Courage and perspective in manufacturing: How to align operations and finance around a common vision

Manufacturers, seeking growth, are held back by their legacy. Ancillary activities added during years of global expansion are draining resources from their core strengths. To prioritize spending and investments strategically, they need to refocus investment on the narrower set of core activities that give their products a competitive edge. This white paper explains how to do so, bringing the finance and operations functions together in support of the overall strategy.

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Courage and perspective in manufacturing How to align operations and finance around a common vision


Berlin Peter Behner Partner +49-30-88705-841 peter.behner Chicago Eric Dustman Partner +1-312-578-4740 eric.dustman Arvind Kaushal Partner +1-312-578-4737 arvind.kaushal Patricia Riedl Principal +1-312-578-4647 patricia.riedl

Düsseldorf Peter Heckmann Partner +49-211-3890-122 peter.heckmann Florham Park Albert Kent Partner +1-973-410-7660 albert.kent Melbourne Benjamin Gilbertson Partner +61-3-9221-1924 ben.gilbertson

Milan Francesco Lucciola Principal +39-02-72-50-91 francesco.lucciola San Francisco Thom Bales Partner +1-415-653-3476 thom.bales

Sydney Tim Jackson Partner +61-2-9321-1923 tim.jackson Tokyo Kenji Mitsui Partner +81-3-6757-8692 kenji.mitsui



About the authors

Albert Kent is a partner with Strategy& based in Florham Park, N.J. A recognized expert on manufacturing strategy, cost reduction, and operations, he works with companies in the industrial, chemicals, and energy industries. Eric Dustman is a partner with Strategy& based in Chicago. He focuses on operations transformation, including strategic sourcing, manufacturing, and supply chain management. Arvind Kaushal is a partner with Strategy& based in Chicago. He leads the firm’s North American manufacturing team and specializes in manufacturing and product strategy, and assessing relative competitive positions across the value chain.

This report was originally published by Booz & Company in 2013.



Executive summary

Many of today’s industrial giants have a problem with their manufacturing footprints. They’re bloated. Ancillary activities added during years of global expansion are draining resources from the core strengths that once fueled growth. Thus it’s harder to prioritize spending and investments strategically. Manufacturers can address this problem by refocusing investment on the narrower set of core activities that give their products a competitive edge. They should de-emphasize or outsource noncore activities that don’t strengthen their competitive position or bottom line. Shifting capital and attention to higher-return core activities will drive growth, expand profit margins, and make manufacturing a powerful strategic advantage in increasingly competitive markets.



The frustrating ritual of manufacturing investment
Anyone who works in a manufacturing company has probably experienced it — finance and operations executives struggling to agree on investment priorities for the next year. The dance goes something like this: CFOs are bombarded with funding proposals from far-flung factories and reflexively bat down the COOs’ initial requests. COOs, in turn, learn to start the bidding well above the amount they really expect to get. Eventual compromises tend to reflect gamesmanship and bargaining power, rather than agreement on the company’s manufacturing objectives. It’s not that finance and operations are natural enemies — they just lack a way to align on the goals of the company to help prioritize investments together. How did we get here? Between 1950 and 2000, a half century of expansion turned many U.S. manufacturers into global giants. But this growth came at a price: a loss of focus on the core strengths that distinguished each manufacturer in the marketplace. Many of these companies invested across a wide range of activities within their manufacturing operations. They made significant investments in new, specialized computer-based manufacturing processes (often to watch them become commodities a few years later); they placed bets on new products that used manufacturing processes and technologies outside their comfort zone (and saw competitors that had more familiarity with those technologies offer their products at lower prices); and they brought in new processes and technologies that worked effectively but applied to only a small subset of their products.



This created a group of unrelated, ad hoc operating models that consumed capital unnecessarily, sapped returns, and made many manufacturers vulnerable to rivals that were more focused. Unfortunately, most companies have not addressed the underlying complexity of their operations. They have added more and more technology and process without stopping to ask whether each element truly adds value. A study conducted in 2011 by the Economist found that executives believe their businesses have become more complex. Moreover, these additional complexities have increased the overall cost of doing business (see Exhibit 1, next page). On average, companies are losing an estimated 7 to 10 percent in profit (EBITDA) as a result of valuedestructive complexity. A reframing of manufacturing investment is sorely needed: to help bring operations and finance together, in line with the company’s strategy, and to make manufacturing more of a source of competitive advantage.



Exhibit 1 An increase in perceived complexity

Yes, substantially more complex 28% Yes, somewhat more complex

86% of executives indicated a three-year rise in complexity

Yes, significantly

86% said complexity is increasing 34% total cost

Yes, marginally 58% 52% No 12% Unknown 2%

No change 12% No, has become somewhat less complex 3% No, has become substantially less complex 0 Has your business become more or less complex over the past three years?

Is complexity increasing the overall cost of doing business?

Source: The Economist; Royal Bank of Scotland; Advanced Institute of Management Research; Strategy& analysis



Creating advantage in manufacturing

Advantage in manufacturing is often misunderstood. It is seen as related either to business strategy, the choice of what products to make and how to meet the needs of customers, or to shop-floor operations, the combination of interrelated processes, tools, people, know-how, and organization that enables a company to deliver on that unique value proposition. Both the business strategy and the operations model are important, but only in the context of what makes a company distinctive — how its mix of product, process, and people enables it to deliver something relevant to customers that nobody else can. Research shows that companies focused on what is core are more profitable. In one study, reported in the Harvard Business Review, Strategy& measured the EBIT margins and shareholder returns of leading consumer packaged goods manufacturers over a six-year period. Companies that closely aligned their way to play in the market with an integrated capabilities system and the full line of products and services enjoyed superior returns by both measures; Coca-Cola, Kimberly-Clark, PepsiCo, and Wrigley were in this group. Companies lacking in focus during this time frame, such as ConAgra and Sara Lee, measured significantly lower on the performance scales.1 Similar results were found in a study of chemical industry manufacturers, which reported that “the TSR for focused, nondiversified, chemical firms is nine percentage points higher year-overyear than that of diversified companies.” The authors posited that these companies are “more internally coherent, resulting in more synergies, more management focus, and potentially larger scale in their selected markets.”2

The business strategy and the operations model are important, but only in the context of what makes a company distinctive.



Bringing operations and finance together

Creating focus in operations requires manufacturing leaders to ensure that the operational plan is focused on supporting and leveraging the company’s core: the strategic value proposition and handful of strong capabilities that truly differentiate it in the market. Operations leaders need to ask themselves what it is about their manufacturing operations that helps make their products distinctive. On the other side of the coin, finance leaders also need to ask themselves a question: Does the investment plan support our true core capabilities, or are our investment dollars focused on supporting operations that are not really differentiators? And once the noncore areas are understood, these leaders need to determine how to address them: Should investments be reduced (focused on an austere version of repair/replace), or should these noncore operations be outsourced? It takes an informed perspective to come to the right conclusions. In many companies, the answer may not be obvious, because it hasn’t been thought through or articulated. It will also take courage to act on the conclusions you reach, and to make the hard choices that align shop-floor investments with a tightly defined set of competitive strengths. Reorienting manufacturing around a chosen group of core activities is a difficult process that will encounter opposition at many levels. Noncore activities may have deep roots in the organization, and powerful defenders would naturally resist any attempt to outsource or scale back their fiefdoms. Success therefore requires a full commitment from top executives and a sustained effort to gain input from the entire organization and deal effectively with people’s concerns. For finance and operations leaders, this is a moment rich in opportunity. Getting it right will free up substantial capital, improve focus, and reduce cost. It will provide you with an operations and investment game plan that could be sustainable well into the next five years.



How to find your core

At the manufacturing level, setting your agenda begins by defining what complexity is important and what complexity is not helping. In other words, you need to understand what is “core” to your business (aligned with your company’s strategy and distinctive capabilities system). The identification of these activities requires a deep understanding of both the economics of the product and what the customer truly values. You begin with a holistic review of the product portfolio and the supporting manufacturing operations to identify core strengths. Your analysis must span both products and manufacturing processes. Examine your assets, processes, and facilities to determine which ones support a sustainable differentiating capability and therefore help your company deliver on its unique value proposition. For a sample evaluation template, see Exhibit 2, next page. When thinking about activities, it’s important to be able to divide them into three strategic categories — core, noncore, and situational (see Exhibit 3, page 12). • Core: A manufacturing activity is core when it contributes to the company’s value proposition. It may contribute to the distinctive features that give a product a differentiating advantage in the marketplace. Or it may be the source of cost advantages through process technology, scale, location, or other factors. A better understanding of these core strengths will enable better decisions about how to develop, expand, and defend your competitive advantage — not just in the manufacturing function, but throughout the enterprise. Direct your capital spending to these areas of existing or potential advantage; create systems to protect these important processes and product technologies from competitors; and adjust your organizational structure to take full advantage of key capabilities across internal boundaries.



Exhibit 2 Criteria for evaluating manufacturing activities (core vs. noncore)

Overall market requirement and degree of differentiation in the marketplace Sources of advantage (e.g., design-driven cost reduction, design for manufacturability) Product Linkages and points of integration with other advantaged products Relative cost position Degree of sustainability of product advantages Relative cost position · Inherent advantages (e.g., process technology) Manufacturing · Structural advantages (e.g., production factors) · Systemic advantages (e.g., a lean operating system, the ability to quickly customize, supply policies) Degrees of integration among processes and capabilities Extent to which process and capability advantages are sustainable over the long term

Source: Strategy&

• Noncore: When it comes to noncore activities, your examination also may reveal some troubling truths. Many companies hold a position in the marketplace that is based on the legacy effects of previous investments, reputation, and old capabilities that no longer represent a competitive advantage. The position may be declining, but it may be hard to let go of these activities, even if they do not count for much in today’s markets. Disconcerting as such insights may be, they highlight previously unseen risks. A closer look at these vulnerabilities will enable you to eliminate them, either by deemphasizing an activity, or by taking the steps necessary to make it a core strength again.



Exhibit 3 Analysis of the core value of a manufacturing activity

Core This activity is responsible for a current or potential differentiating advantage in the marketplace Delivers a cost advantage through process technology, scale, location, factor costs,distribution, etc. Connected to an advantaged process in a way that cannot be economically separated Provides systemic advantage (as part of a general process, like lean or fast new product launches, which also lead to inherent and realized advantage) Ideally these advantages are sustainable and can enable continued sustainable advantage in a core product

Situational It is unclear whether a protectable advantage currently exists or can be created for this activity May offer an advantage but is available to all players (maybe a process technology)—the advantage is not developed by client (but it could be “core” if client’s scale enables client to be one of a few competitors to have access to the technology) Can derive a cost advantage relative to other local or regional options, due to lack of capable suppliers (certain heat treatment processes in China or chroming processes in the U.S.) Is connected to core processes in certain situations but not in others

Noncore This activity provides little or no advantage: no improvement of the product’s differentiation Other options exist to perform the process that are equally or more cost-effective Process capabilities are well understood and executed in the market (by competitors, suppliers, etc.) Separable from a core process In the hands of a competitor, does not confer an advantage Not part of a systemic advantage

Source: Strategy&

• Situational: In the middle are some hard decisions, deemed “situational.” These activities might potentially create a sustainable advantage under certain circumstances, or they differentiate products in some regions or markets but not in others, or they’re sometimes but not always embedded in core processes. Sometimes a situational operations practice can represent a signal that you have an outlier product — one that differs enough from the rest of your products that it cannot realize its potential under your roof, and the company would be better off divesting it.



Identifying core activities: The ISSR analysis

Many manufacturing organizations have real difficulty in visualizing a streamlined company focused on only a few key areas that really matter. How does that translate into day-to-day decisions and specific investments? To be able to effectively answer this question, and bring people on board, you need a disciplined analysis that can be defended and communicated throughout your organization. We recommend that you assess your activities across four dimensions of manufacturing operations: inherent (I), structural (S), systemic (S), and realized (R). The resulting analytical framework, known as ISSR, sheds light on the decisions and other factors that led to your current manufacturing cost structure. Understanding these factors will help you separate core activities from situational and noncore functions. Then you can make the right choices about which operations to build up and which to de-emphasize or outsource. For each dimension of this ISSR analysis, determine if an activity has a sustainable advantage (see Exhibit 4, next page). • Inherent advantage: An inherent advantage often derives from differentiating technology that enables a manufacturer to create unique value for customers through product design or production processes that competitors can’t replicate. For example, advanced injection-molding equipment with faster cycle times can give you an advantage over rivals using slower machines. A railcar manufacturer might set itself apart by designing cars with straight walls, which offer customers more efficiency than competitors’ curved-wall cars. As the analysis proceeds, consider the technological aspects of this advantage, the underlying intellectual property, the process steps necessary to create it, and the actions that can be taken to enhance it.



Exhibit 4 An ISSR analysis

Typical questions “How do we satisfy the customer product and service requirements?” Location economics Scale and utilization Plant focus and complexity Experience Manufacturing strategy

Market requirements

Probable focus of action Technology investment and product redesign Sourcing/ distribution economics

Product design

Inherent costs

Process technology

“How do we deploy our assets to best serve customers at the lowest cost, and who should own them?”

Structural costs

Supply chain structure

Sourcing policy Inventory policy Customer demographics

Restructuring manufacturing and distribution assets

“How do we manage and control the business operations?”

Service and supply policies Tactical planning processes

Supply chain control architecture

Systemic costs

Systems support and infrastructure

Business processes Enabling structure

Changes to system and organization structure

“How do we maximize ef ciency in the daily work?”

Manufacturing efficiency Material usage Manufacturing flexibility Realized costs

Purchasing skills Distribution efficiency Service effectiveness Operational improvements

Source: Strategy&

• Structural advantage: A structural advantage is rooted in scale: the size and location of a manufacturer’s plants, its level of vertical integration, factor costs, distribution systems, or other characteristics that increase market power or create cost advantages. If you are in a labor-intensive industry, you might gain a structural advantage by locating plants in low-wage countries. Another way of gaining structural advantage is to reduce per-unit overhead costs by consolidating operations in a single plant.



To determine whether a company has a structural advantage over competitors, look at factors like industry structure and the production volumes of various rivals. Also consider whether your manufacturing processes are optimized to create a sustainable cost advantage through tools, automation, supplier integration, or new production technologies. Are there steps that can be taken to bolster structural advantages and their sustainability? • Systemic advantage: Systemic advantages arise from the way the plants operate — the policies, procedures, and methods that define the manufacturing processes. These factors determine the quality of the products and the efficiency of the factories. Toyota’s widely admired lean manufacturing system is a classic example of a factor that creates systemic advantage. It gives the automaker advantages in cost, efficiency, and flexibility. But a systemic advantage can be as simple as finding a better approach to inventory management. • Realized advantage: The actual results achieved on the factory floor. For example, a company that changes over its equipment faster has a realized cost advantage over competitors. It comes down to execution — how well various manufacturing tasks are performed. Without strong execution, other advantages can break down. For example, the cost advantage gained from a better inventory management approach won’t materialize if the people in your plants can’t carry it out. A complete analysis gives a deep understanding of the extent, nature, and durability of the competitive advantages in each product and process. It forms a basis for decisions about where to invest and where to cut back or outsource (see “Restructuring a Large Equipment Manufacturer,” next page). As a manufacturing leader following a core-versus-noncore agenda, you will need to channel spending to activities that give your company a cost advantage in the market, or that make your products valuable to customers in a way competitors can’t match.



Restructuring a large equipment manufacturer
A multinational industrial manufacturer needed to reduce the cost of one line of large equipment as part of an annual investment strategy aimed at creating a low-cost value proposition for this key product. The manufacturer had amassed many investment requests, all geared to reducing cost. At the same time, many of the requests asked for substantial investment in metal bending. An analysis was conducted of coreversus-noncore operations practices, comparing cost structures against those of competitors. The analysis identified the problem: The manufacturer’s metalbending and fabrication processes were too expensive in light of their strategic relevance. Most competitors had reduced their spending in these areas by farming out metal bending to fabricators in lowcost regions of the U.S. and northern Mexico. Guided by the core-versus-noncore perspective, the company decided that it could follow suit without affecting its core strengths in the design and engineering of distinctive manufacturing systems. Outsourcing metal bending would put this noncore activity in the hands of a capable supplier, which was positioned to take advantage of lower labor rates that the primary company couldn’t manage at its own plants. Ultimately, several processes were outsourced or moved to low-cost locales. The company’s union and engineering department wanted to keep the work, and the move required three months of difficult change management. The case was made to the union that outsourcing noncore activities would allow for deeper reinvestment in core capabilities. In the end, the restructuring strategy paid off. It increased the company’s return on capital and earnings per share. Perhaps the best result is the company’s increased focus on return on investment and asset profitability and its new ability to play effectively in the market — with clear support from the union, and a strategic rationale recognized by all stakeholders. As an added bonus, the client was able to reduce investment requests by nearly half — allowing it to focus spending on some of its true differentiators, such as compression and control.



A door to proficiency

One company we know well, a manufacturer of hardware building products, used the ISSR approach to identify core and noncore elements in the production process for one component of the systems — steel security doors. An analysis of each step in the value chain allowed the client to isolate core capabilities. As part of the analysis, activities were divided into the three strategic categories: Noncore: The analytic process identified activities that could be outsourced without compromising a competitive advantage, such as assembly and painting of security doors. Situational: The process also showed that the uncoiling and the cutting of sheet metal for the doors aren’t core strengths but are so tightly linked to the core activity of metal bending that they probably shouldn’t be outsourced. Core: Interestingly, only the bending of metal turned out to be a truly core capability (because of the complexity associated with correct and trouble-free programming of bending equipment). In our assessment, there was little about manufacturing security doors that was actually core — most of the processes were easily reproducible by other competitors, even startups. Through work with sales and marketing, it became clear that one major core element was the role of the final product itself. Although the doors themselves aren’t competitively advantaged, it was important to have a product that could be specified together with the higher-margin security hardware. Any manufacturer can reap the benefits of a core-versus-noncore manufacturing agenda by determining which of its many activities underpin a key competitive advantage, and focusing its investments, resources, and management attention on those areas. Other aspects of production may be outsourced or, if they can’t easily be separated from core activities, targeted for deep spending cuts.

Any manufacturer can reap the benefits of a core-versusnoncore manufacturing agenda by determining which of its activities underpin a key competitive advantage.



Toward a more focused future

In many companies, it’s time for finance and operations to join forces around a common plan to recapture the focus their organizations lost during decades of global expansion. Working together, they can boost investment in the core strengths that set them apart from competitors. Shedding or de-emphasizing noncore activities will free up capital, cash, and talent for the activities that support the company’s differentiating capabilities and create unique value in the marketplace. It’s not easy — making the needed changes will take real leadership and a dispassionate perspective on what really matters. But we have seen enough successful cases to know that it can be done, with a little bit of courage and perspective. The battle is worth fighting. Refocusing on core strengths enables a manufacturer to simultaneously cut costs and boost investments in high-return activities. Financial results will improve as manufacturing operations create sustainable competitive advantages. Sales, profit margins, and returns on assets will all rise as investments shift from low-yielding noncore functions to the core activities that produce more bang for the buck.




Paul Leinwand and Cesare Mainardi, “The Coherence Premium,” Harvard Business Review, June 2010.

Kees Cools and Marco Zuijderwijk, “Wisdom of Winners,” ICIS Chemical Business, Jan. 4, 2013.



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This report was originally published by Booz & Company in 2013.
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