The Coming Infrastructure Crisis - BCG

The Coming Infrastructure Crisis Is Your Supply Chain Ready?

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The Coming Infrastructure Crisis Is Your Supply Chain Ready?

Pierre Mercier and George Stalk February 2011

AT A GLANCE It’s just a matter of time until our ports, roads, rails, and airports are unable to keep up with the ever-increasing demands we place on them. And as growing congestion impedes the flow of goods, our supply chains will become less reliable and less able to deliver on time and at the expected cost. The Impact on Supply Chains and Profitability The bottom line is that logistics costs will increase significantly—and companies must rethink and redesign their supply chains or become victims. Taking a Strategic Approach Without an effective strategy for the coming crisis, either a company’s supply chain will be overwhelmed by infrastructure constraints or its performance will be undifferentiated from that of the competition. What Companies Can Do Four strategies for improving supply chain performance—boosting process efficiency, improving information flows, reducing variability, and compressing transit times—can lower costs, increase response times, and dramatically improve profitability.

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s the lingering effects of the global recession continue to gnaw at economies around the world, container ships are being laid up and the rail and trucking industries are dealing with layoffs and decreased demand. But this slowdown in the transportation sector can’t mask a fundamental reality: the crisis in the logistics infrastructure that was building before the recession is now just a matter of time. This coming crisis is a megatrend—one that is going to sweep all of us along in its path. Fueled by increasing cross-border trade and rising global demand for everything from toothpaste to automobiles, the growing strain on transport capacity can be seen at the world’s container ports, on the railroads that move goods inland, on highways and urban roads strangled by gridlock, and at airports that struggle to operate with outdated air traffic control facilities and limited runway space. In North America and Europe, these key components of infrastructure—the bones, muscles, and nerves that keep our goods in motion—are not being adequately maintained, much less enhanced. Squeezed by budget constraints, governments are putting infrastructure investment on the back burner. Our ports, roads, rails, and airports cannot keep up with the ever-greater demands we place on them. And as increasing congestion hinders the flow of goods, our supply chains will become less reliable—and less able to deliver on time and at anticipated costs.

The Impact on Supply Chains and Profitability Companies have a choice: to accept the growing infrastructure shortcomings or to take strategic, game-changing action. Few companies think of their supply chains as strategic differentiators, but the ability to deliver goods faster and more reliably than the competition—and at lower cost—will become an increasingly important source of advantage. Given two retailers, one with great merchandising skills and the other with great supply-chain management skills, the retailer with the supply chain skills will always win in the long run. Why? Because it can adjust to changes in demand and will suffer fewer margin-depleting stockouts and overstocks. Unfortunately, many of the supply chain “fixes” we see today are tactical—the type found in any competent publication on supply chain management—and are easily followed by everyone in the industry. They reduce costs and increase effectiveness. But instead of pocketing the savings, most companies lower their prices to stay competitive. As a result, customers reap most of the benefits.

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Without an effective strategy for the coming crisis, either your company’s supply chain will be overwhelmed by infrastructure constraints or its performance will be undifferentiated from that of your competitors. It’s time to rethink your current supply-chain configurations and reexamine the available options. So how does a company move from a tactical supply-chain focus to a strategic one? The first step is to understand the magnitude of the coming crisis: what drives it, how it affects companies, and how to minimize its impact (while your competitors struggle).

Container Port Capacity Is Not Keeping Up with Long-Term Demand Today’s infrastructure discussions center on maintenance. But even if we assume that everything is in perfect shape—roads do not have potholes, trains do not derail, and bridges do not fall into the Mississippi River—we are facing a serious problem. For example, until the first half of 2008, container ports on both the West Coast and East Coast of North America were nearing capacity as imports and exports from China and other Asian countries soared. In the last ten years, container volume in and out of North America has grown by about 27 percent. By some estimates, demand for container handling was projected to outstrip port capacity in 2010.

By some estimates, demand for container handling was projected to outstrip port capacity in 2010. The recession postponed this day of reckoning—but we could reach the pinch point in 2015.

The recession postponed this day of reckoning. Those in the transport industry now believe that ports in North America will reach the pinch point in 2015. Similar constraints are predicted for Western Europe, but not as soon. The United States has invested nearly $7.5 billion in port expansion and modernization in the last five years, but Western European nations have invested heavily too, and they are relatively less dependent on goods made in Asia. Most existing container ports in North America and in much of Western Europe are “city locked.” That is, they are almost completely surrounded by water and city. Few city residents are fans of container ports, which are seen as unsightly, noisy, polluting, and contributing to road congestion. In fact, the U.S. Environmental Protection Agency is currently seeking to tighten pollution controls on ships entering U.S. ports and on the trucks that service those ports. There is not much hope for expansion of the container-handling capacity of the West Coast ports of North America. Plans to increase contiguous land use for container handling are hopelessly bogged down in political wrangling from Vancouver to the port cities of Los Angeles and Long Beach. The expansion of the Panama Canal will double its capacity and allow the passage of larger ships. The Panama Canal Authority continues to maintain that the project will be completed on schedule in 2014, which may ease congestion at the Los Angeles and Long Beach ports. But this is a very ambitious project that many feel is underbudgeted and aggressively scheduled.

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The Coming Infrastructure Crisis

Land Transport Networks Are Becoming Saturated In 2006 and 2007, the railways that carry containers inland were near capacity in many key U.S. cities, including Los Angeles, Chicago, Atlanta, and New York. The expected transit times from the ports of Los Angeles and Long Beach to Chicago had increased steadily from 84 hours at the end of 2004 to 134 hours in early 2008. The problem would likely have worsened had the recession not arrived. There is a public perception that Western Europe was prescient by building a modern, fast railway system while the United States allowed its system to languish. With regard to freight, however, the facts do not support this perception. About 70 percent of freight tonnage in North America travels by rail, compared with less than 30 percent in Western Europe, where the bulk of the tonnage moves by trucks over roadways and a smaller amount—about 6 percent—is carried by inland waterways. What’s more, the pan-European freight-rail system is plagued by mismatched track gauges (the width of the track), inconsistent electrical standards (three in Spain alone), and customs and operating procedures at country frontiers that verge on harassment. Europe is limited in its ability to expand its freight-rail capacity because of the same “city locked” problem faced by North American ports. Other barriers in Europe include rails saturated with passenger traffic, the high cost of rail shipments for short distances, and relatively slow transit times. Highway systems in North America and Western Europe are also feeling the strain. One measure of the capacity to move vehicles is lane miles. The United States greatly expanded its lane miles in the 1950s, 1960s, and 1970s, but growth has since slowed dramatically and lane miles are now expected to double only about every 370 years. Meanwhile, the load factor on the system is projected to double every 30 years (load factor equals total vehicle miles traveled divided by lane miles). In other words, the load factor is growing more than ten times as fast as capacity. Even more alarming, the increase in load factor is not uniformly spread across North America but is concentrated in population centers, including Los Angeles, San Francisco, Seattle, Chicago, Atlanta, and the Northeast. One measure of the impact of this concentration is that yearly delay times (time lost stuck in traffic) for major metropolitan areas in the United States increased from 14 hours per year in 1982 to 36 hours per year in 2007. (The situation is comparable in Europe.)

Airports and Airways Are Also Under Pressure Air freight poses another set of challenges. Airports in North America and Europe are hamstrung by very congested air traffic control systems, limited runway capacity, and a shortage of fuel-efficient air freighters. The U.S. Federal Aviation Authority (FAA) is attempting to rebuild the country’s outdated air traffic control system. According to an FAA press release in May 2007, “The current system is already straining and will reach gridlock by 2015 if we fail to act.” The FAA’s sense of urgency is understandable. Even if the planned improvements are in place by 2015, congestion will still be a critical issue. The five U.S. airports with the highest volumes—San Francisco, Los Angeles, Chicago, New York,


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There is a public perception that Western Europe built a modern, fast railway system while the U.S. allowed its system to languish. The facts, however, do not support this perception.

and Philadelphia—will be far from trouble free at that point in time. Moreover, if current trends continue, the number of severely congested airports will increase to 14, including such unlikely airports as the one in Providence, Rhode Island. But air traffic control is just one aspect of the air transit challenge. Airport and runway capacities are also strained. In the last 40 years, only three major new airports have been built in North America: Dallas/Fort Worth International, Montréal-Mirabel International, and Denver International. All were meant to replace existing airports. For political reasons, Mirabel is now closed to scheduled commercial-passenger traffic, although it is still used for freight and general aviation. Some countries are building freight airports dedicated to cargo, such as Paris-Vatry in France, which will help reduce airport loads. An airport’s air-transport capacity is very strongly related to its runway capacity. Since 1975, 41 new runways have been announced at U.S. airports. Of these, 16 have been canceled or are stalled because of lobbying by special-interest groups. Approvals and construction tend to proceed at a glacial pace. The 25 completed runways took from 2 to 30 years to build, with an average time of about 11 years. In Europe, the situation for air traffic control, airports, and new runways is similar to that in the United States. London continues to debate the merits of building either a third runway at Heathrow or possibly even a new airport, while Paris’s Charles de Gaulle Airport struggled to get four runways—and to get clearance to use them once they were built. But there are other complications, including flight path restrictions, different unions in different countries, and more.

Since 1975, 41 new runways have been announced at U.S. airports. Of these, 16 were canceled or are stalled—and the 25 completed runways took from 2 to 30 years to build, with an average of 11 years.

Only in Asia—particularly in China and India—is air transport capacity increasing. In 2008, the Chinese government announced its intention to build 97 new airports throughout the country by the year 2020. It should come as no surprise that the Chinese will also be building more than 80 container-handling terminals in the next five years, compared with three in North America.

How the Infrastructure Crisis Will Affect Companies The bottom line is that logistics costs will increase significantly—and companies must rethink and redesign their supply chains or become victims. Although the global recession severely dampened demand and decreased the load on the transportation infrastructures of North America and Western Europe, the congestion problem is still waiting in the wings. Managers obsessed with fuel costs should also factor in congestion costs, which not only increase the time it takes to move goods but also drive up all operating costs per ton handled. At most companies, the networks of suppliers, factories, distributors, and retailers that form the global supply chain (sometimes called the “business footprint”) were built in the 1950s, 1960s, and 1970s. During this time, logistics costs steadily declined as transportation efficiencies increased and the cost of fuel decreased in real terms. That’s why people built big plants and distribution centers in remote, inexpensive locations, transporting goods made in the backcountry of Iowa to points of sale in Chicago and Pittsburgh. Better roads, trucks, and scheduling, along

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with the growth of containerization and intermodal shipping, resulted in steadily increasing transportation efficiencies on highways and railroads. The most significant recent change to the supply chains of many companies took place in the 1980s and 1990s, as companies began sourcing from China and other Asian countries. These changes caused supply chains to be more geographically dispersed and complicated as companies sought to achieve the lowest landedproduct costs through a combination of low-cost sourcing and world-scale manufacturing facilities. In the pursuit of lower costs, however, many companies saddled themselves with long and sometimes unreliable supply chains that were far harder to manage. As infrastructure demand outstrips capacity, companies that built their supply chains over the last 40 years and that ship their goods by some combination of sea, land (rail and road), and air will be profoundly affected. For instance, Procter & Gamble’s logistics costs already exceed such key value-adding costs as manufacturing. Longer supply chains also increase inventory levels as well as the carrying costs related to financing and storing this inventory to maintain in-stock service levels. Fuel costs rise as well, because congestion lengthens the total time needed to move goods. These are just the first-order costs, however. The second-order implications of congestion are greater, more insidious, and more difficult to manage because they are harder to see. The more time needed to move from the supply source to the point of sale—and the greater the number of steps in the supply chain—the more challenging it becomes to match supply and demand at each step. Supply and demand are easily matched if demand is steady over time with no change in volume or mix. But as soon as demand changes, a company must adjust supply levels accordingly at each step of the chain. Given the lag time before changes in demand are actually felt at various points along the supply chain, however, their effects are often amplified when they hit, leading to inventory shortages or pileups. Companies then tend to overcompensate by slowing or speeding production lines, and inventory levels can fluctuate wildly. This is the “whipsaw” effect, and congestion can exacerbate it. This dynamic can drive vicious cycles of stockouts and missed sales, inventory overstocks and deep discounting, high carrying costs, and inevitable write-offs. These second-order costs can be significant. Lost profits from a stockout equal the gross margin of a product—generally in the range of 20 to 50 percent but as much as 90 percent for some fashion products. Product overstocks result in discounted prices—usually about half to two-thirds of the gross margin. For fashion products with their generally higher gross margins, the loss can be much greater. These are the often-hidden costs that companies must identify, measure, and manage as they respond to the looming infrastructure crisis. But doing so requires an integrated, systemwide approach, because taking action in one area can have consequences elsewhere—for better or for worse. Instead, however, most companies will focus on consolidation, layoffs, and other ways to reduce overhead.


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The more time needed to move from the supply source to the point of sale—and the greater the number of steps in the supply chain—the more challenging it becomes to match supply and demand at each step.

Second-Order Implications: How Congestion Affects a Supply Chain Consider a basic supply chain with a factory, a distribution center, and a point of sale. When supply and demand are steady and predictable, a product with a $10 price has a profit of $3 after subtracting manufacturing and distribution costs. Now imagine that the same supply chain must deal with the effects of congestion for just one random week in the course of a year. The resulting increase in costs from stockouts and overstocks would reduce that $3 profit to $0.77. This is the impact of the whipsaw effect. If the product is sourced from a distant, low-cost country such as China and shipped to the United States or Western Europe, the gross profit increases from $3 to $4. But the added handling and transportation costs and the cost of the whipsaw effect reduce the operating profit to about $1.21. Sourcing from China is still cheaper than domestic sourcing, but not by as great a margin as the factory-to-doorstep comparison would suggest. If port, rail, and road congestion are considered, both the length and variability of transit time increase dramatically. This has a devastating impact on the economics of sourcing from China, with the average operating profit of $1.21 plummeting to an average loss of $1.43.

If port, rail, and road congestion are considered, both the length and variability of transit time increase dramatically. This has a devastating impact on the economics of sourcing from a distant country.

If transit times for the China-sourced product could be reduced by one-third through aggressive cycle-time improvements, this potential loss would become a profit of more than $2 and would again be competitively advantageous relative to domestic sourcing. Similarly, if cycle-time reductions could cut delivery times in half for domestically sourced products, then the decrease in overstocks and stockouts would cause profits to soar from an average of $0.77 to $2.19—in other words, domestic sourcing would have an edge over China sourcing. But these improvements would require aggressive, focused efforts to reduce supply chain cycle times, as described in the next section. The key takeaways are clear:

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Supply chain transit time and variability can dramatically affect profitability.

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Congestion from the infrastructure crisis is increasing supply chain transit time and variability and will be a growing impediment to profitability.

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Unless the infrastructure crisis is addressed, the costly first- and second-order effects of congestion will increasingly offset the cost savings of offshoring.

What Companies Can Do Companies cannot reverse the looming infrastructure crisis by themselves, but they can minimize its business impact—and gain a strategic advantage over less-prepared competitors—by enhancing supply chain performance in four critical ways:

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Boosting process efficiency


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Improving information flows

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Reducing variability

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Compressing transit times

The competitive advantages can be substantial. (See the sidebar “Staying Ahead of the Competition.”) Boosting Process Efficiency. In most businesses, the time needed to fill a customer

order or provide a service is just a small fraction of the elapsed time between order and delivery—because most order-to-delivery processes are woefully timeinefficient. A truck manufacturer may take 45 days to prepare a vehicle order for assembly but only 16 hours to actually assemble the vehicle. The vehicle is worked on less than 1 percent of the time from order to final assembly. The rest of the time

Staying Ahead of the Competition BCG’s founder, Bruce Henderson, said, “You don’t have to be the best. You just have to be better than your competitors.” Having a fast and reliable supply chain when competitors are struggling is a huge advantage. Companies in this enviable position can do the following:

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Commit to quick-turnaround orders

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Be more flexible when customers want to change their order mix and volume

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Increase variety, freshness, and turnover of store offerings

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Gain leverage with key suppliers and ensure preferential treatment

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Squeeze competitors by lowering prices—or respond to changes in input costs more quickly

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Give customers better terms and service to strengthen loyalty and increase share of wallet

is spent waiting for three things: completion of the batch that the product is part of; completion of the batches ahead of the batch that the product is part of; and management’s decision to send the batch on to the next step of the production process. Working harder has only limited impact, but working smarter can save an enormous amount of time. Companies that reduce batch sizes—whether for physical goods or packets of information—and streamline the workflow will sharply improve productivity. When a manufacturer of hospital equipment reduced standard lot sizes by 50 percent, production times plunged by 65 percent. By streamlining the production process to cut back on material handling and intermediate steps, the company was able to reduce total process time by another 65 percent. Time productivity more than doubled.


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The same concept applies to supply chains. One source of delays that companies could often manage better is the customs clearance process. Shipments that do not match the paperwork can easily result in two or three days’ lag time. To speed up the process, aim for error-free matching of container content and paperwork, send the proper documentation electronically, and pay specialists to “hot hatch” your goods and shepherd them through customs. (“Hot hatching” involves loading containers last and offloading them first.) Speeding up delivery can result in remarkable performance improvements. A 25 percent reduction in the time needed to deliver a product or service can double the productivity of labor and working capital, leading to cost savings of up to 20 percent. Companies that deliver value more quickly than their competitors grow faster and are more profitable.1 Improving Information Flows. Forecast accuracy and constant monitoring of

demand are critical for supply chain performance. Without good information, decision-making suffers. Aim for integrated, global IT systems for greater transparency and control, and make decisions on the basis of a high-level, cross-enterprise perspective. The most up-to-date information on inventory levels, capacity utilization, sales, and changes in demand should be communicated early and often throughout the supply chain to improve response times. This can be a challenge, because information systems both inside and outside a company are not always compatible. Compounding the problem is the fact that supply chains are often managed in a top-down, linear fashion: the original equipment manufacturer (OEM) tells its tier 1 supplier what it needs, and the supplier interprets and modifies the request and passes it on. This can result in delays or distortions in communications that ripple down the supply chain. An alternative approach is the “networked” supply chain, with information on all aspects of operations broadly shared so that all parties act on it in a timely manner. OEMs in the auto industry have a long history of integrating their suppliers—creating transparent, interconnected systems that support just-in-time production and virtually eliminate downtime. Suppliers take responsibility for stock replenishment and have a clear view of what parts are needed for each day’s production schedule. Toyota has demonstrated the power of its networked system many times, including its spectacular recovery from a fire at a Japanese brake-valve factory in 1997 that threatened to shut down the automaker for months. Within hours, Toyota and its network of suppliers began working together to produce an uninterrupted supply of production-quality valves, setting up ad hoc production lines wherever factory space could be found. Roughly two weeks after the halt, the entire supply chain was back to full production.2 Supply chain speed and responsiveness are exponentially better with this networked approach than with a top-down management structure, and the right information systems—such as collaborative planning, forecasting, and replenishment (CPFR) tools—are critical. For instance, Wal-Mart’s “Retail Link” offers an electronic bridge to the retail giant’s suppliers, providing data on sales and invento-

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ry levels and allowing them to download purchase orders. This close integration also gives suppliers a better sense of true demand, which can lead to optimized inventory levels throughout the supply chain. The Internet offers a cost-effective way to better integrate information, and IT service providers can assist in this area as well. Also, some international freight companies, such as United Parcel Service and FedEx, provide logistics services to help companies better manage the flow of information and goods. External partners or contractors can often offer services more effectively and inexpensively owing to the expertise and scale that come from having a large customer base. Reducing Variability. Generally speaking, the longer your supply chain, the greater

is the risk of variability. But most supply-chain variability is self-inflicted, the result of poor planning and needless complexity in processes, products, and portfolios. Companies can eliminate much of this variability by rigorously attacking its root causes. As previously noted, improving process efficiency will reduce production cycle times, a good first step toward reducing variability. But companies should also look for ways to shorten and simplify their supply chains, which can greatly improve performance. Consider sourcing some products closer to home—from Mexico for North American markets, and from Central and Eastern Europe for markets in Western Europe. (See Global Sourcing in the Postdownturn Era, BCG White Paper, September 2010.) In a growing number of situations, this “near” sourcing results in lower costs at the point of sale. Other companies are moving away from high-volume, world-scale plants that make just a few broadly distributed products, and instead are building smaller plants that make a wider range of products for local markets. Increases in unit production costs are often more than offset by lower logistics costs, faster replenishment cycles, and fewer stockouts and overstocks. Rethink distribution logistics, too. When feasible, build regional warehouses to keep inventory closer to customers. To minimize the impact of demand volatility and improve overall flexibility, companies should keep their options open wherever possible—by delaying customization or final assembly, for instance, or by warehousing inventory until demand signals are clearer. If feasible, shorten lead times, shift from a make-to-stock approach to a make-to-order approach, and reserve extra capacity or set up resource-sharing arrangements with other companies. Finally, consider establishing a large, centralized distribution center instead of many smaller local ones, which can dilute and distort demand signals. Compressing Transit Times. Besides improving process efficiency and shortening their supply chains, companies can improve cycle times by rethinking how they transport their goods. One tactical approach is to make more use of air freight. Ocean shipping costs account for 0.5 to 2 percent of the shelf price of most products. Air cargo costs per ton are four to six times greater than ocean shipping costs. For the right products, however—those with high margins, high variability of demand, a limited shelf life, or short product life cycles, such as fashion and technology items—the added costs of air freight are more than offset by the positive


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Supply chain speed and responsiveness are exponentially better with a networked approach than with a top-down management structure—and the right information systems are critical.

impact on profits of fewer stockouts and overstocks. Air freight can take weeks out of China-anchored supply chains that serve North America and Western Europe. Other options for compressing time that may justify the added cost include the following:

For the right products—such as fashion and technology items—the added costs of air freight are more than offset by the positive impact on profits resulting from fewer stockouts and overstocks.

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Arrange for hot hatching. Many leading retailers pay a premium for this service to ensure that their merchandise arrives at stores more quickly.

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Use “unit trains.” These are dedicated trains that bring goods straight to their destination to avoid transportation delays and rail-yard layovers. American President Lines offers this service from its terminals in Tacoma and Long Beach to eastern destinations.

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Build container-handling facilities. To ensure timely handling, companies can buy or build their own land-based container-handling facilities.

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Reserve supplier capacity. Companies can buy and hold capacity for key inputs from suppliers to ensure that they receive preferential treatment if demand fluctuates and shortages occur.

These four strategies for improving supply chain performance—boosting process efficiency, improving information flows, reducing variability, and compressing transit times—can lower costs, increase response times, and dramatically improve profitability. With greater profits, companies can invest more in the business, develop new business models, and change the rules of the game—pulling even further ahead of the competition.

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any companies underestimate the strategic importance of fast, reliable, and effective supply chains. Although most know that supply chain management is important, few realize the full, often-hidden costs of longer and more variable transit times and reduced responsiveness—and the dramatic impact of these factors on profitability. The infrastructure crisis presents a major strategic opportunity for forward-looking companies that understand—and are ready for— the coming challenges.

Notes 1. For more information, see George Stalk, Jr., “Time—The Next Source of Competitive Advantage,” Harvard Business Review, July–August 1988. 2. For more details, see Philip Evans and Bob Wolf, “Collaboration Rules,” Harvard Business Review, July–August 2005.

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About the Authors Pierre Mercier is a partner and managing director in the London office of The Boston Consulting Group. You may contact him by e-mail at [email protected]. George Stalk is a senior advisor and BCG Fellow in the firm’s Toronto office. You may contact him by e-mail at [email protected].

Acknowledgments The authors would like to thank Katherine Andrews, Gary Callahan, Martha Craumer, Kim Friedman, and Janice Willett for their contributions to the writing, editing, design, and production of this report.

For Further Contact If you would like to discuss this report, please contact one of the authors.


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