The world's largest companies are constantly on the move, looking for new business opportunities in all corners of the globe. Many have experienced incredible success. Caterpillar Inc. grew to become a global leader in construction equipment over 80 years, and Dell Computer Corporation was able to expand from a dorm room hobby to a billion-dollar global high technology supplier in just 20 years.

Despite these and many other successes, the fact remains that most organizations fail to capture the real value of their globalization efforts.

In pursuit of new revenue and lower-cost operations, manufacturers around the world have created ever-more complex networks of marketing, sales and service, sourcing, manufacturing and distribution, and research and development activities. However, those who let their global footprint grow without continuously determining how the pieces could be rationalized and optimized unwittingly build in huge redundant costs and lose opportunities for higher growth and profits.

Over the last two years, we have studied the global operations of nearly 800 manufacturers in North America, Europe, and Asia-Pacific. These companies come from a range of industries including consumer business, automotive, high tech, diversified industrials, pharmaceuticals, and the chemical process sector. Our research finds that most have made little progress in optimizing their operations from a global perspective. Despite launching many improvement initiatives across their global operations, most are overwhelmed by increasing operational complexity. The complexity will only increase as companies continue their global expansion efforts.

Coordinating product development, supply chain, sales, and marketing activities that are oceans and time zones apart will become even more difficult in the years ahead. The reason is continued globalization and fragmentation of most companies' operations. The data on this trend is undeniable. For example, over the next three years, more than 50 percent of North American manufacturers plan to enter or expand sourcing and marketing/sales operations in China. More than 40 percent say they will enter or expand into markets in Central and Eastern Europe. And more than 20 percent will initiate or expand sourcing and manufacturing operations in Mexico.

Such moves cannot help but introduce major inefficiencies into value chains of global manufacturers. In addition, shrinking product cycles means less time for an increasingly dispersed workforce to collaborate and manage product transitions in each product cycle. On average, companies expect new product share of total revenues to hit 35 percent in 2007, a 66 percent increase from 1998.

Despite the clear value of optimizing the value chain, most manufacturers lack the capabilities to do so. Less than a third (30 percent) report a competitive advantage in supply chain cost structure. In comparison, 70 percent say they had better product quality than their primary competitors. Perhaps not surprisingly, over the last three years, they ranked initiatives to improve the supply chain network structure at the bottom of their list of improvements. Less than a third had significant ("extensive" or "near extensive") initiatives to improve supply chain network structure performance over the last three years. Thus, despite the globalization of just about everything, most optimization still remains "local." This is what we refer to as the "global optimization paradox." The paradox and lack of optimization of global and regional networks create a number of problems.

Entering new markets with new or existing products is fraught with challenges. Manufacturers that underestimate the strain on the global network and have limited insight into the true cost of products sold can jeopardize their investments and growth plans. Some companies are pursuing opportunities in low-cost countries such as China without realizing that the gains from lower unit costs of products can be eaten up by huge logistics costs, delays and uncertainty, and regulatory, and tax issues.

Failure to optimize networks

Today, the pace of change in most industries is significantly faster than it was 10 to 20 years ago. Shorter product cycles, new and more diverse sources of supply, and ever-more complex global networks increase the need for continuously optimizing value chain networks. Our research shows that the average time for all manufacturers to bring new products to market will reach less than 13 months by 2007-down more than 30 percent from the 18-month cycle time in 2001. Putting more new products through the "demand" and "supply" chain will further raise cost and complexity-particularly if there are more plants, warehouses, and R&D centers through which those products must pass. Also, as outsourcing of major pieces of manufacturers' value chain continues unabated, companies will find it increasingly difficult to monitor and assess the total network cost and impact of new initiatives. In addition, if they are not executed well, mergers and acquisitions can play havoc with existing networks. Financial markets increasingly penalize companies that make acquisitions without harvesting the fruits of consolidation and optimization of global networks.

More complex economic and political environments-changes in regulations, environmental protection, international trade and investments, currency rate fluctuations, and taxation-compound the problem. This includes recent developments such as increased border controls and security concerns, the continued evolution of World Trade Organization (WTO) rules, the expansion of the European Union, new regulations on environmental safety and health, fluctuating currencies, and the emergence of new global players such as China and India, to name a few.

To meet these new standards, companies must also prove they comply at every stage of the value chain, from design and production, to service and disposal. This means detailed product traceability across the entire global network. To comply, companies will need to spend a lot of money to change current business practices.

Keeping pace with change on a global scale is a challenge for even the best companies. Sony realized this when it had to recall 1.3 million Sony Playstation 1 game systems and 800,000 accessories because of cadmium levels in peripheral coupling cables that did not meet environmental standards.

The global automotive industry is under similar pressure to address environmental issues throughout the product lifecycle. Consider the "End of Life Vehicle Directive" (ELV) in Europe that will come into effect by January 1, 2006. Cars will have to be 85 percent recyclable, increasing to 95 percent by 2015, and up from 75 percent today.

The global chemicals industry is also a ripe target for environmental regulation. If enacted as expected by 2006, new EU legislation-Registration, Evaluation and Authorization of Chemicals (REACH)-would force producers to track up to 30,000 of the estimated 100,000 unregulated chemicals. Companies would have to register these chemicals and prove they are safe.

The impact of the legislation is daunting. While analysts say the United States government is lobbying hard to weaken or stop the new laws, they predict such efforts will only be a stopgap measure. As health issues continue to be uncovered, companies in the leading industrial economies should expect to see increasing legislation in the near future.

Segregated management of functional, business unit and geographic divisions of most companies means that significant opportunity areas for improvement-such as global supply chain redesign or tax-efficient global intellectual property management-are rarely pursued. This silo mentality is further driven by the often short-term considerations of capital markets that companies respond to. Designing and optimizing a network of operations takes time, and most benefits accrue over the life of investments.

One might ask: Is it worth it? Should global manufacturers even consider such wrenching change? The answer is that they should, for several reasons. Global expansion is inevitable. Vast new markets await most manufacturers in areas such as China, India, Eastern Europe, and South America. This will pressure manufacturers to move their supply lines and demand-generating activities quickly. With the rapid acceleration in new product introductions and the need to leverage R&D expenditures on a global scale, companies will face mounting pressure to boost the efficiency of their global networks-not just every 5 or 10 years, but on an ongoing basis. They must ensure new initiatives are always aligned with current and future global network structures. This will help them minimize or avoid costly future network changes and gradual loss of competitive position due to poorly structured operations.

The profits of continuous optimization

The optimization of global networks is not a trivial task. However, it is becoming a key capability of the world's leading manufacturers. In our research, we have identified a small group of global manufacturers that has significantly outdistanced the competition through superior capabilities for managing complex global networks. We call these companies the "complexity masters." These companies not only have better customer, supply chain, and product development operations, they design their operations more holistically when determining where to place and how to manage manufacturing, distribution, R&D, sales, marketing and other activities. The result is a more optimized business with a better balancing of growth goals, cost reductions, and risk. Comprising just 7 percent of all companies in the analysis, and less than 15 percent of the most global companies (quadrant 3 and complexity masters combined), complexity masters are a select group. With profit levels up to 73 percent higher than their competition, higher asset returns, and faster growth, the complexity masters outperform their competitors. Compared to the peer group of the most globalized and complex companies in quadrant 3, complexity masters are nearly 50 percent more profitable.

The most successful manufacturers optimize their global operations holistically. Leading companies such as Procter & Gamble, Toyota, and Dell, are deliberate about including a broad set of relevant factors (such as customer service levels, lead time, flexibility, cost, risk, tax, regulatory issues, and environmental aspects) when making major decisions on sourcing, manufacturing, or new market entry.

Crucially, they understand that building these factors into the design of the network is key to optimization. They know that excluding any of them (such as R&D, tax, and other regulatory issues) can expose the firm to higher costs or additional risks further down the road. This is equivalent to the process of designing new products. If sourcing and design of the supply chain are not taken into account early in product development, a manufacturer can lose 70-80 percent of its future cost reduction opportunities in the lifecycle of its product. The reason: Certain product features and designs can make it harder to reduce cost and incorporate new features and functions quickly and inexpensively later. This principle applies to most other factors as well. As companies restructure their networks to introduce new products, bring in new suppliers, or enter new markets, the optimal design of the network is bound to change as well. And as each restructuring moves beyond the design and planning stage, the ability to efficiently optimize the entire network becomes limited. Continuously optimizing the network to ensure that each new initiative is designed and implemented with the overall network structure in mind is now critical to staying competitive

Doing so requires significant "visibility" into all parts of the value chain-a picture that is aided by better technologies and information processes. It requires better management processes for decision-making and execution. Finally, it requires that top management oversees and supports continuous network optimization. It is not surprising, for example, that complexity masters are up to 50 percent more likely to have one executive in charge of the overall supply chain than other groups studied. Without the organizational, process, and technology infrastructure to support global optimization, most initiatives will fail.

At one of the world's largest industrial product manufacturing companies, a global network optimization initiative boosted performance dramatically. Pressured by competition in an oversupplied market, the company benchmarked its value chain against those of other companies around the globe. The findings showed that the company lagged behind in a number of key areas. The manufacturer then traced the roots of its deficiencies. One factor was its decentralized operations. Because of misaligned incentive structures, country executives rarely worked together to reduce costs or improve operations. Each plant operated largely independently and focused on reducing its own costs. There was little standardization from business unit to business unit in business processes, procedures, performance metrics and software applications. Production allocations to plants were suboptimal. For example, decisions on the product mix at each plant were based on optimizing individual plant utilization and local business unit profitability rather than optimizing overall enterprise profitability and total cost management, including tax, freight, and inventory costs. Even after building a leading-edge plant in one of its largest markets to reduce costs, the company could not deliver the savings because it had inadvertently increased lead times to markets overseas. With high variability in demand, the company quickly realized that increased inventory costs consumed the unit cost savings it had achieved in manufacturing. The company went back to the drawing board. After assessing key value chain functions, it launched a global initiative to restructure and continuously optimize the business.

Supply chain: The global pursuit of lower manufacturing and supply costs

Companies are constantly on the hunt for new growth opportunities-launching new products to expand existing markets or entering new markets with existing or new products. These efforts, however, put significant strains on the global network. Bringing supply chains into new markets not only increases supply chain complexity and costs, it also can create challenges for marketing and sales strategies in other markets. While the initiative may have been "local," the repercussions on the network are "global."

Sourcing from low-cost countries is the obsession of the day at multinationals around the world. Pushed by maturing markets and price competition from competitors in those low-cost locations, companies in all industries are aggressively assessing new locations for sourcing components and manufacturing goods.

For example, our research suggests that China is at the top of everyone's list for sourcing. Over the next three years, 55 percent of North American manufacturers and 39 percent of Western European manufacturers plan to enter or expand their sourcing in China. While the promises are great, the obstacles for leveraging the opportunities are vast. Consider the supply chain challenges. Thirty to 45 percent of the cost of goods sold is logistics cost-up to double the level in Europe and the United States by some estimates-and there are few national third-party logistic providers. Road, air, and rail transportation systems have trouble keeping up with the requirements for a 21st-century supply chain. (One sign of the shortfall: 40 to 50 airports are in the planning stage.) In addition, quality risks are plentiful. One company redirecting sourcing of critical pumps to a Chinese supplier experienced a 70 percent defect rate-seven out of 10 pumps failed-with a severe impact on ongoing operations. Nevertheless, the opportunities for low-cost sourcing and selling to vast and fast-growing markets are too great to ignore. Companies in just about all industries need to find a way to incorporate emerging economies like China and India into their global network.

Despite having product innovation at the top of their growth agenda, few manufacturers are organizing R&D and product lifecycle management operations from a global perspective. From our research, however, it is clear that some companies are better at guarding and exploiting their product innovation and process techniques. They build closer links between R&D, supply chain, and marketing and sales to improve the global design of their networks and maximize profitability over the lifecycle of products and services. Key action points include:

• Build supply chain considerations into product development processes early to make it easy and less expensive to upgrade products. Not surprisingly, complexity masters are much further ahead in using product data and lifecycle management technologies and processes to design more flexible product structures.
  
• Incorporate intellectual property matters into supply chain design initiatives early on to protect patents and manage regulatory and tax issues. After experiencing copyright infringements by competitors from China, Invacare, a U.S.-based medical product manufacturer and distributor with US$1.5 billion dollar in sales, is now including lawyers extensively in the product design process to ensure protection of intellectual assets.

Unlocking the value of globalization through continuous network optimization is important today and will only be more important tomorrow. To effectively optimize their networks, companies must factor in both competitive and compliance drivers. Without deep insight into operations, including current and future customers, distributors, and suppliers and in-depth knowledge of the effects of regulatory, tax, and other issues, it will be difficult to consistently make the right decisions. To get continuous network optimization off the ground, companies must carefully consider their investment in the needed people, organizational, process, and technology capabilities.

Optimization of the global network can no longer be done just every three, five or 10 years. With the dramatic changes that continue to impact global networks, leading companies are building the capabilities to look holistically at their operations on an ongoing basis. This form of continuous network optimization is the goal-a key competitive advantage that can help to substantially differentiate global business networks. As our research shows, companies making the greatest strides in global optimization are reaping the benefits through higher growth, profitability, and shareholder value.

Sidebar: 50% of Companies Fail to Meet the Cost of Capital in their Global Value Chains

Peter Koudal is Director of Global Manufacturing at Deloitte Research, a part of Deloitte Services LP, and focuses on business strategy and performance, supply chain management, customer relationship management, and demand-supply integration and optimization. He recently discussed the background and implications of his report with World Trade Editorial Director Neil Shister.

"There's been lots of research on the performance of the global manufacturing supply chain over the last few years. Using publicly available data our own research suggests that as many as 50 percent or more of the 1000 largest global industrial companies are failing to meet their cost of capital. That's quite dramatic. It says, in effect, that for each dollar you invest in the global value chain, you're getting less than a dollar back."

"The public data, however, doesn't tell us 'why' this is so. In order to find out what drives the globalization process and how it impacts performance, we have surveyed more than 800 companies and business units typically at the COO, CFO and head of operations level. We were particularly interested in their level of capabilities and optimization across their global network."

"In one area we asked companies, "Where do you think your big competitive advantage lies?' and offered 10 choices--product quality, logistics, customer service, etc. Nearly everybody thinks their product quality is better than the competition. But that implies product quality in many sectors is now approaching parity, which means you can't compete on it anymore. When we asked about areas where a company can still create an advantage--supply chain cost structure or time-to-market--only 35 percent or less think they have an advantage. Which means this area is wide open for competitive advantage."

"Take product innovation as an example. Everybody says product and services innovation are at the top of their growth factors for the next three years. But when we ask, 'How are you prioritizing your supply chain strategy to support innovation?' most respondents say, 'Not very high.' Again, the answer is contradictory. They're using standard supply chain metrics at the same time their trying to live off new products which may require wholly different supply chain approaches."

"To gain further insights into the visibility companies have into the performance of their global operations, we ask specific questions to get the answer, like, 'How visible are your metrics into product manufacturing costs? Product profitability? Customer profitability? Customer service level?' The answers generally are very low. Few companies have clear visibility into these kinds of metrics that are key to managing the performance of their global business. The problem is that if visibility into these kinds of metrics isn't very good, then there's little chance that the investment decisions currently being made around the world are optimal."

"Indeed, it's very hard for the average company thinking about globalizing production to put together in advance optimization processes for such things as manufacturing, shipping, direct investment or sourcing location, moving exchange rates, etc. Lots of them are using 'back of the envelope' calculations, relying on unit cost as the prime factor with labor cost being the most significant component. More complicated calculations are necessary to avoid making mistakes. Companies need to develop more sophisticated measures for managing product cost, product profitability, the value of lead time, putting factories in the right places, finding the right customers, pricing products and services correctly."

"What are the lessons? Companies need to optimize holistically with all relevant factors taken into account, including not just standard supply chain metrics but also tax and regulatory issues. And they need to optimize much earlier in the investment phase--in the design phase of product development, new market entry, or new sourcing initiatives in emerging markets. Essentially, at a stage when the entire network of factories, warehouses and business units can be adjusted more economically than later on when adjustments only come at a very high cost."

"Furthermore, because changes in new products, new markets, and new sources of supply are more and more frequent, companies need to create the capability to continuously optimize their global business networks. For most global and complex companies that is a major challenge. However, as our research indicates, the (still few) companies putting in place those capabilities are far better performers than their competitors, with higher profits, returns on assets, and shareholder value as a result."

Sidebar: Global Networks as Works in Progress

Companies have struggled for decades to optimally design and restructure their value chain networks. Yet, the need for network redesign and restructuring has increased for two primary reasons:

1. Competitive Drivers. Not only are the networks themselves more complex than ever, they are also changing at an unprecedented rate. The reasons are many. Product and technology cycles are becoming shorter, time to market is shrinking, new locations for low-cost sourcing are emerging, and customer demand is growing more fickle by the day. This forces companies to constantly rethink the optimal location and configuration of their facilities.

2. Compliance Drivers. Factors such as the complexity and changes in national regulations, taxation, and international trade and investment regimes (e.g., new WTO rules and admission of new WTO members such as China) can wreak havoc with existing network designs.