F

The Power of Cost

Transparency
Finding Hidden Value in Manufacturing Networks
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 The Power of Cost
Transparency
Finding Hidden Value in Manufacturing Networks
T
he economic downturn
has companies scram-
bling to cut costs and
generate cash—espe-
cially in the face of
tight capital markets and the implod-
ing financial sector. Some forward-
looking companies are finding major
cost savings beyond the usual broad-
based budget cuts and salary freezes
by rethinking their global manufac-
turing operations. What’s more,
they’re using a detailed cost analysis,
not best-guess benchmarking, to
drive their redesign decisions. This
approach can unlock an enormous
amount of hidden value, yet it’s of-
ten overlooked as a cost-cutting
measure. When costs and cost driv-
ers are truly transparent, the insights
gained can be surprising and, if acted
on, can improve a company’s overall
competitive position.
Case in point: a major food producer
planned to achieve greater scale by
consolidating all of its production
lines into a few centralized mega-
plants. It assumed that higher logis-
tics costs would be offset by new
scale economies. A detailed scale
analysis of different types of over-
head costs did, indeed, reveal huge
potential savings—but only for very
large production lines, with few addi-
tional effects at the plant level. In
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other words, where scale was con-
cerned, one big line trumped multi-
ple smaller lines in the same loca-
tion. As a result, the company put
aside the notion of centralized mega-
plants and instead consolidated only
certain plants and set up big produc-
tion lines where they made the most
sense. Besides gaining far more flex-
ibility in its new network footprint,
the company could afford more
plants, which cut the cost of logistics.
By going beyond a simple cost analy-
sis and understanding its true cost
drivers, the company avoided mak-
ing an expensive mistake.
Too oen, production networks don’t
keep up with evolving global markets
or they are fragmented and inefficient
owing to a laissez-faire attitude fol-
lowing a merger. But because the task
of rethinking the manufacturing foot-
print is complex and politically diffi-
cult, it oen falls to the bottom of a
company’s to-do list. With so many
cost factors to consider—related to
location, product mix, plant capabili-
ties, and supply chain design—the
right answers are rarely obvious, and
assumptions about cost savings are
oen wrong. (See the example in the
sidebar “What Drives Costs?”)
A deep analysis of manufacturing
costs and drivers can generate valu-
able insights into the tradeoffs and
performance differences among
plants and regions. Armed with these
insights, companies can build an op-
timized production network that can
reduce total manufacturing costs by
10 to 15 percent and deliver major
improvements in resource utilization,
asset productivity, and output. (See
Exhibit 1.) By making these changes
now, during the downturn, compa-
nies can emerge even stronger—and
better positioned for growth—when
the economy recovers.
Why Production Networks
Must Evolve
A wide range of internal and exter-
nal factors can make factories and
networks that once were low cost
and efficient far less so. Energy pric-
es, work force availability, and labor
costs can change over time; distance
from customers can grow as new
markets develop and others recede;
and currency volatility can shrink
revenues or make inputs more costly.
Older plants may become outdated
as new technologies take hold, and
outsourcing may become a viable op-
tion as low-cost service providers
emerge. Internal changes can also
have an impact. M&A activity may
add redundant plants to the manu-
facturing network, the product port-

folio may shi , and growing complex- Despite the obvious benefits of doing costs is very complex. With so many
ity or changes in the global strategy so, many companies are reluctant to cost variables in play, intuition or gut
may demand a new manufacturing fundamentally rethink and redesign feeling can lead to the wrong deci-
footprint. their global networks because of the sions. What’s needed is a rational, an-
challenges involved. Since responsi- alytical approach that can provide
Owing to one or more of these fac- bility for manufacturing is oen greater clarity about the best way
tors, the manufacturing operations of spread across business units or re- forward.
most companies are far from opti- gions, a single individual is not likely
mized. In a global production net- to have overall authority. Implemen- Beyond Benchmarking
work, in particular, there may be tation is another challenge. The
many subpar plants consuming far need for a network restructuring is While many companies start with a
more resources than necessary. By re- very difficult to communicate to the benchmarking analysis, the reality is
structuring the global footprint and work force and to the public because that this falls short as a tool for com-
managing existing capacity better, it’s oen synonymous with layoffs. panies that are serious about restruc-
companies can find and release hid- Then there’s the time involved: al- turing. Comparing the performance
den value—and may well discover though much can be accomplished of different plants against industry-
that the new factories they had in the first six months, most restruc- or companywide standards and iden-
planned to buy or build are not need- turings take two to three years to tifying best practices are useless exer-
ed at all. Of course, cleaning up complete. cises unless the reasons for the cost
plants in the existing manufacturing differences are fully understood.
network will improve any major lean Besides being a daunting task, a re- Even subtle differences in business
initiative or other performance-im- structuring has analytical challenges focus or strategy can lead to errone-
provement effort by providing a that can make a successful outcome ous benchmarks and suboptimal de-
strong starting baseline and minimiz- far from assured. The correlation be- cisions. Without good data up front,
ing redundant activities. tween network setup and production any conclusions will be seriously
flawed. A cost-driver analysis gets at
Exhibit 1. An Optimized Production Network Delivers the root causes that underlie perfor-
mance variations, so companies can
Major Savings
clearly see which cost levers to pull
Typical cost savings to make a real difference. This trans-
parency is critical to a successful re-
◊ Process or ◊ Network ◊ Make-or-buy structuring.
shop floor footprint decisions
redesign Added benefits
◊ Capacity ◊ Sourcing typically include: A detailed analysis helps to identify
◊ New product and capital
optimization management exactly how to design manufacturing
5%–15% 25%–50% ◊ 10%–15% increase
in resource
networks for the greatest enter-
◊ Inventory ◊ Productivity
management management utilization prisewide savings. When restructur-
◊ Lean 10%–15% ing a network, companies must con-
◊ 20%–50% increase
production in run time for sider economics, location, and
manufacturing resources, taking into account not just
assets
10%–20% the current situation but also likely
◊ 15%–25% increase
in output developments and trends that could
affect the future, such as rising labor
costs, increased shipping costs, and
resource constraints.
Operational Network Production Total potential
measures optimization scope cost savings ◊ Economics. Besides analyzing sup-
ply chain costs, the complexity of
Source: BCG analysis and project experience.
the product portfolio, and the cost,

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 What Drives Costs?

When the same product costs more
to make at one plant than at
another, the difference can be
explained by the underlying cost
drivers. Plants have three categories
of cost driver:
◊ Scale: the effect of volume on cost
per unit made
◊ Efficiency: relative productivity,
utilization, and process com-
plexity
◊ Factor costs: input costs (such as
labor), operating costs (such as
fuel), and logistics costs (such as
shipping)
A company’s specific cost drivers
should be customized on the basis
of industry and types of production.
A detailed analysis reveals the most
relevant cost drivers and the relative
effect of each. As shown in the exhib-
it below, a plant’s cost per unit of
production goes up or down depend-
ing on the interplay of drivers such
as yearly production volume (scale),
equipment utilization rates (a
measure of efficiency), and local
labor rates (a factor cost). Armed
with this information, companies
can make better decisions about
how to structure the optimal
manufacturing network.
A Cost-Driver Analysis
in Action
A European manufacturing com-
pany offers a wide array of products
ranging from standardized items to
high-end, customized models.
Before it began to rethink its
network, the company had six plants
in Europe—most from acquisitions.
The plants varied in size from small
workshops to large facilities. Each
produced complete products, and
most components were made
in-house. Component specifications
differed from plant to plant, so
collaboration across plants was
minimal.
The initial data showed that product
and component costs varied
significantly by plant. Further
analysis revealed the source of these
differences to be direct and indirect
labor and other indirect costs.
Material costs were more or less
similar across plants.

A Cost-Driver Analysis Maps Drivers to Cost Structure

Direct Indirect
Key performance labor labor Nonlabor Logistics
Cost driver indicator (KPI) costs costs costs Depreciation costs
Scale
Scale Units per year effects

Number of SKUs,
Complexity tooling time, etc.
Output per Efficiency
Productivity hour effects

Run time
Utilization (% of total time)
Personnel
Labor costs costs per hour
Personnel
Salary costs costs per hour Factor
cost
Average logistics effects
Logistics costs costs per unit
Factor cost level
Other factor costs (indexed)

Cost
per
unit
Relevant KPI

Source: BCG analysis.

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 What Drives Costs? (continued)
A detailed analysis showed that two
drivers accounted for the cost
differences:
◊ Efficiency. Since all the plants
were located in Western Europe,
the direct labor rate was compa-
rable across plants. But because
the small and midsize plants had
put much more effort into stan-
dardizing components and mak-
ing products more modular, the
workers at those plants were able
to work more efficiently and pro-
ductively than their counterparts
at the other plants. As a result,
direct labor costs were lower
overall.
◊ Scale. By contrast, indirect labor
and other indirect costs were low-
efficiency, and productivity of ex-
isting plants, companies must con-
sider the one-time costs of shut-
ting down plants. These include
severance, hiring, and transfer
costs as well as loss of productivity
during implementation.
◊ Location. Customer proximity
shortens delivery times and costs
and allows companies to better
understand and meet market
needs. Moreover, brand position-
ing is oen linked to specific coun-
tries, where plants therefore must
be maintained. Swiss watches, for
instance, can’t be made in China.
Other considerations include local
content requirements, import tar-
iffs and taxes, and currency risk.
◊ Resources. When designing a net-
work, companies must consider
the availability of talent, suppliers,
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er at the larger plants, where the
higher volume reduced overhead
and production costs. The small
and midsize plants lacked dedi-
cated production lines for each
component, so they had to switch
machine setups more oen. This
increased tooling times and also
affected the types of equipment
used: machines were chosen for
their flexibility, which further in-
creased costs.
On the basis of these results, the
company closed two small plants
and changed its production strategy.
It replaced standalone plants with
an integrated network of specialized
plants, each making specific
components. The result was
consolidated production lines
inputs, and technology. Are man-
agers, engineers, and production
workers available? Is the needed
infrastructure—roads, ports, air-
ports, communication networks,
energy grids—in place to support
commerce?
A cost-driver analysis focuses specifi-
cally on the economics of the manu-
facturing network. It uses actual data
from operations: revenues and costs
by both product line and profit or
cost center; production volumes by
plant and product line; cost, capacity,
and utilization of equipment; and in-
bound, outbound, and intraplant lo-
gistics. (See Exhibit 2.) These data,
when combined with an analysis of
location options and resource avail-
ability at different sites, provide the
full cost picture that companies need
in order to make more informed re-
structuring decisions.
allowing for greater scale and
minimal line changes. These
modest footprint changes will save
the company 15 to 25 percent of its
total component cost (aer added
logistics costs).
Making It Work
A cost-driver analysis involves four
steps: collecting data, analyzing the
cost drivers, modeling network sce-
narios, and choosing a network de-
sign and implementation plan. (See
Exhibit 3.)
Collect meaningful, detailed data
on products and production. To
be useful, the data must meet specif-
ic criteria. For instance, for an analy-
sis focusing on products that are
manufactured in-house at more than
one plant, or that represent a mean-
ingful share of the value of the end
product, cost data must be compiled
for each individual product. In addi-
tion, the products’ characteristics—
such as size, weight, materials, com-
ponents, functionality, and qual-
ity—must be common across plants.
And the plants must take the same
 Exhibit 2. A Cost-Driver Analysis Uses Actual Data from Operations

Plant profit-and-loss statements Production portfolio

Profit-and-loss data Volumes by plant and product line
◊ By product line ◊ In-house production
◊ By profit or cost center ◊ Production capacity
◊ Subcontracted volumes
Trends
◊ Factor costs Trends
◊ Financing costs ◊ Outsourcing
◊ Depreciation ◊ Product portfolio changes
◊ Accounting methods ◊ Standardization

Machinery and resource data Logistics setup

Machinery data Supply chain and logistics

◊ Cost per machine hour ◊ Inbound supply chain
◊ Capacity ◊ Intraplant logistics
◊ Performance data ◊ Product flows from plant
◊ Overall capacity and to market regions
utilization
Trends
Trends ◊ Transportation costs
◊ New technologies ◊ Shis in target market
◊ Market requirements
◊ Efficiency increase

Data collection rules ensure reliable interpretation

Source: BCG analysis and project experience.

value-adding steps in finishing the
products.
The data collection step also involves
gathering information on the prod-
uct portfolio and volume by location,
a cost breakdown for each value-add-
ing step, and the cost of logistics.
These data-collection rules ensure
that the findings are reliable—that
apples are being compared with ap-
ples, not oranges. Taken together, the
data provide valuable clarity on the
relative performance of each plant.
Analyze the cost drivers and their
impact. The next step is to analyze
which drivers—related to scale, effi-
ciency, or factor costs—account for
the cost differences among plants
and the impact of the relevant driv-
ers on each cost type. For instance,
does the higher volume at one plant
result in economies of scale that re-
duce overhead and overall produc-
tion costs relative to other plants in
the network? Does a more efficient
process at another plant reduce pro-
duction time and overall labor costs?
Companies should customize their
specific cost drivers on the basis of
their industry and types of produc-
tion. The findings of the cost-driver
analysis are aggregated at the plant
level to provide a picture of the over-
all network.
Model different network scenarios.
Sometimes the analysis of products
or process steps reveals strengths or
weaknesses relative to the competi-
tion that can be acted on. For in-
stance, a company with a major scale
advantage in a specific step of the
production process could set up a
contract manufacturing business.
This extension of the core business
could increase the cost advantage
even more. By contrast, if the analy-
sis reveals a scale or location disad-
vantage, the company might decide
to focus on market segments in
which its products are more differen-
tiated.
The insights gained can also clarify
make-or-buy decisions. For example,
if the analysis reveals a huge scale
disadvantage that makes it impossi-
ble ever to match the cost that
contract manufacturers can offer,
the company might choose to out-
source the bulk of its production
and focus on other, more strategic
activities.
The knowledge gained from cost
transparency can sometimes result in
a plethora of options. For example, a
consumer durables company was
evaluating two cost-cutting scenarios.
Option A was to automate its exist-

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 Exhibit 3. Analyzing Cost Drivers Involves Four Steps

Analyze Model network Choose a network

Collect data cost drivers scenarios design and
implementation plan

◊ Gather data ◊ Analyze network constraints ◊ Define options for future ◊ Evaluate options based on
– Production portfolio – Technology networks economics (NPV, payback)
and volumes by location – Operations and implementation risk
– Cost breakdown per – Market ◊ Model scenarios
value step for each – Customer – Cost position by ◊ Consider network
product product constraints
– Plant performance ◊ Analyze cost drivers behind – Capacities by site
– Logistics flows ◊ Generate a shortlist of
– Logistics (inbound, production cost differences
(inbound, interplant, preferred scenarios
outbound, and and the impact of cost drivers
interplant) on each cost type and outbound)
◊ Analyze network fit with
◊ Analyze investments, future challenges
◊ Align definitions and data ◊ Aggregate findings at the
gains, and transition
across plants plant level ◊ Develop a high-level
costs for each scenario
◊ Assess current and future implementation plan
dynamics of technologies,
portfolio, and markets

Source: BCG analysis and project experience.

ing plants, and option B was to shi
production to a low-cost country
(LCC). Both scenarios aimed to re-
duce labor costs. The plant automa-
tion would require a larger invest-
ment, but moving production to an
LCC would be more of an organiza-
tional challenge. The cost-driver
analysis showed that the two levers
would have the same financial im-
pact. In the end, the company opted
to move production to an LCC be-
cause of the risk that any change to
the product design would make the
automation technology obsolete; an
offshore production facility in an
LLC, however, would likely stand the
test of time by providing greater flex-
ibility and relying less on costly auto-
mation.
When rethinking the manufacturing
footprint, be sure to model a range
of scenarios, such as allocating more
volume to existing plants, adding
new capacity in strategic locations,
or outsourcing all or part of the pro-
duction process for one or more
products.
Choose a new network design and
develop a high-level implementa-
tion plan. We usually use net pres-
ent value (NPV) and the payback
time to evaluate potential scenarios.
Easy wins typically have a low NPV
and a short payback time. Not sur-
prisingly, more comprehensive re-
structurings have a high NPV but
greater risk and a longer payback
time. Most companies choose a mid-
dle path rather than go for the easy
wins, largely because the impact is
greater—and major projects are too
daunting. But it’s also important to
look beyond cost when choosing a
new network design. Oen there are
strategic reasons to rethink the man-
ufacturing network—for instance, to
create a presence in an emerging
market.
Engaging the Organization
In some performance-improvement
efforts, turf issues can keep the best
solutions from being revealed or im-
plemented. But the transparency of
the cost-driver analysis can sidestep
these potential roadblocks and un-
cover the hidden dynamics that ex-
plain the cost differences among
plants. It is critical to involve plant
managers and staff in data collection
and to confirm the findings with
them. Generally, we find that people
are very motivated to understand
why their own plant is underper-
forming relative to another—espe-

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cially when there seems to be no ob-
vious reason for the difference. It can
also be reassuring for people to see
that the difference is truly beyond
their control given the current cost
dynamics.
As the analysis proceeds, people from
various plants typically begin talking
to each other in depth for the first
time, discussing the different ways
they do things. In the process of these
exchanges, the teams oen discover
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improvement levers that have noth-
ing to do with the original cost analy-
ses. This knowledge sharing is an im-
portant byproduct of a cost-driver
analysis.
D
uring tough economic times,
inefficient companies with
bloated cost structures are
most at risk—and slower to recover.
Instead of battening down the hatch-
es and waiting for the storm to pass,
forward-looking companies are tak-
ing the opportunity to rethink and
restructure their manufacturing op-
erations, using the insights that full
cost transparency can deliver to un-
lock oen vast amounts of hidden
value. In a countercyclical move,
they’re investing money now to do it
right—and to save far more in the
future.

About the Authors
Andreas Maurer is a senior
partner and managing director
in the Düsseldorf office of The
Boston Consulting Group. You
may contact him by e-mail at
maurer.andreas@bcg.com.
Daniel Spindelndreier is a
partner and managing director in
the firm’s Düsseldorf office. You
may contact him by e-mail at
spindelndreier.daniel@bcg.com.
Alexander Türpitz is a principal
in BCG’s Dubai office. You may
contact him by e-mail at
tuerpitz.alexander@bcg.com.
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Acknowledgments
The authors would like to thank
their colleagues Harold Sirkin and
Michael Zinser for their input and
Annette Häfele for support in
research and consolidation of
project findings. We also thank Gary
Callahan, Martha Craumer, Angela
DiBattista, Gina Goldstein, and
Janice Willett for their contributions
to the editing, design, and produc-
tion of this report.
For Further Contact
If you would like to discuss this
report, which was sponsored by
BCG’s Operations practice, please
contact one of the authors. For
inquiries about the practice, please
contact its global leader:
Harold L. Sirkin
Senior Partner and Managing Director
BCG Chicago
hal.ops@bcg.com
For a complete list of BCG publications and information about how to obtain copies, please visit our Web site at
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