(Six Trends Impacting Commercial Vehicle Suppliers) If you ask anyone at the “water cooler” of the automotive industry about the future, they will probably recite these top two trends right away: autonomous driving vehicles and advanced manufacturing (a.k.a. Industry 4.0). The experts will possibly add three more changes to take effect in the next 15 to 20 years: electrification of vehicles, connectivity and advanced materials. These five trends are driven by global tendencies, but mainly macro economic ones, such as slowing growth, environmental distress (creating stricter rules), demographic shifts and growing urbanization. While it’s reassuring that everyone shares a similar vision, it’s not exactly clear how these changes are going to impact vehicle OEMs and their auto parts suppliers. More specifically, how they will change the commercial vehicle (CV) manufacturers and their suppliers. And the reason why we should think about the CV industry first, is the high probability that the next autonomous car might be a truck. Trucks have very compelling reasons to receive autonomous driving capabilities before passenger cars do, especially long-haul trucks in US and Europe. The economic benefits of ALHTs (autonomous long-haul trucks) are undisputable: fuel economy, safety, emissions, delivery efficiencies, tackling driver shortage and so on. On top of economic reasons, closed-loop transportation systems will be first to market, since they are easier to maintain control, versus passenger cars. Trucks already have a semi-open architecture for power and drive train systems, using a network of electronic control units (ECUs) over standard data-links. Many of the ALHT’s enabling technologies are in place today and new ones are being tested as we speak. The sensor arrays and number of ECUs continue to grow. Suppliers such as Knorr-Bremse and Wabco offer full stability control systems, lane departure and radar-based anti-collision systems, to mention a few. Trucks were the first adopters of telematics back in the 90’s, becoming a showcase for Qualcomm and for how connectivity can improve overall transportation efficiency. In fact, major suppliers piggyback on telematics to communicate with their products on the go. Many in the industry believe that we are only one or two design cycles away from having convoys of ALHTs going down some highways in US and Europe, in the next 10 to 15 years. Unlike cars, autonomous driving trucks will not require radical changes to their power/drive train technologies to get there. The changes are likely to be less than revolutionary. The modern diesel engine and transmission, for example, are fully capable and very likely to power the ALHTs with some enhancements. Diesel fuel will continue to be cheap for the foreseeable future, even though we might see some electrification as hybrid and power storage technologies develop. So change is coming for the trucking industry and so far all we hear is discussion about product and manufacturing hardware technologies. And although these technologies are important and disruptive, the central question for suppliers is how will these changes impact their business in the next 10 to 15 years. Or how can an existing supplier capitalize on these trends? Based on my observations, I believe there are at least six specific areas that CV suppliers must look at, in order to succeed in a changing CV industry: (1) move up in the supply-chain (tier 0.5 supplier), (2) increase lean and agility, (3) glocalization, (4) new service business model, (5) analytics capability and (6) the millennial generation. Become a Tier 0.5 Supplier Commercial Vehicle OEMs are pressured to meet both the growing need for automation features and cost reductions for competitive and regulatory purposes. The cost of non-compliance is growing bigger every day (remember the recent debacles around International Trucks and VW diesel cars). OEMs are adding new models and features while reducing the number of vehicle architectures and suppliers. This complexity will inevitably influence ALHT’s architecture to become more modular, through more subsystems (modules) designed with interfaces that form similar structures, from which a number of derivative vehicles can be developed, while preserving the identity of each OEM. While OEMs will continue to be the system integrators, Tier 0.5 suppliers will be a step ahead of the Tier Ones in the supply chain, working in close cooperation with OEMs and component suppliers, offering modules with common interfaces and technologies that are aligned with ALHT’s architecture. The design characteristics of the best modules will include simpler interfaces to the truck, energy conservation capabilities, remanufacture ability, data-gathering intelligence, network connectivity, above average reliability and competitive cost. It will take smart and integrative design by the supplier, beyond and above the addition of more ECUs to the product. A module will be more than today’s conventional subsystem assembly, where labor is the main value added to isolated components. Take for example the rear drive axle assembly; composed of an axle, brakes, wheel ends with tires and ABS/EBS controls. Today, these components are sourced separately from different suppliers, by most OEMs, with little integration amongst them. This is the result of an evolutionary design and sourcing mindset created by a multitude of unique interfaces and functionalities, in the absence of modular system architectures for trucks. When you boil down the functionality for this subsystem, the rear end is primarily trying to manage torque between the vehicle and the asphalt, in the most efficient way possible. As the ALHT architecture evolves, it is not difficult to envision that all of these mechanical and electronic components could be optimized to provide higher levels of performance. Smart tires and axle differentials, for example, could share the intelligence embedded in the ABS/EBS controls. Mechanical integration between axle, brake and wheel-end using new materials, could save a lot of weight and cost. Tire pressures could be controlled to optimize tire wear in conjunction with traction and torque control. The rear end module should be capable of adjusting its torque characteristics on the fly, based on road conditions and duty-cycles. It should also be able to ask for help when it senses a problem and requires service, based on usage patterns and prognostics. The possibilities are endless, but I know many people will bring up the commercial barriers for suppliers, to climb up to tier 0.5. And that is true, until the new architecture emerges and the interfaces are better defined for each functional vehicle element. The best example we can relate to is the personal computer. Once the architecture became stable and the interfaces well defined, a whole new industry emerged. Some component suppliers were able to climb up the ladder and evolve into complete subsystem providers, while others were acquired or disappeared altogether in the process. Who is going to be best positioned to supply high-value modules under the new architecture, remains to be seen. There is also the question about how vertically integrated truck OEMs will deal with this change. Are they going to collaborate more with suppliers or are they going to try to become modular suppliers themselves to other OEMs? Would someone like a Google or a Tesla become intelligent modules supplier in the future? Some suppliers are better prepared than others. Eaton, for example, had a good start developing and supplying hybrid power packages to bus truck manufacturers. Cummins did the same in the natural gas space, with engines and fuel systems. They eventually became a supplier of fuel and emissions systems to other engine makers. The important thing is to consider this disruptive change in the horizon and start developing your company’s strategic choices and desired position in the new supply chain. Increase Lean and Agility Lean manufacturing has been around for 50 years now. Still, not every manufacturer has transformed itself with lean. Many have not managed to apply it beyond the shop floor. Suppliers will need one or two more gears, in order to cope with squeezing margins, if they want to grow profitably. Becoming leaner, beyond the shop floor, and increasing agility are imperatives to survive and thrive. And to gain agility, suppliers must reduce internal complexity and keep it under control. It means simplifying supply-chains, de-proliferating product portfolios, optimizing sales and distribution practices and streamlining business processes. Getting leaner beyond the shop floor requires a compelling economic benefit, for most suppliers. Most see the power of lean to eliminate waste in manufacturing, but when it comes to other areas, the enthusiasm is not the same. This is why I believe suppliers need 80/20 or “lean on steroids”. As I’ve written before, lean and 80/20 are “sisters” and they need to work in tandem, if you want to cut waste and become more agile at the same time. Lean is primarily an “inside-out” methodology, while 80/20 is an “outside-in” process. 80/20 starts with the customer and the market. Lean starts with a strategic intent or purpose from within the company and eventually becomes a transformation tool, which impacts the way people think and the way the processes work. Combining lean and 80/20 will increase focus, profitability and reduce complexity. It will sharpen your company’s focus on the market’s sweet spot, simplify your offering and drive complexity out of the critical business processes. It will also create a more decentralized and autonomous organization, capable of faster organic growth. Lean and 80/20 will also lead you to a sensible automation approach for your manufacturing processes, for maximum productiveness and lowest cost, and not just automation and connectivity for the sake of staying in tune with the latest buzzword (Industry 4.0?). Let the market demand drive the need for 3D printers and robots in your high volume production lines and not the other way around. Ease of connectivity on the shop floor is happening anyway! But that is the hardware, while lean and 80/20 represent the software. Adopt Glocalization There are no surprises about the global nature of the CV industry and the need for suppliers to support their OEM customers around the world. But there are different approaches to helping your customers globally. Glocalization can be thought of as another buzzword, but it has a role in our industry. Some times, you must offer different versions of the same product for different markets, but you don’t necessarily need to become more complex and proliferate your product lines to do that. You also have to create product availability close to the customer site, but you don’t necessarily have to own all the means of production yourself. To use another jargon, glocalization means that you think globally (product architecture, supply chain, partnerships) and act locally (product features, cost and service needs). A good example of a company that does this very well is Cummins. While the same mid-range engine platforms (ISB and ISC) are used all over the world, the final products get customized in different markets to meet local competitive requirements and service needs. And production is not carried-on directly by Cummins in every region either. In China, for example, Cummins has a joint venture with OEM customers, such as Foton Trucks. Cummins has “glocalized” production in China, in order to produce the ISB four cylinder engines, with different fuel systems and accessories, which are more adequate for local emissions, cost and service practices. In other markets, Cummins uses a combination of its own plants, JVs and licensees to create availability of “glocalized” products. Normally glocalization happens in two fronts: manufacturing footprint and products. But there is more to it, such as localizing design and maintenance of global product platforms for major developing markets. The growing number of technical centers in India and China are good examples. Engineers work in collaborative manner with their peers in US and Europe, to create new designs and tweak existing platforms. The product design, for a high volume emerging market truck component, should ideally be done in the region. OEMs are quickly learning the lesson and turning more often to suppliers in region, capable of true localization, based on global platforms. Think of BharatBenz in India and Foton Trucks in China, as companies that are adopting a glocalized sourcing strategy. Change the Service Business Model The concepts of vehicle uptime and TCO (total cost of ownership or life-cycle cost) will be top priorities for fleet customers, since they can now operate their transportation system 24 hours a day, seven days a week. Nevertheless, the fact that ALHTs are connected all the time to the network creates a major business opportunity for suppliers willing to innovate on their service business model. Customers will continue to demand a seamless purchase experience for parts and service. They will also want to monitor the health of their vehicles online, using predictors to decide when its time to pull the truck for service, and select strategically located service shops to minimize downtime. Loyalty to the channel (OE or independent) and to the brand of the parts on the box will diminish, as customers pay a lot more attention to TCO and uptime. In fact, end users will care less and less if the parts are new or remanufactured, as long as they get the job done from cost and availability angles. There is a major opportunity in remanufacturing of components, in the broader sense. It is not only more economical but it also makes a lot of sense from an environmental standpoint. And the biggest revolution in remanufacturing has to do with the supplier’s expertise in the areas of electronic salvage technology and reverse logistics. Remanufacturing of electronic components will go way up. The ability to reprogram the hardware with new or upgraded code, and delivering the new software via de network, will be huge differentiators. We are now talking about real-time remanufacturing of products, in some cases. But suppliers will have to dedicate engineering resources to developing new salvage techniques for hardware and software, so they can change fewer parts and have better margins. Develop In-house Analytics Capability The key reasons to be good at analytics are two fold: first, customers will demand that your products and services offer predictive capabilities and two, you will want to use the abundance of information to develop market foresight and optimize your product portfolio. Your products will become a node in the ALHT’s data network. Capturing only miles and hours of operation are OK, but not sufficient to create predictors that you can act upon. Usage and duty-cycle data, operating environment information, product health and performance, maintenance interventions and a host of additional data will become available. Being capable of making sense of the data, to predict the future and to make it happen for you and for the customer will be a huge differentiator in the market. Predictive analytics capability will allow you to get closer to customers and derive usage practices that you can apply for multiple purposes. Predictors will help with early problem detection and service prognostics, which is critical for the operation of ALHTs. No one will want a disabling failure to happen without previous warning, when it comes to autonomous driving. The risk is too high. Suppliers will have to learn these new skills, since most of what they have today is warranty information analysis and service diagnostics, which is only capable of telling “what happened” and “why it did happen”. Current analysis is not geared to point to “what will happen” and “how you can make it happen”. Once these new analytical skills are developed, you will be able to use them to improve performance of your own sales and product portfolio. Suppliers will use analytics to continuously optimize offerings, as product mix will vary even more, for different OEMs and regions. The customer pain points and usage patterns will feed right into the supplier’s product plans and service strategies. There will be less guessing and subjectivity. And without active and objective management of the product portfolio to sustain momentum, suppliers will likely suffer from slow growth and sub-optimal contribution margins. Empower the Millennial Generation Last but not least, CV suppliers need to have their experienced leaders focused on developing and empowering the next generation, before it’s too late. An industry that has traditionally thrived on experience and people’s networking abilities must learn to succeed with tech-savvy and connected people, who don’t necessarily want to stay in the same company for all of their lives. Suppliers will have to adjust to the fact that the Gen Y workers are more inclined to be “employed consultants” who want better flexibility and recognition. The good news is that the new generation is a lot more global and in tune with the trends affecting the commercial vehicle industry. They are likely to see the advent of autonomous vehicles as a natural and needed evolution in the entire transportation matrix. They will want to be challenged and recognized, working in focused business units, with clear KPIs, as opposed to the overly functional global matrix organizations. They will be more like the ALHTs themselves, where the network creates the strength and not any specific node in isolation. Surely there are other things that CV suppliers have to worry about in the next 20 years. And you don’t have to be good at all of these areas to be successful either. But some of these can have a perverse effect, if you don’t pay attention to them. Case in point is the arrival of the millennial generation in the work force. Failure to bridge between baby boomers and the millennials can create disruptive shock waves throughout the culture and distract the organization. Other areas such as glocalization, if poorly executed, can create cost and limit growth in a global CV industry. Lack of innovation to your service business model can cost you a lot of money in customer support and reputation.
Other areas like lean 80/20 and analytics are performance differentiators. The suppliers who excel in these attributes will pull ahead of the pack and make more profits. And Tier 0.5 is the ultimate aspiration and a delighter to customers. If you are able to deliver innovation and value that is aligned with the new truck design architecture, you will have an edge. But only a few of the basic areas are attributes to becoming a Tier 0.5 supplier. Other competencies are required and not all of them are present in our industry today.
3 Comments
Almost every business starts simple and becomes complex as it grows and develops. As scale changes, simplicity gives way to layers of structure and controls. When complexity creeps in without control and is not properly measured and managed, it can push against value creation and profitability. In reality, the problem is not extra scale but extra complexity. Additional scale, without additional complexity, will always give lower costs. As a business grows, it wants to provide more services and products, which end up stimulating other overhead drivers, such sales and purchase transactions, manufacturing footprint, accounting systems, organizational structure and managerial habits, to mention a few. But of all the complexity sources, the swelling of the product portfolio and the elevated number of discrete components, can be the largest hindrances to attaining high levels of profitability, growth and customer satisfaction. When the product offering contains just a small amount of variation, the impact of adding new parts is relatively minor. However, as complexity grows in the form of low-volume products and customers, just a few additional part numbers can create a disproportional increase in complexity costs. Without deliberate and systematic actions to simplify the product offering, non-value-added complexity will prevail over time. On the other hand, part number de-proliferation can have a huge positive impact on profitability. Thomas Johnson and Anders Broms wrote about tackling product proliferation and how it can improve profitability in a 1995 article, in the AME Magazine[i], talking about Scania’s approach to dealing with complexity: “Everyone believes that a manufacturer will improve costs and profitability by reducing the number of different parts in its products. And for good reason. With fewer different parts, less effort and resources are required to design, make, and service a product line. Accordingly, activity-based cost management systems routinely use part-number count as a cost driver to estimate how much financial performance will improve by reducing the number of different parts. However, it is not well understood that cost-driver information may capture only a small fraction of the financial improvement that part-number austerity makes possible.” The good news is that product line complexity is easily detectable, such as in too many products and too many customers, or too many part numbers and too many suppliers and transactions. The number of discrete parts or products and number of transactions are two important cost drivers to estimate the financial opportunity of tackling complexity, since they are directly responsible for less apparent issues, such as too many systems, too many reports, too many procedures, and last but not least, too many people creating and maintaining part numbers and SKUs. Not to mention the complexity created by tailored parts that interfere with standard products everyday. But how do you tackle proliferation of part numbers and complexity in the product portfolio? There are three steps to do this: diagnosis, simplification and prevention. First you need to quantify and qualify complexity. Second you need to apply what I call "causative simplification", to reduce complexity. Third, you need to prevent new complexity from slipping into the system, by creating a filter to avoid new parts and products from entering without scrutiny; and you also need to measure product line complexity on an ongoing basis. Prevention can eventually lead you to create a vision for a product line architecture that is more modular and simpler, while extremely aligned with your business model. This approach to simplicity is very effective and long lasting, as seen in companies such as the European truck maker Scania. However, it is not trivial. If your company was not created with such product architecture in mind, you will have to muscle through the simplification work, before attempting to build such a system. Diagnosing Complexity Complexity can be quantified using metrics that are associated with the symptoms of having too many part numbers and SKUs. Shipping performance or shipping late and incomplete, for example, can be an indicator of elevated complexity. Sales performance of items that you normally carry in inventory, in terms of “turns and earns”, can be another good choice. Other metrics relate to the health (and sanity) of your engineering database, such as how many product designs are made for similar applications, but sold to different customers; number of subtle design variations in similar parts; and one of my favorites, the number of engineering change requests (ECRs) that enter the system every day or every month with little or no discussion. You would be surprised by the number of ECRs processed every day by many manufacturing companies, without really understanding the benefits and the impact to the cost of complexity. In many cases, it is useful to estimate the cost of complexity associated with each part number. People need to see and relate to the problem in order to get involved in the solution. And one of the best ways to estimate the cost of complexity is to calculate the impact of product proliferation on the overall cost of goods sold (COGS). This is best done by product line, if the P&L is structured that way, but an overall number also helps visualize the issue. Most companies use a “clean-sheet-based cost model” or design cost to determine the “should cost” for each part or SKU. Every month they take the total variable cost dollars, add the period costs and compare the sum with the total “should cost” (design cost multiplied by the volume in the same period). Even though the “should cost” is close to being a theoretical cost, the difference between the actual and should gives you a good benchmark to measure yourself against. The chart below shows a typical cumulative distribution of sales dollars versus part numbers or SKU’s, compared with a cost of complexity curve, using the method above. As parts-count increase, the complexity cost goes up exponentially. Limiting your portfolio to the high-volume SKUs or the sweet spot of the market is ideal, from a complexity standpoint, but not practical. The question is always how much complexity you can afford to let into the business, to be able to meet the needs of your core customers, and at the same time avoid getting into the “red” zone of complexity cost. In other words, complexity needs to be actively managed. To qualify complexity, we use 80/20 analytics. More specifically, we use the “customer versus product matrix” (CP Matrix) and the quadrant analysis (Quad Analysis). The analytics are extremely important to visualize the problem and the data patterns and to provide a path for the next step, or causative simplification. The figure below exemplifies the different areas in the CP matrix and the different approaches to simplification. Just by looking at the data and by performing the quad analysis, you can reach several conclusions that will lead to improvement. Do less than 20% of the products account for 80% of the sales? Is there a large number of SKU’s with minimal sales, while there is slow and obsolete inventory of such items? How porous or compact is your portfolio? How large is your low-volume offering compared to the high volume or sweet spot? The density or the sparsity in the portfolio, for example, can be very revealing, in terms of frequency of sales and effectiveness of the different product lines. The shape of the data – clustered or patchy and whether you have gradients or receding patterns – can reveal distortions in buying patterns and point to subsegments or regions that have different needs.
Causative Simplification The next step is to start unloading product complexity from your company, using the outcome of your 80/20 analytics to optimize the product portfolio, combined with a disciplined approach to simplify the product line. I call this phase “causative simplification” because it is designed to produce simplification. With the help of 80/20 analytics, you focus first on the business reasons, to outsource, consolidate, price-up or simply eliminate part numbers and SKU’s that are not aligned with your strategy. Low volume products sold primarily to low volume customers should be priced-up accordingly, to reflect the cost of complexity. You should also look how your inventory investment is performing for these low volume items, using the “turns and earns” index (inventory turns multiplied by contribution margin percentage), and adjust your commercial policies and inventory practices accordingly. In summary, you first let the market respond to your simplification measures (outside in) and then you apply a conscientious effort to reduce proliferation from inside out using PLS (product line simplification). Successful product line simplification is customer-centric and capable of identifying products or features that will satisfy application needs and address market pain points, as opposed to just offering a variety of designs to choose from. PLS cannot be driven by manufacturing, engineering, or purchasing in isolation from other areas. It needs to be a collaborative and multidisciplinary effort by different areas of the business with an eye on the customer application. PLS takes time and effort and is not an overnight exercise. There are three major goals in PLS: 1) to reduce parts-count or the number of discrete products within a product portfolio, consistent with your business strategy; 2) to define a clear position on tailored products: who should get them and how they are to be priced and produced; and 3) align manufacturing processes to support the streamlined product offering. PLS and portfolio optimization need to work hand-in-hand. PLS needs to support both parts-count reduction and overall margin improvement work at the same time. It should not be used to eliminate a complete business line or just the low-volume part numbers and by no means it is intended to leave customers without viable options to satisfy their application needs. The initial focus of PLS should only be whether a product or an item will be included in the product offering or not. Leave the make or buy decisions for later. At the beginning of the PLS process, it is a lot more important to decide what to drop and what to include. The decision to include a product is primarily made by the commercial people in support of marketing strategies, market pain points, and end user needs. Focus on high-volume and high-potential products first and compare your portfolio with the high-volume products of the market. Look at how much customization you are providing, and ask yourself whether it is done on the behest of the core or “eighty” customers. Then shift your attention to simplifying the low-volume products. Consider physically separating production of low-volume parts, outsourcing, redesigning certain products, and even dropping marginal products from the portfolio altogether. Creative strategies surface when the task force performing the PLS is truly multidisciplinary and has engaged participants from different areas. When a few core customers require a certain level of customization, for example, manufacturing team members may be able to devise a way to tailor a standard high-volume product at the end of the line (postponed customization). The engineering members may be able to redesign one product to perform the function of two or more products, for example. At the end, sales and marketing members need to consider what else should be pruned or eliminated at the bottom of the CP matrix where the sales density is very low. Preventing New Complexity The third action in reducing complexity is to control the introduction of new items and to create complexity metrics. The control step is central to avoid creating new part numbers that are not in line with the unique value propositions (UVPs) of the business. Any new part or SKU entering the development process needs to go through a two-stage screening process or filter. The first filter is a deal breaker that evaluates the product’s strategic fit. It asks whether the new product or part number aligns with both the needs of the core customers and the business’ UVP. It also tries to understand the contribution margin potential early on. It asks why a new product should be added to the portfolio and what types of evidence prove that it will make money. The second screening stage is conditional (yes, but…), establishing how the company will position the product to meet its profitability targets. It asks several questions: What is the minimum contribution margin acceptable? How are we going to price the new product? If the company is creating a “twenty” product, is it done for an “eighty” customer? How are we going to create availability? Can we produce it using an existing manufacturing line? Should we create availability by outsourcing this product? No product change request or new product charter should be approved without going through this screening process. Companies with effective screening processes have clear product complexity metrics that indicate how many new requests have been approved or rejected and provide a clear vision of the development pipeline. These metrics keep track of the numbers of products, part numbers, and SKUs that are eliminated from the system each month. I’ve talked about complexity metrics above and in previous articles, and there are several options that you can use, depending on your specific situation: sales dollars per SKU, contribution margin dollars per SKU, total number of items entering and leaving the system every month, etc. If the business has a strong distribution component, you may want to use the turns and earns index or CMROI (contribution margin return on investment), to monitor the profitability of your inventory. The point here is to pick only a few metrics that people can relate to and to stay with them overtime. In summary, in order eliminate complexity you have to create simplicity. Simplicity is the ultimate “lean transformation”. 80/20 analytics and PLS are excellent tools to help you create simplicity and increase your profitability. And once you’ve gone through this exercise you will be better prepared to envision new and better product line architectures that have simplicity in their DNA, like Scania did many years ago. [i] H. Thomas Johnson and Anders Broms, Association for Manufacturing Excellence (AME) Magazine - “The Spirit in the Walls: A Pattern for High Performance at Scania,” (May/June 1995). Top-line growth is essential for the long-term viability of any business. There is evidence showing that companies that do not grow over a certain number of economic cycles are destined to go out of business or be assimilated. Growing below the industry or the GDP rates can be a significant drawback for companies and leaders. But you can’t just add revenues at any cost. If growth is not executed in a lean and profitable manner, the additional revenues can bring along extra complexity and more overhead. Low quality growth can increase financial leverage and reduce cash flow, compromising performance and long-term viability. I was recently invited to participate in a discussion panel, at the SelectUSA 2016 Summit in Washington DC, regarding my experience with our company. More than 2,500 participants from 70 countries listened to speeches and experiences from international companies doing business in the US, on how to enter and grow in the largest consumer market in the world. The questions I kept hearing were certainly related to entering the US market but mainly about sustaining profitable growth afterwards. In other words, how to balance the need for growth with the risk of entering an extremely competitive market? A lot of complexity that goes unmeasured and unmanaged in organizations is created when companies embark on revenue growth at any cost. In many cases, when they try to grow their product and customer portfolios in mature, developed markets without a plan to keep complexity at bay. Trying to gain market share in established markets or growing on too many fronts, can create a lot of transactional complexity and increase overhead faster than revenues and profits. In fact, there is the misconception that, when entering a new market, the growth options are limited to taking market share from existing competitors and merging or acquiring an existing business (M&A). I know by experience there is a third option that should be explored, which is most effective and often neglected. 80/20’s approach to quality growth calls for a sharp focus on select few market segments, coupled with portfolio optimization, in order to specialize your offering and maximize growth. When you specialize your value proposition in select niches, using segment-focused business units (often decentralized), market share gain comes naturally and not at a higher cost. M&A initiatives can then be used to gain portfolio momentum, focusing first on new product lines and bolt-on acquisitions and second on growth via new business platforms. In their book The Granularity of Growth[i], the authors from McKinsey & Co. split a company’s growth into three main components they call “growth cylinders”:
In their study of 416 US companies over two economic cycles, they show data that portfolio momentum or market growth explains 46% of the difference in growth performance between large companies. Only 21% came from share gain. Furthermore, regardless of which growth cylinders you choose, the top three success factors are the same ones touted by real estate agent’s everywhere: “location, location and location”. Granularity is king and I was not surprised to hear similar reports from almost every successful investor at the SelectUSA Summit. What they mean is, in order to succeed, you need to be very selective and dive deeper into industry segments and niches (and regions and cities) that you wish to target. You need depth and granularity in your growth strategy when deciding where to focus your efforts to compete and grow.
Picking the most attractive segments to compete is just as (or even more) important than knowing how to compete. There are better market sweet spots or niches, where you can sustain a higher level of organic growth for your specific product or service offering. And to find out where these niches are, just like in the real estate business, you need to do more than understand the market fundamentals, such as the competitive structure, cyclicality and regulations. You need to use primary research coupled with analytics, to find uncommon knowledge such as the average contribution margins practiced in the segment and how operating cash is used, in the form of working capital (receivables, payables and inventory), for example. Once you’ve selected the market and defined the initial composition of your portfolio, there are only three ways to improve momentum. The first one is to reallocate the resources and the efforts from the “twenty” areas (sour spots) to the “eighty” area of the portfolio (sweet spot). The second way is to change the structure of your portfolio by changing commercial policies (pricing, rechanneling) and reducing complexity (consolidating SKUs), for example. The third way to grow momentum is to actually grow your markets, by expanding your portfolio, via bolt-on or product line acquisitions, and to expand into new customer pockets or niches (a new region or a new level of granularity in your segmentation). You can find out how much portfolio momentum you have by looking at top line growth and quality of sales in each segment, determining how your business stacks versus the market and the competition. 80/20 analytics can give you a very good idea about the “fitness level” of your portfolio, focusing on sales efficiency, productivity, revenues and margins. Here’s a list of indicators to look at:
Growing top line in a new region is obviously less risky and more profitable, if you have a track record of successfully entering new markets. Some companies have developed this capability really well, like many in the pharmaceutical industry. But even then, you can’t just assume that you will grow by taking market share from competitors in a market like the US for example, just because you are the leader someplace else. If taking share is your only strategy, you might struggle with margins and sustainable growth. You need more than a single growth option and a higher level of specificity in relation to where you play (location, segment, niche) and how you play. You need to be firing on more cylinders than just market share. The questions above should help you rethink your target segments and adjust your growth plans. Doing your “location” homework and fine-tuning your portfolio to acquire momentum are the best strategies to enter a market like the US. An acquisition helps if it’s done in support of your portfolio customization strategy, but you need to be careful not to add too much complexity from day one, and not to inherit a skewed portfolio. The best lessons from companies that succeeded in entering and growing in mature markets have more to do with outstanding niche selection and portfolio acclimatization and less to do with fighting for market share and doing mergers and acquisitions upfront. [i] The Granularity of Growth (How to Identify the Sources of Growth and Drive Enduring Company Performance) – Patrick Viguerie, Sven Smit, Mehrdad Baghai. Published by John Wiley & Sons, Inc., Hoboken, New Jersey (United States 2008). |
AuthorPedro Ferro Archives
August 2016
Categories
All
|