From fragile to agile: operations in the 21st century Companies who truly understand what it means to be agile are aligned across functions, and know how and when to exercise it for competitive advantage by Mike Doheny, Christophe Franois, Isabel Hartung, and Alexander Niemeyer

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April 2012

TOMORROWS HEADLINE Out of chaos, a new mobile champion emerges The Wall Street Journal, February 17, 2014 Adding to the mobile-phone industrys woes from sharp wage increases at Chinese factories, an earthquake near Taipei with a magnitude of 7.9 has damaged four critical semiconductor plants. Almost every handset manufacturer is now warning of supply shortages and margin pressure. But one, fast-growing startup ABC Mobi, had already shifted its original-equipment-manufacturing base to emerging centers in Southeast Asia

Todays volatility has little precedent. Since 2000, commodity prices have become quite unpredictable. Greater reliance on outsourcing has vastly increased operational complexity, especially for quality control. And catastrophic events, such as last falls historic flooding in Thailand, are occurring more frequently and incurring greater expenses, with new worst ever disasters almost every year. At the same time, an interconnected, trade-dependent world economy means that almost every company today has a global footprint. As a result, faraway events are much more likely to affect businesses than in the past (Exhibit 1). When disruption hits, the impact is significant Recent academic research (which our client experience has validated) shows that, on average, unprepared companies lose 10 percent of their market value when a major disruption hits. For some, the effects are magnified: one manufacturers share price dropped by more than 50 percent after the company bungled its response to a product-contamination scandal. But companies with deep, organization-wide agility can cash in. One high-tech giant estimates that it saved nearly $500 million over three years through its rigorous, end-to-end approach to supply-chain risk management. As former Caterpillar CEO Jim Owens noted in a recent McKinsey interview, the competitor thats best at managing the supply chain is probably going be the most successful competitor over time.

From inertia to action with five core beliefs One would assume that companies naturally follow the old Boy Scout maxim, Be prepared. However, we have found that most are fragile, not agile (Exhibit 2).

April 2012

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Exhibit 1

McKinsey & Company 0|

Global interconnectedness increases vulnerabilitiesNumber of Automaker X assembly sites and suppliers; Exposure to disruptive events (3 yrs)

15+ Tier 1 suppliers3-15 Tier 1 suppliers1-2 Tier 1 suppliers Assembly sites, 1990

Assembly sites, 2010Disruptive event, 2008 - 2011

Since 1990, Automaker Xs operations have become more vulnerable to major disruptions

Automaker X factory network in 1990: 11 final assembly sites in 11 countries In 2010: More than 25 final assembly sites in more than 20 countries

In 2010, Automaker X had more than 250 Tier 1 suppliers with a global footprint

Exhibit 2

McKinsey & Company 1|SOURCE: Kevin Hendricks, University of Western Ontario, Vinod Singhal, Georgia Institute of TechnologyJuly 2009 Lloyds 3600 Risk Insight and Economist Intelligence Unit

Disruptions can result in significant financial loss to shareholders

Despite high potential losses from disruptions, executives feel unprepared

Disruptions

Average shareholder returns, percent

Asset price volatility 0.05

Trade protectionism 0.20

Regulation 0.45

Cancelled orders 0.60

Currency fluctuations 0.60

Loss of customers 0.65

Supplier insolvency 0.70

Cost and availability of credit 0.85

-9

Ramp-up/rollout problems

Parts shortages -8

Quality problems

Production problems -10

Product developmentproblems -11

-11

Unexpectedcustomer changes -12

... yet, executives report that they are inadequately prepared to effectively manage their high-priority risks

The preparedness gap index

(1 = completely unprepared and 0 = well prepared)

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Why? Many executives assume that their companies are exposed to so many different possible risks that any attempt to manage them all would be a waste of time. They give up, thinking that they might as well save the effort. Other leaders focus on the supposed expense of agility. But becoming agile is easier than most CEOs think. Although it will take time, the transformation typically occurs in phases and can start almost immediately, with changes that pay for themselves. And increased external volatility means that executives can no longer count on being lucky. We have found that companies can become agile operators by establishing five core beliefs: 1. Agility is strategic, not just operational. Every company needs to decide which types of potential shocks to prepare for. We have found that there are three main categories of scenarios: (i) specific, high-impact risks (such as losing a critical source of supply); (ii) impossible-to-predict but easy-to-group small risks (for example, sharp swings in demand necessitating reallocation of capacity); and (iii) events that for pragmatic reasons can be ignored, either because they are too rare or small to have much impactor because mitigation is impossible. 2. Upside matters as much as downside. In most industries, one players pain can be anothers gainif that competitor is prepared. In industries where most players rely on the same supplier, a company that finds an alternative source can quickly gain market share should disaster strike the lead supplier. The tech industry again provides an example: after a sudden shutdown at a leading component factory, one consumer-electronics player was able to round up secondary supplies quickly, while a slower-moving competitor ended up losing hundreds of millions of dollars in sales and about one-quarter of its market share. 3. Rewards require commitment. Agility delivers its greatest benefits only when leaders pursue it consistently and embed it in the culture. The CEOs role is critical. For decades, a major global household-goods manufacturer has required that all molds for its injection presses be globally interchangeable. That simple commandment saves countless dollars by enabling the company to shift molds globally in response to mold failures or to big shifts in customer demand. 4. Think cross-functionally. Agile companies develop real competitive advantage by using all of their resources when they plan for uncertainties. A response to potentially large demand fluctuations would involve the whole enterprise, from procurement prequalifying alternative suppliers and the manufacturing function instituting new, more flexible labor models to revamping leadership practices for rigorous reviews of agility actions after the fact. 5. Win-wins are available. Agility can come from initiatives that improve a companys performance every day. In the mid-2000s, a major US basic-materials manufacturer sought to increase output via an end-to-end lean program. When the US building industry shrank dramatically in 2008, the companys productivity gains let it use its capacity more flexibly, protecting its return on sales even as its competitors were losing money. CEOs who recognize agilitys advantages often realize that their organization is not aligned on what agility means or on where it will

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create value. The starting point is to prioritize the uncertainties that matter the most for the companys operations and strategy. The company can then assess its agility across functions, initially focusing on its ability to preempt and detect uncertaintiesthat is, its technical agility. Next, the company must learn how to activate its agility to respond as needed and capture value, building organizational agility in two ways: by assembling a cross-functional team to handle major uncertainties and by anchoring uncertainty management in the corporate culture so that it informs all major decisions. Ultimately, the effort is worth the investment: companies with both technical and organizational agility will be able to find new profit by riding waves of uncertainty better and faster than competitors can

About the authors: Mike Doheny is a principal in McKinseys Atlanta office, Christophe Franois is a principal in the Lyon office, Isabel Hartung is director of knowledge, global operations, in the Stuttgart office, and Alexander Niemeyer is a director in the Miami office

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