Simpler is (sometimes) better: Managing complexity in consumer goods
Here’s
how consumer-goods manufacturers can master complexity—and even turn it to
their advantage.
With consumers’ product preferences diverging and retail formats proliferating,
consumer-packaged-goods (CPG) companies have compelling reasons to constantly
launch new SKUs. Fast-growing niche markets—such as health and wellness
products, socially and environmentally responsible wares, and ethnic
foods—represent enticing opportunities for CPG companies, as do new online and
offline retail channels. Indeed, product innovation can help CPG companies win
shelf space and capture growth, which is crucial at a time when many CPG
categories are experiencing flat sales. But manufacturing more SKUs means
having more complexity in the entire business system—and that’s not a trivial
matter to CPG companies already under pressure to cut costs and to become ever
more efficient. We estimate that complexity among food-and-beverage
manufacturers, for example, is costing them as much as $50 billion in gross
profit in the US market alone.
Many companies are painfully aware of the
problem, and acknowledge the difficulty of keeping complexity under control.
CPG executives from a range of companies—including Campbell Soup,
Colgate-Palmolive, ConAgra Brands, and Hershey—have made public statements
about their efforts to reduce complexity in their businesses. It’s a tricky
undertaking, precisely because some level of complexity is necessary and
advantageous. Traditional approaches to simplification—such as “cutting the
tail,” or discontinuing the lowest-volume SKUs—are suboptimal, both because
they tend to address only one aspect of the business system (a cut-the-tail
program is all about assortment) and because they can produce unintended
consequences. For example, by discontinuing a low-volume SKU, a manufacturer
might inadvertently eliminate a product that plays a unique strategic role in
the assortment. Or it might unknowingly drive up the per-unit cost of
manufacturing other SKUs made on the same production line.
Companies should take a
more nuanced approach to managing complexity. Specifically, they need an
approach that takes into account both commercial and operational perspectives,
uses big data and analytical insights, and sets aspirations and action plans that the entire
organization can agree on. In our experience, such an approach can help a CPG
manufacturer achieve significant impact: a net revenue increase of one to four
percentage points, margin improvements of three to six percentage points, and
asset-productivity gains of 10 to 25 percent—even as it trims its SKU count by
25 percent. To top it off, the company will also likely increase its speed to
market, improve shelf availability, and boost customer satisfaction.
Two
kinds of complexity
The key to mastering complexity is to
recognize that there is both good and bad complexity, and then to
systematically distinguish one kind from the other. Good complexity drives
incremental sales and volume that exceed the incremental expenses incurred, or
results in a favorable shift of the product mix. Good complexity can take the
form of new SKUs that fill unmet consumer needs or that capture growth in
emerging segments (such as gluten-free foods or organic products), new price
tiers that allow for better margin management or that fulfill additional need
states, or the addition of unique ingredients that influence consumers’
purchasing decisions (such as Angus beef or antibiotic-free chicken). In other
words, good complexity more than pays for itself. Bad complexity, on the other
hand, erodes profit, increases inventory, and makes the supply chain less agile.
To ensure that it’s adding only good
complexity to its business, a company must become adept at figuring out what
products and features consumers are willing to pay for. The company must then
put in place the supply-chain systems and capabilities that will enable it to
bring those products to market profitably.
Consider the case of a global food
manufacturer. In one of its leading business units in North America, SKU count
had risen by 66 percent in just three years, mainly because of three types of
items: line extensions (such as low-calorie versions of existing products), new
pack sizes, and products developed for specific retailers or channels (SKUs
customized for the dollar-store channel, for instance). In response to retailer
pressure and fierce competition, the company had added new items without
discontinuing any older ones. During the three-year period, sales per SKU
dropped by 40 percent. Furthermore, some of the new SKUs contained allergens
that required separate storage space and long changeover times; other new SKUs
had packaging configurations that required co-manufacturing and new online
capabilities. The company thus found its productivity and efficiency declining.
Margins fell by as much as 10 percent in select categories.
Alarmed at the company’s deteriorating
performance, the top team launched an ambitious simplification program. Instead
of resorting to a traditional cut-the-tail exercise, it used advanced analytics
to understand sales by region and to assess the true incremental value and cost
of each of its SKUs. It found that the new pack sizes drove incremental sales
and could be manufactured less expensively; on the other hand, sales of the new
SKUs containing the allergen, although stronger than expected, fell short of
covering the additional costs of manufacturing them—so those SKUs were
discontinued. The results of the program: SKU count dropped by 25 percent,
changeovers became speedier, and gross margins improved by 2 to 4 percent . In
short, the company dramatically reduced the bad complexity that had clogged up
its supply chain.
Another company, a US-based packaged-food
producer, didn’t just get rid of bad complexity but also added a considerable
amount of good complexity. For one of its main brands, the company eliminated
ten low-volume SKUs but didn’t reduce its SKU count. It instead replaced those
SKUs with new items that filled identified gaps in its assortment—for example,
it introduced more vegetarian items, which consumer research showed would
attract new customers to the brand. It created a new price tier targeted at
consumers looking for trade-up options. The company also reformulated certain
low-margin SKUs and reduced the number of ingredient variants for selected
categories. The expected impact of these and other program initiatives: more
than $50 million in run-rate gross margin across five brands.
An
end-to-end view of complexity
Many CPG companies tackle complexity by
undertaking either a SKU rationalization or a manufacturing optimization,
usually led by the supply-chain side of the business. While such initiatives
can certainly tame complexity, they are limited in scope and won’t be nearly as
effective as a multifunctional program.
We recommend that companies take a
full-system view instead—that is, they should examine all the possible entry
points for complexity using what we call “market back” and “supply forward”
lenses. Market-back considerations have to do with what consumers and retailers
care about—for example, assortment, pricing, and promotions. The supply-forward lens gets at how the company should manage operations, including its innovation
pipeline, product-design processes and platforms, and supply-chain structure.
The most relevant market-back and
supply-forward levers will differ for each company. A CPG manufacturer may find
it useful to think about a series of questions from both a market-back and
supply-forward perspective. Answering these questions can serve as a quick
diagnostic to uncover the root causes of complexity, or the “complexity hot
spots,” in a company’s business.
For example, as shown on the exhibit,
Company A—a manufacturer of both branded and private-label products—relies
heavily on inorganic growth, frequently introduces new products, has an
efficient but relatively inflexible manufacturing network (which makes
launching each new product a rather expensive venture), and is highly exposed
to commodity risk. Given these hot spots, assortment optimization would be an
important lever for Company A. Less so for Company B, which isn’t acquisitive
and has a limited product portfolio that it sells through only a few channels.
A complexity-management program at Company B should instead prioritize other
levers, such as revamping the promotion architecture.
Regardless of which specific market-back
or supply-forward levers a company decides to focus on, it should seek to tap
into the powerful insights that big data and advanced analytics can deliver. Take
assortment as an example: successful assortment optimization relies in part on
how well a company
understands consumers’ buying decisions—which product attributes matter most to them when
buying a certain product, which products they consider interchangeable, and so
on. Through big data analytics, CPG
companies can now generate quantified and actionable insights into consumers’
decision-making processes, thus helping them more precisely refine their
assortments.
Preventing
‘complexity creep’
To prevent bad complexity from creeping
back in after a complexity-management effort, a company must redesign its
business processes so that they systematically eliminate waste and inefficiency
while also supporting good complexity. In particular, companies can take the
following steps.
Establish a cross-functional governance
structure. It’s easy for each function to
revert to the habit of focusing exclusively on its own goals and coming up with
siloed functional solutions, instead of taking an end-to-end view of
complexity. To ensure that various functions continue to collaborate with each
other, CPG companies would do well to create a cross-functional governance
structure, with a defined cadence of meetings. For example, a leading food
manufacturer established a recurring series of cross-functional working
sessions involving brand teams, product-development teams, and line-level
factory workers. During these sessions, participants discuss which SKUs and
ingredients drive complexity, align on the biggest areas of opportunity, and
develop potential solutions. When line workers observed that the penne in a
pasta dish tended to bounce out of trays during the manufacturing
process—requiring human intervention, slowing production time, and sometimes
resulting in food waste—the cross-functional team decided to replace the penne
with a different pasta shape. Changes like these amounted to $1 million in
annual savings across three manufacturing plants.
Regularly pay attention to a range of
metrics. When leaders become overly focused
on only one or two financial measures—say, sales or gross margins—they ignore
metrics that might be just as important, and often end up making suboptimal
business decisions. The most successful companies consider metrics such as
incrementality, velocity, and all-commodity volume distribution (a measure of a
product’s availability at retail stores), giving them a fuller understanding of
each SKU’s costs and contributions.
Change mind-sets. Complexity management shouldn’t be an episodic, ad
hoc activity. Sustained improvement requires wholesale changes in mind-sets and behaviors. As part of broader efforts to embed a
complexity-management mind-set into its business processes, a CPG company established a “one in, one out” rule for line
extensions: each time it introduced a new SKU, an older SKU had to be
discontinued. It created and maintained a “SKU watch list” that was on the
agenda at every portfolio review and at annual planning meetings, and
executives engaged in active SKU-discontinuation conversations throughout the
year, both internally and with retailers.
Mastering complexity need not be a long and arduous
undertaking. We’ve seen companies assess their situation, identify the most
relevant complexity-management levers, prioritize and plan initiatives,
implement those initiatives, and reap the benefits—all within a three- or
four-month period. These companies then took steps to ensure they sustain the
right level (and the right kind) of complexity in their supply chain. The
results are anything but complicated: better financial performance, faster
innovation, and greater customer satisfaction.
By Christina Adams, Kari Alldredge, Curt Mueller, and Justin
Whitmore
http://www.mckinsey.com/industries/consumer-packaged-goods/our-insights/simpler-is-sometimes-better-managing-complexity-in-consumer-goods?cid=other-alt-mip-mck-oth-1612
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