A. T. Kearney specializes in transforming organizations to be stronger, more agile and better positioned for the future. Earle Steinberg, vice president and practice leader of the company’s Americas Operations Practice, predicts that in five years we will see “a dramatically different picture” of companies in the food industry.
In the food business over the last decade, innovation and new product introduction has been the key driver. Brand names no longer command the same premium they used to. Steinberg points to recent market shares for new candy bars, snack foods and specialty cereals that have come and gone as evidence that new product life cycles often are very short. “This means the innovation engine has to be cranked up pretty high,” he says. So most food companies have invested heavily in plants, equipment and process technology over the last decade. According to Steinberg, a growing number of food companies now have “too much specialized and inflexible technology that often was designed to make a product that may not be as competitive now as it once was.”
To become competitive, many consistently over the last decade have been asked to take money out of the supply chain. Profitability has come from continuous cost cutting, rather than top-line growth. “Innovation, after all, is difficult; and it’s not easy to consistently come up with great ideas that appeal to your market and that will command a premium,” Steinberg explains. “And brand management is becoming much more difficult with all of the private label products now available.”
A solution would be not to own the assets. But a food company needs to be able to control the quality, cost and delivery of its products, and Steinberg asserts that many food companies “beat their contract manufacturers to death on price, so they are skating on the edge of insolvency.”
Thus, food companies are now forced to reconsider their value proposition. They are not good at everything they do, and they must make choices. Their core expertise has shifted from making food products or relying on contract manufacturing to branding and introducing innovative new products.
Food companies are in transition. Peter Bendor-Samuel, CEO of Outsourcing Center, plots their future course on a Product Adoption Life Cycle that illustrates when and why companies outsource at certain times. Companies at the transition stage of the life cycle need to outsource. In doing so, they extract their capital from old infrastructure and processes, which allows them to free up mindshare and invest capital on new product introduction, marketing and brand management, rather than plant operations and equipment.
A long-term outsourcing relationship allows the supplier to invest in ongoing improvement of infrastructure and processes and still be able to get its investment back out of the deal. Outsourcers can take under-invested processes, build economies of scale and leverage their process expertise and supply chain management, thus achieving improved operations and lower costs to achieve the food company’s objectives.†
Original outsourcer, EDS, and its frequent strategic partner, A. T. Kearney, are leading the way in advice and solutions for the food industry’s dilemma. Steinberg says that asset management companies will emerge over the next year or two and that food companies will sell their assets to the new asset managers, which will then operate the current plants (with the current employees) with a strong focus on improving operations. A. T. Kearney finds the appropriately skilled asset manager, structures the sale of the assets, arranges the outsourcing of the manufacturing process to increase production efficiency and lower costs and transforms the supply chain. He notes that typically there also would be a contract between the original owner and the new asset manager that requires the asset manager to provide a specific product at a specific price and also requires the original owner of the food company to accept that product at the specified price.
Bendor-Samuel assesses the traditionally troubling elements of contract manufacturing. There is too much risk in not having access to a sustained supply of products because of the razor-thin margins, and relationships are transitory. Over time, the manufacturers cannot sustain themselves. Moreover, the contract manufacturer works by lot or run and makes products to spec. “There is no room for process improvement nor any funding for R&D nor a means of attracting capital investments. The contract manufacturing vehicle, therefore, is not adequate and drives to an outsourcing model,” he states. “An outsourcing relationship welds the two parties together and allows supplier commitment for capital investment in process improvement, resulting in more revenue to both the asset manager and the food company.”
The A. T. Kearney solution “is different from contract manufacturing because you still have control, but you don’t own the assets,” explains Steinberg. Bendor-Samuel points out that it becomes a pure play. To be competitive and successful in the future, more companies in the food, chemicals and pharmaceutical industries will turn to outsourcing as the solution to their asset and product dilemmas. “Outsourcing provides an improved vehicle that is better able to fund the asset buy,” Bendor-Samuel says. It improves the company’s balance sheet, increases the return on assets and, thus, increases the growth of shareholder value.
The Future of Contract Manufacturing
