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OperationalExcellence:Indianvs.InternationalPracticesCONFIDENTIALThisreportissolelyfortheuseofclientpersonnel.Nopartofitmaybecirculated,quoted,orreproducedfordistributionoutsidetheclientorganizationwithoutpriorwrittenapprovalfromMcKinsey&Company.ThismaterialwasusedbyMcKinsey&Companyduringanoralpresentation;itisnotacompleterecordofthediscussion.WesternRegionAnnualMeetingApril11,2002KEYMESSAGESI.SuperioroperationsdrivesvaluecreationII.IndianmanufacturingcompaniesfacesignificantoperationschallengesIII.NewtoolsandmindsetrequiredtobuildoperationalexcellenceIV.Rewardsfrompursuingoperationalexcellencecanbelarge–thejourneymustbeginnowINTERNATIONALRESEARCHSUGGESTSTHATCOMPANIESWITHSUPERIOROPERATIONSDELIVERSUPERIORRETURNS…30560990*ExcellentareUScompanies(fromtheDiscoveryscreenedtargetlist)whichincreasedtheirmovingaverageROICeveryyearduringa5-yearperiod(1995-99),andhadaROICgreaterthantheirindustrialaverage**CompaniesfromtheS&P500industrialswhichpassedtheExcellencefilter,fullspreaddataavailableforonly320companies***Basispointsreflectsabsolutechangeinspread(i.e.,aspreadincreasefrom5.0%to7.0%equals200basispoints)Excellent–Superioroperationalperformance(12companies)*S&P500IndustrialsROIC-WACC,basispoints***Excellent-Other**companies(32companies)Approach•Short-listed44“excellent”companiesforanalysis–ROICWACC(from95-99)–ROICIndustrialaverage•Short-listed12“excellentcompanies”basedonqualitativereviewofoperationsAverageTotalreturnstoshareholders1,0003,0005,0007,0009,00011,00013,00015,00017,00019,0001994199519961997199819992000WilshireIndex(market)Excellent-Top12*Excellent“–Next32S&P500Industrials*Operationalexcellentcompaniesdefinedas12companiesthatpassedoperationsexcellencefilterfromtheIndustryWeekGlobal1000Source:McKinseyOperationsDiscoveryProject3XTRSperformancerelativetomarket…WHICHTRANSLATEINTOSUPERIORVALUATIONSOPERATIONALEXCELLENCEDRIVESTHESERETURNS•Newproductintroductioncycletimeandcost50%lowerthancompetition•Manufacturingfloorspacerequired50%lessforcomparableproduct•Ordertodeliverytimelessbyafactoroffive•P/E20+pointshigherthanothermajorplayers•Make-to-ordersupplychain•Inventorylevel60%lower•Receivablesturns45%higher•Revenuegrowth40%fasterandROIC1.5timesindustryaverage•3-yearcostsavingsgoalofUSD1billionachievedthroughAlcoaProductionSystem•AdditionalUSD1billionsavingstargetedfor2003•From1996to2000,CAGRofrevenuesandnetincome15%and30%,respectively,inspiteofplungeinaluminumpricesOperationalInitiativesOverallfinancialimpactALCOACASESTUDY–CORPORATE-WIDELEANTRANSFORMATIONLeanoperatingpractices(APS)TransformationfoundationPerformance-basedmeasurementsystemFacilitiesmodernizationRenegotiatedlaborcontractsVariablecompensation(salaryandhourly)Qualityassurance,SPCReducedset-uptimesFlexiblejobdesignPayforperformance/skillAlcoaBusinessSystem*Alcoa’squarterlynetincomeadjustedforspecialitemsSource:Platt’sMetalWeek;WallStreetJournal;McKinseyMetalsPracticeAlcoaadjustednetincomeAluminumspotpriceAdjustednetincome*$MillionsSpotpriceofaluminum$/lb.Alcoaperformancevs.priceofaluminum-1001002003000.400.600.801.001.200198283848586878889909192930InitiatedAlcoaproductionsystemALCOACASESTUDY–THERESULTS949596979899BrokeoutofpricecycleEVA-1995-99(ROIC-WACC)Growth-2000-05(5-yearprojected)AlcoaCompetitorIndustryAlcoaCompetitorIndustry1.1-2.8-0.215813KEYMESSAGESI.SuperioroperationsdrivesvaluecreationII.IndianmanufacturingcompaniesfacesignificantoperationschallengesIII.NewtoolsandmindsetrequiredtobuildoperationalexcellenceIV.Rewardsfrompursuingoperationalexcellencecanbelarge–thejourneymustbeginnowINDIANMANUFACTURINGCOMPANIESFACEAPROFITABILITYCRISIS6.65.2199720%decreaseProfitmargins*2000PAT,percentageofsalesPercentageofcompaniesmakinglossesPercent1523199750%increase2000-4.30-4.6019977%decreaseEVA(ROICminuscostofcapital)2000Percent*Basedonasetof132companiesin10sectors(IndustrialMachinery,Ferrous,NonFerrous,ConsumerDurables,Chemicals,Petrochemicals,Pulp&Paper,Power,TyresandAutomotive)Source:Prowess;McKinseyteamanalysisPOORFINANCIALPERFORMANCEISDRIVENBYPOORLABOURANDCAPITALPRODUCTIVITY…24111025AutomotiveSteelPower(generation)LabourProductivityCapitalproductivityIndex,US=100Apparel4065Index,US=100Source:McKinseyGlobalInstitutestudyoftheIndianeconomyEXAMPLESNANAManufacturingSupplychainChannelmanagementKeyaccountmanagement/SalesforceeffectivenessPricingPurchasing/supplymanagementGAPSEXISTINALLAREASOFOPERATIONALPERFORMANCEToomanysuppliers(250*vs.100forbest-practice)Unawareof‘pocketmargins’80%timeonnon-valueaddedactivitiesPoorchannelcapabilityandreturnsNosystematictrackingoftopcustomersandtheirsatisfactionToomuchinventory(140daysvs.35forbest-practice*)*AutomotiveindustryanalysisKEYMESSAGESI.SuperioroperationsdrivesvaluecreationII.IndianmanufacturingcompaniesfacesignificantoperationschallengesIII.NewtoolsandmindsetrequiredtobuildoperationalexcellenceIV.Rewardsfrompursuingoperationalexcellencecanbelarge–thejourneymustbeginnowNEWMINDSETREQUIREDTODRIVEOPERATIONALEXCELLENCETypicalmindsetRequiredmindset•Limitedtopmanagementinvolvement•DrivenbyCEOagenda•Incrementaltarg