Author: Patrick Van den Bossche, Americas Lead Partner at A. T. Kearney's Strategic Operations Practice and Rajeev Prabhakar, Manager in Energy and Process Industries Practice at A.T. Kearney
The 2009 recession forced manufacturers to increasingly turn to outsourcing to solve their cost challenges - but this has greatly reduced control over their supply chains and influence over their cost structures. We propose a method for correcting this challenge, one that works.
The method is designed to help organizations assess the maturity of their processes throughout the contracting lifecycle and figure out how to interact better with suppliers – particularly third party manufacturers. We have titled it, The Contract Manufacturing Stages of Excellence Model. But first, let's quickly review major challenges.
Outsourcing needs better management control
Increasing product and process complexity continues to drive up overheads and fixed costs. So, organizations across all industries are looking again at which competencies are critical to their competiveness. They then use contract manufacturing to outsource non-critical operations - and with them the associated complexity and cost.
But this increased outsourcing has increased challenges in managing third party manufacturers. For example, at Original Equipment Manufacturers (OEMs) in the Germany automotive industry, vertical integration (where the entire supply chain of a company is owned by that company) has fallen to about 20%, according to VDA, Verband der Automobilindustrie (Association of the German Automotive Industry). .
As companies dismantle their internal manufacturing operations, they would be wise to maintain control. The best way to stay in charge very much depends on what, why and how manufacturing operations are outsourced.
Using third parties calls for a stronger supply chain process
People tend to think of contract manufacturing as the straightforward outsourcing of the manufacturing of products that an organization sells under its brand name. For example, iPads, athletic shoes and private label products in grocery stores are among the best known examples of the involvement of external parties.
But third-party manufacturing is used in a variety of industries, often even for discrete manufacturing steps such as producing custom raw materials, performing intermediate processing steps or converting semi-finished goods into finished products.
Typically, the use of third parties is driven by a strategy to lower total delivered cost or by a lack of capital to invest internally. Increasingly, organizations also use contract manufacturing strategy to reduce risk of product launches or new market entry, increase speed to market, increase supply flexibility, and even for product, process or packaging innovations.
But regardless of the choice, outsourcing forces organizations to depend on contract manufacturers to deliver strong supply chain performance and satisfy their customers. To achieve these objectives management of every aspect of the contract manufacturing process must be decisive and well planned.
Contract Manufacturing Stages of Excellence
To help companies figure out how to get better at interacting with and managing their contract manufacturing suppliers, A. T. Kearney has developed a Contract Manufacturing Stages of Excellence model to assess the maturity of practices throughout the entire contract manufacturing lifecycle (see Figure 1).
Seven dimensions of the model's framework (described below) test how the practices of organizations compare with best practices across industries that cover all aspects of contract manufacturing. Each dimension contains multiple elements that illustrate practices applicable to that dimension.
Each element describes practices, based on cross-industry input, that fall into four stages, in increasing order of excellence: nascent (just beginning); emerging; robust; and advanced. The chevrons in the top half of Figure 1 show the seven dimensions. The bottom half of the Figure shows the four stages of excellence.
Figure 1: A.T. Kearney's Contract Manufacturing Stages of Excellence model
The aim is for companies to understand where exactly their current contract manufacturing practices are lacking relative to their industry (or cross-industry) benchmarks and therefore be able to develop targeted improvement plans.
The model's dimensions are as follows:
Please note that the Stages of Excellence model is meant to highlight performance gaps versus leading practice, but it does not advocate reaching the highest level of maturity in ALL dimensions.
You should always base your decision to close performance gaps on the strategy and the overall business objectives you are pursuing. For example, a strategy built on innovating ahead of the competition and being first to market will likely give a lower priority to practices that primarily are helpful in achieving cost reduction objectives.
Stages of Excellence Survey Results
In late 2013, we conducted a survey to test and better understand the maturity of outsourcing practices in six industry groups:
Representative samples of respondents (Figure 2) from both large and small companies active in these industries completed the survey by selecting the descriptions of practices for each element that most closely resembled their current practices.
We also asked respondents to provide additional qualitative and quantitative insights into their practices. We analyzed their responses to determine the average performance within an industry on each dimension as well as the “leading” performance, defined as the average of the top quartile of performers within the industry.
Figure 2: Contract Manufacturing Stages of Excellence survey demographics
The survey results shown in Figure 3 revealed that across the respondent pool, companies exhibit “robust” performance on average in every dimension.
Figure 3: Survey results across all industries
Most companies seem to get the basics right with more than three out of four reporting “robust” or ”advanced” practices for protecting their intellectual property rights and managing quality.
Companies also seem to recognize the importance of contract manufacturers in overall supply chain performance and are shaping their organizations accordingly. For instance, 53% of respondents had the organization managing contract manufacturers reside within the supply chain or manufacturing functions, a significantly higher proportion than in past surveys where the function was a part of the procurement organization and contract manufacturing was primarily seen as just another “buy” item.
Despite the relatively good performance on average, the top quartile of performers, labeled the “leaders,” showed significantly better performance, with approximately one stage higher performance on every dimension. The performance of leaders in different industries show interesting differences (see Figure 4), which can be understood based on the industry's history of outsourcing, its outsourcing drivers and prevailing business models.
Figure 4: Leading performance by industry
For example, companies in the electronics industry rely heavily on contract manufacturers for making individual components as well as assembling entire products. As a result, electronics leaders have developed strong practices in every single dimension, and exhibit the most consistently strong performance among leaders of different industries.
The textiles/garments industry, on the other hand, primarily appears to be seeking labor cost arbitrage in its contract manufacturing strategy, moving from one country to another in search of the next low cost location. Accordingly, leaders in this industry have strong outsourcing strategy and supplier selection practices, but do not invest as heavily in managing supplier relationships over the long term.
The food ingredients leaders exhibit the poorest performance across all dimensions relative to other industry leaders. It appears that this industry has not quite embraced outsourcing as much as other industries. Food ingredients companies typically either operate on the small volume-high margin side of the spectrum, where there's little strategic rationale for outsourcing, or they produce huge volumes on the lower margin side of the scale that require such high capital investment that no third party could be convinced to make. The processes that are occasionally outsourced are typically lower value operations like blending or pure commodity products, neither of which warrants much management attention.
Opportunities for improvement
One-size-fits-all approaches to manage the entire contract manufacturing base are not very successful, especially for global organizations with operations in both developed and emerging markets and with, likely, a history of mergers, acquisitions and divestitures. Companies with that profile may have a wide variety of contract manufacturing relationships.
Reasons for outsourcing can vary even for the same products in different geographies. For example, in the developed markets, outsourcing may be driven by cost efficiency goals, while in new markets the outsourcing activity may be motivated by speed-to-market considerations. As such, different approaches to how the relationship with a contract manufacturer is managed are required.
Successful supplier relationship management hinges on understanding the value each supplier brings to the relationship and the role they play in helping attain the company's strategic goals. Companies that understand this measure supplier performance not just on the basic deliverables of cost, quality and service, but on tailored metrics designed to evaluate progress towards the specific goals for outsourcing the particular activity.
Suppliers are also segmented into different categories based on their value and each category is managed differently according to its needs. For example, managing highly strategic suppliers may require peer-to-peer relationships at multiple levels in the organization. On the other hand, suppliers with strong planning and quality processes, significant experience in making the required products and a long relationship history with the company may need only a light touch.
Successful companies understand these nuances and manage the contract manufacturers accordingly. These companies also make sure to align contract manufacturers' incentives with the company's goals through well-structured contracts and shared risk-reward incentive structures. They also help manufacturers succeed by providing greater transparency into production forecasts, not overprescribing the requirements and collaborating on performance improvement initiatives.
Supplier segmentation also helps in designing the organization that is responsible for managing contract manufacturers. Requirements for managing different supplier segments provide input into the necessary skills and expertise, laying the groundwork for developing successful staffing models. Designing the organization structure from a requirements perspective helps align the organization with the operating model for managing the contract manufacturing base and enables efficient use of resources.
Room for improvement but moving forward!
Both the survey and our own observations reveal that companies are doing a reasonable job overall in using contract manufacturers to achieve desired business objectives. However, leading practitioners in most industries exhibit advanced practices on several dimensions. While closing individual performance gaps depends on companies' business strategies, the survey specifically highlights broad opportunity for improving on-going management of supplier relationships and designing effective and efficient organizations to manage contract manufacturers.
The next frontier is getting the most out of contract manufacturers as well as companies' own resources that manage those third parties, in a way that best aligns with the strategic role that contract manufacturing is expected to play in the business.
ABOUT THE AUTHORS
Patrick Van den Bossche is the Americas Lead Partner of A.T. Kearney's, Strategic Operations Practice. Patrick has 20+ years of business and consulting experience helping executive teams of companies of all sizes, think and work through challenges and opportunities in the operations area. Patrick has especially deep expertise in global supply chain strategy, contract manufacturing, complexity management, manufacturing and distribution. A sample of industries served includes specialty chemicals, consumer goods, paper & pulp, pharmaceutical, health care etc.
Before joining A. T. Kearney, Patrick was a senior logistics consultant at Plant Location International, a division of PwC, responsible for coordinating and implementing pan-European supply chain integration projects.
He earned his university degree in electro-mechanical engineering at the University of Ghent (Belgium). Patrick is based in A. T. Kearney's Washington DC office.
Rajeev Prabhakar is a Manager in the Energy and Process Industries practice at A.T. Kearney. He has more than nine years of experience in industry and consulting, helping chemical and energy companies with challenges in contract manufacturing, procurement, and operations and in developing their business strategy. Rajeev has a PhD in chemical engineering from the University of Texas at Austin and an MBA from the Wharton school at the University of Pennsylvania. Rajeev is based in A. T. Kearney's New York office.