Less Can Be More for Product Portfolio

https://www.bcgperspectives.com/content/articles/lean_manufacturing_consumers_products_less_can_be_more_product_portfolios/

by Hannes Pichler, Peter Dawe, and Love Edquist

How many varieties of your favorite soft drink do you see on supermarket shelves? Does “diet and decaffeinated, with cherry-lime flavor” appeal to you more than “lemon flavor with energy boost”?

A high degree of product diversity has become the norm across all industries in recent years as manufacturers have expanded their product portfolios to capture new revenue sources. The product variations can be staggering to consider. For example:

• More than ten different fragrances for one fabric-softener product

• More than 30 different refrigerator-door handles for one white-goods brand

• Nine sizes of one flavor of a cookie brand in a single region

Many companies have found that offering a diverse product portfolio is essential for maintaining a competitive edge. However, companies often launch product variations without fully understanding the extent to which the variants will increase complexity and costs in the supply chain or be considered valuable by customers. As a result, the avalanche of new products has often generated higher costs without a clear payoff. U.S. consumer-goods companies, for example, increased the number of new products introduced annually by nearly 60 percent from 2002 through 2011, resulting in significantly higher costs throughout their supply chains. However, those companies’ total sales during that period grew at just 2.8 percent per year, a rate that only slightly exceeded inflation. A similar disparity between the number of products launched and the revenue growth achieved has occurred in Europe, across industries.

Recognizing the Dangers of Complexity

The complexity that results from expanding a product portfolio’s diversity increases costs throughout an organization, but many companies have not recognized the full scope of the danger:

• Production facilities often need to be reequipped each time a variant is processed, which results in downtime that reduces capacity utilization and increases processing costs. Downtime from a single product changeover can exceed ten hours, even if the differences between products (such as size, color, or packaging) are minimal. Experience with clients of The Boston Consulting Group shows that complexity-driven downtime can reduce overall equipment effectiveness (OEE) by up to 20 percentage points.

• The procurement department needs to purchase a large variety of ingredients and materials and enlist a large number of suppliers, making it hard to leverage scale. The higher procurement costs imposed by complexity can amount to 2 to 5 percent of the cost of goods sold (COGS).

• Because it is difficult to accurately forecast demand for a large number of products, fill-rate targets are often hard to achieve and the distribution department is burdened with high inventory levels that increase the net working capital. Some manufacturers end up maintaining twice the inventory level that they actually need.

• Costs for overhead and administration increase significantly as the company struggles to manage a large product portfolio.

• The overabundance of products and high level of complexity make it hard for sales teams to identify, and focus their efforts on, the most valuable products in the portfolio. And because a diverse product assortment often lacks a clear value proposition, the marketing and promotion budget is not spent effectively. Higher marketing costs and lower sales-force effectiveness result.

Although many companies have attempted to reduce the complexity of their product portfolios, their programs have often had a misplaced emphasis on eliminating low-volume products (the “long tail”). But because in many cases low-volume items are produced at different plants and on different production lines, eliminating them rarely addresses the root causes of complexity’s higher costs. Such efforts may also inadvertently result in a decline in revenues and market share because companies often underestimate the value of low-volume products to customers.

Given these challenges, it should come as no surprise that a BCG survey of top consumer-goods executives found that many are dissatisfied with their company’s efforts to reduce portfolio complexity. Although more than 90 percent of these executives indicated that their companies had launched complexity reduction projects, only 15 percent considered their projects to be successful. Many executives were concerned that complexity reduction could be achieved only at the expense of revenues. Many also indicated that they lack reliable market data, so it is difficult to identify the product variants that are the most valuable and thus should be kept. Additionally, executives cited the absence of cross-functional coordination and of senior-level participation as obstacles to engaging the entire organization in complexity reduction projects.

Combining Insights from the Market and the Supply Chain

In our experience, companies can overcome the challenges and emerge with a product portfolio that is less complex without negatively affecting consumer perceptions of the product portfolio’s variety. The solution entails combining insights about the market and supply chain to make the right trade-offs between the value of diversity and the cost of complexity. (See Exhibit 1.) By maintaining portfolio diversity at a significantly lower COGS, companies can achieve higher profit margins as well as tap new sources of revenues.

A food manufacturer used this combined approach to analyze complexity and value within its biscuit portfolio. It found that the wide variety of biscuit diameters among its brands and regions was the main driver of complexity in its manufacturing operations; however, it also determined that consumers did not consider this variety valuable. Applying these insights, the manufacturer was able to reduce the number
of product specifications (including but not limited to diameter) in its biscuit portfolio by nearly 60 percent (from approximately 680 to approximately 280), while reducing the number of SKUs by only 15 percent (from about 2,000 to about 1,700). (See Exhibit 2.) Over the next several years, the company expects to lower its COGS by 4 to 7 percentage points and increase its sales by up to 2 percentage points through this complexity-reduction program.

The combined approach builds on analyses that many companies already conduct. Almost all companies invest significant resources to obtain an in-depth understanding of the market for their products. They conduct market research to identify the strengths of their offerings as perceived by existing and potential customers and as relative to competitors’ offerings.

However, leading companies go further: They determine precisely which product attributes consumers value and then develop a strategy for diversifying products only to the extent required to meet consumer needs. At the same time, they use supply chain insights to standardize the product components responsible for the highest costs of complexity. Combining market and supply chain insights allows these companies to determine which products and attributes are their most successful “platforms” from the perspectives of value and cost. These platforms can serve as the basis for developing offerings that serve new customer needs, price points, channels, or regions with minimal added complexity.

Leading companies focus their complexity-reduction efforts primarily on high-volume products because these items offer the greatest savings opportunities. They also provide the marketing and supply chain functions with a “common language,” including terminology and metrics, to facilitate communication and decision making. And they create full transparency into the costs of complexity to provide a solid fact base for decisions throughout the organization.

Identifying the successful product platforms and the related high-volume items allows companies to target their efforts to optimize their supply chains. Leading companies analyze their production network to understand which specifications or components are the sources of complexity that lead to bottlenecks, downtime, and, ultimately, higher costs. By pinpointing where complexity requires the greatest use of resources, companies gain insights into the types of complexity reduction that will yield the greatest value in terms of supply chain efficiencies. For example, a white-goods company determined that its multiple formats for display and handle cutouts in refrigerator doors drove its greatest supply-chain complexity; however, market research found that these attributes did not significantly affect consumers’ purchasing decisions. The company determined that it could reduce changeover times and free up valuable production capacity by reducing the number of formats by half.

Based on insights such as these, companies can apply several measures to optimize the supply chain. (See the sidebar “Practical Steps for Attacking Complexity Without Jeopardizing Value.”) Such measures can enable companies to reduce the number of suppliers, redeploy freed-up production capacity, streamline plant operations, or even close plants. Because complexity affects the entire organization, these efforts can generate savings in multiple areas. In our experience, however, most of the savings is achieved through increased OEE, greater network consolidation, and reduced costs for logistics, procurement, and overhead. Companies achieve the greatest savings if the reduced complexity allows them to free up production resources in markets suffering from capacity constraints. In fact, BCG’s experience shows that companies can reduce COGS by 2 to 7 percentage points while maintaining steady production volume and not diminishing consumers’ perceptions of the product portfolio’s variety. More than 25 percent of the total cost savings can be realized within the first year, which is generally sufficient to cover the costs of implementing such projects.

Practical Steps for Attacking Complexity Without Jeopardizing Value

Companies need to take a variety of practical steps to put their combined insights from the market and the supply chain into action. Each approach should be designed to attack the sources of complexity without jeopardizing the sources of value. Here are two examples:

Harmonize Specifications
Harmonizing specifications along the supply chain (such as for ingredients and formulations, product specifications, and packaging) enables the company to reduce changeover times and free up line capacity, thereby generating savings through improved line efficiency. Growth opportunities for products with harmonized specifications can be pursued at lower incremental costs. Companies can achieve the greatest impact by harmonizing the specifications of high-volume products.

Standardize Ingredients and Packaging Materials
Companies can increase scale in procurement by introducing a “menu card” that sets out standard ingredients and packaging materials. A company should select product ingredients and materials on the basis of cost, with the objective of developing a minimum number of base formulations. It should then diversify products only where the market analysis has identified a value to customers. This creates savings for procurement by allowing that function to purchase greater quantities of fewer ingredients, packaging materials, and raw materials.

Menu cards have the additional benefit of clarifying the costs of materials, which can promote a shift to less expensive components that provide the same overall experience for customers. For example, by limiting purchases of metal components to those set out on a menu card, a white-goods company reduced its COGS by 1 percentage point (approximately $1.5 million) without affecting consumer perceptions.

Sustaining complexity reductions over the long term can be difficult, especially for companies with high rates of innovation and frequent product launches. If a new generation of products is not designed in a way that minimizes complexity, the improvements from past complexity-reduction efforts may be lost. To address this issue, leading companies establish clear criteria for acceptable levels of additional complexity with respect to formulas, packaging, technology, and regional variations. The criteria can also include limiting the production of certain product groups to particular plants to increase specialization. A committee of top managers from the marketing and supply chain functions supervises compliance with these criteria and has the authority to halt development efforts or require new designs for products that do not comply.

Starting the Journey

As an initial “health check” to evaluate the potential for improvement through this approach, companies should consider a number of issues:

• How many different products does the portfolio contain—considering not only product types and brands but also variants based on shape, color, flavor, and packaging dimensions? Do consumers value this variety?

• Does the company clearly understand each product variant’s value proposition and impact on complexity within the supply chain? Does it know the true cost of changeovers associated with high complexity? To what extent do the marketing and supply chain functions collaborate to obtain a cross-functional perspective on the trade-offs between value and complexity?

• Does the company know the incremental value and added complexity arising from its product-innovation efforts?

• How widely dispersed are the company’s production facilities? Would harmonizing the product portfolio among regions offer a significant opportunity to reduce the number of facilities and combine their operations?

For many companies, this quick health check will point to significant improvement opportunities. By combining the perspectives of the market and supply chain, companies can reduce complexity where it is most harmful while maintaining product diversity where it is most valuable. Companies that lead the way in taking this approach can achieve an important competitive advantage through both lower-cost operations and higher-value product portfolios.

Move Manufacturing Back to the U.S.? Do the Math

https://www.bcgperspectives.com/content/podcasts/manufacturing_supply_chain_management_move_manufacturing_back_to_us_do_the_math/

Welcome to the BCG Business Podcast. I’m Simon Targett, editor in chief at The Boston Consulting Group, and with me today is Hal Sirkin, a senior partner based in Chicago and an expert, among other things, on globalization and the operational challenges facing companies. He has written or co-written a number of books, including Globality: Competing with Everyone from Everywhere for Everything, and he writes a regular column for Bloomberg Businessweek. Today we’re going to talk about his new work on global manufacturing and, in particular, what he’s calling the “manufacturing renaissance” in the United States. Hal, what’s the evidence of a manufacturing comeback for the U.S.?

It’s very simple. Things are changing in the world. Back in 2000, it was an easy decision to start moving production to China. Labor was 50 cents an hour, and you could get as much of it as you wanted. The Chinese government was very focused on making sure China got the jobs. And it started doing certain things that created, in essence, a perfect storm—but in reverse. The government was very smart in how it managed everything, creating dozens of clusters by taking companies that were in the same industry and forcing them to go to pretty much the same place along the coastline. It worked very well. The clusters had access to seaports, which helped boost exports, and they also contained their own schools—giving every company the ability to train people and make them more productive. This reverse perfect storm was a very important thing for China.

So what’s changed then?

The laws of supply and demand are taking hold. With labor at 50 cents an hour, lots of companies ran to China and started producing goods there, initiating a spiral of wage inflation—from 50 cents, to 60 cents, to 70 cents, to $1, to hourly wages that are on the order of $3 now along the coastline. That may still seem low, but it’s a sixfold increase over that period of time. And that makes a huge difference.

So which sectors are in the frontline of those returning to the U.S.?

Things like appliances, computers and electronics, transportation goods, plastics, and rubber. Which makes sense, because as wages rise, they are losing the advantage of low labor costs, which are very important to them.

You talk about these as tipping-point industries.

Yes, because we’re not there yet. We believe that sometime around 2015, these industries will start to get to the point where the difference in terms of manufacturing costs—not delivery costs but manufacturing costs—will be less than 10 percent. Then when you start adding in things like delivery and being far away from the customer, having lots of inventory on the water, intellectual property risks, and even country risks, it begins to make sense for companies to start bringing the goods back to America.

Can you quantify what the value of this transition will be to the U.S. economy?

We’ve tried to make some conservative estimates. This is a trend that is just beginning, so we are trying to be very conservative about it. But a fairly conservative estimate is that $100 billion to $120 billion worth of goods could return to the U.S.

Why aren’t all companies returning if the economics make so much sense? What’s the point of staying in China?

For some goods, the labor content is not at 25 percent but more like 50 percent, so in those cases the labor advantage remains. Some good companies will stay in China. For shoes and apparel, for example, labor content is 50 percent or 60 percent. Some manufacturers of those goods will leave China, but they won’t come to the U.S. They’ll go to places like Vietnam or Sri Lanka because the labor pools there are perfectly capable of producing the goods at pretty good quality.

Does this signal the end of China as the world’s manufacturing hub?

Absolutely not. It is clearly going to remain a major manufacturing hub for the world, if only because of its 1.3 billion people. We don’t think plants are going to close in China, which is growing at 8 percent to 12 percent a year. Even the lower estimate of 8 percent is a pretty good growth rate. So if you’re going to try to serve the Chinese market, you’re still going to have to build plants there. But a lot of companies that are planning new plants are going to look carefully at their supply chains. In 2010, the default position was to build them in China, but now a company may consider putting a plant in the U.S. instead. It can then take one of its Chinese plants that was exporting to the U.S. and repurpose it for domestic Chinese, or maybe Asian, consumption. The Chinese plants will remain important, but the one built in the U.S. is now closer to a very important customer base with a population of 300 million and the world’s largest economy.

And does pitching to the Chinese in their domestic market require a dramatic refurbishing of the local factories?

It depends what they’re producing. For many, many goods, it’s not going to require much of a change at all. But the Chinese consumer’s demands are growing very rapidly. Not that long ago, a large percentage of China was worrying about getting the number of calories necessary for survival each day. And now we’re way beyond that—certainly in most of the cities. People have gone from wanting bicycles—which was at one point a luxury good for many—to wanting motor scooters, cars, TVs. And like Americans and everyone else around the world, the Chinese would like to have a better lifestyle. So domestic demand in China will be growing, which means opportunities to repurpose the plants.

This seems like such a great good-news story for the American economy. Are there any negative implications of what you’ve discovered?

I’m not sure there are a lot of negative implications. We’d all like this to happen instantaneously, to have those jobs come back and reduce unemployment. This is something that’s going to happen over the course of this decade. It takes a while to build plants. It takes a while for people to understand that the economics have shifted. We’re seeing more of that taking place, but it will be another eight years to complete the process.

It’s a decision being made by individual companies, then, as they look at their own individual needs. Is that correct?

As was true with outsourcing, as well. Each individual company made a decision based on the economics, which were very powerful in 2001 when China entered the World Trade Organization. The economics are getting less powerful now, and sometime around 2015 or so, those economics for a lot of goods are not going to be very powerful at all—and that’ll make the change. But this is all about individual companies making decisions and not about some broad tariff or regulations that go into effect. This is the law of supply and demand as Adam Smith laid it out.

Is there anything that the U.S. government should be doing to ensure that these individual decisions become a full-time trend?

It will happen naturally. The issue is about speeding it up, right? One thing that the government could do would be to implement more aggressive tax credits for the creation of jobs, so that there are some plans in place that would provide faster write-offs. There are blanket programs that probably should be better targeted to have the maximum impact. One of the things we do need to do is make sure that we build training programs. Some people may have worked in plants before, but many will have no experience and will need training. And then I think at some point in time we need to think long-term about what we want our workforce to look like—building on the things that we’ve taught our children, such as going to college. But college doesn’t have to mean getting a white-collar job. We need to think of a system of vocational colleges, where students spend half of their four-year education in a liberal-arts program and the other half in welding or plumbing or other skills that will be important in plants. Those people will be very valuable. Right now, people coming from vocational schools are in far higher demand than people with liberal-arts degrees. And it would be nice to have a balance.

So are you saying that there’s a paucity of plant-trained employees in the U.S.?

It’s locational. In the U.S., even 30 years ago, the North was the manufacturing facility and the South was the agricultural area. And that has shifted pretty dramatically, but we still don’t necessarily have the people in the right place.

What advice are you giving to companies that are making decisions about, first of all, whether to relocate from China back to the U.S. and then where to place their plants?

This goes back to a situation that I found myself in with a set of clients in 2010, and it’s what got us thinking about all of this. I was sitting in a board meeting and was about ready to get approval to put another plant in China. I pointed out that we had 80 percent of our production in China, and now we’re going to have 83 percent. I asked, “Is that really what we want to do?” And they said yes because China was much lower cost. That triggered a discussion around whether it really was lower cost, and what did the long term look like? So they ran the math, and it turned out that in 2010, China was still lower cost. But they also ran the math for 2015, knowing that wages were rising 15 to 20 percent a year in China. They put that in the model, and they entered small deviations for the R&D shifts, and lo and behold, the number became something on the order of less than 10 percent. And they said maybe we need to rethink this—maybe having all our capacity in China isn’t the right thing.

And that’s what companies have to do. The default location for plants making any industrial goods and a lot of nonperishable consumer goods has been China. That was a great answer when labor costs were lower. But that is not going to be the right answer for a lot of companies anymore. They have to go back and do the fundamental math.

How do you advise companies about where to build plants in the U.S., or even in Mexico?

Mexico is going to play an important role in all of this. It has a pretty good labor force, but it does have some drawbacks right now. It is a difficult environment to operate in because of the drug cartels and other issues. I think Mexico would be a very big winner if it weren’t for that. But we still believe that the reshoring will be around 20 percent in Mexico and 80 percent in the U.S. When it comes to siting, it’s necessary to think about your entire supply chain, not just one piece of it, and it’s important not to think of it as an independent decision. If you’re building a supply chain, you’re building a 30-year supply chain. You will adjust it as things change. But don’t think about throwing everything into one location, because that would be too risky. If you put 100 percent or 80 percent of your manufacturing in one place, you lose a lot of flexibility. And if something changes, you can potentially put the company at risk because of that.

Are there any other key decisions that CEOs need to think about?

The key thing is to do the math, do the homework. People have it in their minds that China is the lowest-cost location, and right now that may still be true for a lot of industries. But part of the homework has to include the notion that you’re building something for 30 years. Costs are not the only issue. There are other risk factors that need to be considered. For instance, I think we undervalue the importance of being close to the customer.

Chesapeake Bay Candle is an interesting example. It’s a small company in Glen Burnie, Maryland. It was started by two former Chinese citizens who are now citizens of the United States. They started a candle company, and, of course, they put their manufacturing in China. This caused some problems with retailers who sold their candles in the U.S. because that long supply chain made it difficult for them to be responsive. So the company looked at the cost and the value of being responsive and decided it made sense to put a plant in Maryland. It is now in the process of making candles in Maryland for the U.S. and even exporting some of them back to China.

If you were to leave CEOs with a single message from what you’ve discovered so far, what would it be?

It’s very simple. Do your homework. The world’s changing. You’ve got to be ready for those changes and you’ve got to keep your supply chains balanced, which means you’re not only in one place. You need to understand where the costs are moving and you need to understand what the real costumer needs are. And then you want to design a supply chain that fits the entire network and gives you the flexibility over the next few years. We’re seeing the end of the phase of the entry of China and now we’re starting to see things just beginning to move back. This is a new equilibrium with a playing field that’s less tilted in China’s favor.

That’s great. Hal Sirkin, thanks very much indeed.

You’re welcome.