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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Improved flexibility. Many facilities opt for a "one size fits all" approach to layout, rather than segmenting assets according to product types and customer requirements. Many managers are also unwilling to alter facility layouts as demand patterns change, eroding performance over time. A pharma warehouse was able to reduce process time by 20 percent simply by eliminating picking from the highest shelves. Sometimes this problem is compounded by investments in costly and highly inflexible automation equipment.

Replacing fixed equipment with flexible, reconfigurable systems can have big benefits, while the penalties of inflexibility can be severe. One retailer made big investments in automating a warehouse before changes in business needs created spare capacity. The retailer tried to resell this capacity to third parties, but its system was so inflexible that it was unable to fulfill the requirements of any of the interested organizations.

A common way to benefit from flexibility is to reorganize the facility layout to position items according to pick frequency. By placing fast and super-fast moving items right by the loading dock, walking distances and pick times can be reduced dramatically. Such implementations must be carried out with care, however. To avoid congestion at the pick face it is useful to mix the fastest-moving items with some slower movers.

Ownership impact. The outsourcing of warehouses to third-party operators is a common strategy for companies that do not consider warehousing to be a core competence. But many such deals simply transfer inefficient processes to a new owner, while cost-plus contract terms seldom create an imperative for improvement on the part of the service provider. Outsourced warehouses are viewed as black boxes, leaving major opportunities for collaboration between suppliers, plants and customers on the table. Moreover, companies that have developed their own lean manufacturing system miss the opportunity to apply their expertise to these outsourced warehouse operations.

Change of ownership usually falls outside the scope of an improvement project. But this optimization approach can be applied just as well by a warehouse operator, creating competitive advantage from its ability to operate at lower cost and at higher flexibility.

Understanding the baseline

While pharmaceutical companies can save as much in transportation as they can in warehouse operations, delivering those savings requires a different approach. If companies have historically ignored their warehouse operations, at least they began with a good idea of the size and location of their facilities. Transportation costs, by contrast, come from many hundreds of thousands of widely distributed individual operations every year.

Complexity is what makes transportation difficult to improve. Many pharmaceutical companies have tremendous variability in their transport operations, with different customers demanding different service levels and a multitude of transport providers delivering services in different ways. Companies can cut through this complexity, however. By building a full picture of their transportation operations, they can see, often for the first time, exactly where to find the primary drivers of transportation cost. Armed with this information, they can identify and exploit opportunities and save up to 20 or even 30 percent of transportation costs.

One large pharma player began optimizing transportation by analyzing historical transport data for a full year. It collected information and analyzed each delivery (e.g., shipment types, sizes, modes of transport, provider, customer, region, type of service and cost) to understand the real drivers of transportation costs. The analysis revealed three critical service categories that had a disproportionate effect on transportation costs:

  • Temperature-controlled distribution. While 98 percent of product by weight passed through the firm's ambient distribution chain, the 2 percent that had to be shipped in refrigerated vehicles accounted for a quarter of all shipments — and nearly half total transportation costs.
  • Special delivery services. Express shipping guaranteed by 10 a.m. the next day can cost two to five times more than conventional 24-hour delivery. These special deliveries represented only 1 percent of the shipments, but accounted for most of the excess cost.
  • Shipment size. The vast majority of shipments weighed less than five kilos, but these small shipments cost the company around six times as much per kilogram as larger shipments. Even where the company did manage to consolidate deliveries into larger shipments, it usually failed to capture all the available savings; by weight, a quarter of product was shipped in the lowest cost bracket, but nearly half fell into the next price bracket up.

Opportunities for action

Once they understand their cost drivers, companies can embark on a systematic approach to reduce transportation costs. They can look broadly at four main levers. First, they can check compliance with freight contracts and minimize surcharges. They can challenge the rates provided by the freight forwarders. They can improve contract terms and conditions to share risks and benefits with their freight forwarding partners. And finally, companies can do much to understand customer breakpoints and incentivize customers to choose cost-effective options.

Compliance auditing. A simple auditing of monthly invoices will reveal the surcharges a company is paying due to special terms. It can check contract compliance by modeling the expected cost of shipments under the contract terms, and compare these with the actual bills from service providers.

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