Playing in the Champions League: Supply chain lessons from consumer goods companies

Transcription

1 Playing in the Champions League: Supply chain lessons from consumer goods companies Peter De Boeck, Deepak Mishra Pharma executives need to place more value on supply chain excellence and reconsider the way their supply chains are managed. The best way for pharmacos to get up to date on global best practices is to understand how supply chain champions in other industries simultaneously deliver superior performance in cost, service levels, and capital effectiveness. The value at stake is significant in consumer goods, for example, supply chain champions achieve on average 4 percent higher EBIT than their peers. For decades now, executives in the pharmaceutical industry have not viewed supply chain management as especially important. Their indifference appeared to be warranted: high gross margins justified building enormous inventories and did little to encourage management to think about holistic approaches to the supply chain. But that was then. Today, the pressures on the pharmaceutical sector mean that traditional industry mindsets about the value of modern supply chain management practices have to change and quickly.

2 2 For a start, pharmas that intend to grow in emerging markets will have to apply different supply chain models to be successful. What works to distribute products to consumers in Germany or Japan will not be anywhere as near as effective in rural China. At the same time, demand is becoming more diverse; tender markets, for example, increasingly require enormous flexibility in capacity and supply. Quality issues are also driving the need for managers to be accountable for their supply chain practices. As concerns about drug quality become big news rattling consumer confidence and raising regulators hackles there are more and more calls for, among other things, better traceability of batches across the full chain. Furthermore, efficiency programs have yielded results on cost and inventory across key parts of the value chain, but not necessarily to the bottom line. There is a greater need to see how the supply chain operates from end to end. A typical question might be: What is the value of delivering in a more agile way to the regional warehouse if this just leads to one day s worth of additional inventory in that warehouse? Furthermore, research shows that supply chain practices also directly drive differences in performance. In consumer goods, supply chain champions had on average 4 percent higher EBIT than median performers a difference that is directly attributable to superior supply chain performance. Why would this differ in pharma? Initial research shows this could be as high as 7 percent for the pharmaceutical industry 1. These are just a few examples to illustrate the increased demands on pharmaceutical supply chains. Now comes the issue of how to respond to those challenges. Although there are real opportunities for improving supply chain management in pharma, there are no easy ways to do so. Managing the supply chain is a complex and constant endeavor. It is markedly different from working to establish operational excellence at a single supply point, such as packing and shipping from one distribution center. All participants from raw materials suppliers and production teams to warehousing staff and transportation providers need to work together across the chain in a coordinated way to derive the full impact of best practice in supply chain management. This has two direct implications. First, there has to be a clear and easily interpreted supply chain vision. How do we want to organize our supply chain in the future, and why? How does this differ from today? What results do we expect from that new setup? What skills do we need to manage the end-to-end supply chain, and which of those skills do we lack? Without the 1 McKinsey analysis.

3 3 alignment of all stakeholders around such a vision, there are perpetual risks of suboptimizing the process and causing friction and mistrust between the business functions involved. The second implication is that there is no room to delegate a supply chain transformation to a staff function or to one of the line functions. Leading and taking a one-directional commitment is a topic for the senior management agenda. In general, it must be a senior manager the chief executive officer, the chief operating officer, or a business-unit head who directly oversees and steers the improvement program and holds the appropriate managers accountable. As pharma executives think about how to re-invent their supply chains, they may be daunted by the enormity of the task. But they can take comfort from the fact that other industries have blazed most of the necessary trails (Exhibit 1.) This article will spotlight what supply chain leaders have been doing in the consumer goods industry. Manufacturers such as Procter & Gamble (P&G), Unilever, and Nestlé are some of the exemplars companies that can boast long-proven and highly effective practices and continual reinvestment in new thinking about supply chain efficiencies. exhibit 1 #16 SC champions Exhibit 1 Better service performance 90% 10% Top performers achieve both cost and service advantage Top performing companies were found in every category More than 85% of these leading companies also have top-third inventory performance Better cost performance SOURCE: Joint research of McKinsey and Institut für Supply Chain Management, University of Münster: Supply Chain Champions survey, of 32 CPG companies from different categories in food and home/personal care" Of course, it is easy for pharma executives to point to the many differences between their sector and consumer goods differences that do indeed place constraints on the ability to improve performance. Just one example:

4 4 Product portfolios in pharma are far more complex than is typical of families of consumer goods products; average revenues per stock-keeping unit (SKU) can be many times higher. Complexity involves longer production lead times, multi-stage manufacturing, the need to never be out of stock because of the implications for patients, and the stringent quality regulations that govern the industry. The counter-argument is that it is also true that many aspects of pharmas supply chains are simpler than those in consumer goods. For instance, there is little sudden variability and predictability in demand for most pharmaceutical products after launch by contrast with consumer products such as yogurt, mobile phones, or apparel. In short, we contend that the intrinsic differences are not enough to prevent pharma executives from adopting proven practices from the consumer business. So, what are the specifics that pharma managers can learn from their colleagues in consumer goods? Most important, supply chain champions focus on many fronts simultaneously. We have identified three elements that should form part of any successful pharma supply chain vision and transformation, and have tried to set out the practices that distinguish great supply chain performance from merely good practice. These elements are: managing a from-the-customer-back supply chain, mastering complexity management, and excelling at launch excellence. These last two are of increasing importance as the lifetimes of pharmaceutical products shrink. Let s look at each in more detail. 1. From the customer back: An end-to-end view of the supply chain The good news is that over the last five years, many pharma companies have indeed improved the level of transparency in their supply chains. One pharmaceutical company recently testified that it has close to real-time information on its end-to-end inventory levels of global product flows. However, the company s management structures and incentive systems have not moved at the same pace. Despite the transparency that the pharma operations managers enjoy, its inventories are still often managed at a single supply point the local commercial organization, for example. Only a few pharmas have succeeded in transforming their operations so that they can manage their supply chains on an end-to-end basis evaluating and integrating every step from the customer s receiving dock all the way back to suppliers own suppliers shipping departments. For example, it

5 5 is still common for there to be a split in the distribution chain between the technical operations and the commercial function, where operations activities are responsible only for delivering the goods to the country warehouse at which point the commercial function takes over. By definition, that means that pharma is not applying a customer-back approach. To illustrate that point, let s look at what global consumer goods companies are doing. First, in a customer-back supply chain, every relevant decision starts from a clear understanding of what drives value for customers. It is important to understand whether customers put a higher premium on more frequent delivery than on shorter lead times, and then to tailor the service offerings specifically against those customers prioritized needs. For example, P&G s supply chain is targeted at ensuring quality at the consumer s moment of truth that is, when the consumer picks up the Tide detergent or the Vicks cold medication at the shelf. This not only puts the focus of supply chain activity squarely on on-shelf availability but also shows that product quality, merchandising, and packaging quality are influential levers, too. Today, pharma companies are not especially proficient at this level of targeting. We contend that they probably need to pay more attention to it since their customer base is becoming more diverse ranging from retailers to hospitals to government tenders and is thus likely to require different consumer outcomes of the supply chain. Second, the tendency among pharma companies has been to view their supply chains as covering activities from product development to customer delivery and then to split them into an upstream function focused on manufacturing and a downstream function focused on logistics, planning, and customer service. The driver for this was a justifiable need to focus on product quality, good manufacturing practices (GMP), and regulatory compliance in high-growth environments. But the silos that result prevent senior managers from optimizing end-to-end performance. They make it much more difficult to make the appropriate trade-offs among cost, inventory, and service in the situations where all three factors matter a great deal to customers. Consumer goods companies don t split their supply chains. At organizations such as Unilever, supply chain responsibility and accountability are clearly tracked from farm to shelf. This enables real end-to-end optimization in how the supply chain is organized and resourced, how cross-cutting processes such as sales and operations planning (S&OP) work, and how incentives are shared. Third, true customer-back supply chains go beyond the boundaries of the company itself. High levels of cooperation (with retailers, suppliers, and

6 6 third-party logistics providers) jointly drive improvements on an end-to-end basis, ensuring that there is no suboptimization at the company level. P&G and Unilever have deep collaborative supply chain relationships with major retailers such as Walmart and Tesco and also with major distributors in emerging markets such as India. Together with senior managers in those varied retail channels, P&G managers plan joint sales targets, inventory levels, and replenishment frequencies as well as the transportation routes that best optimize end-to-end supply chain costs. Fourth, most consumer goods companies are expert at differentiating their supply chain models according to their products and customer segments. For example, P&G regularly differentiates in how it configures and plans for high-volume, low-variability products focusing on replenishment rather than forecasts, configuring factories for scale and long batch runs, and organizing just-in-time supplies of raw materials. For its promotions or new products, where the volumes may be lower but the variability can be much higher, the company deploys more of a push approach or engineers more agility into the appropriate supply chain configuration, which is supported by a forecast. This means that the endto-end chain for a product is planned according to its size and product characteristics that is, according to demand variability. With this segmentation, most consumer goods companies also stand out for their seamless cross-functional processes in particular, for their activities with S&OP, new product development, strategic planning and capital expenditure, and order to cash. These processes genuinely make it easier to reach decisions that are the best mix of cost, service, agility, and other relevant factors. For example, most fast-moving consumer goods players use an S&OP process, backed by market-based demand planning, regional supply planning, and site-based scheduling. Those efforts are tightly integrated not only with financial planning and budgeting but also with management of commercial activity in order to best balance supply and demand. For their part, most pharma companies still tend to place long leadtime internal orders between their commercial markets and their global manufacturing hubs a practice that can create frequent disconnects on the supply side and limit the organization s ability to react quickly to changes in demand or margin structures. Fifth, the consumer sector is heavily dependent on key metrics. Most producers of fast-moving consumer goods gauge their supply chain performance not just on conventional measures such as inventory levels or cost of goods sold (COGS), but also on metrics that are shared with their commercial functions such as gross margin, customer-service levels, and

7 7 time-to-market, appropriately supported by joint-reward structures. This ensures that the companies supply chain functions manage the careful balance between delivering the commercial goals and optimizing supply chain functions. If pharma executives are to determine whether their supply chains are truly customer back, they have to judge the progress of their supply chain transformations against each of these five characteristics. 2. Mastering complexity management: Simpler is better Many companies certainly pharma companies struggle with mature portfolios that generate a great deal of complexity and drive hidden costs within the system. Some organizations have been successful at rationalizing their product portfolios, yet very few have been able to scale those efforts from one-off SKU rationalization to a continuous approach to complexity management that is part of the institutional fabric of the organization. One beverages company has recently put in place a cross-functional process for managing its product portfolio. The process spans its R&D, marketing, and supply chain operations; the cross-functional team meets quarterly to make joint decisions about new products, rationalization, and harmonization of SKUs and packaging formats. The group s value engineering and technology decisions drive gross margin improvement across its operations. To help make this cross-functional process even more effective at combating complexity, the beverages producer has designed a number of category platforms combinations of recipes and packaging formats that are fully standardized across the company. The portfolio management process then encourages the adoption of elements of the approved platform standards during new product development; that way, the company can build scale in purchasing while becoming agile in manufacturing. Some pharmas do make use of a similar approach for certain parts, but our observations indicate that such approaches are rarely as institutionalized or as well integrated across functions as they are in consumer goods. Complexity can often be the result of the siloed efforts of sales and marketing organizations, which are motivated to create new products, explore new market opportunities, and respond to emerging customer needs. As they do so, new 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 SKUs in its product portfolio together represented just

8 8 1 percent of total revenues. This complexity comes at a cost; economies of scale dictate that low-volume products cost more to make per unit than highvolume ones. The company found that its production costs for low-volume products were 129 percent higher than those for its best-sellers. Low-volume products also require a disproportionate effort in sales and administrative processes. And they drive up supply chain costs: It s necessary to hold high inventory levels to meet agreed-upon service levels across a broad range of low-volume products. When all of these extra costs are taken into account, the impact can be eyeopening. One company found that 25 percent of its SKUs actually lost money. In the face of these numbers, companies might be tempted to take an axe to the long tails of their product portfolios. However, blind axe-swinging based on sales figures alone often does more harm than good. Some lowvolume products have benefits that outweigh their costs; only through close collaboration across functional boundaries can companies make the right decisions. Such collaboration won t eliminate the need for more carefully segmented supply chain strategies, but it should help to ensure that such efforts are well targeted. 2 A pharma can start to claim mastery of complexity management if it masters a few of the traits of the true supply chain champions. First, a senior executive should check to determine whether proper cross-functional portfolio review processes are in place. Otherwise, complexity management is really just a one-off exercise in SKU reduction. Cross-functional typically means ensuring that the team includes representatives from procurement, supply chain, R&D, and marketing. The dialogues should start from a detailed, fact-based understanding of the true drivers of complexity costs, with full transparency of complexity costs. Second, all of these activities should be embedded in a portfolio review process that combines a quarterly review of the profitability of each product in the portfolio with integrated decision-making about which SKUs to rationalize, value-engineer, and invest in. This should involve more than just the cutting of SKUs; it must enable managers to structure product platforms from which portfolios of products can be produced and must lead to an asset strategy to fully capture the benefits of the efforts. 3. Excelling at product launch: Off to a good start Launch excellence is becoming an increasingly important topic for companies in every industry. This is particularly so in pharma because the window for 2 Christoph Glatzel, Jochen Großpietsch, and Ildefonso Silva, Is your top team undermining your supply chain? McKinsey Quarterly, January 2011.

9 9 benefiting fully from product exclusivity is always shrinking, while cost factors are putting more and more pressure on the traditional methods of building launch inventory. Our experience indicates that supply chain champions focus on several key factors in order to execute their product launches efficiently and effectively. To begin with, they integrate supply chain and R&D tightly into a clear categoryfocused backbone. Fast-moving consumer goods companies are especially adept at this. For example, a major food producer is simultaneously developing a supply chain hub in Europe and an R&D hub in the same location. This initiative has made it easier to build cross-functional category launch teams across procurement, manufacturing, engineering, R&D, and packaging and to form the new product development category platform for each product category. As a result, when regional marketing staff come up with new product ideas, this cross-functional category group can rapidly develop and test prototypes, re-use components, develop quick costings for product and capital expenditure, create capacity in pilot plants to test commercialization and feasibility, and work jointly with material, equipment, and contract manufacturing suppliers to bring the product rapidly to market at the lowest cost. The net result: The food company acquires a major competitive edge. Supply chain champions are also notable for involving supply chain professionals and practices early in every new product development process. They have dedicated activity managers from the supply chain group who project-manage launches. They also tend to involve suppliers in the early stages of the innovation process. Moreover, the champions are quick to use virtual computer-aided design/ computer-aided manufacturing (CAD/CAM) concurrent design technologies to collaborate on new product designs among their manufacturing, R&D, and marketing teams and often with their suppliers, as well. The supply chain champions also stand out because they bring an innovation mindset to their supplier relations and to their sourcing strategies in general. For example, they ensure that their contracts with suppliers of raw materials or packaging materials have flexibility built into the volumes and lead times for their planned new products. In such cases, the champions will often pay for pre-launch stock-building. They will also write innovation partnering clauses into their contracts with suppliers. Supply chain exemplars also have dedicated agile factories, or lines within factories that are dedicated to innovation. The effectiveness of those facilities is gauged by factors such as how quickly they can move new product to

10 10 market, not by conventional measures such as overall equipment effectiveness or conversion costs. Indeed, time-to-market will often be an explicit performance indicator for the supply chain organization. * * * These days, there is a clear competitive advantage to be gained by improving the effectiveness of the pharma supply chain. That s evident in the 4 percent EBIT margin edge that supply chain champions in the consumer sector have over their peers. There is indeed a great deal to be learned from the global consumer goods companies, where the champions excel at addressing their supply chains from the retail shelf backward, combating supply chain complexity, and getting new products to market quickly. The issue of excellence in supply chain management is no longer just about inventory optimization or lowest production costs or rapid shipping it is all of those factors and more, geared to the needs of discrete groups of customers. Pharma COOs must now work to reinvent their supply chain practices, with the executive suite ensuring real collaboration across functions and embedding a new capability in the organization. Peter De Boeck (Peter_De_Boeck,@mckinsey.com) is a principal in the Brussels office. Deepak Mishra (Deepak_Mishra@mckinsey. com) is a principal in the London office. Copyright 2012 McKinsey & Company. All rights reserved.