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Virtual Vertical Collaboration As competition forces retailers and manufacturers to get closer to their customers, it is imperative that both sides abandon their adversarial relationships—going beyond secrecy and distrust to build a bond of collaboration. It is a lot like a merger integration minus the merger.

Virtual Vertical Collaboration

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© 2013, A.T. Kearney, Inc. All rights reserved. Joy Peters Partner New York Sean Monahan Partner New York Mike Sansone Principal Chicago

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Page 1: Virtual Vertical Collaboration

1Virtual Vertical Collaboration

Virtual Vertical CollaborationAs competition forces retailers and manufacturers to get closer to their customers, it is imperative that both sides abandon their adversarial relationships—going beyond secrecy and distrust to build a bond of collaboration. It is a lot like a merger integration minus the merger.

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2Virtual Vertical Collaboration

An adversarial relationship, and the mistrust it engenders, is in some ways essential to free enterprise. If you do not charge customers the highest possible price or drive the hardest possible bargain with your suppliers, you not only hurt yourself but also risk a misallocation of resources. The genius of Adam Smith’s “invisible hand” is that it not only allows all parties to act with vigorous self-interest—it requires that they do.

Yet mistrust can create waste. Suppliers double-check product quality before shipping, and buyers triple-check quality upon arrival. A retailer keeps customer insights secret from suppliers, for fear they’ll share it with competitors. A supplier keeps manufacturing constraints secret due to similar fears. Although collaboration is a faster path to progress—based on the adage that two heads are better than one—conflict is often the normal cost of doing business.

Indeed, some industries are so competitive, with such small margins, that any normal cost of doing business has to be questioned. Consider the U.S. food retail industry where shifting demographics, technology, consumer behavior, and new regulations are shedding new light on what retail business will look like in the future. Or, remember the impact of the global recession that left consumer packaged goods (CPG) companies and food retailers fighting for increasingly fickle—and empowered—consumers. Retailers squeeze their suppliers, and manufacturers feel bled out.

Success in such an environment requires retailers and manufacturers to get closer to their customers, provide more choices and superior service, and reduce costs. It may sound crazy, but it is imperative that both sides perform a merger without actually merging.

Merger Integration Minus the MergerNot only is the concept of merging without merging not crazy, it’s already happening. We call it virtual vertical collaboration, and it involves a retailer and manufacturer acting as though they are about to merge and creating the efficiencies that come with merger integration (see sidebar: Adopting a Virtual Vertical Mindset on page 3). They abandon their adversarial relationship, going beyond secrecy and distrust to build a bond and make mutually beneficial business decisions.

The results can be significant:

• 10 to 15 percent increase in sales

• 40 to 60 percent faster new product launches

• 7 to 15 percent decrease in transportation costs

• 20 percent reduction in cost of materials

• 10 to 20 percent decline in total system inventory

• 600 to 1,000 basis-point drop in forecast errors

• 50 to 100 basis-point surge in in-stocks

As the ties get stronger, so do the results. It is not unusual to see fundamental restructurings of the entire value chain as relationships develop with suppliers, customers, and even competitors.

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3Virtual Vertical Collaboration

In new product development, sharing insights and resources early on means the strengths of retailer merchandising and manufacturer innovations are combined to develop a retail category strategy. Deeper insights into customers can produce breakthrough new products rather than too-late-to-market me-too knockoffs.

Collaborative business planning means strategies are linked with internal business unit processes and execution across both companies and addressed all-inclusively in areas such as packaging design, marketing, and shelf placement. Category buyers and business unit leaders assess expected demand and its potential effect on the two companies, while collaborative global innovation summits are a way for retailers to see the next wave of products.

Demand management templates are used to compare manufacturer and retailer views of demand by week and by product, thus minimizing the need to manage last-minute supply constraints in emergency mode. A metrics dashboard helps track performance and value created. With both companies aligned on a single plan, each brings unique insights that contribute to reducing inventories and costs.

Supply and manufacturing can share best practices to improve procurement processes, perhaps even allowing products to be co-manufactured. For example, select private-label products are manufactured with their brand-label competitors or replaced with a branded equivalent. Production planning is streamlined and manufacturing nears full capacity, resulting in lower production costs across the board, not to mention increased share-of-shelf, longer product runs, fewer changeovers, and scale advantages in negotiating with suppliers of raw materials and packaging.

Adopting a Virtual Vertical Mindset

A global retailer and a multina-tional fast-moving consumer goods (FMCG) company had worked as partners for many years. Their businesses were inherently intertwined: The retailer was the manufacturer’s biggest customer, and the manufacturer dominated the product category central to the retailer’s growth strategy. Having exhausted efficiency tactics based on competitive market forces, both companies were ready for a new approach.

The manufacturer’s sales director and several of the retailer’s buyers knew there was opportunity in a corporate relationship, but there was no obvious way to approach it without risking a compromise of commercial terms in categories slowed by the poor economy. The problem was similar to merger

discussions requiring confidential information to be shared in a structured yet safe manner.

A.T. Kearney was brought in to facilitate a virtual vertical collaboration. After initial discussions, the companies agreed on a three-team approach. The A.T. Kearney team established a clean room in a separate location to consolidate data, develop hypotheses, and complete value chain analyses. The manufacturer and retailer teams acted as intermediaries and advocates for each of the businesses, devel-oping a cross-functional gover-nance structure aligned to product categories and deploying a category-by-category approach to strengthen relationships between buyers and category managers.

The results were significant: Reductions of 7 to 15 percent in transportation costs, 10 to 20 percent in material costs, and 10 to 20 percent in system inventory were identified. Additionally, gaps in operating practices resulted in a 1 percent stock improvement.

Most important, however, was establishing a new method of product development. Working in a new environment of trust and joint risk taking, the retailer and manufacturer teamed up to develop a new product line that was launched in half the time it would normally take. Thanks to a virtual vertical mindset, these two firms developed new products that thrived in categories rendered stagnant by the global recession.

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Merchandising and store operations improve as pooled information means fewer out-of-stocks and better launches. In distribution, assets across the entire network join forces to reduce total delivered costs by eliminating overlapping distribution centers, stocking points, handling, and empty trucks.

The genius of Adam Smith’s “invisible hand” is that it not only allows all parties to act with vigorous self-interest— it requires that they do.

The Power of TwoCollaboration is not new. Companies have exchanged data and forecasts for years. Wal-Mart and its suppliers cut costs by sharing information, Kroger and Dr Pepper Snapple Group jointly redesigned beverage category management, and Tesco and Nestlé continue to work together in joint business planning.

There are various levels of collaboration (see figure 1). Much of it today is at a basic, transactional, and data-oriented level, or at an intermediate level, usually in logistics. Although these activities create value, they only scratch the surface of collaboration’s true potential.

Figure 1Levels at which retailer and supplier collaborate

Notes: CPFR is collaborative planning, forecasting, and replenishment; VMI is vendor-managed inventory; DC is distribution center; POS is point of sale; NPI is new product introduction.

Source: A.T. Kearney analysis

Level ofintegration

Increasing time and maturity of relationship

Low

High

• Forecast sharing• CPFR® • VMI

• Di�erentiated flowpaths• DC bypass or backhaul• Asset sharing• Store-ready pallets• Display management• Store labor optimization

• Joint forecasting and category planning

• Promotions planning• POS analytics• Sharing of shopper

marketing insights• Merchandising

optimization

• Collaborative product development, NPI

• Joint procurement opportunities

• Joint category assortment, private label strategy

• Joint profit and lossData exchange and planning coordination

Stage I: Basic

Optimized supplier-to-shelf product flow

Stage II: Intermediate

Collaborative business planning

Stage III: Advanced

Virtual vertical collaboration

Stage IV: Expert

May include elements from Stages I and II

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5Virtual Vertical Collaboration

Virtual vertical collaboration means capturing the benefits of M&A without the associated complexities (see figure 2). Manufacturers and retailers jointly pursue shared objectives—growth, better margins, more and bigger sales, fewer out-of-stocks, fresher assortments, newer products, and lower costs. The manufacturer doesn’t have to worry that a new product launch is botched at the shelf, and the retailer doesn’t have to worry that consumers will snub the new product because execution and new product development are performed jointly.

Figure 2Virtual vertical collaboration o�ers pros without cons

Source: A.T. Kearney analysis

What virtual vertical means• Margin enhancement and growth opportunities jointly pursued across entire manufacturer-retailer value chain• Scope extended to integrating assets, resources, and capabilities: “What if we were just a touch away from merging?”

Manufacturer

RetailerInnovate

Plan Source Make Sell,merch-andise Deliver

PlanProcure

Deliver Merchandise,sell

In the old way of thinking, such possibilities would be, well, impossible, since the costs would likely fall on one party while the benefits accrue to the other. That’s why it is important to act as though a merger is just a touch away. If you can trust each other, then figuring out how to pay for your collaborative efforts and how to distribute the benefits is transformed from a matter of competitive survival to a value-sharing opportunity.

Transparency: The Secret to IntegrationThe value of virtual vertical collaboration lies largely in the perspective that transparency leads to insights about how to integrate more efficiently and create team wins rather than individual ones.

Consider cost transparency. Yes, costs can be reduced by streamlining distribution and transportation, but when manufacturer and retailer create a combined cost waterfall, they are likely to gain new insights. In the example illustrated in figure 3 on page 6, distribution and transportation represent just 6 percent of the final retail price. There are more cost-saving opportunities in rethinking assortment and cost-to-price strategies as raw materials, packaging, and manufacturing represent 42 percent of the final price. In this example, even streamlining store operations by 16 percent offers a better opportunity for cost reduction.

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The same is true for process transparency. A product development process free from manufacturer and retailer constraints provides opportunities to not just reduce costs but also to increase top-line growth. We recently helped a client launch a new product line in a stagnant category by combining its knowledge of current assortment limitations with value chain improvement opportunities. The launch took place in one-third the usual time, and consumption increased into the high single digits. Again, the point is to build on mutual strengths.

In an integrated distribution model the manufacturer can “see” a store’s inventory. Transparency in the flow of information and goods is also important at manufacturing plants, regional warehouses, distribution centers, and stores. In an integrated distribution model, the manufacturer can “see” a store’s inventory. A single netted demand removes variables to improve forecast accuracy, so the manufacturer can flexibly move product in a way that optimizes the plant-to-shelf network system, inventory, and cost. The result is more predictable replenishment and less inventory.

Figure 3How a combined cost waterfall can reveal key insights

Notes: CPG is consumer packaged goods; D&T is distribution and transportation; DC is distribution center; G&A is general and administrative.

Source: A.T. Kearney analysis

• Item production costs

• Receiving to shelf handling• In-store labor and facility costs • CPG in-store sales and merchandising

• Support functions• Building and o�ice expenses• Indirect materials spend

• Trade funding• Consumer and marketing expenses• Advertising

• CPG D&T (Plant to DC to store)• Retailer D&T (DC to store)

Retail shelf price index = $1.00 (food example)

Raw materials and packaging

Manufacturing

Distribution and transportation

Trade marketing and selling

Store operations

G&A

Combined profit

0.33

0.09

Retail price 1.00

0.06

0.14

0.16

0.07

0.15

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Three Phases of CollaborationA successful virtual vertical collaboration takes place in three phases, all of which must be undertaken by at least one of the companies (see figure 4).

Figure 410 steps to virtual vertical collaboration

Source: A.T. Kearney analysis

Strategic assessment

• Define collaboration objectives• Identify potential opportunities and value• Screen potential partners

Opportunity realization

• Pilot opportunities and test operating model• Expand opportunities into adjacencies• Monitor results and refine opportunities

Partner engagement

• Initiate discussions with potential partners• Establish joint collaboration objectives and goals• Evaluate opportunities through “clean room”• Agree on investment and value sharing

Strategic assessment. The first phase is all about determining current positions and how collaboration supports the company’s strategic objectives. For instance, essential capabilities might lie with one or more of your trading partners, so instead of building these capabilities and resources yourself, partnering allows for better access. Because screening is crucial, the assessment typically begins with creating a list of prospective partners, keeping in mind the potential for marketplace acceptance of such a collaboration. The list is then whittled down to a short list of prospects.

Partner engagement. This phase is the pitch to prospective partners. It requires top-to-top leadership communications to ensure a cross-functional agenda that is not limited by cultural preconceptions. Where there is mutual interest, there is a program with clear objectives that benefit both parties. Organizing cross-functional initiatives around a product category or a customer channel is effective for managing the process and also allows for cross-functional synergies. Here, we typically establish a joint team and the equivalent of a merger integration clean room to evaluate opportunities in each company’s value chain, establish an investment model, and determine value sharing options (see sidebar: Inside the Clean Room on page 8).

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Opportunity realization. In phase three, both companies decide whether the opportunities are substantial enough to justify dedicating resources to implementing joint initiatives. Pilots are launched within a small portfolio of products or markets, with the goal of demonstrating the real value of virtual vertical collaboration and working out kinks in the operating model. Successful pilots lead to broader launches. As a guiding principle, value from cost reductions is directed toward innovations and joint areas of growth, which essentially means that incentives are aligned with behaviors to sustain a long-term relationship. Both partners review their options annually— if not more frequently—to determine whether or not the partnership is living up to expectations.

Making the First MoveVirtual vertical collaboration is a way of doing business, not a means of driving return-on-investments. Although a collaboration effort can seem complex, it’s really not difficult. What is difficult, however, is making the first move: deciding to engage in such an endeavor and systematically finding the right partner with the right strengths to create a mutually beneficial alliance. This requires a profound level of trust and is not something done with just any company. You need to know with absolute certainty that your objectives are mutual. When executed correctly, a virtual vertical collaboration is worth the effort, providing a strong foundation for category growth, faster new product launches, and reduced costs all along the value chain.

Inside the Clean Room

In a merger, a clean room allows for the legal sharing of confi-dential information under special conditions. In a virtual vertical collaboration, a clean room is a location where A.T. Kearney teams conduct analytics, map value chains, and develop hypotheses. Our two integration teams act as intermediaries to facilitate

collaboration. Regular meetings—some involving each company alone, some involving both companies—are held to develop hypotheses, review progress, and act on recommendations.

Similar to a merger or acqui-sition, we use a virtual site to restrict access to information so

that each company team sees only data in its own folder. Source data files are not shared with the other company, and information that is shared with both companies is redacted appropriately to protect product-specific financial confidentiality while allowing for discussion of opportunities.

Authors

Joy Peters, partner, New York [email protected]

Michael Sansone, principal, Chicago [email protected]

Sean Monahan, partner, New York [email protected]

The authors wish to thank Niklas Vogelpohl for his valuable contributions to this paper.

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A.T. Kearney is a global team of forward-thinking partners that delivers immediate impact and growing advantage for its clients. We are passionate problem solvers who excel in collaborating across borders to co-create and realize elegantly simple, practical, and sustainable results. Since 1926, we have been trusted advisors on the most mission-critical issues to the world’s leading organizations across all major industries and service sectors. A.T. Kearney has 57 offices located in major business centers across 39 countries.

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© 2013, A.T. Kearney, Inc. All rights reserved.

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