Outsourcing what was thought to be a critical “scale” capability proved to be a profitable idea for another of our clients — a major pet-food company. For years, this firm had assumed that owning its own large centralized manufacturing plant in the middle of the grain belt was an important way to realize economies. After all, its executives reasoned, grain is the major component of many dry pet foods, and a huge plant near the source of this input cuts down on transportation costs, while realizing scale benefits in large centralized plants.
By unbundling the vertical process flows, however, our client came to see that there was an offsetting factor — high distribution costs for the packaged finished product — that substantially undermined, and even reversed, the scale benefits. The real economics of the process proved that shipping pet-food boxes across the country cost more than was saved by centralized production. The solution was outsourcing production to regional copackers, thus creating a national footprint of plants closer to the customer base. These regional copackers already had large plants that served many other manufacturers and retailers. This allowed our pet-food client to capture substantial distribution and lead-time benefits while not giving up any economies of scale.
It is important to note that we do not propose outsourcing as the single tool in the box. Reinventing scale means recapturing value that is hidden within the value chain because of fundamental misconceptions about scale. Once it is identified, such value can be recaptured by a restructuring of the value chain, or through a change of ownership, such as an acquisition, divestiture, or outsourcing. Although outsourcing worked well in the pet-food example, it did not apply to the seafood packer or the battery manufacturer.
Escaping the scale trap has potential applications not only in manufacturing, but also in retailing, and more widely in service industries. Although service businesses don’t manufacture products, they certainly have internal processes and value chains that can be subjected to fruitful analysis. Scale might be enjoyed in numerous localized instances, such as back-office operations. Each step in a service value chain has cost drivers, and wherever larger volume drives costs lower, scale economies can emerge.
A New Approach to Operations Strategy
Economies of scale are the blessing and the curse of manufacturing life. We have seen how it simply makes no sense to apply this basic idea indiscriminately across any organization. If a value chain is a series of steps from raw materials to final sale, then each value-adding step of that chain can be thought of as a mini-manufacturing process all its own — with inherent real costs, and a real market value for the product. Looked at this way, the manufacturing process is not a holistic either/or proposition with respect to scale, but rather a series of incremental opportunities to appropriately exploit real rather than perceived scale economies. Capturing all these incremental opportunities leads to significant change.
We believe our concept of understanding, unbundling, and unleashing to be a new approach to developing operations strategies. Traditional strategy focuses on developing a single deterministic solution, rather than optimizing a flexible web of partners (supply chains) facing demand and supply uncertainties. It optimizes operations functions within traditional vertical trade-offs (e.g., manufacturing scale versus distribution costs), versus finding nonobvious trade-offs based on horizontal product flows. It focuses on product costs, rather than a deep understanding of cost drivers and value creation. And, finally, it typically optimizes one measure (labor, or inventory, or costs, etc.), rather than maximizing value capture across an extended enterprise.
The opportunity to understand, unbundle, and unleash has never been greater, given unprecedented pressure on most companies’ supply chains. Globalization and increased product complexity have escalated competition. Capacity has increased, due mainly to productivity’s improving at a faster rate than market growth. At the same time, flexibility is more in demand, and asset effectiveness is declining as manufacturing’s relative share of added value continues its own decline — now, less than 10 percent of profit contribution utilizes up to 50 percent of asset investments. It is within this environment of rapid supply chain rationalization that fundamental concepts such as scale must be revisited.