Virtual Vertical Collaboration


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© 2013, A.T. Kearney, Inc. All rights reserved.
Joy Peters Partner New York
Sean Monahan Partner New York
Mike Sansone Principal Chicago

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Virtual Vertical Collaboration

  1. 1. 1Virtual Vertical Collaboration Virtual 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.
  2. 2. 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 business decisions. 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 competitors.
  3. 3. 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 workedaspartnersformanyyears. Theirbusinesseswereinherently intertwined:Theretailerwasthe manufacturer’sbiggestcustomer, andthemanufacturerdominated theproductcategorycentraltothe retailer’sgrowthstrategy.Having exhaustedefficiencytacticsbased on competitive market forces, both companies were ready for a new approach. Themanufacturer’ssalesdirector andseveraloftheretailer’sbuyers knewtherewasopportunityina corporaterelationship,butthere wasnoobviouswaytoapproachit withoutriskingacompromiseof commercialtermsincategories slowedbythepooreconomy.The problemwassimilartomerger discussionsrequiringconfidential information to be shared in a structured yet safe manner. A.T.Kearneywasbroughtin tofacilitateavirtualvertical collaboration.Afterinitial discussions,thecompanies agreedonathree-teamapproach. TheA.T.Kearneyteamestablished acleanroominaseparatelocation toconsolidatedata,develop hypotheses,andcompletevalue chainanalyses.Themanufacturer andretailerteamsactedas intermediariesandadvocatesfor eachofthebusinesses,devel- opingacross-functionalgover- nancestructurealignedtoproduct categoriesanddeployinga category-by-categoryapproachto strengthenrelationshipsbetween buyersandcategorymanagers. Theresultsweresignificant: Reductions of7to15percentin transportationcosts,10to20 percentinmaterialcosts,and10 to20percentinsysteminventory wereidentified.Additionally,gaps inoperatingpracticesresultedin a1percentstockimprovement. Mostimportant,however,was establishinganewmethodof productdevelopment.Workingin anewenvironmentoftrustand jointrisktaking,theretailerand manufacturerteamedupto developanewproductlinethat waslaunchedinhalfthetimeit wouldnormallytake.Thankstoa virtualverticalmindset,thesetwo firmsdevelopednewproductsthat thrivedincategoriesrendered stagnantbytheglobalrecession.
  4. 4. 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 empty trucks. 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. Figure 1 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 Level of integration Increasing time and maturity of relationship Low High • Forecast sharing • CPFR® • VMI • Differentiated flowpaths • DC bypass or backhaul • Asset sharing • Store-ready pallets • Display management • Store labor optimization • Joint forecasting and category planning • Promotions planning • POS analytics • Sharing of shopper marketing insights • Merchandising optimization • Collaborative product development, NPI • Joint procurement opportunities • Joint category assortment, private label strategy • Joint profit and loss Data exchange and planning coordination Stage I: Basic Optimized supplier-to-shelf product flow Stage II: Intermediate Collaborative business planning Stage III: Advanced Virtual vertical collaboration Stage IV: Expert May include elements from Stages I and II
  5. 5. 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. Figure 2 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?” Manufacturer Retailer Innovate Plan Source Make Sell, merch- andise Deliver Plan Procure Deliver Merchandise, sell 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.
  6. 6. 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. Figure 3 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 • Advertising • 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 Manufacturing Distribution and transportation Trade marketing and selling Store operations G&A Combined profit 0.33 0.09 Retail price 1.00 0.06 0.14 0.16 0.07 0.15
  7. 7. 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). Figure 4 10 steps to virtual vertical collaboration Source: A.T. Kearney analysis Strategic assessment • Define collaboration objectives • Identify potential opportunities and value • Screen potential partners Opportunity realization • Pilot opportunities and test operating model • Expand opportunities into adjacencies • Monitor results and refine opportunities Partner engagement • 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).
  8. 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 Inamerger,acleanroomallows forthelegalsharingofconfi- dentialinformationunderspecial conditions.Inavirtualvertical collaboration,acleanroomisa locationwhereA.T.Kearneyteams conductanalytics,mapvalue chains,anddevelophypotheses. Ourtwointegrationteamsactas intermediariestofacilitate collaboration.Regularmeetings— someinvolvingeachcompany alone,someinvolvingboth companies—areheldtodevelop hypotheses,reviewprogress,and actonrecommendations. Similar to a merger or acqui- sition, we use a virtual site to restrict access to information so that each company team sees onlydatainitsownfolder.Source datafilesarenotsharedwiththe othercompany,andinformation thatissharedwithbothcompanies isredactedappropriatelyto protectproduct-specificfinancial confidentialitywhileallowingfor discussionofopportunities. Authors 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.
  9. 9. A.T. Kearney is a global team of forward-thinking partners that delivers immediate impact and growing advantage for its clients. We are passionate problem solvers who excel in collaborating across borders to co-create and realize elegantly simple, practical, and sustainable results. Since 1926, we have been trusted advisors on the most mission-critical issues to the world’s leading organizations across all major industries and service sectors. A.T. Kearney has 57 offices located in major business centers across 39 countries. Americas Asia Pacific Europe Middle East and Africa Atlanta Calgary Chicago Dallas Detroit Houston Mexico City New York San Francisco São Paulo Toronto Washington, D.C. Bangkok Beijing Hong Kong Jakarta Kuala Lumpur Melbourne Mumbai New Delhi Seoul Shanghai Singapore Sydney Tokyo Abu Dhabi Dubai Johannesburg Manama Riyadh A.T. Kearney Korea LLC is a separate and independent legal entity operating under the A.T. Kearney name in Korea. © 2013, A.T. Kearney, Inc. All rights reserved. The signature of our namesake and founder, Andrew Thomas Kearney, on the cover of this document represents our pledge to live the values he instilled in our firm and uphold his commitment to ensuring “essential rightness” in all that we do. For more information, permission to reprint or translate this work, and all other correspondence, please email: Amsterdam Berlin Brussels Bucharest Budapest Copenhagen Düsseldorf Frankfurt Helsinki Istanbul Kiev Lisbon Ljubljana London Madrid Milan Moscow Munich Oslo Paris Prague Rome Stockholm Stuttgart Vienna Warsaw Zurich