Operational Excellence Indian Vs. International Practices

Operational Excellence: Indian vs. International PracticesOperational Excellence: Indian vs. International Practices

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Western Region Annual Meeting

April 11, 2002

KEY MESSAGES

I. Superior operations drives value creation

II. Indian manufacturing companies face significant operations challenges

III. New tools and mindset required to build operational excellence

IV. Rewards from pursuing operational excellence can be large – the journey must begin now





INTERNATIONAL RESEARCH SUGGESTS THAT COMPANIES WITH SUPERIOR OPERATIONS DELIVER SUPERIOR RETURNS…

30

560

990

*Excellent" 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)

ApproachApproach

• Short-listed 44 “excellent” companies for analysis– ROIC > WACC (from

95-99)– ROIC > Industrial

average• Short-listed 12

“excellent companies” based on qualitative review of operations

Average Total returns to shareholders

1,000

3,000

5,000

7,000

9,000

11,000

13,000

15,000

17,000

19,000

1994 1995 1996 1997 1998 1999 2000

Wilshire Index (market)

"Excellent" - Top 12*

"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

…WHICH TRANSLATE INTO SUPERIOR VALUATIONS

OPERATIONAL EXCELLENCE DRIVES THESE RETURNS

• New product introduction cycle time and cost 50% lower than competition

• Manufacturing floor space required 50% less for comparable product

• Order to delivery time less by a factor of five

• P/E 20+ points higher than other major players

• Make-to-order supply chain• Inventory level 60% lower • Receivables turns 45% higher

• Revenue growth 40% faster and ROIC 1.5 times industry average

• 3-year cost savings goal of USD 1 billion achieved through Alcoa Production System

• Additional USD 1 billion savings targeted for 2003

• From 1996 to 2000, CAGR of revenues and net income 15% and 30%, respectively, in spite of plunge in aluminum prices

Operational Initiatives Overall financial impact

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

Alcoa Business System

*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

InitiatedAlcoa production system

ALCOA CASE STUDY – THE RESULTS

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

15

8

13

KEY MESSAGES









INDIAN MANUFACTURING COMPANIES FACE A PROFITABILITY CRISIS

6.65.2

1997

20% decrease

Profit margins*

2000

PAT, percentage of sales

Percentage of companies making losses

Per cent

15

23

1997

50% increase

2000

-4.30

-4.60

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

POOR FINANCIAL PERFORMANCE IS DRIVEN BY POOR LABOUR AND CAPITAL PRODUCTIVITY…

24

11

10

25

Automotive

Steel

Power (generation)

Labour Productivity Capital productivity

Index, US = 100

Apparel

40

65

Index, US = 100

Source: McKinsey Global Institute study of the Indian economy

EXAMPLES

NA

NA

ManufacturingManufacturing

Supply chainSupply chain Channelmanagement

Channelmanagement

Key account management/ Sales forceeffectiveness

Key account management/ Sales forceeffectiveness

PricingPricingPurchasing/supply management

Purchasing/supply management

GAPS EXIST IN ALL AREAS OF OPERATIONAL PERFORMANCE

Too many suppliers (250* vs. 100 for best-

practice)

Too many suppliers (250* vs. 100 for best-

practice)

Unaware of ‘pocket

margins’

Unaware of ‘pocket

margins’

80% time on non-value

added activities

80% time on non-value

added activities

Poor channel capability and

returns

Poor channel capability and

returns

No systematic tracking of top customers and

their satisfaction

No systematic tracking of top customers and

their satisfaction

Too much inventory (140 days vs. 35 for best-practice*)

Too much inventory (140 days vs. 35 for best-practice*)

*Automotive industry analysis

KEY MESSAGES









NEW MINDSET REQUIRED TO DRIVE OPERATIONAL EXCELLENCE

Typical mindset Required mindset

• Limited top management involvement

• Driven by CEO agenda

• Incremental targets • Step-change improvement

• Subjective problem solving • Focus on facts and root causes

• Ad-hoc implementation • Relentless focus on change and consequence management

• Programme driven by “sparable” executives

• Led by the brightest and the best

Source: Interviews

Source: Interviews; SIAM; Harbor Report

Equivalent cars per equivalent employee; Index, US average in 1998 = 100

SEVERAL SOURCES OF GAPS EXIST IN MANUFACTURING

Pre-libera-szation plants

Excess workers, OFT*, DFM**, techno-logy, scale

Post-libera-lisation plants

Supplierrelations

Scale/ Utili-sation

Organisation of functions and tasks and training

India Potential

Non-viable Auto-mation

US average

632

38 17

75

84 16

100

16

Design for manufacturing

India average = 241

Viable Auto-mation

1. Manufacturing

AUTOMOTIVE EXAMPLE

*According to DRI-segmentationSource: Interviews; McKinsey Automotive Practice

DESIGN FOR MANUFACTURE OF SELECT INDIAN SEGMENT A CARS*

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

• Press shop: 31% (represents 4% of total employment)

• Body shop : 25% (represents 19% of total employment)

India

India

BOTTOM UP IMPROVEMENT PROGRAMS EVALUATE NUMEROUS IDEAS AND CAN YIELD LARGE BENEFITS

• In a typical program, more than 2,000 ideas are generated, rigorously evaluated and implemented

• Ideas are not capital-intensive

• Should yield payback in not more than one year

• Should be implementable in 3-6 months

Rigorous evaluation of simple ideas…

…could yield impressive results• 30-40% reduction in

compressible costs (10-20% reduction in total manufacturing costs)

• Significant reduction in downtime

• Large reduction in defect rate

• Better reliability and shorter throughput time in deliveries

SUPPLY CHAIN – SIGNIFICANT GAPS EXIST

From… To…

“Single solution for entire company” – one size fit all approach

• Define what needs to be offered– Different customer service levels– Product variety and configuration

• Multiple chains within a company

“Redesign to meet competitive benchmarks”

• Design to meet segment-specific customer breakpoints

“Push-system is the only way Indian supply chains work”

• Pull (wherever possible) based on better forecasting and order management

“IT system will solve all supply-chain issues”

• Use IT selectively (not before, but after redesign) for:– Information transparency– Order management and forecasting

2. Supply chain

CROSS-FUNCTIONAL COMMODITY SOURCING TEAMS HELP REDUCE PURCHASING COSTS

3. Purchase cost reduction

• Imperative to reduce purchasing costs to gain overall cost advantage

• Traditional functional organisations

• Limited engineering and operations inputs into purchase decisions

• Most cost reduction is negotiation driven, rather than total-cost driven

Context Some elements of strategy

• Performance specifications- “fit for use”

• In-house involvement (make vs. buy)

• Supplier discovery

• Sole source vs. multi-source

• Contract type, pricing and duration

• Joint cost elimination (transportation, inventory etc.)

Composition of sourcing teams

• Cross functional with participation and support from all areas (purchasing, plant, engineering, marketing etc.) and by commodity

THE TOTAL COST OWNERSHIP (TCO) FRAMEWORK HELPS IDENTIFY COST LEVERS BEYOND PURCHASE PRICE

Production capacity Production capacity

Transportation Transportation

Inventory carrying costs

Inventory carrying costs

Warehousing Warehousing

Purchasingadministration

Purchasingadministration

Factory yield

Factory yield

R&D R&D Damaged productDamaged product

Specifications Specifications

Warranty expeditingWarranty expediting

Internal and joint levers

•Change specifications

•Load schedules into supplier scheduling system via EDI

• Involve suppliers in design/reviews

•Analyze supplier’s TCO to identify cost-reduction opportunities

•Evaluate yield improvement potential from alternative specifications

•Consolidate part numbers to build scale

Purchase price

Purchase price

Traditional Purchasing Levers

• Identify new suppliers (local and global)

• Include non-performance penalties (e.g., missed deliveries, non-conforming parts) in contracts

Illustrative action areas

KEY MESSAGES









EACH AREA CAN HAVE SIGNIFICANT IMPACT ON PROFITS AND VALUE CREATION

Revenues

Per tax ROIC

EBIT

Costs

Invested capital

Working capital

Fixed assets

:

LeversRange of impact possible based on McKinsey experience

Pricing management • 2-6% increase in return on sales

Key account management/sales force effectiveness

• 5-30% revenue increase

Channel management • 10-20 percentage points increase in market share

1

2

3

Purchasing cost reduction

• 10-15% reduction in purchase costs

Manufacturing effectiveness and overheads cost reduction

• 20% reduction in manufacturing costs

• 20-50% reduction in downtime and defects

• 80-90% improvement in supply reliability

• 20% reduction in overhead costs

4

5

Supply chain management

• 30-50% reduction in inventory

• Stock outs nearly eliminated with 1-3% increase in sales

6

SET AGGRESSIVE ASPIRATIONS FOR OPERATIONAL EXCELLENCE

Source: McKinsey

Performance comparison/gaps

Company

Processeffective-ness

Process efficiency

Factorcost

Best com-petitor bench-mark

Other

Material

Capital

Personnel

100

15 – 25%

Best ofbest bench-mark

35 – 40%

Theore-ticallimits

60 – 75%

EVOLUTION OF THE OPERATIONAL EXCELLENCE JOURNEY

Lean value chainLean value chain

• Application of best practices to redesign and optimize the overall end-to-end value chain

Lean corporationLean corporation

• Integrated application of best practices and tools (including culture change) to transform the entire company – drive cross functional behaviour

Lean “functions”Lean “functions”

• Application of best practices and tools to achieve improvement in focused cells/processes

APPROACH TO IDENTIFY AND CAPTURE THE OPPORTUNITY

What’s the opportunity?What’s the opportunity?What’s the opportunity?What’s the opportunity?

?

• Start with a diagnostic, including the business case

• Focus on all, relevant operational levers

• Set stretch targets based on benchmarking

• Start with a diagnostic, including the business case

• Focus on all, relevant operational levers

• Set stretch targets based on benchmarking

How to capture it?How to capture it?How to capture it?How to capture it?

Rs?

• Small pilot in each area and then quick roll-out

• Specific tools for each part of the value chain

• Small pilot in each area and then quick roll-out

• Specific tools for each part of the value chain

Sustaining MomentumSustaining MomentumSustaining MomentumSustaining Momentum

20002001

20022003

• Strong performance management systems

• Modified organisation structure and people

• Ensure significant top-management involvement

• Strong performance management systems

• Modified organisation structure and people

• Ensure significant top-management involvement