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Published: August 26, 2005

 
 

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.

After determining the specific ways that Virtual Scale can benefit your company, compile a list of potential partners from organizations involved in businesses that in some fashion overlap the areas where scale is most needed. Some companies can be quickly eliminated; among them should be large organizations that already enjoy significant operational scale and small companies lacking enough volume to create any appreciable scale even in a partnership.

Whether to ally with a competitor is a trickier question. Companies need to make a clearheaded identification of their real hard-bitten predators and exclude them from Virtual Scale relationships. But at the same time, it’s essential to take a fluid approach to alliances. For example, it may make good business sense — and pose almost no risk — to share with a direct rival high-volume procurement of a commodity part when the component has no bearing on differentiating one product from another. In our experience, the failure to realistically analyze the competition and determine which companies are truly a threat to your business strategies and business model and which are prospective partners can significantly narrow the potential value from Virtual Scale.

Next, evaluate the relative merits of each potential partner by answering these questions:

  • What is the value in partnering? Will there be benefits in terms of improved margins and market share, increased return on investments, and enhanced capabilities?
  • Why is my company interested in forming this alliance?
  • What would be the other company’s gain from this alliance and what would the company bring to the partnership?
  • Can these two companies work together successfully? Is there a cultural and regional fit?
  • What other external factors need to be considered, including safety, regulatory, environmental, and sociopolitical issues?

The final implementation step involves negotiating the Virtual Scale partnership. Before contacting potential allies, companies should prepare draft contracts that include specific rules of engagement and working joint-venture guidelines, including production prioritization, intellectual capital usage, and performance targets.

Considering that Virtual Scale offers the hope of turning companies that are under competitive pressure into virtual giants, it’s surprising that more companies have not yet adopted this strategy. The hesitance seems to stem from the fear of losing control in an alliance. Small companies sharing trucks with midmarket ones, for instance, might be concerned that large retailers would blame them — and even cancel their orders — if a shipment were late, even though the small companies would have had little sway over the distribution center. Or a midsized company might be wary that confidential marketing data could be leaked to a competitor by its smaller partner.

These are certainly legitimate worries, but they imply that strategies like Virtual Scale require abdication of good business judgment. Issues of control, supervision, and oversight should be covered in detail in the working agreement, and none of the partners in a Virtual Scale arrangement should relinquish their responsibility to closely manage activities, including joint ventures that could affect the future of their organizations.

The larger reality is that before long, Virtual Scale may not be simply an option; it may be a requirement. Without it, many companies could fall further and further behind their larger scaled competitors — and risk being swallowed up by them. Indeed, for these companies, Virtual Scale’s true value could be as the sole criterion for prejudging the success of alliances. Those ventures that are specifically designed to close the distance between a midsized company and its larger competition will be the only ones that are strategically worth undertaking.

Author Profiles:


Doug Hardman ([email protected]) is a vice president in Booz Allen Hamilton’s Chicago office. He specializes in operations strategy, organization productivity, and supply chain management for consumer products and retail companies.
David Messinger ([email protected]) is a principal with Booz Allen Hamilton in New York. He focuses on supply chain and consumer channel strategies primarily for packaged-goods and retail companies.
Sara Bergson ([email protected]) is an associate with Booz Allen Hamilton in New York. She works with consumer products companies on value chain strategies.
 
 
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