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 / Fall 2005 / Issue 40(originally published by Booz & Company)


Virtual Scale: Alliances for Leverage

Smaller companies can compete with industry giants by pooling resources with carefully chosen partners.

Only a few companies — giants such as Procter & Gamble, Wal-Mart, Dell, and Toyota — are in the enviable position of being able to leverage their size into operational scale that consistently drives down per-unit costs and increases efficiency, creating sustainable competitive advantages. And as these companies enhance their lead, the rest of the pack faces a disturbing prospect: Lacking a dominant market position or funds to acquire other businesses, smaller companies are finding that achieving the level of scale required to catch up to industry behemoths is fast becoming a futile pursuit. To make matters worse, “predators” are coming from all sides — that is, predators are now not just traditional competitors in the same industry, but also customers and suppliers, who are dead set on taking a bigger bite out of the margins earned by manufacturers.

It sounds dire, but it needn’t be. There’s a strategy that could solve this dilemma. Through carefully structured alliances, organizations can combine mutual assets and capabilities to gain the benefits of scale that they would be unable to achieve alone. For instance, a midmarket consumer goods company whose factories frequently operate at much less than capacity could share its plants with smaller competitors or private-label companies. Manufacturing and labor costs per unit would be reduced for both the midmarket company and the companies using its facilities. And more frequent full truckloads carrying products from all of the manufacturers involved in this arrangement — instead of separate shipments from each of these companies — could be dispatched to big retailers like Wal-Mart. In turn, Wal-Mart would be more eager to purchase from these companies because fewer trucks to unload translates into less expensive and more efficient operations.

We call this “Virtual Scale” — a customer-centric pooling of resources that is mutually beneficial, and a paradigm shift that goes beyond simple transactional relationships to build long-term capabilities through alliances that drive corporate growth and value. Besides manufacturing and logistics, Virtual Scale can be applied to such areas as procurement, research and development, marketing, promotion, and even media buying. We estimate that companies adopting Virtual Scale partnerships can increase annual revenues by as much as 14 percent and cut costs by as much as 7 percent — a performance improvement that will allow midsized companies to punch well above their weight class and compete more effectively with their largest rivals.

To implement Virtual Scale, begin by identifying where scale matters the most within the organization. Some companies in highly innovative fields need to leverage R&D; shared research networks or modular designs that could be used by many enterprises might be a solution. Other companies seek to cut procurement or marketing costs; co-locating suppliers or cosponsoring focus groups could be the best options.

Often, a Virtual Scale arrangement is most beneficial when an organization is making a significant structural change or capital investment, such as building a new factory. In those cases, Virtual Scale can greatly amplify the value generated by the project. For example, a company could build a plant with 60,000 tons of capacity to meet its own needs. However, by constructing a factory with 90,000 tons of capacity, filling the additional capacity with a partner’s manufacturing operations and leveraging third-party operators, the combined alliance can reduce operating costs by 10 to 20 percent and significantly improve the return on the capital invested by all participants.

Keep in mind, though, that pursuit of scale without a clear understanding of immediate and future corporate strategies can lead to futility rather than dominance. Placing the wrong bet can lock your company into long-term obligations that destroy rather than create value. For these reasons, it’s important to balance complexity and value by assessing the trade-offs between the added costs associated with multiple partners — such as more complicated operations management — and the strategic advantages that these partnerships bring.

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