The arrival of the Single Market (however incomplete) and several years of difficult economic and competitive conditions have forced many manufacturers to rethink the way they operate in Europe.
IMD surveyed 93 manufacturing companies that operate in more than one European country to see how they were responding to the strategic challenges posed by the Single Market. The results, together with other research and analysis, point to some important lessons not only for companies operating in Europe but also for those looking for opportunities in other trade areas such as the Asia-Pacific region and the North American Free Trade Association.
The survey highlighted the difference between the traditional organisation of manufacturing found in many long-established European companies and the pan-regional organisation of more progressive European manufacturers and some US and Japanese companies in Europe.
One important difference is plant location. Many European manufacturers have located, or have inherited, plants that traditionally served their host countries and, perhaps, small neighbouring countries and former colonies. Typically each plant produces the entire range of output that the company's local sales force sells, or at least much of it.
Because some of the countries served have limited populations the plants themselves may be small compared to similar plants in major markets. The locations are typically dictated by historical accident or proximity to the company's major market. The plants are paired with their local sales companies and they run their operations independently of similar company operations in other European countries. Product characteristics and packaging are generally the province of the local sales companies. Above marketing and sales and production operations reigns a country managing director.
The pan-European manufacturer is organised in dramatically different fashion, though it is a fashion that is familiar to many American or Japanese companies operating in Europe. Rather than a geographically based strategy, the pan-European producer follows a product-based strategy. Different products are made in different factories and are shipped over a broad geographic area.
A company switch to a pan-European orientation typically involves a narrowing of product line responsibilities for plants and an increase in the markets they serve. Importantly, such a switch in strategy frees management to concentrate on a limited product line in any one factory. Such a reorientation results in more attention being paid to product flows, redesign of plant layouts, better materials handling, new investments in equipment and different workforce practices. Critical mass can be achieved in staff areas such as new product development, purchasing and process engineering.
With a change to a pan-European strategy, the scale of operations is likely to increase. Thus, more specialisation within manufacturing can be sought. Reorganisation can concentrate manufacturing and design know-how, and state-of-the-art approaches can be more easily mastered. Overheads may decline, especially relative to the volumes produced. This is because the narrowed product line can facilitate a more "visible" production process and less need for "systems" to run the factory because teams can act to delayer the levels of military-style hierarchy that prevail in some European companies.
Company organisation typically changes. Because the brand and product have become pan-European in character, it usually makes sense to centralise selected aspects of the marketing and sales functions. This is becoming a vital prerequisite if major customers are themselves organised as pan-European companies.
Centralisation leaves the country manager with considerably less responsibility and power. Even more power is ceded if manufacturing is reorganised as well so that the country's plants produce less than a full line of products. Manufacturing management then becomes a co-ordinator of networks of plants, rather than autonomous units.
The results of such a switch in strategy can be dramatic, particularly with respect to the lowering of production costs.
Take Company A, a confectionery marker. As a result of aggressive merger and acquisition activity it had almost 20 plants scattered throughout Europe, each making an assortment of products for small, well-defined geographic areas. With the advent of pan-European thinking the company closed about half of them and recommissioned the others so that product lines are now made at separate locations in what are termed international manufacturing centres. The national sales organisations and distribution channels are unchanged but are now fed by the product line-specific international manufacturing centres.
Company A has been able to reconfigure the layouts of its factories so that materials move from factories to markets much more economically. The increase in volume has justified more automation. There are fewer set-ups and the time lag in the feedback of information regarding quality and other operational issues is now much shorter than before. Not only has this reorganisation increased productivity, but the simplification of the factories has also meant that products costs are now better known. This, in turn, has permitted manufacturing to resist marketing "whimsy" more effectively than ever.
Pan-European manufacturers are rethinking their approach to plant scale. The choice of product line for each plant can be made with an eye to "minimum efficient scale". Furthermore, the capacity utilisation of these plants can be more effectively managed. In moving to pan-European operations, the generous buffer capacity typically present in the independent, country-based plants are squeezed out of the reduced number of plants kept in operation.
The shift to pan-European manufacturing offers more than cost and scale benefits. Our research shows that although many European manufacturers are adopting at least some of the latest manufacturing initiatives - JIT, TQM, employee involvement and so on - pan-European manufacturers are moving much more swiftly. They are far ahead of the competition in understanding and implementing the key ideas of time-based competition and lean production.
Companies that have successfully introduced pan-regional manufacturing strategies in Europe have become experienced in managing operations in a multicultural, multilingual environment and in coping with differences in economic performance and national political agendas. American and Japanese multinationals in particular have been able to treat Europe as a greenfield site in terms of plant size and location. They tend to think of it in the same way as their home markets, where product-specific plants servicing geographical areas are the norm. Nevertheless, more progressive European companies, such as TetraPak, Schindler and Borealis have used the introduction of the Single Market to implement pan-regional manufacturing strategies.
Their European experience will be invaluable to many of these companies as they prepare for the major opportunities opening up in other areas of the world. For example, with high import tariffs and low labour market efficiency, Brazil today is in a situation similar to that of Spain and Portugal before they joined the European Union. Equally, the impressive economic growth rates and expanding markets of the Asia-Pacific region pose similar complex choices to those faced by American and Japanese companies when they entered Europe.
In looking at pan-regional strategies based on the European experience, companies need to consider the following:
1. Avoid manufacturing myopia. Companies moving into a new region for the first time have an excellent opportunity to adopt a pan-regional rather than a national perspective in defining markets and locating plants. This can help them avoid the problems of overcapacity, duplication and insufficient scale that often hamper traditional companies in Europe. For some companies it may mean overcoming the "national market" mindset and opposition from internal "country king" supporters.
For the pan-regional producer, costs are an increasingly important factor in choosing plant locations: particularly labour costs and the costs of access to suppliers and sister plants within the company. Other factors include government location incentives and local or national policies on such issues as building regulations, the environment and employment laws.
Companies may be influenced by pan-regional customers. To serve a demanding pan-European company, one supplier had to build several new plants using dramatically improved designs that facilitated teamwork, improved quality as well as speeding up materials handling.
The decision to open or close a plant is often highly political, particularly if opening a plant in a new region affects production "at home". To make the decision more objective, some companies use classical mathematical programming techniques. Based on the forecast level of demand for individual countries or sub-markets in the region, these techniques can allocate output of particular products to specific plants and assess the total costs, including physical distribution, of various possible plant networks.
2. Build product-focused plant networks. As we have seen from the experience of pan-European strategies, product-focused operations concentrate experience in a few locations and these tend to increase in size to reach optimal efficiencies. Single-market plants may often be under-sized relative to the prevailing technology and therefore more costly. Just over half the plants in the IMD survey supplied domestic markets and, on average, were a quarter of the size of plants serving larger export markets. Even mass-market producers such as Renault, Volvo, Peugeot and Fiat are wondering whether they have sufficient scale. In the chemicals industry, where Europe has traditionally been a world player, concerns about scale and overcapacity have led to a number of asset swaps; for example, ICI and Du Pont in nylon, and ICI and BASF in polypropylene.
But "optimal" plant size does not automatically mean very large. One electronics and electrical machinery company has recently concluded that sites employing 1,000 to 2,000 people are preferable to their existing manufacturing network, which has both small sites employing 100 to 200 people and very large ones employing 5,000 or more.
3. Build pan-regional organisational structures. Many European firms are organised into "manufacturing companies" that distribute their products through "sales companies" - often one in each of the major countries. These local companies are used to being largely independent in product formulation, pricing, packaging and sourcing policies. The result is more customisation, more small-scale runs and more unco-ordinated manufacturing activity than in equivalent operations in companies from other regions.
Moving to a pan-regional manufacturing strategy means reassessing the balance between centralised task-sharing and local autonomy. A pan-regional organisation is not a confederation of national entities and, as we have seen, centralisation leaves country managers (if any) with considerably less power and responsibility. Marketing and sales strategy becomes a headquarters role, although implementation remains with local management. This in turn means that production planning and logistics for the various manufacturing facilities need to be co-ordinated regionally.
Pan-regional strategies also affect the distribution system. Although the number of warehouses can be reduced as plants ship larger quantities directly to major customers, transportation costs may actually rise because the finished goods need to be shipped over a wider area. However, most pan-regional companies estimate that increases in transportation expenses will be offset by savings in the manufacturing process.
Not all companies will centralise their organisations to the same degree. One European food producer has centralised quality control, production engineering and financial control much more than marketing and production, believing taste differences between countries call for caution in introducing pan-regional manufacturing.
4. Adopt rigid flexibility. Research by IMD suggests that pan-regional manufacturers understand more clearly than nationally based manufacturers the need for flexibility in production. Flexibility is needed to customise products, to create additional product features, to shorten product development times or to ensure short lead times from order to delivery.
Flexibility is not achieved by having numerous plants produce a wide range of products for one country. It is achieved by redesigning the way a plant operates. It means combining simplicity with discipline - a combination we term "rigid flexibility". (The concept of rigid flexibility was dealt with in detail in Part 5 of Mastering Management.)
Many packaged goods producers exemplify rigid flexibility. They have achieved low unit manufacturing costs by adopting standard product "footprints", such as can diameters and bottle heights. These contribute to simplicity in operations such as filling, packaging and palletising, with fewer changeovers and greater operating speeds, yet permit great diversity in the look of the container and its contents. Such simplicity has been developed though the discipline of design for manufacturability, where systematic thinking and rule of thumb are rigorously applied to the design cycle.
5. Standardise systems and procedures. Efficient material flow and information exchange within a pan-regional strategy require standardised systems and procedures - quality, parts management, production control - as well as more standardised products and packages. Our survey showed that pan-European producers tend to be much more standardised in all categories than nationally based firms. For example, 86 per cent of pan-European companies had increased standardisation in product formulations/engineering in the past five to ten years compared with 70 per cent of nationally based companies. Pan-European companies are also more likely to have standardised packaging, product numbering, component and part numbering, quality-assurance standards, and computer-based planning and control systems.
This suggests that standardisation is not only a function of the size of a plant's market but also of how much product-line responsibilities are narrowed. It also suggests that pan-regional manufacturers are more likely to adopt "rigid flexibility" in their approach to manufacturing. For example, a pan-European television manufacturer faced with the multiplicity of television "standards" in Europe designed an electronics module that was standard for all its TV receivers of a certain size. The module could be easily customised on the assembly line to meet specific country requirements while all other assembly steps remained unchanged.
6. Identify obstacles to implementation. In Europe many manufacturing firms have found that progress towards a pan-regional strategy can be severely hampered by the constraints of external stakeholders such as national governments, international agencies and pressure groups. These constraints need to be recognised at an early stage.
Some of them are political, such as government regulations that affect pharmaceutical companies in the location of formulation plants or public-sector procurement policies that deny foreign telecommunications firms access to a number of national markets.
The level of environmental awareness and control can also be important. Chemicals companies operating in Europe are faced with significant capital investments to support health, safety and environmental initiatives. As a result, they tend to concentrate disparate process units in a small number of large, complex sites.
Other obstacles are far more subtle. Differences in culture, customs and cuisine across a region force manufacturers of consumer goods to decide whether individual country requirements can be satisfied through a number of plants in various markets or fewer plants dedicated to a sub-set of those markets. A lack of common standards and product harmonisation in industries such as telecommunications and electronics can raise the same issues.
In conclusion, it is apparent that lower trading barriers, improved physical distribution and competitive cost pressures are all driving companies towards pan-regional, even global, manufacturing. Companies moving into new geographic regions have an opportunity to pursue pan-regional strategies from the outset. However, these strategies require new competencies, in particular a disciplined approach to standards and procedures. Without them, pan-regional manufacturing networks will steadily come to resemble the confederations of national entities that exist in many European companies in their home region today.
Signpost
Production and Operations Management
The Module concludes with a section on pan-regional manufacturing. Previous sections appeared in Parts 3,5,8,11 and 12. Topics covered have been: re-engineering and benchmarking, changes to manufacturing, planning and control systems, measuring improvements in manufacturing systems, lean manufacturing, supply chain management, the strategic management of operations, environmental issues and the transformation of the manufacturing enterprise.
Summary
The single market has forced a rethink of many companies' European operations. Traditional plants typically produce an entire range of goods which are then sold by their local salesforce. Pan-European producers, by contrast, follow a product led strategy and tend to centralise marketing and sales.
Pan-regional manufacturing offers more than cost and scale benefits - research shows that such companies are ahead in the adoption of the latest manufacturing initiatives, and have become experienced in cross cultural management.
Companies considering the pan-regional approach need to overcome "national market" mindsets and opposition from "country kings"; they may well be influenced by pan-regional customers. Optimal plant size does not necessarily mean very large. The exercise will involve reassessing the task sharing between centralised authority and local autonomy. Flexibility can be achieved by redesigning the way plants operate, while standardisation in product formulations/engineering is likely to increase. Obstacles - political, cultural, etc - need to be identified at an early stage.
Robert Collins
Robert Collins is professor of business administration at IMD, Lausanne. His research interests are in strategy formulation and implementation in the transformation of the manufacturing enterprise
Roger Schmenner
Roger Schmenner is professor of operations management at Indiana University School of Business, Indianapolis, US and a regular visiting professor at IMD, Lausanne. His areas of research interest include manufacturing strategy, factory productivity and location decisions for manufacturing services
