1Virtual Vertical Collaboration
As competition forces retailers and manufacturers to get
closer to their customers, it is imperative that both sides
abandon their adversarial relationships—going beyond
secrecy and distrust to build a bond of collaboration.
It is a lot like a merger integration minus the merger.
2Virtual Vertical Collaboration
An adversarial relationship, and the mistrust it engenders, is in some ways essential to free
enterprise. If you do not charge customers the highest possible price or drive the hardest
possible bargain with your suppliers, you not only hurt yourself but also risk a misallocation
of resources. The genius of Adam Smith’s “invisible hand” is that it not only allows all parties
to act with vigorous self-interest—it requires that they do.
Yet mistrust can create waste. Suppliers double-check product quality before shipping,
and buyers triple-check quality upon arrival. A retailer keeps customer insights secret from
suppliers, for fear they’ll share it with competitors. A supplier keeps manufacturing constraints
secret due to similar fears. Although collaboration is a faster path to progress—based on the
adage that two heads are better than one—conflict is often the normal cost of doing business.
Indeed, some industries are so competitive, with such small margins, that any normal cost of
doing business has to be questioned. Consider the U.S. food retail industry where shifting
demographics, technology, consumer behavior, and new regulations are shedding new light
on what retail business will look like in the future. Or, remember the impact of the global
recession that left consumer packaged goods (CPG) companies and food retailers fighting
for increasingly fickle—and empowered—consumers. Retailers squeeze their suppliers, and
manufacturers feel bled out.
Success in such an environment requires retailers and manufacturers to get closer to their
customers, provide more choices and superior service, and reduce costs. It may sound crazy,
but it is imperative that both sides perform a merger without actually merging.
Merger Integration Minus the Merger
Not only is the concept of merging without merging not crazy, it’s already happening. We call
it virtual vertical collaboration, and it involves a retailer and manufacturer acting as though
they are about to merge and creating the efficiencies that come with merger integration
(see sidebar: Adopting a Virtual Vertical Mindset on page 3). They abandon their adversarial
relationship, going beyond secrecy and distrust to build a bond and make mutually beneficial
The results can be significant:
• 10 to 15 percent increase in sales
• 40 to 60 percent faster new product launches
• 7 to 15 percent decrease in transportation costs
• 20 percent reduction in cost of materials
• 10 to 20 percent decline in total system inventory
• 600 to 1,000 basis-point drop in forecast errors
• 50 to 100 basis-point surge in in-stocks
As the ties get stronger, so do the results. It is not unusual to see fundamental restructurings
of the entire value chain as relationships develop with suppliers, customers, and even
3Virtual Vertical Collaboration
In new product development, sharing insights and resources early on means the strengths of
retailer merchandising and manufacturer innovations are combined to develop a retail category
strategy. Deeper insights into customers can produce breakthrough new products rather than
too-late-to-market me-too knockoffs.
Collaborative business planning means strategies are linked with internal business unit
processes and execution across both companies and addressed all-inclusively in areas such as
packaging design, marketing, and shelf placement. Category buyers and business unit leaders
assess expected demand and its potential effect on the two companies, while collaborative
global innovation summits are a way for retailers to see the next wave of products.
Demand management templates are used to compare manufacturer and retailer views of
demand by week and by product, thus minimizing the need to manage last-minute supply
constraints in emergency mode. A metrics dashboard helps track performance and value
created. With both companies aligned on a single plan, each brings unique insights that
contribute to reducing inventories and costs.
Supply and manufacturing can share best practices to improve procurement processes,
perhaps even allowing products to be co-manufactured. For example, select private-label
products are manufactured with their brand-label competitors or replaced with a branded
equivalent. Production planning is streamlined and manufacturing nears full capacity,
resulting in lower production costs across the board, not to mention increased share-of-shelf,
longer product runs, fewer changeovers, and scale advantages in negotiating with suppliers
of raw materials and packaging.
Adopting a Virtual Vertical Mindset
A global retailer and a multina-
tional fast-moving consumer
goods (FMCG) company had
on competitive market forces,
both companies were ready for
a new approach.
information to be shared in a
structured yet safe manner.
4Virtual Vertical Collaboration
Merchandising and store operations improve as pooled information means fewer out-of-stocks
and better launches. In distribution, assets across the entire network join forces to reduce total
delivered costs by eliminating overlapping distribution centers, stocking points, handling, and
The genius of Adam Smith’s “invisible
hand” is that it not only allows all parties
to act with vigorous self-interest—
it requires that they do.
The Power of Two
Collaboration is not new. Companies have exchanged data and forecasts for years. Wal-Mart
and its suppliers cut costs by sharing information, Kroger and Dr Pepper Snapple Group jointly
redesigned beverage category management, and Tesco and Nestlé continue to work together
in joint business planning.
There are various levels of collaboration (see figure 1). Much of it today is at a basic, transactional,
and data-oriented level, or at an intermediate level, usually in logistics. Although these activities
create value, they only scratch the surface of collaboration’s true potential.
Levels at which retailer and supplier collaborate
Notes: CPFR is collaborative planning, forecasting, and replenishment; VMI is vendor-managed inventory; DC is distribution center; POS is point of sale;
NPI is new product introduction.
Source: A.T. Kearney analysis
Increasing time and maturity of relationship
• Forecast sharing
• Differentiated flowpaths
• DC bypass or backhaul
• Asset sharing
• Store-ready pallets
• Display management
• Store labor optimization
• Joint forecasting and
• Promotions planning
• POS analytics
• Sharing of shopper
• Collaborative product
• Joint procurement
• Joint category
• Joint profit and loss
Stage I: Basic
Stage II: Intermediate
Stage III: Advanced
Stage IV: Expert
May include elements from Stages I and II
5Virtual Vertical Collaboration
Virtual vertical collaboration means capturing the benefits of M&A without the associated
complexities (see figure 2). Manufacturers and retailers jointly pursue shared objectives—growth,
better margins, more and bigger sales, fewer out-of-stocks, fresher assortments, newer products,
and lower costs. The manufacturer doesn’t have to worry that a new product launch is botched at
the shelf, and the retailer doesn’t have to worry that consumers will snub the new product because
execution and new product development are performed jointly.
Virtual vertical collaboration offers pros without cons
Source: A.T. Kearney analysis
What virtual vertical means
• Margin enhancement and growth opportunities jointly pursued across entire manufacturer-retailer value chain
• Scope extended to integrating assets, resources, and capabilities: “What if we were just a touch away from merging?”
In the old way of thinking, such possibilities would be, well, impossible, since the costs would
likely fall on one party while the benefits accrue to the other. That’s why it is important to act as
though a merger is just a touch away. If you can trust each other, then figuring out how to pay
for your collaborative efforts and how to distribute the benefits is transformed from a matter of
competitive survival to a value-sharing opportunity.
Transparency: The Secret to Integration
The value of virtual vertical collaboration lies largely in the perspective that transparency leads to
insights about how to integrate more efficiently and create team wins rather than individual ones.
Consider cost transparency. Yes, costs can be reduced by streamlining distribution and
transportation, but when manufacturer and retailer create a combined cost waterfall, they are
likely to gain new insights. In the example illustrated in figure 3 on page 6, distribution and
transportation represent just 6 percent of the final retail price. There are more cost-saving
opportunities in rethinking assortment and cost-to-price strategies as raw materials,
packaging, and manufacturing represent 42 percent of the final price. In this example, even
streamlining store operations by 16 percent offers a better opportunity for cost reduction.
6Virtual Vertical Collaboration
The same is true for process transparency. A product development process free from
manufacturer and retailer constraints provides opportunities to not just reduce costs but also
to increase top-line growth. We recently helped a client launch a new product line in a stagnant
category by combining its knowledge of current assortment limitations with value chain
improvement opportunities. The launch took place in one-third the usual time, and consumption
increased into the high single digits. Again, the point is to build on mutual strengths.
In an integrated distribution model the
manufacturer can “see” a store’s inventory.
Transparencyintheflowofinformationandgoodsis also important at manufacturing plants,
regional warehouses, distribution centers, and stores. In an integrated distribution model, the
manufacturer can “see” a store’s inventory. A single netted demand removes variables to improve
forecast accuracy, so the manufacturer can flexibly move product in a way that optimizes the
plant-to-shelf network system, inventory, and cost. The result is more predictable replenishment
and less inventory.
How a combined cost waterfall can reveal key insights
Notes: CPG is consumer packaged goods; D&T is distribution and transportation; DC is distribution center; G&A is general and administrative.
Source: A.T. Kearney analysis
• Item production costs
• Receiving to shelf handling
• In-store labor and facility costs
• CPG in-store sales and merchandising
• Support functions
• Building and office expenses
• Indirect materials spend
• Trade funding
• Consumer and marketing expenses
• CPG D&T (Plant to DC to store)
• Retailer D&T (DC to store)
Retail shelf price index = $1.00 (food example)
Raw materials and packaging
Distribution and transportation
Trade marketing and selling
Retail price 1.00
7Virtual Vertical Collaboration
Three Phases of Collaboration
A successful virtual vertical collaboration takes place in three phases, all of which must be
undertaken by at least one of the companies (see figure 4).
10 steps to virtual vertical collaboration
Source: A.T. Kearney analysis
• Define collaboration objectives
• Identify potential opportunities and value
• Screen potential partners
• Pilot opportunities and test operating model
• Expand opportunities into adjacencies
• Monitor results and refine opportunities
• Initiate discussions with potential partners
• Establish joint collaboration objectives and goals
• Evaluate opportunities through “clean room”
• Agree on investment and value sharing
Strategic assessment. The first phase is all about determining current positions and how
collaboration supports the company’s strategic objectives. For instance, essential capabilities
might lie with one or more of your trading partners, so instead of building these capabilities
and resources yourself, partnering allows for better access. Because screening is crucial, the
assessment typically begins with creating a list of prospective partners, keeping in mind the
potential for marketplace acceptance of such a collaboration. The list is then whittled down
to a short list of prospects.
Partner engagement. This phase is the pitch to prospective partners. It requires top-to-top
leadership communications to ensure a cross-functional agenda that is not limited by cultural
preconceptions. Where there is mutual interest, there is a program with clear objectives that
benefit both parties. Organizing cross-functional initiatives around a product category or a
customer channel is effective for managing the process and also allows for cross-functional
synergies. Here, we typically establish a joint team and the equivalent of a merger integration
clean room to evaluate opportunities in each company’s value chain, establish an investment
model, and determine value sharing options (see sidebar: Inside the Clean Room on page 8).
8Virtual Vertical Collaboration
Opportunityrealization. In phase three, both companies decide whether the opportunities are
substantial enough to justify dedicating resources to implementing joint initiatives. Pilots are
launched within a small portfolio of products or markets, with the goal of demonstrating the real
value of virtual vertical collaboration and working out kinks in the operating model. Successful
pilots lead to broader launches. As a guiding principle, value from cost reductions is directed
toward innovations and joint areas of growth, which essentially means that incentives are aligned
with behaviors to sustain a long-term relationship. Both partners review their options annually—
if not more frequently—to determine whether or not the partnership is living up to expectations.
Making the First Move
Virtual vertical collaboration is a way of doing business, not a means of driving return-on-
investments. Although a collaboration effort can seem complex, it’s really not difficult. What
is difficult, however, is making the first move: deciding to engage in such an endeavor and
systematically finding the right partner with the right strengths to create a mutually beneficial
alliance. This requires a profound level of trust and is not something done with just any
company. You need to know with absolute certainty that your objectives are mutual. When
executed correctly, a virtual vertical collaboration is worth the effort, providing a strong
foundation for category growth, faster new product launches, and reduced costs all along
the value chain.
Inside the Clean Room
Similar to a merger or acqui-
sition, we use a virtual site to
restrict access to information so
that each company team sees
Joy Peters, partner, New York
Michael Sansone, principal, Chicago
Sean Monahan, partner, New York
The authors wish to thank Niklas Vogelpohl for his valuable contributions to this paper.