The holiday season is a time for celebrating — and prognostications for the coming year. I’m typically an optimist, but not this time. Though many factors point to a rosier 2014, every company faces some significant direct and indirect risks, many of which lurk below the surface. Fortunately, these dangers can be alleviated with good analytics and planning.
Recent positive economic news (e.g. the strength of equity markets, low interest rates and the abatement of EU and U.S. debt crises) have given corporate managers some cause for optimism. It would be understandable, but hazardous, for managers to let their guard down. Many risks continue to menace organizations, four of which are:
Raising prices is a quick path to higher profits. To wit, a 1% increase in prices with a 30% margin can improve the bottom line by 20%. Just try making it happen. Since the financial meltdown of 2008, it has been difficult to raise prices while maintaining market share. In Canada’s retail sector, for example, the arrival of Target and Marshalls plus recent grocery price wars, is expected to depress industry profitability for some time. Many other sectors like services, manufacturing and communications are finding it difficult to sustain margins due to buyer pressure, global competition and steadily increasing costs.
Mitigating the risk
From a pricing perspective, firms need to more aggressively sell their products in markets that are less price sensitive or that are rapidly growing markets, both locally and in the developing world. Furthermore, those companies with differentiated value should look to take pricing up by better aligning price points to the unique benefits delivered.
Global consultancy EY estimates that a 1% reduction in costs can produce the equivalent of a 10% increase in sales. Achieving this is another story. In many firms, most of the easy supply chain and headcount rationalization savings have already been tapped. Moreover, the era of low raw material and wage inflation may be coming to an end, tracing to two key drivers — the recent uptick in consumer demand and the possibility that China’s growth engine will reignite, driving up raw material costs. Adding fuel to the fire is continued exchange and interest rates volatility, which can play havoc with costs.
Mitigating the risk
Product and operational innovation is the key to driving margin improvement. On the cost side, it is possible for organizations to further reduce cost without cutting key capabilities. For example, managers can reduce development costs and better target needs by co-creating products with their customers and leveraging rapid experimentation practices. Innovative operational strategies can drive higher efficiencies through the implementation of initiatives that reduce complexity, as well as crowdsourcing and gamificationpractices.
Supply chain disruptions
As has been shown many times, unforeseen events like natural disasters or political crises can seriously disrupt a firm’s operations, dramatically impacting product supply and revenue. Risks are magnified when a company’s supply chains are regionally concentrated and highly integrated. For example, Japan’s Fukoshima nuclear disaster led to global shortages of spare parts and shuttered assembly plants for Honda and Nissan. A recent report by Swiss Re, a reinsurance company, highlights the ongoing risk of major natural disasters such as flooding, earthquakes and storms. The report identifies above-average risk for many global economic hubs including: Tokyo, Hong Kong-Guangzhou, New York, Los Angeles and Amsterdam-Rotterdam.
Mitigating the risk
Maintaining a low-cost supply chain must be balanced with the need for added production flexibility and agility. Managers can minimize this operational risk by having: multiple supply-chain partners for critical and expensive inputs; close and symbiotic relationships with each vendor; and the internal capability (e.g., engineering, procurement) to quickly shift production if necessary.
Computer attacks and viruses represent a clear and present threat to every enterpriseand industry. This year, the Securities Industry and Financial Markets Association released a report that showed more than half of the world’s securities exchanges had experienced cyber attacks during the past 12 months. Janet Napolitano, the outgoing U.S. homeland security chief, recently said, “Our country will, at some point, face a major cyber event that will have a serious effect on our lives, our economy, and the everyday functioning of our society.” Importantly, these cyber attacks can appear out of the blue. According to software provider Symantec, 40% of all the computers that were impacted by the Stuxnet virus, which allegedly targeted Iran’s nuclear infrastructure, were located outside of Iran.
Mitigating the risk
Reducing the impact of cyber attacks requires an acknowledgement of the threat, an understanding of internal vulnerabilities and the business continuity plans to deal with potential disruptions. Furthermore, IT managers should work together with their industry peers to explore industry early warning systems and safeguards.
Offshoring IT operations have always been difficult and risky; the RBC/iGATE flap is merely the public tip of the iceberg. Alex Rodov, CEO of a leading Canadian IT testing firm QA Consultants, has seen the damage of these arrangements first hand: “Offshoring is no longer the bargain it once was. It is not uncommon to see higher – not lower – costs, more hassles, delayed time to market and compromised quality.”
Our research uncovered the following example of an offshoring ‘burn victim:’
Financial Services project is “A Bridge Too Far”
A leading financial services company was looking to launch a major, new online offering. The firm did not have the internal capabilities to build this platform themselves. They chose to outsource the initiative to a large Indian IT services provider. This is where the problems began. The Indian firm underpriced the project to get the deal. They also took the client’s business and technical requirements ‘as is’ without vetting its feasibility.
Ultra low cost pricing is a common strategy for offshore providers to gain market share. In this case, unfortunately, it did not leave them much margin room to validate the client requirements or assign enough experienced staff. As a result, the provider missed gaps in the software architecture and did not fully understand the client’s needs and expectations. Not surprisingly, each version of the delivered code did not meet quality expectations. Furthermore, the cultural, time and language differences hampered alignment around expectations and trouble-shooting. The provider tried to redress the quality issues by throwing more staff at the problem – and then tried to get the client to pay for them. Not only did this generate more friction in the relationship but it also failed to address the root cause of the problem namely misaligned goals, poor Indian staff quality and an unbridgeable cultural and linguistic divide.
This is not a case of a single deal gone bad but rather one example of the real difficulties commissioning knowledge-based work thousands of miles away. This story did not end well. The initiative had a target budget and delivery of $3.2 million and 7 months respectively. It eventually was delivered in 22 months for a total cost exceeding $65 million.
Blaming one party or another is too simplistic. Failure has many fathers. Business conditions have fundamentally changed – and not in India’s favour. For one thing, India is losing its luster as the lowest cost place to undertake IT activities. According to 2010 U.S. Bureau of Labour Statistics, India’s average per hour cost advantage has shrunk to only 6-7x U.S. rates (versus a 20x times advantage 10 years earlier). Furthermore, the quality of the Indian workforce has never lived up to expectations. The Wall Street Journal has reported that 75% of technical graduates are unemployable by their IT sector. Finally, bridging the relationship/cultural divide has proven to be more challenging and pervasive than anticipated. In all its forms, distance really does matter.
At the same time, Canadian IT service companies have become more competitive, taking advantage of moderating Canadian wage rates, a steadily increasing, educated (and stable) workforce and a growing sentiment that we need to cultivate strong local businesses. The emergence of globally competitive Canadian IT services firms is giving North American companies more choice, not to mention highlighting the value of good old fashion Canadian innovation and hard work. To wit, QA Consultant’s roster of blue chip clients such as Loblaw, Bank of America, Praxair and Canadian Tire, demonstrates that leading North American firms recognize the business and reputational advantage of staying closer to home when outsourcing key processes.
Most likely, the optimal outsourcing strategy will include a mixture of local and offshore operations, with the ultimate decision based on an assessment of total delivered cost, the importance of local control and predictability and; a prudent evaluation of brand and intellectual property risk. Managers should approach these decisions objectively and not be afraid to challenge conventional wisdom that lower cost and higher performance can only be found offshore.
Syncing your strategy and supply chain is a ticket to superior performance. There are many examples of market-leading firms with strategic congruency including Dell,Walmart, Nordstrom, Cisco and McDonald’s. These firms diligently manage their supply chains to support their core positioning and deliver superior value — not to mention creating industry barriers to entry. For example, Walmart has achieved outstanding operational performance by developing sophisticated inventory management, logistics and procurement systems. These capabilities have played a key role in Walmart delivering on its everyday-low price brand promise while achieving industry-leading margins and profitability. In another case, Dell vaulted to the leadership of the PC industry in the 1990s by offering low-cost and customized products through a build-to-order manufacturing model backed up by extensive procurement and inventory-management competencies.
Most companies, however, are not strategically coherent. This can occur for a variety of reasons. For example, firms competing in multiple product categories face a myriad of competing demands from different product teams and functional departments, leading to a convoluted supply chain design and bloated product portfolio. In other cases, weak centralized management control combined with an outsourced and global supply chain will often result in misalignment. Finally, some firms do not posses a consistent strategic position in their marketplaces. Instead, supply chain decisions ebb and flow depending on short-term market conditions rather than long-term considerations like sustaining a differentiated market position.
One of our consulting projects illustrates the causes and dangers of supply chain incongruence. We were engaged by a customer-driven industrial goods company to help fix its customer satisfaction problem. The company was losing revenue, facing higher cost-to-serve expenses and experiencing historically low customer satisfaction scores. Its distributors were getting short shipped of high-velocity items and incurring extra costs through persistent errors in filling orders. After a thorough analysis, we discovered the problem was not localized to the logistics group (as assumed by management) but had to do with the design of the supply chain. Over time, major parts of its operations had drifted away from the firm’s core positioning around maximizing customer satisfaction. Specifically, production planning was being under-resourced and the product management and procurement teams had quietly (and independently) shifted their focus towards launching multiple products and aggressive cost reduction respectively. Our solution got their supply chain back on track by enhancing their product life cycle management policies, improving order fulfillment capabilities and moving production to a more flexible manufacturing model.
Senior leaders need to develop the right supply chain and capabilities for their business strategy and keep it there. To do this, we recommend a simple three-step approach:
Although many companies pursue a hodge-podge of strategies, they tend to focus on a couple of parameters (singly or in combination) like cost leadership, premium positioning, or service excellence. However, many managers may not know what levers drive their success and what to leave for their competitors. By undertaking a thorough strategic planning process, leaders will understand their ‘winning’ positioning, where they merely need to meet competition and what they can ignore because of poor strategic fit.
Misalignments often occur when short-term management decisions undercut the optimal supply chain model. This is understandable given the dynamic nature of some markets and quarterly financial imperatives. One example could be the launch of a cost savings initiative for a premium car brand. The purchasing department may choose the lowest cost, but least reliable and innovative, parts suppliers. Managers need guiding policies and discipline to ensure their supply chain decisions and capability investments efficiently reinforce their core business strategy and value proposition.
As the saying goes, you can’t manage what you don’t measure. I will add the truism that you need to measure the right things, too. Unfortunately, numerous organizations rely on incomplete metrics, which do not measure the link between corporate strategy and supply chain design. Leaders must focus on or identify key performance indicators (KPI) that reinforce strategic coherence. For example, one KPI — ‘shipments on-time, and complete’ – is a good proxy in customer-drive product companies for supply chain performance areas including production, customer service and logistics performance.
In most organizations today, IT is firmly planted near the top of the strategic agenda. Businesses continue to require new software and hardware to interact with customers, manage supply chains, and process transactions. However, the bygone days of CIOs getting a blank check for the latest IT application is long gone. Infrastructure and operating (I&O) cost reduction is now an important priority. Even after multiple rounds of cost cutting over the past few years, many CEOs and CFOs continue to look hungrily at IT budgets that could now approach 15-20% of total spending in many companies. Fortunately, opportunities abound. A proactive and systematic cost reduction initiative could reduce IT expenditures in the short term by 10%, and 25% over the following 3 years.
According to Gartner Research, I&O costs make up 60% of the typical enterprise IT budget. These costs encompass all the activities that deliver IT to the organization, including: facilities, hardware, software, services, labour and network costs. Up to 80% of these costs fall into 3 omnibus areas: data center operations, network fees and supporting the lines of business. Shaving these expenditures is a major opportunity area in most firms. In a 2011 survey of IT executives, Gartner found that only a minority of companies were more than halfway down their IT cost savings path.
There is no magic bullet to reducing IT expenditures while ensuring ‘always on’ computing remains responsive to dynamics business needs. Our work with savvy CIOs has identified many cost reduction best practices, some of which include:
Significant savings of 15-20% can be garnered by consolidating IT through server rationalization, moving to standardized software platforms, negotiating better IT provider terms and by optimizing the data center. For example, many IT managers out of habit or risk aversion put all their computing needs in the most robust and secure data centers. This not need be the case. Lower tier requirements (e.g., development, testing environments) and applications (e.g., training, HR) can be placed in lower-tier facilities with minimal business impact. Furthermore, lower-tier facilities can still be used for hosting production environments and critical applications if they use virtualized failover— where redundant capacity kicks in automatically— and the loss of session data is acceptable (as it is for internal e-mail platforms for example).
Most IT infrastructures operate at less than 15% capacity on average due to uneven demand, decentralized purchasing and “siloed” resourcing. Driving up utilization through grid or virtualized computing is a cheaper and easier option than buying expensive hardware & software and building new data center to handle the new assets. “Dedicated infrastructure will usually be an order of magnitude lower in utilization than an intelligently shared infrastructure,” said Gary Tyreman CEO Univa Corporation. “Using grid computing to share infrastructure across multiple applications is more efficient, saves money and simplifies capacity planning and governance.” We have seen many companies use server virtualization and grid computing to boost IT utilization rates in excess of 75% while reducing energy, facilities and operating costs.
Target power and cooling efficiencies
Power and cooling are significant cost centres and barriers to higher IT utilization. Many companies can cut 5-20% in operating costs by deploying energy-efficient power and HVAC equipment and making simple infrastructure upgrades. Furthermore, augmenting cooling can also boost scalability. In many cases, older data centers have dated air-conditioning systems that limit the amount of server, storage, and network equipment that can be placed in these sites. Capacity can often be inexpensively and quickly improved by upgrading infrastructure cooling efficiency, using free cooling and installing energy management systems.
Adding hardware, software and facilities isn’t always the most direct or effective way of making applications more available. The vast majority of IT downtime is the result of architecture, application or system design flaws not hardware or software problems. Instead of looking first to upgrade the infrastructure, smart firms are adopting integrated problem management capabilities that gets to the root cause of problems, significantly reducing infrastructure costs and maximizing application up-time. Additionally, major cost savings can be gained by pushing IT support down from expensive tiers to lower, less expensive tiers that are able to satisfactorily resolve the user’s issues. Right-sizing IT support should include the deployment of low cost, self-service portals to handle issues like password resets and ‘how-to’ queries.
These days, the cost of IT is too big to be ignored. CIOs can quickly increase IT’s returns on assets and operational performance without increasing business risk by: thoroughly understanding their cost base (and how it compares to their peers); diligently pursuing ‘low hanging’ cost reduction opportunities and; deploying new architectural and virtualization schemes that deliver more IT for less money.
Recent advances in digital fabrication technologies have the potential to revolutionize how companies build products and target consumers. Manufacturers can now produce many customized products and prototypes ‘when needed, as needed’ with the same economics as high volume production. DF technologies will transform many industries including apparel, consumer & industrial products and healthcare – as well as local economies, which may experience a manufacturing revitalization. Savvy manufacturers are exploring how they can leverage these new technologies to compete better.
The rapidly evolving field of DF is doing for manufacturing what the Internet did for information-based goods and services. DF turns traditional, volume-based manufacturing economics upside down. In the conventional “subtractive” production model, the existence of scale economies means that it costs much more money to produce one unit than it does to produce say 100,000 units. When DF technologies and approaches are employed, it now becomes cost effective to manufacture much smaller batches of customized products on demand, while shortening the cycle time between design and production.
Not surprisingly, DF has disruptive characteristics. “3D printing can provide the garage entrepreneur with the same productive capabilities as the large corporation,” says Abe Reichental, CEO of industry leader 3D Systems.
At the heart of DF has been the development of additive-based technologies like 3D printers. These machines allow firms to take digital designs and rapidly print (i.e. build) products or parts from a variety of materials using bonding or fusing techniques. The 3D printer’s advantages in programmability, quick set up times and rapid change-overs enable firms to produce small batches and prototypes for the same cost per unit as long production runs. Furthermore, companies can rapidly adjust production to meet customer demand and changes in taste.
3D printing is best suited for products or parts that are expensive to inventory, need high levels of customization and require quick production runs. In the healthcare sector, the 3D printing future is already here. Over 10 million 3D-printed hearing aids are currently in circulation worldwide. 3D printing is being adopted by industry leaders such as GE, Medtronic, Boeing and Mattel as well as a host of smaller enterprises to make a myriad of items such as aerospace parts, iPhone accessories, orthopaedic implants, jewelry and toys.
The future looks promising: additive technologies are evolving on a path similar to Moore’s Law: machine capability is growing while cost is decreasing exponentially. Jeff Immelt, CEO of engineering giant General Electric, is convinced. “I think it’s going to be big, I really do… [particularly for] shortening cycle times between designing products and making them.” This advantage could help North American manufacturers compensate for higher wage costs compared with those in emerging economies such as China.
Of course, DF has its limitations. The technology is not mature enough to handle large or complex products. Furthermore, additive technologies cannot match the low cost and throughput of conventional manufacturing for routine parts.
Perhaps the most intriguing facet of the DF revolution has been the emergence of an ‘Open Source’ manufacturing movement. Booze & Co. describes this as the rise of a ‘Maker Culture’ – a self-organizing community and supply chain made up of hundreds of connected manufacturers, consumer groups, on-line shopping sites, and hacker groups.
The Maker Culture encompasses an ecosystem of players. Online fabrication services like i.materialise and Sculpteo provide on-demand 3D printing for personalized small volume production, at rates that are affordable to individuals and small businesses. Customers forward a digital design and receive the corresponding physical item by mail a few days later.
New open design repositories and DF-powered supply chains are sprouting up on the Web. Thingiverse is an online hub where people can freely download each other’s designs and programming code for such ubiquitous products as bottle openers, gears, and coat hooks. Distributed manufacturing networks like Makerfactory and 100kGarages connect digital manufacturers directly with a global market. Potential customers post job requests, which are then bid on by individual fabricators.
Similar to their programming cousins, Makers are forming open source collaboratives and workshops around the world. These spaces are not centrally owned or organized, but they share information collectively and collaborate on each others projects. Makers are expected to publish their plans and specifications, typically under an open source license. This allows others to copy, adapt, and co-develop designs, along with ensuring credit and mutual access to ideas. This cultural shift has the potential to germinate a diverse, dense and innovative network of local vendors centered around large original equipment manufacturers or by industry.
The rise of DF has important implications for every manufacturer. Those that embrace the technological and cultural opportunities will benefit from lower production costs, greater innovation, a faster design-to-build cycle, and the support of a more responsive supply chain.
Companies regularly collect reams of data from their customer interactions and operations. Increasingly, they are looking to build capabilities that can synthesize this raw asset into actionable insights (a competency known as Data Analytics), dramatically improving operational performance, enabling promotion & product ‘mass customization’ and spawning new business models. Leveraging data, however, is easier said than done. Many companies do not have a data-analytics vision and, therefore, tend to underestimate its potential impact. Before investing in capabilities (the combination of talent, technology and math), managers should first consider how analytics can transform their business.
For select firms, data and the capabilities that manage it is a competitive differentiator, on par with other valuable assets like a brand. Recent academic research shows that companies that use DA to guide decision making are more productive and experience higher returns on equity than competitors that don’t. However, not all industries offer the same opportunities. Some sectors like entertainment, construction and services will have modest requirements for high performance analytics, given their market dynamics and structure,. Based on our consulting experience, we believe that companies in retail, manufacturing, banking, telecom, wholesale, and healthcare industries are best positioned to exploit the breakthrough opportunities provided by data analytics.
Brian Ross, president of Precima, a part of the LoyaltyOne analytics solution is on the front lines of transformational DA. “We believe that today’s advantage is quickly becoming tomorrow’s necessity. The first step in this transformation starts at the top. The C-Suite has to establish the long-term vision and align the organization to build the capabilities, processes and tools.” Strategy-minded leaders should consider the following four areas for breakthrough DA:
1. Optimizing operations
Powerful analytics can significantly improve operational performance, reduce cost and minimize risk. For example, collating supply chain data onto one integrated platform will allow manufacturers to better collaborate with suppliers during product development, reducing cost, shrinking development time and minimizing the risk of costly errors. In other cases, analytics can enable the deployment of self-optimizing manufacturing systems. McKinsey has written about impact of data analytics on the oil industry. Operational data from wells, pipelines, and mechanical systems can be collected and analyzed, feeding back real-time commands to control systems that adjust oil flows to optimize production and minimize downtimes. One major oil company has used this approach to cut operating and staffing costs by 10-25% while increasing production by 5%.
2. Transforming marketing & products
Real time data analytics enables companies to quickly customize products and promotional offers on the fly for different customer segments. As an example, retailers can track the behavior of individual customers through their usage patterns — both at their site, through social media and from location-specific smartphones — and predict their likely behavior in real time. Once they can predict behavior, retailers can better drive purchases by triggering customized offers, special discounts, or product bundles. In another example, McKinsey works with a personal-line insurer client who leverages DA to tailor insurance policies for each customer, using constantly updated profiles of customer risk, home asset value and changes in wealth.
According to Brian Ross, “Our most telling case studies today lie in enhanced one-to-one communications between vendor and customer. We have seen DA deliver impressive results of 90+% sales lifts, direct response rates as high as 87% and 4% retention gains.”
3. Enhancing decision making
The capability to quickly process and synthesize large amounts of data opens up the possibility of using controlled experiments to test different scenarios around important investment, marketing and operational decisions. For example, Amazon assigns a number of their web page views to run experiments; they seek to understand which factors promote sales and drive higher user engagement. McDonald’s has equipped some restaurants with sensors that gathers operational data through tracking store traffic and ordering patterns. The gleaned insights are used to model the impact of variations in menus, restaurant designs, and training on sales and operational productivity.
4. Enabling new business models
Firms with world class analytics competencies have the opportunity to germinate totally new business models and services. McKinsey has worked with a global manufacturer that learned so much from analyzing its own data that it decided to create a new business doing similar work for other companies. This service business now outperforms the company’s manufacturing one. Information aggregation is another business model that can be spawned from analytics. Consider this: UPS regularly collects a mountain of data on shipment patterns, energy usage etc. on the estimated 3-5% of U.S. GDP they ship annually. This data could be mined, synthesized and then sold to organizations that provide economic forecasting services.
Within five years, analytics will be a game-changer for many companies. However, building capabilities will not be easy or inexpensive. Developing a bold vision of analytics; transformational impact is a good first step.
Companies in industries as diverse as consumer and industrial products, banking, IT and telecom looking to sustain growth and reduce risk will naturally evolve towards a high degree of business complexity. The level of complexity will be directly correlated with the range of products and services offered, the intricacies of the operations, and the organizational structures deployed. Not surprisingly, complexity (both visible and hidden) come with an expensive price tag including unnecessary input, production, and selling costs as well as operational lethargy. Companies that can eliminate needless complexity and prevent its return will build margins, increase agility and improve resource allocation.
Cutting complexity is a significant enterprise-wide opportunity for organizations. Complexity reduction projects can produce more than $10-million in annual savings by eliminating labour redundancies, consolidating raw material inputs and optimizing supply chain networks. Moreover, indirect benefits such as higher productivity, fewer errors, and better employee engagement were forecasted to generate up to twice the amount of direct savings. The Boston Consulting Group estimates firms with the right strategies and cost transparency can realize a 25% to 100% increase in profit margins.
Excessive complexity is often found in organizations with the following traits:
A strong ‘customer is king’ mission
Many companies go overboard satisfying customers with little regard to the long-term organizational impact. Managers regularly offer new products, features and marketing programs to customers as specials or targeted against small niche segments. Inevitably, product proliferation occurs, and with it comes complexity challenges around inventory management, production scheduling, and sales efforts.
For many firms, a matrix structure is the default organizational model. As these companies grow, so does the complexity especially when the structures and processes are poorly designed and implemented (e.g., overlapping roles & responsibilities, inadequate information flows, unclear decision rights). Complexity is manifested through process redundancy, increased conflict over mandate & priorities, and slower decision making.
Complicated supply chains
Most large firms maintain a large (often global) network of suppliers plugged into a convoluted supply chain. Managing this network is inherently difficult in the best of times. However, one small change in the external environment like adding a new supplier or connecting to a new IT system can dramatically increase operational complexity within the firm.
It should be pointed out that not all complexity is created equal. Clearly, some actions and choices are needed to reduce business risk, maintain core competitiveness and retain important clients. However, problems arise when the revenue or value derived from these activities is far below the actual, enterprise-wide cost of delivering them. The management challenge is to separate the good complexity from the bad complexity and to deal with the bad.
To do this, managers need visibility into the problem, some strategies for tackling complexity across the organization and the fortitude to prevent its return.
1. Understand the problem
You can only fix what you can see. Conduct a product, department or company-wide review to comprehend the scope of the complexity problem. You could start by analyzing how each SKU within the product portfolio or extensive activity in a major value chain contributes to revenue, margin or enterprise-wide cost.
2. Identify the culprits
Complexity follows the “80/20” rule – typically, 80% of complexity will trace to 20% of products or activities. The analytical challenge is to identify these 20% margin-killers, while safeguarding “good” complexity like strategic stock keeping units (SKUs) or prudent risk management activities. Once the culprits are identified, managers should break them down into their component parts for analysis. For example, SKUs can be broken down into ingredient and packaging inputs. A value chain can be mapped into discrete processes, touches and approvals etc.
3. Start Pruning
Once managers have the data, it’s time to reduce the logjam. Below are three common strategies for cutting complexity:
Consolidate and streamline
With products, look for opportunities to eliminate poorly performing SKUs and to consolidate the number of raw material and packaging inputs that go into the remaining portfolio. To reduce operational complexity, consider ways to minimize or remove unnecessary touches in areas like internal reviews, team & communication practices, and sub-optimal processes.
Bundle to increase standardization
Some companies have the ability to standardize complexity. For example, automotive and PC makers have been successful at combining dozens of product features, styles etc. into standard consumer bundles that could more readily be manufactured, inventoried and sold in volume.
Price for complexity
Some businesses must learn to live with certain complexity due to key client or regulatory demands. In these situations, managers should look to recoup some of the cost of complexity by raising prices – and communicating these reasons to customers so as to manage churn.
Pruning can often be the easy part. The bigger challenge might be ensuring the complexity doesn’t not return. Managers need to take steps like instituting disciplined product line management systems to make sure complexity does not creep back.
Although a strong customer focus, powerful supply chain or large product portfolio can differentiate a company, it can also burden it with undue complexity – much of it hidden and insidious. Firms can unlock significant savings and accelerate the speed of their business by systematically tackling the complexity challenge.
For North American companies looking to stay competitive, outsourcing some or all of their back-office business operations to India has achieved the status of dogma. However, in the past couple of years poor outcomes, changing cost dynamics and continued cultural challenges have swung the value and performance advantage back to North American providers in many cases.
The times they are a-changin’
Firms migrated operations to India to save money, focus on their core competencies, and move way from a fixed cost structure. Today, faith in offshoring must be tempered by reason. In the last few years, India’s significant advantages have yielded to some harsh economic realities. New cost dynamics and the reality of doing business halfway around the world with a very different culture have reduced the attraction of offshoring many operations, particularly those in knowledge intensive industries.
India’s fading appeal
Four key developments, unlikely to dim in the medium term, are contributing to offshoring’s declining appeal:
Shrinking wage differentials
India’s primary advantage, low labour costs, has been steadily declining. According to the U.S. Bureau of Labor Statistics, India’s average per-hour cost advantage in 2010 had shrunk to only 6-7 times U.S. rates versus 11 times the rate in 2001. This shrinking differential traces to a combination of Indian wage inflation and North American wage moderation. If present trends continue, this gap could shrink to five times the U.S. rate by 2014.
Pervasive cultural challenges
India remains a culturally challenging place to do business; a situation unlikely to change in the medium term. The differences–language, cultural mores, business practices–generate high indirect costs by introducing complexity, miscommunication and risk. Furthermore, persistently high labour turnover in all Indian firms complicates attempts to close this ‘cultural gap’.
Higher than expected administrative costs
When they began outsourcing, firms understood there would be transaction costs — travel, communication, compliance and relationship management. What virtually every company has experienced are administrative costs typically three times higher than their estimates and all tracing back to geographic and cultural challenges. In some cases, these costs can make up close to 20% of the total project cost.
Increased business risk
Today, effective risk management (e.g., protecting intellectual property and sensitive data, business continuity) is a strategic prerequisite for many companies. Lingering doubts remain that sensitive data and intellectual property sent over to India (or any other emerging economy) is as secure as it would be in North America. Not surprisingly, some government regulations continue to prevent certain types of IP and sensitive data from leaving North America. Furthermore, India remains in the center of one of the world’s most dangerous regions, with instability on all of her borders and inside to boot.
Case in point: IT services
IT services provide a good illustration of the challenges of offshoring. For the past 10 years, CIOs and professional services firms have enthusiastically offshored to India large swathes of their IT work in order to reap the advantages of lower wages and round-the-clock development.
In many cases, however, the promise has not kept up with reality. India no longer possesses the same IT cost advantage versus innovative Canadian firms. Alex Rodov, managing partner of North America’s largest dedicated software testing firm, QA Consultants, contends that “Canadian IT labour rates on average are no more than 20% higher than India’s. After you factor in the high administrative costs, lack of visibility and hassle of doing business around the world, then our delivered costs are roughly equivalent.” Secondly, India’s workers continue to suffer from poor productivity. Despite working in modern facilities, most Indian IT workers (including recent grads) lack basic technical skills and rudimentary English language proficiency. In fact, the Wall Street Journal has reported that 75% of India’s technical graduates are unemployable by their IT sector.
Finally, the integrated structure favoured by most Indian software enterprises — firms develop and test their own code — poses real quality and delivery risks. “This [model] often leads to poor outcomes. Testing should never be done by the same firm and people writing the code,” says Rodov, “as they lack objectivity and independence. Furthermore, when a project runs late or is over-budget, the same Indian firm will prioritize development, often cutting corners with vital testing operations.”
For many business operations the pendulum is beginning to swing back to North America. Many companies have done the math and now realize that some local providers can deliver better value and lower risk versus an offshore Indian solution. A forthcoming article looks will look at how innovative North American firms are beating the offshorers at their own game.
Cost savings initiatives are not pre-ordained to deliver sub-optimal results. Failure shares many causes, ranging from timid managers and sloppy implementations to employee resistance and a poor understanding of the firm’s cost structure. What they all have in common is a tactical, short term approach. My firm has devised a better way to deliver real and long term cost reduction. Our Strategic Cost Reduction approach considers cost savings activities not as a one-time event but within the context of driving strategic priorities, capabilities and organizational alignment. We have battle-tested this methodology in over a dozen enterprise-wide, cost reduction initiatives. Below is a simplified overview of our 3-step approach:
1. Align on priorities
Common sense dictates that you aim cost savings efforts against non-core, low priority corporate activities. However, in a complicated organization or in the absence of a comprehensive strategic plan these priorities will not always be apparent. Asking 2 fundamental questions will help shed light on your true cost picture. i) What are the major short to medium term product priorities and capabilities that guide your capital and resourcing decisions? To be focused and ensure proper execution, managers should have a list of 4-6 product and capability priorities needed for profitable growth. And, ii) do the majority of your costs and resources line up against these priorities and capabilities?
Asking these questions can illuminate a harsh reality. In many companies – particularly large, matrixed and decentralized ones – there is a poor connection between key business building priorities and spending. This leads to inefficiencies and waste as well as under-investment in vital parts of the enterprise. When capital and management attention are finite, leaders must effectively and efficiently allocate capital to their key priorities.
2. Focus your cuts
Once a spend-priority misalignment is identified, the key challenge becomes where, what and how to cut – and where to reinvest for growth. We have witnessed hasty executives radically cut costs at the same time carelessly damaging key competencies and hurting morale. On the other hand, we have seen hesitant managers aim only for easy, superficial cost savings, ignoring the considerable amount of fat lurking just below the surface.
This is where SCR comes into play: managers need to cut spending in areas that do not support growth-focused product initiatives and differentiating capabilities. At the same time they should reinvest some of the savings in high potential, business-building programs. To find the waste and inefficiency, managers should take the costs that were not directly tied to identified priorities in step 1 (e.g., cross business/functional costs and expenses associated with non-priority activities) and then reallocate them against the same priorities and core capabilities to get a true read on costs. This can be accomplished by classifying spending into one of 3 strategic buckets. Of course, each firm will bucket their costs differently depending on their competitive position and strategic choices
1) Differentiating products and capabilities that drive support their unique value proposition and growth. Priorities like product innovation, analytics and brand development could make up 50% of a firm’s total cost structure. These will often require more, not less, capital and resources than is currently deployed;
2) Table stakes operations and competencies. Examples of these market ‘cost of entry’ activities include logistics, customer service and manufacturing. They can often yield savings of 3-10% by area through operational enhancements such as Lean or strategic procurement.
3) ‘Keep the lights on’ spending that is used to maintain operations. These cost centers (e.g., HR, facilities management, professional services) frequently have the ability to deliver up to 25% reduction in savings through far-reaching cost reduction strategies like outsourcing or performance cutbacks.
This analysis can yield telling results. We have seen organizations allocate 50% of their available capital to ‘keep the lights on’ activities yet spend only spending 20% of their capital against strategic and growth-focused initiatives. On the other hand, we have seen careless firms expend 55% of their capital on multiple growth priorities (still under spending on each of them!) yet spend only 15% on competitive matching functions that support client retention and basic marketing.
To cut strategically, managers should focus cost reduction efforts against Bucket 3 areas that do not directly support growth, ensure customer retention or build market-beating capabilities. If more pruning is needed, the emphasis would move to non customer-facing Bucket 2 activities. Leaders should be cautious not to mortgage the future by crudely cutting (optimizing is fine) Bucket 1 expenditures.
3. Consider business enablers
In many cases, firms with complex organizational structures, processes and policies will be challenged to cut costs, even with SCR and proven cost savings methodologies. In these environments, leaders should consider more sophisticated cost reduction strategies such as complexity reduction, supply chain re-engineering or in-sourcing expensive outsourced functions. Not only can these methods produce compelling cost savings, but they also can help accelerate program execution and further develop core capabilities.
Firms worldwide will be gauging Samsung’s shift and likely will keep a close eye on the company’s supply chain component, widely reported to be one of its biggest competitive advantages.
Samsung’s Supply Chain Philosophy
Samsung initiated a collaborative plan to foster growth and stability among its key suppliers. According to Samsung’s corporate sustainability report, the company is shifting its “Mutual Growth” program to smaller firms lower on its green supply chain. The CEO is directly responsible for implementing seven key collaborative programs:
- Win-win fund for partner companies
- Timely reflection of raw material price changes in parts purchasing prices
- Temporary registration scheme to promote e-transactions
- Support for indirect suppliers
- Joint technology development center
- Fostering “global best companies”
- Support for recruiting activities of small and medium enterprises
In addition, Samsung offers support to its partner companies in human resources, innovation, communication and corporate social responsibility. This approach to supply chain management has resulted in a strong and loyal network of partners. Samsung also has implemented a number of other methods to ensure sustainability in its supply chain
Successful Supply Chain Management
For Samsung, successful supply chain management (SCM) means tapping into the power of its global footprint. The company’s SCM utilizes suppliers in the developing world and highly industrialized areas. This diversity helps buffer Samsung from economic, natural or political disruptions in the supply chain and also creates a wider customer base.
Another idea Samsung has leveraged is that of being a “fast follower.” The company watches the market for new business ventures, purchasing small, leading-edge companies. Samsung becomes familiar with new technologies through these acquisitions, which deliver expertise, talent and customers. Once it finds an area primed for growth, it pours in cash, ramps up production and becomes a key customer for its suppliers, fostering positive relationships that give it a competitive advantage.
CPFR Method: How Samsung Implemented It
Collaborative Planning, Forecasting and Replenishment (CPFR) focuses on improving supply chain management by combining the intelligence of a variety of partners in satisfying customer demand. CPFR uses a set of template-based standards for supply chain management and partner collaboration. Among the corporations to have used CPFR are Wal-Mart, Procter & Gamble and Samsung.
In 2004, Samsung signed a CPFR agreement with electronics retailer Best Buy for the North American market. The initiative improved efficiency by cutting costs for merchandising, inventory, logistics and transportation. In 2009, the two firms expanded the agreement to the Chinese market, agreeing to enhance each other’s supply chains by supporting and assisting in joint practices, including:
- Monitoring market demands
- Sharing customer feedback
- Working together to reduce operating costs
Six Sigma at Samsung
With a global supply chain as complex as Samsung’s, advanced approaches to planning, scheduling and operations are necessary for stability and success. Since 2004, an innovative program combining supply chain management and Six Sigma has been a key driver of both.
Samsung first researched how Six Sigma was being used at companies like General Electric, Honeywell and DuPont. Methods of matching customer requirements to products and services, while applying lean methodologies to manufacturing, were seen as particularly valuable.
In the end, Samsung determined about 75% of its Six Sigma projects would involve redesigning processes and 25% would focus on process improvement. It then tailored Six Sigma’s methodology to better support Samsung’s supply chain management projects.
In addition, Samsung’s team also created design principles to guide the SCM Six Sigma projects throughout each stage:
- Global Optimum – speaks to a global, rather than local alignment of improvement ideas
- Process KPI Mapping – defines objectives and monitors the process towards management improvement plan goals
- Systemization – a critical component of SCM Six Sigma at Samsung
- Five Design Parameters – used to characterize the changes that need to be managed.
Samsung’s Success Based on Sound SCM
By beginning with a collaborative philosophy and adopting smart supply chain management processes, such as “fast follower,” CPFR and specialized Six Sigma, Samsung has maintained its position as a world leader in consumer electronics.
As the company moves into a diversified business model, it is expected to continue utilizing those methods to remain competitive and profitable, while fostering similar benefits for its suppliers, retailers and other supply chain partners.