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The Supply Chain Shift: Taking Manufacturing from a Cost Center to a Profit Driver

March 2, 2013
Manufacturing and operations can unlock significant latent value by developing the capabilities that support a company’s strategic value proposition. Winning companies already are starting to tap into that value.

A wave of change in business strategy is quietly transforming U.S. manufacturing. Just a few years after the deepest recession in a generation forced many companies to slash costs and outsource production, the focus in many companies has shifted back to growth. For manufacturers, this means finding ways to ramp up production in an environment where every dollar counts.

Growth doesn’t come easy in a sluggish economy. It is especially difficult in a time of major change in purchasing patterns, driven by technology, consumer demand and the retail industry. Consumers have learned to expect variety in products increasingly tailored to them – creating tremendous complexity for traditional supply chains and for operations in general. Every company, even those which haven’t invested heavily in R&D in the past, is feeling the pressure for novelty.

In addition, much of the current wave of business growth is moving away from traditional channels. For example, groceries are increasingly sold now in outlets that would have seemed like peculiar homes for them a few years ago: dollar stores, club chains and drug retailers. Simple healthcare is dispensed through clinics operated by pharmacy chains. Consumer electronics and apparel are sold in manufacturers’ own outlets, while shoppers are increasingly accustomed to buying everything, up to and including automobiles and real estate, through the Internet.

In this environment, manufacturers looking to capture a larger share of a slowly expanding pie can no longer count on their existing branding or merchandising tactics. They need to distinguish themselves by adopting a more strategic approach. This means changing supply chain functions from order-taking cost centers into drivers of profit and competitive differentiation. Moreover, with many companies eliminating the COO position, the door is open for operations executives to play a larger role in shaping corporate strategy.

The details will vary from one company to the next, but some aspects of manufacturing strategy will be the same for all. Since competitive pressures are higher, there needs to be a continuous eye toward innovation and speed. To keep pace with the proliferation of channels and shifting customer preferences, manufacturers need to make more deliberate choices about the right array of products, the best way to shorten lead times, and the most effective means to cut production costs while making goods that better attract customers. In short, manufacturers need supply chains that are “fit for purpose,” i.e., oriented to the particular way that the company creates value through its products.

This means that the supply chain must be capable of producing distinctive goods, ideally in a way that no one else can copy, and that is instantly recognizable as part of the company’s identity. At the same time, the supply chain must be flexible enough to manage increasing complexity and to shift rapidly, when necessary, to meet changing customer demands.

This challenge represents an unprecedented opportunity for the executives who lead the manufacturing organization. They can align their production capabilities with the company’s broader strategy, redesigning the overall supply chain architecture to reach distinct market segments with products tailored for them. With a better understanding of their capabilities, the value that the market places on their products and the implications for their asset base, they can help develop a supply chain and manufacturing footprint that distinguishes their company from competitors.

Capabilities: The Critical Choice

The new manufacturing agenda revolves around capabilities. No company can excel in every area. So executives must identify and cultivate the manufacturing and supply chain activities that serve the broader agenda, and deemphasize or outsource the rest.

These strategically important capabilities can be divided into two groups. The first are “competitive necessities”: every company needs them just to stay viable in their sector. The second are “distinctive capabilities”: those which create a competitive advantage by delivering value to customers in ways competitors can’t match. Each company bases its strategic value proposition, or “way to play” in the market, on that second group of differentiating capabilities—the unique, cross-functional combinations of processes, assets, tools, talent and culture that set the company apart in the marketplace.

For example, three companies might produce cosmetics; they all possess competitive necessities in distribution, packaging and back-office operations just to survive. But their distinctive capabilities would be very different. The first company might define itself as a value player, offering products with the features customers want most at a lower price than competitors; it needs a low-cost manufacturing footprint and supply chain capabilities that allow it to quickly move products to the right outlet stores and other centers for value shoppers. The second company might go to market as an innovator focused on technically sophisticated new products; it needs highly flexible turnarounds and the ability to add new fragrances and experiment with new packaging. The third company, a premium player, needs strict quality standards, investments in mission-critical IT, and direct links between R&D and the shop floor.

Strategically-minded manufacturing executives align their priorities in this way with the company’s way to play. They allocate resources—money, staff and managerial attention—to the manufacturing activities that enable the company to deliver on its unique value proposition. They devote less time, attention and resources to the other activities. They may choose, for example, not to purchase some types of production machines, even at the risk of being less than world-class, because those fabrication capabilities are not linked to the company’s overall strategic direction. They would provide advantage to another company, but not to this one.

Turning manufacturing into a driving force behind a capabilities-driven strategy requires an assessment of all assets, operations and processes to distinguish the distinctive capabilities—which differentiate a company—from the competitive necessities that it shares with competitors. Both of these advance the company’s strategic value proposition, but they require different types of investment.

For competitive necessities, executives should conduct a make/buy analysis. If the product or process can be obtained at a reasonable cost from an outside supplier, it’s likely an area to minimize investment and a candidate for outsourcing. By contrast, differentiating capabilities should rarely, if ever, be outsourced. Outsourcing your distinctive manufacturing capabilities, in particular, will give competitors the same edge you have, and could lead to loss of intellectual property.

Looking at manufacturing this way means making hard choices. Executives must redirect investment and other resources toward strategically relevant capabilities and away from other functions. They will need courage and perseverance to overcome the internal resistance sure to arise from areas targeted for cutbacks or outsourcing.

Flexibility and a Better Footprint

Among the top capabilities to consider is a more flexible supply chain. By today’s standards, most supply chains have been reasonably flexible; they can accommodate multiple products and relatively rapid production changeovers. But as consumers demand more variety, and expect frequent changes in recipes, portion sizes and packaging, the complexity of the product mix has grown dramatically in the past few years. In the food industry, for example, there may be dozens of versions of products as simple as boxed macaroni and cheese.

By focusing on making a supply chain flexible, rather than on cutting costs across the board, manufacturers can more easily provide shoppers with more variety and, at the same time, help differentiate their goods. They can produce some goods with lower margins, for low-cost channels such as dollar stores and discount club chains—without squeezing profits unsustainably—and, at the same time, offer retailers some unique products that competing stores won’t have. In this way, manufacturing makes the jump from cost center to profit driver.

A more differentiated capability around organizing the supply chain footprint is also critical. Over the years, in their quest for ever-increasing economies of scale, many manufacturers have built up vast networks for plants to churn out whatever products they had the equipment and floor space to produce. These structures weren’t built to handle the complexity and variability that markets now require.

This requires a fundamental change in thinking for supply chain organizations; they have hewed to a cost-containment agenda for decades, and now must think instead about which locations and arrangements will enable the most growth. Typically, this will mean having smaller, more agile manufacturing footprints that can manage variety without being overwhelmed by complexity—often by focusing each plant on one or two activities where its capabilities give it a competitive advantage. After deciding on the role of each plant, manufacturers can link them together in a cohesive, flexible network capable of responding smoothly and quickly to a wide range of customer demands.

Executives are also learning that some of the most prevalent ways of driving down costs—factory automation, outsourcing production to low-wage plants in China and other distant locales—can undermine the capabilities manufacturers need for expansion.

For example: Despite the advantages of automation, some manufacturers are discovering that they are better off with manual assembly in some steps; it can make it easier to introduce variability into their products. Similarly, the long shipping times from low-wage countries have made it harder to rapidly refine the product mix in response to changing customer requirements and market opportunities. This is a major factor behind in-sourcing: moving manufacturing closer to home.

Internal and External Connections

To rebuild their supply chain capabilities, manufacturers may need to renew their connections with other functions. The pressure for complexity affects all of them. Eliminating internal barriers can give executives an integrated, end-to-end view of operations that better aligns supply chain activities with strategic goals.

The experience of a brewing company that needed to improve innovation shows how a supply chain organization can drive value when manufacturing integrates more closely with the rest of the enterprise. For years, the company’s research and development team had worked in isolation, cooking up new flavors in isolation from the brewing operation. When the researchers thought they had a winning recipe, they would “toss it over the wall” to the brewers.

Not enough of these new formulations translated into commercially successful products. But when the company put brewers and researchers together on cross-functional teams, their combined expertise produced more successful new products.

Manufacturers also must forge stronger links with the wholesalers and retailers that carry their products. Historically, mistrust and conflicting priorities have prevented them from working closely together to improve the end-to-end profitability of the entire product cycle, from factory to store shelf.

Retailers have been reluctant to share sales data that could help manufacturers tailor products and delivery schedules to customer demand. Manufacturers, meanwhile, have tried to maximize their profitability through extended production runs of a single product. This approach conflicts with retailers’ preference for deliveries of mixed pallets with multiple SKUs.

More effective collaboration would benefit both parties. As better partners, they can develop a more complete understanding of total costs and total profits across their combined operations. Access to point-of-sale data would enable manufacturers to help retailers expand their profits. Knowing which products are selling well and which aren’t would allow manufacturers to give retailers more of what customers want in a timely manner.

This more integrated approach will require operational changes, such as more-frequent deliveries, that may raise a manufacturer’s costs. But as the overall financial picture becomes clearer to both parties, they can agree on ways to share the benefits and costs of improving the system.

Time to Get Going

Manufacturing and operations can unlock significant latent value by developing the capabilities that support a company’s strategic value proposition. Winning companies already are starting to tap into that value.

If you’re a manufacturing executive, you need to start thinking strategically now. It’s time to shift your focus from bringing costs down to driving growth up. All your innovative efforts should be focused on building the capabilities you need, aligned with your company’s strategic value proposition.

Some capabilities will be competitive necessities that keep you in the game. Some will be differentiated, distinctive capabilities that give you the right to win against competitors. Which is which? That depends on your own mix of products, markets and competitors. In other words, the time has come to be more conscious about the value that manufacturing provides.

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