Thursday, October 16, 2008

HP increasingly turning to touch-screen technology.

HP increasingly turning to touch-screen technology.

The Wall Street Journal (10/16) reports, "Hewlett-Packard Co., aiming to boost its personal computer sales amid a deteriorating economy and soft holiday season, is increasingly turning to touch-screen technology." The company is now "developing a consumer notebook machine with a touch screen that will debut before year end," and "will include special HP software that supports the touch screen," sources said. "Other details, such as pricing, remained unclear." The new laptops' "touch-sensitive screens allow PC users to move items around, surf the Web, or open files with their fingertips, replacing functions normally performed by a mouse and keyboard." This marks "the latest in a series of touch-oriented devices, including an upcoming line of cellphones that will become a priority of HP's consumer strategy as it tries to differentiate itself from rivals such as Dell Inc.," according to reports. "The new touch-screen notebook comes in time for a holiday sales season that's expected to drag heavily on PC makers."

The value of China's emerging middle class

The value of China's emerging middle class

Demographic shifts and a burgeoning economy will unleash a huge wave of consumer spending in urban China.

June 2006

As China's economy has soared at consistently astonishing rates, many global companies have focused on serving the country's most affluent urban customers. When these well-off urbanites were the only consumers with significant disposable income,1 this strategy of skimming the cream from the top made sense. But new research by the McKinsey Global Institute (MGI) highlights the emergence of a far larger, more complex segment—the urban middle class, whose spending power2 will soon redefine the Chinese market (see sidebar, "About the research"). While some companies are already focusing on the evolution of this new class, many others have yet to broaden their vision and thus risk missing a significant opportunity.

The lure of China's urban-affluent segment is easy to understand. These consumers earn more than 100,000 renminbi (about $12,500) a year3 and command 500 billion renminbi—nearly 10 percent of urban disposable income4—despite accounting for just 1 percent of the total population. They consume globally branded luxury goods voraciously, allowing many companies to succeed in China without significantly modifying their product offerings or the business systems behind them. And since this segment is currently concentrated in the biggest cities, it's easy to serve, both for companies now entering the Chinese market and for old hands seeking a steady revenue stream.

However, fixating on the urban-affluent consumer could mean that companies fail to capitalize on the dramatic changes that lie ahead as China's economic growth, barring unforeseen shocks, improves the livelihood of hundreds of millions of its citizens. Over the next 20 years more people will migrate to China's cities for higher-paying jobs. These working consumers, once the country's poorest, will steadily climb the income ladder, creating a new and massive middle class.

Although producers of luxury goods may continue to cater only to the wealthiest households, other companies—especially manufacturers of mass consumer goods—can win the bigger prize by broadening their focus to include the emerging middle class. Because tomorrow's middle-class consumers are today's urban workers (dispersed across many cities and still relatively poor), serving them will naturally require a company to change its strategy significantly. Early movers, such as Coca-Cola and P&G, have already begun creating models to target this segment profitably.

Recognizing tomorrow's middle class

The rising economy in China will lift hundreds of millions of households out of poverty. Today 77 percent of urban Chinese households live on less than 25,000 renminbi a year; we estimate that by 2025 that figure will drop to 10 percent (Exhibit 1). By then, urban households in China will make up one of the largest consumer markets in the world, spending about 20 trillion renminbi annually5—almost as much as all Japanese households spend today.6 Furthermore, since these estimates were calculated at today's tightly managed exchange rates, they may significantly underestimate China's future consumer purchasing power.7

Rapid economic growth will continue to transform the impoverished but largely egalitarian society of China's past into one with distinct income classes. This evolution is already creating a widening gap between rich and poor, and tackling the resulting social and economic tension has become a focus of government policy. Our projections indicate, however, that China will avoid the "barbell economy" that plagues much of the developing world: large numbers of poor, a small group of the very wealthy, and only a few in the middle.8 Even as the absolute difference between the richest and poorest continues to widen, incomes will increase across all urban segments.

As this economic tide rises, we anticipate two phases of steep growth in the middle class, with waves of consumers in distinct income brackets emerging and receding at specific points (Exhibit 2). The first wave, in 2010, will be the lower middle class, defined as households with annual incomes of 25,001 to 40,000 renminbi. A decade later the upper middle class, with annual household incomes of 40,001 to 100,000 renminbi, will follow. These numbers may seem low compared with consumer incomes in the world's richest countries—current exchange rates and relative prices tend to underplay China's buying power—but such people are solidly middle class by global standards. When accounting for purchasing-power parity, a household income of 100,000 renminbi, for instance, buys a lifestyle in China similar to that of a household earning $40,000 in the United States.

By around 2011 the lower middle class will number some 290 million people, representing the largest segment in urban China and accounting for about 44 percent of the urban population, according to our model. Growth in this group should peak around 2015, with a total spending power of 4.8 trillion renminbi. A second transition is projected to occur in the following decade, when hundreds of millions will join the upper middle class. By 2025 this segment will comprise a staggering 520 million people—more than half of the expected urban population of China—with a combined total disposable income of 13.3 trillion renminbi.

Two features of China's emerging middle class are already particularly notable. First, it will be unusually young compared with that of most developed markets, whose highest earners tend to be middle aged. In the United States, for example, income generally peaks between the ages of 45 to 54.9 Since higher-paying jobs, on average, require a higher level of education and training than what older generations have obtained, the Chinese government currently makes substantial investments in higher education for the younger cohorts, meaning that the country's wealthiest consumers will be from 25 to 44 years old.10

Second, the urban middle class will dwarf the current urban-affluent segment in both size and total spending power. From 2010 onward we will see some distinct subsegments among the affluent—including the mass- and global-affluent categories—but they will still total only 40 million households by 2025, accounting for just 11 percent of all urban dwellers. Their total consumption will equal 5.7 trillion renminbi11—just 41 percent of middle-class consumption.

While total spending by the middle class will exceed that of urban-affluent consumers, the latter will remain a critical market for some companies. These upper-tier households already account for 25 percent of Chinese household savings and will continue to control the bulk of the nation's accumulated wealth—60 percent by 2025. Their importance to banks and other financial-services firms will therefore increase. As in other countries that have underdeveloped consumer credit markets, Chinese households with sizable savings are the most likely to buy relatively expensive items, such as automobiles and durable goods.

Nevertheless, the biggest opportunity for companies selling mass-consumer goods and services will be the newly empowered middle class. To serve these households successfully, companies will need to understand how the saving and spending patterns of consumers change as their incomes increase.

Hitting a moving target

Although the middle class will not reach its full spending potential for nearly 20 years, its household saving and consumption patterns have already begun to take shape. Today China's thrifty households tuck away a quarter12 of their after-tax income—one of the highest saving rates13 in the world. Our research suggests that while the emerging middle class will continue to save heavily, they will also spend increasing amounts of money.

A McKinsey survey indicates that the top two reasons for high saving rates in China are concerns about health care and retirement.14 Although China's social safety net may gradually improve as the country grows richer, ingrained attitudes toward saving will change even more slowly. We project that urban saving rates will decline moderately but remain above 20 percent over the next two decades, boosting total urban consumption by 8.7 percent a year during this period. The growth will be driven not only by the rapidly increasing urbanization rate but also by a substantial (6.1 percent) annual increase in per capita consumption.

As incomes rise, spending patterns change. Families tend to buy more discretionary and small luxury items, and the share of the household budget that goes toward food, clothing, and other necessities shrinks. In China this shift seems to be happening more quickly than it has in other developing countries. For several years now, urban Chinese consumers have dedicated a smaller share of their household budgets to the basics than South Koreans did at a similar point in their country's economic development, for example.15

While basics may decline as a share of consumption, in absolute terms they will continue to grow as the overall economy expands. We expect, for example, that urban spending on food16 will grow by 6.7 percent annually during the next two decades, holding its place as the largest consumption category in urban areas and making China one of the fastest-growing food markets in the world (Exhibit 3). Spending on most other categories will rise faster, however, so food's relative share of wallet will actually decline (Exhibit 4).

Housing and health care will be two of the fastest-growing categories. In many emerging economies consumers spend proportionately less on housing as their incomes increase. Since private ownership of China's housing stock has only recently begun and government subsidies for housing have been reduced, Chinese consumers will have to allocate more of their income to paying for shelter and utilities. These outlays are expected to reach a combined 16.6 percent of household budgets by 2025. In addition, increased home ownership will fuel spending on construction services, building materials, and furnishings. Given the importance of health care to Chinese families, the country's rapidly aging population, and the challenges facing the public health care system, we project that private health expenditures by urban consumers will grow at a rate of more than 11 percent annually over the next two decades. This increase in spending will create significant opportunities for health care providers, insurance companies, medical-equipment manufacturers, and pharmaceutical companies.

As incomes rise, Chinese consumers will also devote a larger proportion of their household budgets to educational expenses (such as tuition, tutors, and textbooks)—more than their counterparts in developed countries. This spending will be driven by the strong link between education and higher salaries, as well as by the growing number of options for both higher and vocational education.

Serving tomorrow's middle class today

Even companies that understand and anticipate changes in consumer saving and spending patterns may struggle to serve China's growing middle class. While the future of the consumers who make up this segment is bright, they are currently relatively poor and dispersed across cities of all sizes in China. Nowadays they are largely blue-collar workers; over the next 20 years they will increasingly migrate into service and knowledge industries. With an average household income of 17,600 renminbi, these people currently have little discretionary income to spend. Differences in exchange rates mean that products with components purchased on the global market rather than sourced domestically will usually be too expensive for them. This limitation applies not only to manufactured and imported goods but also to services, such as international travel.

Despite such obstacles, some companies have already begun targeting urban working households. As incomes rise, new entrants will find more profitable opportunities to accompany these consumers up the growth curve. By serving them today, businesses will gain the exposure and experience necessary to stay relevant as the incomes—and tastes—of urban consumers evolve.

Given the challenges of such a rapidly changing market, some companies have already had to think creatively about lowering product costs, reconfiguring business systems, and shifting to local sourcing strategies. The German retailer Metro, for example, keeps costs down by sourcing 95 percent of the products for its Metro China shops from domestic suppliers. Even a successful formula for current market conditions can soon become obsolete, however. Companies that target current urban working consumers—say, by reducing prices and repositioning products for lower-end segments—may find that these customers will abandon the brands as soon as their pocketbooks allow. To avoid this trap, several companies have adopted multitiered branding strategies, enabling them to follow their customers up the income ladder. P&G, for example, offers more affordable Olay products in supermarkets and hypermarkets and high-end lines such as Olay Regenerist in department stores.

China is evolving from a relatively monolithic, poor country into a vibrant marketplace with complex and rapidly developing consumer segments. Instead of focusing mostly on urban-affluent customers, who are just the tip of the consumer iceberg, more companies should adjust their strategies to include the emerging middle class as a core customer segment. This approach poses many challenges, but for companies that anticipate the changes that lie ahead, the opportunities will be as vast as the country itself.

About the Authors

Diana Farrell is director of the McKinsey Global Institute, Ulrich Gersch is a consultant in McKinsey's New York office, and Elizabeth Stephenson is a consultant in the San Francisco office.

The authors would like to acknowledge the contributions of their colleagues on the McKinsey Global Institute China demand team—Jonathan Ablett, Eric Beinhocker, Ezra Greenberg, Grace Hu, Yuan Luo, Jani Moliis, and Vivien Singer, and of Geoff Greene, an external adviser to MGI—as well as Kevin Lane and Ian St-Maurice.


1Disposable income = after-tax income, including savings.

2Spending power or consumption expenditure = disposable income - savings.

3All renminbi figures are given in real year 2000 terms.

4All data in this article were generated by the Q1 2006 version of an MGI econometric model on Chinese consumer demand.

5Urban households will, on average, save slightly more than 20 percent of their total disposable income each year, translating into annual savings of 6 trillion renminbi in 2025.

6According to the Organisation for Economic Co-operation and Development (OECD), Japanese household consumption was $2.7 trillion in 2004.

7The Chinese government currently manages the renminbi's exchange rate. If the renminbi were allowed to float freely to its natural purchasing-power-parity level, goods at global market prices would become more affordable to Chinese consumers and the total size of the market, measured in US dollars, would be even larger. Some analysts estimate the renminbi's purchasing-power parity at 2.3 to $1, for example, implying an urban Chinese consumer market of $8.7 trillion in real dollars in 2025. By comparison, the US consumer market was worth $7.6 trillion in 2004, according to the OECD.

8We project that the Gini Index, a common measure of income inequality, will remain relatively stable in urban China through the next two decades as incomes rise at all levels.

9Consumer Expenditure Survey 2002, US Census Bureau.

10McKinsey & Company's proprietary 2004 personal-financial-services surveys in China.

11We project that by 2025 urban-affluent households will save 3.8 trillion renminbi, or approximately 40 percent, of their disposable income.

12"National Bureau of Statistics of China Household Income and Expenditure Survey," China Statistical Yearbook, 2004.

13Household saving rate is measured as a percentage of household disposable income.

14Kevin P. Lane and Ian St-Maurice, "The Chinese consumer: To spend or to save?" The McKinsey Quarterly, 2006 Number 1, pp. 6-8.

15Measured by real GDP per capita in US dollars.

16This category also includes tobacco and both alcoholic and nonalcoholic beverages.

How IT can drive business process reorganization: An interview with the CIO of Volkswagen

How IT can drive business process reorganization: An interview with the CIO of Volkswagen

Volkswagen chief information officer, Klaus Hardy Mühleck, has championed the CIO's role as the arbiter of business process and enablement.

Detlev Hoch and Jürgen Laartz

September 2006

At a time when many CIOs find themselves increasingly distanced from the executive suite, Volkswagen's CIO Klaus-Hardy Mühleck sits on the executive board and has responsibility for defining business processes throughout the company. In that capacity he has championed a new organizational IT structure to use resources more efficiently and effectively. Process integration officers work across business units to simplify the capabilities of entire business domains—for example, a PIO in the order-to-delivery unit evaluates processes from the customer order back through sales, manufacturing, and design. Throughout Mühleck's career, he has promoted the use of IT to simplify processes, gain a competitive advantage, and create value. Detlev Hoch and Jürgen Laartz, directors in McKinsey's Düsseldorf and Berlin offices, respectively, recently spoke with him about how and why he has reorganized the IT function and the results that Volkswagen expects from the effort.

The Quarterly: You've helped lead Volkswagen through a transformation over the past few years—from a company whose IT function just supported the business to one where IT leads change and works hand in hand with the other functional leaders to innovate. Can you tell us about that transformation?

Klaus-Hardy Mühleck: In many companies and in a lot of industries, you will find that IT isn't a core competency. It's more or less a historical discipline—running data centers, preparing and servicing different clients. And management views it as a cost center.

But over the past ten years at Volkswagen, we've begun to talk about the role of the CIOs and how to focus their skills on business enablement. This is not a hard leap to make for executives in some younger industries, like mobile communications. But in more established industries, like automotive or energy, it takes a little more work, since explaining to senior managers in other functions how IT can help play this leading role is a real paradigm shift. So if we discuss finance and control with finance leaders, we tell them how we work with SAP to prepare standard processes for accounting and controlling work. From there, we have to agree that to map out new processes, we must work collaboratively, bringing together the IT and business knowledge to design what's possible. We call this "concurrent engineering."

And of course the same is true in automotive design. It's no longer possible to talk about designing automobiles or manufacturing facilities without IT's input, because the vehicles and the factories are all digital—all based on digital models. In fact the biggest challenge in the product part of our business is to accelerate product development and manage the complexity of different products and versions. In a company like ours, this complexity is intensified by the high degree of interaction we need between the R&D departments of our various brands and of our external engineering partners. It's no longer enough just to involve IT; innovation must be driven by IT.

The Quarterly: So you reorganized the IT function to align it with the business domains?

Klaus-Hardy Mühleck: Yes, we designed the organization to better suit this evolving vision of IT. First, we created a new role, that of the PIO, to lead the strategic redesign in several areas of the business. We have four of these positions so far. One PIO works in the product creation process, including design, engineering, prototyping, production planning, and tooling—the total process of creating a new automobile. A second works in order to delivery and helps to rethink processes from the first customer order back to the factories, supply chain management, shop floor processes, and then back to the customer. The third is in sales, marketing, and after-sales support, coordinating these activities between Volkswagen, the wholesalers, and the retailers. This responsibility includes auto sales through all distribution channels, as well as after-sales service, warranties, and spare parts. And the fourth manages strategic and supporting processes, which include human resources, finance and control, and treasury. All of these officers work closely with their counterparts in the business departments, whether in accounting, engineering, production, or logistics, to design new architectures and processes to enable innovation. And they've also had to develop new skills within their own organizations, to bring those IT people up to speed on the businesses they're working with.

We also defined a new organization of IT architects under the chief technology officer. We carved this group out of the old IT organization and staffed it with developers and application-management folks with strong architectural skills. This group is responsible for all the technology definitions and platform standards and also for managing delivery. And we grouped our application-management activities—separate from development—into one organization, to provide higher-quality services at lower cost.

The Quarterly: Much of Volkswagen's IT supply organization is found in gedas, Volkswagen's former subsidiary, which was taken over by T-Systems in late 2005. How does that fit within this transformation?

Klaus-Hardy Mühleck: As we redefined our IT strategy, we thought about how IT demand and supply work within our organization. Our main IT services supplier is gedas, but it needed more scale if it was to bring its costs down. Although gedas was a subsidiary, we operated it as an independent third-party business so that we could expect industry-competitive services and costs. And its competitiveness is demonstrated by the fact that it recently won a big contract with Fraport, the owner and operator of the Frankfurt airport. Our board looked at several options, including taking gedas public or investing more in it. But in the end we got a good partnering model with T-Systems—they offered a long-term commitment, being culturally in sync while covering the full-service portfolio of gedas. So we made that deal.

Now, while our PIOs focus on project management and relationships with our internal customers, we outsource much of the commodity IT to gedas, which focuses on IT operations and application development. And since we were already running gedas as an independent business unit with its own management capabilities, we do not expect any new challenges or obstacles to be caused by separating it from Volkswagen.

The Quarterly: Does any of the remaining in-house IT compete with gedas?

Klaus-Hardy Mühleck: Since our objective is to continue our partnership with gedas, we are aiming for a complementary relationship. But that hardly means that gedas doesn't have to keep an eye on its competitiveness. It means that gedas may have to compete with other IT service providers, not with Volkswagen's in-house IT.

The Quarterly: Has this new structure changed the portfolio of initiatives you're working on?

Klaus-Hardy Mühleck: Even in the short period we've had the structure in place, we've seen some fairly dramatic indicators of change. Before we set up the process integration teams, only about 18 percent of our work was on new projects; the rest was services. Over the past year, we've changed to 30 percent project work and 70 percent services—all while decreasing the total IT budget. So the integration work done in these teams has resulted in focusing investment on innovation.

For example, using this integration process, we've redesigned the sales channels, centralizing our global spare-parts business and redefining our model for customer relationship management. Volkswagen has 18,000 retailers around the world, and before this there was no standard for customer relationship management. But we've designed one, and as we roll it out this innovation will save a lot of money.

Product life cycle management is another initiative with extraordinary importance. The complexity of product data has grown enormously over the last years, with broader product portfolios and many more functions within each. It becomes essential to continuously improve your product data management. In our case, a process-oriented structure was a precondition for integrating processes and systems for product development and order management.
About the Authors

Detlev Hoch is a director in McKinsey's Düsseldorf office, and Jürgen Laartz is a director in the Berlin office.

Recentralizing IT

Recentralizing IT

Companies can run their IT systems more efficiently by creating new organizational structures in which IT departments and business units share responsibility.

May 2003

Companies know that centralized IT infrastructures—the hardware, operating systems, networks, and services that support IT systems—can cut their costs.1 What is more, centralized infrastructures are more reliable.2 Yet many business managers have resisted efforts to tighten up this crucial aspect of their operations, preferring a model that steers away from the highly centralized IT departments of earlier years and toward a more decentralized, customized approach, which increases not only flexibility but also inefficiency and conflict.

A number of large banks, telcos, and consumer goods manufacturers may have found the answer to that problem: a middle way that creates new financial and governance structures for IT organizations and the business units they serve. In the old versions of centralization, IT infrastructure costs were simply allocated among business units, which had little control over the system and few incentives to manage its usage effectively. The new model strikes a balance between the simplicity of central control and the transparency and accountability of local control (Exhibit 1).

Chart: A middle way

At the center of this new arrangement are service managers, who usually have technical backgrounds but later graduated to management. Service managers work for IT organizations and support specific technologies, such as servers or mainframes. They gather requirements from their client organizations and develop price guides (for instance, a choice between high- or low-end servers and laptops), much as they would for hardware companies or systems integration firms. Before each budget year, they provide price quotations for available products and service agreements; a service manager might charge $300 a month for each server supported, for example, and guarantee 99.9 percent uptime.

Within the business units, demand managers, who may have some technical training but usually concentrate on business, assess the units' needs and select products and support from among the choices presented by service managers. At one global company, one unit's demand manager, given the means to control costs and set service levels, shaved 25 percent off its help desk expenses by differentiating between high- and low-priority calls and by deferring less urgent requests (Exhibit 2).

Chart: demand managers make a difference

Operations managers—each of whom handles a technology cluster such as data centers, servers, or network equipment—have a strong technical orientation and work in the centralized IT infrastructure organization. They oversee the day-to-day delivery of IT services and are accountable for the business units' specific performance goals, such as the time it takes to install new hardware or to fix systems faults.

Central IT departments manage the supply of products and services—data lines, servers, technical support, and so on. The business units, in turn, base their requests for services on how much data they transmit as well as on the number of servers and the level of help desk support they feel they must have. Businesses get the service they require and pay for it. They therefore have more incentive to buy only what they need, while the IT group must hold to the previously agreed cost and service levels—an arrangement that alleviates the suspicions of managers that IT departments are either overcharging or underserving them.

Chart: Consolidaate and save

This service-based approach has helped both to improve the reliability of corporate IT infrastructures and to reduce spending on them by as much as 30 percent; the more a decentralized infrastructure is consolidated, the more savings a company can expect (Exhibit 3). Within that consolidation process, the company can decide which other functions, such as the development of applications and the management of World Wide Web sites, ought to be centralized. Moreover, by clarifying its performance requirements and the cost of IT services, the company puts itself in a better position to assess its opportunities for outsourcing them. Ultimately, such decisions must be based on long-term strategic considerations, such as the uniqueness of a company's IT requirements (which would argue for in-house control) or the need to scale up its IT operations quickly (which would argue for outsourcing).

But IT infrastructures should be consolidated in any case. The system we describe is more complex to administer than are traditional approaches to IT; for one thing, the IT group must know how to set prices to reflect the true cost of services. Transparent pricing and clear accountability, however, bring economic and operational benefits—and may at last allow IT and business managers to find a model that suits both parties.

About the Authors

Brad Brown is a principal and James Kaplan is an associate principal in McKinsey's New York office, and Thomas Weber is a consultant in the Stamford office.


1Infrastructure typically accounts for some 40 to 60 percent of a company's total IT costs, and 20 percent or more of those expenses can be trimmed by consolidating and standardizing hardware and services.

2Quality control is a major concern. Well-managed, centralized infrastructures cut the number of "severity 1 faults"—systems outages that directly reduce a company's revenue or adversely affect its reputation—by about 50 percent. This kind of improved performance can save a large company tens of millions of dollars a year in operating costs.

A global road map for China’s automakers

A global road map for China’s automakers

China’s carmakers have a great future on the world stage—but not in the immediate future.

June 2008

A decade of astonishing growth has catapulted China past Germany and Japan to become the world’s second-largest market for automobiles, trailing only the United States. Global OEMs such as GM, Toyota Motor, and Volkswagen still command the lion’s share of sales in China. Nonetheless, the impressive inroads of homegrown upstarts such as Chery Automobile and Geely in the local market are fueling a desire among China’s OEMs to become not only domestic but also global competitors—aspirations encouraged by the government. Such ambitions aren’t far fetched: as recently as 2004, China was a net importer of automobiles; in 2005, the country became a net exporter, and in 2007 it exported over half a million cars and trucks, the majority of them Chinese-branded vehicles shipped to developing markets around the world.

A disquieting body of evidence, however, suggests that China’s automakers aren’t ready to go global. Chinese vehicles have languished in recent J. D. Power and Associates Initial Quality Study (IQS) results, and the recent models of several Chinese automakers have scored poorly in independent safety tests. Our own experience with some of China’s leading OEMs has uncovered significant shortcomings, including insufficient quality- and talent-management approaches, as well as a lack of strategic focus. Unless rectified, these problems could hinder the realization of the industry’s significant global potential.

China’s OEMs ought to reexamine their plans for entering overseas markets and, in some cases, scale back or postpone such moves. At the same time, they should improve their pricing and margins by repositioning brands around value, not just low prices. Moreover, the OEMs must push their quality-improvement efforts further upstream—for example, into product development and to their suppliers—and stop associating product quality solely with shop floor activities. Such efforts will require the automakers to bolster their management teams with global talent and to explore ways of encouraging much greater cross-functional collaboration. Also, some OEMs must reject the mind-set of pure wholesalers or exporters and instead focus on building sustainable businesses that include marketing, sales, and distribution activities.

Under the hood

Less than a decade ago, the annual production of a typical global automaker dwarfed the output of China’s entire auto industry. Since 2002, however, the country’s automotive sales have grown by 25 percent a year—up from 10 percent a year between 1997 and 2001—and in 2006 China overtook Japan, to become the world’s second-largest market for automobiles. What’s more, from 2001 to 2006, China’s vehicle exports rose by a remarkable 67 percent a year, to more than 340,000 units. Gone are the days when carmakers such as Shanghai Automotive Industry Corporation (SAIC), First Automobile Works (FAW), and Dongfeng Motor relied solely on joint ventures with foreign OEMs to make automobiles. Today, these carmakers have joined Brilliance Auto, Chery, Geely, and other local players in either launching or announcing plans to produce branded vehicles. In 2007, China exported upward of 500,000 cars and trucks—more than 70 percent of them bearing domestic Chinese brands—to Africa, Eastern Europe, Latin America, Russia, and Southeast Asia.

Significant strategic and structural advantages underpin these successes. Compared with the starting point of the Japanese and South Korean OEMs, in the 1970s and 1980s, respectively, Chinese carmakers enjoy a massive, fast-growing home market that allows them to scale up operations quickly and avoid any reliance on exports for growth. Compared with today’s global carmakers, Chinese OEMs command substantial cost advantages, including lower capital and labor costs, to say nothing of much lower levels of capital investment. (Chinese OEMs typically substitute cheaper labor for more expensive plant automation.) Altogether, China’s cost advantages over OEMs based in mature markets have now reached 30 to 40 percent, even after the recent appreciation of China’s currency. Projections foreseeing increased global demand for low-cost cars, as well as growing openness to Chinese brands on the part of Western consumers, suggest that the country’s OEMs do have global opportunities in the long term. Finally, these carmakers, unencumbered by a legacy infrastructure, could leapfrog their global competitors—for example, by developing alternative power-train vehicles to capitalize on growing demand for environmentally friendly products.

Yet the industry’s significant shortcomings must temper such optimism. According to the 2006 J. D. Power and Associates IQS, the Chinese industry average for problems per hundred vehicles, at 231, was nearly twice the US average. Worse still, the average was almost twice as high for domestic Chinese OEMs, at 368, than for locally built international brands. In safety tests conducted by independent agencies in Europe and elsewhere, Chinese carmakers, including Brilliance and Jiangling Motors, fared terribly. In 2005, Jiangling’s Landwind SUV earned no stars at all from ADAC, an independent German automotive organization.

Our experience working with Chinese OEMs suggests that many of these problems have operational roots. But there are other issues, too. Some OEMs, in their zeal to go global, fail to prioritize target markets sufficiently and therefore divert precious management attention away from product quality. Some embark on ambitious globalization plans before establishing strong market positions at home and so fail to take advantage of the important learning opportunities available there. And some don’t pay enough attention to marketing and distribution—even outsourcing these activities to local partners (see sidebar, “Beyond production”). Such quick-and-dirty approaches risk permanently damaging brands.

Further, organizational shortcomings can short-circuit operational processes and thus raise costs and lower quality. One Chinese carmaker we studied, for instance, had a seemingly robust and well-documented quality-gate system to catch defects during product development. Although the system detected problems adequately, many errors went unfixed, largely because of poor collaboration within the company and intense pressure on engineers to deliver products quickly.

Other OEMs take a scattershot approach to talent. To jumpstart product development, for example, one of them hurried to recruit dozens of experienced Chinese-born engineers from the Big Three automakers. Although the engineers were skilled in safety, interior design, and other specific technical areas, they lacked the project-management and system-integration skills needed to run an overall vehicle program and had little experience managing interactions with suppliers or colleagues in other departments. The resulting lackluster improvements disappointed top executives.

The road ahead

To improve, China’s automakers must adopt a focused strategy, upgrade their operational skills and product quality, and develop rigorous performance evaluation systems that promote a culture of continuous improvement from the C-suite to the shop floor.

A focused strategy

Chinese auto executives should start by asking themselves a tough question: do we have sufficient scale and financial and management resources to go abroad? For the majority, particularly OEMs selling fewer than 300,000 cars a year, the answer is probably “not yet.” Hyundai, for example, entered the US market, in the mid 1980s, with volumes comparable to those of many smaller Chinese OEMs today. Its fast start was hampered by quality and other problems that damaged the company’s reputation with consumers and took several years to repair.

The risks are greatest for China’s smallest OEMs—those selling fewer than 100,000 units a year—which face a difficult trade-off, because the cost of meeting stringent Western safety and emission standards could price vehicles beyond the reach of Chinese consumers. These companies should consider licensing their technology to partners. The fledgling Chinese automaker BYD Auto, for example, which began as a supplier of batteries and electronic components to mobile-phone makers, might be well served by this approach, because the company’s experience with rechargeable batteries gives it advantages in the growing market for vehicles using alternative fuels.

For automakers intent on globalization, the imperative is focus and, in some cases, patience. We’ve seen Chinese OEMs—in their eagerness to expand—overlook or misjudge the size, competitive intensity, or consumer tastes of target markets and consequently find themselves overstretched and playing catch-up against competitors with stronger offerings. Some Chinese OEMs plan to enter 20 or more individual markets simultaneously. The strategic rationale for such plans is weak. In Africa and Southeast Asia, competition isn’t less intense than it is in China, and such markets, even combined, are considerably smaller than China’s domestic market.

Overly ambitious plans can also divert management’s attention and thus compound operational problems and strategic oversights. In 2006, for example, both Brilliance and Jiangling not only suffered quality and safety problems in their rush to crack the lucrative European market but also unnecessarily limited their potential by misjudging important market characteristics. Neither company offered diesel engines, which power about half of Western Europe’s passenger cars. Brilliance targeted a declining category—Sedan-D, a midsize segment in which European sales are falling by about 6 percent a year—and didn’t offer station wagons, though they constitute about half of Europe’s Sedan-D segment. The results were disappointing: together, the two companies sold only about 150 vehicles in Europe in 2007, far below initial forecasts.

Some OEMs are doing better. Chery and Great Wall Motor, for example, postponed expansion in Europe and North America, instead focusing on Russia, where the market dynamics are more favorable. Russia, for example, has a relatively large fleet of aging, domestically produced vehicles, and the country’s growing economy has spurred strongly growing demand for new cars. Yet because many imports from Western OEMs are out of reach for ordinary Russians, Chinese automakers have opportunities to target consumers seeking new, low-priced cars. Both Chery and Great Wall have capitalized on these advantages: Chery sold about 40,000 vehicles in Russia in 2007, Great Wall more than 8,000. At times, Chery has struggled to ship enough cars to meet Russian demand.

To grow further, Chinese OEMs must develop cars with proprietary design features. Many of China’s automakers have reached their present size by reverse-engineering the models of competitors. Over the long run, this approach will fall flat in export markets, particularly developed ones. Compact and standard vehicles, representing about 40 percent of the EU and US markets, offer good near-term prospects, although they are underrepresented in the offerings of most Chinese OEMs. In the longer term, however, Chinese automakers should aspire to create truly innovative product lines—for example, high-quality electric or hybrid vehicles.

The quality imperative

Strategic considerations will be irrelevant if China’s automakers can’t improve the quality of their products in the eyes of global consumers. To do so, the OEMs must reexamine their operational processes and adopt a broader view of quality. Among some Chinese OEMs we’ve studied, quality control means visual inspections on the shop floor to spot assembly defects. In our experience, however, problems that occur at that point can represent as few as 10 percent of all defects. One OEM, for example, traced the excessive brake noise of one model to the raw materials selected during the earliest stages of design. Complaints about leaky power-steering pumps led this company to uncover deficient quality-control processes at a key supplier. Overall, 85 percent of the 50 most significant defects the automaker found had been introduced before assembly (Exhibit 1).

Solving such problems will require Chinese OEMs to work more closely with their suppliers during the product-development and production phases to ensure that both parties have the same high-quality standards. Examining a supplier’s processes is crucial—a lesson that leading global OEMs already take to heart.1 Chinese carmakers also must incorporate into their thinking ideas such as performance quality (ensuring that vehicles and components perform to specifications) and “ramp up” quality (so that products, parts, and processes can be scaled up during manufacturing without compromising the cars). This mentality, commonplace among top global OEMs, isn’t widely entrenched in China.

To get started, OEMs should beef up their quality-gate systems—the critical series of evaluation procedures and decision points allowing automakers to address, long before production, potential problems with quality, manufacturability, and the maturity of operational processes. Many Chinese OEMs will have to develop sharper quantitative insights about appropriate quality targets and conduct follow-up activities in a more disciplined way. Often, we find that poorly defined specifications or definitions lead designers to benchmark their products against inappropriate offerings from competitors.

The rewards of retooling a quality-gate system are substantial: one European automaker, for example, strengthened its approach and shaved ten months off a new model’s development time, reduced production defects fivefold, and lowered costs to boot. Given the greater experience of OEMs in the developed world, the gains for Chinese automakers would be greater still.

China’s OEMs must recognize that today’s cost advantages aren’t necessarily sustainable, particularly given the rising wages and currency appreciation of recent months. Moreover, almost all leading global OEMs produce cars in China and thus enjoy the same labor advantages Chinese OEMs do. That’s why Chinese automakers must raise the output of assembly workers, who are less productive in China than in Brazil, India, and Mexico. Our analysis suggests that China’s OEMs could cut their costs 20 to 30 percent—for example, by reducing waste and rebalancing production lines to minimize the time workers remain idle. OEMs could also reduce the cost of product development. We found that improving the productivity of one leading Chinese automaker to the levels of Japanese OEMs would lower its development costs by half, without sacrificing speed.

Strengthen the organization

Many Chinese automakers, like their global counterparts, attempt to emulate Toyota’s lean-manufacturing processes. But Chinese OEMs struggle to instill the organizational focus on constant improvement that underpins Toyota’s historic successes. Most of the blame for these disappointments stems from poor talent management and poor cross-functional collaboration.

At one carmaker, for example, a dearth of project know-how and weak collaboration among key engineers—more than half with less than two years of experience—led to the unnecessary replication of design flaws across several models of vehicles. Poor linkages between marketers and engineers created delays and required substantial rework to incorporate critical design features properly. Particularly in product development, difficulties associated with poor project management and coordination are common among Chinese OEMs. The problem, to a certain extent, is that foreign partners in joint ventures in China have managed key product-development activities themselves, which slowed the transfer of these critical skills to their Chinese partners. Consequently, many Chinese OEMs excel at localizing products for domestic tastes (say, restyling existing models to include rear-seat DVD players) but lack the broader product-development skills involved in creating entirely new vehicles from scratch.

To address such gaps, OEMs can place junior engineers in mentoring programs that expose them to fresh skills—in particular, collaborating with different functions. Other OEMs have instituted weekly quality reviews that bring together engineers from the R&D, quality, and purchasing units in order to examine specific components that seem likely to present quality risks later on. Such efforts have helped one automaker to increase the transparency of a new project and to clarify the responsibilities of line leaders.

Automakers should adopt a similar approach with suppliers. A Chinese OEM, for example, found that in one of its new models, the gap between the bumper and the headlight was too big. The problem was brought to the attention of the R&D team, which worked with colleagues in the quality and production units to determine its root cause. In the past, the team would have forwarded its recommendations to the supplier. Instead, it worked closely with the supplier to solve the problem together. As a result, the supplier made the necessary corrections without losing production time—a crucial point, since launch delays can sap a new project’s overall profitability. Moreover, the exercise enabled the supplier to save money on tooling.

To improve operations continuously, China’s automakers must also harness the talents of their production workers. Often, this kind of collaboration calls for new performance-management schemes that support and reward it. While many Chinese OEMs employ billboards and other visual aids to inspire performance on the shop floor, relatively few encourage frontline workers to suggest quality and productivity improvements, let alone follow through on the ideas those workers do propose. Some existing compensation structures even discourage quality improvements—for instance, by rewarding workers for the number of units they produce. In plants run in this way, we have observed shop floor workers ignoring scratches and other visible defects in order to keep production moving briskly.

Finally, China’s automakers must aggressively bolster the ranks of their senior product developers by bringing in experienced foreign managers, including those from rival automakers. Here, they might take a page from the playbooks of Lenovo and other successful Chinese companies that have embraced veteran global talent as they expanded.

China’s auto industry has made remarkable progress and enjoys considerable opportunities. If the country’s leading OEMs focus their strategies, develop the right organizational skills, and—above all—improve the quality of their products and their operational performance, they could propel themselves to the top of the global automotive business.

About the Author

Paul Gao is a principal in McKinsey’s Shanghai office.


1During the prototyping phase, for example, one European OEM we know discovered that the manual processes of its supplier of door components introduced enough variability to increase the risk of integration problems with other components dramatically.

Managing IT to support rapid growth: An interview with the CIO of NetApp

Managing IT to support rapid growth: An interview with the CIO of NetApp

To keep pace with a rapidly growing company, CIO Marina Levinson must choose her priorities carefully.

June 2008

When Marina Levinson joined NetApp as chief information officer, in 2005, the data storage business “had a very good IT operation for a $500 million company,” according to her. In reality, however, the company was already four times that large—and growing by 25 percent a year. Her primary task has been to build an IT organization that can help, rather than hinder, NetApp’s continuing fast-paced growth. As Levinson says, “You never want IT to show up in a quarterly report as the reason the company didn’t meet its revenue numbers.”

Soon after joining NetApp, Levinson assessed the IT organization’s capabilities and identified dozens of processes and activities in need of improvement. Launching a broad organizational transformation of the function was out of the question, given the need to scale it up quickly to remain in step with the growth of the business. Instead, she identified and then tackled concrete sets of high-value improvements. To ensure that they aligned with the company’s strategic direction, she adopted a governance model placing positions for key IT decision makers within the business units and appointed people who could help her ascertain whether IT resources were invested in the right projects.

The implementation of these change initiatives hasn’t always been smooth: business leaders (and IT managers) who had grown used to an IT department that merely took and fulfilled orders had to get comfortable with IT leaders who challenged them and kept an eye on the IT strategy of the broader enterprise. But the changes were necessary—and, despite the bumps, ultimately successful.

Working to change the profile of IT requires close collaboration with the business and—even in tech-friendly Silicon Valley—the ability to show colleagues inside and outside the IT department why change is necessary and possible. To understand how high-tech CIOs manage this type of transformation, McKinsey’s Roger Roberts and Tom Stephenson talked with Levinson at NetApp’s office in Sunnyvale, California.

Marina Levinson

Graduated with BS in computer science in 1979 from St. Petersburg Institute of Precision Mechanics and Optics, Russia

Career highlights


  • Senior vice president and chief information officer (2005–present)


  • Vice president and chief information officer (1999–2005)


  • Senior IT leadership positions (1987–99)

Fast Facts

  • Winner of CIO Magazine’s CIO 100 Award for innovation (2001) and agility (2004)
  • Honored as Premier 100 IT Leader by IDG’s Computerworld (2004)
  • Member of SpikeSource CIO Council
  • Hobbies include reading, travel, gourmet cooking for family and friends, and wine tasting

The Quarterly: When you came in, how did you identify what had to be fixed?

Marina Levinson: To figure that out, we conducted high-level interviews with executives and a series of work sessions to identify the biggest problems we faced, as well as the top five or six things that we needed to focus on in the next 18 months to be successful.

NetApp has always been strong in product innovation, which has helped us gain new customers. But in recent years, closeness to customers has become a much more important component of our company’s strategy, as we’ve deepened our ongoing service relationships with them. When you sell to CIOs and other senior IT execs who understand IT operations, the expectations around IT customer support and professional services are very high. I think that we’ve done a marvelous job in the last four or five years and truly developed excellent capabilities in this area—for example, with systems that can remotely diagnose trouble in our products and signal it to us, sometimes even before the customer becomes aware that there may be a problem.

The Quarterly: How did you decide on your transformational priorities?

Marina Levinson: Because of the company’s rapid growth, we had never really focused on improving business processes, but we knew we would have to as part of our long-term growth strategy. In a normal business process transformation, you would focus primarily on making improvements on the process side. But 90 percent of our critical processes have IT implications, so we have to deal with business processes together with the IT that supports them. Our systems and processes are very tightly linked.

Our assessment revealed that we had something like 200 capability gaps between where we were and where we needed to be. We believed that embracing something like Six Sigma would mean death to the company and to the change program because Six Sigma is a change methodology that does not enable you to move quickly enough to get from here to there. Instead, we found that a more effective approach was to identify the five top critical process capability gaps that could prevent us from scaling up our business and then to attack those gaps with gusto. This allowed us to continue to build quickly while also looking at least two or three years ahead to make sure that we had a road map of where we wanted our business and our technology to go. We revisit the road map every year because our business is pretty dynamic. Our problem areas will change, and we need to be nimble enough to address changes in the strategy.

For example, we identified our order-to-cash process as something we needed to improve in order to be able to scale up our business. When I started, a large percentage of our sales orders had to be manually touched by someone on the order-management team. Since so much of our business comes at the end of a quarter, that really threatened our ability to scale. So about a year ago, we started attacking that from the business process and systems perspectives and we’ve managed to reduce orders requiring a manual touch by 75 percent.

It’s somewhat challenging in this environment because NetApp is so driven by results, and there’s a need to deliver tangible business value in 90-day increments. When the company doesn’t see the results fast enough, questions start to pop up. So communication and change management are paramount because you want to show clearly not only the road map but also the results that we’re generating by working on this transformation.

The Quarterly: What are your longer-term transformational priorities and what kind of oversight model do you use to manage them?

Marina Levinson: Any system that allows us to be closer to our customers and partners is something that we want to invest in as part of our strategy, especially when it differentiates us from the competition—something such as the diagnostic tools I mentioned.

As for oversight, we have a team of senior people who report to, and are evaluated by, the business. Rather than match these people up with functions, we identified cross-functional processes, like the order-to-cash one, and each cross-functional process has a sponsor at the senior or executive vice president level.

For each area targeted for improvement, we have an operational leader whose responsibility includes that business process. We found that when people have process design and operational responsibilities, they’re more successful in delivering business process improvements.

We also have a one-to-one relationship between the business process leader and an enterprise applications leader—for example, between the order-to-cash process person on my staff and the order-to-cash applications person. This relationship creates synergies between the IT side and the business process side of the organization.

And we’re also moving toward a model of portfolio management where each process group has an account manager—basically, like demand managers—who handle the application priorities for that part of the business. I am a firm believer in the account-management structure, because we don’t want our business partners worrying about how we’re organized internally within IT. We want to have a streamlined way of prioritizing demand for the company. Before we did that, whoever screamed louder would get the IT resources.

The Quarterly: What sort of governance do you have in place to make sure IT’s priorities match those of the business?

Marina Levinson: We have a scalability steering committee—consisting of top functional executives and cochaired by the CIO, corporate controller, and senior vice president of field operations—to make sure that our investments in IT and business processes are focused on the most important priorities for the company. We usually have businesspeople and IT presenting these investments as a partnership.

Before investments get to this level, they are prioritized at the functional level. We also monitor our large initiatives, on the process side and the IT side, to make sure that we’re delivering on our commitments. We built a pain factor into this by asking the business to justify its IT investments and to present a tangible return on investment for all projects. While folks in lower levels of the organization occasionally criticize the process as painful and time consuming, folks at the leadership level see the benefits of what we’re doing, because we clearly have a pretty good handle on how we spend our money on IT projects.

The Quarterly: What’s greater—your challenge inside IT or with the rest of the company?

Marina Levinson: Within IT, a big challenge is getting people out of the “order taker” mode. We shouldn’t be saying to our business partners, “Tell us what to do.” We should instead be saying, “Tell us what your business challenges are, and don’t worry about how we’re going to get there. Let’s work together, and we’ll come back to you with a proposal for how we can change both the business process and the systems supporting it to get you to where you’re trying to go.” Our IT leaders have to feel comfortable and empowered to work as equal partners with the rest of the business, and, frankly, we’ve had to make some changes in leadership to make that happen.

But this is probably less challenging than changing how the business works with IT. When we first began this transformation—from being an order taker to a business partner—some business managers were irritated: “Why are you asking me all these questions? I know exactly what I want. I want two servers with this package installed on them. That’s all you need to know. You don’t need to know about my business.”

This obviously was not the right answer. We had to demonstrate that unless the company took a different approach, the business environment could become unstable. We had to make sure that the executive team understood that if our approach to IT didn’t change, our IT systems and processes would actually cause us to fail as a business. So there was some fear factor at work there helping to give me the authority to take that risk off the table.

I also spent a lot of time building relationships at the executive level. I explained to my peers that I measure my success by their success. And then I had to walk the talk.

The Quarterly: How do you think about standard versus innovative new technologies in the NetApp environment?

Marina Levinson: I have a very simple rule of thumb. For standard functions, like finance and HR—anything that is an important operational component but not strategic—we need to use standard technologies. We buy rather than build.

For areas where we can gain competitive differentiation, I believe in custom solutions and innovative new technologies that get us to market faster than our competition—for example, the self-diagnosing systems I mentioned earlier or our customer service portal, NOW (NetApp on the Web), where our customers can acquire an array of content and self-service tools designed to help them manage their storage solutions. Those are technologies that let us gain a competitive edge in the marketplace.

The Quarterly: How are you experimenting with new technologies within your own organization?

Marina Levinson: We have an architecture team looking at a service-oriented architecture (SOA) framework, and we’re implementing the SOA foundation using packaged technology. But we will go pretty slow because it’s still very new. Also under the umbrella of this enterprise architecture, we have a team that’s focused on collaborative technologies for improving the productivity of employees, as well as collaboration with our customers, partners, and suppliers.

The Quarterly: In the last decade, companies made major investments in automating structured processes and routine tasks. More recently, investment has supported knowledge workers who base decisions on a combination of structured and unstructured input and dialogue. How do you see this shift?

Marina Levinson: There isn’t much innovation left in the structured world. If you want to innovate, you really need to look at collaboration and the creation of communities. Businesses are not as advanced as consumers in creating these communities, but I think there are a lot of opportunities for very interesting innovation that we haven’t seen yet.

We have some of this activity happening at the grassroots level in our company, such as deploying wikis for the engineering staff. But it will become necessary to develop a Web 2.0 strategy that benefits the entire company. You have to allow some chaos at first to get people to experiment. But at some point, you have to create a framework, some kind of order. And, of course, it’s impossible to quantify the benefits right now—you just need to believe that collaborative technologies help to improve employee productivity.

The Quarterly: How has the role of the CIO changed during your time in the technology sector?

Marina Levinson: In the past, it was much more important for a CIO to be a technologist who optimized how technology was used in a corporation. These days, in companies where IT can bring competitive advantage, CIOs should have significant business experience or have worked with the business, so they can clearly and easily understand the business strategy and translate that into IT strategy. You can always hire a chief technology officer or buy technology knowledge from third parties. That’s not as important as having a sense of the business strategy. And I’m a firm believer that anything that we do in IT has to be driven by business strategy. I don’t believe in technology projects for technology’s sake.

In our business and in other high-tech companies, the CIO’s role also includes deploying the company’s own technology and then showcasing it to external customers. That is a strategic component of our IT strategy, but one that’s unique to high-tech companies. The strategic value we add is our ability to help our business managers understand what sells to customers, what doesn’t sell, and why. I tell our salespeople that I’m the customer. If you can sell to me, you can sell to my peers. It is quite valuable to have a friendly face listening to your sales pitch and helping you understand the value proposition of your products from the end-customer perspective.

About the Authors

Roger Roberts is a principal who leads McKinsey’s IT strategy practice in North America, and Tom Stephenson is a principal who leads McKinsey’s high-tech sales and marketing practice. Both are located in the Silicon Valley office.

French and German trucking: IT for the long haul

French and German trucking: IT for the long haul

Continued consolidation is needed but won’t be enough—only IT-enabled innovation can help road freight companies enjoy productivity growth rates like those of the late ‘90s.

February 2003

The creation of a single market in Europe, coupled with deregulation, has undoubtedly benefited road freight companies in France and Germany. While the productivity of US trucking companies stagnated during much of the 1990s, their French and German counterparts enjoyed growth of about 5 percent a year (Exhibit 1).

Chart: French and German road freight: Productivity in motion

But looking down the road, the journey may become more difficult. Falling prices are keeping profit margins low, and Eastern European companies, with their lower-paid workers, eagerly await a chance to capture some of the market following the expected EU expansion in 2004. Customers today are generally more demanding. And after the acquisition spree of the late 1990s, many large French and German road freight companies remain barely more than loose-knit groups of independent distri-bution networks.

The spree had its roots earlier in the decade, when the European Union began relaxing and harmonizing the restrictions on truck capacity, abolishing mandatory prices for domestic and international freight, and liberalizing cross-border market access (Exhibit 2). At the same time, the establishment of the single market increased demand for cross-border transport, and customers began insisting on higher-value-added services such as faster shipments and time-definite deliveries. These developments intensified competition, and road freight companies responded by consolidating, increasing the size of their trucks, and using capacity more efficiently.

Chart: Regulatory changes paved  the way in Germany

IT innovations such as the optimization of networks and the automation of back-office functions accounted for only about a fifth of the productivity growth in the 1990s, and there is much more potential for improvement. In fact, by the end of the decade, French and German freight companies turned even more to IT to squeeze out productivity gains. These efforts focused on the integration of legacy IT systems of companies acquired during the consolidation spurt and on the further improvement of capacity utilization.

But French and German freight companies still lag behind their US counterparts and will have to go on investing in IT to catch up. Innovations in IT account for more than half of the productivity gap with the US trucking sector, which admittedly had a head start, since deregulation began in the United States about a decade earlier than it did in Europe. By the 1990s, the US industry had already consolidated, thus letting trucking companies concentrate on using IT to optimize their networks further and to improve their capacity utilization—for instance, through the deployment of advanced tools such as remote-tracking systems that can pinpoint the location of any vehicle in a fleet.

Structural differences explain the rest of the gap with the United States. Average hauls are twice as long there, for example, and US companies haul a slightly higher share of goods (such as coal) that are heavy but easy to load—goods that drive up the average ton-kilometer1 per hour worked.

Increased competition brought about by deregulation has pushed French and German road freight companies to consolidate and thereby to capture quick productivity improvements. Even so, the job isn’t done. Once consolidation reaches optimal levels, productivity advances will peak, and these companies will have to look elsewhere for continued improvements. But by applying innovations across a newly consolidated industry, road freight companies can enjoy productivity growth rates similar to those of the late 1990s.

About the Authors

François Bouvard is a principal in McKinsey’s Paris office, and Stephan Kriesel is a consultant in the Berlin office.


1A generally recognized measure of road freight production, ton-kilometers take into account both the weight of the shipment and the distance shipped per hour worked. The tons in this case are metric tons, which equal 2,205 pounds.

Logistics in emerging markets

Logistics in emerging markets

Streamlining the flow of goods within an existing infrastructure often makes more sense than expanding it.

February 2005

Many developing countries, out of necessity, concentrate on building critical infrastructure such as airports, highways, and shipping ports to foster their growing economies. But once the basics are in place, less visible efforts to improve the flow of goods through a country can have a stronger economic impact than another pier, runway, or paved mile, a recent McKinsey study shows.1

Governments in markets such as Dubai, Hong Kong, and Singapore already understand the need to balance brick-and-mortar projects with policies, regulations, and enforcement measures. But many other developing nations have a single-minded devotion to expanding their hard infrastructure and thus overlook network components—such as efficient customs clearance and quality trucking services—that can have a strong impact on GDP. We estimate that one Asian country, for example, could increase its GDP by 1.5 to 2 percent as of 2010 if it reduced its logistics costs by 15 to 20 percent. Cutting indirect costs, such as excessive inventory resulting from inefficient supply chains, would account for the bulk of the savings. This estimate doesn't include multiplier effects,2 which, we believe, could contribute an additional percentage point to GDP growth. Our experience in other countries shows that these savings are well within reach. By contrast, ongoing infrastructure projects, costing a total of about $10 billion, would generate only a 0.7 to 1 percent increase in this country's GDP over the same period.

Without question, countries in the early stages of development should focus on building serviceable roads and adequate ports. But initiatives to make supply chains more efficient should rapidly supplement core infrastructure programs. The time is right for a shift if, for instance, the domestic logistics industry is fragmented and has few international players despite a high-quality infrastructure. In other words, if old, rattletrap delivery trucks clutter up pristine multilane highways, there is substantial room for improvement.

In any economy, the logistics industry bears substantial direct and indirect costs. In emerging markets, where networks have significant shortcomings, they are even larger (Exhibit 1). Direct costs, including transportation, warehousing, and handling, tend to be transparent. Indirect ones, such as stock-outs, unnecessarily high inventories, and obsolescence, are much less visible and thus often overlooked, particularly by small or unsophisticated companies.

Chart: The emerging-market disadvantage

Governments looking to manage their logistics networks must first identify the system's pain points. For the Asian country cited earlier, we estimate that policy changes or better enforcement of existing regulations could cut annual transportation and logistics expenses by $600 million to $960 million. In just three years, the total value created could exceed 1 percent of GDP. The savings would either increase corporate profitability or reduce prices for customers. Both would fuel economic growth.

Indirect costs account for the bulk of these savings, though direct ones can contribute as well. A close look at trucking costs in a typical Asian market shows how this approach could work (Exhibit 2). At some companies, up to a quarter of all deliveries arrive late and 2 to 4 percent of all goods are damaged in transit. The root of these problems is the overloading of trucks, which causes them to age faster and to break down more frequently. Late or damaged deliveries add $100 million to $140 million a year in indirect costs to inland transportation. Paradoxically, trucks overloaded in one direction are usually empty on the return trip, so overall asset utilization is low and price competition severe. This environment fuels a vicious circle, since incumbents can't afford to invest in maintenance or new equipment, and potential attackers have no incentive to enter the fray.

Chart: Old, overloaded, and slow

In emerging markets, no one party can make supply chains more efficient. Too few companies understand indirect logistics costs well enough to see the value in paying a premium for reliable trucking services, for instance, and those that do are hard-pressed to find quality suppliers. Generally, governments are responsible for enforcing weight limits more strictly (as in the example of trucking), reducing the corruption that allows overweight trucks on the road, and lowering barriers for new entrants. Other measures could improve the quality of a country's logistics network. Speeding up customs clearance and making processing times more consistent, for example, would allow companies to reduce their inventory levels, since they could depend on supplies arriving punctually. Or governments could educate logistics suppliers and customers—many of them mom-and-pop stores and other small businesses—about the benefits of better speed and reliability.

Improving logistics and encouraging a more efficient supply chain would provide an attractive growth opportunity for emerging economies. While such initiatives are relatively inexpensive and don't have to compete for capital with highly visible infrastructure projects, they do need attention. It is much easier for a government to approve and embark on an expensive infrastructure project involving only one ministry than to improve the efficiency of supply chains by carefully coordinating the work of several branches of government. But a close look at the numbers makes the advantages of a better logistics network for any developing country plain to see.

About the Authors

Nikolai Dobberstein is a principal in McKinsey's Kuala Lumpur office, Carl-Stefan Neumann is a director in the Frankfurt office, and Markus Zils is a consultant in the Cologne office.


1 We examined 19 countries to weigh the impact of capital infrastructure projects, such as port expansions and new airports, and of initiatives to improve the quality of logistics networks and to make domestic supply chains more efficient.

2 Lower costs from more efficient supply chains, for instance, could reduce consumer prices and increase demand. The World Bank estimates that a 10 percent reduction in transportation costs would raise international and domestic trade by 20 percent.