Lean and Mean: How Does Your Supply Chain Shape Up?

Up to half the cost of many supply chains lurks ignored and unmanaged; much of that cost can be eliminated by applying lean manufacturing techniques.

By Knut Alicke and Martin Lösch, McKinsey & Company

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For all the effort and ingenuity that pharma companies are putting into streamlining sales and operations planning, inventory management and logistics, major opportunities remain in the outbound supply chain, from packaging to delivery.

The typical pharma company operates a historically grown network with one or many warehouses in each country, different contracting terms and diverse transportation companies. Pharma logistics represent about 2 percent of sales, or 7-8 percent of the cost of goods sold, less than what we find in other industries (see Exhibit 1), and the outbound supply chain is often outsourced.

McKinsey Fig1

Under these circumstances, optimizing outbound logistics has not been a strategic priority for pharma companies. We think it should be — especially in light of current industry cost and performance pressures. Distribution is the logistical interface with the customer. Inefficient or unreliable warehouse operations and transportation cost more than money ó delivery delays can do quick and lasting damage to a company's reputation.

Companies have made significant improvements to manufacturing, service and maintenance operations through lean techniques: eliminating waste, inflexibility and variability in their systems and reducing costs by up to 50 percent in the process. Yet few apply the same lean techniques in warehouse operations or transportation, even though they can have a dramatic effect. These operations represent 95 percent of the pharma logistics costs and, in our experience, companies can save 20-50 percent in warehousing and up to 40 percent in transportation.

Companies that have run successful lean programs not only save money in warehouse operations, but also enjoy more flexibility and much better service, without significant capital investment. Companies that focus on transportation cost drivers gain on two fronts: they can control cost overruns or reduce current costs, and they can improve customer service and satisfaction by tailoring services, such as lead times and delivery frequencies, to customer needs.

Understanding the baseline

The first challenge in optimizing warehouse operations is that there is no "standard" — they tend to be as diverse as the products they store. A multi-client facility, for example, with a huge number of SKUs and diverse inventory turnover, looks vastly different from a small-volume operation with a few SKUs. As a consequence, it has been difficult to identify best practices or apply them across a broad variety of settings. Warehouse managers struggle with special circumstances as they try to improve lackluster performance.

We have developed a comprehensive approach to performance measurement across all types of warehouse, providing supply chain managers with a tool to rate warehouse efficiency. We begin by calculating the clean-sheet cost, space and capital that an "ideal" warehouse would need to handle the given volume. We then adjust for site-specific circumstances, such as multiple floors and high labor costs. We add logistic service provider margins if the warehouse is outsourced. The results reveal the warehouse's theoretical and realistic performance gaps.

A wide gap

We have used the model to evaluate more than 40 diverse facilities worldwide. Most are operating 20 to 50 percent less efficiently than the clean-sheet reference. In one European warehouse, our clean-sheet model showed a performance gap of more than 50 percent.

The gap arose not because the warehouse lacked technology or suffered from the structural disadvantages of the goods it handles. Instead, we found that it is the cumulative effect of dozens of slightly sub-optimal processes and the lack of lean mindset. A few fundamental changes in the way these facilities are organized and managed could immediately close at least half of the gap between current performance and the benchmark.

Some warehouses simply suffer from lack of attention. Designed for one purpose a decade ago, their managers make only minor modifications to cope with dramatic business changes such as increasing product and delivery complexity, a merger or acquisition, or new technologies or supply chain structures.

Some solutions intended to improve performance often have exactly the opposite effect. Technology-heavy approaches, such as automated storage areas, sorting technology or classical transaction-based ERP systems, have a strong tendency to reduce flexibility, particularly short-notice flexibility, which is exactly what many modern supply chains demand. The payback on such systems is poor, with the capital cost being many multiples of the savings achieved by reducing relatively low-cost labor.

Outsourcing is a common practice in pharma, but it often fails to remedy bad warehouse practice. Managers may be tempted to outsource their operations to leverage factor cost advantages, for example, but outsourcing inefficient processes simply offers service providers higher margins. And since warehouse inefficiencies can arise externally, such as volatile demand patterns or undisciplined ordering, providers are often unable to create real cost advantage.

…Easy to bridge

At the heart of transforming warehouse operations is the rigorous and relentless application of lean and six sigma techniques to eliminate sources of waste, variability and inflexibility. Most are simple, pragmatic activities that require little or no financial investment — they rest on six building blocks of performance: processes, people, performance management, third parties interaction, layout and ownership (see Exhibit 2). The examples below are typical of projects worldwide.

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