Growing pains for logistics outsourcers

Growing pains for logistics outsourcers

The customers’ demands are outpacing the logistics providers’ ability to meet them.

Bernard L. Bot and Carl-Stefan Neumann

May 2003---from the McKinsey Quarterly

From beginnings in the 1980s as humble additions to road, sea, and air carrier services, third-party logistics providers (3PLs) have built a $100 billion industry that plays an increasingly important role in the world economy. Determined to save money and to focus on core businesses, companies in the automotive, electronics, chemical, and fast-moving consumer goods sectors, among others, are outsourcing more and more of their warehousing, distribution, and other supply chain activities to these 3PLs. In Western Europe, they already handle more than a quarter of the total volume of shipments, while in the United States the figure isn't far behind. In the world as a whole, the market the 3PLs serve has grown at a compounded annual rate of more than 10 percent since the mid-1990s—a level of expansion that will probably be sustained (Exhibit 1).

Yet customers want more. They are starting, for example, to ask 3PLs to redesign their supply chains and to make those chains as efficient and inexpensive as possible. And as customers move from local to regional and then global scale, they want logistics specialists to serve them with consistent skills wherever they do business. Although the industry is at pains to respond, many logistics providers are hard-pressed to meet such demands.

Even as customers ask more of their 3PLs, they are beating down prices through canny contract negotiations that shrink profit margins and make returns on invested capital inadequate. The result is a business model increasingly under pressure precisely as related transportation businesses—freight forwarders, express integrators, contract manufacturers, and wholesale distributors—are encroaching on the 3PLs' territory.¹

Raising profitability in such an environment poses its own logistics challenge for the industry, since the customers' expectations have clearly outpaced the 3PLs' ability to respond. For the winners, catching up is likely to mean adopting a business model built on greater structural and technological savvy and, in many cases, greater consolidation. More specifically, the 3PLs must build regional and global scope by establishing themselves in geographies ahead of their customers. They will also have to achieve economies of scale by orchestrating ways for their customers to share warehouse and distribution facilities instead of bowing to demands for customized service. Doubling the number of spare parts delivered through a single distribution network, for example, could cut a 3PL's costs by up to 15 percent (Exhibit 2).

For this kind of multiuser approach to work without provoking nightmarish operational lapses, 3PLs will have to invest heavily in standardizing their IT systems interfaces. They will also have to hone their skills to design efficient supply chains and to pursue best practices in far-flung offices. And if their main customers—global industries—are going to be served efficiently, they will have to bulk up, fueling the continued consolidation of an industry that continues to be fragmented.

The world of the 3PLs

Logistics specialists have made their bread and butter by offering customers 15 to 20 percent savings on warehousing and transportation costs. In particular, 3PLs help clients reduce their capital spending (by eliminating assets such as trucks and warehouses), their working capital (by cutting inventories), and, especially, their personnel costs (through the 3PLs' more advantageous labor contracts).

More recently, the logistics companies, focusing on improving their customers' supply chains, have promised a 10 to 25 percent reduction in their customers' delivery cycle times by eliminating certain goods-storage steps and improving their information-management skills. Such efficiencies can boost sales because they help producers to respond more quickly to market trends and to reduce stock-out costs. In a recent worldwide survey of 50 large customers, we found that those using 3PLs to manage their warehouses moved goods in and out more than twice as quickly as those relying on in-house logistics departments. Logistics specialists also increasingly finance their customers' activities by taking ownership of inventories.

Another new wrinkle in the logistics game is the fact that many 3PL customers are changing the scale of their outsourcing. In the electronics and automotive industries, customers are moving from contracts for single localized services—a solitary warehouse in one country, say—to contracts for integrated services in several countries. Top logistics providers are following suit: Exel, for example, has a contract with Motorola to manage large parts of its supply chain to and from warehouses in Amsterdam, Chicago, Hong Kong, and Singapore. Given the importance of cross-border flows in these sectors, such contracts are likely to proliferate; in electronics, cross-border flows already represent 35 percent of total industry value.

Besides managing physical assets, leading logistics companies are using sophisticated IT to optimize the flow of information through the supply chain. In many industries, information-related logistics costs—lost sales, rebates, and inventory financing—surpass asset-related direct costs such as freight and warehousing. The impact of markdowns and lost sales in the apparel industry, for instance, means that information-related costs make up nearly 70 percent of total logistics costs (Exhibit 3); in toys and games, the figure is 60 percent. Moreover, the potential savings are frequently larger for information-related logistics costs than for asset-related ones, which in many cases have already been squeezed dry.

A tougher world for logistics providers

Still, logistics specialists are falling short in profitability. The average return on invested capital (including goodwill) for pure 3PL players—7 to 8 percent—has been below their weighted average cost of capital for years, so they have destroyed shareholder value. These disappointing returns can be explained only in part by overpayment for acquisitions and delays in capturing integration benefits. Margins, measured as earnings before interest, taxes, and amortization, have also declined, from about 5.3 percent in 1997 to 3.4 percent in 2002 (Exhibit 4).

Many of these economic woes can be traced to flawed contractual relationships. Customers specify requirements in detail, often parceling out pieces of the supply chain to different 3PLs and limiting their opportunities to differentiate themselves, since the division of responsibility prevents them from optimizing their operations. Essentially, customers buy commodity services largely on the basis of price and continue to design their supply chains in-house. In addition, the 3PLs' cost structures are transparent. About half of the industry's contracts are "open book"—so customers know what costs the 3PLs bear—and include contract-margin and cost-reduction commitments. With "closed-book" contracts, by contrast, customers get fixed, indexed prices for given volumes but don't see the 3PLs' actual costs. Customers can, however, usually make good estimates based on experience and benchmarks from in-house operations. Tire manufacturers, for instance, employ specialists capable of walking through a tire warehouse and estimating the cost of warehousing to within 1 or 2 percent of the best-practice level.

Another problem is the fact that logistics operators find it hard to cash in on good performance: customers demand more stringent performance levels at the end of contracts, which typically run from three to five years. In addition, low renewal rates of around 40 percent—prompted in part by disappointment over the quality of service—mean that 3PLs can get stuck with expensive warehouse capacity and freight purchase obligations. And because contracts abound with individual requirements, 3PLs have difficulty exploiting economies of scale. Instead of installing an industry best-practice IT system developed and improved over the course of many client contracts, for example, 3PLs must often build expensive customized systems or links into legacy logistics systems providing for limited or no economies of scale.

The contract-by-contract approach also harms operations. In the rush to move from one customer to the next, 3PLs often fail to benchmark and establish best practices, instead constantly reinventing the operational wheel. Within any given company, it isn't uncommon to find productivity differences of 50 to 75 percent among similar operations in the same industrial sector and even the same country. Furthermore, the industry's single-contract norm means that a logistics provider's business-development employees spend their time fixing problems rather than studying clients in depth and building mutual trust.

Building a leading logistics player

Our research suggests that logistics providers eager to establish more equitable customer relationships and to shore up their long-term business models might consider a strategy built on three related approaches: offering more value, creating structural scale advantages, and pursuing consolidation.

New sources of value for the customer

The micromanagement of contracts will go on until customers stop seeing 3PLs only as lower-cost alternatives to in-house logistics operations. To strike out in a new direction, 3PLs should first improve their supply-chain-design skills, focusing on industries with reducible asset- and information-related costs. The potential varies: bulk commodities, for example, largely involve transportation, whereas the more complicated and time-sensitive flow and storage of electronics and automotive parts offer greater scope for reducing customer costs. Companies in some industries regard the optimization of logistics as a core success factor and see little point in outsourcing the design of their supply chains. These kinds of companies are best ignored.

To get the most from logistics once an opportunity has been identified, 3PLs must master the specifics of the industry supply chain by analyzing supply-and-demand flows and matching them with the cost and performance (speed, reliability, flexibility) of various warehouse and distribution options. Savings can be had by managing a complex, labor-intensive, and fragmented supply base and by getting a grip on the suppliers' lead times. To do so, logistics managers need IT systems that make it easy to follow the flow of goods in the supply chain. Certain 3PLs have already developed relevant skills and systems. TNT Logistics, for instance, uses a software tool that makes it easier to see the inbound flow of parts in an automotive operation, thereby helping vehicle manufacturers to fine-tune production schedules up to the last moment.

Economies of scope offer 3PLs a chance to expand the range of their services to a degree that customers could never accomplish in-house. Integrated logistics and freight forwarding, for example, might be attractive to companies that prefer to deal with fewer transport and logistics providers. Exel has successfully introduced such a combination; 40 percent of its new business is generated by cross-selling freight-forwarding services. Integrating a freight forwarder with a logistics provider also offers advantages such as improved customs handling and a greater international presence.

But combining these two kinds of businesses isn't right for all companies in the industry. Freight-forwarding capabilities, for instance, have greater importance in some sectors than in others—a 3PL that focused on electronics would need these services more than one specializing in chemicals. Besides, many 3PLs are too small to acquire a freight forwarder, and integration can raise operational difficulties: a freight forwarder's business, based on trading, is light on assets and longer-term contractual risks; the operations of 3PLs, by contrast, require longer-term commitments as well as investments in assets.

Enhanced regional and global scope becomes more important to logistics providers as their customers expand around the world, because it helps providers offer consistent service and supply chain transparency. Unilever, for example, is looking to Exel to provide warehouse services in Brazil, Mexico, the United Kingdom, and the United States—all countries where it has built a presence. But at times, a 3PL will have no assets on the ground. It will then have to decide whether to find a local partner, to buy one, or to build from a standing start.

Structural scale advantages

New services are important, but they aren't enough to revitalize a 3PL's business model; some could be matched by competitors and, in certain cases, by customers. The 3PLs, to buttress their position, must build scale advantages that will be harder for competitors to duplicate. To that end, they can learn from leading network companies such as United Parcel Service. UPS has come to dominate the US parcels and express market by realizing scale benefits other operators can't copy. Logistics providers should seek scale advantages by striving to use the same warehouses and transportation assets to serve many customers, which will share in the savings. Logistics providers can offer these savings to encourage a move away from shorter-term, commodity-like contracts that are unlikely to be renewed. With every new customer, the system gains scale and appeal. The individual components of logistics contracts—warehousing, freight transport, local distribution, IT, the back office—provide many opportunities to leverage scale. Larger volumes enable 3PLs to consolidate and renegotiate freight purchases at better rates and to spread back-office and IT costs over a larger customer base.

Density too is a vital factor in the cost of local delivery: since route costs are fixed, doubling volumes can reduce the expense of delivering individual items by about 20 percent. Several logistics operators² have joined forces with CAT, formerly Renault's automotive-logistics branch, to operate a network serving a range of automotive customers for new vehicles and spare parts; at 48 logistics centers, they are stocked side by side and delivery is shared. Shared networks exist in other industries too. Exel's Tradeteam has consolidated deliveries to the UK drinks industry, for example, and TNT Newsfast has done the same for the UK publishing market.

The benefits of networks can be significant, but putting them in place will be hard. First, the 3PL will have the complicated task of linking several participants in one network. This challenge will involve standardizing and integrating various IT systems—for example, by installing middleware that links the IT systems of a 3PL with those of its customers and by aligning communications and product standards and operating procedures. Only then can the 3PL decide on the rules of the game in the joint network. Priorities must be set; which customer, say, takes precedence in the case of rush orders, and how are costs to be allocated? Finally, the 3PL will have to negotiate the way benefits will be shared and which company must shoulder the fixed network costs if, for instance, the system's volumes fall.

How more consolidation may help

Globally, the third-party logistics market is fragmented: Exel, the largest operator, has only about a 4 percent share. Although Exel is particularly strong in electronics, TNT Logistics in automotive products, and Hays Logistics in fast-moving consumer goods, no company has yet gained a leading European or North American, let alone global, position in these sectors. Mergers and acquisitions could help logistics providers improve their economics by combining volumes in some sectors and shedding activities in others. Such deals would also help providers meet the demands of their customers by filling geographic or capability gaps; some European logistics specialists, for example, have used acquisitions to enter the US market,³others to build freight-forwarding capabilities.

Mergers, however, offer limited economies of scale in the immediate term, for there are no established networks to be integrated; most of the business is configured client by client. Nonetheless, longer-term benefits of integration, such as the streamlining of back-office and IT activities, might be available. The potential for building multiclient user networks would improve if the merged companies had customers in the same sector; moreover, a 3PL's reputation might be enhanced if, after a merger, it could claim to serve all of a country's leading OEMs in a sector. Finally, the more concentration of this kind takes place, the more power 3PLs will have to resist onerous contracts.

Industry consolidation is already under way, and two clear groups have emerged. Companies in the first, which includes Exel, TNT Logistics, and the DHL Worldwide Express/Danzas logistics unit of DPWN,⁴ are developing strong regional (and often global) positions in a number of sectors. These positions make it possible to accumulate scope and skill advantages and to build denser networks. Companies in the first group are likely to shape the industry by virtue of their competitive customer offers and their financial flexibility to pursue mergers and acquisitions. Some freight forwarders have the same aspiration: Kuehne & Nagel International, for instance, bought USCO Logistics in the United States and completed a cross-equity holding with SembCorp Logistics in Asia.

Companies in this first group have already been consolidating. Exel as it currently stands was created through the merger of the Ocean Group and Exel, in February 2000. DPWN has made a string of acquisitions: Danzas in 1999, the European Transportation and Distribution division of Nedlloyd and ASG in 1999, and Air Express International (AEI) in 2000. This trend will probably continue as larger players buy up smaller ones that can't meet the industry's cost and service challenges but do fill geographic or capability gaps for the big players. Mergers of logistics providers present their own special hurdles—foremost among them the fact that in acquiring a 3PL, the purchaser is actually buying a pile of contracts (with change-of-ownership clauses), not a streamlined business. It must then find ways to integrate a multitude of administrative, transport, and warehousing systems, all built around customized solutions.

The second group of 3PLs comprises companies that have the potential to dominate at least one sector, often in a single region. TDG, for example, gets more than 60 percent of its revenue from the fast-moving consumer goods and retail sectors, and 75 percent of its total revenue comes from the United Kingdom. Microlog concentrates on small and midsize German companies in the automotive and industrial sectors. The challenge for such providers will be to maintain their lead in specific sectors and geographies and, given their limited focus, to grow. They will have to prove that local, specialized operations can meet the challenge of more global generalists that might try to leverage size and global skills to encroach on their territory.

The worldwide trend toward outsourcing noncore activities plays directly to the strengths of the logistics industry. But as the 3PLs have discovered, growth and healthy profitability don't necessarily go hand in hand. Logistics companies have much work to do if they are to rewrite a business model dulled by ever more demanding customers and bolder competitors.

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Opportunities in Asia

More and more, customers are demanding that logistics companies follow them around the globe. That is particularly true in Asia, the source of so much of the world's manufacturing, especially in electronics. The region holds huge potential for logistics providers: annual sales of third-party logistics services are forecast to increase at three to four times Asia's overall rate of economic growth through 2010. At just over $1.1 trillion, Asia's logistics markets are probably half the size of those in Europe or the United States, but the potential savings—more than $140 billion a year—are far greater.

Three forces are firing up logistics demand in Asia: the spread of wealth beyond its major cities, the emergence of modern retailing, and global demand for its manufactured goods. Until now, Asia's major manufacturers and retailers preferred to set up in-house logistics chains rather than use local operators that offered neither efficiency nor an integrated, quality service.¹ Yet those manufacturers and retailers, hoping to free up capital for their core businesses, now want to outsource logistics.

Direct logistics costs—transporting, handling, and storing goods—are ripe for pruning in Asia, since they account for an average of 13.7 percent of total revenues, compared with an estimated 10.4 percent in Europe (exhibit). Closing only half of that efficiency gap could create a business opportunity worth $90 billion to $120 billion, an assessment based on industry cost structures in comparable economies, on pilot initiatives that have reduced costs by 40 to 60 percent, and on interviews with manufacturers to confirm their current and potential practices. Several companies reported that in Asia their stock spends an average of 30 days between manufacture and sale to consumers, but very little of that time is spent on store shelves; transportation, storage, and processing take up a full 27 days. The introduction of hub-and-spoke transport networks and of centralized dispatch functions is the most immediate step needed to reduce this lengthy period.

Improving the efficiency of logistics would also reduce stock obsolescence problems and missed sales—indirect, information-related costs that are 25 to 50 percent higher in Asia than in Europe, depending on the product. Goods that remain unsold and are then superceded by new models cost manufacturers, wholesalers, and retailers in Asia some 4 to 5 percent of their combined revenues. Sales lost when goods aren't in stock represent a further 5 to 7 percent hit to revenues. The more quickly and reliably stock is delivered, the less must be held on premises and the more likely it is that sales orders can be filled. A 15 percent improvement in the efficiency of logistics would cut indirect costs by $50 billion to $60 billion.

To capture these savings, logistics providers must first configure their vehicle fleets, containers, and warehouses to an industry's requirements and develop industry-tailored IT systems that could manage the flow of goods through those fleets, containers, and warehouses. Then the providers will have to learn how to use their customers' real-time inventory data in their IT systems. Even in Asia, it is no longer enough to compete on the cost or even the quality of basic freight and warehousing services, since their cost and quality are easy to replicate. The crying need is for logistics providers and their customers to build insights and loyalty around shared information. This need is especially strong in a region characterized by unreliable data sources, fragmented supply chains, bureaucratic information and payment systems, and uncertain regulation. Integrity of information is extremely valuable.

The attractive targets in Asia include electronics, fast-moving consumer goods, chemicals, automotive, and textiles because in these industries logistics accounts for a relatively high proportion of the value chain. Third-party providers are thought to be more fragmented and less efficient than those in Europe, so providers that made quick and lucrative inroads there will have a ready base of knowledge and some assurance of a profitable future role in Asia.

—Kaushik Das, Benoit Dumont, and Karsten Schween

Notes

Kaushik Das is a consultant in McKinsey's Singapore office; Benoit Dumont is a consultant in the Amsterdam office; Karsten Schween is a principal in the Munich office.

¹See the Quarterly Web exclusive "Moving goods in China."

About the Authors

Bernard Bot is a principal in McKinsey's Amsterdam office, and Carl-Stefan Neumann is a director in the Frankfurt office.

The authors wish to thank Steven Vossepoel and Jan Willem Breen for their contributions to this article.

Notes

¹For the purposes of this article, our definition of logistics excludes independent freight forwarding (the contracting of land, sea, or air transport for customers) and contract land, sea, and air transport services. Nonetheless, many of them are rapidly converging under the logistics umbrella.

²AutoLogic, TNT Logistics, and Wallenius Wilhelmsen Lines.

³TNT acquired CTI Logistx; Ocean (now Exel), Mark VII Transportation; and Deutsche Post World Net, AEI.

⁴Deutsche Post World Net.

Interview---From the Mckinsey Quaterly

A pioneer in Chinese globalization: An interview with CIMC's president

A company that has already disrupted the container business is moving into transportation equipment and services.

Martin Joerss and Henry Zhang

May 2008

About 20 years ago, China International Marine Containers (CIMC) was a small, little-known container manufacturer with just 59 employees. Since then, under the leadership of Mai Boliang, the company has become the industry’s global leader. It has succeeded thanks to an aggressive domestic and global M&A program, a successful human-resources approach that stresses the retention of local talent to run its overseas operations, and a relentless push to innovate and to disrupt the status quo.

CIMC is the world’s largest manufacturer of dry-cargo and refrigerated containers. The most important sea- and land-based logistics systems in Asia, Europe, and North America use its products, which range from regular containers to shipping equipment for energy, chemicals, and food. In 2007, the company had sales of more than 6.4 billion (45 billion renminbi), owned over 100 domestic and international subsidiaries, and employed nearly 60,000 people.

Mai Boliang, CIMC’s president, recently talked with McKinsey principals Martin Joerss and Henry Zhang in Boliang’s office, in Shenzhen, China.

Mai Boliang

Vital statistics

Born January 1959, in Zhaoqing, Guandong Province

Education

Graduated with BS in mechanical engineering in 1982 from South China University of Technology, in Guangzhou

Career highlights

China International Marine Containers (1982–present)

• Member of board of directors and president (1992–present)
• Acting general manager (1990–92)
• Vice general manager (1987–90)

Fast facts

• Executive director of China Container Industry Association (CCIA)
• Vice president of China Society of Economic Reform (CSER)
• Vice president of China Logistics Association (CLA)
• Received CCTV “Magnificent Ten of the Chinese Economy” award (2004)
• Ranked among top 25 most powerful businessmen in China by Fortune China (2005)

 

The Quarterly: What do you consider to be the drivers of CIMC’s success?

Mai Boliang: First of all, the reform and opening up of China. This enabled China’s economy and foreign trade to take off, and the sustained growth of foreign trade has made it possible for China to become a global container-manufacturing center.

A second reason for CIMC’s success was its ability to predict and promptly react to business megatrends. In 1990, I predicted that China would become the global center of container manufacturing, replacing South Korea, the world’s number-one dry-cargo-container manufacturer at the time. I based my prediction on how the growth of world trade, and China’s role in it, would spur demand for containers, as well as the pricing advantage we would have over any foreign player. I recognized this possibility earlier than my South Korean competitors and preempted them by establishing a manufacturing footprint along China’s coastal areas.

The company’s ownership structure has also contributed to our success. We have two majority shareholders—COSCO and China Merchants¹ This is an unusual arrangement among Chinese state-owned enterprises, which usually have just one parent. We have found that the dual-shareholding structure has given us more of an opportunity to pursue medium- to long-term strategies, and we can worry less about short-term performance.

The Quarterly: What was the greatest difficulty at the beginning?

Mai Boliang: We didn’t have much money, but we did have a very clear strategy, position, and objective back in 1990—to be the world’s leading company in container manufacturing. However, the board and shareholders would not give me funding, so I had to figure out a way to expand without money. I put a lot of effort into doing an initial public offering as soon as possible to raise funds; CIMC was listed in Shenzen in 1994.

The Quarterly: How did you carry out your expansion strategy when financial resources were insufficient?

Mai Boliang: We signed agreements with other manufacturing companies under which we operated their businesses, paid them lease fees for the opportunity, and pocketed whatever was left over. At the beginning, we focused on building dry-cargo containers—these were low in cost and had low entry barriers, technically speaking, but the business was also extremely competitive and margins were falling all the time. Using this model allowed us to operate with little cash-flow pressure and to build our business organically before beginning to consolidate the other domestic players through mergers and acquisitions.

From 1993, CIMC merged over ten container makers along China’s coast, including those in Qingdao, Dalian, Tianjin, Shanghai, Nantong, and Xinhui; there were about 40 domestic makers in China at the height of our domestic merger activity. As a result, we won a more than 20 percent market share in the dry-cargo-container market and disrupted South Korea’s dominance in the global industry. Among our advantages were our price per container—a few hundred dollars less than the Koreans charged—and our location, since China had a trade surplus, and shipping clients wanted to buy the containers at the locations where they could ship right away rather than moving the containers around.

The Quarterly: What happened next?

Mai Boliang: We only had a single product line—dry-cargo containers—and low technology. Under these circumstances, no one could say we were number one in the world. So we diversified into refrigerated containers, or “reefers.” The technical barriers were high, and the market was dominated by Japan, which had 95 percent of the reefer market with its aluminum containers. Germany, which produced stainless-steel reefers, had the minority share of the market. In 1995, we did a joint venture with Graaff, of Germany—the first of our international M&A efforts. By working with the Germans and gradually improving on their technology, CIMC made steel reefers the norm for the global market after eight years. That ended Japanese dominance in this field.

Later, we expanded into tank and collapsible containers, gradually becoming the company with the most comprehensive range of goods in the industry.

The Quarterly: Now that the company has secured a dominant position, what comes next for CIMC?

Mai Boliang: When our market share approached 55 percent, I felt that we had reached the ceiling to growth—it is unlikely that our container-manufacturing business will grow as quickly now. We have to identify new areas for growth. However, given CIMC’s own strengths and weaknesses and the highly competitive environment in the industry, we are certain of one thing: we cannot do container shipping or leasing. Moreover, we should especially avoid moving upstream to make steel, the raw material of containers.

We realized that CIMC’s core advantages lie in manufacturing in China—that is, in our ability to control manufacturing costs. Therefore, the company was repositioned to supply modern transportation equipment and services. This new positioning has greatly expanded the scope of our business and made it possible for us to produce road transportation vehicles, as well as tanks for use in the energy, chemical, and food industries. With this repositioning, we placed on our agenda the possibility of building trains and ships. In other words, we will look closely at manufacturing a variety of transportation equipment.

The Quarterly: What role has innovation played in CIMC’s global strategy?

Mai Boliang: Innovation has been essential to each of CIMC’s successes. Our slogan is learn, improve, and disrupt. CIMC is a latecomer in every field in which we are involved. There is only one way for the latecomers to catch up with and outpace the forerunners—to disrupt their practices—and only innovation can make the disruption possible.

Take the production of reefers. Aluminum reefers, a market dominated by the Japanese, used to be the industry standard. CIMC imported sandwich-foaming technology from Germany, improved the reefer production process, reduced capital inputs, and improved capacity and efficiency by leveraging automotive technology. Production volume was expanded 1.5 times with merely 20 percent of the original capital input. Productivity improved to nearly 5 minutes per container from the previous rate of over 20 minutes. Innovation by CIMC in the areas of labor and materials costs, technology, and engineering processes has enabled steel reefers—which are inexpensive to maintain, high strength, and corrosion proof—to completely replace Japanese aluminum reefers and upset the old order.

Let me tell you another story about our operational innovations. Chassis for one type of container used to be produced and supplied in the United States. Later, they were made in South Korea and shipped, partially assembled, to the United States for assembly. We are now producing them 100 percent in China. All spare parts and materials are sourced in China, and all products are completed here before they are finally shipped to the United States. All US factories producing chassis had no choice but to shut down because of the fundamental changes we made in their production. CIMC captured a dominant position in the North American market for this product in three years, with a 60 percent market share. If we had refused to change the operational model, it would have been hard to exploit China’s advantages, and CIMC would not enjoy the market position it has now.

The Quarterly: CIMC has acquired quite a few overseas enterprises in recent years. Would you share with us your experience in integrating these companies?

Mai Boliang: Global competition is transforming the world into a single economic community, in which production activities are integrated and all resources are optimized globally. When we buy a company, we integrate it with this megatrend in mind. We see all our operating units as part of a single CIMC, and we share the same vision across those units. We must have a common understanding and consensus, so when we buy a company, we prefer to use one brand—CIMC.

At the operational level, our teams around the world must align themselves with the corporate business strategy. For example, everyone acknowledges that the Chinese team has a competitive edge in costs and manufacturing, while our overseas teams have a competitive edge in technology, management, and marketing. This common understanding is the basis for our work after we integrate other companies.

The Quarterly: What have you done to make the acquired companies feel a part of CIMC?

Mai Boliang: Under the rubric of One CIMC and One Shared Vision, we launched two initiatives—China–US interaction and China–Europe interaction—that brought overseas teams to China to improve communication and to develop more effective interactions. When overseas teams see what we mean by sincere cooperation, sharing competitive advantage, and mutual growth, why wouldn’t they believe that One CIMC will help everyone? In return, Chinese engineers were sent to Europe to get first-hand information about its markets and to conduct research and development. CIMC Europe has also sent people here to help with product quality control.

This has quickly and significantly improved our competitiveness in Europe. The acquired companies, now called European teams, were not comfortable with providing standard products, since their pricing was not competitive. Now they can leverage CIMC’s labor cost advantage, so they have full confidence in their ability to capture 50 percent of the European market for standard products. With the newly improved confidence and the ability to capture a bigger market share, why wouldn’t Europeans embrace the CIMC identity?

The Quarterly: How does CIMC meet the demand for global management talent?

Mai Boliang: The CIMC staff is a global staff. There is a general belief among Chinese executives that whenever a foreign company is acquired, Chinese executives have to be sent to manage it. I don’t think a Chinese team has to be assigned to Europe to manage companies acquired there. Many Chinese companies have failed in their overseas ventures because of this mind-set.

It would take three years, at least, for a Chinese team to get oriented to and acquainted with a foreign territory. How can that be efficient and profitable? In Europe, why don’t we simply hire Europeans? In fact, the optimization of global resources also includes the optimization of talent. After CIMC acquired Burg Industries, in Europe, someone at CIMC asked me whom we would send to Europe. I replied that we should look to the Europeans for our talent. Through Burg, we acquired 1,600 staff members in Europe. They are all CIMC people. Our European management team, which understands the local economy, market, and human environment, has managed this company well. Is there any need to send anyone from China there?

Indeed, we treat our European employees as core CIMC staff. Whatever I can offer is offered to them, including bonuses, stock options, and stocks. We provide the Europeans with as much as—or even more than—what they used to have from their previous, European employers. Of course, I have to tie their compensation to performance measured with key performance indicators.

It has been over four years since CIMC acquired its first foreign company. Every one we acquired has successfully survived the integration and is doing well.

The Quarterly: What are the biggest challenges facing the company?

Mai Boliang: Although we use as much local talent as we can, we still have a talent-development problem. CIMC operates in broader geographies, on a larger scale, and in more diversified fields than it did in the past, and that poses more severe challenges. Talent developed in our conventional Chinese manufacturing setting—just emphasizing the improvement of technical skills—will find it hard to deal with the new situations demanded by our increasingly sophisticated global context. For example, we find that the starting point of Chinese staff members who are developed internally, often from the shop floor, is relatively low and that it takes them longer than better-educated people to reach the point we think is sufficient for work at an international level.

Another challenge is how to capture the mainstream market for semitrailers, which CIMC began to manufacture for the first time in 2002, in Europe and the United States. We built our manufacturing base, added capacity through M&A in China, and later continued to expand our production and service base in the US market. For example, we set up a US subsidiary, Vanguard National Trailer, and later bought HPA Monon, a semitrailer and chassis manufacturer in the state of Indiana. Now CIMC is one of the largest companies in the world in terms of annual sales of all types of semitrailers. Still, the real challenge for me is how this business can gain recognition in mainstream markets and from mainstream customers and how CIMC’s design, technology, and engineering processes can shape the standards and the changing trends in this industry globally. 

About the Authors

Martin Joerss is a principal in McKinsey’s Beijing office, and Henry Zhang is a principal in the Hong Kong office.

Notes

¹China Ocean Shipping (Group) Company (COSCO), a $17 billion corporation, specializes in shipping and modern logistics and also serves as a shipping agency by providing services in freight forwarding, building and repairing ships, and operating terminals. The Hong Kong–based China Merchants is the major investor and operator of transportation infrastructure in the mainland and Hong Kong. It ranks among the world’s top three public port operators, with total assets of $14.6 billion and total assets under management of nearly $131 billion.

What China can learn from Japan on cleaning up the environment

By Invitation

What China can learn from Japan on cleaning up the environment

Japan’s experience provides an excellent road map for anyone who wants to gauge how China can deal with its environmental problems.

Bill Emmott

September 2008

Analyses of China veer wildly between the awestruck and the apocalyptic, between the view that the country has achieved wholly exceptional and unstoppable economic growth and that its growth must end in disaster, probably soon. Lately, the polluted environment has taken pride of place in the apocalyptic argument, on the theory that China’s current economic model is unsustainable, whether because of the domestic implications of dirty growth, the planetary implications, or both. The worldwide focus on the country during the recent Beijing Olympic Games gave greater prominence than ever to these environmental issues.

But both the awestruck and the apocalyptic analyses miss the blend of helpful precedent and hard-fought adaptation that has guided China’s course since market-based liberalization began, in the 1970s. Far from being unprecedented, the broad shape and nature of the country’s growth from the 1980s onward has been pretty similar to the pattern shown in earlier decades by Japan, South Korea, Taiwan, and other East Asian success stories. Like them, moreover, China has had to adapt constantly as circumstances changed and new challenges arose to confront policy makers and managers alike.

In the late 1980s, the country was roiled by hyperinflation and the post-Tiananmen reform crisis; in the 1990s, by the mountain of nonperforming bank loans and the huge task of closing or selling off dud state-owned enterprises. Today’s vast pollution problem is just the latest in a series of obstacles that have fed the pessimistic tendency in Western commentary. The fact that China succeeded in overcoming past obstacles doesn’t guarantee future success, of course. But the good news is that China’s current situation is not at all unprecedented. To its east lies a country that provides an excellent road map for policy makers and executives who wish to gauge how China can come to grips with its environmental problems during the next decade. This country is called Japan.

Think back 40 years

During the current decade, China’s economy has become almost a caricature of the East Asian model pioneered by Japan and South Korea. Investment has surged, taking the share of capital formation in GDP to 45 percent. High and rising domestic savings, accumulated by households, companies, and the government, have made that level of investment easy to finance. The renminbi, undervalued by most measures, has been allowed to appreciate only modestly and only since 2005. An extraordinary $2 trillion in foreign-exchange reserves has been built up to keep the currency cheap, even as the surplus on the current account of China’s balance of payments has climbed to more than 9 percent of GDP.

Yet for all the success of that low-cost, cheap-currency, high-investment model, China now faces twin challenges. The first is a sudden swing, in the past two years, from deflation to quite rapid inflation driven not only by oil and food prices but also rising wages. The second is a sharp worsening of air and water pollution, because resource- and emission-intensive heavy industries—such as aluminum, chemicals, and steel—have led the country’s economic growth. Until 2002, China’s energy intensity (energy used per unit of GDP) had been declining for two decades. Since then, it has been rising, along with emissions of greenhouse gases. In 2007, China overtook the United States as the world’s biggest producer (in absolute terms, rather than emissions per head).

It looks daunting—and it is. But the twin challenges are also strikingly similar to those that beset Japan’s economy as it entered the 1970s. Like China now and South Korea in the 1980s, Japan, in its high-growth years of the 1950s and ’60s, propelled its economy through investment, which rose to 40 percent of GDP in 1970. Under the Bretton Woods system, the yen enjoyed a fixed rate against the dollar, and this made the country’s currency more and more undervalued as Japanese industry became increasingly competitive. Fixed exchange rates and capital controls prevented Japan from building up a current-account surplus and foreign-exchange reserves as large as China’s today. Nonetheless, surpluses caused international friction, especially with the United States. Meanwhile, environmental problems caused domestic friction.

Many will recall that in the early 1970s, Japan encountered two shocks. The “Nixon Shock” came when the US president alarmed Japan by visiting Mao’s China and by abruptly abandoning fixed exchange rates, forcing a sudden revaluation of the yen. Then the oil shock of 1973 sharply worsened Japan’s terms of trade and sent its inflation rate soaring to 25 percent. What is often forgotten is that Japan, like China today, had a disastrously dirty environment, for its heavy industry was highly polluting and unrestrained by environmental-control laws. Consider this passage from a 1975 book by Frank Gibney, Japan: The Fragile Superpower¹:

Most of the beautifully scenic Inland Sea was hopelessly dirtied by the so-called red tides of polluted waters from the factories on its shores. Smog warnings became regular and asthma sufferers began trekking to the hospitals. Regional complaints and petitions about pollution, about 20,000 in 1966, had risen to 76,000 in 1971. . . . In the south, hundreds of people fell ill from eating the local fish. Many died. Similar problems occurred in the north, with mercury-filled drainage from one factory and where a painful bone disease was caused by cadmium.

Now compare that passage with one from a book, published last year, about China:

For two decades, the government treated environmental protection as a distraction from economic growth. . . . Breakneck industrialization produced some of the worst air and water pollution in the world. According to environmental officials, acid rain is falling on one-third of the country, half of the water in its seven largest rivers is “completely useless” . . . one-third of the urban population is breathing polluted air. . . . More than 70 percent of the rivers and lakes are polluted, and groundwater in 90 percent of the cities is tainted.

That extract comes from a book by Susan L. Shirk called—guess what—China: Fragile Superpower.² Clearly, fragility and Asian superpowerdom go together in Western minds.

The place in Japan where thousands fell ill from eating fish was Minamata Bay, in Kyushu. There, the Japanese company Chisso poured methylmercury into the sea during the 1950s and 1960s, with disastrous consequences for the health of the local people—consequences that are still seen today. The cadmium poisoning, caused by Mitsui Mining & Smelting, produced a disease known as itai-itai, or “it hurts, it hurts.” The mercury-filled drainage came from the company Showa Denko, whose effluent triggered a second outbreak of Minamata disease, in Niigata Prefecture, in northwest Japan.

If you look at a photograph taken in a Japanese city in 1970—Tokyo, Osaka, or Kitakyushu, or any city with industry right at its heart—you will find a strong resemblance to most big Chinese cities today, including Beijing, Guangzhou, Shanghai, and Chongqing. In these photos, the air is thick with smog and dust. The rare days when blue skies could be seen were causes for celebration. If you go to any of those Japanese cities now, however, the air is completely different. Blue skies are no longer a rarity, people need wear face masks only when they suffer from colds, not in an attempt to filter out pollution (as they did during the 1960s), and it is no longer hazardous to be a traffic policeman.

A combination of two things cleaned the air in Japan. One was popular protest, which even in a democracy dominated by a single party, the Liberal Democrats, forced government policy to change. The country’s first proper environmental laws were passed in the early 1970s, when its first environment agency was created. The second was macroeconomic: the revaluation of the yen, combined with the oil shock and the ensuing inflation. This sudden change in Japan’s circumstances brought about an abrupt switch in its industrial structure. The low-cost model was dead. Capital investment in heavy, polluting industry began to drop. Energy had become more expensive, and new taxes made it more expensive still. Companies adopted energy-saving and more efficient technologies and started to make products, especially cars, suited to the new, cleaner times. Also at this point, electronics companies, encouraged by the government, made big investments in new high-tech gadgetry, which led the economy in a new direction.

Following the Japanese example

The coincidence of inflation and environmental protests made Japanese industry’s sharp move upmarket inescapable. This move was also extremely successful, leading the way toward a further decade and a half of world-beating growth. At first, it was tough for the economy as a whole, but the Japanese government’s strong fiscal position enabled it to run growth-supporting deficits for much of the next decade.

Can China do the same? Everything there is on a larger scale than elsewhere: only India comes close in population, and only Russia, Canada, and the United States are comparable in geographic size. This can make China’s problems look more daunting than those of other countries. But that is misleading, for alongside the scale of the country’s pollution problems must be placed the scale of its resources to deal with them—if it chooses to do so. China has plenty of officials to enforce laws, the world’s largest security forces, and a central-government budget that is now happily in surplus.

Its inflationary pressures so far are milder than Japan’s in the ’70s (an annual rate of 8 percent, versus 25 percent in Japan in 1974–75). Its currency policy is in its own hands rather than Richard Nixon’s, and the pressure from environmental protests, while real and growing, is muted. The biggest problem is decentralization: China has excellent environmental laws, but local governments have so far tended to ignore them.

Nevertheless, China’s central-government policy makers have already shown, through their speeches, that they too see inflation and the environment as the biggest obstacles the economy must now surmount. The ground has been prepared for changes both in macroeconomic and environmental policy. If they are carried out in both areas, the two sets of changes would reinforce each other. Without a faster revaluation of the renminbi, monetary policy will not come to grips with inflation, as interest rates will have to stay too low. Without greater central-government control over local authorities, environmental laws will not be enforced. Most of all, without powerful market signals that the low-cost, resource- and capital-intensive phase of China’s development is over, neither private enterprises nor state-owned ones (which dominate heavy industry and are the biggest polluters) will move upmarket and clean up their processes.

Like Japan in the 1970s, China has the advantage of strong public finances, which can support the economy through its next transition and finance an environmental cleanup. Like Japan in those years as well, China is a country where the state plays a large role, which could influence industrial restructuring and investment in R&D. Unlike Japan, China could benefit from the worldwide concern over climate change: just as in the 1990s membership in the World Trade Organization was used to overcome domestic opponents of reform, so too negotiations over global climate change could now be used to overcome resistance to environmental enforcement. The biggest difficulty is that in China, unlike Japan, neither politics nor policy is tightly centralized—they cannot be, given China’s scale and complexity. Beneficial change won’t come easily. But it can indeed come. 

About the Author

Bill Emmott is the former editor of The Economist and author of the recently published book Rivals: How the Power Struggle Between China, India and Japan Will Shape Our Next Decade.

Notes

¹Frank Gibney, Japan: The Fragile Superpower, New York: W. W. Norton & Co., 1975.

²Susan L. Shirk, China: Fragile Superpower, New York: Oxford University Press, 2007.

Wednesday, September 10, 2008

A Model for Hurricane Evacuation

Software developed at MIT could save lives and money by improving hurricane planning.

By Brittany Sauser

As Hurricane Ike approaches the Gulf Coast, local authorities and emergency managers face critical decisions: when and how to evacuate residents, and when to draft in supplies and other aid. Proper planning could help save thousands of lives and hundreds of millions of dollars, but the unpredictable nature of any storm also makes effective decision making difficult. A researcher at MIT is now testing computer software that combines an unprecedented amount of data to help emergency managers make faster, more informed decisions.

"Evacuation planning is very complicated," says Ozlem Ergun, an associate professor and codirector of theResearch Center for Humanitarian Logistics, at the Georgia Institute of Technology. "Given how bad the [2005 hurricane] Katrina process was, it is evident that there is a big need for this to be done in a systematic way."

To coordinate a hurricane response, emergency managers have to rely on locally-drafted evacuation plans andguidelines provided by the Federal Emergency Management Agency (FEMA). After the chaotic and poorly planned evacuations carried out during the 2005 hurricane season, new planning procedures were introduced. FEMA also now uses a computer model to estimate how long it will take to clear a city based on its population, although this model can't advise on when and how best to evacuate it.

These new measures appear to have had at least some impact. Last week, Hurricane Gustav forced most of south Louisiana to be evacuated--some two million people--in just two and a half days. The process went smoothly, but Ergun believes that this may be partly because the memory of Katrina is so fresh in so many people's minds. "In five years, people won't be so conscious about it and again may wait until the last minute to take action," she says.

The new software might help the authorities avoid future catastrophes by alerting them to unforeseen problems. The software combines historical hurricane data, current weather conditions, and projected hurricane paths to help authorities work out where a hurricane will most likely strike and how intense it may be. "The model is more efficient in clearing people over time because it eliminates the confusion that leads to gridlock," says Michael Metzger, who developed the model and is a PhD student in the Operations Research Center (ORC), at MIT.

haotic congestion: On August 30, traffic on Interstate 10 in Louisiana backed up as residents sought to escape Hurricane Gustav. Approximately two million people fled in two and a half days.  Credit: AP Photo/Brian Lawdermilk

The software is also flexible, allowing emergency managers to input their city's demographics and geography. And it adopts a novel approach, categorizing a city's population into different demographics, such as the elderly, tourists, hospital patients, and families with children, for separate evacuation. In addition, says Metzger, the model considers details of available evacuation routes. For example, as there is only one highway that leads out of Key West, FL, emergency managers would need to phase out evacuations to avoid congestion. This allows the software to provide more finely tuned recommendations, he says. The software can even advise emergency managers when to start bringing in supplies, where to set up shelter locations, and when to call in the National Guard.

The new software was built using dynamic programming--a technique often employed to solve problems involving uncertainty and parameters that change over time. "It evaluates all the different, possible future outcomes of a decision and then works backwards to make a decision at current time," says Metzger. Richard Larson, a professor of engineering systems and civil and environmental engineering at MIT and Metzger's advisor, says that the technique is well proven. For example, similar approaches are used by American Airlines to determine seat pricing and by football coaches to make real-time strategy decisions.

Better methods: The new computer model requires a population to be grouped into different key demographics. It estimates the cost of evacuating each group and the amount of lead time required.  Credit: Michael Metzger

As the system has not yet been tested on a real evacuation scenario, Metzger says that it is difficult to estimate how much time or money it could save. However, Ergun describes the technology as "very impressive."

Once the data is available, Metzger's model will be tested against the decisions made by officials during the 2008 hurricane season. Larson says that this will be completed by May 2009, and he believes that the model could be used initially as a training tool. "Just as pilots use flight simulators, if decision makers can go through different scenarios, they are going to be better at it when the real thing happens."

Ike is expected to make landfall this weekend near Corpus Christi, TX. Texas governor Rick Perry has put 7,500 National Guard members on standby, and Louisiana governor Bobby Jindal has told residents to start stocking up on supplies as shelters and evacuation transportation is readied.

Managing IT in a downturn: Beyond cost cutting

Managing IT in a downturn: Beyond cost cutting

Looking to slash your IT investments? Consider the possibility that targeted ones might generate savings and revenues exceeding what you could save through cost cutting.

James M. Kaplan, Roger P. Roberts, and Johnson Sikes

September 2008

Economies around the world are slowing down, and companies are looking for ways to trim spending and improve the bottom line. Although information technology often represents a small fraction of the corporate cost base, senior executives inevitably turn their attention to IT budgets for substantial contributions. Yet in some instances, IT investments deliver more value to a company’s top and bottom lines—by creating new efficiencies and increasing revenues—than any savings gained from traditional IT cost cutting.

IT has come a long way over the past decade. Budgets grew rapidly during the dot-com boom and the run-up to Y2K, then declined drastically when the bubble burst. Over the following years, CIOs, working with business unit leaders, improved the performance of IT departments by streamlining application portfolios, reducing infrastructure costs, improving governance, consolidating vendors, and outsourcing many activities.

Much has changed across the business landscape as well. Technology now meshes tightly with operations in ways that weren’t possible a decade ago; the apparel maker Li & Fung, for instance, uses IT to manage supply chains with a network of over 7,500 different suppliers. At the same time, e-business, once a buzzword, now forms a part of the corporate status quo. IT capabilities have fostered new sales channels, defined new customer segments, and even helped create new business models.

These factors make reductions in IT spending more complicated than ever. Simplistic cuts, applied across the board, may endanger critical business priorities from sales support to customer service. That potent message should resonate even among corporate officers anxious to find quick savings.

CIOs, of course, should continue to make their operations more efficient and to reduce costs, especially in areas that show signs of bloat. Discipline tends to slip during a lengthy upturn in spending such as the one that has occurred in recent years. Reducing pockets of unproductive expenditure will bring savings that help meet corporate cost targets.

Still, except in the most dire circumstances, turning off technology investments during a downturn is counterproductive. When business picks up, you may lack critical capabilities. Besides, many technology investments can improve profitability in the short to medium term.

When business and IT executives jointly take an end-to-end look at business processes, the resulting investments can have up to ten times the impact of traditional IT cost reduction efforts (Exhibit 1). The trick is to scan for opportunities—such as improving the customer experience, reducing revenue leakage, and improving operating leverage.

Creating impact with technology

Such an effort begins with a survey of operations for areas likely to produce near-term revenue and efficiency gains. In our work across a variety of industries, we have identified a number ways technology investments can have a substantial impact (Exhibit 2).

• Manage sales and pricing. Develop insights into customer segments and improve pricing discipline to increase revenues without increasing prices.
• Optimize sourcing and production. Rethink supply chains and logistics to improve the scheduling of deliveries and inventory management.
• Enhance support processes. Improve the management and use of field forces (such as installers and field technicians) and of customer support centers.
• Optimize overhead and performance management. Sharpen awareness of risk exposure and improve decision-making and performance-management processes.

To extract value from these opportunities, our experience shows, companies must make managerial improvements in two areas.

Developing new insights

Few companies have successfully capitalized on the explosion of data in recent years. Often this information, residing in separate IT systems or spread across different business units, has never been mined for insights that could add value. Small teams of business and IT staffers can find opportunities by combining a detailed understanding of business processes with straightforward analyses of consolidated data sets. When such teams use the data to compare best practices across regions or to identify under- and overserved customers, for example, they can identify hotspots of revenue leakage.

Optimizing processes

As IT becomes tightly integrated with processes, breaks in workflows often get built into systems and diminish productivity. Shining a light on these areas with an integrated view of operations and technology may well surface problems, which often involve outdated processes, manual steps, redundancies, and bottlenecks. An 80/20 approach can highlight a modest number of activities that, when corrected, deliver a disproportionate amount of value. Companies can usually apply these fixes in short order. At times, new systems may be needed, but modest enhancements or targeted work-arounds often suffice: an additional error check in a credit application, for instance, can reduce the need to rework incorrectly entered data. Adjustments to workflow processes may also promote greater adherence to corporate sales-discounting and bidding policies.

Applying these methods

Applied in high-opportunity areas, these two levers can not only make a short-term contribution to earnings but also build a foundation for future performance. Two cases illustrate this approach.

Revenue and pricing discipline

Maximizing revenues is always important, but even more so during a downturn—particularly when revenues can be increased without raising prices. For many companies, especially those with complex pricing in business-to-business transactions, poor pricing discipline is endemic. Since most pricing regimes depend on IT systems for the process and the workflow, these systems can play a central role by capturing lost revenues.

A telecommunications company has started to attack such issues by building high-value but inexpensive links between multiple silos of information. Contracts databases, sales funnels, compensation systems, CRM data warehouses, and other siloed systems formerly spanned a range of the company’s business-focused products. Just centralizing this information in one accessible repository was a big step forward: it facilitated analyses that uncovered opportunities to improve revenues by controlling unnecessary discounts and by harmonizing inconsistent pricing policies across different products and regions. The value came from integrating information flows at key points, not from creating new systems.

Introducing this degree of transparency also increased the team’s credibility with the sales force. Better information flows made it clearer which practices resulted from uncontrollable market forces and which of them the sales reps could truly control, allowing the company to evaluate them on a comparable basis.

The telco began closing the pricing gaps first by developing and testing new procedures and then by scaling up new metrics, as well as new performance-management and compensation systems. These linked the new procedures all the way from frontline salespeople up to the president of sales.

Technology played a critical role. The project team consolidated information from various product systems into a unified reporting database and developed simple pricing scorecards to make information more transparent and visible across groups. Tools linked the compensation of the sales reps to their performance on pricing by comparing their discounting and pricing records with comparable averages. Simple dashboards managed the performance of the sales force at each level, cascading up to the president of sales.

These policy and IT changes helped the telco to reduce its price leakage and to increase its revenue on new contracts by 3 to 5 percent, which translated into a margin expansion of 15 to 20 percent or more.

Employee productivity

Another critical goal during a downturn is getting more “bang for the buck” from employees—for example, by increasing a company’s operating scale, making processes more efficient to reduce rework, and stepping up efforts to automate manual procedures. IT is essential to all of these efforts.

Targeted technology investments helped one retail bank to increase the productivity of its branch office sales forces. The bank needed to adopt a more systematic approach to winning new accounts and to improve its cross-sales to existing customers. Technology helped to increase the hit rate for sales leads from marketing staffers and to create a more robust, “industrialized” way of handling referrals from tellers. These improvements allowed the company to convert such leads more quickly and to raise its revenues per employee.

The bank had relied heavily on manual, paper-based processes to identify and distribute leads, customize offers, and close deals. There were islands of automation at points throughout the sales process but no end-to-end view of its workings or how technology could improve them.

A team of business and IT staffers reviewed branch operations and quickly identified areas where focused action could produce substantial gains. The distribution of leads to the sales staff was automated, and more of them were directed to the reps with the best performance in previous campaigns. The tracking of customer outreach efforts and the keeping of sales conversion histories were automated as well, which made sales efforts more efficient and helped the company to avoid hitting clients with multiple offers. To give sales reps a full view of a client’s bank relationship at the click of a mouse, the lead-management system and the enterprise CRM platform were integrated. The system could supply “next-best offers” for each customer, as well as call scripts to help reps push new products. Data entry after each closed sale was streamlined, and vital information that could be used to model strategies for future conversions was captured more fully and efficiently.

After making these investments, the bank reported that it was on track to double the number of daily branchwide sales calls, improve its conversion rates, and significantly raise productivity. Uniform sales procedures, applied throughout the system, were expected to yield further efficiencies.

Downturns give companies a chance to buck conventional wisdom and increase their IT investments. From our experience, targeted investments in many areas can generate efficiencies and revenue growth that surpass the savings from straight cost reductions. 

About the Authors

James Kaplan, a principal in McKinsey’s New York office, leads the technology infrastructure practice for McKinsey's global IT group. Johnson Sikes is a consultant in the New York office. Roger Roberts, a principal in the Silicon Valley office, leads the firm’s IT strategy practice.