
for several markets quickly. By contrast,
in automotive and other assembly-based
industries, we find that the customers
responsiveness and the complexity of
individual products are important inputs
that help determine where supply chains
might be splintered.
Second-order benefits
While dividing a supply chain into splin-
ters may seem complicated, in fact this
approach allows companies to reduce
complexity and manage it better because
operational assets can be focused on
tasks theyre best equipped to handle. At
the same time, the added visibility that a
splintered approach offers into the guts
of a supply chain helps senior manag-
ers more effectively employ traditional
improvement tools that would have
been too overwhelming to tackle before.

After the consumer durables maker
divided its supply chain into smaller
ones, for example, it was able to use
formerly impractical postponement
approaches (producing closer in time to
demand to keep holding costs low). The
companys US plants now combined
various SKUs into semifinished compo-
nents that could quickly be assembled
into products to meet customer orders
(Exhibit 2). Indeed, the lower inventory
costs this move generated partially
offset the higher labor costs of the
US factories.
Likewise, the global CPG maker found
that after splintering its supply chain, it
was more successful at applying lean
management techniques in its plants.
Among the benefits: much faster change-
over times in higher-cost production
locations, enabling them to handle pro-
duct-related complexity more effectively.
Use your network as a hedge
The advantages that multiple supply
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
Supply to forecast
Finished goods
supplier
After Order to forecast
Supply to
Component forecast
supplier
19
chains confer are most valuable if com-
panies view them dynamically, with an
eye toward the resiliency of the overall
supply chain under a variety of circum-
stances. Will the various strands of a
particular global supply network, for
example, still make sense if Chinas cur-
rency appreciates by 20 percent, oil costs
$90 a barrel, and shipping lanes have
25 percent excess capacity? Its critical
for organizations to determine which of
the many questions like these are right to
ask and to invest energy in understand-
ing the global trends underpinning them.
Some companies are already thinking in
this way. Nike, for example, long a leader
in emerging market production, manu-
factured more shoes in Vietnam than in
China for the first time in 2010.6
In fact, we believe that the ability of supply
chains to withstand a variety of different
scenarios could influence the profitability
and even the viability of organizations in
the not-too-distant future. In light of this,
companies should design their portfolios
of manufacturing and supplier networks
to minimize the total landed-cost risk 6 Fiscal year.
Order
Customer
Ship to order
Finished goods
inventory
Order
Work in process Assembly
Customer
Assemble
Component
inventory to order
Exhibit 2
20
under different scenarios. The goal
should be identifying a resilient manu-
facturing and sourcing footprinteven
when its not necessarily the lowest cost
one today. This approach calls for a sig-
nificant mindset shift not just from opera-
tions leaders but also from CEOs and
executives across the C-suite.
At the consumer durables manufacturer,
for example, senior executives worried
that its reliance on China as a hub could
become a liability if conditions changed
quickly. Consequently, the companys
senior team looked at its cost structure
and how that might change over the next
five to ten years under a range of global
wage and currency rate conditions. They
also considered how the company could
be affected by factors such as swinging
commodity prices and logisticscosts.
The company determined that while
China remained the most attractive man-
ufacturing option in the short term, the
risks associated with wage inflation and
currency rate changes were real enough
to make Mexico a preferable alternative
under several plausible scenarios.
Consequently, the company has begun
quietly building its supplier base there in
anticipation of ramping up
While China remained its manufacturing presence
the most attractive so that it can quickly flex
manufacturing option production between China
in the short term, and Mexico should condi-
Mexico was preferable tions so dictate. Similarly,
under several the global CPG manu-
plausible scenarios. facturer is examining where
dormant capacity in alter-
native low-cost countries might help it
hedge against a range of labor cost, tariff,
tax, and exchange rate scenarios. The
company is also factoring in unexpected
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.
supply disruptions, including fires, earth-
quakes, and labor-related strife.
A North American industrial manufacturer
chose to broaden its footprint in Brazil
and Mexico to hedge against swings in
foreign exchange rates. In particular, the
company invested in spare capacity to
make several innovative, high-end com-
ponents that it had formerly produced
only in Europe and the US because of the
advanced machining and engineering
required. The investment is helping the
company hedge against currency swings
by quickly transferring production of the
components across its global network to
match economic conditions. Moreover,
the arrangement helps it better support its
supply partners as they serve important
growth markets.
Making these kinds of moves isnt easy,
of course, since any alterations to a com-
panys supply chain have far-ranging
implications throughout the organization.
For starters, such changes require much
more cooperation and information sharing
across business units than many compa-
nies are accustomed to. Indeed, the orga-
nizational challenges are so significant that
for many companies, a hands-on effort by
the CEO and others across the C-suite is
needed for success (for more, see Is your
top team undermining your supply chain?
on mckinsey.com).
Nonetheless, the rewards are worthwhile.
By creating more resilient and focused
supply chains that can thrive amid height-
ened uncertainty and complexity, compa-
nies will gain significant advantages in the
coming years.
21
22

Excellence in planning:
From silos to collaboration

Bridging the
procurement-supply
chain divide
Ashutosh Dekhne, Xin Huang, and Apratim Sarkar
Procurement teams are good neighbors
with their counterparts in supply chain
management. But they really need to
become family. If they can find ways to
interact more closely, they may find they
can cut total inventory levels across the
value chain by at least 15 percentand
lower overall supply chain costs in
the bargain.
Although many companies have been
focusing on improving the effectiveness
of their procurement operations, relatively
few have had much success with prop-
erly integrating suppliers into their supply
chain operations. Theres a mismatch:
companies and their suppliers optimize
their operations to suit their own environ-
ments. The consequences are far reach-
ingeverything from significant supply
shortages and excess supply inventory
to frequent write-downs and excessively
long shipment times.
You dont need to look far for telltale signs
of this misalignment. We know of a food
processing company that stored excess
raw material inventory while its packaging
supplier was also burdened with finished
goods inventory. There is a CPG pro-
ducer that suffered from shortages of a
common raw material after it introduced a
new product that shared the material
with the companys old products. And
we have come across a medical device
manufacturer that moved to a local
production footprint to improve the
responsiveness of its supply chain, but
then found that it had to ship raw
materials around the world.
The misalignment is not the fault of one
side or the other. Each has evolved
naturally toward efficiencies that make
sense for its immediate objectives, but
not for the whole. But a root cause of
the supplier-customer mismatch is the
disconnect between the customers pro-
curement and supply chain operations.
Procurement, the primary face to suppli-
ers, usually takes a static view of busi-
23
ness requirements to drive cost reduction
while the supply chain operations main
goal is to deliver products and services
that satisfy end-customer demand, which
is dynamic by nature.
What is needed now is a cross-functional
approach that embeds a total supply
chain perspective in procurements opera-
tions. Given the continued worries over
global economic recoveryand the par-
ticular concerns of business leaders about
profitable growth amid signs of slowdown
worldwidewe consider it imperative for
business leaders to first recognize that
there is a mismatch between procure-
ments static perspective of supply-side
interactions and the supply chain opera-
tions very dynamic view, and then to act
promptly to close it. This article offers six
ways to begin to do that.
A closer look at the mismatch
On the face of it, a companys supply
chain and procurement functions should
have a lot in common. They both act as
primary interfaces between an organiza-
tion and its suppliers, for example. And
they are both incentivized to ensure that
materials and components bought from
elsewhere are available in the right qual-
ity, at the right time, and the right price.
Yet at many companies, procurement
and supply chain processes dont work
hand in hand, but sequentially. At discrete
intervalsduring the development of a
new product line, for example, or every
few years after launchthe procurement
function will launch a project to identify
suppliers that are capable of delivering
specific material requirements at the
forecast volume and the required quality.
It will then engage with qualifying suppli-
ers to negotiate favorable terms and fix
those terms in a robust contract. At that
point, procurement hands over much of
the management of the ongoing supplier
relationship to the supply chain function.
24

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

Exhibit 1
 25

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

Ways procurement and supply chain can work better together

Signi- Footprint
ficant design

Capacity
Lead-time planning
optimization
Product
lifecycle
Inventory management
planning
Impact
Sales and
operations
planning
Demand
planning
Lean

Procurement
Base
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
B
A Supp X
B

Exhibit 2
26
controls on manual adjustments to fore-
casts, production plans, and schedules.
And it requires that people be held account-
able for the accuracy of the data they key
into the planning system in the first place.
2. Inventory planning
A renewed focus on collaborative inven-
tory management can help to ensure the
best balance and distribution of inventory
stocking points across the supply chain
for example, helping to eliminate redun-
dant inventory buffers between supplier
and customerand to create transpar-
ency for all supply chain partners. It will
lead to alignment on inventory strategy
on specific issues such as safety stock
levels, inventory planning methodolo-
gies, and supply chain parameters. The
use of multi-echelon inventory planning
techniques can help to set safety stock
requirements holistically, pinpointing the
trade-offs between supplier inventory, cli-
ents raw material inventory, and clients
stocks of finished goods.
At one large retailer we know of, the joint
development of a demand sharing and
inventory planning strategy slashed the
inventory of big-ticket items by about
60 percentequivalent to a months stock.
3. Lead-time optimization
Lead-time optimization puts the spotlight
on quick responses to changes in demand
from end customers. It helps companies
determine their optimal supply lead-time
requirements holistically, using a seg-
mented approachfor example, by align-
ing lead times across all components to
support the supply chain strategy. It calls
for trade-offs between logistics costs and
lead times, makes use of lean concepts
to identify bottlenecks at any point up
and down the supply chain (and to devise
cost-effective ways to get around them),
and determines and enforces guidelines
and processes for rush orders, based on
cost and benefit trade-offs.
4. Product lifecycle management
The objective of this path is to ensure opti-
mal support from suppliers during product
introduction and phaseout. Done right,
product lifecycle management implies that
the supply chain partners can optimize
end-of-product-life purchases (for exam-
ple, last-time buys of components) using
analytical models instead of gut feel
decisions. It means that companies have
to establish rigorous supply ramp-up and
ramp-down processes with suppliers
communicating in detail about design
nuances, bills of materials, etc. There has
to be close interaction with suppliers so
they can increase capability flexibility to
shift between new and old supply chains.
And it is essential to leverage suppliers
capability to drive product innovation and
shorten the cycles for product develop-
ment and commercialization.
A large industrial manufacturer that ad-
hered to these practices saw a 6percent
pickup in EBIT because its end-to-end
product strategy and comanufacturing
approaches with suppliers enabled it to
get new products to market in half the
time of its competitors.
5. Footprint design
The intent is to align each suppliers
footprint with the customers supply
chain strategy. Proper footprint design
makes sense of the mix of offshore and
nearshore facilities, taking into account
the trade-offs between purchase prices
and supply chain benefitsfor instance,
responsiveness and logistics costs.
It also helps to fine-tune the vertical
supply chain collaboration/integration
strategyidentifying the circumstances
in which it is appropriate to set up colo-
cated facilities with suppliers to increase
supply chain flexibility. (The colocation
supply chain strategy of one large high-
tech manufacturer helped it cut inventory
by about 20 percent and boost EBIT by
roughly 6 percent.) At the same time,

footprint design helps the company to
optimize the transportation network strat-
egythe use of cross-dock locations,
pool points, and the best mix of third-par-
ty logistics service providers and internal
logistics capabilities.
6. Capacity planning
This factor is important in order to align
long-term capacity plans between sup-
pliers and customers, and to mitigate the
risks of supply shortages. The bedrock
point is that there has to be joint planning
of capacity with suppliers. That activity will
help to determine optimal excess network
capacity based on the trade-off between
the costs and benefits of risk mitigation
approaches for handling demand spikes.
Joint capacity planning will also help both
sides to develop alternate sourcing strate-
gies. The benefits can be rapid and imme-
diate: we know of a CPG leader that real-
ized a 2 to 3 percent uptick in EBIT after
planning capacity in collaboration with its
suppliers, and thus optimizing the capac-
ity of its whole supply chain network.
Benefits for both sides
In practice, supply chain levers are par-
ticularly useful for procurement functions
because they typically offer genuine ben-
efits for both buyer and supplier. Retailers
can improve demand and inventory plan-
ning by giving suppliers access to point-
of-sale data, for example. This can lead to
smoother demand profiles than the peri-
odic signals sent by store buyers. In turn,
it allows suppliers to reduce their own
finished goods inventories, or to run their
production equipment more smoothly,
creating important cost savings they can
share with their customers.
In some cases, closer supply chain col-
laboration has allowed companies to
build whole new kinds of relationships
with key suppliers. One company in the
high-tech sector used footprint design
27
and lead-time optimization to do just that.
The high-tech company wanted to dra-
matically reduce its service delivery lead
times in order to improve the availability of
its broad product range without the need
to carry cripplingly high levels of finished
goods inventory. The companys supply
chain group worked with its procure-
ment function to find a way of integrating
the supply of critical components in the
new distribution regime. The cross-
functional group quickly recognized that
it risked simply pushing large amounts of
inventory upstream to suppliers, which
would not ultimately deliver the impact
itwanted.
To avoid this, the team sought suppli-
ers that were willing to locate their own
parts inventories in the same distribution
center as the companys, and to deliver
parts to its production and configuration
lines on a just-in-time basis. This tight
integration allowed the suppliers to keep
relatively low on-site inventories of parts,
which the company could pull as required
to assemble specific, highly configured
finished goods in response to demand
signals from its customers. (Although
this arrangement seems similar to a tra-
ditional vendor-managed inventory (VMI)
approach, the differentiating factor was
that the setup was operated as a joint
venture, requiring adequate process and
management controls while ensuring a
mutually agreed sharing of benefits from
the arrangement.)
Building on the typical levers of procure-
ment, the high-tech companys strategic
capacity planning and footprint design
provided a construct to enable end-to-
end inventory planning and lead time
optimization across the supply chain.
The results were eye opening: systemwide
inventory fell by 19 percent, the companys
freight costs fell by 22 percent, and its sup-
pliers freight costs ended up 14 percent
lower. Average lead times approached
zero; customer service levels improved
from 68 percent to 94 percent. Operating
28
as a joint venture meant that the com-
pany could take advantage of unified IT
systems, which led to reduction in the
headcounts of planners/buyers from 27
to 16. The company also experienced a
significant improvement in EBITa testa-
ment to the impact of the cohesive inte-
gration of functional organizations. This
example was by no means confined to
the high-tech sector; it could just as eas-
ily have occurred in any other industry.
Real impact on EBIT
In our experience, the combined applica-
tion of all six supply chain levers in pro-
curement has the potential to reduce total
inventory levels across the value chain by
15 to 30 percent, while also producing
overall EBIT improvement of 2 to 5 per-
cent, as shown in Exhibit 3. Companies
that apply them well enjoy a host of oper-
ational benefits too: they gain improved
agilitysuch as greater responsive-
ness to changes in demand mixsim-
pler logistics processes (for instance,
transfer of ownership from supplier to
customer without the need to manually
Typical impact from deploying integration initiatives
Range of possible application
Lead-time optimization
Demand planning
Inventory savings 10-20 10-30
Percent
EBIT savings
Percent
Exhibit 3
handle products), and smoother financial
transactions with suppliers (as seen, for
example, in the systemic generation and
processing of invoice and related pay-
ments between the transacting parties).
Lastly, sustainable results will require a
rigorous companywide effort to ensure that
capability building and performance man-
agement not only are institutionalized within
the organizations culture, but that they
include suppliers organizations aswell.
In our experience, many companies launch
initiatives that rapidly achieve short-term
value, but they fail to maintain momentum
long-term because cross-functional sup-
port drops off, core players are pulled into
other initiatives, and new players are not
trained in time (see sidebar on the follow-
ing page, Why Procurement and Supply
Chain Dont Talk as Often as They Should).
Companies that succeed over the long
term tend to focus on both performance
and health, with heavy emphasis on up-
front training in new tools, processes, and
approaches so they can build up a cadre
of experienced managers who can sustain
this effort far into the future.
Decision making and execution
responsibility
Capacity planning
Footprint design
Product lifecycle management
Inventory planning
Total
15-30 5-10 15-30 15-30+
0.5-1 1.5-2.5 2-3 2-5
 29

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
process

Flexible production with idle capacity

vs. mass production without flexibility

Superior customer service vs. cost to

serve enforcement

Supplier consolidation vs. supplier

diversification

Centralized production vs. fragmented

manufacturing footprint

SOURCE: McKinsey quarterlyWeb site survey with over 400 executives

Exhibit 4
30
Why procurement and supply chain
dont talk as often as they should
Intuitively, leaders understand cross-
functional issues, but there are three key
reasons why they dont succeed when
attempting to address them.
1. Inability to address cross-functional
trade-offs and maximize value.
Often, senior managers lack the com-
prehensive perspective and pragmatic
approaches needed to tackle cross-
functional challenges. Its rare for them
to have systematic methodologies
with which to understand and arbitrate
among inherent trade-offs. Too often,
their fact bases are incomplete (for
example, supply chain planners may
order smaller batch sizes because
they lack a clear understanding of
the contracted volume discounts),
and they have too few tools to make
an impactfor instance, the kinds of
sophisticated tools that can analyze
total cost of ownership of products,
including inventory carrying and
ordering costs. Moreover, there may
be only limited links between the
business and the supply chain
strategy, and between the supply
chain strategy and the quality of
supply chain implementation.
2. Dealing with issues in the wrong
forums and without proper enabling
elements. A recent executive survey
shows that top cross-functional trade-
off discussions still take place at the
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 (www.scmr.com)
and is reprinted here with permission.
wrong organizational levels (Exhibit 4).
There is too little recognition of the
factors that really enable change,
and inadequate means to implement
them even if they are recognized. Its
common for there to be too little trans-
parency, inadequate performance
metrics, and too few incentives to drive
true end-to-end integration. Worse:
when middle managers attempt to
resolve issues, they typically fight for
whats best for the function and not for
whats best for the company.
3. Incentives are often misaligned.
Even if procurement and supply chain
managers do talk with each other,
their incentives dont often match the
objectives that they should share.
Procurement may be measured on
savings from applying traditional pro-
curement levers using a total cost of
ownership (TCO) approach, while supply
chain managers are usually incentivized
based on service levels, logistics costs,
and inventory levels. A perfect example
of such conflict was evident at a large
retailer, where procurement defined vol-
ume-based supplier contracts that were
executed early in a finite financial period
whereas supply chain operations only
ordered as needed in order to minimize
inventory levels. This resulted not only
in increased procurement costs (higher
logistics costs) but also in the loss, later
on, of substantial volume discounts.

CPG-retail collaboration:
The next generation
Andreas Brinkhoff, Luis Benavides, Jochen Gropietsch, Cdric Losdat, and Daniel Swan
Consumer goods retailers and manufac-
turers have many good reasons to collab-
orate on supply chain topics, but to make
progress, theyll have to improve the way
such efforts are planned and managed
and get better at sharing the benefits.
With disposable incomes and consumer
confidence remaining low across Europe
and the US, value-conscious consumers
are continuing to put pressure on prices.
Meanwhile, costs of commodities and
raw materials keep rising. In this environ-
ment, its no surprise that many consumer
goods manufacturers and retailers are
seeking to collaborate tostimulate con-
sumer demand and control costs.
Collaborationpartnering on joint initia-
tives that extend beyond day-to-day busi-
ness and that aim to deliver significant
long-term improvement and value for both
partiesoffers a welcome alternative to
price-driven (and at times antagonistic)
supplier-retailer relationships. Indeed,
collaboration efforts have grown in popu-
larity since the economic downturn.
Impact of collaboration on both commercial and supply chain sides
is significant
Percent
Commercial areas Increased sales
Strategy and calendar for promotions
In-store programs/promotions
In-store layout/visual merchandising
Category management and product
assortment
Joint innovation
Supply chain areas Decreased OOS
Supply chain flows and processes
Demand planning and fulfillment
Materials and products handling
Asset utilization in manufacturing
Joint purchasing of raw material
SOURCE: ECR Europe/McKinsey The next generation retailer and manufacturer collaboration survey 2012
31
Based on data from a 2010 survey
conducted together with the Grocery
Manufacturers Association (GMA) in the
US, more than 80 percent of compa-
nies are involved in collaboration efforts
today. In a 2012 survey with 140 compa-
nies conducted by Efficient Consumer
Response (ECR) Europe and McKinsey,
all respondents said they collaborate in
at least one area of their business, and
more than half said they collaborate in
at least six areas. The survey brought
to light the collaboration practices of
97 manufacturers, 31 retailers, and 12
service providers from 13 European
countries. The goal of the survey was to
identify the areas in which CPG players
are collaborating, their success in doing
so, the areas in which they hope to col-
laborate in the future, and the factors that
hinder successful collaboration.
In this article, we discuss findings on the
status of collaboration today and describe
six steps that CPG manufacturers and
retailers can take to boost the chances that
their collaboration efforts will succeed.
Increased profit
6.2 3.0
7.3 4.2
5.2 4.4
5.3 3.8
5.8 4.2
Decreased cost
4.7 5.1
4.1 5.6
2.1 3.1
3.3 4.5
n/a n/a
Exhibit 1
32
Areas identified for improved collaboration by survey participants
Share of respondents
Percent
Collaboration areas Today
1 Supply chain flows and processes
2 Demand planning and fulfillment
3 Category's product assortment
4 Strategy and calendar for promotions
5 In-store layout/visual merchandising
6 In-store programs/promotions
7 Materials and products handling
8 Joint innovations
9 Asset utilization in manufacturing
10 Joint purchasing of raw material
Exhibit 2
The rewards can be substantial: our experi-
ence shows that successful collaborations
involving two or three initiatives in a cate-
gory deliver a profit uplift of 5 to 11 percent
in that category, through a combination of
increased sales and reduced costs.
All collaborations are not equal
The surveys underscore some important
trends that become apparent in our analy-
sis of collaboration in both commercial
areas (such as in-store programs and
merchandising) and supply chain areas
(such as demand planning and materials
handling). Survey respondents are more
likely to collaborateand see financial
impactin commercial areas: they report
that successful commercial collaborations
boosted sales by approximately 6 percent
and profits by about 4 percent, and these
benefits were shared equally between
retailers and manufacturers (Exhibit 1).
By contrast, although successful supply
chain collaborations resulted in an almost
4 percent decrease in stockouts and a
cost reduction of nearly 5 percent, those
benefits were distributed less equitably.
X Supply chain X Commercial Top collaboration areas
Near future
12.1 13.3
11.0 13.3
14.1 12.7
14.8 12.6
14.6 12.4
14.8 11.1
9.6 9.9
6.7 8.4
1.8 4.2
0.5 2.1
Retailers tend to gain more from sup-
ply chain collaboration efforts than their
manufacturing partnersabout 8 percent
in cost reduction for retailers versus 2 per-
cent for manufacturers.
The fact that costs and benefits of supply
chain collaborations fall unevenly might not
come as a surprise. A retailer often ben-
efits directly from processes that make it
cheaper and easier to keep the shelves full,
while manufacturers may have to pay more
for such changes, for example, by reducing
delivery lead times in the hope that this will
lead to improvements in customer satisfac-
tion and higher sales over the longer term.
Some companies do manage to run suc-
cessful collaborations even when the distri-
bution of benefits is skewed, however. They
do this by addressing the problem head
on and taking a focused effort to identify
the planned benefits and agree upon how
they will be shared. One approach is for
the winning partner to put a share of the
achieved savings into a special fund that it
then uses to pay for additional joint efforts
to boost sales or improve performance
elsewhere in the relationship.

Supply chain issue offer opportunities for future collaboration
Collaboration areas of the future
1 Consumer and shopper journey
2 Advanced collaborative logistics networks
3 E-commerce/m-commerce
4 Leveraging digital/social media
5 Supply chain benchmarking
6 Waste management
7 Cross-border logistics
8 E-category management
9 RFID and innovative labeling
10 Innovative unit loads
11 Store as media
12 Endless aisle/multichannel inventory mgmt
Collaboration in the future
Turning a win-lose situation into win-win
does take effort and persistence, but the
indications are that companies have an
increasing willingness to take on the task.
Our survey demonstrates a widespread
recognition that improved supply chain
performance will be critical in both con-
trolling costs and boosting service in the
coming years. When asked to identify
the areas in which they were most keen
to collaborate in the near future, survey
participants ranked supply chain flows
and processes and demand planning
and fulfillment as number one and two
(Exhibit 2).
When we asked respondents to look
even further into the future at topics that
they have not collaborated on in the past,
the continuing importance of supply
chain collaboration was clear. Although
the number one topic was a commercial
one (consumer and shopper journey),
a key supply chain issue came a very
close second (Exhibit 3). That topic was
advanced collaborative logistics net-
works, a concept that embraces, among
33
X Supply chain X Commercial
Share of respondents
12.1
11.9
10.9
9.7
9.2
9.0
6.8
6.4
6.4
5.6
4.7
4.1
Exhibit 3
others, the idea of broadening logistics
collaboration not just in the integration of
assets, data, and services but also in the
number of possible partners both hori-
zontally and vertically.
Deeper supply chain collaborationon
optimizing processes, sharing data, and
building logistics networks togetheris
eagerly anticipated by all the participants
in our survey, whether they are retailers
or manufacturers. Now it is time to turn
desire into reality and make those col-
laborations happen.
Why collaboration is hard
While a majorityabout 60 percentof
collaboration initiatives in Europe report
substantial financial benefits, the remain-
ing 40 percent failed to deliver impact,
despite the cost and effort invested by
both parties. In earlier US analyses to
validate the impact of collaboration, only
20 percent have proven sustainable
improvements. In our work helping retail-
ers and CPG manufacturers manage
their collaboration efforts, we have seen a
34
handful of factors that make collaboration
problematic. Some of these will be famil-
iar to any organization thats involved in a
large-scale change process. Companies
may, for example, lack the commitment
they need from senior management to
drive the collaborations, or the message
that the collaboration is important may
be lost in translation as it passes down
through the organization, with the result
that middle managers or frontline teams
dont show the same enthusiasm and
commitment as their leadership does.
Sometimes companies fail to provide suf-
ficient resources to make collaborations
work, or they spread limited resources
too thin over too many initiatives.
These issues are difficult enough to over-
come and are compounded by the fact
that collaboration initiatives must align
two separate organizations. To make the
collaborations work, the players involved
must navigate differences in organizational
design and culture. At the same time, a
history of difficult relationships can make
partners reluctant to share important
information, leading them to work on their
parts of the collaboration in separate
silosa recipe for suboptimal solutions.
Finally, the incentives of the different
parties involved in the collaboration may
be fundamentally misaligned, making it
difficult even for enthusiastic, committed
staff to make the collaboration work while
still fulfilling their other targets. These
misaligned incentives arise because dif-
ferent players in the supply chain may see
the world in very different ways. A manu-
facturer, for instance, might want to grow
its market share by improving its own
offerings relative to competitors, whereas
a retailer might be interested in increasing
sales or margins across the category, not
in making changes to the product mix.
This difference in outlook can mean that
retailers and manufacturers want very
different things from the collaboration.
Growth-focused manufacturers may
be enthusiastic about new promotional
opportunities, while retailers operating
on thin profit margins may be much more
interested in taking cost out of product
handling and storage. The relationship
and power dynamics between collabo-
rating partners can be dramatically differ-
ent, too. Manufacturers typically will have
relationships with a small number of key
retailers, while those same retail partners
will have relationships with hundreds of
different suppliers.
The following case of a major food manu-
facturer and a retail chain provides an
instructive example of how collabora-
tion can go wrong when participants
dont trust each other enough. The two
companies agreed to collaborate on
a cobranded product line. The retailer
hoped that the manufacturers brand
name would boost both the credibility
and the sales of its product, while the
manufacturer saw the partnership as a
way of increasing its own market share
within the retailers network.
The collaborative effort failed to play to
either companys strengths, however.
The retailers rich point-of-sale and
consumer preferences data provided
the information needed to develop an
accurate profile of its customers require-
ments, but concerns about sharing that
information led the retailer to analyze
the data and develop the product speci-
fication itself without the benefit of the
manufacturers category expertise. The
resulting product was expensive to make
and missed the mark on package size,
product specifications, and shelf appeal.
Sales were disappointing, and within
months, the partners were forced to re-
assess their relationship.
Making the right choices
CPG companies can greatly improve
their prospects for success by taking a
thoughtful approach to the areas they
 35

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
their collaborations. Based on our expe-
rience, we have identified six essential
steps (Exhibit 4) that can make the differ-
ence between a productive collaboration
and a frustrating one.
1. Collaborate in areas where you
have a solid footing
Companies are often tempted to use
collaboration as a way to fill gaps in
their own capabilities. In practice, the
most successful collaborations build on
strengths rather than compensate for
weaknesses. A manufacturer seeking
to collaborate with a major retailer in
order to improve its own forecasting
performance, for example, will have
little to gain from access to the retailers
point-of-sale data unless it has the
in-house analytical capability to make
effective use of that data. Similarly, there
is little point in entering collaborations to
boost sales if any increase in demand is
likely to run into manufacturing capacity
constraints.
sure they have the right supporting
infrastructure in place in advance of any
collaborative effort. Is top management
committed to the collaboration process
and ready to offer support over the long
term? Are in-house IT systems robust
enough to facilitate real-time data sharing
if required?
2. Turn win-lose situations into
win-win opportunities with the
right benefit sharing models
Some collaborations promise equal ben-
efits for both parties. If, for example, a
manufacturer and a retailer collaborate to
optimize product mix, both could expect
to benefit from the resulting increase in
sales. In other cases, however, the col-
laboration might create as much value
overall, but the benefit could fall more
to one partner than to the other. Heres
one real-life example: a retailer and a
manufacturer were able to reduce overall
logistics costs between factory and store
by cutting out the manufacturers distri-
bution centers and treating the retailers
36
distribution network as one integrated
supply chain, from manufacturing plant
to store shelf. However, the retailers
supply chain executives struggled to
gain acceptance for the idea from their
leadership because it resulted in the
retailer carrying a far larger fraction of
the logistics cost.
Rather than shying away from such
asymmetric collaborations, smart com-
panies can make them work by agreeing
on more sophisticated benefit sharing
models. These can come in the form of
discounts or price increases to more
fairly share increased margins or cost
reductions, or they can involve com-
pensation in other parts of the relation-
ship. For example, when one retailer
collaborated with a manufacturer on
a cobranded product line, the manu-
facturer agreed to absorb the up-front
product development costs in return
for an expanded share of the retailers
product offerings across a wider set of
categories.
Benefit sharing can help to overcome
differences in strategic priorities, too.
One growth-focused manufacturer was
persuaded to join a supply chain waste
reduction collaboration with a retailer by
establishing an agreement to deposit
part of the savings both companies
achieved into a joint pool, which would
then be invested in efforts to generate
additional sales.
Similarly, in the product flow improve-
ment case described in Making it work
in practice, the manufacturer provided
the up-front investment in new retail-
ready packaging, while its retail partner
reaped most of the benefits of increased
availability and reduced labor costs. The
two companies established a joint ben-
efits pool and agreed to use a percent-
age of the savings to fund future cost
reduction efforts and a sales improve-
ment program.
3. Select partners based on capa-
bility and strategic alignment,
not just size.
The biggest potential partner might not
be the best one. Many companies aim
to collaborate with their largest suppliers
or customers because they assume that
the greatest value is to be found there. In
many cases, however, this turns out not
to be true. Collaboration may be of more
interest to a smaller partner, which might
invest more time and effort in the pro-
gram than a very large one that is already
juggling dozens of similar initiatives.
A better approach is one that assesses
current customers or suppliers across
three key dimensions. First, is there
enough potential value in collaborating
with this partner to merit the effort? Both
partners in a prospective collaboration
need to be sure that it will deliver a suf-
ficient return to justify the up-front invest-
ment. Second, do both partners have
sufficiently common strategic interests
to support the collaboration? A retailer
that has prioritized growth in a particular
region or segment will have more to gain
from collaborating with a manufacturer
that has a strong offering in the same
area. Third, does the partner have the
right infrastructure and processes in
place to provide a basis for the collabora-
tion? Collaborating to improve forecast-
ing and demand planning is likely to be
frustrating if one partners existing plan-
ning processes, systems, or performance
are inadequate.
4. Invest in the right infrastructure
and people
Both manufacturers and retailers that
participated in our research cited a lack
of dedicated resources as one of the top
three reasons for the failure of collabora-
tion efforts. Companies frequently under-
estimate the resources required to make
collaborations work, assuming that staff in

various functions can do whats required
in addition to their other responsibilities.
In practice, even relatively simple col-
laborative tasks will be more difficult than
equivalent activities conducted within the
walls of the organization. Thats because
staff must overcome differences in cul-
ture, organization, and terminology, not to
mention the basic challenge of finding the
right contact within the partner organiza-
tion with whom to liaise.
Disconnects within one organization can
create problems, too. A grassroots col-
laboration started between two supply
chain managers can lead to rapid perfor-
mance improvements, only to be snuffed
out when those higher in the organization
fail to understand the initiatives poten-
tial. Alternatively, a collaboration agree-
ment made between two board-level
executives will fizzle out if the managers
responsible for executing it think it is yet
another short-lived senior management
whim, if they cant see how the collabo-
ration will help them achieve their own
objectives, or if they lack the incentive to
put additional effort into the project on
top of their existing day-to-day roles.
To prevent both of these problems, best-
practice companies devote extra resourc-
es to their collaborations, particularly in
the early stages of a new relationship.
Appropriate infrastructure for a success-
ful collaboration begins at the top of the
organization, with a steering committee
of senior leaders who can set the defining
vision for the collaborative effort and allo-
cate resources to support it. The detailed
design of the collaboration program is
then completed by a team that comprises
members of all relevant functions from
both partners in the collaboration. The
team for a demand planning effort, for
example, should include members from
sales, finance, and supply chain for the
manufacturer, and from purchasing, mer-
chandising, and store operations for the
37
retailer. This team will also be responsible
for the day-to-day monitoring of the effort
once it is up and running.
Execution of the collaboration should
take place within the line organization and
will ultimately form part of the everyday
responsibility of the staff assigned to it.
The best companies avoid forcing their
frontline staff to reinvent the wheel by
providing strong support when establish-
ing each new collaboration. They may,
for example, leverage experience gained
in previous collaborations by setting up
teams to support their colleagues during
the initial phase of subsequent efforts.
5. Jointly manage performance
and measure impact
An effective performance management
system helps a company to ensure that
any long-term project is on track and
delivering the results it should. In supply
chain collaboration efforts, both partici-
pants should use the same performance
management system. By building com-
mon metrics targets and jointly monitor-
ing progress, companies avoid the mis-
aligned incentives that damage so many
collaboration efforts. Picking the right
metrics can be challenging, however,
and it will inevitably involve trade-offs. In
a collaboration to reduce logistics costs,
for example, the partners may have to
choose between a pallet configura-
tion thats optimized to suit a retailers
restocking processes, which will reduce
in-store labor costs, and one that opti-
mizes truck fill, which will reduce trans-
portation costs from distribution center to
retail store.
How to overcome these potential con-
flicts? The trick is to keep things simple
by picking the smallest possible number
of metrics required to give a picture of the
collaborations overall performance, and
then to manage those metrics closely,
with regular joint reviews and problem
38
solving sessions to address trade-offs.
The real power of any performance
management system comes from this
frequent, robust dialogue between part-
ners, yet this is also the element most
commonly ignored or underemphasized
by collaborating companies.
6. Collaborate for the long term
The final vital ingredient of a successful
collaboration is stamina. It may take time
and effort to overcome the initial hurdles
and make a new collaboration work. Both
parties need to recognize this and build
an appropriate long-term perspective into
their goals and expectations. This means
including metrics that review performance
beyond the first year, as well as conduct-
ing joint, long-term planning so both part-
ners can understand each others longer-
term objectives and identify initiatives they
can work on together over time. Such
planning helps companies to break out of
the short-term-project mentality that can
limit the beneficial impact of collaboration.
Nevertheless, partners must also ensure
that they are doing everything they can to
capture any available quick wins, so the
collaboration starts delivering value as
quickly as possible.
When companies take a long-term
perspective, their collaborative efforts
can become a virtuous circle: a greater
understanding of each others capa-
bilities, knowledge, and costs will often
reveal new potential sources of value,
while the experience of working closely
together means that later initiatives will
take less time and be easier to execute
than early ones.

Making it work in practice
It should be clear by now that success-
ful supply chain collaboration is neither
quick nor simple. But is it worthwhile? The
answer has to be an emphatic yes. The
following are some examples to this end:
A beverage manufacturer and a retailer
collaborated to improve demand planning
and fulfillment. Prior to the collaboration,
the retailers ordering process did not
match changes in consumer demand,
with the result that shipments from the
manufacturer fluctuated twice as much as
did retail sales. To avoid stockouts under
this regime, both the manufacturer and the
retailer were forced to keep high levels of
inventory on hand.
Working together, the manufacturer and
retailer agreed on a joint forecasting and
demand-analysis system. They improved
their information sharing, toothe retailer
gave the manufacturer access to its on-
shelf availability data, which allowed the
two companies to modify product distri-
bution to maximize availability in individual
stores, while the manufacturer informed
the retailer about supply constraints that
might limit its ability to meet high levels of
demand at short notice. The partners also
agreed to stagger promotional activities
among regions to reduce overall demand
peaks. The introduction of the new system
cut shipment volatility by one-third, allow-
ing both the retailer and the manufacturer
to achieve inventory reductions of more
than 15 percent and increase profit mar-
gins by three percentage points.
Another area for fruitful collaboration is
sourcing. One large US retail chain has
used collaborative sourcing to great effect
across a broad range of categories and
geographies. In an effort to combat rising
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.
39
categories, the company established
joint sourcing programs with manufac-
turers to purchase key commodities for
both its own private label products and
the manufacturers brand name items.
Collaborations have included the sourcing
of potatoes for chips manufactured in the
US and sugar for soft drinks manufactured
in the UK, with the latter effort securing a
14 percent cost saving.
Finally, the case of a retailer and food man-
ufacturer shows how collaboration can
work to dramatically improve product flow
efficiency. The manufacturer produced
packaged foods in a large assortment of
flavors, making it difficult for its retail part-
ner to manage inventories across the cat-
egory. This required time-consuming and
labor-intensive efforts to keep the shelves
stocked.
The two companies tackled these issues
by developing retail-ready packaging that
made it easier to keep the shelves stocked
while also optimizing the way delivery
trucks were loaded. The new packages
were designed to fit into jointly developed
in-store display units that held more prod-
ucts and made items easier to find than
the conventional shelves they replaced.
As a result, the average time it took con-
sumers to select an item dropped from
58 seconds to just 8 seconds. The com-
panies then changed the replenishment
system to accommodate the new display
units. They segmented various retail sites
by volume, velocity, and volatility, and then
optimized shipment sizes and replenish-
ment frequency for each segment. For
the highest-velocity stores, the partners
introduced a rapid replenishment program
in which deliveries were timed to coincide
with peak selling days.
40
Capturing value
from supply chain
management IT
Per-Magnus Karlsson and Markus Leopoldseder
Leading fast-moving consumer goods
(FMCG) manufacturers have made signifi-
cant investments in supply chain manage-
ment IT systems, but these investments
havent always delivered the expected
returns. To get the most from such sys-
tems, organizations have to adapt to new
ways of working and be prepared for con-
siderable fine-tuning after they go live. A
host of new technologies is emerging too,
but companies need to think hard about
how these will fit with their current and
future supply chain strategies.
The consumer goods industry is a fiercely
competitive environment strongly influ-
enced by changing retailer and consumer
expectations. Over the past decade, many
of those changes have had a direct effect
on supply chain practices. Retailers are
demanding lower prices, smaller and more
frequent deliveries, more frequent promo-
tions, and improved on-shelf availability. At
the same time, consumers ask for environ-
mentally certified products, greater choice,
frequent product updates, and better value
for money.
The inherent conflict between these
demands and supply chain efficiency
means supply chain metrics such as work-
ing capital, service levels, and overall sup-
ply chain costs are under increasing pres-
sure. More frequent deliveries imply smaller
trucks or lower fill rates. SKU proliferation
implies increased planning complexity and
increased demand volatility. Increased
promotional activity is also a strong driver
of demand volatility. Unless other process
improvements are found, stock quantities
will creep up to safeguard service levels.
These circumstances call for a review of
supply chain strategies, and of the IT tools
that make those strategies come alive. For
FMCG companies, key questions include
whether they are currently using the right
tools to support their evolving supply chain
processes, whether they are implementing
and running those tools in the most effec-
tive way, and whether they are prepared to
make the best use of new tools and tech-
nologies as they emerge.
Capturing value from supply chain
management IT solutions
For FMCG companies, one common posi-
tive result of the money and time invested
in ERP and supply chain management IT
projects is an unprecedented level of sup-
ply chain transparency and data integration.
Disappointingly, however, this technical
progress has not always resulted in tangible
operational performance improvements or
bottom-line impact. There is plenty of evi-
dence among consumer goods companies
that supply chain management IT invest-
ments have not yielded the expected return.
Projects often take longer than expected
to implement, cost more, and deliver less.
Understandably, senior executives are
pushing hard to capture greater returns
from their investments. Our research and
client experience has revealed three suc-
cess factors shared by organizations that
have managed to do this well.
Organizational capabilities
The end-to-end optimization enabled by
an integrated planning solution requires a
corresponding organization to implement
those plans. If decision making along the
supply chain is siloed in various sales,
production, and supply management func-
tions, then execution on the ground rarely
succeeds in capturing the potential of the
original integrated plan.
Capability requirements have also changed
significantly. Supply chain management
solutions can allow companies to free up to
half their planning capacity. The planners
they do use, however, must have a deep
understanding of both their functional area
and the supporting IT solution.
Typical introductory training in key user
concepts is not sufficient. Advanced supply
chain mangement planners should not shy

away from becoming system expertsand
they must get support from their manage
ment to do so. Learning can also be accel-
erated through participation in groups that
bring together advanced users from dif-
ferent industries to share experiences and
best practices. This effort is rewarding:
once a companys staff has seen a true
expert seamlessly conduct the mighty
supply chain orchestra from a planning
application, they will be reluctant to return
to their old ways.
System tuning
While it is usually a significant effort to reach
the go-live day for a new IT system, the
mindset that the mission is accomplished
at that point leaves considerable value
on the table. In practice, much of the real
implementation work actually starts when
the new system is used in real day-to-day
work. Many projects would benefit if more
of their budget were allocated to tuning
activities for the live system. Common
improvement areas include:
Planning stability. Many advanced
planning systems suffer from major
instability in the results they produce.
Plans are optimized, but every planning
run produces a new optimum, some-
times as a result of minimal changes
to input variables. Stakeholders along
the supply chain quickly come to dis-
trust such volatile plans and will start
to ignore them. There are dozens of
parameters that need to be understood
and controlled in order to drive stabil-
ity, from consumption forecast rules to
averaging periods and supply freezing
horizons.
Differentiation. One-size-fits-all
planning approaches need further
segmentation. Examples include dif-
ferentiating between automatically and
manually planned products/locations
or replacing complex integrated plan-
ning logic with simpler pull loops where
appropriate. Doing this makes results
41
more transparent and traceable for
the supply chain planner, which helps
increase acceptance of the supply
chain management software solution.
Data accuracy. To deliver their full
potential, integrated planning applica-
tions require a high level of data qual-
ity. Too often, however, safety stock
parameters, planning lead times, or
planned capacities deviate from real-
ity soon after system implementa-
tion. These parameters must be fully
understood in detail (and not only by the
implementation consultant),
actual values must be monitored, and
an appropriate organization needs to
be put in place to take care of planning
data. A good practice is to track the
accuracy of parameters through KPI
style portals to create transparency and
to make individuals accountable for the
accuracy of those parameters.
Complementary solutions
No single IT solution off the shelf can offer
best-practice processes or the best pos-
sible results for every company in every
industry sector. While extensive custom
development is not a replacement for the
organizational changes, capability build-
ing, and system tuning described above, it
is our experience that a truly useful supply
chain management IT backbone usu-
ally requires smart, custom-developed
planning functions and selective use of
best-of-breed software solutions, all tightly
integrated into the main system. In this
respect, supply chain planning differs from
other, more transactional functions of ERP
systems, where rigorous standardization is
often key to success.
We have observed the greatest opportuni-
ties for complementary solutions in the
areas of demand planning, S&OP (Sales &
Operations Planning), and transportation
planning and execution. These areas all
require functionalities that many ERP ven-
dors have been slow to develop,
42
leading to a comparable advantage to
smaller specialist vendors.
Three emerging technology
opportunities in supply chain IT
for consumer goods
Even as companies struggle to get the best
performance out of existing IT solutions,
new technologies are emerging fast. For
FMCG supply chains, we see three areas
of particular importance: new tools to
structure, analyze, and extract value from
vast amounts of increasingly available data,
advanced analytics to drive real improve-
ments in forecast accuracy, and real-time
S&OP processes to capture the full impact
of those improved forecasts.
Using big data to drive collaboration
Leading retailers increasingly share a
wealth of data with their suppliersand
expect them to use it to improve supply
chain efficiency. Walmart, for example,
shares point-of-sale demand, warehouse,
and store level inventories, and expects
suppliers to improve their store-level prod-
uct availability. Tesco and Coles started
sharing supplier shipment forecasts in
addition to PoS demand forecasts. Several
retailers are experimenting with electronic
stock-out detection in stores and will share
their results with suppliers. The resulting
enormous volumes of data are commonly
referred to as big data. There are two criti-
cal steps to make use of them:
Big data needs to be structured and
made transparent. To do this, retail-
ers and consumer goods firms need
to create a shared data layer that holds
data relevant to both, such as granular
POS data, stock levels, their respective
forecasts, and planned promotions.
A number of smaller software vendors
already specialize in providing solutions
to make data available for supply chain
planning, marketing, and
commercial analyses. Companies
should watch out for synergies
between marketing and supply chain
forecasting analytics. In fact, similar
analytics, interests, and approaches
may bring those historically separated
worlds closer together than ever.
Processes need to be redesigned
to become more collaborative in
nature. With perfect joint visibility,
should the retailer forecast, should the
consumer goods company forecast,
should both parties forecast separately,
or should there be as collaborative fore-
casting process? Who has the stron-
gest forecast accuracy historically?
How should fulfillment be triggered?
While companies have experimented
with collaborative planning forecast-
ing and replenishment for the past 15
yearswith mixed resultsbig data
availability gives the concept a powerful
new push. Creating the right joint busi-
ness process around joint information
is what ultimately will create the value
between the consumer goods com-
pany and the retailer.
Advanced forecasting analytics
While many consumer goods organiza-
tions have made strategic choices for their
demand planning software, only a few have
already exploited the full analytical power
available. There is untapped opportunity
to enhance forecast accuracy by using the
most advanced forecasting technology
available today. Key levers to look for more
advanced tools include:
A rich library of algorithms. Different
demand patterns require different sta-
tistical forecasting models to deliver a
good forecast. Forecasting tools need
a rich library of forecasting models, as
well as the capability to enhance cur-
rent models and build new ones.
Automated model selection capa-
bilities. With a library of roughly
30 different and exotic forecasting

models, even forecasting specialists
will need decision supportpreferably
automatedto select the right forecast-
ing model for the given demand pattern.
Causal data streams. By providing the
model with more demand-correlated
data (e.g., weather, price, social data),
forecasting accuracy can be greatly
improved. There are endless oppor-
tunities to experiment with new data
sources, like the data mining of social
media.
Attribute-based forecasting. For
new products with no demand history,
statistical forecasting engines typi-
cally struggle. A way to overcome this
is through attribute-based forecast-
ing, where demand is forecast based
on a set of attributes associated with
an item. In consumer electronics, for
example, these might include screen
size, memory, and processor speed.
Companies use information on existing
items that share some of these attri-
butes to build an artificial demand his-
tory and improve forecast accuracy for
the new item.
Real-time business optimization
While most consumer goods companies
have some sort of S&OP process in place,
few have considered how software can
improve that process. Frequently S&OP
processes are supported by spreadsheets,
e-mails and slide presentations, with all
the associated limitations of such a data-
intensive and collaborative process. As a
result, consensus plans are not securely
managed, stored and monitored for perfor-
mance, and S&OP processes start to lose
momentum. Appropriate S&OP software
support can address these shortcomings
by accelerating the process and increase
both its rigor and the degree of analysis
used. The key aspects that companies
need to address with S&OP technology are:
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.
43
Data integration. The tool should
help ensure that everyone is working
towards the same objectives. It should
be able to integrate plans from different
organizations (manufacturing, supply
chain, financial budgets and forecasts,
sales forecasts, market mix modeling,
etc.) into the S&OP consensus plan-
ning framework, then push back the
agreedupon plan into the planning
tools used by individual business units.
Real-time demand/supply balanc-
ing. New in-memory planning tech-
nologies allow a radically new approach
to planning. Instead of having to wait for
planning results from nightly batch pro-
cessing runs, new technologies allow
interactive plan optimization and sce-
nario evaluation. Leading companies
have already started transforming their
regular S&OP process cadence into
real-time planning capabilities.
Process and decision management.
Cross-functional planning processes
need a great deal of alignment. This is
especially true for increasingly global
planning activities like S&OP. Beyond
pure analytics and data management,
process management and S&OP deci-
sion making have to be supported by
work flow systems that are deeply inte-
grated with planning applications.
Advanced IT systems can help consumer
goods companies meet many of their cur-
rent and emerging supply chain challenges,
but getting full value from such systems
requires considerable care in selection,
implementation, and tuning. Companies
also need to integrate their organizations to
match the end-to-end capabilities of their
systems. These challenges will only inten-
sify as a new generation of advanced col-
laboration, analysis, and optimization tools
becomes available.
44
When a plan
comes together
Luis Benavides, Nitin Khanna, Hendrik Kohleick, Frank Snger, and Daniel Swan
Cooperation is a hot topic for manu-
facturers and retailers today. ECR Europe
(a European organization of retailers and
manufacturers that promotes collabora-
tion) gives further proof to that: 59 percent
of the companies surveyed engage on
collaboration across a broad series of
topics. And partners teaming up from the
consumer goods industry and retail have
long since moved beyond their initial focus
on promotions or assortment optimiza-
tion. Instead, far more survey participants
named a better coordinated supply chain
as their number one priority to tap sales
and cost potential in the coming years.
They see working together to plan and
shape demand and improve product avail-
ability as their most important goal, and
also want to exchange planning, inventory,
and sales dataideally in real time (see
sidebar at end).
Just a few years ago, most industry play-
ers would have dismissed the idea that
retailers and manufacturers could share
data this intensively, arguing that such
a level of cooperation was technically
impossible, involved too much effort, or
simply cost too much. But in the mean-
time, this vision has become a reality.
Thanks to rapid advances in information
technology, companies can now collect
enormous amounts of data automatically
at almost every point along the value chain
and process it in seconds. For example,
a manufacturer can potentially check its
production volumes and delivery capacity
against a retailers real-time forecasts of
customer demandproviding a far better
basis for planning. Capabilities like these
make improvements possible along the
entire supply chain:
Fact-based decision making. Greater
transparency when it comes to
demand data, inventory, and priorities
enables better decisions when avail-
ability issues occur or inventory runs
short. The advantages are especially
clear in exceptional circumstances or
periods of increasing volatility.
Smaller inventories. Demand-based
production plans help avoid over-
stocking and write-offs of unsold
merchandise without endangering
availability.
Fully stocked shelves. Supplying
goods to retailers faster and in line with
demand minimizes both stockout
situations and administrative work.
Fewer returns. Optimally coordi-
nated logistics between the partners
improves truck routing and utilization
and lowers the number of returns.
Advances along a broad front. In
time, more intensive sharing and closer
relationships between manufacturers
and retailers bring further progress in a
range of areas (such as joint efforts to
further develop products, plan catego-
ries, and design store layouts).
Retailers take the lead
The ECR study shows where companies
pursue collaboration, they can boost avail-
ability by 3 percent on averagewhile low-
ering supply chain costs by 6 percent and
increasing sales by the same share. And in
many cases, the results are even better.
The prospect of such improvements has
spurred a number of companies to take
action. Retailers in particular are asking
suppliers to draw more heavily on their
data for joint planning. As a result, they
are providing their suppliers with vast
amounts of information, including register
records and demand forecasts updated
daily. In exchange, they expect to see
improvements on distribution and ser-
vice. Three examples illustrate this:
1. Back in the 1980s, Walmart tested
early cooperation approaches with
Procter & Gamble that involved shar-
ing register and demand data. Today,
with its Retail Link system, Walmart

provides all suppliers worldwide with
access to weekly forecasts of point-
of-sale demand, store and warehouse
inventories, and service levels along
the supply chain for every article. As
a result of this transparency, the focus
throughout supply chain management
shifts from the service level of manu-
facturer warehouses to availability
instores.
2. The UKs Tesco and the Australian
retailer Coles have been using online
portals since 2012 that not only provide
forecasts of point-of-sale demand, but
alsothanks to backward planning
show when manufacturer deliveries will
likely be necessary. Armed with this
knowledge, suppliers can create bet-
ter demand and production plans, and
even get an advance view of the trans-
port capacities they will need, lower-
ing inventories and logistics costs.
Finally, a detailed view of the expected
increase in volumes through promo-
tions and the amounts sold to date
leads to significantly higher availability
and fewer left-over promotional items.
3. C arrefour and other French retail
companies, in turn, rely on VMI. In
France, more than half of the overall
volume of consumer goods is deliv-
ered to retailers using this process.
A more advanced version involves
joint VMI for several manufactur-
ers, who transport their goods to
their retail customers warehouses
in shared trucks. In this approach,
the VMI system provides rough order
volumes, which are later adjusted to
optimize truck utilization.
Among German retailers, Metro and the
dm drugstore chain provide the most
extensive supply chain data to their sup-
pliers. However, far less use is made of
this data in Germany than in other coun-
tries, meaning theres plenty of improve-
ment potential for German companies
tocapture.
45
Fact-based planning for future
promotions
Opportunities clearly exist for retailers, but
whats happening on the manufacturer
side? Exhibit 1 shows how consumer
goods companies can put greater supply
chain transparency to work for them. Many
are increasingly using IT tools to crunch
the data more easily and quickly, so they
can identify causes of recurring availability
problems throughout the entire supply
chain and eliminate them. In working with
retailer data this way, manufacturers are
therefore less oriented toward meeting sta-
ble demand than toward anticipating devia-
tions due to promotions, product launches,
and the like. For example, these tools help
in situations such as estimating demand at
the store level to better plan future product
rollouts. They also enable decision makers
to quickly evaluate those that are under-
way, so they can swiftly adjust demand
planning and marketing activities. Even the
impact of promotions on demand can be
analyzed, with the results flowing into future
promotion planning. Furthermore, the tools
provide detailed tracking of the demand
and inventories along the full value chain,
minimizing outdated overstock.
Other no less important tools analyze
stockout situations and their causes, creat-
ing the fact basis required for availability
boosting initiatives. Analytical planning
software like demand-sensing solutions
forge an even closer link between manu-
facturers and their customers supply chain
data. The benefits that result include better
forecasts of short-term demand.
Solutions with similar functions are also
currently being developed and deployed
in marketing managementalthough to
somewhat different ends. Since sharing
data and tools can pave the way for an
integrated approach, companies in these
cases likewise face the organizational
challenge of creating a closer connection
between planning on the marketing and
supply chain sides.
46
Manufacturers can process retailers supply chain information by using
one of the following 3 approaches
Retailer
Manual analysis
of retailer data Retailer
portals
Analysis using
consolidation Retailer
software portals
Integrated
planning Retailer
portals
Exhibit 1
Next up, manufacturers:
how it works
What exactly should makers of consumer
goods do next, and how can they work
with their customers to achieve joint
improvements as they do it? The real-life
story of one cooperative effort provides a
good example. A global food company and
a leading international retailer were both
dissatisfied by the lack of transparency
and rigor in their relationship. Established
processes were lacking, a great deal of
available data was not adequately con-
sidered during planning, and the service
level as a whole was simply not up to par.
In response, the food manufacturer initi-
ated a collaboration effort with a twofold
objective: to boost data transparency and
sharing, and to establish a standard pro-
cedure linking this shared data with a joint
integrated planning process. The partners
achieved this goal in three steps.
First, they defined in detail what the joint
collaboration effort would require.
Essential elements included access to the
retailers supply chain data in close to real
Manufacturer
Manufacturer
planning
systems
Manufacturer
Analysis
planning
software
systems
Selected software providers
Retail solutions
Retail right
Salient
Accelerated analytics
Manufacturer
Planning planning
solutions systems
Selected software providers
Terra demand sensing
SAS
Retail solutions
time, as well as joint planning of demand
and promotions in a clearly defined pro-
cess involving mutually available data.
In addition, they would need to optimize
inventory and ordering parameters and
investigate options for improving the entire
flow of goods. Then both companies ana-
lyzed existing capabilities and processes:
What data were they already sharing, how
often did they share it, and what was its
level of quality and detail? To what extent
was this data actually used in planning
processes? What coordination and other
contact takes place between the two
parties? At the end of this step, a highly
detailed concept had already taken shape
and could be discussed with the retailer,
who responded positively.
In the second step, the food company
reached an agreement with the retailer
about the collaborations objectives,
methods, and general framework, and
developed the idea in more concrete
terms. Then a rough collaboration plan
was drawn up and refined in a series of
workshops. During this phase, the focus
was to quickly reach a consensus on key

points and get both sides thinking about
the project in terms of win-win solutions.
In this way, the two companies laid the
foundation for a successful collaboration:
a project team with committed experts
from every area, a collaborative mindset,
and performance indicators that made it
possible to measure how well they were
doing (in terms of service level at various
points of the supply chain, with inventory
requirements and even penalties for miss-
ing targets). The success of this part of the
process was largely due to the manufac-
turers concept, which was detailed while
still leaving the retailer opportunities to
shape the program.
Now the point had come to draft the new
process, along with the tools and tem-
plates it required. The most important
end product of this design phase was
a detailed planning process for the next
30, 60, and 90 days because the advan-
tages of data transparency are only real-
ized through rolling plans based on these
intervals. Throughout this process, an
Excel-based tool brings all the critical data
together to provide a comprehensive view
of the situation. The food company and
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.
The partners completed all this prepara-
tion within just three months. Then they
piloted the new planning process to adjust
or refine individual elements and instru-
ments before both companies codified
them into standard procedures and car-
ried them over to other aspects of their
collaboration.
47
Win-win: Both partners profit
The main reason that the work on the
new planning process went so well was
that all relevant functions and stakehold-
ers from both sides were involved. People
from throughout the food company con-
tributed their expertise: the sales team
contributed its market insights, contact
with the retailer, and long-term strategic
perspective; the planning team its techni-
cal know-how, modeling capability, and
data on historic trends; and the customer
service team its experience of both the
retailers ordering behavior and its own
companys supply chain performance.
The new process has now been exten-
sively tested and has proven its value for
both partners. The food manufacturer
was able to turn around an originally
tense customer relationship: thanks to
the collaboration, each company now
values and appreciates the other. The
service level also jumped, with product
availability at stores reaching 98 per-
cent. Most importantly, both companies
achieved ambitious growth targets in a
generally slow-growing category.
This example demonstrates three points.
First, even large international manufac-
turers and retailers have only begun to
exhaust the tremendous potential that
closer collaboration offers. Second, tap-
ping this potential takes less time and
effort than many companies assume. And
third, both sides profit enormously over
the long term from the improvements that
such a collaborative project brings.
48
ECR Europe: Survey on
partnerships in the consumer
goods sector
In a joint study, McKinsey and the con-
sumer goods/retail network ECR asked
140 retailers and consumer-goods com-
panies in 13 European countries about
the status, impact, and outlook for man-
ufacturer-retailer partnerships, as well as
what makes them successful. The main
findings: while many European retailers
and manufacturers are already working
together (59 percent), the level of coop-
eration still lags far behind that in America
(95 percent). Furthermore, successful
efforts bring considerable sales growth
(6 percent on average for both parties),
reduce supply chain costs (7 percent for
retailers and 2 percent for manufacturers),
and boost availability (6 percent for retail-
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.
At the same time, about 40 percent
of all initiatives fail to meet their goals
because the partners lack the willing-
ness, persistence, or skills to make
cooperation work, or because they
cant agree on how to share data or split
up the profits.
The study also shows that the focus of
such partnerships is undergoing a shift.
Most efforts until now have centered
on topics at the interface of sales and
purchasing. In the future, improving the
supply chain will play a greater role, as
companies work together to plan and
meet demand and optimize supply
route processes.
49
50

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
for pharmacos, one that will confer a signif-
icant competitive advantage. Pharmacos
need to become agile so that they can
respond to increasing volatility and uncer-
tainty in global supply chains and markets.
However, most companies say they arent
becoming as agile as they need to be. In
fact, companies often struggle to decide
where to build agility and how to make the
right trade-offs between the costs and
benefits of agility. Pharmacos can become
agile by understanding the effects that
uncertainties have on operations, by build-
ing agility across functions, and by includ-
ing the abilities to detect and respond to
volatility among their core capabilities.
The case for agility
Pharmacos have become all too familiar
with the rising number of disruptions and
increased uncertainty and volatility affect-
ing supply chains. And it is not a matter
of concern for the supply chain function
alonein addition to impeding the delivery
of life-saving drugs, these issues threaten
the performance of the whole enterprise. Yet
few companies are responding to this new
reality by systematically implementing agile
operations and enterprise risk management.
Its time for pharmacos to move agility from
nice to have to the center of the opera-
tions arenamaking it a core enterprise
capability that, in volatile times, will differ-
entiate the champions from the laggards.
Doing this effectively requires specific
processes and capabilities for detecting
uncertainty, the incorporation of agility into
operations functions and processes, and
strong leadership from top management.
Worrisome trends, but an
inadequate response so far
In recent years, the level of uncertainty
has increased throughout the global
business environment. Disruptive events
51
ranging from political uprisings to natural
disasters are posing challenges to phar-
macos increasingly globaland fragile
supply chains. Indeed, in a recent survey
of manufacturing companies across
industries, 80 percent of respondents
said they believed the level of uncertainty
is rising.1
A wide range of trends can worsen the
severity of uncertaintys impact on
pharmacos. Complexity in operations
has increased as pharmacos have
expanded their product ranges and lines
and entered new markets. Local market
requirements and global production
strategies have added to the manage-
ment challenges. Pressure on working
capital is increasing the need to finance
new drug pipelines and acquisitions.
Emerging markets are increasingly
important to the business, but these
markets have more volatile demand
(especially as tendering has increased)
and less mature distribution channels.
Pharmacos are managing more generic
drug launches each year that have uncer-
tain timing and demand. Furthermore,
public health officials expect pharmacos
to rapidly ramp up new supply chains in
response to pandemics and epidemics
so that they can provide millions of vac-
cine doses. And payers have pushed to
achieve cost savings through regular ten-
ders and rebate contracts for generics.
Adding to these uncertainties and
potential shifts of market share, some
regulators have imposed import bans.
For example, in 2009, the FDA banned
imports into the US of drugs produced by
the Canadian manufacturer Apotex. The
company estimated that it lost sales of
$520 million as a result. In 2013, the FDA
banned the import of products made by
the Indian generics manufacturer Ranbaxy
at its new factory in the Punjab region of
India, causing a 30 percent drop in the
companys share price overnight. This was 1 Survey of 42 global companies
during McKinsey Global Agile
the third time the companys imports had Manufacturing Conference,
been blocked in the US since 2008. Munich, June 5, 2013.
52
Fortunately, pharmacos can improve their
ability to respond to uncertainty. Leading
companies are rising to the challenge by
becoming agile. Companies with agile
operations have the ability to sense,
assess, and respond to uncertainty
allowing them to both mitigate downside
risks and capture upside opportunities in a
fast, flexible, and cost-effective manner.
As an example of the innovative ap-
proaches to dealing with increasing
uncertainty, one pharmaco recently set
up a postponement operation in a central
hub in Europe with unpacked blisters ready
for final language and pack-size custom-
ization. This approach enabled the phar-
maco to dramatically reduce lead times
and achieve up to a 50 percent reduction
in safety stock, which in turn allowed it to
nearly eliminate obsolete products.
Another pharmaco increased revenues and
agility by implementing end-to-end supply
chain planning. The company defined three
clear planning loops to ensure that each
part of the value chainmaterials, supplies,
drug substance production, and finished
product replenishmentsynchronized
Despite the need and impact, most companies say they arent improving
as much as they should
Most clients are working on agility
Do you think your company is investing enough
in building agility?
Percent of respondents; n = 33
Not at all 0 Not at all
27
Some, but it is minimal
We are improving our
agility, but it is not a
priority
Agility is an integral part
18
of the operations agenda
Agility is a priority
and we have dedicated 9 0
resources to it
SOURCE: McKinsey Agile Operations WebEx, July 19, 2012
Exhibit 1
with patient demand. It defined one owner
for each planning loop and systematically
challenged demand figures by flagging key
changes or inconsistencies and deploy-
ing scenario planning. By setting the right
planning frequency and alerts, it was able
to trigger appropriate action throughout the
entire supply chain. A sales and operations
planning governance process facilitated
management decisions on critical issues
and bottlenecks. This focus on end-to-
end planning led to a 5 percent increase
in revenues and a 30 percent reduction of
supply variability. It also put the company in
a better position to respond to any sudden
increases in demand due to epidemics.
Although many companies recognize
the need for agility, most say they arent
becoming as agile as they should. Only
about a quarter of the executives we sur-
veyed told us that agility was a priority or
an integral part of their operations agenda.
And the vast majority85percentsaid
that their company was not improving the
agility of its operations enough (Exhibit 1).
Indeed, in a recent assessment of supply
chain agility in dimensions such as demand
shaping, integrated planning, and inventory
but not to the extent they feel they should
How much is your company improving the
agility of its operations?
Percent of respondents; n = 26
8
Some, but 85
not enough
About the
45 8
right amount
Somewhat
0
overinvesting
Significantly
overinvesting
 53

Pharma shows a spike on postponement, Most important pharma levers

but lags behind in all other dimensions

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

Build Postponement and modularization Pharma

structural
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

operational
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
behind other industries (Exhibit 2).
A three-step approach
How can pharmacos succeed in increas-
ing the agility of their operations, and
where does building agility provide a pay-
off? We discuss a three-step approach:
understanding how uncertainties trans-
late into operational effects, building
agility across all the core functions, and
developing capabilities to detect and
respond to uncertainty.
Step 1: Understanding how
uncertainties translate into
operational effects.
Each pharmaco encounters hundreds of
uncertainties in planning its operations.
For example, a generics competitor might
suddenly receive approval to enter a
market, and another competitor might be
forced to remove products from the same
market. Identifying and preparing for each
uncertainty can appear to be an expensive
and potentially impossible task.
To simplify and focus agility building
efforts, it is critical to understand uncer-
tainties in terms of the effects they have on
operations. For example, the entry of new
competitors or launch of promotions can
each result in short-term demand variabil-
ity, which can be managed with the same
supply chain tools.
Once the uncertainties have been trans
lated into effects, companies can imple-
ment an agile strategy review (ASR) pro-
cess to quantify the magnitude, frequency,
and duration of the effects they face. For
example, an automotive and assembly
company set up an ASR process for sup-
plier issues that takes place monthly and
involves key operations personnel such as
the leaders of procurement, quality, manu-
facturing, R&D, and supply chain. An ana-
lyst prepares a clear overview of current
uncertainties and quantifies the effects.
The reviews output allows the company
to prioritize the uncertainties that require
reaction.
Uncertainty typically has the following
seven effects on operations. For each
effect, we specify the questions pharmacos
54
should ask to determine the right actions
for an agile response:
Cyclic demand. How can operations
preserve margin in down cycles while
capturing disproportionate volume in
up cycles? This is relevant for drugs
used to treat flu or any other illness
that is seasonal or cyclical.
Mix shifts. How can operations be set
up to increase the likelihood of devel-
oping blockbusters in a large portfolio
of drugs without overinvesting in
capacity for every drug? For example,
can a facility make multiple products,
allowing it to shift between them in
response to changes in the demand
mix so that it can reduce the chances
of idle or underutilized capacity?
Short-term demand volatility. How
can operations maintain service without
compressing margins through haphaz-
ard reactions? Among other options,
this might entail asking a contract man-
ufacturing organization to contribute a
greater share of products to ensure an
agile response to a demand surge.
Supply disruption. How can opera-
tions ensure that an external disruption
to supply affects the company to a
lesser extent than its peers, allowing
the company to capture share as a
result? The company should consider
issues such as whether it could insulate
itself from disruption if a common sup-
plier for the market loses three months
of capacity after failing an FDA audit.
Internal disruption. How can opera-
tions quickly react to minimize the
impact on volume of an internal dis-
ruption to supply? For example, a
company might have a rapid-response
team that goes to a plant whenever a
quality issue flares up. Their objective
would be to quickly put out the fire
and then design a sustainable solution
to address the root causes.
Input cost volatility. How can opera-
tions go beyond financial mechanisms
to further insulate the supply chain from
input-cost volatility? A company might
launch a supplier collaboration program
in an effort to share the risk for a key API
that is also used by other manufactur-
ers. This can help ensure preferred
treatment when the API is in short sup-
ply and thereby lessen cost increases.
Safety and operational risk. How
can operations increase its ability
to predict equipment and process
failures? Pharmacos that apply best
practices in agile maintenance, for
instance, would use leading indica-
tors such as machine temperature
or operating hours to reliably predict
potential breakdowns.
Based on the answers to these ques-
tions, a pharmaco can better understand
how its operations can manage each
effect and thus the key uncertainties.
Within the pharmaceutical industry, we
tend to see mix shifts, internal disruptions,
and supply disruptions as the biggest
challenges:
A mix shift can occur when, for exam-
ple, a tender selects one pharmacos
drug over others. This can result in a
sudden and drastic increase in volume
for the selected drug and a significant
drop in volume for those drugs not
selected.
Significant internal disruptions can
result from an FDA warning letter stem-
ming from poor performance on an
auditrecovery from such a disruption
can take many months.
Supply disruptions are becoming more
frequent with the increasing length of
supply chains. For example, one phar-
maco recently shut down its internal
vial-filling operations, only to find out
that its outsourced provider had serious

quality issues and was suddenly very
risky to rely on. The pharmaco needed
to step in and develop the suppliers
capabilities in-house so that it could
avert a supply catastrophe for its billion
dollar drug.
Step 2: Building agility across
functions, coherently.
After a company identifies and prioritizes
uncertainties based on the effects, it must
quickly move to embed agility in organiza-
tional areas in which it will have the greatest
payoff. The company should conduct a
review of regions and end-to-end product
supply chains to understand where the
effects of uncertainty will require the most
agility to best serve customers and drive
profitability. This should be followed by a
review of the current state of the agility-
related capabilities of its core operational
functions. The company can then apply
the appropriate levers to build agility in the
targeted areas.
There are some areas for which agility
promotes cost improvements (for example,
To succeed, a balanced agility strategy is needed which combines
no-regret moves with long-term strategic investments
No-regret moves agility levers
Implementing can actually reduce costs
Can be quick wins
Require an end-to-end view of business to
understand cost-benefit trade-off
Expected
costs
Companies can increase agility while
lowering cost
Example Lean fulfillment (e.g., speeding up internal
processes)
Labor flexibility (e.g., work time accounts)
55
labor flexibility both improves service and
reduces over- and idle time), thus making
investments in agility a no-regret move.
Other areas will require long-term strategic
investments that entail trade-offs between
agility and costs (Exhibit 3).
A typical trade-off entails adding redun-
dant capacity to meet spikes in demand
or cover for a failure at a facility. Another
common agility investment relates to
inventory placementpharmacos can
choose to store inventory closer to cus-
tomers to react more quickly in case of
urgent demand due to a disease outbreak.
Exhibit 4 sets out the levers that com-
panies can apply to build agility in each
function and indicates which levers can
have the greatest impact for pharmacos.
Together, these levers constitute an
agility toolbox.
One of these agility levers is having a
true multi-echelon philosophy. Instead of
managing stock levels at each loop of the
supply chain separately, a multi-echelon
philosophy dictates a comprehensive
Agility investments
Can yield significant return on investment
Involve cost-benefit trade-off
Choices done at a strategic level
Agile initiatives
Companies struggle to make big bets on
agility, but can work through strategy, risk,
and ROI for agility
Diversified network (e.g., redundant capacity)
Inventory placement (e.g., forfeit pooling effect
to be closer to customers)
There is no one-size-fits-all solution
each industry and company is different
Exhibit 3
56

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,
tablets, and blister packs, as well as
finished goods inventory at internal ware-
houses, distributors, wholesalers, hospi-
tals, and pharmacies.
Pharmacos can increase their agility by
designing the optimal configuration for the
supply chain to leverage the benefits of
late-stage customization and postpone-
ment. They can substantially reduce total
cost to serve, for example, by customizing
to orderthat is, using anonymous blisters
for primary packaging, and customizing
on a postponement line based on country
orders (Exhibit 5). This gives the company
additional flexibility to react to sudden
changes in mix (for example, packaging
type or volume per country) and makes
it less vulnerable to obsolescence (as
could happen if, for example, a packaging
change rendered large quantities of pack-
aged products obsolete, requiring expen-
sive rework or disposal). This approach is
especially attractive for products with low
packaging volume per SKU, high bulk vol-
ume, high value, or high demand variability.
The sales and marketing organization
should forecast demand by applying
advanced market insights, directly linking
operations with patient demand where
possible. For example, short-term fore-
casting of a newly launched weight control
drug could include mining Facebook and
Twitter posts to gather information about
preferences and side effects. Just as man-
ufacturers and retailers use weather fore-
casts to predict consumption of weather-
sensitive foods (such as ice cream),
pharmacos can use climate predictions to
forecast expected volumes for cold and flu
medicines for the upcoming season.
Step 3: Making detection-and-
response core capabilities.
With key agility elements integrated into
its operations, a pharmaco can shift its
attention to building capabilities to detect
and respond to capacity plan to cope with
volatility. The company faced shortages of a
vaccine critical to public health as the result
of significant volatility in vaccine demand
coupled with poor capacity planning.
 57

There are various technological solutions allowing

late-stage customization

Description
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
and improved decision making by allow-
ing it to distinguish between predictable
and unpredictable demand. It also built a
quantitative model to clearly understand the
impact of uncertainty in different scenarios.
A cost-benefit analysis across a range of
probability-weighted scenarios allowed the
company to correct misconceptions regard-
ing the required capacity levels. The com-
pany also identified capital and noncapital
levers that would allow it to release capacity
with a clear understanding of operating pro-
cedures under various demand scenarios.
To achieve such improvements, pharma-
cos need to follow a disciplined approach
to understand uncertainties, build cross-
functional agility, and implement rapid
detection-and-response capabilities. How
do you know if you should be investing in
agility? How agile is your company already?
An agile operator would be able to provide
positive answers to a series of pointed
questions about its operations (see box,
How agile are your operations?).
high-level assessment have room for
improvement in both managing the down-
side of uncertainty and capturing gains
when opportunities present themselves.
events as they occur. As a role model,
pharmacos can look to military organiza-
tions. Consider the high stakes (victory or
defeat, life or death) and the extraordinary
level of agility required when conducting a
military operation in an unfamiliar territory
or a hostage rescue mission. Although
business is not war, what can pharmacos
learn about agility from the military?
Military organizations are conscious of
how much and what kind of agility to
build into each division within a branch.
The regular army, peace keeping forces,
and special forces fulfill different types of
missions, requiring dramatically different
degrees of agility:
A regular army makes heavy invest-
ments to develop standard work pro-
cesses and training given its emphasis
on broad interventions in visible terrain.
58

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
and explain it to their direct team
upon assuming command. Landscape
analysis includes the IT security simula-
tions used by financial institutions to
anticipate unexpected deviations from
plans, such as intrusions by rogue oper-
ators. As an example of team-leading
procedures, industrial and logistics oper-
ators develop irregular ops playbooks
based on different, frequently recurring
conditions (such as the weather). After-
action reviews are exemplified by NASAs
midcourse pause-and-learn exercises
during long programs; the agency uses
these to identify and immediately incor-
porate improvements.
Getting started
Becoming agile has significant benefits,
but a structured approach is required to
capture them. Indeed, although we have
seen many pharmacos begin targeted
efforts to increase agility, only those
59
that have launched holistic efforts have
achieved large, sustainable gains.
Among the successful ones is a pharmaco
that increased revenues by 16 percent over
five years by introducing a comprehensive
capacity plan to cope with volatility. The
company faced shortages of a vaccine crit-
ical to public health as the result of signifi-
cant volatility in vaccine demand coupled
with poor capacity planning. A comprehen-
sive analysis of uncertainty gave the com-
pany greater transparency and improved
decision making by allowing it to distinguish
between predictable and unpredictable
demand. It also built a quantitative model
to clearly understand the impact of uncer-
tainty in different scenarios. A cost-benefit
analysis across a range of probability-
weighted scenarios allowed the company
to correct misconceptions regarding the
required capacity levels. The company
also identified capital and noncapital levers
that would allow it to release capacity with
a clear understanding of operating proce-
dures under various demand scenarios.
60
How agile are your operations?
Pharmacos can use the following ques-
tions for a high-level assessment of their
operations agility:
Understanding how uncertainties
translate into operational effects.
Would each functional leader agree on
the top uncertainties the company faces?
For each of the top uncertainties, what
magnitude, frequency, and duration is
the company prepared for (such as the
number of supplier failures or the intensity
and duration of the next cyclical demand
increase)?
Building agility across functions,
coherently.
What happens to the P&L, balance sheet,
and customer service at the coverage
level youve established?
How do you build uncertainty into your
ROI calculations?
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.
When uncertainty strikes, can all func-
tions respond with equal levels of agility?
To what extent can they, for example, flex
capacity up and down without undue mar-
gin pressure, or shift supply, formulation,
and conversion if a disruption occurs?
Are your suppliers and logistics provid-
ers contributing to your agility, or do they
slow you down?
Making detection and response core
capabilities.
For key uncertainties, do you have a
dashboard of leading indicators and clear
thresholds?
Who is responsible for identifying each
type of uncertainty to the organization as
they are gaining speed?
For key uncertainties, do you have a
cross-functional response team (special
forces) and clear decision rights?
How do you build agility in your leaders?
What level of the organization gets that
training?

Next-shoring:
A CEOs guide
Katy George, Sree Ramaswamy, and Lou Rassey
Proximity to demand and innovative
supply ecosystems will trump labor costs
as technology transforms operations in
the years ahead.
Demand for manufactured goods in
emerging markets is surging and frag-
menting as factor costs shift; technologi-
cal advances, such as more powerful
robotics and the Internet of Things, are
creating a range of new opportunities for
manufacturers to digitize operations.
Why it matters and what to do
about it
Manufacturing strategies built on labor-cost
arbitrage are becoming outmoded; the
race is on to get ahead of what comes next.
Place greater emphasis on proximity to
both demand and innovation while:
Making location decisions that bal-
ance economies of scale against the
growing diversity of tastes within and
across global markets
Building supplier ecosystems that
combine technical expertise with
local domain and market knowledge
Developing the people and skills need-
ed to make the most of technological
advances across the organization.
When offshoring entered the popular lexi-
con, in the 1990s, it became shorthand
for efforts to arbitrage labor costs by using
lower wage workers in developing nations.
But savvy manufacturing leaders saw it as
more: a decisive change in globalization,
made possible by a wave of liberalization
in countries such as China and India, a
steady improvement in the capabilities of
emerging market suppliers and workers,
a growing ability to transfer proven man-
agement processes to new locales, and
increasingly favorable transportation and
communications economics.
61
Something of equal moment is occurring
today. As we settle into a new normal
catalyzed by the global financial crisis,
the ensuing recession, and an uneven
global recovery, traditional arbitrage
models seem increasingly outmoded.1
For some products, low labor costs still
furnish a decisive competitive edge, of
course. But as wages and purchasing
power rise in emerging markets, their rel-
ative importance as centers of demand,
not just supply, is growing.
Global energy dynamics too are evolv-
ingnot just the now-familiar shale gas
revolution in the US, but also rising levels
of innovation in areassuch as battery stor-
age and renewablespotentially refram-
ing manufacturers strategic options.
Simultaneously, advances stemming from
the expanding Internet of Things, the next
wave of robotics, and other disruptive tech-
nologies are enabling radical operational
innovations while boosting the importance
of new workforce skills.
Rather than focus on offshoring or even
reshoringa term used to describe
the return of manufacturing to devel-
oped markets as wages rise in emerging
onestodays manufacturing strategies
need to concentrate on whats coming
next. A next-shoring perspective empha-
sizes proximity to demand and proximity
to innovation. Both are crucial in a world
where evolving demand from new mar-
kets places a premium on the ability to
adapt products to different regions and
where emerging technologies that could
disrupt costs and processes are making
new supply ecosystems a differentiator.
Next shoring strategies encompass ele-
ments such as a diverse and agile set of
production locations, a rich network of
innovation-oriented partnerships, and a
strong focus on technical skills.
In this article, well describe the economic
forces sweeping across the manufacturing
1 See Ian Davis, The new
landscape and examine technologies com- normal, McKinsey Quarterly,
ing to the fore. Then well suggest some March 2009, mckinsey.com.
62
2 See Manufacturing the future:
The next era of global growth
and innovation, McKinsey
Global Institute, November
2012, on mckinsey.com,
for an in-depth analysis of
the economics and trends
surrounding five types of
manufacturing industries:
global technologies (for
instance, electronics) that
are R&D intensive and highly
traded; global innovation
for local markets (autos,
machinery) that are R&D
intensive but tend to produce
adjacent to demand; labor-
intensive regional processors
(food, fabricated metals) that
are highly localized and locate
adjacent to demand; resource-
intensive commodities (metals,
paper and pulp) that are
energy intensive and locate
near demand or resources;
and labor-intensive tradables
(apparel, footwear) that are
highly traded and locate where
labor is cheap.
Exhibit 1
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,
underlying its predecessor, offshoring, are food and beverages, and fabricated
giving way to something new. metals. In the US, about 85 percent
of the industrial rebound (half a mil-
lion jobs since 2010) can be explained
Economic fundamentals just by output growth in automobiles,
machinery, and oil and gasalong with
The case for next-shoring starts with the linkages between these sectors and
the economic fundamentals of demand locally oriented suppliers of fabricated
(since the importance of local factors is metals, rubber, and plastics (Exhibit 1). 2
growing) and supply (as the dynamics of The automotive, machinery, and oil and
labor and energy costs evolve). gas industries consume nearly 80 per-
cent of US metals output, for example.
The importance of local demand
factors In China too, locally oriented manufac-
turers have contributed significantly to
More than two-thirds of global manufac- rising regional investment and employ-
turing activity takes place in industries ment. The country has, for example,
that tend to locate close to demand. This emerged as the worlds largest market
simple fact helps explain why manu- and producer for the automotive indus-
facturing output and employment have try, and many rapidly growing manufac-
recently risennot only in Europe and turing sectors there have deep ties to it.
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
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)
70
65
60
55
50
45
40
35
30
25
20
15
10
5
0
1995 2000 05
SOURCE: IHS global insight; McKinsey global institute analysis
As automotive OEMs expand their capac-
ity in emerging markets to serve regional
demand, their suppliers have followed;
the number of automotive supplier plants
in Asia has tripled in just the past decade.
The emerging markets share of global
demand is steadily climbing, from roughly
40 percent in 2008 to an expected
66 percent by 2025 (Exhibit 2). As that
share rises, it also is fragmenting into
many product varieties, feature and qual-
ity levels, price points, service needs, and
marketing channels. The regional, ethnic,
income, and cultural diversity of markets
such as Africa, Brazil, China, and India
(where some local segments exceed
the size of entire markets in developed
nations) is raising the ante for meeting
local demand. In the automobile indus-
try, for example, fragmenting customer
demand has led to a 30 to 50 percent
increase in the number of models.
90 percent of recent capital expenditures
in the automotive sector have involved
product derivatives worldwide and
capacity expansions in new markets.
63
Consumption of
manufactured goods
Global GDP
10 15 20 2025
Exhibit 2
The limits of labor-cost arbitrage
Surging local demand helps explain
why rapid wage growth in China hasnt
choked off manufacturing expansion
there. Wages have nearly doubled since
2008, partly as a result of domestic mini-
mum wage policies.3 (The countrys
2011 five-year plan called for 13 percent
average annual minimum wage increas-
es, a rate some provinces have already
exceeded.) True, in a few labor-intensive,
trade-oriented industries, such as
apparel production and consumer
electronics, labor-cost changes do tend
to tip the balance between different
geographic regions; manufacturing
employment in Bangladesh and Vietnam,
for instance, has benefited from Chinas
wage surge, even as Chinese manufac-
turers are seeking to raise productivity.
But these are far from the only implica-
tions of rising wages. Just as Henry
Fords $5 a day helped create a new
consuming class, so higher wages in
China are increasing local demand, thus 3 Measured in nominal dollars.
64
4 For more, see the full McKinsey
Global Institute report, Game
changers: Five opportunities
for US growth and renewal,
July 2013, on mckinsey.com.
5 See Guangyu Li and Jonathan
Woetzel, What Chinas five-
year plan means for business,
July 2011, mckinsey.com.
6 For more, see Disruptive
technologies: Advances that
will transform life, business,
and the global economy,
McKinsey Global Institute,
May 2013, on mckinsey.com.
reinforcing the local investment choices
of OEMs and suppliers. At the same
time, there is little evidence of a zero-sum
game between China and advanced
economies, such as the US. Rather,
the narrowing labor-cost gap reinforces
the importance of local demand factors
in driving manufacturing employment.
Indeed, factor costs often have the great-
est impact on location decisions within
a regionfor example, Airbus moving
to Alabama instead of Texas or North
Carolina. These costs interact with policy
factors, such as infrastructure spending
and tax incentives, to shape a regions
overall economic attractiveness.
The impact of energy costs
The price of natural gas in the US has fall-
en by two-thirds as gas production from
shale deposits rose by 50 percent annu-
ally since 2007. A narrow range of sec-
torsgas-intensive manufacturing, such
as the production of petrochemicals,
fertilizer, and steelare benefiting most
directly. Some downstream players in the
energy value chain have begun shifting
investments. Dow Chemical, BASF, and
Methanex, for example, have announced
plans for new US manufacturing capacity
to take advantage of cheaper, abundant
energysupplies.
These moves are important for such
companies and subsectors; McKinsey
Global Institute (MGI) research suggests
that by 2020, lower-cost energy could
boost US GDP by somewhere between
$400 billion and $700 billion.4 But do
they presage a dramatic rebalancing of
global manufacturing activity? Electricity
costs were already lower in the US than in
many countries, including Chinawhich,
along with others, also has opportunities
to boost its own energy output through
hydraulic fracturing. And fossil fuels arent
the only area where the energy supply
picture is morphing.
Consider, for example, the potential
impact of energy storage technologies,
especially lithium-ion batteries and fuel
cells, which are becoming more capable
and less costly. At the same time, the
improving economics of renewable
energy productionparticularly solar and
wind poweroffers manufacturers an
expanding range of future supply options.
In some developing regions where power
grids are unreliable or nonexistent, factory
complexes served by distributed solar
power may be feasible. Distributed gen-
eration is also growing in combined heat-
power (CHP) plants, which use
heat created in the production process
to run steam turbines and generate
electricity locally.
None of these are a silver bullet today.
But as advances continue over time,
more and more companies may
become able to ask themselves where
they would place major strategic bets if
the availability and price of energy were
lesser concerns. That too will probably
lead back to a focus on local demand
patterns. Interestingly, the country
representing the greatest source of
future demand growthChinais also
actively stimulating the development
of a range of new energy sources and
storage technologies through a focus
on new strategic industries in its
five-year plans.5
Technology disruption ahead
Technology is affecting far more than
energy dynamics. Advanced robotics,
3-D printers, and the large-scale
digitization of operations are poised to
alter fundamental assumptions about
manufacturing costs and footprints.6
To derive value from these shifts, com-
panies will have to make significant
investments and ensure access to hubs
of innovation, capable suppliers, and
highly skilled workers.

Advanced robotics
Investments in industrial robots have
increased by nearly 50 percent since
2008even in emerging nations such as
Chinaas a new generation of advanced
systems develops, with greater dexterity
and ability to process information. These
robots can perform an expanding array of
factory tasksfor instance, manipulating
small electronic parts, and picking and
packing individual products. They can
work side by side with humans and be
trained by factory floor operators rather
than programmed by teams of highly paid
engineers. Improved economics and
capabilities eventually may yield produc-
tivity gains that are unforeseen today, as
well as better products and faster speed
to market. As that happens, companies
will be able to retool their manufacturing
systems to provide new roles for these
mechanical workers.
Cheaper, more proficient robots that can
substitute for a wider variety of human
tasks are another reason companies may
locate more manufacturing closer to major
demand markets, even where wage rates
are higher. In developing nations, robots
could speed up rates of automation and
help bridge shortages of some production
skills. MGI research suggests that 15 to
25 percent of the tasks of industrial work-
ers in developed countries and 5 to 15
percent of those in developing countries
could be automated by 2025.
Further out, highly robotized factories
also equipped with other information
technologies might shift competition to
areas such as the ownership of customer
networks, which should become increas-
ingly valuable as information embedded
in them starts guiding production priori-
ties and flows. Flexible, intelligent assem-
bly robots also should enable contract
manufacturers to serve an increasingly
diverse range of customers, creating
new opportunities for attackers to target
attractive microsegments.
65
3-D printing
The economics of 3-D printing are
improving rapidly, as well. While still only
a sliver of value in the manufacturing sec-
tor (0.02 percent), sales of 3-D printers
are set to double, to $4 billion, by 2015,
and prices for the equipment are declin-
ing swiftly.7 Also, 3-D printers open up the
possibility of more distributed production
networks and radical customization. In
early manufacturing applications, some
companies are using the devices to
accelerate product development, since
they eliminate wait times for prototyping
by faraway specialists. Companies will
be able to consider new supply chain
models and, in some cases, replace tra-
ditional suppliers of parts with targeted
usage of in-house printers.
These printers wont replace traditional
high-volume modes of production, such
as die casting and stamping. For more
specialized goods, though, its easy
to imagine the emergence of service
businessesthe equivalent of copy or
print shopsthat would manufacture
items based on design specifications
provided by B2B or B2C customers.
Crowdsourcing networks for new pro
duct ideas could one day complement
traditional R&D activities for some manu-
facturers.
Digitized operations
Significant as advanced robotics and
3-D printers are, they represent just two
plot lines in a much bigger story about
the digitization of operations. Cloud
computing, mobile communications,
and the Internet of Things8 are begin-
ning to combine with advanced analytics
to create threads of intelligent data that 7 Wohlers Report 2013: Additive
link assets and stakeholders as never Manufacturing and 3-D
Printing State of the Industry,
before. Increasingly, products will com- Wohlers Associates, May 2013,
municate with each other, with robots wohlersassociates.com.
and advanced machines inside factories, 8 The growing collection
of sensors and actuators
and with customers and suppliers. Digital embedded in products and
DNA for parts (including the materials, equipment.
66
9 See Manufacturings new era:
A conversation with Timken
CEO James Griffith, interview
by Katy George, December
2012, mckinsey.com.
equipment, and time required to make
them) will also be increasingly available.
The implication is that we are approach-
ing a day when manufacturers will have
unprecedented global visibility into who
makes what, where, and how well. Theyll
be able to run virtual operations war
rooms on their phones. Theyll have new
opportunities to solve plant-floor optimi-
zation problems as intelligent machines
interface with each other and with people
on the line. In the near future, manufac-
turers also will exploit opportunities for
crowdsourced design and on-demand
production. These opportunities will
extend well beyond goods made by 3-D
printers; manufacturers will pursue the
buying and selling of previously underuti-
lized production lines by the hour and
will rely on dynamic databases to deter-
mine what every part should cost. And
new forms of technology-enabled col-
laboration, such as the three-dimensional
virtual assembly and testing of vehicles,
will redefine what it means to be proxi-
mate to innovationwhich may be locally
generated or accessed via broadband.
Digital operations arent a far-off fantasy.
GE already has a 400-person industrial
Internet software team and its employees
use iPads to run an advanced battery
factory in New York State. Amazon is
employing growing numbers of smart
warehouse robots. Fiat has reduced the
number of physical prototypes needed
to introduce a new product; Alcoa has
compressed prototyping time and costs
for some products; and an auto supplier
recently slashed an eight-month prototyp-
ing process to one week.
Next-shoring
Although these forces are still gathering
strength, theyre already pointing toward
two defining priorities for manufactur-
ing strategy in the era of next-shoring:
proximity to demand and proximity to
innovation, particularly an innovative base
of suppliers. In developed and emerging
markets alike, both ingredients will be crit-
ical. Next-shoring isnt about the shift of
manufacturing from one place to another
but about adapting to, and preparing for,
the changing nature of manufacturing
everywhere.
Optimizing location decisions
Being close to demand is particularly
important at a time when consumption
in emerging markets is growing rapidly,
boosting with it the diversity of the re-
gional preferences that manufacturers
must contend with. In a 2012 inter-
view with McKinsey, Timken CEO
James Griffith explained his companys
approach: Over the last ten years, weve
added a very strong Eastern European,
Indian, and Chinese manufacturing base,
not because wages are low there, but
because those were the markets that
were growing. This expansion has been
accompanied by a strategic shift away
from a focus on automotive partswe
could make a car last for a million miles,
but nobody cares. The new emphasis
is on fast-growing mining, trucking, steel
making, and cement making customers
in emerging markets. For them, Timkens
reliability is a decisive asset.9
Locating manufacturing close to demand
makes it easier to identify and meet
local needs. Its a delicate balancing act,
though, to create an efficient global man-
ufacturing footprint that embraces a wide
range of local tastes, since economies
of scale still matter in many industries.
Volkswagen has coped by moving from
vehicle platforms to more modular archi-
tectures that provide greater flexibility for
manufacturing several product variants or
derivatives.
New products, market segments, and
consumer preferences are combining
with perennial risks (such as seasonal
variations in demand and fluctuations

in wages and currency rates) to boost
uncertainty in manufacturing and sup-
ply networks. That uncertainty places a
premium on operational agilitythe ability
to adapt design, production, and supply
chains rapidly to fluctuating conditions.10
This too may play into location decisions.
Take the experience of a consumer
products company that had relied on one
plant to supply its major market. When
the company began experiencing unac-
customed spikes in regional and seasonal
purchasing patterns, shortages and lost
sales ensued. To accommodate rising
variations in demand, the company built a
second plant with similar cost character-
istics in a different region. This additional
capacity helped ensure supplies to the
prime market, where the problems were
most acute, while also allowing the com-
pany to meet growing demand opportu-
nistically in several new markets close to
the new plant. Although the investment
was considerable, it lowered the compa-
nys risk exposure, eliminated damaging
stockouts, and improved the bottom line.
Building supplier ecosystems
New combinations of technical expertise
and local domain knowledge will become
the basis for powerful new product strate-
gies. Responsive, collaborative, and tech-
savvy supplier ecosystems will therefore
be increasingly important competitive
assets in a growing number of regional
markets. To keep up with the opportuni-
ties afforded by technological change, for
example, a major manufacturer that until
recently had relied on a low-cost supplier
in Mexico for parts has begun working
with a new supplier that has cutting-edge
3-D printing capabilities. The new rela-
tionship has lowered stocking costs (since
parts are made on demand), while provid-
ing avenues for developing prototypes
more quickly.
Examples like this are just a start. As infor-
mation flows among partners become
67
more robust, they will usher in a range of
improvements, from surer logistics to bet-
ter payment systems. These will create a
virtuous cycle of collaborative benefits.
The supply bases of many manufacturers
thus may soon need significant upgrades
and capital investments to create joint
competencies in areas such as robotics.
Collaboration and management invest-
ment in skill development programs could
be necessary as well. In some cases, it
may be valuable to collaborate with local
or national governments to create the
conditions in which the manufacturing
ecosystems of the future can flourish.
Tighter supply networks will also foster
production systems that reduce the need
for virgin natural resources.
A failure to develop innovative supply
ecosystems will have growing competi-
tive implications for countries as well as
companies. The competitive challenges
facing the US sometimes look more like
a system failure than an economic one.
US investment in advanced robotics, for
example, often lags behind that of other
developed economies, with trade deficits
prevailing even in sectors where wage
rate differentials arent a big influence on
location decisions.
Developing people and skills
All this will place a premium on manufac-
turing talent, creating a range of regional
challenges. In Europe and the US,
educational institutions arent producing
workers with the technical skills advanced
manufacturers need. In developing
economies, such as China, the millions
of lower-cost production associates who
are well adapted to routine manufactur-
ing may find it difficult to climb to the next
level. Line supervisorsoften fresh out of
regional universitiesstruggle to manage
baseline operations and to coordinate 10 For more on operational agility,
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,
coaching to bridge the gaps. They must McKinsey Quarterly, May
also cast a wider net, supporting local 2012, mckinsey.com.
68

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

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
leaner, and companies are continuously
seeking out new sources of value to sustain
its business. One of the most promising is
also among the least explored: the every-
day logistics of getting products from facto-
ries to customers.
Accurate, timely logistics performance
is so essential in todays business that
for many companies, it no longer serves
as a major strategic differentiator. That
achievement can lull companies into pay-
ing little attention to their warehousing and
transport capabilities until problems
such as delayed orders, incorrect ship-
ments, or damaged inventoryarise.
A closer look, however, would show that
complacency comes at a very high price:
most companies logistics costs are much
higher than they could be, in mature mar-
kets andeven more dramaticallyin
emerging markets. Moreover, some of
the most popular short-term fixes that
companies have pursued are pushing
costs higher still. Heavy investments into
IT, such as for sophisticated transport or
warehouse management systems, fail
to pay off because they end up layering
flashier equipment on top of long-standing
operational weaknesses. And automation
projects, prone to cost overruns, prove too
expensive to maintain and too inflexible to
respond to market changes.
Given those headaches, turning over logis-
tics to third-party service providers, as has
been the case in most industries, might
seem easier. But to manage providers
effectively, companies still need to retain
their expertise in logistics or join peers
that find themselves at the mercy of rising
provider fees. The common practice of
aggregating transport and warehousing,
for example, obscures costs in a way that
further weakens a companys ability to win
even minor savings from its contractors.
Indeed, our research over the past decade
into the logistics practices of dozens of
69
companies, confirms that these strate-
gies generally fail to meet the companies
goals. But the findings also confirm that
with the right application of well-tested
methodologies (many of them already in
use in manufacturing operations), trans-
port and warehousing are an untapped
gold mine that together offer savings
equivalent to 15 to 30 percent of a com-
panys total distribution costs (Exhibit 1).
It will, however, require a deeper commit-
ment of time and effort. As an example,
one European pharmacos experience
illustrates the potential. Through a com-
bination of better management of trans-
portation, network consolidation, and
lean warehouse operations, it reduced its
logistics costs by 33 percent. At the same
time, pick errorssending the wrong
productfell by 50 percent, while overall
delivery performance actually improved.
Slim prospects from existing
efforts
For many companies seeking addi-
tional logistics efficiencies, the promise
of reduced cost at greater precision has
made automation the improvement invest-
ment of choice. But too often the gains
then fade quickly, if they arrive at all.
A regional distributor followed the standard
pattern when it pinned its cost reduction
hopes on an expensive automated stor-
age and retrieval system (ASRS) to handle
detailed picking at its warehouses. The
belief was that the systems high up-front
price would be balanced by the reduc-
ing operating expenses the system was
expected to deliver. Once installed, how-
ever, the ASRS yielded no operating cost
savingsin fact, it was more expensive
to run than an optimized manual system,
especially once less visible costs such
as those for maintenance or specialized
labor were factored in. Yet reverting to the
old system proved to be impractical: the
company would not recover any of its sunk
70
Logistics optimization can yield savings of ~15-30% of distribution costs
Indexed costs, total supply chain costs
Percent
Initial distribution costs
Transport optimization
(inbound, outbound)
Warehouse optimization
Outsourcing select
2-4
warehouse services
Improved network
15 - 30
Exhibit 1
costs, and ripping out the ASRS would
itself be so expensive as to swallow any
benefit that the company might earn.
Understandably, a lot of companies
seek to wash their hands of the issue by
outsourcing as much of their transport
and warehousing responsibilities as they
can. Some aspects in some industries
virtually require outsourcing. The pharma
industry provides an example. With lim-
ited transport infrastructure of their own
and warehouses that may be too small
to run very efficiently, pharmacos can
sometimes reduce costs and raise quality
almost instantly by turning to third-party
logistics specialists. But unless compa-
nies are exceptionally careful in select-
ing and managing their logistics service
providers (LSPs), the cost benefits can
fade. A recent analysis of European ware-
house performance, for example, found
that across industries, LSP-managed
warehouses showed the greatest cost
variation and the highest average savings
potentialmeaning that as a sector, their
average cost performance was the low-
est (Exhibit 2).
Levers for improvement
100
Consolidation of loads
3-7
Route optimization
Procurement approach/supplier selection
Lean warehousing
Economies of scale/leveling of workload
10-20
Layout improvements
Process standardization
Economies of scale
Labor/salaries cost advantages
Reduced depreciation
Given that LSPs are building a margin into
their cost structures, this result is perhaps
not surprising. But it shows that in relying on
outsourcing, companies are often trading
one set of problems for another. And it sug-
gests a real opportunity for companies to
achieve much more than the 2 to 3 percent
in savings that many have regarded as a sat-
isfactory result of their cost reduction efforts.
A gold mine of opportunity
In fact, a broader, more integrated pers-
pective will show that reductions of 20, 30,
and even 40 percent are not only possible
but achievable, so as long as the company
raises its ambitions and sharpens its skills.
The question any company must ask is
not How much savings could our vendors
give us?, but How would we build our
network today if we were starting again
from the ground up?
The answer will let the company make
better-informed trade-offs and create
value by improving vendor management,
revamping the logistics networks

Typical warehouse improvement potential
Percent of total warehouse costs
Potential savings
Percent
60
55
50
45
40
35 32
30 27
25
20
15 10
10
5 6
5
0
Industry sector A&A GEM Health- High tech
care
Average savings 13 16
potential
structure, and reexamining internal
practices, especially via lean manage-
ment of the companys warehouses.
Building from a clean sheet
As a first step, any company must learn
not only what its logistics costs are but
what drivers account for those costs. It
therefore must identify all of the compo-
nents of logistics to see which of them
are costing the company more than they
should. The goal is a ground-up cost per-
spective that starts from a clean sheet,
which will consist of the lowest possible
cost of each component, rather than the
actual cost the company is now paying.
The component-by-component price dif-
ferences reveal where the company must
focus its cost-cutting efforts.
The level of detail involved presents an
initial hurdle, as the analysis must not
only cover the materials, equipment, and
people required, at the volumes that the
logistics system must actually handle, but
also provide estimates on an activity-by-
activity basis. For warehousing, how much
71
Minimum
Maximum
56
36
33 32
27
25
10 11
8 7
6
PAC Pharma Retail LSP
13 14 18 17 16 28
Exhibit 2
labor is required for picking? How much
for packaging? For transport, how much
does the typical round-trip cost? How
many shipments can be consolidated?
Overhead costs must be included on a
function-by-function basis: an allocated
percentage of dispatching, HR, compli-
ance, etc., as well as of senior-manage-
ment time.
Certain costs, especially in transport,
may require adjustment for the synergies
that third-party providers earn by serving
several pharmacos at once. In warehous-
ing, the impact is usually fairly small if
even noticeable: better space utilization
and greater economies of scale for cer-
tain types of overhead. In transport, by
contrast, the benefits can be much larger.
Putting two companies goods on the
same truck to the same destination could
cut the providers costs in half, seriously
throwing off estimates.
Yet as daunting as the data demands may
appear at first, even a company that relies
heavily on third-party providers can
create a reasonably accurate picture of
72
what logistics should costand by using
mainly internal resources. Companies
procurement and logistics specialists typi-
cally have enough local market knowledge
to estimate many of the most important
external inputs, such as prevailing wage
rates for drivers or warehouse workers,
average rents, and utility costs. For many
other factors, such as volume figures or the
cost of individual functions, a company can
use its own history in the relevant markets
or visit existing logistics sites to assess con-
ditions on the ground. The one exception
will be for transport: with external market
research, a company can generate a rough
model of the volumes the provider is mov-
ing between the same places for different
companiesand therefore get a picture of
its cost structure.
For each of these logistics components,
the data that the inquiry generates will pro-
vide a range of values. The sum of the low-
Renewing the network
Even more savings can result from combin-
ing the clean-sheet data with strategic con-
siderations as part of a reevaluation of the
entire logistics network. A European phar-
maco started with a network comprising
a minimum of one warehouse for virtually
every EU member country, with additional
locations in some countries for specialized
requirements, such as cold chain capabili-
ties. The ensuing complexity and redun-
dancy made for an unsustainable cost
base, particularly given the larger economic
and regulatory burdens that pharmacos
operating in Europe now face.
Managers therefore took a hard look at
the logistical implications of the strategic
moves that the company might make, given
growth projects for the various EU markets,
competitive dynamics, and public policy
matters such as possible changes to payer
relationships or manufacturing incentives.
est values is the hypothetical ideal: the low-
est-cost warehouse, for example, and the
lowest-cost transport options. The more
data a company can gather, especially from
outside benchmarks, the more robust that
ideal will become.
Finding the gap
The next step is to compare the actual
cost of each separate component against
the lowest cost that the analysis could
find. The details in the data will point the
company towards the root causes of
major differences. For example, if receiv-
ing activities show the largest variation
among labor costs, the reason may be
excess idle time from feast or famine
delivery schedules. High variation in
picking costs often result from poorly
designed layouts that force staff to run
from one end of the warehouse to another
to complete orders.
The answers provided an initial filter on the
locations where the logistics network would
need more or less coverage.
The next considerations to incorporate
were largely operational, including the
location of current vendors and the service-
level requirements of major customers
frequency and speed of shipment, priority
for allocation of difficult-to-source products,
etc. Finally, accounting and finance con-
siderations played a role in deciding where
inventory should best be located in light of
tax or regulatory requirements.
The ultimate conclusion was a recommen-
dation to close about half of the warehouses
in the current network for a savings of about
20 percent. But the process of consolida-
tion would take at least three years in light
of the companys existing contracts and a
need to minimize disruption to its business.

With this deeper insight into the true costs
that third-party providers are experiencing,
companies can use a combination of sticks
and carrots to make significant improve-
ments in managing their contracts. If rising
wages on Chinas coast are the chief factor
pushing local warehousing fees skyward,
a company can seek either to limit the
vendors fee increases to actual labor infla-
tion rates, or, if cooperation seems more
promising, to shift the whole operation to a
different vendor warehouse located further
inland. In a similar manner, a company may
find that its own practices are the cause of
other inefficienciesincomplete address
information for shipment, or last-minute
bookings for long-haul transportand it
can eliminate those inefficiencies for further
savings. Finally, in exchange for lower fees,
companies may be able to identify best
practices that providers could follow, such
as better management of back-haul loads
so that trucks travel full in both directions.
Quicker riches from lean
warehousing
That delay is fairly typical, if well worth the
In wide range of warehouse savings potential, average savings is 39%
Percent of
warehouses (n = 151)
34
35
30
25
20
15
10 8
5
0
75+ 50-75 25-50
SOURCE: McKinsey Clean Sheet Pharma Database
73
wait. But both for this company and for
most other companies, faster results are
also possible by revamping how current
warehouses operate.
For example, we have analyzed well over
100 pharmaceutical warehouses across
Europe and this showed a broad range
of performance, with an average gap of
39 percent between actual and potential
warehouse costs (Exhibit 3). Even the top-
quartile warehouses showed costs that
were an average of 15 percent higher than
what they could be.
However, deeper analysis of the data
revealed that there is no simple formula
for reducing warehouse costs that a
company could apply across the board.
Instead, identifying the areas that a
particular warehouse must address will
rest on the clean-sheet analysis of that
warehouses individual performance. But
even though the specific issues will vary,
the approach that companies can use
in addressing those issues will share the
same principles, which are rooted in the
lean management principles that have
renewed corporate performance across
Outliers (75+% and no sav-
ings) occur mainly because
at certain sites, model cannot
Average clean-sheet reflect full set of operations
savings is 39%
29
20
7
0-25 No savings
Savings potential
Percent
Exhibit 3
74

Clean-sheet cost assessment reveals performance gap SANITIZED

CLIENT EXAMPLE
EUR thousands

Gap analysis Actions to close gap

Layout
Clean-sheet cost1 1,519 431
optimization

Process
Preliminary gap 2,811 558
design

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

Organiza-
Rental rate 122 180
tional setup

Performance gap 2,039 External 180

-47%
Remaining
Current cost 4,330 2,039
gap closed

Exhibit 4
settings ranging from auto factories to
wholesale banking.
Clean to lean
For an individual warehouse, the clean-
sheet comparison will generate a large
preliminary gap that is simply the total
costs of the current facility against the
ideal, as shown at the left side of Exhibit 4.
But that ideal is necessarily artificial and
must be adjusted for external conditions
that the warehouse cannot control, such
as compliance with specific customer
labeling and documentation requirements,
or local wages and land prices that are
higher than average. The final tally is the
warehouses total cost-performance gap,
which is somewhat smallerhere, 47 per-
cent instead of 65 percent.
The next step is to translate the clean-
sheet findings into tangible actions that
close the gap. This is the stage where
companies are often tempted by technical
solutions, such as the automated picking
system described earlier. But the experi-
ences of dozens of companies, operat-
ing hundreds of warehouses around
the world, have reinforced our view that
these tactics alone are not enough. For
improvement to last, it must fundamen-
tally change the way people work across
the entire operationsomething that no
picking system can do on its own.
Conversely, the companies that have truly
transformed their warehouses not only
sustain the changes they have made but
continue improving well into the future.
What these companies have in common
is that they redesigned their warehouse
operations using lean management con-
cepts, which incorporate deep insights
about the human side of change into
a rigorous system for identifying and
addressing waste.
The basic ideas behind lean are decep-
tively simple and are listed at the right
side of Exhibit 4. A lean organization
redesigns its layout and processes to
provide exactly what its customers really
wantno more, no lessat the right
quality and with only the resources (labor,
time, capital) that are truly necessary. It
makes performance transparent, with
visual management techniques to aid in

the uncovering (and resolution) of prob-
lems and the deployment of resources.
Its organizational setup evolves with new
leadership norms that emphasize coach-
ing and capability building at every level,
along with strategy and goals that provide
a meaningful purpose for everyday work.
The trick, of course, is to strengthen all
of these elements at once. Finding the
right actions to take at a warehouse will
therefore require a pharmaco to under-
stand more than the warehouses visible
mechanics and processes. A company
must have a clear picture of the manage-
ment practices and organizational culture
as well.
Striking gold: A case example
One clients warehouse illustrates this
diagnostic in action. The warehouse was
one of the companys better performers,
but its operating costs were too high.
Management sensed that it could reduce
the warehouses costs substantially while
improving service still further.
A walk-through revealed quite a few very
basic process problems, such as inef-
ficient workstation layouts for hospital
products, time-consuming manual label-
ing of packages, and redundant data
checks. But even more important were
several things that the walk-through
should have found, but did not. Day-
to-day performance management was
essentially nonexistent; workers and
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
capability building was occasional and
informal, giving workers few opportuni-
ties to build new skills.
Over the next year, the warehouse
underwent a complete transformation.
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.
75
The visible changes were simple: the
company revamped its factories label-
ing practices so that everything arrived
at the warehouse correctly labeled
drastically reducing time to receive
product. Within the racks, products
were slotted according to their velocity
(that is, where they were fast- or slow-
moving). And new operating practices at
the start and end of each shift (such as
standard locations for the picking carts
and reduced time for receiving the next
picking batch) raised picker productivity
by 20 percent.
Some of the crucial changes were much
less visible. The company clarified the
warehouses performance metrics, then
used them to create a new system
of brief daily huddles to review results
and identify problems. Managers
started spending much more time on
the work floor, coaching employees,
observing real work flows, and reallo-
cating people to balance the workload.
Unit leaders who previously had little
contact with one another now had
regular meetings to resolve problems
that cut across boundaries.
The combination of structural, manage-
ment, and mindset changes together
doubled the warehouses volume, and
the number of employees actually fell
(mainly because of attrition). Packaging
usage reduced substantially. On-time, in-
full performance rose to 99 percent, and
picking errors fell to almost zero.
True excellence in logistics cost perfor-
mance is still an opportunity for many
companies. However, as with all gold
rushes, the highest profits will go to the
earliest movers. Those that seize the
opportunity quickly can attain a difficult-
to-imitate competitive advantage.
76
Five lessons for
supply chains from the
financial crisis
Knut Alicke and Kai Hoberg
For many supply chain executives, the
financial crisis has been one of the tough-
est challenges in their careers. Firms
across industries were required to deal
with huge demand-supply mismatches
caused by collapsing demand. However,
the supply chain community found inno-
vative ways to deal with the challenges
of these tough times. Here are five action
areas supply chain managers should be
aware ofbefore the next crisis.
Firms have always been challenged to
adapt their supply chains to their success
in the market. During boom periods,
firms are eager to avoid costly backlogs,
to align manufacturing capacities with
growing demand, and to ensure raw
materials from new suppliers. Meanwhile,
supply chains are accelerated, costly air
freight is accepted, and large batches
are produced because goods will be sold
at some stage. In contrast, during diffi
cult times, firms must address shrinking
customer orders, face increasing com-
petition, and see decreasing margins.
Accordingly, priorities for supply chains
differ significantly. Firms must focus on
cutting costs, reducing capacities,
Change in annual orders in selected US manufacturing sectors,
2008-09
Percent
Consumer and electronic products
Electrical equipment, appliances,
and components
Furniture and related products
Fabricated metal products
Durable goods industries
Machinery
Primary metals
Transportation equipment
SOURCE: US Census Bureau
Exhibit 1
consolidating suppliers, and freeing up
cash by taking out inventory.
Difficult times frequently relate to an
individual firms situation: these could
include poor top management decisions,
cost pressures from a new competitor,
or demand being hit by poor customer
service. However, difficult times are also
frequently caused by changing economic
climates.
During the financial crisis that started five
years ago, an unforeseen contraction
in demand across numerous industries
challenged supply chains globally beyond
anything observed in the past. As the
economy continued to drift downward,
a significant turning point occurred on
September 15, 2008, when Lehman
Brothers, the fourth largest US investment
bank at that time, declared bankruptcy.
The collapse of Lehman Brothers sent a
shock wave through the financial world
and triggered an unprecedented decline in
the global economy.
In particular, the manufacturing sector suf-
fered severe consequences as a result of
-18.6
-21.8
-24.9
-25.4
-30.3
-31.9
-40.3
-42.3

the recession: industries such as machin-
ery, metals, and transportation equip-
ment observed drops in customer orders
by up to 42 percent within a single year
(Exhibit1). Many companies struggled
to survive and entire supply chains were
threatened with collapse. Those firms that
survived the financial crisis reacted swiftly
and decisively. Often, they leveraged
innovative approaches to safeguard their
internal and external supply chains amid
the challenging business climate.
Today, many firms continue to deal with
individual challenges. Similarly, the eco-
nomic situation in many parts of the world
has become unstable. For those reasons,
innovative approaches for managing sup-
ply chains in a downturn could become as
important now as they were just five years
ago. Based on a series of interviews with
executives from numerous firms affected
in the financial crisis, we identified five
action areas supply chain executives
should be familiar with (Exhibit 2).
Supply chain actions in
difficult times
Management actions in difficult times are
well known and are typically in line with
classic turnaround approaches. These
actions include engaging in significant cost
reduction (including overhead costs), intro-
ducing zero-based budgets, establishing
war rooms, and redefining footprints and
networks. However, it is also crucial to
understand the trade-offs between myopic
and sustainable actions. In addition, it is
key to plan for the inevitable and prepare
the supply chain to deal with tough times.
For example, when a medium-sized
third-tier automotive supplier in Southern
Germany was confronted with significant
demand reductions, the company reacted
quickly. The supplier closed one produc-
tion site, shifted production volumes
to low-cost countries, and furloughed
employees to adjust to the decrease
77
in volume. Unfortunately, the specific
knowledge that was required to establish
new production lines was not transferred.
Moreover, the company went through
a lean manufacturing program, setting
inventory holding cost at a high level of 40
percent, which was excessive for its low- to
medium-value-dense products. Although
all of the crisis measures were appropriate,
applying the measures in parallel placed
the company under severe pressure, caus-
ing the firm to deplete its cash stores near
to the point of bankruptcy.
In a supply chain context, the five action
areas that are illustrated in Exhibit 2 are
essential to cope with any type of crisis
situationindividual as well as economic.
First, supply chain managers should
gain a clear understanding of potential
demand scenarios, as demand should
be the basis of all supply chain planning.
Second, firms should safeguard their
supplies to avoid any critical bottlenecks
as suppliers go out of business. Third,
firms must accelerate all efforts to cre-
ate flexible and breathing supply chains
that can cope with all types of variability.
Fourth, managers should carefully reduce
inventories to free up cash that is essen-
tial for turnaround actions. Finally, firms
should also consider the light at the end
of the tunnel and should begin to position
themselves for the inevitable upswing.
Based on our experience, all five action
areas must be considered in parallel,
which will cause exceptional challenges
for supply chain managers while also
dealing with all types of operational
glitches. Accordingly, we believe that
firms should begin to prepare as early as
possible for difficult times ahead. In the
end, they will not only benefit in the crisis
but actions are also beneficial to the busi-
ness from a long-term perspective.
1. Understanding true demand
One key lesson from the financial crisis
was that numerous firms underestimated
78
Action areas for supply chain management during periods of
economic crisis
Action area
Understanding true
demand
Monitoring and safe-
guarding supply
Creating flexible, breathing
supply chains
Aligning inventories to free
up cash
Preparing for the upswing
Exhibit 2
the severity of the declines in demand,
which reached 90 percent in some firms.
Because forecasting demand is the start-
ing point of all planning (i.e., capacity
planning, supply planning, and produc-
tion planning), it is crucial to understand
true demand. Indeed, any significant
over- or underreaction could trigger a
disaster. Accordingly, successful com-
panies have pursued three key actions to
improve their understanding of demand:
(i) identifying reliable demand information,
(ii) communicating with customers, and
(iii) developing demand scenarios.
Identify reliable demand information.
For most firms, the visibility of true cus-
tomer demand was close to zero at the
beginning of the crisis. Many found it
challenging to identify reliable demand
information. In addition to high levels
of economic uncertainty, opportunis-
tic competitor actions to fill capacities
induced additional uncertainty. Even
long-standing orders were subjectto
cancellation as a result of collapsing
customer demand. For example, a
Scandinavian heavy equipment manu-
facturer lost nearly all previously booked
Key actions
Identify reliable demand information
Communicate frequently with customers
Prepare multiple demand scenarios
Identify supplier criticality
Monitor supplier health and lead times
Ensure the survival of critical suppliers
Understand the effects of demand fluctuations
Convert fixed costs into variable costs
Define smart contracts
Avoid surplus inventory intake
Align inventory policies
Streamline service offerings
Retain and develop talent
Prepare long-term projects
Provide upside capacity
orders from Russia because of limited
credit availability of these customers. For
this reason, successful firms established
a process to monitor the probability of
order cancellations that is similar to the
processes for monitoring the probability
for winning orders. Frequently, compa-
nies began to realize that leveraging infor-
mation from the over-opportunistic sales
force did not provide any transparency,
as sales personnel were still handcuffed
to their budget thinking. When chal-
lenged to explain their sales forecasts,
personnel often expressed concerns that
capacity could be reduced too sharply
and that longer lead times would alien-
ate customers. Successful firms rapidly
moved away from initial budgets and tar-
gets by implementing a new zero-based
budgeting process.
Communicate frequently with cus-
tomers. Numerous companies also
established more frequent communica-
tion with customers and placed more
emphasis on short-term forecasts.
When the symptoms of recession began
to emerge, one automotive supplier
reduced the firms forecast horizon and

sales personnel increased chatter with
customers. However, communication
through established channels between
sales and procurement departments
often did not provide sufficient visibility,
as the information flow was slow within
the customer organization. Procurement
departments themselves frequently
had no visibility regarding procurement
volumes in the upcoming weeks and
months. Accordingly, increased direct
communication began to occur among
planning departments while contract
details were coordinated between sales
and procurement departments. Some
companies also began to further inte-
grate planning systems and established
EDI to obtain real-time updates on
planned volumes.
Another example of effective communi-
cation is a vertically integrated chemical
company based in Germany that pro-
duces goods for all stages of the chemical
value chain. By sharing demand informa-
tion on all types of fine and base chemi-
cals internally, managers established a
reasonable picture of the market demand
for different products several months in
advance.
Prepare multiple demand scenarios.
Because of limited visibility, a single fore-
cast for a product line was often difficult
to obtain. Therefore, successful compa-
nies began to prepare multiple demand
scenarios and to plan their actions within
these scenarios. Such scenarios included
consideration of the following questions:
Is the worst case that demand
decreases by more than 80 percent?
What is the outcome if all of our cus-
tomers in France close their plants for
three months?
What are the aggregated inventories
of all European customers, and would
these customers need to divest all of
their stocks?
79
How long can we employ our workers
given the current order book and the
lack of new demand?
Top companies have endeavored to
answer these types of questions and
have typically aggregated them into a few
scenarios. Several companies have even
developed more advanced economic
models to analyze the effects of early
indicators on the world economy and
to develop scenarios and action steps
accordingly.
2. Monitoring and safeguarding
supply
The suddenness and severity of the
recession forced many firms to the brink
of bankruptcy. While sales and demand
reached all-time lows, sourcing depart-
ments faced an entirely new challenge
the risk of losing suppliers and entire sup-
ply chains due to bankruptcy.
Accordingly, successful firms exerted sig-
nificant efforts to safeguard their supply.
Typically, they implemented an advanced
supplier risk management system that
included three actions: (i) identifying sup-
plier criticality; (ii) monitoring supplier
health and lead times; and (iii) ensuring
the survival of critical suppliers.
Identify supplier criticality. Although
most firms have established a regular risk
assessment and management process,
these processes typically focus on physi-
cal supply chain disruptions such as nat-
ural disasters or strikes. The risk of losing
suppliers next door is often neglected.
Therefore, supplier criticality needed to
be reevaluated based on the risk of sup-
plier insolvency. Which critical parts and
how much volume do we obtain from a
supplier? Which alternative suppliers are
certified? What volumes can these alter-
native suppliers provide?
Who owns the tools and forms? Often,
second-tier suppliers and subcontractors
80
also contributed to the problem, particu-
larly in the automotive industry. For this
reason, firms that had prepared supply
chain mapping scenarios could now
more easily identify the potential effects
of supplier defaults.
Monitor supplier health and lead times.
Once supplier criticality was identified,
firms were required to monitor sup-
plier health and lead times. To monitor
supplier health, successful firms lever-
aged all types of internal and external
sources, such as buyers information on
the speed at which suppliers were com-
mitting to orders or requesting earlier
payments, information from plant visits
regarding utilization, and newspaper/
industry discussions on sell-and-lease-
back deals or the loss of key people to
understand the real situation of the
supplier. Additionally, many firms carefully
reviewed the quarterly financial state-
ments of their suppliers. In any scenario,
the monitoring of suppliers must be
carefully coordinated, including the iden-
tification of lead persons who collect all
information.
In addition to supplier health, success-
ful firms also carefully reviewed supplier
lead times. Low order intake often had an
inverse effect on lead times because sup-
pliers reduced their capacities to stretch
their order books over longer periods.
Therefore, firms needed to proactively
align with suppliers with respect to new
delivery schedules.
Ensure the survival of critical suppliers.
Communicating frequently with suppli-
ers and being a good customer is often
beneficial for firms during more com-
fortable financial times. Paying invoices
on time rather than stretching payment
terms can ensure a preferred customer
rating that allows additional favors in the
future. Nevertheless, several companies
have been forced to ensure the survival
of critical suppliers. In instances where
no alternative suppliers for critical goods
were (yet) available, firms supported
suppliers by pooling spending or taking
inventory ownership from suppliers to
ease their financial burdens. Particularly
in small oligopoly supply markets, firms
have tended to prefer supporting a strug-
gling supplier rather than coping with an
even more concentrated supply base
in the future. In extreme cases, firms
also attempted to actively reshape their
supply base according to their strategic
objectives. For example, one automotive
OEM defined its preferred supplier land-
scape for a certain category and actively
reallocated sourcing spending to the
preferred suppliers, thereby destabilizing
out-of-favor suppliers and rendering them
easy acquisition targets.
3. Creating flexible, breathing
supply chains
When demand plunged in the financial
crisis, numerous firms grappled with
overcapacity and struggled to right size
their operations in the short term. These
challenges were often inevitable because
network design and footprint decisions
had been carefully planned and imple-
mented over the course of several years
for a very specific demand scenario.
For the future, we suggest managers
proactively address demand uncertainty
and create supply chains that are flex-
ible to a wider range of demand. We use
the term breathing supply chains for
setups that can efficiently provide output
at different quantities. Breathing supply
chains are also a means to deal with fluc-
tuations in more regular operations. We
find that successful companies pursued
three key actions to implement them: (i)
understanding the effects of demand
fluctuations; (ii) converting fixed costs
into variable costs; and (iii) defining smart
contracts.
Understand the effects of demand fluc-
tuations. One key task in defining supply
chains is to match capacity with demand.
Accordingly, it is crucial to obtain a fair

understanding of the effects of demand
fluctuations. Firms must identify which
actions should be selected based on the
prepared demand scenarios and must
embed the breathing supply chain think-
ing into their supply chain strategies by
asking questions such as: How do we
provide the most flexibility regarding any
changes in demand? For each demand
scenario, a firm must identify preferable
actions that holistically consider the
effects of selling, closing, or idling manu-
facturing assets as well as any potential
insourcing or outsourcing effects. On a
more operational basis, situations are fre-
quently complicated by increased MRP
complexity in low-demand situations as
a result of coupled production, minimum
batch sizes, and order quantities.
Convert fixed costs into variable
costs. Ultimately, it is crucial to convert
fixed costs into variable costs to com-
pensate for lower production levels by
diminishing marginal costs. Firms have
often closed or idled assets with lower
productivity while carefully considering
the incremental costs of moving produc-
tion to other plants. One alternative for
reducing fixed costs involves increasing
the utilization of fixed assets and labor
by insourcing. Whereas outsourcing has
become a common practice for address-
ing bottlenecks and reducing costs in
normal economic conditions, many firms
have focused on insourcing during the
financial crisis. For example, for firms in
the machinery sector, insourcing stan-
dard manufacturing processes, such as
milling, welding, or assembly operations,
appears to be rather simple. Through
insourcing, firms were able to increase
worker and asset utilization even when
internal productivity was lower. However,
firms must minimize insourcing costs by
cross-training workers, maintaining the
required tools, and developing smart
contracts that avoid penalties.
Define smart contracts. The definition
of smart contracts with suppliers plays a
81
crucial role in creating breathing supply
chains. Many firms closed long-term con-
tracts with suppliers to benefit from dis-
counts. However, once locked in, volume
or price reductions often depend entirely
on the good will of suppliers. Successful
companies have considered fluctuations
in demand when defining their contracts.
For example, one Dutch chemical com-
pany had an annual contract with a
provider of tank capacity beginning on
January 1. The firm received a volume
discount based on the tank capacity
signed for the year. However, company
officials realized that the firm would need
to pay for unused tanks or would fail to
receive volume discounts if capacity
requirements deviated from the plan in
mid-year. Therefore, the firm opted for
a smart contract design. Rather than
renting all tank capacity on January 1,
the firm now begins its annual rents on
a rolling basis throughout the year (e.g.,
certain capacity on January 1, certain
capacity on February 1). Rather than
receiving a volume discount on the
capacity signed at the same time, the
discount is now based on the capacity
rented at a given time. The firm can easily
discontinue the rent for the tank with the
next expiring contract to adjust capacity
while continuing to receive high-volume
discounts for the remaining tanks rented.
The example highlights the importance of
considering your options before any crisis
arises to ensure flexibility in tough times.
4. Aligning inventories to free up cash
Reducing inventories while meeting
service level requirements has always
been a key challenge for supply chain
managers. However, the limited avail-
ability of credit during the financial crisis
triggered a skyrocketing interest in opti-
mizing inventories, as firms were required
to free up significant amounts of cash on
short notice. The situation became even
more challenging as a result of unfavor-
able inventory dynamics. A significant
82
Quarterly inventory in days of supply between 2007 and 2010 for
different industries
Metals
(Basis = 89.3 days)
1.3
1.2
1.1
1.0
0.9
0.8
Electronics and equipment
(Basis = 109.8 days)
1.3
1.2
1.1
1.0
0.9
0.8
2007 08 09
Note: Index with basis Q2/2008
SOURCE: KLU analysis; S&P Compustat
Exhibit 3
reduction in sales slowed the outflow of
goods to customers; customers were
consuming their usual inventories at a
lower rate and additionally reduced their
safety stock levels to a lower level, thus
triggering a multiplier effect. Accordingly,
supplier production plummeted, and
firms could only gradually consume their
raw material stocks. As a result, many
firms observed the characteristic inven-
tory hump (Exhibit 3). Inventories hit
the roof across industries in 2009 and
increased by up to 70 percent within six
months until the trajectory reversed.
Our interviews with successful inventory
managers highlight three practices that
enabled managers to avoid or at least
to balance the inventory hump: (i) avoid-
ing surplus inventory intake; (ii) aligning
inventory policies; and (iii) managing ser-
vice offerings.
Avoid surplus inventory intake. Although
inventory managers have few options to
increase the sales that trigger the outflow
of goods, it is essential to halt the inflow
of surplus goods that will require a long
Machinery
(Basis = 116.5 days)
Transportation equipment
(Basis = 82.4 days)
2010 2007 08 09 2010
time to turn. We found that successful
firms reacted firmly to the decrease in
demand and implemented a moratorium
on material orders to avoid any intake of
surplus goods. Similar to a travel ban,
firms reviewed all material orders against
their demand scenarios and scrutinized
their supplier contracts for cancellation
opportunities. Even if contracts did not
allow for order cancellations, firms often
successfully negotiated with suppliers to
extend volume commitments over longer
periods of time. Several companies also
managed to sell raw materials to other
manufacturers that in turn benefited from
favorable prices.
Align inventory policies. The significant
change in demand required numerous
firms to review and align their inventory
policies. Frequently, order quantities were
reviewed and reduced. For example, one
leading European automotive supplier
changed the typical order size for a cer-
tain category from full truckload to half
truckload in an effort to minimize cycle
inventory. Likewise, firms reduced their
batch quantities in accordance with the

new demand reality, which required more
frequent changeovers. However, surplus
personnel were available at virtually no
incremental cost. Further, an increasing
number of firms implemented analytical
safety stock targets to avoid or reduce
safety stocks and aligned their processes
based on the management of slow mov-
ing items.
Streamline service offerings. Finally,
successful firms streamlined their service
offerings to customers based on their
value add. One well-known trade-off in
inventory management relates to the
service level that is offered to custom-
ers: higher service level targets require
greater safety stock inventory. During
the crisis, successful firms reduced
their service levels to move from a full-
service to a cost-efficient setup. In one
case, a supplier to the furniture industry
reduced service levels from 98 percent
to 90 percent unless products were in
heavy competition, provided significant
value add, or customers were willing to
pay a premium for higher service level.
Furthermore, firms aligned their make
to stock/make to order (MTS/MTO) mix
to eliminate inventories, particularly for
SKUs that were sold to a single customer
only. However, this approach required
careful communication with customers,
as they were required to plan and order
these now-MTO items further in advance.
After the crisis, many companies relaxed
their strict standards on the service offer-
ing while successful firms introduced new
processes to carefully evaluate which
items to really serve from stock.
5. Preparing for the upswing
As the financial crisis began to ease in
2009, numerous managers were caught
by surprise by the sudden economic
upturn. For example, the demand plan of
one transportation equipment company
suggested a slow return to precrisis
demand levels over the course of six
years. Nevertheless, in less than two
83
years, demand bumped back to the pre-
vious dizzying heights. Likewise, many
firms were still in the right sizing mode and
realized the challenges of moving from full
reverse to full steam ahead as production
capacities had been reduced and talent
had been released. However, farsighted
firms were prepared for the upturn and
managed to gain significant market share
by meeting customer demand while
competitors struggled. We have identified
three practices that enabled firms to suc-
cessfully meet the increased demand at
the end of the crisis: (i) retaining and devel-
oping talent; (ii) preparing long-term proj-
ects; and (iii) providing upside capacity.
Retain and develop talent. Although
the length of the crisis was unclear to
most managers, many successful firms
realized the utmost importance of retain-
ing and developing talent throughout the
recession. Because manufacturing pro-
cesses in many countries have become
more complex in recent decades, the
importance of expertise has similarly
skyrocketed. Although firms had to lay off
workers while adjusting their capacity,
talent retention was crucial for the eventual
upturn. Many firms reduced employee
work hours to ensure that the given order
book provided sufficient cover to retain
key personnel. Another successful exam-
ple is Germanys chemical and automotive
industry, in which many firms leveraged
government-supported part-time work to
avoid layoffs (1.47 million employees were
operating under part-time government
support in May 2009 compared to 0.05
million in May 2008). The ability to retain
talent enabled the firms to rebound as the
economy began to recover.
Prepare long-term initiatives. Many
firms realized that the downturn could
also be viewed as an opportunity to pre-
pare long-term initiatives as long as no
significant investments were involved. In
the boom years before the financial crisis,
many firms did not have the resources
necessary to carefully review their supply
84
chains, as skilled experts were struggling
to maintain pace with business expan-
sion. However, the sudden downturn halt-
ed further expansions and provided firms
with breathing space to focus on long-
term initiatives. For example, one CPG
manufacturer reevaluated its manufac-
turing footprint using the newly available
project management capacities that were
implemented as investments became
available at the end of the downturn.
Provide upside capacity. When plan-
ning for business in the financial crisis,
many firms did not consider the need to
provide upside capacity. Although sup-
pliers were frequently required to retain
some capacity on standby to prepare for
sudden demand increases, many firms
did not sufficiently prepare for this scenar-
io and were surprised by labor and asset
shortages. One example of upside capac-
ity is provided by a chemical company
that needed to employ temporary workers
during the upturn. By paying a temporary
employment agency a small standby fee
for the preferred provision of personnel,
the firm was able to select the temporary
workers first when the economy began
to recover. Accordingly, the firm was able
to take on the temporary workers who
had previously been working in the firm,
thus minimizing the ramp-up time. Other
examples include firms that were able
to secure capacity early at key suppli-
ers because they sensed the upcoming
increase in demand rather quickly.
Being agile
Many firms suffered seriously or closed
their business during the financial crisis:
they did not reduce capacity as rapidly
as demand plummeted, they lost critical
suppliers and thus could not fill customer
demand, they nearly went bankrupt
because of high inventory levels and
a lack of cash, and they did not have
the talent or the capacity to fill soaring
demand and therefore lost market share.
Were these outcomes purely the result of
misfortune? In some cases, misfortune
was perhaps to blame; however, we
believe that the financial crisis harshly
revealed the weak points in many firms
supply chains. Based on our experience,
we highlighted five key areas that many
firms did not sufficiently address. These
five key areas are not necessarily crisis
related. In fact, successful companies do
not require significant changes because
these firms already address these topics.
However, firms that do not consistently
consider these key areas are much more
vulnerable in downturns. What does this
finding mean for the next crisiseco-
nomic or on an individual firm level?
First, firms must always be carefully scan-
ning for major changes in its specific mar-
ket conditions or in the overall economic
climate. Managers must ensure demand
transparency, establish early warning
mechanisms using internal and external
data, and reconcile with other functions
as well as suppliers and customers. To
accomplish these goals, managers must
establish the relevant processes.
In addition, firms must constantly chal-
lenge and test their abilities to adapt to
major changes in demand and supply.
One valuable tool is an agility assessment
of the supply chain to determine whether
a firm is truly prepared for an inevitable
downturn. Numerous firms have already
embedded semiannual or annual agil-
ity assessments into their routine risk
management processes. In this context,
alternative demand scenarios are out-
lined and supply chain adaptations and
contingency plans may be developed.
Overall, we believe that firms should
continuously improve their agility, which
is a means of ensuring success in any
economic situation. Fewer stockpiles
are accumulated when state-of-the-
art inventory management policies are
implemented, capacity can be adjusted
quickly when contracts with suppliers
 85

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 (www.scmr.com)
and is reprinted here with permission.
86

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
wealth make Latin America increasingly
appealing as an emerging marketbut
only for companies that can overcome
the regions supply chain complexities.
Many companies today consider Latin
America to be an intrinsic part of their
emerging market strategy. And no won-
der: with a total gross domestic product
(GDP) of $5.5 trillion, the region offers the
potential to reach more than half a billion
consumers. Moreover, Latin Americas
GDP is projected to grow 4 percent annu-
ally until at least 2017, twice as fast as GDP
in the major developed economies.
In the aggregate, people in Latin America
are relatively well-off compared to other
developing markets. GDP per capita in
Brazil, for example, is 45 percent higher
than that of China and three times that of
India. But despite its degree of personal
wealth, the region is still very much an
emerging economy. Its total GDP is only
one-third the size of that for the US, and
40 percent of Europes. Per capita GDP
is lower still: one-fifth that of the US and a
quarter that of the main EU countries.
All of this means that companies operat-
ing in Latin America transport smaller
volumes and less value there than they
do in more mature markets. Volumes can
vary significantly from country to coun-
try and region to region, too, making it
hard for companies to take advantage of
scale effects by consolidating regions,
or to design efficient transport networks.
Despite such challenges, and as the sta-
tistics above suggest, Latin America is a
promising market that merits time, atten-
tion, and investment.
Historically, many multinational com-
panies have focused on one or two key
markets in the region, such as Brazil
and Mexico. These markets are indeed
important to the success of any company
doing business in Latin America. But in
order to access this regions full potential,
87
companies must strengthen their cover-
age across the entire area. From a supply
chain perspective, this necessity forces
them for the first time to think about Latin
America as a whole as they seek to drive
up service levels while keeping costs
under control. To do that well, supply
chain managers must first understand
the region-specific challenges they will
face, and then adopt strategies for miti-
gating or overcoming them.
Challenges on a grand scale
Look at a map, and the challenge pre-
sented by the regions sheer geographic
size becomes clear. The flying distance
between two important commercial cen-
ters in South America, So Paulo (Brazil)
and Santiago (Chile), for example, is 2,500
kilometers, around the same as the dis-
tance between London and Moscow. The
flying distance between So Paulo and
Mexico City is 7,500 kilometers, the same
distance as from London to Kathmandu.
This huge spread might not be much of
a problem if the spaces between major
population centers were occupied.
But that is not the case. The direct,
2,500 kilometer route from So Paulo to
Santiago passes within 100 kilometers of
only two secondary cities (Mendoza and
Crdoba in Argentina). In fact, the top
10 cities in Latin America are 3,900kilo-
meters apart on average. Thats
2,500kilometers more than the same
figure for Europe. If you exclude Brazils
relatively concentrated population, the
average rises to 4,200 kilometers.
Covering these huge distances is dif-
ficult. According to the World Economic
Forum, most Latin American countries fall
behind world averages for infrastructure
availability and quality. These dispari-
ties are shown in Exhibit 1. Moreover, rail
coverage is poor compared to EU or US
standards, and ports are running at many
times their designed capacity.
88

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
Rosario
~300 km
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: iProfessional.com Comex, March 27th, 2013
supply chain manager in Brazil, for
example, is now on a par with that for the
equivalent role in the US.
Challenges across borders
Latin Americafor the purposes of this
article, the Spanish- and Portuguese-
speaking countries in Central and South
America, plus Mexicoincludes 17 coun-
tries, each with its own customs and tax
laws, bilateral agreements, and tariffs. In
Brazil, tax regulations even vary signifi-
cantly from state to state. Many countries
in the region are trying to protect their local
industries through import duties, quotas,
and tax regulations. The sheer complexity
of these rules makes it difficult for compa-
nies to simply keep up to date with current
charges and regulations, let alone account
for all the many variables affecting their
supply chain optimization efforts.
Political developments can exacer-
bate supply chain challenges. Tensions
between countries in the region frequently
lead to the closure of border crossings
or to limitations on the movement of
89
Hong Kong
~18,500 km
Buenos Aires
Exhibit 2
goods. In the past, such situations have
arisen between Colombia and Venezuela,
Venezuela and the US, and Bolivia and
Chile, to name three examples. Internal
instability can also lead to unsafe road con-
ditions or closures, with activity by guerril-
las in Colombia and by coca producers in
Bolivia being two notable recent examples.
To complicate matters even further, the
region has a tradition of government-con-
trolled exchange rates, with a tendency
to engage in local currency wars. As a
consequence, sudden devaluations can
make one country more or less competi-
tive in relative terms without any signifi-
cant changes in productivity. For exam-
ple, after Argentina recently devaluated
its currency, Brazils currency also fell in
dollar termsbut not enough to compen-
sate for Argentinas devaluation, which
made Argentine goods relatively more
competitive in Brazil. Combined with the
often painful bureaucratic processes at
ports and border crossings, these effects
can make managing manufacturing and
distribution footprints, lead times, and
inventories in Latin America more an art
than a science.
90
Supply chain strategies for
success
Taken together, these challenges make
it difficult for companies to optimize the
performance of their Latin American sup-
ply chains. They also have driven some
supply chain decisions that seem illogical
at face value.
For example, it is not uncommon for
companies to maintain idle manufactur-
ing capacity in both Brazil and Argentina.
This strategy allows companies to quickly
change the percentage of goods they are
manufacturing in one country or the other
in response to changes in exchange rates
or tax policies, or when there are border
issues. Another example: in Argentina,
tax policies have encouraged many
consumer electronics companies to set
up assembly plants in Rio Grande, a city
in the extremely cold Tierra del Fuego
region that lies around 3,500 kilometers
south of Buenos Aires, Argentinas main
market. Similarly, tax policies explain why
many consumer goods and electron-
ics manufacturers have large plants in
Manaus, Brazil, located in the Amazonian
forest region some 4,000 kilometers from
So Paulo, Brazils main market.
Despite the challenges outlined above,
some multinational and local companies
have built extremely successful Latin
American businesses. An intrinsic part
of this success has, in many cases, been
the adoption of a Latin-America-specific
approach to the design and execution of
their supply chains, together with a tar-
geted investment in supply chain capa-
bilities in the region. Lets review some of
the key elements of these strategies.
A significant local footprint
A significant local footprint forms a
core part of the most successful Latin
American supply chain strategies. The
top four mobile handset makers in Latin
America each manufacture or assemble
locally more than 90 percent of the prod-
ucts they sell in the region. Argentinas
top automotive brands all produce signifi-
cant numbers of vehicles in the country,
both for local consumption and for export
to other regional markets, especially
Brazil, thanks in part to special treaties
for bilateral automotive trade between
the two countries. Maintaining this local
footprint, especially in expensive places
such as Argentina and Brazil, can be
significantly more expensive than con-
centrating production in one low-labor-
cost country. However, doing so allows
companies to be faster and more agile in
a volatile market.
From operational expedience
In many cases, these localized supply
chains have been specifically designed
to meet the requirements of local tax and
duty regimes or to overcome import quo-
tas. In the case of mobile handsets, for
example, this may entail sourcing 80 per-
cent of the component value in the hand-
set from within the country. The benefits
of this type of tax-efficient approach can
be highly significant, often far outweigh-
ing the potentially higher costs of local
manufacture. One consumer products
company, for example, was able to
increase its contribution margin for a key
product category in Brazil by 30 percent
by shifting to local production, despite
the fact that doing this also increased its
cost of production by 30 percent. The
difference came entirely from savings on
import duties, internal tax benefits, and
other regulatory effects.
to competitive advantage
While regulatory conditions may have
driven the development of local footprints,
the most successful companies take
deliberate steps to turn both of these fac-
tors into a source of competitive advan-
tage, typically by tailoring products to suit
the needs and tastes of Latin American

consumers. For example, in the 1980s, the
German carmaker Volkswagen designed
the subcompact Gol specifically for manu-
facture and sale in Brazil. The vehicle was
built to replace the popular but aging
Beetle, catering to local tastes and taking
advantage of tax breaks for local produc-
tion. It was later introduced in neighboring
Argentina under a similar strategy. The
Gol has been the best-selling car in both
Brazil and Argentina; counting all its vari-
ants, it has sold over 10 million units, and
Volkswagen has used its Brazilian facto-
ries to make compact, low-cost city cars
for other international markets.
In the apparel industry, fast fashion
player Zara makes design adjustments
especially for Brazil, something that it
does not do for most other countries. It
has also cultivated a flexible local supply
base, which allows it to quickly change its
production plans in response to demand.
Other apparel manufacturers have turned
their Latin American supply chains into
sources of product for export, increasing
scale and allowing them to accumulate
export tax credits, which help to increase
the profitability of the local operation.
An appropriate organizational
split
Few Latin American countries offer a
large-enough market to justify an entirely
local supply chain. A strong supply chain
design requires companies to define the
right regional split, one that maximizes
the benefits of scale while also reflecting
the individual needs of particular regions.
The right supply chain clusters
An efficient supply chain organizational
split must take into account the physical
(long distances, jungles, mountain ranges),
cultural (different languages, incomes,
and tastes), and political barriers in Latin
America. Language differences may require
91
multiple labeling variants for adjacent
regions, for example, while the existence
of various free trade agreements can have
significant implications for the movement
of goods between and within countries,
sometimes even requiring companies to
change package sizes or the number of
products per case to meet local regulations.
As a result of these complexities, most
large companies operating in Latin America
choose to segment their supply chain
organizations into regional clusters. These
clusters are designed to balance market
size, cultural similarity, and the cost and
ease of moving goods across internal
borders within the cluster. A typical
approach uses four segments: Central
America (including the Caribbean countries
and Mexico), Brazil (which is often large
enough to justify a dedicated supply chain
organization), the Northern Andean region,
and the rest of the Southern Cone. Exhibit3
outlines these typical segments and the
main considerations that affect where com-
panies will decide to draw those lines.
The right organization within each
cluster
Within and across these supply chain
clusters, companies must then make the
right decisions to ensure that research
and development, purchasing, manufac-
turing, sales, warehousing, and distribu-
tion assets are located in a way that bal-
ances cost, service, and local taxation.
Often this entails concentrating assets
in the largest market in a cluster, but the
best design depends very much on the
details of each organizations products
and markets. Ideally, the organizational
structure should foster quick reaction at
the appropriate level within and across
the established network cluster.
Pragmatic, agile execution
Leading companies modify their supply
chain execution strategies to suit the
92
The organizational structure should foster quick reaction at the
appropriate level within and across the established network clusters
Challenges for Latin America
Different time zones 5 different time
zones in Latin America provide 16 straight
hours of work coverage in the region
Multiple languages, cultures and politics
different languages/regulations in Central
America lead to multiple labeling
Long distances transporting items with
low-value add increases total costs
Geographical barriers mountain passes
between Argentina and Chile can close for
heavy snow making lead times and
inventory management challenging
Various freetrade agreements (from
subregional to ones between 2
countries) different counts of products
per case and different sizes per country
increase portfolio complexity
Exhibit 3
realities of operation in Latin America. The
best of them do this with a hope for the
best, prepare for the worst approach, in
which they accept the higher levels of risk
and volatility in the region and run their
supply chains accordingly. This requires
a high degree of agility and flexibility, both
on a day-to-day basis and in the face of
changing, longer-term trends. This, in turn,
calls for significant investment in supply
chain capability and talent, something that
many companies struggle with today.
Tactical responsiveness
A common strategy used to meet the
day-to-day challenges of operating in
Latin America includes the use of higher
risk-adjusted safety stocks than would
be typical elsewhere in the world, in order
to maintain continuity of supply if local
logistics activities are subject to delays or
disruptions. To keep the costs of higher
inventories under control, companies also
take steps to improve the overall agility of
their Latin American supply chains. They
do this by actively monitoring changing
supply chain conditions in order to have
Typical configuration of
Latin American organization
Northern Andean
countries
D
C
Mexico and
Central
America
Brazil
A
Although Latin B
American structures
typically fall into South
these clusters, America
variations may occur excl. Brazil
the best and earliest possible warning of
situations that may affect their ability to
cost-effectively deliver to customers, and
then dynamically adjusting supply chain
parameters in response.
One consumer goods company with
manufacturing facilities in Argentina, for
example, found that consistent supply to
customers in Brazil was affected by varia-
tions in the time required for goods to
clear customs at the border, which could
vary from a single day to several weeks.
To minimize the effect of these delays,
the company monitored border transit
times and dynamically adjusted its safety
stocks in Brazil, increasing them when
border congestion rose and cutting them
back to reduce costs as goods began to
move more freely.
Strategic agility
Leading companies improve their abil-
ity to react to changing situations in two
ways: by creating and rehearsing con-
tingency plans to deal with a wide range
of possible scenarios, and by improving

their ability to collaboratively plan for and
react to unpredicted events. These capa-
bilities are critical in Latin America, where
political and regulatory changesboth
expected and unexpectedcan have a
swift and significant impact on supply
chain costs and efficiency.
In 2012, for example, the Brazilian govern-
ment announced a law with strict new
limits on the time and distance that truck
drivers could cover between mandatory
rest stops. From one year to the next,
these requirements had the potential to
increase the cost of road transportation in
the country by up to 30 percent and to lead
to a shortage of both vehicles and drivers.
One leading food company quickly rec-
ognized the potential impact the new law
would have on its supply chain costs, and
it embarked on a wide-ranging response
while the law was still being drafted. The
company established communication
with the government at the top level of
the organization, with the aim of prevent-
ing certain unreasonable clauses from
being written into the law. It redesigned
its distribution footprint to adjust for lon-
ger lead times and shorter feasible daily
distances. It also opened early negotia-
tions with suppliers and transport com-
panies to secure additional capacity. As
a result of this quick and comprehensive
response, the company helped to ensure
some critical modifications were made to
the draft law before it was passed, and
it was well positioned to minimize addi-
tional costs and potential disruption by
the time the law came into force.
A focus on capabilities
Design and execution of an effective sup-
ply chain in the challenging conditions
encountered in Latin America requires
considerable individual and institutional
capabilities. As the examples earlier in
this article show, some companies that
are operating in the region have devel-
oped these abilities to a high level.
93
However, our research has shown that
these leading organizations are the excep-
tion, rather than the rule. Since 2010, we
have evaluated the supply chain capa-
bilities and performance of more than
600 companies worldwide, using the
maturity assessment diagnostic tool
included in the McKinsey Supply Chain
360 benchmarking suite. The maturity
assessment tool covers hundreds of
practices, which are grouped into 20 topic
categories. For each practice, the evalu-
ated companies received a 1 to 5 score
that reflected the current implementation
level at the company. The Latin American
consumer goods supply chain organiza-
tions in our survey had an average score
across all dimensions of 2.73 out of 5,
compared with 3.1 for Europe and 3.13
for North America. As shown in Exhibit4,
this research reveals that among Latin
American companies (both locally owned
and locally based multinationals), critical
maturity gaps exist in two aspects of sup-
ply chain management that are among the
most important for success in the region:
risk management and forecasting.
Many companies operating in Latin
America need a systematic approach
to compensate for these critical gaps in
supply chain maturity. Above and beyond
gaps in institutional capabilities, the short-
age of supply chain talent in the region
makes it difficult to fill these skill gaps
through recruitment alone. Instead, com-
panies need to build their own individual
and institutional capabilities from within.
The best organizations do this through a
combination of actions, like facilitating the
exchange of knowledge and best prac-
tices from their global supply chain orga-
nizations, investing in capability building,
and transforming their local organizations
to better adapt to local conditions.
Unlock Latin Americas potential
Latin America offers companies a differ-
ent kind of emerging market, with faster
94

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

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

(www.SupplyChainQuarterly.com) 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
region, with promising and sometimes
startling prospects for more sustainable
developmentand with huge oppor-
tunities for pharmacos. However, on
many levels, the challenges involved in
capturing those opportunities constantly
threaten to undercut the lofty margins
and double-digit market growth that
some pharmacos have enjoyed for more
than a decade in Africa. Five key factors,
drawn from other industries as well as
pharma, show that, increasingly, success
across the continent will demand fresh
approachesapproaches very different
from those that have worked so well for
so long in Europe, the US, and the BRIC
nations (Brazil, Russia, India, and China).
A continents worth of growth
opportunities for pharma
Let there be no doubt that the African
continent is a cornucopia of opportu-
nity for pharmaceutical companies.
Since 2000, Africas pharma market has
expanded at a rapid clip: 15 percent,
compounded annually. Today, leading
pharmacos generate more than $200
million in annual sales in Africa and one
has even topped $1 billionequivalent
to about 2 to 4 percent of total company
revenue.
The future looks just as bright: there is
enormous potential to increase per capita
spending, and the factors driving growth
in pharma sales are very promising. The
latest estimates project that Africas
pharma market will grow by an annual
average of between 10 and 14 percent
over the next few years. Those projec-
tions anticipate sales volumes of between
$44 billion and $66 billion by 2020on
a par with current pharma sales in China
and outpacing those in either France or
Germany today. Already, pharmacos 35
to 50 percent earnings before interest
and taxes (EBIT) profit margins in Africa
are higher than those obtained in most
95
other emerging economies. These EBIT
margins are also notably larger than
in many developed markets, with the
exception of the US.
The potential is also visible in the conti-
nents low per capita spending compared
with that of other emerging markets
just $17 on pharma products per year
compared with $39 in Chinaand in the
big differences in per capita spending
between African nations. Whereas South
Africans and Algerians already spend
roughly $90 per head on pharmaceuti-
cals, other fast-growing economies, such
as Ghana and Nigeria, with per capita
spending of just $19 and $8, respectively,
offer significant growth potential.
A look at the underlying drivers of growth
creates further confidence. Four main
trends are propelling Africas pharma
ceutical market:
Increasing spending on healthcare
The burden of disease continues to rise,
most markedly as a result of NCDs (non-
communicable diseases such as cancer,
diabetes, as well as cardiovascular and
respiratory diseases) and maternal ill-
nesses. At the same time, the continents
population is growing, and by 2020, more
than 50 percent of households will have
discretionary income. Also, increased
urbanization improves access to health-
care services. Already, 52 African cities
are home to more than one million people
eachas many cities of that size in
Europe and the US togetherwhich pro-
vides unprecedented opportunities for
targeted market penetration.
Expanding provision of health care
The capacity of African health systems is
growing. Between 2006 and 2009 alone,
about 70,000 new hospital beds became
availablemore than the total of 55,000 in
Greece today. In that same period, roughly
16,000 doctors and 60,000nurses were
96
added. Additionally, private hospital
investments and public-private partner-
ships (PPPs) are growing, and health-
care is becoming a strategic priority for
governments, particularly in nations that
are subject to growing pressure from their
own populations and from the global
community.
Maturing business environment
Across much of Africa, the business envi-
ronment for pharmacos is becoming more
stable and predictable. Lawmakers in
many countries are pushing the develop-
ment of local pharmaceutical sectors and
bolstering efforts to harmonize regula-
tions. The African Union, together with
major nongovernmental organizations
(NGOs) such as the Bill & Melinda Gates
Foundation and international institutions
such as the World Health Organization
(WHO) and World Bank, is striving to
harmonize the registration of medicines
and accelerate product approval in four
regional economic communities: West
African Health Organization, South
African Development Community, Organe
excutif de la CEMAC, and East African
Community. The progress of these efforts
has been uneven over much of the last
decade, however.
Growing acceptance of generic
(Gx) drugs
The push for lower drug prices will con-
tinue throughout the continent, open-
ing doors wider for Gx drugs. However,
two different trends are at work here.
First, public tenders, which are mainly
for essential drug list medicines, favor
low-cost nonbranded generics (INN) and
often go to Gx drug manufacturers based
in Asia. For example, Indian manufactur-
ers have a stronghold in the regulated
markets of East Africa, selling both to
NGOs and public healthcare systems. In
2011, Indian manufacturers accounted
for 17.7 percent of African pharmaceuti-
cal imports. Second, in contrast, private
channels favor branded generics over
INN generics. Product safety remains a
key concern to African patients given the
prevalent issues with substandard prod-
ucts and counterfeit drugs. Here, branded
generics serve the brand-conscious
African consumers well and guarantee a
certain quality standard.
Indeed, global influences may accelerate
the African nations embrace of gener-
ics. Although most countries in sub-
Saharan Africa still use the globalized
patent regime, Indias raising of the bar
for patent protection increasingly influ-
ences the discussion in African countries.
For instance, in South Africa, officials
are reviewing patent protection laws
together with the WHO and the World
Trade Organization (WTO), and patient
advocacy groups are lobbying vocifer-
ously to implement the WTO agreement
on Trade-Related Aspects of Intellectual
Property Rights (TRIPS)a move that
would offer compulsory licensing as an
option in order to make patented drugs
more affordable for citizens.
Facing up to Africas abundant
challenges
Pharmacos still confront tremendous chal-
lenges in many corners of Africachal-
lenges that range from political instability
to counterfeit drugs. Yes, in general, those
hurdles have been lowered somewhat in
recent years, but they are still substantially
higher than is typical in other markets.
Lets examine five categories of difficulty:
Political uncertainty and
regulatory burdens
Recent uprisings in Maghreb countries
as well as upcoming elections in Nigeria
and Mozambique create political uncer-
tainty for pharmacos. Beyond the political
uncertainty, regulatory burdens make
Africa a challenging place to operate
in. According to the World Bank Doing
 97

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
Nigeria
Investment incentives for
Cape Verde Mauritania
Mali Chad local pharma manufactures
Senegal Niger
Burkina
Sudan Eritrea July 2011
The Gambia Faso Central
Nigeria Djibouti
Guinea-Bissau Guinea African Somalia South Africa
Sierra Leone Republic South Ethiopia
Liberia
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
Seychelles

Angola
Zambia Mozambique
Saint Helena
Zimbabwe Mauritius
Namibia
Botswana Madagascar
Swaziland
Lesotho
South Africa

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

Exhibit 1
98
compared with the BRIC average. The
challenge is particularly relevant in land-
locked countries where distribution of
imports takes up to nine days longer than
it would take for equivalent distances
within seaport countries. Although there
have been, and continue to be, sizable
public and private investments in logis-
tics infrastructure in Africa, especially
around major urban areas, the shipping
of goods within and across countries
remains challenging. Poor road infra-
structure, port congestion, and delays
in custom clearance are just the most
prominent of the factors that distort lead
times, extending the need to keep local
inventory on hand and making supply
chain planning extremely difficult and
logistics quite costly. In addition to these
well-known limitations, controlled cold
chains required by products such as
vaccines barely exist in many African
countries. Nigeria illustrates the extent of
this challenge. One recent study found
that 90percent of the nations refrigera-
tors were not working and 95 percent of
health workers had little or no knowledge
of vaccine vial management. So, in many
states in Nigeria, less than 15 percent of
drug distribution facilities are equipped
with cold-chain equipment. Stockouts of
vaccines can be as high as 90 percent.
Limited supply chain management
capabilities and lack of local
resources
Commercial and public-sector distribu-
tors alike are dogged by Africas supply
chain limitations. Arguably the most
pressing need is for better forecasting
and planning. Inventories are often too
low or do not have the right product mix,
resulting in poor availability at the point of
sale. As a consequence, indirect supply
chain cost such as lost sales and high
levels of obsolescence have a negative
impact on end-to-end cost and margins.
Studies led by the Gates Foundation
have shown that family planning products
(particularly injectable and implantable
contraceptives) were out of stock at
least half of the time in public facilities in
Senegal and Nigeria, even though prod-
ucts were available at the national level.
National forecasts typically rely on actual
consumption and thus generally under-
estimate real demand.
There is another significant limitation: the
paucity of talent and capital to manage
Africas pharma supply chains. Local dis-
tributors often lack the money to finance
inventory sufficient to ensure high service
levels. Many African nations public health
care systems have no centralized logis-
tics, with almost no resources dedicated
to supply chain activities; they rely on
poorly trained staff and inadequate physi-
cal facilities to pull products from central
or regional depots.
Counterfeit drugs and informal
distribution channels
In nations such as Kenya, counterfeit
products account for as much as half of
all sales in many drug categories. (It can
spike as high as 85 percent for antimalaria
drugs.) More than 100,000 deaths a year
across Africa are tied to fake medicines.
At the same time, informal distribution
channels present major difficulties. In
French-speaking West Africa, for exam-
ple, relatives and friends of patients will,
as a matter of course, purchase phar-
maceutical products in other countries,
particularly when they travel abroad,
and bring them home for patients use.
In these countries, one to three distribu-
tors benefit from oligopolistic market
structures and high, regulated margins.
Hence, ordinary citizens are doing what
they can to circumvent the high prices.
How pharmacos operate in
Africa today
The current hurdles might make it seem
impossible for pharmacos to do any

Today, pharmaceutical companies use 4 different supply chain
models in Africa
Public supply chains
Centralized supply
chain
Products shipped to central warehouse location in
Africa or NGO warehouse outside Africa
Central pharmacy man-
aged by MoH1 undertakes
procurement and
Model distribution
Hospitals and clinics order
from regional entity
(dependent of central
pharmacy)
Frequent stockouts
Real demand underestimated as forecast based
on real consumption
Result
1 Ministry of health
meaningful business at all in Africa. But as
noted earlier, there are many successful
pharma ventures there already. So how do
they do it?
In general, there are big differences in
distribution channels for public-sector
productsfor example, medicines for
public hospitals, sometimes bought or
donated by NGOs or UN agenciesand
commercial pharma products, such as
those sold in pharmacies and private
clinics, and through social marketing
(Exhibit 2). In the public distribution chan-
nel, pharmacos typically ship to a central
warehousing location or, where NGOs or
agencies are the intermediaries, they hand
over products at the production sites out-
side of Africa or ship to central European
warehouses. Forecasting, planning, and
distribution are then handled locally by the
public institutions, NGOs, or agencies.
Within this model, there are two distinct
supply chains. In one case, countries
such as Senegal and Kenya operate cen-
tral pharmacies that take care of procure-
ment and distribution to the regional level
for all public-sector medications. Local
99
Commercial supply chains
Product level supply Wholesaler/
chain Local manufacturing distributor model
Local manufacturing Shipment to local whole-
Local wholesalers and saler/distributor
Multiple supply chains distributors manage Local wholesalers/distri-
within country split by supply chain, own invent- butors handle customs and
product groups ory, forecast, plan, and own inventory
distribute the products Local distributors report
Each program respon-
sible for forecasting, forecasts and supply chain
procurement, and management KPIs
distribution to pharmaco
Rely on local facilities
to pull the products
Cost advantage form low Margins squeezed by
import duties wholesalers in regulated/
Higher degree of control centralized countries (e.g.,
Senegal)
Low supply chain
management talent leads Low transparency and
to inaccurate forecasting influence leading to lower
and low availability market penetration and
frequent stockous
Exhibit 2
hospitals and service delivery points then
order products from that regional entity.
In the other case, there are multiple sup-
ply chains but no central pharmacy, with
each program (immunization, family plan-
ning, etc.) responsible for forecasting and
procurement, and with its own warehous-
es and facilities for delivering products.
In both cases, forecasting and planning
are deficient, which often leads to stock-
outs. And when many forecasts are based
on actual consumption rather than real
demand, the full market potential for those
drugs remains untapped.
In the commercial distribution channel,
pharmacos must manage local distribu-
tion. Their supply chains differ substan-
tially by region, driven mainly by regulatory
requirements and the availability of local
contract manufacturers. Here, too, there
are two distinctly different supply models:
one in which drugs are produced locally
and distributed by local wholesalers and
distributors to pharmacies, private clin-
ics, etc., and another in which medicines
are air-freighted from manufacturing sites
outside Africa to local wholesalers and
100
distributors that distribute the products to
pharmacies, private clinics, etc.
The former supply model is more typical
of the relatively mature markets of North
Africa and the nation of South Africa.
Pharmacos are often required to have
local production sites or to use those
countries existing contract manufactur-
ers. Distributors and wholesalers then
assume ownership of the product inven-
tory; they also forecast demand, plan
and manage distribution to pharmacies
and private clinics, and handle social
marketing. This model usually is the more
cost-efficient one because it entails lower
import duties, reduced transport costs,
and greater control of distribution. Again,
subpar capabilities in demand forecast-
ing and planning, limited capital to finance
inventories, and lack of supply chain talent
leave abundant room forgrowth.
The latter modelin which drugs are
freighted in by air from Europe and else-
wherecan be much more fragmented.
Local wholesalers and distributors take
care of customs clearance and own the
goods from customs onward. Importantly,
there are big differences between African
nations that are primarily English-speaking
and those where French is a major lan-
guage. In French-speaking nations such
as Senegal, there is heavy regulation,
and pharmacos typically are obliged to
use specific wholesalers that benefit
from high, regulated margins. In English-
speaking countries such as Ghana and
Nigeria, regulation is lighter, resulting in
a much more fragmented landscape of
wholesalers and distributors.
One clear consequence of these com-
mercial setups is that pharmacos have
little visibility into the supply chain and
thus little influence over pricing or other
factors. Hence, pharmacos increasingly
move toward local production and tighter
integration with wholesalers and distribu-
tors in order to be able to influence mar-
ket penetration, pricing, and quality.
According to the IFC, already today
approximately 30 percent of the final for-
mulation takes place in Africa. However,
local production is limited to only a few
markets, with South Africa accounting
for 70 percent, and Nigeria, Kenya, and
Ghana together accounting for 20 per-
cent of local production. But local pro-
duction is growing as pharma companies
enforce their local footprint. According
to the IFC, 40 percent of the incremental
healthcare investment of the cumulative
$1.6 billion to $2.9 billion will go into local
final formulation manufacturing.
Needed next: Out-of-the-box
approaches
The routes to success in Africa that have
worked thus far for pharmacos are not
likely to serve them as they continue to
grow. Although companies can lever-
age their experience in other marketsin
particular, the BRIC marketsAfrica
requires an even more localized approach
and innovative solutions to distribution.
McKinsey & Company believes that phar-
macos will be successful in Africa if they
adapt their traditional models to the chal-
lenges on the ground. They must be will-
ing to look to other industries for innovative
ideas. At the end of the day, winning sup-
ply chains in Africa are focused on local
requirements. They link customers, distri-
bution, financing, regulation, as well as pri-
vate and public players. And they provide
or facilitate end-to-end solutions to the
very practical challenges on the ground.
Our research and client work with a vari-
ety of industries in Africa point to five key
success factors (Exhibit 3). Each merits a
closer look:
Make it simple: Focus on key
products and megacities in select
markets
Political uncertainty and regulatory
burdens mean that pharmacos must

Africa's optimal supply chain approach
Define product port-
folio that matches
local patient needs
Select key markets
Focus on key products
starting with large
and megacities
urban areas
Screen other sectors to Think
innovative solutions for key outside
challenges, such as last-mile the box
distribution, transparency,
fighting counterfeit drugs
Develop, pilot, learn
Roll out innovative solutions Develop end-
to-end supply
chain
solutions
Identify end-to-end break points
Identify key stakeholders across the
supply chain
Develop end-to-end solutions and engage with
supply chain partners to shape the operating
environment
pick their priorities carefully. Successful
companies share one common way to
do this, regardless of industry sector:
they focus on a few main markets and
products when they start out and tar-
get megacities first. Pharmacos should
define product portfolios that match local
patient requirements and local healthcare
systems. Then they need to prioritize
markets. They will likely focus on a mix
of more mature markets (for example,
those in South Africa, Algeria, Egypt, and
Tunisia) and high-potential markets (those
in sub-Saharan Africa, such as Nigeria,
Ghana, Kenya, and Senegal). McKinsey
believes that winning in Africa means
winning in megacities. One-third of total
growth in Africa will come from 50 mega-
cities with more than 1 million inhabit-
ants each. In addition to their enormous
growth potential, these cities offer better
logistics infrastructure and healthcare
capabilities than rural areas. At the same
time, city dwellers are usually more willing
to adopt modern medication than those
in rural areas. Then and only then should
pharmacos consider targeting midsize
markets and rural micromarkets in
those shortlisted countries.
101
Assess the operating con-
ditions, such as regulation,
availability of partners,
logistics infrastructure
Analyze risks
Define supply chain seg-
Tailor ments based on common
supply requirements
chains
Africa
supply chain
Define a
physical
distribution
network
Understand demand centers
Define inventory holding
points (warehouses)
Model logistics cost
Define national/regional
solutions
Exhibit 3
Realize that one size does not fit
all: Tailor supply chains to local
requirements
Next, pharmacos need to understand
each markets entry barriers and local-
content requirements in order to define
supply chain segments whose product
and market combinations share the same
characteristics. In particular, this includes
distribution channels for specific prod-
ucts (public as distinct from commercial),
regulatory requirements (for example,
those governing local content, the roles
of wholesalers and distributors), and the
availability of potential partners for pro-
duction and distribution. In addition, it
is crucial to assess the country-specific
riskspolitical stability and investment
security, for instancein order to evalu-
ate the risks of allocating capital.
On the basis of these tailoring steps,
pharmacos should then define the con-
tours of solutions for any given product
and market combinationfor example,
products for the commercial market with
local-content requirements but no limita-
tions on the selection of distributors and
102
Healthy urbanization large cities will drive more than one-third of total
economic growth
Contribution to African GDP growth, 2011-25
Percent of total GDP growth
Megacities
3 370
>10 million inhabitants
Large middleweights
3 37%
5-10 million
Midsize middleweights
31
1-5 million
Small middleweights
200,000-1 million
Other cities and rural
African GDP growth
SOURCE: McKinsey global institute: cityscape 1.3; C-GIDD
Exhibit 3
wholesalers. As a result, supply chain
segments can be defined and tailored
strategies developed.
Consider regional distribution
hubs: Define a physical
distribution network
In Africa, poor logistics infrastructure and
high distribution costs require a careful
design of physical distribution networks
(warehousing, transport) for commercial
supply chains. Take road transportation
as an example: the cost per ton-kilometer
in Africa exceeds the cost in Western
Europe by as much as 20 to 120 percent
depending on the route. Hence, distribu-
tion cost becomes a major cost factor in
Africa, exceeding the approximately 2 to
3 percent of sales that pharmacos spend
on distribution in Europe. Examples
from other industries, such as consumer
goods and mining, illustrate best prac-
tices that can help pharmacos optimize
these direct logistics costs.
Increasingly, companies from these other
industries are moving from national to
Per capita Share of popu-
GDP, indexed lation, 2011 Number of
100 = all Africa Percent cities, 2011
1 1
110 2 2
250 10 47
20 205 7 156
43 68 80 204
57 43 100% = $2.5 trillion
regional distribution hubs as they push
into Africas smaller markets. While they
keep national distribution systems in
Nigeria, South Africa, and many of the
larger Northern African countries, they
build regional distribution centers in
West and East Africa to serve neighbor-
ing countries by sea, road, or air (or all of
the above) and to optimize their logistics
costs. For example, many companies
use Dakar or Senegal as a hub to serve
francophone West Africa, Accra or
Ghana, to serve English-speaking West
Africa, and Tanzania or Kenya to serve
East Africa. These countries tend to have
more reliable inbound infrastructurethe
airport in Dakar and the port in Accra, for
instanceand their customs legislation
is less onerous for exporting goods. In
Senegal, for example, companies can
leverage bonded warehouses for some
products. In this model, there is no need
to pay custom duties for products distrib-
uted to other countries; all that applies
are import duties to the final destination.
Such regional setups can have significant
cost advantages and may serve as an
example for pharmacos in the future.

Develop end-to-end solutions:
Strive to shape the operating
environment
A successful approach in Africa requires
an integrated view across commercial,
operational, and regulatory schemes.
Pharmacos need to take an integrated
approach and shape the operating envi-
ronment. Here, the supply chain plays a
key role in developing end-to-end solu-
tions that go beyond organizing logistics.
Winning supply chains in Africa take on
an integrator role, from production all the
way to customers, and develop solutions
to a broad range of challengesfrom
financing of inventories at wholesalers, to
establishing cold chains in public distribu-
tion channels, to increasing planning and
forecasting capabilities at distributors.
Pfizer in Nigeria provides an excellent
example of how engaging with local part-
ners in a commercial distribution chan-
nel can provide an end-to-end solution.
Pfizer entered a partnership with a local
distributor (Biofem Pharmaceuticals),
hired a company (Sproxil) to provide tech-
nical assistance, and engaged national
authorities (NAFDAC). Collectively, this
Pfizer team implemented scratch-
off technology along the supply chain
whereby codes can be automatically veri-
fied by mobile phone texting. The results
speak for themselves: after suffering a
75 percent drop in sales in the previous
three years, Pfizer saw its sales in Nigeria
soar by 10 percent in just three months.
Regional problemsfor example, coun-
terfeit drugswere identified immedi-
ately, and Pfizer was able to develop
targeted promotions.
Similar examples exist in public distri-
bution channels. In Senegal, Merck,
through its foundation Merck for Mothers,
together with the Gates Foundation, is
supporting the transformation of the pub-
lic distribution channel from a collection
to a distribution system, helping public
authorities and public distributors to build
103
new capabilities and using private-sector
vendors for the last step of distribution.
Likewise, in Morocco, Pfizer invests in
cold chain capabilities and assets such
as cold storage to improve the quality and
coverage of cold chains.
Similarly, GlaxoSmithKline (GSK) is shap-
ing a strategy to focus on the needs of
emerging markets. Together with more
than a dozen other pharmacos, and
with government agencies and other
organizations, GSK is working toward
the goal of eliminating or controlling 10
neglected tropical diseases by 2020. The
collaboration is also aimed at improving
the regulation associated with manage-
ment of those diseases. This effort is
complemented with initiatives in selected
countries to build local capabilities. These
efforts include the education of a nations
or regions health professionals and con-
sumers as well as stimulation of demand
through ancillary services. They can also
help African nations governments to fix or
improve their public-sector supply chains
with targeted support or local visible
grants. Improving these operating condi-
tions ultimately has an impact on the per-
formance of supply chains on the ground,
in terms of higher and more reliable
demand, higher availability as public and
private partners become more mature,
and ultimately lower cost to serve patients.
Be innovative: think outside the
box to solve challenges
Finding cost-efficient and scalable solu-
tions to some of the challenges on the
ground requires innovative ideas. There
are impressive examples of innovative
solutions that make a difference on both
a small and a large scalein particu-
lar with regard to last-mile distribution,
supply chain transparency, and fighting
counterfeit drugs.
For final-mile distribution, the ColaLife
initiative is an excellent example of how
to learn from and leverage solutions that
104
proved to be successful in other indus-
tries (see the box ColaLife piggybacks
drugs to African villages).
Another example of an innovative way to
manage last-mile delivery is that of the
cosmetics company Avon in South Africa.
Avon found a way to cost-efficiently dis-
tribute products to rural areas by hiring
and training less-advantaged women as
door-to-door salespeople. The approach
changed the lives of many marginalized
women in South Africaand made Avon
one of the most respected brands in
that nation.
The SMS for Life program showed how
thinking outside the box and engaging
partners outside of traditional supply
chains can add value and create end-to-
end solutions. Novartis, Vodafone, and the
Roll Back Malaria Partnership launched
the project in 2009. The initiative involved
129 health facilities providing healthcare
to 1.2 million people across rural Tanzania.
The objective was to overcome regular
stockouts of malaria medicine. During the
SMS for Life process
Stock take and
Stock inquiry
response at
text is sent from
local healthcare
SMS for Life
provider
Exhibit 5
pilot program, health facilities sent SMS
messages showing their current stock
levels; the data were aggregated every
week at a district level in order to optimize
replenishment (Exhibit 5). All in all, the ini-
tiative succeeded in reducing malaria drug
stockouts by half.
Another innovative example is mPedigree.
Together with a series of partnerstele-
communications operators, leading tech-
nology companies, and regulatory authori-
ties in several countriesmPedigree
provides a solution to solve the big chal-
lenge of counterfeit drugs. A basic phone,
a scratch-off code on the pack, and a
toll-free SMS number enable customers to
check the quality of a product at the point
of sale. Given the importance of quality
to customers and the risk of counterfeit-
ing, this simple-to-use and highly scalable
technology is a step change in managing
secure supply chains in many countries
across Africa.
District medical
officer
Automatic
compilation of 7 central WH Novartis
information
Web-based
reporting tool

Given the array of difficulties facing phar-
macos that want to tap into African mar-
kets, many executives could be excused
for asking whether the effort is worth it.
The answer: yes, it is. Africas pharma
opportunity can beand for many com-
panies, will behighly rewarding.
As growth opportunities from blockbuster
drugs (those that earn $1 billion or more
per year) are becoming more and more
limited, more granular approaches to
growth are gaining importance. Africa is
one of the growth clusters for pharma-
cos, though it is still largely uncharted
territory. Because many African markets
have yet to take off, competitive intensity
is rather low and there are significant
opportunities for early movers to achieve
a competitive advantage with branded
generics that address the quality con-
cerns of patients for drugs that go through
private channels. Building a strong brand
early on can establish sturdy entry barri-
ers for followers and create a belonging
Hassan Belkhayat is a principal in McKinseys Casablanca office and Johannes Rhren is a
consultant in the Berlin office.
105
of a brand and community and hence
sustain brand positioning over time.
Moreover, the market structure in many
African countries allows pharmacos to
obtain significant market shares by form-
ing agreements with governments and
supplying a broad range of basic medica-
tion (mainly through nonbranded generics)
to national health systems. And a blend
of preferential deals, targeted technical
assistance for local partners, and innova-
tive solutions to some of the most pressing
challenges can boost market size and
augment the quality of delivered solutions.
Building relationships with local communi-
ties and authorities can be the decisive
advantage in these public tenders that
look beyond price.
Those wins will not materialize overnight,
and they cannot be achieved without
substantial commitment. But its our
belief that the efforts and the time spent
will be more than worth it.
106

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
structural differences between industries
can make true supply chain performance
hard to evaluate, and even harder to bench-
mark. A new single performance indicator
cuts through the complexity.
You know that your business depends
on a well-designed, efficiently executed
supply chain to keep customers happy,
manage risks, and keep costs and com-
plexity under control, but do you really
understand if your current supply chain is
performing as well as it should?
By their nature, supply chains are com-
plex, and most companies today monitor
supply chain performance with a portfo-
lio of metrics, including inventory levels
and turns, delivery performance, logis-
tics costs, and many more. Each one
of these metrics matters, but together
these fistfuls of numbers can obscure as
much as they reveal. Are high inventory
levels compensating for poor manufac-
turing agility, or enabling vital service
responsiveness? Is costly expedited
transportation really needed to meet
volatile demand, or just a symptom of
poor planning?
SCPI calculated using industry-specific scales and weights for each KPI
Service level
Customer case fill
rate or orderline
OTIF
1 Industry-specific, 10
nonlinear scales 9
to evaluate 8
performance on 7
each dimension 6
5
4
3
2
1
2 Industry-specific
weighting of
dimensions
reflecting impact
on ROIC
SOURCE: McKinsey SCPI
107
It was the need to answer exactly these
kinds of questions for our clients that led
us to search for a single, simple metric that
senior leaders could use to understand
whether they are getting the best pos-
sible return on their supply chain invest-
ment. After more than six months and
the analysis of nearly 2,000 data points,
the McKinsey Supply Chain Performance
Index (SCPI) achieves that elusive goal.
One metric
The SCPI aggregates more than 20 differ-
ent measures of supply chain performance
in four key groups: service, measured by
on-time, in-full (OTIF) levels or case fill rates
depending on the industry; the costs of
transport and warehousing; the size of
inventories; and the maturity of a com-
panys supply chain organization (Exhibit 1).
Critically, it compensates for the structural
differences between industries by normal-
izing those metrics based on real-world
performance achieved by other compa-
nies in the same sector, and gives them
industry-specific weightings (depending on
the relative impact of each) on real financial
performance, as measured by return on
invested capital (ROIC).
Supply chain
Logistics cost Inventory process maturity
Transport cost and Total inventory days Qualitative assess-
warehouse cost (in (finished goods, ment of 20 supply
percent of COGS) work in progress, chain dimensions on
raw materials) a scale from 1 - 10
Exhibit 1
108

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

This chart shows two key results. First,
the spread of supply chain performance,
even among large, leading companies
in their respective sectors, is broad:
SCPI indices range between 2.7 and 8.4.
Second, companies with higher-perform-
ing supply chains are reaping the benefits:
one extra point on the SCPI was worth
an extra 0.7 percentage points in ROIC,
against an average ROIC of 11 percent in
the sample as a whole.
This finding matters. While the apprecia-
tion of the importance of service is rela-
tively widespread, two-fifths of the CPG
managers we surveyed for the index said
they currently prioritize cost over service in
their own supply chain decision making.
Of course, companies cant afford simply
to buy service at the expense of cost
and inventory levels, but the SCPI shows
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
ROIC
Percent
14.0
13.5 Best
performers
13.0
12.5 Correlation 0.5
12.0 R 0.3
11.5
11.0
10.5
10.0
9.5
9.0
8.5
Poorest
8.0 performers
1.0
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
 109

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
paul_carbonneau@mckinsey.com knut_alicke@mckinsey.com sumit_dutta@mckinsey.com

Alex Niemeyer Christophe Franois Mads Lauritzen

Miami Lyon Bangkok
+1 (305) 961 8710 +33 (1) 4069 9303 +66 (2) 694 8513
alex_niemeyer@mckinsey.com christophe_francois@mckinsey.com mads_lauritzen@mckinsey.com

Ildefonso Silva Christoph Glatzel Martin Lehnich

So Paulo Cologne Shanghai
+55 (11) 5189 1686 +49 (221) 208 7210 +86 (21) 6133 4527
ildefonso_silva@mckinsey.com christoph_glatzel@mckinsey.com martin_lehnich@mckinsey.com

Daniel Swan Jochen Gropietsch Kenji Nonaka

Chicago Barcelona Tokyo
+1 (312) 551 3541 +34 64913 8977 +81 (3) 5562 2194
daniel_swan@mckinsey.com jochen_grosspietsch@mckinsey.com kenji_nonaka@mckinsey.com

Editorial team

Ashutosh Dekhne

Jochen Gropietsch

Christofer Kohn

Yogesh Malik

Erika Schroederus

Ron Stach

Operations Practice
June 2014
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