Operational Excellence Indian Vs. International Practices


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  • Operational Excellence Indian Vs. International Practices

    1. 1. Operational Excellence: Indian vs. International Practices CONFIDENTIAL This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion. Western Region Annual Meeting April 11, 2002
    2. 2. KEY MESSAGES <ul><li>Superior operations drives value creation </li></ul><ul><li>Indian manufacturing companies face significant operations challenges </li></ul><ul><li>New tools and mindset required to build operational excellence </li></ul><ul><li>Rewards from pursuing operational excellence can be large – the journey must begin now </li></ul>
    3. 3. INTERNATIONAL RESEARCH SUGGESTS THAT COMPANIES WITH SUPERIOR OPERATIONS DELIVER SUPERIOR RETURNS… * Excellent&quot; are US companies (from the Discovery screened target list) which increased their moving average ROIC every year during a 5-year period (1995-99), and had a ROIC greater than their industrial average ** Companies from the S&P 500 industrials which passed the Excellence filter, full spread data available for only 320 companies *** Basis points reflects absolute change in spread (i.e., a spread increase from 5.0% to 7.0% equals 200 basis points) Excellent – Superior operational performance (12 companies)* S&P 500 Industrials ROIC-WACC, basis points*** Excellent - Other** companies (32 companies) Approach <ul><ul><li>Short-listed 44 “excellent” companies for analysis </li></ul></ul><ul><ul><ul><li>ROIC > WACC (from 95-99) </li></ul></ul></ul><ul><ul><ul><li>ROIC > Industrial average </li></ul></ul></ul><ul><ul><li>Short-listed 12 “excellent companies” based on qualitative review of operations </li></ul></ul>
    4. 4. …WHICH TRANSLATE INTO SUPERIOR VALUATIONS Average Total returns to shareholders Wilshire Index (market) &quot;Excellent&quot; - Top 12* &quot;Excellent“ – Next 32 S&P 500 Industrials * Operational excellent companies defined as 12 companies that passed operations excellence filter from the Industry Week Global 1000 Source: McKinsey Operations Discovery Project 3X TRS performance relative to market
    5. 5. OPERATIONAL EXCELLENCE DRIVES THESE RETURNS <ul><ul><li>New product introduction cycle time and cost 50% lower than competition </li></ul></ul><ul><ul><li>Manufacturing floor space required 50% less for comparable product </li></ul></ul><ul><ul><li>Order to delivery time less by a factor of five </li></ul></ul><ul><ul><li>P/E 20+ points higher than other major players </li></ul></ul><ul><ul><li>Make-to-order supply chain </li></ul></ul><ul><ul><li>Inventory level 60% lower </li></ul></ul><ul><ul><li>Receivables turns 45% higher </li></ul></ul><ul><ul><li>Revenue growth 40% faster and ROIC 1.5 times industry average </li></ul></ul><ul><ul><li>3-year cost savings goal of USD 1 billion achieved through Alcoa Production System </li></ul></ul><ul><ul><li>Additional USD 1 billion savings targeted for 2003 </li></ul></ul><ul><ul><li>From 1996 to 2000, CAGR of revenues and net income 15% and 30%, respectively, in spite of plunge in aluminum prices </li></ul></ul>Operational Initiatives Overall financial impact
    6. 6. ALCOA CASE STUDY – CORPORATE-WIDE LEAN TRANSFORMATION Lean operating practices (APS) Transformation foundation Performance-based measurement system Facilities modernization Renegotiated labor contracts Variable compensation (salary and hourly) Quality assurance, SPC Reduced set-up times Flexible job design Pay for performance/skill Alcoa Business System
    7. 7. ALCOA CASE STUDY – THE RESULTS * Alcoa’s quarterly net income adjusted for special items Source: Platt’s Metal Week; Wall Street Journal; McKinsey Metals Practice Alcoa adjusted net income Aluminum spot price Adjusted net income* $ Millions Spot price of aluminum $/lb. Alcoa performance vs. price of aluminum -100 100 200 300 0.40 0.60 0.80 1.00 1.20 0 1982 83 84 85 86 87 88 89 90 91 92 93 0 Initiated Alcoa production system 94 95 96 97 98 99 Broke out of price cycle EVA- 1995-99 (ROIC-WACC) Growth- 2000-05 (5-year projected) Alcoa Competitor Industry Alcoa Competitor Industry
    8. 8. KEY MESSAGES <ul><li>Superior operations drives value creation </li></ul><ul><li>Indian manufacturing companies face significant operations challenges </li></ul><ul><li>New tools and mindset required to build operational excellence </li></ul><ul><li>Rewards from pursuing operational excellence can be large – the journey must begin now </li></ul>
    9. 9. INDIAN MANUFACTURING COMPANIES FACE A PROFITABILITY CRISIS 1997 20% decrease Profit margins* 2000 PAT, percentage of sales Percentage of companies making losses Per cent 1997 50% increase 2000 1997 7% decrease EVA (ROIC minus cost of capital) 2000 Per cent * Based on a set of 132 companies in 10 sectors (Industrial Machinery, Ferrous, Non Ferrous, Consumer Durables, Chemicals, Petrochemicals, Pulp & Paper, Power, Tyres and Automotive) Source: Prowess; McKinsey team analysis
    10. 10. POOR FINANCIAL PERFORMANCE IS DRIVEN BY POOR LABOUR AND CAPITAL PRODUCTIVITY… Automotive Steel Power (generation) Labour Productivity Capital productivity Index, US = 100 Apparel Index, US = 100 Source: McKinsey Global Institute study of the Indian economy NA NA EXAMPLES
    11. 11. GAPS EXIST IN ALL AREAS OF OPERATIONAL PERFORMANCE * Automotive industry analysis Manufacturing Supply chain Channel management Key account management/ Sales force effectiveness Pricing Purchasing/ supply management Too many suppliers (250* vs. 100 for best-practice) <ul><ul><li>Unaware of ‘pocket margins’ </li></ul></ul>80% time on non-value added activities Poor channel capability and returns No systematic tracking of top customers and their satisfaction Too much inventory (140 days vs. 35 for best-practice*)
    12. 12. KEY MESSAGES <ul><li>Superior operations drives value creation </li></ul><ul><li>Indian manufacturing companies face significant operations challenges </li></ul><ul><li>New tools and mindset required to build operational excellence </li></ul><ul><li>Rewards from pursuing operational excellence can be large – the journey must begin now </li></ul>
    13. 13. NEW MINDSET REQUIRED TO DRIVE OPERATIONAL EXCELLENCE Typical mindset Required mindset Source: Interviews <ul><ul><li>Limited top management involvement </li></ul></ul><ul><ul><li>Driven by CEO agenda </li></ul></ul><ul><ul><li>Incremental targets </li></ul></ul><ul><ul><li>Step-change improvement </li></ul></ul><ul><ul><li>Subjective problem solving </li></ul></ul><ul><ul><li>Focus on facts and root causes </li></ul></ul><ul><ul><li>Ad-hoc implementation </li></ul></ul><ul><ul><li>Relentless focus on change and consequence management </li></ul></ul><ul><ul><li>Programme driven by “sparable” executives </li></ul></ul><ul><ul><li>Led by the brightest and the best </li></ul></ul>
    14. 14. SEVERAL SOURCES OF GAPS EXIST IN MANUFACTURING Source: Interviews; SIAM; Harbor Report Equivalent cars per equivalent employee; Index, US average in 1998 = 100 Pre-libera-szation plants Excess workers, OFT*, DFM**, techno-logy, scale Post-libera-lisation plants Supplier relations Scale/ Utili-sation Organisation of functions and tasks and training India Potential Non-viable Auto- mation US average 6 32 38 17 7 5 84 16 100 16 Design for manufacturing India average = 24 1 Viable Auto- mation 1. Manufacturing AUTOMOTIVE EXAMPLE
    15. 15. DESIGN FOR MANUFACTURE OF SELECT INDIAN SEGMENT A CARS* * According to DRI-segmentation Source: Interviews; McKinsey Automotive Practice Productivity penalty Global best- practice Car 1 Car 2 Car 3 Global best- practice Car 1 Car 2 Car 3 Number of body panels Number of spot welds <ul><ul><li>Press shop: 31% (represents 4% of total employment) </li></ul></ul><ul><ul><li>Body shop : 25% (represents 19% of total employment) </li></ul></ul>India India
    16. 16. BOTTOM UP IMPROVEMENT PROGRAMS EVALUATE NUMEROUS IDEAS AND CAN YIELD LARGE BENEFITS <ul><ul><li>In a typical program, more than 2,000 ideas are generated, rigorously evaluated and implemented </li></ul></ul><ul><ul><li>Ideas are not capital-intensive </li></ul></ul><ul><ul><li>Should yield payback in not more than one year </li></ul></ul><ul><ul><li>Should be implementable in 3-6 months </li></ul></ul>Rigorous evaluation of simple ideas… … could yield impressive results <ul><ul><li>30-40% reduction in compressible costs (10-20% reduction in total manufacturing costs) </li></ul></ul><ul><ul><li>Significant reduction in downtime </li></ul></ul><ul><ul><li>Large reduction in defect rate </li></ul></ul><ul><ul><li>Better reliability and shorter throughput time in deliveries </li></ul></ul>
    17. 17. SUPPLY CHAIN – SIGNIFICANT GAPS EXIST From… To… 2. Supply chain “ Single solution for entire company” – one size fit all approach <ul><ul><li>Define what needs to be offered </li></ul></ul><ul><ul><ul><li>Different customer service levels </li></ul></ul></ul><ul><ul><ul><li>Product variety and configuration </li></ul></ul></ul><ul><ul><li>Multiple chains within a company </li></ul></ul>“ Redesign to meet competitive benchmarks” <ul><ul><li>Design to meet segment-specific customer breakpoints </li></ul></ul>“ Push-system is the only way Indian supply chains work” <ul><ul><li>Pull (wherever possible) based on better forecasting and order management </li></ul></ul>“ IT system will solve all supply-chain issues” <ul><ul><li>Use IT selectively (not before, but after redesign) for: </li></ul></ul><ul><ul><ul><li>Information transparency </li></ul></ul></ul><ul><ul><ul><li>Order management and forecasting </li></ul></ul></ul>
    18. 18. CROSS-FUNCTIONAL COMMODITY SOURCING TEAMS HELP REDUCE PURCHASING COSTS 3. Purchase cost reduction <ul><ul><li>Imperative to reduce purchasing costs to gain overall cost advantage </li></ul></ul><ul><ul><li>Traditional functional organisations </li></ul></ul><ul><ul><li>Limited engineering and operations inputs into purchase decisions </li></ul></ul><ul><ul><li>Most cost reduction is negotiation driven, rather than total-cost driven </li></ul></ul>Context Some elements of strategy <ul><ul><li>Performance specifications- “fit for use” </li></ul></ul><ul><ul><li>In-house involvement (make vs. buy) </li></ul></ul><ul><ul><li>Supplier discovery </li></ul></ul><ul><ul><li>Sole source vs. multi-source </li></ul></ul><ul><ul><li>Contract type, pricing and duration </li></ul></ul><ul><ul><li>Joint cost elimination (transportation, inventory etc.) </li></ul></ul>Composition of sourcing teams <ul><ul><li>Cross functional with participation and support from all areas (purchasing, plant, engineering, marketing etc.) and by commodity </li></ul></ul>
    19. 19. THE TOTAL COST OWNERSHIP (TCO) FRAMEWORK HELPS IDENTIFY COST LEVERS BEYOND PURCHASE PRICE Production capacity Transportation Inventory carrying costs Warehousing Purchasing administration Factory yield R&D Damaged product Specifications Warranty expediting Internal and joint levers <ul><ul><li>Change specifications </li></ul></ul><ul><ul><li>Load schedules into supplier scheduling system via EDI </li></ul></ul><ul><ul><li>Involve suppliers in design/reviews </li></ul></ul><ul><ul><li>Analyze supplier’s TCO to identify cost-reduction opportunities </li></ul></ul><ul><ul><li>Evaluate yield improvement potential from alternative specifications </li></ul></ul><ul><ul><li>Consolidate part numbers to build scale </li></ul></ul>Purchase price Traditional Purchasing Levers <ul><ul><li>Identify new suppliers (local and global) </li></ul></ul><ul><ul><li>Include non-performance penalties (e.g., missed deliveries, non-conforming parts) in contracts </li></ul></ul>Illustrative action areas
    20. 20. KEY MESSAGES <ul><li>Superior operations drives value creation </li></ul><ul><li>Indian manufacturing companies face significant operations challenges </li></ul><ul><li>New tools and mindset required to build operational excellence </li></ul><ul><li>Rewards from pursuing operational excellence can be large – the journey must begin now </li></ul>
    21. 21. EACH AREA CAN HAVE SIGNIFICANT IMPACT ON PROFITS AND VALUE CREATION Revenues Per tax ROIC EBIT Costs Invested capital Working capital Fixed assets : Levers Range of impact possible based on McKinsey experience Pricing management <ul><ul><li>2-6% increase in return on sales </li></ul></ul>Key account management/sales force effectiveness <ul><ul><li>5-30% revenue increase </li></ul></ul>Channel management <ul><ul><li>10-20 percentage points increase in market share </li></ul></ul>1 2 3 Purchasing cost reduction <ul><ul><li>10-15% reduction in purchase costs </li></ul></ul>Manufacturing effectiveness and overheads cost reduction <ul><ul><li>20% reduction in manufacturing costs </li></ul></ul><ul><ul><li>20-50% reduction in downtime and defects </li></ul></ul><ul><ul><li>80-90% improvement in supply reliability </li></ul></ul><ul><ul><li>20% reduction in overhead costs </li></ul></ul>4 5 Supply chain management <ul><ul><li>30-50% reduction in inventory </li></ul></ul><ul><ul><li>Stock outs nearly eliminated with 1-3% increase in sales </li></ul></ul>6
    22. 22. SET AGGRESSIVE ASPIRATIONS FOR OPERATIONAL EXCELLENCE Source: McKinsey Performance comparison/gaps Com pany Process effective- ness Process efficiency Factor cost Best com- petitor bench- mark Other Material Capital Personnel 100 15 – 25% Best of best bench- mark 35 – 40% Theore- tical limits 60 – 75%
    23. 23. EVOLUTION OF THE OPERATIONAL EXCELLENCE JOURNEY Lean value chain <ul><ul><li>Application of best practices to redesign and optimize the overall end-to-end value chain </li></ul></ul>Lean corporation <ul><ul><li>Integrated application of best practices and tools (including culture change) to transform the entire company – drive cross functional behaviour </li></ul></ul>Lean “functions” <ul><ul><li>Application of best practices and tools to achieve improvement in focused cells/processes </li></ul></ul>
    24. 24. APPROACH TO IDENTIFY AND CAPTURE THE OPPORTUNITY What’s the opportunity? ? <ul><ul><li>Start with a diagnostic, including the business case </li></ul></ul><ul><ul><li>Focus on all, relevant operational levers </li></ul></ul><ul><ul><li>Set stretch targets based on benchmarking </li></ul></ul>How to capture it? Rs ? <ul><ul><li>Small pilot in each area and then quick roll-out </li></ul></ul><ul><ul><li>Specific tools for each part of the value chain </li></ul></ul>Sustaining Momentum 2000 2001 2002 2003 <ul><ul><li>Strong performance management systems </li></ul></ul><ul><ul><li>Modified organisation structure and people </li></ul></ul><ul><ul><li>Ensure significant top-management involvement </li></ul></ul>