Future of retail operations: Winning in a digital era

January 2020

This compendium explores the breadth of change

and risk throughout the modern retail industry.

Future of retail

operations: Winning

in a digital era

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Contents

Store operations

Supply chain

A transformation in store

Brick-and-mortar retail stores need to up their game.

Technology could give them a signicant boost.

Smarter schedules, better budgets: How to improve

store operations

Through activity–based labor scheduling and budgeting,

retailers can become more ecient while improving customer

service and employee satisfaction.

Bending the co

st curve in brick-and-mortar retail

Retailers can achieve next-generation store eciency

by breaking down silos and optimizing total cost across the

value chain.

Supply chain of the future: Key principles in building

an omnichannel distribution network

As omnichannel shopping is becoming the new norm,

consumer and retail companies must be ready to deliver fast,

impeccable omnichannel service. Doing so requires a new

supply chain network approach.

A retailer’s guide to successfully navigating the race

for same-day delivery

Same-day delivery: Consumers’ expectation for same-day

delivery is rising and putting pressure on retailers’ supply

chains.

Better service with connected inventory

It is not just the customer experience that manufacturers

and retailers enhance by extending their reach to the entirety

of stocks in the market.

Hamburg

Cologne

Munich

>1,000,000

Inhabitants

>500,000–1,000,000

>200,000–500,000

Warehouse

coverage

Retailer same-day o ering

in top 20 cities

Amazon vs top 20 non-food

and top 13 grocery retailers

Same-day coverage of relevant population,1 Amazon vs disguised

omnichannel fashion retailer

by type of competition, %

28 stores across Germany, covering 5 of

Germany’s 20 biggest cities

Ongoing testing and buildup of

ship-from-store capabilities

Competition area

(Amazon and retailer)

Area at risk

(Amazon only)

Retailer

monopoly area

(retailer only)

Source: Alteryx; BKG; ESRI ArcGIS; MB-Research; McKinsey analysis

Relevant population areas dened as high density (>750 inhabitants/km²) and/or high income (purchasing power >€21,900 per capita); viable market

coverage dened as area within 30 minutes driving time from respective retail location.

Population 22 16 7

23 17 7

Purchasing

power coverage

Viable market coverage for same-day

delivery via ship from store1

Relevant population areas dened as high density (>750 inhabitants/km²) and/or high income (purchasing power >€21,900 per capita); viable market

coverage dened as area within 30 minutes driving time from respective retail location.

Stores

100

Source: Alteryx; BKG; ESRI ArcGIS; MB-Research; McKinsey analysis

Store location

Berlin

Beyond procurement: Transforming indirect

spending in retail

If retailers treat indirect costs as an opportunity for business

transformation rather than just a procurement matter, they can

boost return on sales by as much as 2 percent.

Rethinking procurement in retail

For retailers, procurement is no longer solely a matter

of negotiating “A” brands. Private labels and verticalization

are trending. Advanced approaches and tools help get

procurement in shape for the future.

Six emerging trends in facilities management

Outsourcing, workplace strategies, and technology innovations

hold immense potential for companies seeking to reduce costs

and improve productivity in facilities management.

The end of IT?

Retailers who want to stay ahead of the pack and drive

business results through technology innovation are rethinking

the setup of their IT departments.

Automation in logistics: Big opportunity, bigger

uncertainty

As e-commerce volumes soar, many logistics and parcel

companies hope that automation is the answer. But as this

second article in our series on disruption explains, things

are not so simple.

Next–generation supply chain—transforming your

supply chain operating model for a digital world

In a digital age, most supply chains run on old principles and

processes. A few leaders can show us how a new operating

model can answer the demands of today—and tomorrow.

Supply chain

(continued)

Procurement

Tech

The invisible hand: On the path to autonomous

planning in food retail

It’s not news to food retailers: sometimes your stocks are too

high, sometimes they’re too low. Advanced planning now gives

them entirely new options for solving the expensive problem—

and cuts costs in the process.

Future of retail operations: Winning in a digital era January 20202

Heightened customer expectations, massive advancements in technology, and the rise of omnichannel

commerce are just a few of the trends reshaping the world of retail. In an industry already known for thin

margins, these changes can increase cost pressures and uncertainty for retailers—all while opening the

door to significant opportunities. Traditional approaches will no longer work in the face of change; now is

the time to clearly define new aspirations, make fundamental changes to operating models, and rethink

retail. Those that make moves now may enjoy a sustained advantage for decades to come.

In this publication we examine some of the most pressing challenges retailers face and the transformative

journeys many are on right now. You will find a range of new perspectives across retail operations,

including, store operations, supply chain, procurement, and information technology (IT). As the rules of

retail are being redefined, these fundamental areas of retail operations are in need of fresh thinking.

Introduction

McK Retail compendium 2020

Introduction

Exhibit

Retail operations

Store operations Supply chain Procurement

Information technology (IT)

We provide a new take on store operations—while flashy technology attracts and engages customers

in the “store of the future,” the make-or-break technology is actually behind the scenes. That’s the

technology that gathers and connects data for a seamless customer experience. In our own “store of the

future” this includes dwell sensing, RFID, heavy investments in the data lake, and the logic needed to map

the customer journey. But technology is only one piece of the puzzle; solving the operations equation also

involves analytics, new store processes, and upskilling the store team. Such a transformation can add

several points of profitability to the average store.

Introduction 3

In supply chain, we identify the measures successful companies have taken, which include fundamentally

transforming their supply chain to enable a true omnichannel experience, taking more agile approaches

when designing their supply chain network, building new capabilities, and adjusting their operating model.

We take a look at how retailers can keep up with customer expectations as omnichannel shopping becomes

the new normal—including building and maintaining a connected inventory strategy, which increases

transparency and access to stock wherever it sits in the supply chain to better fulfill customer needs.

In procurement, we explore the unrealized opportunity in indirect spending—spend on goods or

services not for resale. Companies can and should take a closer look at indirect spending and embed

new processes and ways of working—including using more sophisticated analytics tools, strengthening

supplier collaboration, and taking a broader, business-level view of indirect spend, rather than making it

simply a procurement issue. Retailers that elevate indirect spending initiatives can cut costs, capture more

value, and uncover cash that can be reinvested as part of a broader business transformation.

We recognize that today, nearly every change a retailer makes depends on technology solutions—and

they often fall short of expectations. With an entrenched divide between the IT department and the rest

of the company, many brick-and-mortar retailers struggle to get value out of their IT investments—or get

started at all. Retailers must become technology-driven organizations, and that will require upending

the status quo. In the end, transforming mind-sets, capabilities, and ways of working is critical not only in

established IT areas like application development and infrastructure but in core commercial divisions like

sales, merchandising, supply chain, and marketing.

Through our research and analysis, we seek to identify opportunities, provide insight into how to act on

them, and learn from those that have forged ahead. We hope these perspectives on retail operations aids

your organization in embracing change and realizing a new vision for retail.

4 Future of retail operations: Winning in a digital era January 2020

Frank Sänger

Senior Partner, Cologne

Karl-Hendrik Magnus

Partner, Frankfurt

Praveen Adhi

Partner, Chicago

A transformation

in store

by Praveen Adhi, Tiany Burns, Sebastien Calais, Andrew Davis, Gerry Hough, Shruti Lal, and Bill Mutell

STORE OPERATIONS

Brick-and-mortar retail stores need to up their game. Technology

could give them a significant boost.

5A transformation in store

Now should be a great time in US retail. Consumer

confidence has finally returned to pre-recession

levels. Americans have seen their per capita,

constant-dollar disposable income rise more than

20 percent between the beginning of 2014 and

early 2019.

Yet despite the buoyant economic environment,

many brick-and-mortar stores are struggling.

In part, that’s due to the rise of e-commerce,

which since 2016 has accounted for more than

40 percent of US retail sales growth. In our

most recent consumer survey, 82 percent of US

shoppers reported spending money online in the

previous three months, and the same percentage

used their smartphones to make purchasing

decisions. Not surprisingly, younger shoppers favor

e-shopping even more: 42 percent of millennials

say they prefer the online retail experience and

avoid stores altogether when they can.

Meanwhile, the strong economy and record-low

unemployment are increasing wage pressure and

store operating costs. In the last three years, more

than 45 US retail chains have gone bankrupt.

Retail stores have a real future

Yet rumors of the physical store’s death are

exaggerated. Even by 2023, e-commerce is

forecast to account for only 21 percent of total

retail sales and just 5 percent of grocery sales.

And with Amazon and other major internet players

developing their own brick-and-mortar networks,

it is becoming increasingly clear that the future of

retail belongs to companies that can offer a true

omnichannel experience.

Retailers are already wrestling with omnichannel’s

demands on their supply chains and back-office

operations. Now they need to think about how they

use emerging technologies and rich, granular data

on customers to transform the in-store experience.

The rewards for those that get this right will be

significant: 83 percent of customers say they want

their shopping experience to be personalized in

some way, and our research suggests that effective

personalization can increase store revenues by

20 to 30 percent.

Several new technologies have reached a tipping

point and are set to spill over onto the retail

floor. Machine learning and big-data analytics

techniques are ready to crunch the vast quantities

of customer data that retailers already accumulate.

Robots and automation systems are moving out

of factories and into warehouses and distribution

centers. The Internet of Things allows products

to be tracked across continents or on shelves

with millimeter precision. Now is a great time for

retailers to embrace that challenge of bringing

technology and data together in the off-line world.

The evolving consumer journey

How will these technologies reshape the shopping

experience? To find out, let’s follow one consumer on

a journey through the store of future (Exhibit 1).

As Jonathan arrives at his favorite grocery retailer,

the store recognizes him, its systems alerted to his

presence either as his smartphone connects to the

in-store Wi-Fi or perhaps by a facial-recognition

technology that he has signed up to use. Once

Jonathan agrees to log in, the store accesses the

Several new technologies have reached

a tipping point and are set to spill over

onto the retail oor.

STORE OPERATIONS

6 Future of retail operations: Winning in a digital era January 2020

shopping list he’s been building at home by scanning

items with his phone as he uses them up. As he walks

the aisles, smart shelf displays illuminate to show

the location of those items, while also highlighting

tailored offers, complementary items, and regular

purchases that didn’t make it onto the list.

Jonathan is tempted by a new, personalized

promotion that pops up on his phone as he

approaches the prepared-meals aisle. But because

he prefers organic foods, he wonders about the

product’s ingredients. As he scans the package

with his smartphone, an augmented-reality display

reveals the origin of its contents, along with its

nutrition information and even its carbon footprint.

His bag full, Jonathan leaves the store. There was

no need to check out: RFID scanners and machine-

vision systems have already identified every item

he packed, and his credit card, already on file in the

retailer’s systems, is debited as he passes through

the doors.

The evolving associate and

manager journeys

Technology won’t just reshape the customer

experience in tomorrow’s stores: working in retail

will look will look very different too (Exhibit 2).

David works part time as an associate in the store’s

fresh-foods department, fitting in shifts around his

studies and family life. He negotiates his schedule

each week using a mobile app. The store runs a

bidding system, and staff can earn a premium by

volunteering for busy or hard-to-fill shifts. The

technology also makes it easy for David to trade

shifts when he has a conflict.

The store rarely struggles to get the people it needs,

however. David loves working there because he

is passionate and knowledgeable about food. His

duties include some manual tasks such as stocking

or picking for online orders, but the work is light.

Sensors on and above the shelves monitor the

status of stock, a machine-learning system plans

Exhibit 1

2019

A transformation in store CJ

Exhibit 1 of 3

The consumer’s journey is evolving.

Based on dened-benet pension funds with funds under management >$1 billion with allocation to private equity.

Source: Pensions & Investments; McKinsey analysis

Technology powers

shopping convenience

In-store communications not

only help customers nish

their shopping lists but also

provide tailored promotions

and detailed product

information. And they

eliminate checkout lines.

7A transformation in store

the replenishment schedule, and items are delivered

or taken away by robot carts that glide silently and

safely through the store.

David spends most of his time interacting with

customers, offering advice on new products and

recipes or answering their questions. He has

a handheld terminal that he can use to acquire

information on each customer’s preferences and

shopping habits. If a customer can’t find something

on the shelves, he can pinpoint the location and

real–time stock level of every item at a glance or

suggest different items based on that customer’s

shopping habits.

Meanwhile, Rebecca, the store manager, is thinking

about plans for a big new promotion that starts next

week. The project will involve significant changes

to the range of items on display including setting

new fixturing in the produce area. But that’s nothing

new: the store is always adapting its stock and

presentation, and Rebecca spends most of her time

working with colleagues to improve and fine-tune

its offerings. It helps that many previously time-

consuming tasks, such as associate scheduling and

reporting, are now handled automatically by artificial-

intelligence tools. Her phone alerts her when a

situation needs real attention in real time, such as a

promotion that’s not selling as well as in other stores.

This means she can focus her efforts on performance

and service improvements, aided by the store’s

sophisticated performance-analysis systems.

David and Rebecca already have a pretty good

idea of how the new promotional set will work

because they’ve tried it out in virtual reality using an

interactive digital twin of the store. Conversations

with customers have given them an idea for

tweaking the offer’s presentation, and they are

discussing the possible changes now to boost

sales, rather than rigidly adhering to a formula

devised and handed down from above.

Exhibit 2

2019

A transformation in store CJ

Exhibit 2 of 3

The associate’s journey is also changing.

Based on dened-benet pension funds with funds under management >$1 billion with allocation to private equity.

Source: Pensions & Investments; McKinsey analysis

New tools improve retail jobs

Mobile–based shift planners

let associates manage their

schedules and give them more

detailed, accurate information

so they can have better

interactions with customers.

STORE OPERATIONS

8 Future of retail operations: Winning in a digital era January 2020

The financial impact of

in-store technology

There’s another area that is set to look very different

in the store of the future, and that’s the store’s P&L

sheet. And while our example has been taken from

grocery retail, this impact will be noticeable across

the sector. Personalized offerings and optimized

assortments will likely raise sales and cut waste,

while opportunities to upsell and cross-sell, either

automatically or in person, can increase basket sizes

and conversion rates.

The profile of the workforce will change as well:

skilled and knowledgeable associates will expect

to earn more, pushing hourly rates up by about

20 percent. Total wages are likely to fall, however, as

automation and technology help shift the balance

of labor spend toward value-added and customer-

facing work.

Overall, we believe the store of the future is likely to

achieve EBIT margins twice those of today, with the

added benefits of improved customer experience,

better employee engagement, and an easier-to-

run store (Exhibit 3). The technology necessary to

achieve this transformed P&L is available now, and

we calculate that it is ROI-positive.

Are you ready?

The store of the future is still in its infancy, but every

one of the technologies described above exists

today as a commercial product not just a prototype

or proof-of-concept. Retail leaders should act now

Exhibit 3

2019

A transformation in store CJ

Exhibit 3 of 3

Technology will likely double store protability.

Earnings before interest and taxes.

Sales, general, and administrative.

2-4%

Inventory

management

Current

EBIT¹ margin

Back-oce

automation

Labor

headwinds

In-store labor

automation and

robotics

-2-3%

Customer

experience

Future EBIT

margin potential

0.5-1%

2-4%

1-2%

1-2% 5-9%

Increase of

3 to 5

percentage

points

Warehouse-

to-shelf

automation,

next-gen

cameras,

supply chain

optimization

Reduction in

shrink

by 20% from

advanced analytics

10% reduction

in store-

management

and SG&A²

costs

Use of in-store

assets to drive

sales (electronic

shelf tags,

consultative

selling tools)

20% increase

in minimum

wages

and benets

increases

Each retailer will

decide what

portion of EBIT

to reinvest

into price/customer

9A transformation in store

to prepare their organizations for a technology-

enabled revolution in customer experience and

efficiency. Ask yourself how your organization is

doing:

— Do you understand the level of performance

your network will need to achieve over the

next decade?

— Have you identified the primary use cases for

technology-enabled improvements to efficiency

or customer experience?

— Are you already testing and piloting new

technologies in store or across the network?

— Do you have the capabilities to ramp up your use

of technology- and data-driven retail innovations?

In forthcoming articles, we’ll take a closer look at the

technologies that are shaping the store of the future,

and how they are set to transform retail P&L.

Praveen Adhi and Andrew Davis are partners in McKinsey’s Chicago office, where Gerry Hough is a senior expert, and

Shruti Lal is an associate partner; Tiffany Burns is a partner in the Atlanta office, where Bill Mutell is an associate partner;

Sebastien Calais is an associate partner in the Paris office.

STORE OPERATIONS

10 Future of retail operations: Winning in a digital era January 2020

Smarter schedules,

better budgets: How to

improve store operations

Through activity–based labor scheduling and budgeting, retailers

can become more efficient while improving customer service and

employee satisfaction.

by Sebastien Calais, Andrew Davis, Daniel Läubli, and Bill Mutell

11Smarter schedules, better budgets: How to improve store operations

Labor scheduling is an evergreen topic for retail

operators with tools, processes, and personnel

demands that are constantly changing. While these

changes bring new constraints and innovations

to a well-defined concept, the fundamentals remain.

Companies that have a clear understanding of

the fundamental building blocks of scheduling

have an advantage over peers in identifying and

operationalizing innovation into store operations.

The following article outlines the most critical

elements of labor scheduling that hold true in

virtually any context.

In recent years, retailers have taken steps to “lean

out” their processes and gain efficiencies—with

impressive results. Lean-retailing initiatives have

yielded as much as a 15 percent reduction in

retailers’ operating costs.¹ But with competition

intensifying and customers expecting ever-higher

service levels, many retailers are now looking for new

ways to further improve productivity and enhance

customer service.

One major area of opportunity is workforce

management: specifically labor scheduling and

budgeting. Because of the complexity inherent

in creating accurate staffing schedules and budgets

for a large number of stores, even sophisticated

retailers find substantial room for improvement in

this area.

Off-the-shelf software and solutions—although

useful for important tasks such as monitoring

employee attendance and managing payroll—

typically produce generic schedules that don’t take

into account store-specific factors and workload

fluctuations. The unfortunate results include high

labor costs, inconsistent customer service, and

dissatisfied customers.

If a retailer could better predict the number and

skill set of employees that each of its stores needs

every day (or, better, every hour) of the week, then

customers would get prompt sales assistance,

shelves would be replenished in a timely manner,

employees would be neither idle nor overworked,

and, in most stores, labor costs would go down.

That is already happening at a few leading retailers.

Chief operating officers have begun looking closely

at store activities and taking a more data-driven

approach to labor scheduling and budgeting. In doing

so, they have captured between 4 and 12 percent in

cost savings while also improving customer service—

for example, by shortening checkout queues or

having more staff available on the sales floor to assist

customers—and boosting employee satisfaction. This

level of impact has been achieved at several different

types of retailers, from large supermarket chains in

the United States and Europe to specialty retailers in

emerging markets.

A mismatch between supply and demand

Many retailers use workforce-management

software to generate a weekly staffing schedule

that is unique to each store. This schedule is usually

based on revenue forecasts—more employees

work during hours or days when sales are projected

to be the highest. Revenue is a sensible criterion

for scheduling, but it’s an insufficient one because

customers’ buying patterns (average basket size,

average purchase price per item, and more) can

vary by hour and by day. A European grocer found,

for example, that manned service counters, such

as deli and bakery counters, account for a much

higher share of revenues on weekends than they

do during the week. On weekends, therefore,

the required labor hours increase at a higher rate

than revenues.

Furthermore, most retailers don’t have a systematic

way to account for store-specific factors that

affect how long activities take—such as the distance

that an employee must walk to transport a pallet

from a delivery truck to the storeroom or how many

For more on lean retailing, see Stefan Görgens, Steffen Greubel, and Andreas Moosdorf, “How to mobilize 20,000 people,” December 2013,

McKinsey.com.

STORE OPERATIONS

12 Future of retail operations: Winning in a digital era January 2020

elevators employees can use for bringing products

to the sales floor. The same activity can be much

more time consuming at one store than at another,

even if the two stores have equal revenues.

Just as staffing schedules rarely align with a

store’s true labor needs, labor budgets are also

often mismatched with a store’s current reality.

Many retailers decide on labor budgets in an

undifferentiated top-down manner: for example,

they mandate that each store’s labor costs must not

exceed a certain percent of sales. Store managers

can then negotiate adjustments based on their

intuition or experience. This simplistic approach

relies too heavily on store managers’ judgment; it

also unfairly penalizes some stores. For instance,

a store in which fresh produce contributes a

large fraction of sales will be at a disadvantage

because fresh produce takes more time and care to

replenish than packaged goods. We found that such

differences among stores can lead to labor-cost

differences of up to 30 percent even if the stores’

sales are equal. A seemingly equitable top-down

directive thus becomes inequitable in practice; some

stores can provide exceptional customer service

and a relaxed pace of work for employees, while

at other stores, stressed workers struggle to meet

their service-level targets.

Four prerequisites to an activity-based approach

To revolutionize their labor scheduling and

budgeting, innovative retailers aren’t simply

relying on off-the-shelf workforce-management

solutions. Instead they are taking an activity-based

approach—one that matches store employees’

working hours to a changing workload, which means

the right employees are working at the right times,

performing the right tasks, and spending the least

amount of time required for those tasks. Equally

important, such an approach helps retailers develop

accurate annual labor budgets for each store. An

activity-based approach can be immensely valuable,

particularly to retailers that employ 20 or more

people per store.

Companies have historically used activity-based

techniques (such as activity-value analysis) to

improve processes and reduce costs, but rarely

have such techniques been applied to labor

scheduling and budgeting. In our analysis of labor-

scheduling logic, we identified four prerequisites

for excellence using an activity-based approach:

— store-specific workload calculations, which

are informed estimates of how long it takes

to complete certain activities (for example,

replenishing one pallet) in a particular store,

taking into account predefined service and

process standards

— reliable forecasts of “volume drivers” (such

as revenues per department, per hour, and

product flows) for each store, based on

sophisticated regression models as well as

store-manager experience

— a flexible workforce—with a mix of full-time,

part-time, and temporary staff—that can adapt

to schedules that may change on a daily and

weekly basis

— robust performance-management processes

and systems, with clear productivity and

service-level targets, to ensure that all stores are

on board and comply with the plan

All four of these prerequisites can be challenging

for retailers. We’ve found, however, that the

first prerequisite—generating accurate workload

calculations—often proves to be the key

improvement lever.

How to calculate workloads accurately

The optimal workload calculations set an

expectation for best-practice performance while

13Smarter schedules, better budgets: How to improve store operations

also acknowledging each store’s unique context. In

activity-based scheduling, the time allotted to each

activity is a network-wide standard time that is the

same for all stores, plus any additional time due to the

specifics of each store (exhibit). The network-wide

standard time in effect establishes a best-practice

benchmark for all stores. Store–specific time drivers

can then be measured by observation.

Some activities will be tricky to model. For

instance, figuring out how long it should take to

ring up purchases at checkout and how many

cashiers should be working at any one time isn’t a

straightforward calculation—customers arrive at

checkouts randomly. For unpredictable customer-

facing activities like these, retailers will need to use

queuing theory.²

Retailers should focus on activities that constitute

a significant amount of store employees’ workload.

On the one hand, developing a detailed model of

how long it takes to adjust a shelf to an updated

planogram isn’t necessary, as this activity typically

accounts for less than 1 percent of the total workload.

On the other hand, replenishment-related activities

can take up to 70 percent of the total work hours in a

store (see case study, “One retailer’s results: Lower

labor costs, better store managers”).

Implementation and rollout

Implementing an activity-based approach requires a

tool that can turn inputs (such as revenue forecasts

and customer-footfall estimates) into useful outputs

for store managers. Outputs might include the

required number of full-time employees per hour

and per day, the specific tasks employees should

be doing during certain hours of the day, and the

associated labor costs.

Retailers typically find it easier and faster to build

such a tool from scratch and then inject its outputs

into their existing workforce-management systems,

rather than build the tool within their current HR

systems. In our experience, it takes approximately

six months to develop an Excel-based prototype,

pilot it in a handful of stores to test the accuracy of

all assumptions and workload calculations, observe

its impact on the workforce, and refine it.

How quickly the tool is rolled out to the entire store

network will depend on available resources, but

a store-by-store rollout—whereby an operations

“coach” helps store employees learn about the new

tool and any new processes—is often most effective.

Leadership must ensure that the tool is embedded

into daily work and fully linked to HR planning and

annual budgeting processes. To keep it constantly

Exhibit

Queuing theory is useful for calculating how many employees are needed at a given time to meet the retailer’s target service level. In the

checkout example, the target could be based on waiting time (for instance, 90 percent of customers will wait in a checkout line for no more than

three minutes) or queue length (for instance, 90 percent of customers will have a maximum of two people in front of them at checkout).

McKinsey on Retail 2020

Smarter schedules

Exhibit 1 of 1

Stores should be allotted the same amount of time for the same task, with some adjustments

based on each store’s unique context.

Time for activity Standard time Store–specic time driver Quantity

Total time for store

employees to

perform a core activity

in a department

Target time for an activity;

should be the same for entire

store network

Additional time needed due

to local store characteristics

(eg, store layout, average

basket size)

Number of times the activity is

performed; variable (can be

derived from historical data)

STORE OPERATIONS

14 Future of retail operations: Winning in a digital era January 2020

up to date and relevant, retailers should consider

setting up a scheduling team of people who have the

requisite analytical skills and who are familiar with

store operations. The team would be responsible for

maintaining and updating the tool and adjusting the

workload calculations to new processes.

An activity-based approach can reveal opportunities

for improving store processes. In fact, it can serve

as the backbone for a continuous-improvement

program; ideally, the new scheduling and budgeting

tool would be able to run “what if” analyses for any

changes in service levels or process standards. And in

the event that labor budget cuts become necessary,

management teams—instead of just imposing top-

down percentage cuts—will be equipped to lead

practical and detailed discussions about which store

activities could be speeded up or eliminated entirely,

or where service-level targets could be relaxed.

In this way, they will be able to ensure sustained

improvements in store productivity, customer service,

and employee satisfaction, all while keeping labor

costs firmly under control. In future publications, we

will outline some of the unique elements that can

drive variation in labor scheduling.

One retailer’s results: Lower labor costs, better store managers

Case study

A large European retailer, with annual

revenue in excess of $20 billion, knew that

its stores’ labor scheduling and budgeting

processes weren’t rigorous enough.

At every store, both the standard weekly

stang schedule and the annual labor

budget were based primarily on revenues

and managerial judgment.

Seeking a more data-driven approach, the

retailer decided to pilot activity-based

labor scheduling and budgeting in two of

its stores over a four-month period. The

eort involved calculating the timing of

65 activities and building an Excel-based

prototype of a new labor-scheduling and

budgeting tool.

The retailer subsequently tested the

prototype in six additional stores that were

quite dierent from one another to ensure

that the tool’s outputs would be relevant

to the entire store network. Along the

way, the retailer discovered and quickly

implemented a number of best practices

and process improvements.

The new stang schedules and labor

budgets yielded an eciency improvement

along with an improvement in customer

service—gratifying results, particularly

in light of the fact that the retailer had

recently undertaken a successful lean-

retailing transformation and in many

ways already had best–practice store

operations. Furthermore, the approach

helped expose poor store management.

For example, one store was perceived

in the company as being well managed

because it had notably low labor costs.

But bottom-up calculation of the store’s

annual labor budgets showed that the low

labor costs were entirely due to favorable

store specics, such as short distances

for transporting products and shelves that

were relatively easy to stock. Once labor

costs were adjusted for those specics,

the store was shown to be among the least

ecient in the network. These and similar

insights allowed the retailer to better

evaluate and train its store managers.

Sebastien Calais is an associate partner in McKinsey’s Paris office, Andrew Davis is a partner in the Chicago office,

Daniel Läubli is a partner in the Zurich office, and Bill Mutell is an associate partner in the Atlanta office.

15Smarter schedules, better budgets: How to improve store operations

Bending the cost

curve in brick-and-

mortar retail

Retailers can achieve next-generation store efficiency by breaking

down silos and optimizing total cost across the value chain.

by Praveen Adhi, Vishwa Chandra, Karl-Hendrik Magnus, and Aneliya Valkova

STORE OPERATIONS

16 Future of retail operations: Winning in a digital era January 2020

Making money in retail—particularly in physical

stores—is becoming harder and more complex

each year. Many retailers around the globe have

addressed many of the possible efficiencies in

labor productivity and process automation. It is

time to consider the next generation of thinking to

make a meaningful difference in brick-and-mortar

economics and remain competitive in an ever-

changing retail environment.

Our colleagues have discussed how an integrated

view on cost can help consumer-goods companies

optimize operations costs across the value chain.¹

In this article, we take a closer look at how retailers

can benefit from a similar end-to-end perspective.

The goal is to help traditionally siloed departments,

from store operations to supply chain to merchan-

dising, understand the total cost of each SKU by

disaggregating the product’s journey from end to

end. This understanding can enable retailers to make

better decisions about what products to purchase,

when to transport them, how to display them, whether

to offer a sale—and, all along, how to make best use

of their employees’ time.

While traditional store efficiency programs

focused on in-store labor productivity can save

5 to 10 percent in overall costs, in our experience

a more comprehensive cost approach can enable

retailers to realize two to three times more savings,

bending the cost curve more toward meaningful

impact than the traditional incremental approach.

Case for change: External environment

Even retailers with stable balance sheets face

mounting cost pressure due to several factors,

including decreased foot traffic, increased SKU

complexity, higher customer expectations, and

rising labor costs.

To start, consumers shop from the comfort of

their couches rather than traveling to the nearest

shopping center; e-commerce has accounted

for 40 percent of retail growth in the United States

since 2016. A recent McKinsey survey found that

82 percent of US consumers reported spending

money online over the preceding three months,

and 42 percent of millennials report they prefer

shopping online to shopping in store.² Still, the

in-store experience is far from obsolete. McKinsey

projects e-commerce will constitute just 21 percent

of total retail sales and 5 percent of grocery sales

by 2023.

Second, brick-and-mortar stores are contending

with increasing SKU complexity; in a world of ever-

shorter product cycles and rapid innovation, SKUs

have proliferated rapidly.

Third, stores are facing increased customer service

and experience expectations, requiring both more

time dedicated to customers and better-trained

frontline staff to serve today’s highly digital, well-

informed customer. In addition, the proliferation

of omnichannel experiences is changing the

very purpose of a physical store.³ Stores are

increasingly expected to offer a variety of omni-

channel services, including in-store fulfillment and

returns of online orders.

Finally, retailers’ traditional labor pool is dwindling

due to low unemployment and rising labor costs.

For example, the United States is experiencing

record-low unemployment.⁴ And to date, states

that account for 30 percent of US workers have

committed to phasing in a minimum wage increase

that will ultimately reach $15 an hour—more than

double the federally mandated wage of $7.25.⁵

What retailers can do

To remain viable in this environment, retailers

must constantly improve their store economics

by simplifying, eliminating, or automating routine

activities. Most retailers have implemented several

rounds of lean cost-improvement programs, such

as automating simple activities (reporting and

Philip Christiani, Sebastian Gatzer, Daniel Rexhausen, and Andreas Seyfert, “How to untap the full potential: An integrated—not isolated—view

on cost,” September 2019, McKinsey.com.

Praveen Adhi, Tiffany Burns, Andrew Davis, Shruti Lal, and Bill Mutell, “A transformation in store,” May 2019, McKinsey.com.

Raj Kumar, Tim Lange, and Patrik Silén, “Building omnichannel excellence,” April 2017, McKinsey.com.

“Employment situation summary,” Bureau of Labor Statistics, October 4, 2019, bls.gov.

Chris Marr, “States with $15 minimum wage laws doubled this year,” Bloomberg Law, May 23, 2019, bloomberglaw.com.

17Bending the cost curve in brick-and-mortar retail

scheduling) and streamlining their inventory stocking

processes. However, most still take a narrow view

of what costs they can optimize, focusing on activities

the store can influence and accepting upstream

activities and decisions as constraints.

To reach the next level of cost efficiency, retailers

must expand their focus outside the four walls of the

store. Only the most advanced look for efficiency at

the intersection of store operations, merchandising,

supply chain, and transportation to adopt a total-cost

view—that is, the sum of cost components across

the value chain (Exhibit 1). By considering underlying

costs, from how products are chosen to how they’re

stocked, in our experience retailers can expand the

scope beyond costs addressed in their brick-and-

mortar stores by 50 percent. These underlying costs

are also more likely to yield efficiency because they

have not been scrutinized as much as in-store costs.

A total cost approach can reveal a host of

unrealized efficiencies (Exhibit 2). For example,

with input from store operations, merchandising

can adjust the store’s promotional calendar by

category and product to incorporate both the

expected incremental margin as well as the

store labor required to change price tags and

build promotional displays. Given this more

comprehensive view of cost, some promotional

activities will be seen as unprofitable and thus

discontinued. Further, a deeper understanding of

net margin and labor implications in distribution

centers and stores can inform decisions about

whether to add or remove shelf space from a given

SKU. The extra labor cost required to stock the

shelf between less frequent deliveries may be

offset by transportation cost savings.

A comprehensive view of cost can also inform

investments into enhanced capabilities such as

automation. For example, if a distribution center can

be outfitted to build custom pallets that match a

store’s layout, frontline staff would spend less time

sorting products and moving between aisles.

It is important to recognize that these efficiencies

will lower costs in some departments but

may be cost-neutral or increase costs in others;

accounting for these cross-functional effects

will be critical to success.

Success factors for bending the

cost curve

Four primary factors are crucial to bending the cost

curve through a total-cost approach: governance

and executive alignment, cost transparency, data and

analytics capabilities, and key performance indicators

(KPIs) and incentive alignment.

To remain viable in this

environment, retailers must constantly

improve their store economics by

simplifying, eliminating, or automating

routine activities.

STORE OPERATIONS

18 Future of retail operations: Winning in a digital era January 2020

Exhibit 1

Cross-functional collaboration to understand total cost of handling can lead to a host of

unrealized eciencies.

Store operations

The store receives less frequent deliveries

to optimize transportation cost—the

savings outweigh the extra labor needed

to manage bigger shipments.

The business case on whether to invest

in distribution-center automation is

amended to include store savings from

stocking product that arrives in better-

organized pallets.

Promotional displays are built upstream in

the distribution center or at the vendor,

reducing the time it takes store employees

to set up.

Supply chain Merchandising

Cost decrease

Neutral

Cost increase/

margin decrease

SO SC

Category and product promotional

protability is adjusted to account for

store labor costs to replace price tags and

build promo displays. This makes some

promotions unprotable, and they are

discontinued.

Extra shelf space is added for fast-moving

SKU A to enable stocking all product at

once. The store labor savings are greater

than the lost margin from removing SKU

B’s shelf space.

Product is purchased from vendors,

shipped, and stocked in shelf-ready

packaging, which makes it easier for

stores to handle and outweighs the extra

vendor costs.

19Bending the cost curve in brick-and-mortar retail

Exhibit 2

Governance and executive alignment

It starts from the top. Senior-level, cross-functional

alignment and sponsorship are required to

communicate change and ensure it sticks. Given the

sensitive nature of cross-functional savings—some

departments will see a cost increase, while others will

see a disproportionate cost decrease—each function

needs to be confident that senior leaders support

them and that every function adheres to the same

new standards.

In addition, the business owner of this new process

should be selected with care. Ideally, they should

reside outside of functions that own a meaningful

number of cost components; finance is often a good

option because it lacks a direct stake in where costs

are incurred. Store operations is another viable

option, as it is furthest downstream in the process.

Cost transparency

Retailers often struggle to calculate their total cost

of handling for two simple reasons: they either lack

a full understanding of cost components or don’t

have the data to quantify each. For example, many

retailers do not have a clear sense of how much

labor is used per unit of product in the store, starting

with unloading it from a truck to placing it on the

shelf, refilling the shelf between deliveries, checking

for out-dates, mounting promotions, and beyond.

Each SKU’s journey should be mapped and

broken down into cost-component steps. Each

step includes multiple iterations based on how it

is executed. For example, in–store labor cost is a

component with at least two iterations based on

how a product is stocked—as a full case or individual

units. Identifying where a product goes and stocking

The total cost of handling a product is determined by considering cost at each step of the

value chain.

Review category

Example

decisions

Impacted cost

components

Create planogram Plan demand

New SKUs to

introduce

Number of stores

for new SKU

introduction

Number of facings

Shelf depth

Space for category

Safety stock

Minimum

presentation

quantity

Location in the

distribution center

for new SKU

Mode of shipping

to the store (case

or individual)

Frequency of

store delivery

Store processes

for stocking

Placement of

overstock (eg,

back room vs top

shelf vs elsewhere)

Cost of goods sold,

write-os, shrink

Store labor cost to

replenish between

shipments based

on shelf capacity

Distribution center

picking cost based

on amount of

product shipped

Inventory holding

cost of safety

stock and minimum

presentation

Store labor cost from

stocking full cases

vs individual units

Store labor cost

to stock product

on shelves and

return overstock

to back room

Introduce to

distribution center

and prepare to ship

Receive and stock

STORE OPERATIONS

20 Future of retail operations: Winning in a digital era January 2020

a full case all at once requires much less labor per

unit compared with stocking individual units and

searching for the correct spot on the shelf after each

one. These cost estimates should be periodically

refined to reflect changes in cost structure.

Data and analytics capabilities

Establishing cost transparency should result in the

creation of a central data repository with access to

multiple sources of data at the SKU and store levels,

including all cost components across sales, cost,

margin, safety stock and presentation requirements,

promotional calendar, planogram versions, and

shipping quantities. Typically, these data sources are

not tied to each other, requiring additional work to

build a 360-degree view of each SKU.

Once the data are assembled, sophisticated data

and analytics capabilities are needed to simulate the

different scenarios based on variable factors—such

as how a product is shipped from the distribution

center, in what quantity, and how often. An advanced

decision-engine algorithm needs to be put in place

to determine the lowest-cost path through the

system and estimate the cost savings should all SKUs

follow the optimal path. Identifying the scenario that

matches the current state and comparing it to the

optimal state can illuminate the concrete savings

gained by moving from the traditional to the proposed

approach. Savings can be realized both initially, when

the decision engine is put in place, and continuously

as the algorithm becomes embedded.

Key performance indicators and

incentive alignment

While advanced analytics can enable decisions that

optimize total cost across the organization, some

areas of the organization may experience relative

cost increases that permit bigger decreases in other

areas. However, many parts of the organization

have narrow P&Ls that don’t account for cross-

functional effects. As such, end-to-end costs must

be embedded in the reporting and KPIs of each

function. For example, a merchandising decision to

remove shelf space from the planogram of a fast-

moving SKU should consider more than the lost

margin and vendor funding. The decision should

also consider whether less shelf space may negate

the benefit of shipping full cases to the store. In that

case, the SKU in that planogram will incur the extra

cost from being shipped as individual units from the

distribution center and the additional cost of having

to be restocked between shipments if its shelf

capacity is decreased.

Brick-and-mortar retail will continue being

challenged to deliver on multiple fronts at once,

including customer experience, omnichannel

services, and cost excellence. While initially impactful,

traditional lean levers employed by store operations

limit the scope of opportunity by ignoring 50 percent

of cost controlled by other functions, including

merchandising and supply chain. To bend the cost

curve and reach performance excellence, retailers

should take an end-to-end view of cost. With a

data–driven decision engine and senior leadership’s

support, retailers can realize significant opportunity

across the organization and make better long-term

operating decisions.

Praveen Adhi is a partner in McKinsey’s Chicago office, where Aneliya Valkova is an associate partner; Vishwa Chandra is a

partner in the San Francisco office; Karl-Hendrik Magnus is a partner in the Frankfurt office.

21Bending the cost curve in brick-and-mortar retail

Supply chain of the

future: Key principles in

building an omnichannel

distribution network

As omnichannel shopping is becoming the new norm, consumer and

retail companies must be ready to deliver fast, impeccable omnichannel

service. Doing so requires a new supply chain network approach.

by Manik Aryapadi, Ashutosh Dekhne, Wolfgang Fleischer, Claudia Graf, and Tim Lange

SUPPLY CHAIN

22 Future of retail operations: Winning in a digital era January 2020

The consumer product and retail landscape

continues to evolve as companies race to catch up

with leading e-tailers. Traditional brick-and-mortar

retailers such as Macy’s, Nordstrom, and Walmart are

expanding their online offerings and introducing new

models, such as in-store fulfillment of online orders.

Online players such as Amazon and Zalando are

opening their own brick-and-mortar stores. Vertically

integrated players such as Bose, Burberry, and

Nike are strongly pushing their direct-to-consumer

business through both online and new physical

stores. And players of all kinds are complementing

their physical stores and e-commerce offerings with

innovative applications and social media to mount a

truly omnichannel presence.

However, many players still struggle with

omnichannel success given the requirements it

places on their supply chains—especially in terms

of speed, complexity, and efficiency. Customers

expect to receive their products anytime and

anywhere with a very short time between order

and delivery, with excellent service and high

convenience. Our research shows that service

represents the primary factor that brands and

retailers can use to differentiate themselves and

“delight” omnichannel shoppers.¹

Companies that succeed, in our experience, master

seven key building blocks of the omnichannel

supply chain (see sidebar, “The seven supply chain

building blocks for omnichannel excellence”). In

this article, we focus on building block number

two, the network and ecosystem of the future, and

describe the principles that can guide companies’

approach to omnichannel network design in an

increasingly complex environment.

The current e-commerce landscape

While apparel trails industries such as electronics

and sporting goods in e-commerce penetration, the

number of people shopping for clothes and shoes

online is rising rapidly. This trend is true across

regions. From 2014 to 2017, online apparel purchases

grew at a CAGR of 24, 15, and 14 percent in Southern

Europe, North and Western Europe, and Central

Europe, respectively. In the United States, online

apparel sales grew 18.5 percent in 2018 alone,

to more than one-third of all apparel sales that year.²

This growth far outpaced total apparel sales

growth of 5.3 percent that same year. In China, total

online retail spending grew 27 percent in 2018,

with 24 percent of retail sales taking place online.³

Companies of all kinds, not only in apparel, are

racing to meet customer needs—and adapting their

supply chain is often one of the primary hurdles.

Traditional supply chain networks are often not

built for same-day delivery with excellent service.

This is an issue especially when fierce competition

offers shorter delivery times with a great customer

experience; for example, Amazon continuously

redefines delivery standards.

Holly Briedis, Tyler Harris, Megan Pacchia, and Kelly Ungerman, “Ready to ‘where’: Getting sharp on apparel omnichannel excellence,” August

2019, McKinsey.com.

April Berthene, “Ecommerce is more than a third of all apparel sales,” Digital Commerce 360, July 23, 2019, digitalcommerce360.com.

Satish Meena et al., “Forrester Analytics: Online retail forecast, 2018 To 2023 (Asia Pacific),” Forrester, May 15, 2019, forrester.com.

Traditional supply chain networks are

often not built for same-day delivery

with excellent service.

23Supply chain of the future: Key principles in building an omnichannel distribution network

The seven supply chain building blocks for omnichannel excellence

The omnichannel supply chain of the

future has seven key elements that

combine best practices with digital

opportunities (exhibit).

Companies that achieve omnichannel

success master seven key building blocks.

The essential questions to ask for each

element are listed below.

Exhibit

McKinsey on Retail 2019

Distribution network design

Exhibit 1 of 2

The omnichannel supply chain of the future has seven key elements that combine best

practices with digital innovation.

Network and ecosystem of

the future

The supply chain’s backbone—

provides required speed and

exibility, leveraging information,

and partner assets and

capabilities.

E2E planning and information

ow

Key information ow capabilities

that access the right products in

the right place at the right time—

real-time—to deliver according to

customer expectations

Operating model and change

management

Key organizational enabler for the

company and its people—captures

supply chain potential and delivers

exceptional customer value.

Omnichannel fulllment: Node

operations

Key physical ow capabilities that

ensure competitive cost

structures and reliable quality

while managing complexity.

Digitization and process

automation

Key technology enabler that uses

available omnichannel data,

analytics, and supply chain

systems along the end-to-end

value chain—and includes

ecosystem partners.

Omnichannel fulllment:

Transportation and LSP

management

Key physical ow capabilities that

provide reliable, fast service to

all customers where it matters,

while ensuring competitive

transport costs.

Customer–centric supply chain strategy

Starting point to design an omnichannel

supply chain that meets customer needs

along all channels.

SUPPLY CHAIN

Customer–centric supply chain strategy

— Supply chain strategy and

segmentation: How many supply

chain segments are required to deliver

the supply chain mission? What is

the objective of each supply chain

segment—responsiveness versus

efficiency?

— Customer–backed service aspirations:

What is the customer offering across

different segments? Where does speed

matter versus flexibility and services?

How can we differentiate ourselves

from competitors?

— Assortment and complexity

management: How can we tailor the

assortment to a retailer or to a channel

(for example, online only)? How is the

product portfolio managed?

— Risk management: What are the key

supply chain risks? How can we best

prepare for supply chain disruptions?

What are the best proactive mitigation

strategies and contingency plans?

— Sustainability: How can we create a

sustainable supply chain using best

practices, such as supporting the

circular economy and using sustainable

raw materials and packaging?

Network and ecosystem of the future

— Supply network: What is the physical

flow of goods through the network?

What are the different product–supply

speed models, and what is the impact on

the supplier and production footprint?

24 Future of retail operations: Winning in a digital era January 2020

The seven supply chain building blocks for omnichannel excellence (continued)

— Supplier management and

collaboration: How are suppliers

managed and integrated to support

an agile upstream supply chain that

responds quickly to changes, as

required by the omnichannel customer?

— Distribution network: Is the distribution

network designed for each channel

individually or is an omnichannel

network beneficial?

What is the right composition of

distribution centers (DCs), new node

types, and partner locations?

— Inventory-sharing concepts: How

can inventory be shared across

channels? Does each channel have

its own inventory? What is the best

governance and business model for

these concepts?

— Customer collaboration: What are key

areas for customer collaboration that

could improve information exchange

and product flow along the value chain?

Where should partners be employed to

drive and access innovation?

End-to-end (E2E) planning and

information ow

— Demand planning: What are the

different demand signals in the

omnichannel environment, and how can

they be captured to predict demand

potential by leveraging advanced

analytics? How can we combine them

into an E2E marketplace perspective?

— Inventory management: What is the

optimal inventory level at each stage of

the value chain—DCs, stores, partners,

etc.? How can we actively manage

inventory to increase availability and

keep cash requirements under control?

— Supply and replenishment planning:

How can we best synchronize the

product supply with customer demand

in stores, DCs, and with partners?

Ensure the right amount of capacity

along the different segments of the SC?

— Sales and operations control tower:

How can we align the different

organizational entities and plans at

key milestones? Manage and decide

on trade-offs? Allocate and prioritize

customers, channels, and orders in

case of constraint?

— Distributed order management: How

can we ensure real-time visibility and

accessibility of inventory across all

channels and locations? Find and

access the right fulfillment node to

fulfill customer orders efficiently?

Omnichannel fulllment: Node

operations

— Warehouse management: How can

we achieve warehouse excellence in a

more complex environment? Leverage

automation to increase speed, quality,

and efficiency? Should DCs be

operated in house or outsourced?

— Return flows and processing: How can

we manage returns in an efficient and

effective way? Optimize return flows

across the network? Which decisions

on flow of goods can be made by which

parts of the value chain?

— In-store operations: How can we enable

the whole downstream supply chain

for omnichannel? Optimize in-store

layout and processes to enable local

fulfillment while securing a great

customer experience?

Omnichannel fulllment: Transportation

and logistics service provider (LSP)

management

— Transport management: What is

needed to manage transport operations

efficiently in an increasingly demanding

world? How do we keep transport cost

under control? Create end-to-end

transparency of product flows?

— Logistics service provider sourcing

and management: What are the right

logistics partners for the different

supply chain segments? How do we

best source and manage LSPs to get

competitive rates and services?

Operating model and change

management

— Processes: How do we design supply

chain processes to support omnichannel

optimization? How can digital innovation

be integrated in the process design?

How do we accelerate decisions?

— Structures: How can we adjust the

organizational structure to capture

cross-channel benefits and make

change happen? Avoid silos between

channels? Use zero-based thinking in

organizational sizing?

— Capabilities and mind-set: Which

additional skills are needed to enable

the future organization? Where

should an agile way of working be

used and how? How can we best

address the cultural change toward

omnichannel behavior?

— Performance management: How

should performance of the E2E

supply chain be measured? How

can we incorporate the omnichannel

dimension, measuring the joint

performance rather than individual

channels? Adjust incentives to enable

the right behavior?

25Supply chain of the future: Key principles in building an omnichannel distribution network

The seven supply chain building blocks for omnichannel excellence (continued)

Digitization and process automation

— Foundational software: What is the

required software and tooling needed

to enable the omnichannel supply

chain? Which optimization decisions

need special tool enablement?

— Data strategy: How can we capture

data and use it along the value chain?

Build the omnichannel data lake to

link the data from different platforms

and systems? How are legacy systems

integrated? How do we integrate into

an ecosystem with our partners?

— Analytics strategy: How can we

contextualize data to conduct

relevant analyses? Is operational data

consolidated and accessible by the right

decision makers? How can we best

visualize data and analytics to make

them accessible to decision makers?

— Process automation: How can

advanced digital tools such as robotic

process automation, blockchain, and

the Internet of Things be deployed?

What are the key benefits of these

technologies, and how can they enable

omnichannel optimization?

In addition, e-commerce fulfillment is much more

complex than traditional brick-and-mortar or

wholesaler fulfillment. When customers can order

24/7, demand is less predictable and more difficult

to shape. Order sizes are significantly lower, and

the number of products offered continuously rises.

The increase in speed and complexity drives up

fulfillment costs. In our experience, an online order’s

cost per unit can easily be four to five times higher

than traditional brick-and-mortar replenishment

and ten times higher than wholesale fulfillment. All

the while, customers demand a seamless

omnichannel journey.

Building out the omnichannel experience can bring

huge value for retailers, e-tailers, and vertically

integrated players with direct-to-consumer

business; our research has found that customers

shopping online tend to buy more, and customers

that pick up online orders in store often make

additional in store purchases. With the seven

building blocks of a successful omnichannel supply

chain in mind, the following principles should be

top of mind while working to build the network and

ecosystem of the future.

Put the customer’s needs first

To start, companies need to adopt a granular

perspective of what the customer really wants, today

and in the future. This understanding will inform

which channels to serve, which products and services

to offer, and where to offer them. For example, a

young adult living in a large city, such as London

or New York City, wants to purchase and receive a

newly launched sneaker that a celebrity presented

on Instagram that same day. However, the customer

does not know where she will be in a few hours, so it is

important that she can track the delivery and reroute

it at any time. If, for example, she goes to a café, the

shoes are rerouted (via an app) to be delivered there.

Developing this detailed understanding of

customers requires harnessing customer data. This

information should be combined with customer-

behavior insights culled from customer interviews,

observations, and the latest research from market

experts, as well as analyses of competitors’

e-commerce offerings. Advanced analytics can be

used to process all this information and gain a clear

understanding of customer expectations.

“Employment situation summary,” Bureau of Labor Statistics, October 4, 2019, bls.gov.

SUPPLY CHAIN

26 Future of retail operations: Winning in a digital era January 2020

In addition to understanding the customer today,

companies must also look to the future and

stay flexible as the market rapidly changes. For

example, while next-day service was novel just

a few years ago, it is common today. How future

incumbents and disrupters will shape the market

is still unknown. As such, serving the customer of

the future requires unprecedented agility—quickly

adapting to changing customer expectations.

Forget one size fits all

A deep understanding of customer desires should

be the foundation of defining the strategy and

building various customer segments based on

preferences, product categories, and locations.

This segmentation recognizes that a one-size-fits-

all approach is a waste of resources. A segmented

approach enables the company to prioritize specific

services for each customer group—for example,

which speed of delivery to offer for each segment and

which differentiated services to offer or not. While

the London customer may expect same-hour service,

customers living in remote areas might not mind

waiting a few days. Developing this understanding

to undergird the strategy is crucial to avoid common

mistakes, such as offering convenience at a premium

to customers that care more about price or building

offerings that quickly become outdated.

Be fast and collaborative

In the traditional supply chain model, companies

often choose a purely quantitative approach to

model the perfect fulfillment network needed for

the service offering. This generally involves a rather

rigid and time-consuming approach: three months

of data collection, six months of modeling, and three

months of decision making before implementation.

This traditional approach leads to a onetime strategy

and long implementation times. However, in an

ever-volatile environment with constantly changing

customer needs, evolving partnerships, and newly

developing competition, reacting quickly is critical to

ensure that the supply chain network is responsive,

flexible, and efficient.

Therefore, companies should remain agile in their

thinking and assemble a cross-functional team.

One best practice is to develop the future supply

chain network in a workshop-based environment.

In practice, this means determining the fulfillment

options suitable for each customer, product, and

location segment and defining the required

product flow. Starting with the segment that has

the most demanding lead time, the best fulfilment

option needs to be found for each segment while

considering operational needs, such as costs to serve

and volume constraints. Once a solution for each

segment in each location is defined, it must all be

combined into one comprehensive service network.

Seek partnerships and share resources

In an ever-volatile environment, speed of

implementation and efficient use of resources are

crucial. Therefore, it is necessary to take advantage

of existing infrastructure, such as warehouses and

retail stores, as well as resources available in the

In an ever-volatile environment, speed

of implementation and ecient use of

resources are crucial.

Raj Kumar, Tim Lange, and Patrik Silén, “Building omnichannel excellence,” April 2017, McKinsey.com.

27Supply chain of the future: Key principles in building an omnichannel distribution network

market. Leading companies are actively seeking

partnerships, not only along their own value chain

but also with players from other industries. Sharing

infrastructure brings synergies—costs and risk are

split, for example—and enables better customer

service and faster delivery times. For instance, a

player operating department stores may offer

in-store pickup services to e-commerce companies,

and e-commerce companies can offer online order

fulfillment to department stores. The partners would

establish commercial terms for compensation,

such as sharing the margin. Connected inventory is

another example of using existing partner resources,

enabling players to offer products that are already

close to the consumer rather than putting additional

inventory into the market. This can increase the

availability of certain products with minimal effort

from the retailer.

Look for innovative fulfillment options

When identifying existing assets within a company

and their partners’ networks, it is important to

consider innovative fulfillment options. The types

of fulfillment options a player regards as suitable

depend on the specificities of the market and the

company, but customer orders can be fulfilled

in a variety of ways. Shipping products from a

warehouse or distribution center is the most

traditional and cost-efficient way. Warehouses

typically have a higher level of automation, handle

significant volumes, and seek locations that

incur low operating costs, such as rural areas or

industrial areas outside of large cities.

However, rising customer expectations for faster

delivery have triggered the development of more

innovative fulfillment options. Thus, one should

consider that products can also be shipped

directly from the production facility or dark stores—

noncustomer-facing miniwarehouses usually within a

city, where products are stored, picked, and shipped

directly to consumers. Pop-up nodes are another

option; for example, a container placed at a major

sports event or a truck, van, or bike driving around

city holding inventory and delivering products to

customers who order via an app. Products could

also be manufactured right where the customer is

with, for example, 3D printing techniques. The main

advantage of these fulfillment options is proximity

to the customer; however, operations are less

efficient and more costly, and they require additional

capabilities. Indeed, retailers have several elements

to weigh when considering the variety of fulfillment

options available to them (Exhibit 1).

Think early about new capabilities and never

stop learning

To enable the identified solutions, companies must

carefully consider the new capabilities required to

run their future network and understand how to

build them. Those capabilities include physical flow

ranging from operating new node types, such as

dark stores and pop-up nodes, to managing new

transport flows and partners, such as last-mile

services. Information flow capabilities such as

planning demand and inventory, stock visibility in

the decentral node network, and distributed order

management should also be implemented (see

sidebar, “The seven supply chain building blocks for

omnichannel excellence”). For example, a new

fulfillment solution such as shipping from a dark

store requires new operational processes and

systems to run a small-scale node efficiently and

an agile and efficient structure that supplies it with

small quantities at a high frequency. In addition,

the planning landscape needed to have the right

inventory in the dark store requires new capabilities,

such as demand sensing, dynamic supply allocation,

and capacity planning at each location. Finally,

the dark store requires real-time and accurate

inventory visibility combined with a distributed order

management system that makes the stock available

and accessible.

This connected fulfillment network should be

deployed along an agile road map to enable quick

testing and learning of different node types that

include capabilities in various locations rather than

SUPPLY CHAIN

For more, see “Better service with connected inventory” in this compendium.

Future of retail operations: Winning in a digital era January 2020

Exhibit 1

McKinsey on Retail 2019

Distribution network design

Exhibit 1 of 2

It is crucial to consider all elements when weighing fulllment options.

Fulllment option

Ship from

factory

Oshore factory

Nearshore factory

Central DC

operated by

retailer

Decentral DC

operated by

retailer or 3PL

Decentral DC

operated by

partner

Decentral DC

operated by

wholesale partner

Ship from own

store

Ship from partner

store

Ship from

wholesale-

partner’s store

Mobile node

Temporary node

Market production

3-D printing

Returns utilization

Shipment from

factory/

production facility

in oshore or

nearshore country

Typically located

in low-cost

countries

Lead time

High

Low

Degree of productivity

Volume-handling capacity

Inventory-holding capacity

Cost of operation (eg, wages and rent)

Products shipped

to destination

based on specic

customer order or

demand sensing

Shipment from

warehouse/

distribution center

Operated

internally, by

partner,

wholesaler, or

3PL

Shipment from

noncustomer-

facing

miniwarehouse—

small scale, not

automated

Located in or

close to a city/

densely populated

area

Shipment from

retail stores using

back-of-house or

in-store inventory

Fullling walk-in

customer

purchases

Can be own

stores, partner

stores, or

wholesaler stores

Shipment from

nonstandardized

node, used on

as-needed basis

(eg, special

events)

Examples:

truck/van/bike,

etc carrying a low

quantity of

products that

shoppers order

via app; temporary

DC with a

plug-and-play

concept

Customer returns

used to fulll new

orders

ConsumerShip inventory

in transit

Ship from

warehouse or

distribution

center

Ship from

dark store

Ship from

retail store

Ship from

pop-up node

High

Low

High

Low

High Low

Low

High

Dierent operational modes Description

29Supply chain of the future: Key principles in building an omnichannel distribution network

A global brand’s omnichannel success

This global brand is becoming a strong

omnichannel player and serving its own

retail stores, wholesale stores, and

e-commerce customers alike. Due to

strong past growth—overall revenue grew

by 9 percent and online penetration by

158 percent from 2012 to 2016—it was

necessary to rethink the entire supply

chain and work in cross-functional teams

to dene an omnichannel strategy of

the future.

The company rst conducted intensive

market research, including interviews

with end customers, store visits, and

competitive analyses to understand

customer expectations of omnichannel

shopping and delivery. Customer

segments were dened and tied with

specic services and delivery times.

The company then dened the supply chain

network to serve the customer segments.

The company used the existing brand’s

player’s and its partners’ infrastructure

to integrate traditional fulllment options,

such as central and decentral warehouse

shipping. At the same time, it was important

to be very close to the customer and

replenish retail stores fast, which is why

the solution included innovative fulllment

options, such as shipping from a dark

store, retail store, or temporary node. The

fulllment network consisted of various

individual solutions per location; for example,

the company identied a partner e-tailer

with spare room for additional inventory

in a German warehouse close to major

cities, whereas in Southern Europe it was

necessary to establish a partnership with a

department store and use its wider network

of warehouses and stores.

The key to success was going beyond

modeling and quantitative analysis to

involve a cross-functional team that

made sure all relevant elements were

considered. For example, marketing

ensured that customer expectations

were always prioritized, the supply chain

team assessed operational feasibility

of fulllment options, the logistics team

played devil´s advocate on transportation

costs, and the commercial team expanded

the partner network.

The implementation road map was built in

an agile way to allow for fast testing and

learning. Individual elements could be

piloted and evaluated quickly to decide if a

fulllment option should be scaled or taken

o the solution space.

the traditional approach that initiates only when

all node types and capabilities are fully developed.

Building these required capabilities should also

be planned in modular sequence. Regardless of

how the omnichannel distribution network looks, it

is important to stay flexible and adjust to any road

map changes, such as an increase in customer

requirements or new logistics service offerings—

for example, delivery solutions for fast last-mile

delivery. Testing, learning, and adjusting quickly

should be the credo.

For an example of a retailer that found success

in building a network and ecosystem of the

future, see sidebar, “Case study: A global brand’s

omnichannel success.”

Enabling a truly end-to-end omnichannel

experience requires a new way of supply chain

thinking. The supply chain needs to be readjusted

based on changing market conditions, and players

should pursue an agile approach that enables them

to adjust quickly to changing trends, options, and

customer expectations. These principles can help

determine the approach to building the network

and ecosystem of the future.

Case study

Manik Aryapadi is an associate partner in McKinsey’s Cleveland office, Ashutosh Dekhne is a partner in the Dallas office,

Wolfgang Fleischer is a consultant in the Munich office, where Claudia Graf is also a consultant, and Tim Lange is a partner in

the Cologne office.

SUPPLY CHAIN

30 Future of retail operations: Winning in a digital era January 2020

A retailer’s guide to

successfully navigating the

race for same-day delivery

A “new normal” has emerged when it comes to the delivery speed that

customers expect in ordering online. The standards have been re-set by

the likes of Amazon and several other market leaders, placing increasingly

more pressure on incumbent players to respond accordingly. We

conducted a broad effort in which we took stock of the current situation,

focusing on Europe and particularly, Germany, from both a market and

consumer perspective. Our analyses show that although the pressure

on incumbent players may appear to be overwhelming, we believe that

retailers have a strategic asset they can leverage in the future: their

dense store network, which provides them proximity and (potentially)

quick access to their customers. But to fully benefit from their network,

omnichannel retailers will need to consider changing gears in four

areas: the local fulfillment network, quick and integrated IT systems, new

store layouts and processes, and a rethink of business economics.

Hamburg

Cologne

Munich

>1,000,000

Inhabitants

>500,000–1,000,000

>200,000–500,000

Warehouse

coverage

Retailer same-day oering

in top 20 cities

Amazon vs top 20 non-food

and top 13 grocery retailers

Same-day coverage of relevant population,1 Amazon vs disguised

omnichannel fashion retailer

by type of competition, %

28 stores across Germany, covering 5 of

Germany’s 20 biggest cities

Ongoing testing and buildup of

ship-from-store capabilities

Competition area

(Amazon and retailer)

Area at risk

(Amazon only)

Retailer

monopoly area

(retailer only)

Source: Alteryx; BKG; ESRI ArcGIS; MB-Research; McKinsey analysis

Relevant population areas dened as high density (>750 inhabitants/km²) and/or high income (purchasing power >€21,900 per capita); viable market

coverage dened as area within 30 minutes driving time from respective retail location.

Population 22 16 7

23 17 7

Purchasing

power coverage

Viable market coverage for same-day

delivery via ship from store1

Relevant population areas dened as high density (>750 inhabitants/km²) and/or high income (purchasing power >€21,900 per capita); viable market

coverage dened as area within 30 minutes driving time from respective retail location.

Stores

100

Source: Alteryx; BKG; ESRI ArcGIS; MB-Research; McKinsey analysis

Store location

Berlin

By Manik Aryapadi, Tim Ecker, and Julia Spielvogel

31A retailer’s guide to successfully navigating the race for same-day delivery

2020F20152010200520001994

US e-commerce market size

Index (2000=100)

2,945

1,546

775

343

100

General willingness to pay extra for same-day delivery

Share of consumers in percent, n=4,700 respondents

>9 days

~8 days ~5 days ≤2 days

46%

abandoned a shopping cart due to a

shipping time that was too long or not

provided

Source: UPS

35%

Customers who did not purchase

an item online due to long

delivery times

of respondents

Younger

+13 p.p.

base delivery choice

mainly on speed and

reliability

Urban

+4 p.p.

willing to pay €3 extra for

same-day delivery

More time-constrained

+5 p.p.

willing to pay €3 to €5

extra for same-day

delivery

China

Germany

United

States

100%

China

2014

Same-day delivery promise

2015 2016 2017 2018 2019

Testing Scaling Market standard

Alibaba

JD.com

Western Europe Amazon

United States Amazon

Product selection by delivery speed

Number of SKUs for 3 exemplary product categories

Relative pricing

Out of 122 products analyzed

Sanding

machines

Screw guns

Batteries

458

226

145

136

Amazon same-day

Top 3 competitors—

non-same-day

Source: Amazon; McKinsey analysis

Amazon’s free delivery time

Same-day

on Amazon

Non-same-day

on Amazon

Amazon cheaperCompetitors

cheaper

Percentage point dierence vs

overall sample of 4,700 survey

respondents across the United

States, China, and Germany.

Willingness to pay > €1 surcharge

for same-day delivery

In the past 20 years there has hardly

been any business success story like

e-commerce. And as online sales have

surged, shipping durations have gone down.

2020F20152010200520001994

US e-commerce market size

Index (2000=100)

2,945

1,546

775

343

100

General willingness to pay extra for same-day delivery

Share of consumers in percent, n=4,700 respondents

>9 days

~8 days ~5 days ≤2 days

46%

abandoned a shopping cart due to a

shipping time that was too long or not

provided

Source: UPS

35%

Customers who did not purchase

an item online due to long

delivery times

of respondents

Younger

+13 p.p.

base delivery choice

mainly on speed and

reliability

Urban

+4 p.p.

willing to pay €3 extra for

same-day delivery

More time-constrained

+5 p.p.

willing to pay €3 to €5

extra for same-day

delivery

China

Germany

United

States

100%

China

2014

Same-day delivery promise

2015 2016 2017 2018 2019

Testing Scaling Market standard

Alibaba

JD.com

Western Europe Amazon

United States Amazon

Product selection by delivery speed

Number of SKUs for 3 exemplary product categories

Relative pricing

Out of 122 products analyzed

Sanding

machines

Screw guns

Batteries

458

226

145

136

Amazon same-day

Top 3 competitors—

non-same-day

Source: Amazon; McKinsey analysis

Amazon’s free delivery time

Same-day

on Amazon

Non-same-day

on Amazon

Amazon cheaperCompetitors

cheaper

Percentage point dierence vs

overall sample of 4,700 survey

respondents across the United

States, China, and Germany.

Willingness to pay > €1 surcharge

for same-day delivery

Same-day delivery:

Ready for takeoff

Today, people expect to receive their

parcels by the next day. And their

shopping decisions increasingly

depend on shipping time.

But consumers are still not satisfied.

Up to half state a general interest in

same-day delivery, despite limited

willingness to pay > €1 surcharge

for that service.

SUPPLY CHAIN

32 Future of retail operations: Winning in a digital era January 2020

2020F20152010200520001994

US e-commerce market size

Index (2000=100)

2,945

1,546

775

343

100

General willingness to pay extra for same-day delivery

Share of consumers in percent, n=4,700 respondents

>9 days

~8 days ~5 days ≤2 days

46%

abandoned a shopping cart due to a

shipping time that was too long or not

provided

Source: UPS

35%

Customers who did not purchase

an item online due to long

delivery times

of respondents

Younger

+13 p.p.

base delivery choice

mainly on speed and

reliability

Urban

+4 p.p.

willing to pay €3 extra for

same-day delivery

More time-constrained

+5 p.p.

willing to pay €3 to €5

extra for same-day

delivery

China

Germany

United

States

100%

China

2014

Same-day delivery promise

2015 2016 2017 2018 2019

Testing Scaling Market standard

Alibaba

JD.com

Western Europe Amazon

United States Amazon

Product selection by delivery speed

Number of SKUs for 3 exemplary product categories

Relative pricing

Out of 122 products analyzed

Sanding

machines

Screw guns

Batteries

458

226

145

136

Amazon same-day

Top 3 competitors—

non-same-day

Source: Amazon; McKinsey analysis

Amazon’s free delivery time

Same-day

on Amazon

Non-same-day

on Amazon

Amazon cheaperCompetitors

cheaper

Percentage point dierence vs

overall sample of 4,700 survey

respondents across the United

States, China, and Germany.

Willingness to pay > €1 surcharge

for same-day delivery

Especially attractive segments that are

young, urban, and time-constrained are

demanding same-day delivery.

It is the next building block in their bid to

win consumers on selection, price, and

convenience.

2020F20152010200520001994

US e-commerce market size

Index (2000=100)

2,945

1,546

775

343

100

General willingness to pay extra for same-day delivery

Share of consumers in percent, n=4,700 respondents

>9 days

~8 days ~5 days ≤2 days

46%

abandoned a shopping cart due to a

shipping time that was too long or not

provided

Source: UPS

35%

Customers who did not purchase

an item online due to long

delivery times

of respondents

Younger

+13 p.p.

base delivery choice

mainly on speed and

reliability

Urban

+4 p.p.

willing to pay €3 extra for

same-day delivery

More time-constrained

+5 p.p.

willing to pay €3 to €5

extra for same-day

delivery

China

Germany

United

States

100%

China

2014

Same-day delivery promise

2015 2016 2017 2018 2019

Testing Scaling Market standard

Alibaba

JD.com

Western Europe Amazon

United States Amazon

Product selection by delivery speed

Number of SKUs for 3 exemplary product categories

Relative pricing

Out of 122 products analyzed

Sanding

machines

Screw guns

Batteries

458

226

145

136

Amazon same-day

Top 3 competitors—

non-same-day

Source: Amazon; McKinsey analysis

Amazon’s free delivery time

Same-day

on Amazon

Non-same-day

on Amazon

Amazon cheaperCompetitors

cheaper

Percentage point dierence vs

overall sample of 4,700 survey

respondents across the United

States, China, and Germany.

Willingness to pay > €1 surcharge

for same-day delivery

For this reason, e-commerce super-

giants Alibaba, JD.com, and Amazon

are committed to pushing same-day

delivery into the mass market now.

33A retailer’s guide to successfully navigating the race for same-day delivery

Hamburg

Cologne

Munich

>1,000,000

Inhabitants

>500,000–1,000,000

>200,000–500,000

Warehouse

coverage

Retailer same-day oering

in top 20 cities

Amazon vs top 20 non-food

and top 13 grocery retailers

Same-day coverage of relevant population,1 Amazon vs disguised

omnichannel fashion retailer

by type of competition, %

28 stores across Germany, covering 5 of

Germany’s 20 biggest cities

Ongoing testing and buildup of

ship-from-store capabilities

Competition area

(Amazon and retailer)

Area at risk

(Amazon only)

Retailer

monopoly area

(retailer only)

Source: Alteryx; BKG; ESRI ArcGIS; MB-Research; McKinsey analysis

Relevant population areas dened as high density (>750 inhabitants/km²) and/or high income (purchasing power >€21,900 per capita); viable market

coverage dened as area within 30 minutes driving time from respective retail location.

Population 22 16 7

23 17 7

Purchasing

power coverage

Viable market coverage for same-day

delivery via ship from store1

Relevant population areas dened as high density (>750 inhabitants/km²) and/or high income (purchasing power >€21,900 per capita); viable market

coverage dened as area within 30 minutes driving time from respective retail location.

Stores

100

Source: Alteryx; BKG; ESRI ArcGIS; MB-Research; McKinsey analysis

Store location

Berlin

Hamburg

Cologne

Munich

>1,000,000

Inhabitants

>500,000–1,000,000

>200,000–500,000

Warehouse

coverage

Retailer same-day oering

in top 20 cities

Amazon vs top 20 non-food

and top 13 grocery retailers

Same-day coverage of relevant population,1 Amazon vs disguised

omnichannel fashion retailer

by type of competition, %

28 stores across Germany, covering 5 of

Germany’s 20 biggest cities

Ongoing testing and buildup of

ship-from-store capabilities

Competition area

(Amazon and retailer)

Area at risk

(Amazon only)

Retailer

monopoly area

(retailer only)

Source: Alteryx; BKG; ESRI ArcGIS; MB-Research; McKinsey analysis

Relevant population areas dened as high density (>750 inhabitants/km²) and/or high income (purchasing power >€21,900 per capita); viable market

coverage dened as area within 30 minutes driving time from respective retail location.

Population 22 16 7

23 17 7

Purchasing

power coverage

Viable market coverage for same-day

delivery via ship from store1

Relevant population areas dened as high density (>750 inhabitants/km²) and/or high income (purchasing power >€21,900 per capita); viable market

coverage dened as area within 30 minutes driving time from respective retail location.

Stores

100

Source: Alteryx; BKG; ESRI ArcGIS; MB-Research; McKinsey analysis

Store location

Berlin

Retail stores: The return

of a strategic key asset

The one central requirement for same-

day delivery is simple, yet challenging:

a dense network of warehouses. In

Germany, for example, it would take

11 well-placed warehouses that stock the

same assortment and are able to move

it from click-to-ship in two hours or less

to cover all tier-1 and tier-2 cities.

Amazon has a very dense delivery network, putting the industry leader far ahead of almost all other major Western retailers with

their same-day offering. For these retailers to catch up, the obvious option would be to invest hundreds of millions of euros or

dollars to match Amazon’s footprint one to one.

Amazon’s same–

day shipping

promise covers all

20 of Germany’s

largest cities

The average

large retailer

covers only 2

SUPPLY CHAIN

34 Future of retail operations: Winning in a digital era January 2020

Hamburg

Cologne

Munich

>1,000,000

Inhabitants

>500,000–1,000,000

>200,000–500,000

Warehouse

coverage

Retailer same-day oering

in top 20 cities

Amazon vs top 20 non-food

and top 13 grocery retailers

Same-day coverage of relevant population,1 Amazon vs disguised

omnichannel fashion retailer

by type of competition, %

28 stores across Germany, covering 5 of

Germany’s 20 biggest cities

Ongoing testing and buildup of

ship-from-store capabilities

Competition area

(Amazon and retailer)

Area at risk

(Amazon only)

Retailer

monopoly area

(retailer only)

Source: Alteryx; BKG; ESRI ArcGIS; MB-Research; McKinsey analysis

Relevant population areas dened as high density (>750 inhabitants/km²) and/or high income (purchasing power >€21,900 per capita); viable market

coverage dened as area within 30 minutes driving time from respective retail location.

Population 22 16 7

23 17 7

Purchasing

power coverage

Viable market coverage for same-day

delivery via ship from store1

Relevant population areas dened as high density (>750 inhabitants/km²) and/or high income (purchasing power >€21,900 per capita); viable market

coverage dened as area within 30 minutes driving time from respective retail location.

Stores

100

Source: Alteryx; BKG; ESRI ArcGIS; MB-Research; McKinsey analysis

Store location

Berlin

But there is a better and much cheaper option for today’s fast-growing

but still moderate market volumes: retailers should shift the rules of

the game and use their existing store networks for same-day shipping.

Hamburg

Cologne

Munich

>1,000,000

Inhabitants

>500,000–1,000,000

>200,000–500,000

Warehouse

coverage

Retailer same-day oering

in top 20 cities

Amazon vs top 20 non-food

and top 13 grocery retailers

Same-day coverage of relevant population,1 Amazon vs disguised

omnichannel fashion retailer

by type of competition, %

28 stores across Germany, covering 5 of

Germany’s 20 biggest cities

Ongoing testing and buildup of

ship-from-store capabilities

Competition area

(Amazon and retailer)

Area at risk

(Amazon only)

Retailer

monopoly area

(retailer only)

Source: Alteryx; BKG; ESRI ArcGIS; MB-Research; McKinsey analysis

Relevant population areas dened as high density (>750 inhabitants/km²) and/or high income (purchasing power >€21,900 per capita); viable market

coverage dened as area within 30 minutes driving time from respective retail location.

Population 22 16 7

23 17 7

Purchasing

power coverage

Viable market coverage for same-day

delivery via ship from store1

Relevant population areas dened as high density (>750 inhabitants/km²) and/or high income (purchasing power >€21,900 per capita); viable market

coverage dened as area within 30 minutes driving time from respective retail location.

Stores

100

Source: Alteryx; BKG; ESRI ArcGIS; MB-Research; McKinsey analysis

Store location

Berlin

But there is a better and much cheaper option for today’s fast-growing

but still moderate market volumes: retailers should shift the rules of

the game and use their existing store networks for same-day shipping.

In Germany, connecting 30 stores to the

grid would be enough to reach almost

half the population and come close to

matching Amazon’s current service offer.

This strategy—using existing stores rather than new warehouses—

could be the entry gate to same-day delivery for aspiring retailers.

Top 30 stores could reach

of German population

46%

35A retailer’s guide to successfully navigating the race for same-day delivery

Innovation road map:

Four areas for shifting gears

Omnichannel retailers who follow this

strategy will need an upgrade in terms

of not only fulfillment but also IT and

store design, as well as a fundamentally

different mind-set in terms of economics.

1. Local fulfillment networks

Urban fulfillment locations within 90 minutes drive time from customer

Optimized E2E click-to-ship in two hours or less

Strong set of last-mile partners that allow for seamless processes

2. Fast, integrated IT systems

Full inventory transparency across all warehouses and stores

Direct transfer of order data between web shop and (in-store) fulfillment

Prioritized picking logic to allow fast-tracking of same-day orders

3. New store layouts and processes

Dedicated and clearly signed collection and return areas

Easy-to-navigate back room set up in line with product demand and characteristics

Sufficiently trained, equipped, and incentivized store staff

4. Rethinking economics

Willingness to bear initial extra costs that can exceed €10 per shipment

Pressure-tested make vs buy logic along the entire supply chain

Clear upside aspiration, eg, CLV increase and/or subscription income

SUPPLY CHAIN

36 Future of retail operations: Winning in a digital era January 2020

Entering the race for same-day delivery

can be hard. Most retailers would initially

fall way short of the volumes required for

at-scale operations and more than triple

their delivery bill when compared to

today's next-day standard.

Current market

volume=at scale

At scaleRetailers’ current

standalone

market potential

4.45

7.35

15.17

1.40

2.75

4.40

8.02

3.73

2.36

0.87

0.69

Same day Next day

More than

Last mile

Intranode

Fulllment

Includes costs of own warehousing and fulllment and third-party transport

and delivery.

Estimated same-day vs next-day delivery costs

EUR/shipment, non-food retail example, Berlin area

Subscription models can cross-nance shipping costs but require high customer

relevance and a broad set of benets. Retailers that adopt same-day delivery need to

explore various paths to monetize their convenience leadership.

Member benets

Selected examples

Same-day shipping

Video streaming

Music streaming

Online data storage

Same-day shipping

Early promotion access

Return pickups

Personal style advice

Customer GMV

EUR p.a.

PrimeNon-prime

~550

PlusNon-plus

~250

SubscribersRegular

~120

>1,200

Amazon Zalando Other retailers

Customer orders

p.a.

10–15 >25 ?4–5 1–3 ?

Membership fee

EUR p.a.

110 19 ?

US market example. All values converted from USD to EUR at FX $1=€0.91 (rounded).

In selected regions. Otherwise premium next-day shipping.

Source: annual reports; press research; Statista

Manik Aryapadi is an associate partner in McKinsey’s Cleveland office, Tim Ecker is an associate partner in the Frankfurt office, and

Julia Spielvogel is a partner in the Vienna office.

37A retailer’s guide to successfully navigating the race for same-day delivery

Better service with

connected inventory

It is not just the customer experience that manufacturers and retailers

enhance by extending their reach to the entirety of stocks in the market.

©Hero Images/Getty Images

by Ashutosh Dekhne, Tim Lange, Karl-Hendrik Magnus, Isabell Scheringer, and Simon Vincken

SUPPLY CHAIN

38 Future of retail operations: Winning in a digital era January 2020

Consumers are very familiar with the scenario:

the T-shirt they have set their heart on is no longer

available in their local store or their preferred online

shop. Or it can’t be delivered on time. The customer

could of course go to another retailer, brand store,

or online shop. But that is often a time-consuming

option or at least inconvenient. In the end the

customer buys another product—or none at all.

That’s unquestionably a frustrating outcome for

all parties. At best, the customer experience is

tarnished, and in the worst case, the customer is

lost. Wouldn’t it be great to have direct access to all

inventories available in the market—regardless of

what company is stocking them? In fact, available

stock levels are typically perfectly sufficient, but

they are distributed among a growing number of

network nodes: at retailers, at vertically integrated

companies with direct-to-consumer business, at

e-tailers and wholesalers, in stores, in warehouses,

or in transit (Exhibit 1).

In response, some companies are beginning to

connect their inventory. This rarely leads to mutual

assistance between direct competitors. Therefore

it is unlikely to soon see a store of a sports goods

retailer providing FC Barcelona soccer jerseys to a

neighboring department store with sold-out stock.

But why shouldn’t the department store place

orders directly with an outlet or warehouse of the

respective sports article manufacturer? After all,

it is in its interest to offer an outstanding customer

experience, irrespective of the sales channel.

Everybody benefits

When two or more companies systematically share

their inventory, they essentially construct a network

of fulfillment nodes and form a pool of stocks that

is larger than what each individual partner had

previously. As a result, customers get a better

buying experience, but the companies involved also

benefit directly.

Not only do connected inventories increase the

availability of individual products, they also broaden

the product range. Delivery times decrease, too, as

goods can be dispatched from multiple points close

to customers. Ideally, transport costs thus decrease

as well. There are also further benefits for consumers.

Any outlet or boutique operated by the partner

companies directly or by franchisees can serve as

a potential pickup point. That gives more options to

buyers, who can lower their environmental impact by

picking up their goods at the nearest store rather than

having them sent home.

The two greatest benefits for companies are self-

evident. First: by connecting their stocks, companies

can interlink customer journeys in online and off-line

channels and thereby increase their chances of

winning new customers and holding on to existing

ones. Second: the improved availability of products,

the faster delivery, and the better consumer

experience enhance the overall likelihood of making

a sale.

Other merits: Thanks to the linked customer

journeys, the partners can now also collect more

information about their customers. Participating

companies can offer faster delivery times without

having to increase the volume of stocks in the

market. In addition, the optimization of inventory

levels across the entire network avoids excess

stocks. That results in a higher sell-through at full

price, which means less discounts and inventory

markdowns at the end of the season. In turn,

working capital is kept low and the overall costs

across the supply chain decrease.

Five networking models

But just how complex is cooperation? Who owns

the goods? Who gets what commission when?

Or in short: how does connected inventory work

in practice?

39Better service with connected inventory

Exhibit 1

McK Retail compendium

Connected inventory

Exhibit 1 of 3

Goods are distributed to end customers over a growing number of network nodes.

Inventory nodes of retailers and manufacturers

Transport

from factory

Customer

Manufacturer’s

central

warehouse

Manufacturer’s

distributed ware-

house/stores

Retailer’s

stores

Retailer’s

warehouse

Online retailer’s

warehouse

Wholesaler’s

warehouse

Inventories can in fact be linked up in a variety

of ways. The simplest model involves shedding

transparency on intracompany inventories,

assuming they are not transparent already. With

transparency in place, the mildest form of connected

inventory between two companies is a unilateral

partnership: the manufacturer assists retailers

faced with out-of-stock articles by delivering the

items ordered. Such partnership arrangements can

be extended to provide retailers access to products

that they do not normally stock (along the lines of

an “endless aisle” concept). More complex, but

also more advantageous, are bilateral partnership

arrangements in which both partners get access

to their respective inventory. Ideally, what results

is a virtual inventory pooling several retailers and

manufacturers. Such a pooling model allows, for

instance, a retailer in Frankfurt to transact a jeans

SUPPLY CHAIN

40 Future of retail operations: Winning in a digital era January 2020

order by a customer in Cologne through a partner

retailer that delivers the jeans from the inventory it

holds in its Cologne warehouse (Exhibit 2).

Underpinning the commercial basis of these

models are several sales concepts. These concepts

are marked by specific ownership structures.

— Commission model. The stocks are owned by

the company that manages them and that can

handle fulfillment. This company processes

the order and pays commission to the partner

company that concludes the business, whether

online or in a brick-and-mortar store.

— Repurchase model. Ownership of the inventory

is transferred from the party that manages

it when it is sold to the party that transacts

the sale to the customer. Commission is paid

as compensation to the party that originally

managed the inventory.

— Joint venture model. The stock is owned by a

joint venture founded by the partners seeking

to network inventory. In this model, the partners

jointly bear the risks and share the benefits,

which makes the model particularly appealing.

Exhibit 2

McK Retail compendium

Connected inventory

Exhibit 2 of 3

Inventory can be interlinked in a variety of ways.

Connected inventory models

Unilateral Bilateral

Number of

participating companies

1: Internal connected inventory

A company connects the inventory in its central

warehouse together with its local distribution

centers and stores. When a customer orders a

product online, the most ecient dispatch

point measured by time and cost is selected or

a store is suggested for personal pickup by

the customer. Sales clerks in stores can also

check at a click if a sold-out product is

available elsewhere.

2: Out-of-stock partnership

Manufacturers and retailers reciprocally

disclose their respective stocks of products

that the retailer regularly sources from the

manufacturer. If the product is out of stock at

the retailer, the customer can still complete the

purchase because the manufacturer can send

the article directly.

4: Bilateral partnership

Manufacturers and retailers reciprocally make

their inventory transparent so that they can

take care of each other’s fulllment as needed.

When a customer places an order in a partner’s

online shop, the product is sent from the best

possible distribution point.

3: Endless-aisle partnership

In the endless aisle model, the manufacturer

provides the retailer virtual access to its entire

inventory, including products that the retailer

does not have in its product range. The retailer

can thus oer an extended product range in its

online shop that is then directly handled by the

manufacturer.

5: Virtual inventory pool

Several retailers and manufacturers connect

their inventories. The pooled inventory is held

by a neutral entity (eg, a joint venture) to which

every partner has access. A customer order is

always fullled from the best possible

distribution point.

Transparency of inventory

1: Internal connected inventory

2: Out-of-stock partnership

4: Bilateral partnership

5: Virtual inventory pool

3: Endless-aisle partnership

41Better service with connected inventory

Determinants of success: From

incentive systems to delivery slips

Regardless of the model that the partners choose:

building a connected inventory concept inevitably

requires new solutions in sales, the supply chain,

and IT that are by no means simple. Furthermore, it is

important that all parties have sufficient incentives

to keep goods in stock. Otherwise, the natural

tendency is to keep one’s own inventory as low as

possible in a bid to lower the risk of excess stocks.

In addition, it has to be clear who owns the stocks in

the pool—specifically, who owns the stocks in which

phase of the fulfillment process and at what points

ownership—and the associated risk—is transferred

to another partner.

Transparency is also key to success. It has to

be clear at all times which product is where and

in what quantity. This requires a distributed

order management system capable of interlinking

the various nodes in the network and instantly

determining the optimal dispatch point.

Furthermore, to have the right quantity of the

right product in the right place, integrated planning

that factors in the inventory levels and forecasts of

all partners is also needed.

The location of inventory in the market can also

have legal and tax implications (e.g., import duties).

Consequently, an advanced assessment should

be conducted to determine the extent to which a

specific networking model might be restricted by

antitrust law in one or several jurisdictions.

In addition, the partners should enter into clear

agreements in order to offer customers a seamless

consumer experience—regardless of which

company executes the order. The partners need

to align an array of details, such as their delivery

and gift packaging, delivery slips, or conditions for

returning goods.

Success stories in other sectors

The associated complexity of requirements is

most certainly one reason why the concept of

connected inventory is only just beginning to take

root—although there are already some high-profile

initiatives (Exhibit 3). Other sectors have made far

more progress in this regard.

Take the aerospace industry, for example, where one

supplier of replacement parts has set up a program

for sharing inventory. Aircrafts have expensive

Exhibit 3

McK Retail compendium

Connected inventory

Exhibit 3 of 3

Connected inventory is still the exception in retail—although there are prominent early adopters.

Amazon, Procter & Gamble

As early as 2013, Amazon and Procter & Gamble (P&G) joined forces to sell products, such as diapers and toilet

paper directly from P&G’s warehouses, where Amazon set up on-site distribution centers to deliver goods directly

to customers.

Source: Fox; L'Oréal; The Street; YOOX NET-A-PORTER; Zalando

Zalando, adidas

In 2015, Zalando and adidas launched a pilot project in which one of adidas’ distribution centers was linked up to

Zalando’s inventory system. As a result, not only do Zalando’s customers have access to a larger oering of adidas

products, but adidas can fulll orders of products that Zalando no longer has in stock.

L’Or

éal

The cosmetics company L’Oréal oers its customers the option of checking whether a product is available

at an online retailer. If so, customers are directed to the corresponding web shop to make their purchase directly.

YOOX NET-A-PORTER,

Valentino

In 2017, online fashion retailer YOOX NET-A-PORTER (YNAP) and the luxury label Valentino unveiled their Next Era

program, which provides customers access to both Valentino and YNAP products on a shared platform. The

program is also intended to allow both companies to reciprocally use each other’s logistics infrastructure spanning

central warehouses, fulllment centers, and boutiques.

SUPPLY CHAIN

42 Future of retail operations: Winning in a digital era January 2020

replacements parts that nevertheless have to be

available everywhere and at all times to enable fast

repairs. The planning system ensures the best-

possible warehousing of parts by drawing on linked

forecasts of requirements. Everybody benefits

from the program: The replacement parts supplier

can hold on to its inventory and also gain access to

the stocks of participating airlines. The latter can

then source replacement parts directly from the

supplier but also generate revenue from their own

inventory by selling it to partner airlines. In addition,

the cooperation arrangement allows the airlines to

adjust their inventory programs to ensure the local

availability of parts while avoiding excess inventory.

Similar initiatives in retail seem only a matter of

time—particularly as the same-day or even hourly

delivery pervasive in online retail is setting a pace

that can likely only be maintained with the backing

of powerful partnerships. Against this backdrop,

connected inventory can make a substantial

contribution toward improving product availability

and the customer experience while reining in costs

and capital intensity.

Key statements

— The first retailers and vertically integrated

players with direct-to-consumer business

are beginning to intelligently connect their

inventories in the marketplace

— Everybody involved, including consumers,

benefits from the advantages of connected

inventory: greater availability and faster delivery

of goods, greater delivery convenience, and

lower environmental impact.

— Retailers and vertically integrated players

that enter into corresponding partnership

arrangements attract more customers, secure

higher conversion rates, and benefit from an

array of additional advantages.

Ashutosh Dekhne is a partner in McKinsey’s Dallas office, Karl Hendrik-Magnus is a partner in the Frankfurt office,

where Isabell Scheringer is a consultant, Tim Lange is a partner in the Cologne office, and Simon Vincken is a consultant

in the Brussels office.

43Better service with connected inventory

The invisible hand: On

the path to autonomous

planning in food retail

It’s not news to food retailers: sometimes your stocks are too high, sometimes

they’re too low. Advanced planning now gives them entirely new options for

solving the expensive problem—and cuts costs in the process.

by Manik Aryapadi, Ashutosh Dekhne, Tim Lange, Markus Leopoldseder, and Karl-Hendrik Magnus

SUPPLY CHAIN

44 Future of retail operations: Winning in a digital era January 2020

Supply chain planners in food retail today are

not to be envied. They have to please customers

who have never made more exacting demands on

availability, freshness, and range. And they ignore

such expectations at their peril: the competition is

relentless, driving all market participants to seek

out improvements incessantly. Those who stick to

their legacy processes can only make comparable

progress at the cost of mounting stocks, increasing

write-offs, and an increasingly complex supply chain.

Internally, planners are often struggling with

outdated IT systems that are isolated from each

other, unreliable sources of information, and in

some cases, largely manual and poorly coordinated

processes. Forecasts are commensurately

inaccurate and personnel expenses high. Externally,

on the other hand, decision makers are faced with

an increasingly unfathomable offering from digital

service providers that—although they can process

huge volumes of data with their solutions—cannot

give retailers any advantages of relevance as long as

they leave their operating models unchanged.

A look at online retail already reveals the shape of

things to come: leading companies are developing

highly integrated planning systems that already

use the most advanced analytics and machine-

learning solutions available today. These high-tech

methods, also referred to as “advanced planning,”

will, in the future, take control of steering in food

retail as well. And they set exacting requirements

on companies: they entail tapping the entire wealth

of transaction data along with external parameters

as sources. Retailers need a completely different

process landscape, new capabilities, more

computing power, and advanced algorithms.

Those who do a particularly good job of establishing

advanced planning in their organizations stand to

reap big rewards. Like an invisible hand, the system

works autonomously, effectively, and efficiently.

Planners only have to intervene in exceptional

cases to check and make corrections. More than

that, the system improves forecasting accuracy, as

not only does it draw on multiple data sources, it

also interconnects them using artificial intelligence

and machine learning. At the same time, advanced

planning enables an ever-tighter integration of stock

management, procurement, logistics, marketing, and

sales, leading to greater efficiency improvements and

sales growth. This approach makes manual transfers

between systems things of the past—process chains

are no longer interrupted, and data remain consistent.

Areas of application across the entire

supply chain

Food retailers can apply advanced planning to

practically all activities along the value chain

(Exhibit 1), with a focus on improved demand

forecasting, which allows better planning of store

processes or a sustained increase in the quality

and shelf life of fresh produce:

— Better demand forecasting. Leading retailers

have already created algorithms with which

software can automate order processes by

“learning” from data—also without having

to rely on rules-based programming. This

entails determining and continually optimizing

all parameters that influence replenishment

management—individually at article and store

levels. Often, more than 50 parameters are

factored into the analysis, among them prices and

sales promotions (including those of competitors),

cannibalization, local weather conditions, store-

opening times, and holidays—and at a far greater

level of detail than standard systems. This results

in more precise demand forecasts and more cost-

effective orders. On average, retailers with such

planning systems report a 25 percent reduction

in stock shortages in their fresh-produce

assortment, at least a 10 percent decrease in

write-offs, up to 9 percent higher gross margins,

and a better inventory range. At the same time,

the cost of inventory planning decreases by as

much as 30 percent due to the higher degree of

automation.

— Better store processes. Advanced planning

also improves store-labor planning. That is

because the system shows how much labor will

actually be needed in a specific period of time—

45The invisible hand: On the path to autonomous planning in food retail

for instance, at checkouts or packing shelves

in individual store departments. On top of that,

precision forecasting helps to lower inventory

in the store’s stockroom radically—and in turn,

reduces movement between shelves and the

stockroom. This effect is amplified when shelf

space per article is adjusted to the demand

forecast, effectively turning shelves into

efficient storage space.

— Better quality of fresh produce and less spoilage.

Thanks to more precise forecasting, retailers can

order their goods from suppliers much earlier and

with greater accuracy. Consequently, fewer fresh

articles are left unsold. Better forecasting also

means increased planning reliability for suppliers.

They can collect their harvests to match demand

and thus reduce the field-to-shelf time. As a

result, retailers can increase the level of freshness

Exhibit 1

Print 2019

Autonomous planning food retail

Exhibit 1 of 2

The future of planning builds on award–winning advanced analytics with real-time,

action-based recommendations for all core functions.

Demand planning

Inventory management

Sales and operations

planning

Pricing and promotion Planogram

Grocery storeSupplier Warehouse Logistics

Continuous business

planning based on real-

time information, scenario

planning, and cross-

functional collaboration

Optimized pricing and

promotion allocation

across network

(potentially by store)

Optimized space

allocation (potentially by

store) to ensure correct

stock facings and

one-touch replenishment

Optimized inventory

management among

channels to maximize

protability and growth

More accurate volume

forecasts for ad hoc

problem solving

with suppliers

SKU location and space allocation

adapted based on expected sales;

optimal inventory levels (especially

safety stock levels) across

distribution-center/store networks

at all times

Higher accuracy on

volume per road,

increased ll rates,

and reduced kilometers

Minimal human interaction

in replenishment process

and accurate information

of workload, with

day/hour granularity

SUPPLY CHAIN

46 Future of retail operations: Winning in a digital era January 2020

of their articles and reduce spoilage by up to

30 percent.

In view of such potential, many food retailers

are showing a keen interest in advanced

planning. However, they are still struggling with

implementation in their businesses. For instance,

the topic is frequently only pursued by a single

function acting alone—typically, IT, logistics, or

procurement. What is lacking is the embedding

of the new method in the organization’s operating

model, along with a corresponding adjustment

of all processes. Often, the backing from other

functions is also lacking, as in the immediate term,

they tend to see the introduction of the new system

primarily as a disruption to their processes and the

corresponding consequences for weekly sales.

Such factors make complete implementation of

advanced planning far too protracted and difficult

for most retailers.

The make-or-buy question poses another

challenge. Many retailers do not have the capacity

and capabilities needed to develop an advanced-

planning solution efficiently in house. If the retailer

opts for an external solution, it has to negotiate

difficult trade-offs. On the one hand, it might be

interesting to choose a smaller, newer service

provider with innovative solutions. On the other

hand, large and established providers often offer

pragmatic, if less innovative, solutions with many

functionalities. Many retailers have a hard time

even coming up with a workable assessment of the

capabilities of individual providers.

Four determinants of success combined

The potential improvements are of such a magnitude

that it pays to overcome these problems. And the

experience of the early adopters shows that in food

retail, too, advanced planning leads to success, if

companies can meet four preconditions:

— Clear, comprehensively set course. Optimizing

planning has to be one of the company’s

overarching objectives and be strategically

embedded accordingly. It is the technology that

supports the strategic transformation, not the

other way around. This requires the committed

support of senior management and of all

organizational functions, in particular. That is

especially the case when initial setbacks create

uncertainty.

— Most advanced technology. A central

determinant of success is the choice of planning

software and its gradual integration across all

organizational units. To this end, retailers should

first draft a requirements profile tailored to their

needs. Pilot projects and experience from other

stores can then help ease the selection process.

In other words, the software is at the end of this

process, not the beginning.

— Rigorous adaptation of the operating model.

The full potential can only be captured when

processes, structures, and employee skills

are fundamentally transformed. To lift the

operating model to this next level, processes

should be redesigned, metrics reworked,

objectives and employees’ performance

dialogues adjusted, new roles created,

responsibilities along processes reallocated,

capabilities needed built up, and specialists

recruited.

— Intensive change management. A comprehensive

advanced-planning transformation affects

many stakeholders and entails new requirement

profiles. Many of those affected often respond

with skepticism or even open rejection. So it is

especially important to explain to everybody

involved what the benefits are, to win their

enthusiasm for the new system, and to celebrate

early successes visibly. It is the combination of all

four determinants of success that actually allows

retailers to make the most of all the technological

capabilities that advanced planning has to offer

and thereby unfold the full performance potential

(Exhibit 2).

Three steps to success

So where should retailers start? A three-step

approach has proven successful in practice. The

first step is to analyze in detail the current planning

47The invisible hand: On the path to autonomous planning in food retail

process: Who is involved in the process? What

tools are they using? How high is the degree of

automation? Where are there quality problems,

such as with regard to availability and stock

quantities? Once these questions have been

answered, it is possible to develop specific use

cases. What is decisive at this stage is a clear

orientation toward business impact, as well as

a precise understanding of the effects of the

changes introduced on the various processes,

structures, and employees concerned.

In the second step, the use cases have to be

assessed by reference to their potential for

improving revenue, margins, costs, and stocks, and

the cost of implementation is estimated. Starting

with the preferred use cases, the company then

derives the vision for its advanced planning. The

Exhibit 2

All major prot-and-loss items are positively inuenced by advanced planning.

Standard prot and loss, illustrative, % of revenue

Varies signicantly among retail types.

Includes rent and maintenance.

Includes labor cost.

Impact assumes range of dierent tools (eg, demand forecasting, inventory management, and workforce management).

Print 2019

Autonomous planning food retail

Exhibit 2 of 2

Business impact from advanced planning,

Revenue

Availability,

revenue gain

Assortment

optimization,

revenue gain

Inventory

reduction

Shrinkage

reduction

Store

labor-cost

reduction

Logistics-cost

reduction in

warehouse

operation

Freight-cost

reduction

Increase in

operating

prot

Cost of

goods sold

Gross

margin

Labor Logistics Other operating

costs

Operating

prot

100

10–20

1–2

2–5

0–5

10–30 10–30

3–5 5–20

5–10

>1.5

SUPPLY CHAIN

48 Future of retail operations: Winning in a digital era January 2020

system’s sustainability then has to be secured with

the aid of a stable business case. In this context, the

company should aim for a balanced mix of quick wins

and long-term improvements.

In the third step, the new planning methods

are piloted in one or two use cases—for

instance, in fruit and vegetable planning and in

automated replenishment. The aim is to test the

improvement potential of advanced planning in

real-world operations. When designing the pilot

trials, a pragmatic, test-and-learn approach is

recommended. After all, the objective is not so

much to come up with a perfect design on day

one but rather to reiterate quickly and continually

improve processes as experience is gained. In

parallel, the operating model should be adjusted

to the new requirements, and the digital know-

how needed should be built up. The latter point, in

particular, is often underestimated, even though

recent studies show that these soft factors

are more frequently the cause of failures in

digital transformations than are shortcomings in

technology or data quality.

Once the pilot programs are completed, the

organization is ready for a wider rollout. To this

end, the road map is adjusted to take into account

the experience gained in the test runs, and the

new planning mechanism, including the operating

model, is then applied to the entire assortment.

Organizations can then expect to see measurable

improvements reasonably quickly—often, within

the first 12 months.

Manik Aryapadi is an associate partner in McKinsey’s Cleveland office, Ashutosh Dekhne is a partner in the Dallas

office, Karl-Hendrik Magnus is a partner in the Frankfurt office, Tim Lange is a partner in the Cologne office, and

Markus Leopoldseder is a consultant in the Vienna office.

49The invisible hand: On the path to autonomous planning in food retail

Automation in logistics:

Big opportunity, bigger

uncertainty

As e-commerce volumes soar, many logistics and parcel companies

hope that automation is the answer. But as this second article in our

series on disruption explains, things are not so simple.

by Ashutosh Dekhne, Greg Hastings, John Murnane, and Florian Neuhaus

SUPPLY CHAIN

50 Future of retail operations: Winning in a digital era January 2020

The history of logistics is also a history of

automation, from the steam engine to the forklift

to today’s robotic pickers and packers. So today’s

fevered interest in new machinery, after a lull

of several years, has plenty of precedent. Many

trends are thrusting automation toward the top

of the logistics CEO’s agenda, not least these

three: a growing shortage of labor, an explosion in

demand from online retailers, and some intriguing

technical advances. Put it all together, and the

McKinsey Global Institute estimates that the

transportation-and-warehousing industry has

the third-highest automation potential of any

sector.

Contract logistics and parcel companies

(which, for sake of convenience, we will call simply

“logistics companies”) particularly stand to benefit.

(Automation is also on the table at other transport

companies, such as trucking companies and port

operators. See sidebar “Automating freight flows:

Changes for every sector.”)

Yet for all the excitement, most logistics companies

have not yet taken the plunge. For every force

pushing companies to automate, countervailing

factors suggest they should go slowly. We see five

reasons companies are hesitating: the unusual com-

petitive dynamics of e-commerce, a lack of clarity

about which technologies will triumph, problems

obtaining the new gizmos, uncertainties arising from

shippers’ new omnichannel-distribution schemes,

and an asymmetry between the length of contracts

with shippers and the much-longer lifetimes of

automation equipment and distribution centers.

This is the second in a series of five articles on

disruption in transport and logistics. In the first, we

examined the implications of autonomous trucks.

Automation is no less potent a force. In this article,

we will review the reasons automation is coming to

the fore, examine the five factors that are hindering

investment, and lay out strategies that can prepare

contract logistics companies for an uncertain future.

Three cheers for automation

At first blush, more automation seems like the

answer to three problems facing contract

logistics companies.

Start with a shortage of workers. It’s no secret that,

at least in the United States, labor markets have

tightened. Unemployment rates are at a 50-year

low, and wages are increasing. Some of the largest

e-commerce facilities currently require 2,000 to

3,000 full-time equivalents, an order of magnitude

more than traditional distribution centers employ,

and need to add even more workers during the

holiday peak season, when labor is most scarce.

While many of the jobs that might be automated

are currently difficult to fill, that’s not to say that

automation will have no effect on the workforce: it

will, and companies must reckon with the significant

costs to their employees and communities. In 2017,

the US Bureau of Labor Statistics estimated that

nearly four million Americans work in warehouses

as supervisors, material handlers, or packers. That’s

almost 3 percent of the total labor force; collectively,

they earn more than $100 billion in annual wages.

Automation won’t make all these workers redundant,

of course, and many can be reassigned to new jobs

that involve collaborating with and maintaining the

new machines. But if even a portion of these jobs

are lost, it will still represent significant upheaval.

E-commerce, the second trend, is remaking the

entire logistics industry. The inexorable rise of online

sales is well documented. In the United States, for

example, growth has averaged 15 percent annually

over the past decade, and the range of goods

has expanded dramatically. That’s been good for

logistics companies. We estimate that, out of every

$100 in e-commerce sales, these companies (or

e-tailers’ in-house logistics units) are collecting

$12 to $20, a massive increase from the $3 to

$5 spent on logistics in a typical brick-and-mortar

retail operation. (It’s important to note that, in our

Michael Chui, James Manyika, and Mehdi Miremadi, “Where machines could replace humans—and where they can’t (yet),” McKinsey Quarterly,

July 2016, McKinsey.com.

51Automation in logistics: Big opportunity, bigger uncertainty

estimate, e-tailers are saving $12 to $16 out of

every $100 of sales versus their brick-and-mortar

competitors, which explains why their economics

work so well.)

But even as logistics companies have benefited

from burgeoning volume, the business is not without

its challenges. Many B2B networks are struggling

to adapt. Many large logistics companies fulfill

e-commerce orders by carving out a corner of

warehouses designed for B2B operations. And

some logistics companies have at times been willing

to use e-commerce as a loss leader to add business

to their transport divisions. But as volume expands,

all such arrangements are coming under immense

strain. Here, too, automation seems to be an answer.

Automating freight ows: Changes for every sector

Automation will aect the supply chain

far beyond the walls of the warehouse and

sorting center; it will change the way goods

ow across all modes (exhibit). In the rst

article in this series, we addressed the

impact of autonomous trucking, a critical

automation technology, on roads, rails,

and ports. And our colleagues recently

produced a detailed look at other forms

of port automation. They nd that while

ports are accelerating their adoption of

automation, they are not yet recouping

their costs. Moreover, while operating

expenses are falling as expected (by 15 to

35 percent), throughput is falling as well

(by 7 to 15 percent). Port operators can

take several steps to get the most out of

automation. Among other moves, they can

build automation-ready capabilities rather

than simply automating old processes. And

they can apply better project discipline

to ensure that automation investments

account for all attributes of port operations.

Of the remaining transport modes,

automation in ocean and air freight is quite

possible but will probably not move the

productivity needle much. In rail, automation

will likely begin in terminals, which oer

controlled environments and repeatable

processes. Intermodal terminals will

likely see increased use of autonomous

hostlers to move containers to and from

trains. Autonomous cranes are also likely to

emerge in the near term. While the physics

of trains makes automation on the main line

a longer-term prospect, rail operators and

governments are investing in technologies

that lay the foundation. Positive train control

(PTC) is a long-desired step toward an

automated future: its data links allow for

real-time automated control of sets of trains.

Several European and US railroads have

PTC schemes in the works, and a few have

fully implemented them.

Over time, railroads will continue to search

for opportunities to automate the main

line, but some limits will persist for the

foreseeable future. For example, trains

traveling heavily populated routes or

hauling hazardous materials will likely

continue to need human oversight.

Exhibit

Automation is emerging to varying degrees across the global logistics chain.

Today’s global logistics chain, illustrative

Degree of automation

Low High

Shipper/origin

Port or hub

storage/loading

Port or hub

storage/loading

Warehouse, contract

hub, and fulllment

Customer

Ocean or long-

distance transport

First-mile

transport

Customs/border Customs/border Inland

transport (B2B)

Delivery

2019

Automation in logistics: Big opportunity, bigger uncertainty

Exhibit 1 of 4

SUPPLY CHAIN

52 Future of retail operations: Winning in a digital era January 2020

There is a third reason for heightened interest:

automation technology has come a long way.

Ocado’s new fully automated warehouse has

demonstrated the potential of several new

technologies—as seen by a big YouTube audience.

Other companies, such as CommonSense Robotics

(CommonSense), GreyOrange, and XPO Logistics,

are rolling out intriguing new offerings.

These three trends make it seem like more

investment in automation is a layup. Indeed, many

are finding success with it. Some companies’

new automated pallet-handling systems cut

shipment-processing time by 50 percent. And DHL

International (DHL) has built almost 100 automated

parcel-delivery bases across Germany to reduce

manual handling and sorting by delivery personnel.

In fact, if you squint hard enough, an entirely new

logistics paradigm is coming into view (Exhibit 1).

Many operations could be automated by 2030, as

artificial intelligence takes over the many repetitive

activities that logistics companies perform.

We expect to see fully automated high-rack

warehouses, with autonomous vehicles navigating

the aisles. Managers with augmented-reality

goggles will be able to “see” the entire operation,

helping them coordinate both people and robots.

Warehouse-management systems will keep track

of inventory in real time, ensuring it is matched to

the ordering system. Three-D printers will crank out

spare parts made to order (see sidebar “Automation

technologies to watch”).

Five reasons for hesitation

Logistics companies are intrigued by the potential of

automation but wary of the risks. Accordingly, they

are investing conservatively. McKinsey research

estimates investment in warehouse automation will

grow the slowest in logistics, at about 3 to 5 percent

per year to 2025. That’s about half the rate of

logistics companies’ customers, such as retail and

automotive (6 to 8 percent) and pharmaceuticals

(8 to 10 percent).

Five issues are holding the sector back. Two are

the flip sides of the forces (e-commerce and

technological advance) that are motivating the

renewed interest in automation. Also clouding the

outlook are purchasing problems, the potential for

change in the omnichannel supply chain, and the

risks associated with short-term contracts.

Frenemies and ‘coopetition’

To capture the large e-commerce-growth

opportunity, any logistics company must meet two

fundamental requirements: speed and variety. Think

same-day delivery of any of a million SKUs. To deal

with that, more automation in picking, packing, and

sorting seems like an easy investment call. But the

unusual dynamics between logistics companies

and e-commerce customers hold many logistics

companies back. The risk manifests in a few

ways. One is that e-commerce companies have a

lot of buying power; if they do not like a logistics

company’s offer, they can easily shift their business

to competitors. That tends to keep prices low and

may keep logistics companies from making an

adequate return on a big investment in automation.

Another wrinkle is that most large e-commerce

companies, such as Amazon and JD.com, have built

their own logistics capabilities. Indeed, we estimate

that if Amazon’s logistics unit were a separate

company, it would be the fifth-largest third-party-

logistics company in the world. To be sure, working

with these companies can present challenges for

shippers. The online giants, with their superior

data and extraordinary scale, can readily offer

white-label products that undercut their shipping

customers’ offerings.

But many thousands of

shippers find the benefits outweigh the risks. The

online giants deploy their in-house logistics first in

the most lucrative niches, such as parcel delivery

in dense urban areas, while slowly expanding into

other areas. As that happens, they threaten to shunt

logistics companies toward low-margin services,

which may not justify an investment in automation.

The moves by big e-commerce companies to build

more warehouses in the last mile, and offer same-

Rick Braddock, “To compete with Amazon, big-name consumer brands have to become more like it,” Harvard Business Review,

June 14, 2018, hbr.org.

53Automation in logistics: Big opportunity, bigger uncertainty

day as well as instant delivery, are a potent step in

that direction, and logistics companies will have to

carefully monitor the pace of change.

A particular challenge of serving e-commerce

companies is that demand is very spiky, easily

doubling around Christmas or Singles’ Day. On

Singles’ Day 2017, Cainiao, Alibaba’s logistics arm,

processed 812 million orders, eight times more than

on a typical day. If logistics companies are to fulfill

customer expectations during peaks, they will have

significant spare capacity for three-quarters of the

year. And if they do not build sufficient capacity for

peaks, e-commerce giants have further incentive to

build their own capabilities, as Amazon did after the

2013 Christmas season.

Exhibit 1

2019

Automation in logistics: Big opportunity, bigger uncertainty

Exhibit 1 of 4

Autonomous guided vehicle.

Source: McKinsey analysis

A new logistics paradigm is emerging.

10 prominent technologies that could remake warehouse operations

Typically used with an

automated storage and retrieval

system (AS/RS) that moves

goods (mostly on pallets) in

3 dimensions to store and

retrieve items without human

intervention.

Algorithms that help operators

analyze performance, identify

trends, and make predictions

that inform operating decisions,

often using machine learning to

improve over time.

Sensors that scan items (often

on 6 axes) to apply sortation and

other logics. Examples include a

conveyor’s diverts, laser-guided

vehicles, and camera-based

movement of drones.

A connection between

2 disparate conveyor systems

that often uses decision logic

to aect the ow of items.

Typically, connections integrate

dierent systems of ow, for

example push and pull ows.

Analytic and digital systems that

integrate analytics, performance

reporting, and forecasting tools,

allowing managers to easily

control a full system such as a

warehouse.

Storage solutions that use

advanced analytics and digital

tools to place and retrieve items

in the most ecient way,

adjusting storage media based

on the product, picking, and

order characteristics.

Also called additive

manufacturing, this process

creates parts by adding layers

of a material (metal or plastic,

typically) to create a desired

shape.

Autonomous guided vehicles

that operate freely or on digital

tracks to bring items (often from

a storage rack) to a picking

station based on instructions

from the order-ow software.

Glasses that augment and assist

reality of wearers—for example,

by displaying directions to

storage locations for picking—

reducing ineciencies of

searching.

Systems with robotic arms that

mimic human picking motion.

Picking robots can be xed (with

goods brought to them) or mobile

(traveling to storage to pick

items).

Multishuttle system Analytics tools Optical recognition Conveyor connection Management system

Smart storage 3-D printing Swarm AGV

robots Smart glasses Picking robot

SUPPLY CHAIN

54 Future of retail operations: Winning in a digital era January 2020

Technology racing ahead

We combed the industry and found more than

50 technologies that could further automate

some part of the supply chain, including many

in logistics (Exhibit 2). All are much more than a

twinkle in some technologist’s eye, but none are

yet in widespread use. The question that confronts

logistics companies (and warehouse companies) is

simple enough: Which ones will take off to yield the

greatest return on investment?

Finding answers is much more difficult, of course

(see sidebar “Automation technologies to watch.”)

No one wants to buy technology that becomes

obsolete shortly after acquisition. Not only would

that leave a company less efficient than competitors

that made better choices, it would also leave it

worse off than those competitors that made no

investment at all. The cost of removing and replacing

equipment, much of it not fully depreciated, would

put unlucky investors in a deep hole.

Purchasing woes

Even if a logistics company makes a great choice

about the automation equipment to buy, it can run

into another problem. The leading warehouse-

automation manufacturers have enjoyed strong

revenue growth of 15 to 20 percent annually since

2014. At many, order books are now full. In 2017, the

order book at Vanderlande Industries reached an

all-time high. Our conversations with many would-

be buyers, especially at parcel companies, suggest

that manufacturers operating at full capacity cannot

even provide them with quotes.

Part of the problem is that the manufacturers are

not yet at scale. Many companies, including the

market leaders, are focused on a narrow range of

Automation technologies to watch

Warehouse automation technologies

can be broadly categorized into devices

that assist the movement of goods

and those that improve their handling.

In the rst group, we’ve already seen

automated guided vehicles (AGVs) that

move cases and pallets. New twists are

the equipment and software needed to

retrot standard forklifts and make them

autonomous. The new gear can be switched

on whenever needed—peak seasonal

shifts, say—and the forklift can remain

manual when demand is slower. Other

recent technologies include swarm robots

(most famously, Amazon’s Kiva robots)

that move shelves with goods to picking

stations and advanced conveyors that can

move goods in any direction. Advanced

automated storage/retrieval systems (AS/

RSs) store goods in large racks, with robotic

shuttles moving in three dimensions on rails

attached to the structure.

New handling devices automate the picking,

sorting, and palletizing of goods. Picking

systems typically include a robotic arm

with sensors that can determine the shape

and structure of an object, then grasp it.

Some devices remain xed and have goods

brought to them (often by AGVs). Others

travel to the goods and retrieve and move

them at once. Magazino’s new TORU cube is

an example of the latter.

With the e-commerce boom, ecient

sorting has become increasingly important,

particularly in parcel operations. Advanced

conveyor systems use scanners that can

pick up bar codes on any side of a package

to determine the appropriate action.

Autonomous palletizers use robotic arms to

build pallets from individual units and cases,

often using advanced analytics to determine

the optimal placement for each box.

Beyond the machines that mimic human

hands and arms, other innovations will

improve the productivity of people in

warehouses. Drones are already in use in

the warehouse for inventory management

and outside the four walls for yard

management. We expect to see much

greater adoption of drones for these uses.

Exoskeletons augment human motion

with mechanical power through gloves or

additional support for legs. The systems

feature electric motors that augment the

person’s own strength to allow them to move

more goods (for example, heavier items) or

move goods more easily and safely.

55Automation in logistics: Big opportunity, bigger uncertainty

technologies and solutions. That may change: the

industry is in turmoil, with significant M&A activity

underway. Notably, large technology conglomerates

are investing in automation start-ups. For example,

in 2015, Siemens took a 50 percent stake in

Magazino, a start-up that builds automated picking

robots. Once the dust has settled, some larger

companies that are better able to meet demand may

emerge. Then again, such companies will also have

stronger pricing power.

A related issue is some confusion at logistics

companies about which advanced equipment they

truly need. Often the equipment on the purchase

order is more expensive than it might have been. We

have seen purchase prices for the same equipment

vary by as much as 50 percent.

Rapid change in shippers’ distribution networks

Brick-and-mortar retailers are reacting to the

e-commerce onslaught in part by evolving their

distribution networks into omnichannel systems in

which consumers can purchase and receive items

through any channel. They might purchase online

and take deliveries at home, the classic e-commerce

model. Increasingly, they can order online and pick

up in stores. Or they might purchase in-store and

receive shipments at home, an option that menswear

company Bonobos and other companies offer. And

of course, they can still go to the store and walk out

Exhibit 2

Dozens of logistics technologies are under development.

Logistics-technology development

Speed of innovation adoption based on maturity.

Vision Innovation

developed

Pilot use Selective use Broad use

(or failure)

Technological

prerequisites

developed

Adoption

rate

Technology categories

Maturity, in stages

Broad use

Failure

Advanced robotics in warehousing

Analytics for transport and

warehousing

Autonomous transport and delivery

Internet of Things/smart-sensor

applications

Virtual- and augmented- reality

applications

Automation technologies for other

parts of the supply chain

High

Low

Exoskeletons

Autonomous trucks

Small parcel lockers

Autonomous

guided vehicles

Advanced resource-

scheduling system

2019

Automation in logistics: Big opportunity, bigger uncertainty

Exhibit 2 of 4

SUPPLY CHAIN

56 Future of retail operations: Winning in a digital era January 2020

with their purchases. On top of that, consumers

demand ever-faster delivery, which requires more

local storage capacity, further driving complexity.

Building a supply chain to support an omnichannel

system is highly complex (Exhibit 3).

With all this complexity comes a lot of uncertainty:

Where should new fulfillment centers be built? What

share of B2C orders should they accommodate?

And perhaps the biggest question: How much and

what kind of automation are ideal? Shippers are

asking the same sorts of questions (see sidebar

“The shipper’s perspective”).

Too-short contracts

Most logistics contracts run for about three years,

sometimes longer. That’s much shorter than

in the past. Shippers have tried to cut costs by

more frequent tendering and have sought greater

flexibility to respond to rapid changes in customer

demand. The trend has exerted significant pressure

on logistics companies. Because they typically

develop sites with a particular customer in mind,

they need to calculate carefully the investment

required to add a new customer. With a significant

initial investment required, logistics contracts are

often not profitable for two years. That leaves only

a year or so of profit before renegotiations begin.

Big investments in automation would push the

break-even point back further, leaving logistics

companies at even greater risk that a customer

would change providers, which would leave the

facility empty and automation equipment unutilized

while the third-party-logistics company searches

for a new customer.

The shipper’s perspective

Shippers—the manufacturers and

retailers that hire logistics providers

to move their goods—will also grapple

with automation in coming years. As

new technologies come online and

omnichannel delivery becomes more

common, most will need to revisit their

long-standing in-house and outsource

decisions. Shippers interested in

automation must rst determine whether

they have the capital and know-how to

invest eectively in automation or whether

it is more economical and easier to

outsource increasingly complex warehouse

operations to a logistics company. The

same uncertainties about omnichannel

that hold back logistics companies’

investments in automation can also

constrain shippers. However, our analysis

indicates that shippers are investing more

in automation than logistics companies

are, in large part because they cannot nd

logistics companies that will invest enough

in automation to meet their needs.

Beyond the level of investment, shippers

and their logistics partners must also

contend with the complexity of omnichannel.

Take one example: to operate eciently,

an omnichannel retailer must either open

the full inventory system to the logistics

company so that it can route orders

between stores and fulllment centers or

add steps to the order-routing process to

determine whether the order remains in

house or is sent to the logistics company.

Supply chain managers should also expect

changes in their negotiations with logistics

partners. As contract logistics players add

more xed costs in the form of automation,

their strategic exibility will decrease.

Shippers should expect their partners to

seek contracts in line with the life cycle

of automation investments. Put another

way, logistics companies will seek to share

some of the technology upside—and some

of the risk—with customers.

Shippers cannot completely outsource

the intricacies of automation and the best

practices of automated warehouses. To

be a smart customer requires enough

knowledge of automation to evaluate bids

intelligently. Contract logistics companies

we speak with often see automation listed

prominently, yet typically with sparse

detail, in requests for proposals. Shippers

frequently know they want automation but

don’t know what kind they need. Getting

a fair shake from logistics companies

will require shippers to stay aware of

technology trends and understand well

how these might meet their needs.

57Automation in logistics: Big opportunity, bigger uncertainty

In the future, contract planning might get even more

difficult. E-commerce requires dense networks,

especially in urban areas. But no single customer

has the scale to support a full-scale network.

Logistics companies must therefore build fulfillment

centers and purchase automation technology

before demand is known, let alone contracted.

Strategy under uncertainty

In these murky waters, what should contract

logistics companies do? As the previous discussion

illustrates, there is no single automation strategy

that guarantees a company will thrive. In the

following sections, we offer some guidance that we

hope can start the thinking process.

Contract logistics

The big changes we’ve discussed—the simultaneous

rise of e-commerce, omnichannel supply chains, and

new automation technologies—present contract

logistics with a great opportunity to sharpen its value

proposition, which has historically relied on one of

two factors:

— Superior services. To meet the needs of small

shippers, which typically lack the capabilities or

scale to set up and manage complex fulfillment,

contract logistics companies offer heavily

customized services, such as differentiated

packing, effective returns management, and

high-speed fulfillment.

Exhibit 3

2019

Automation in logistics: Big opportunity, bigger uncertainty

Exhibit 3 of 4

To fulll omnichannel orders, shippers are redesigning their supply chain.

Supply chain Strategies

Network strategy

• Use segmented

approach to place

inventory in larger

(regional) and

smaller (local,

metro) sites

Applicability

• National/regional

Network strategy

• Locate near hubs

and competitor

facilities to benet

from availability

of labor and

collaborative

transportation

Applicability

• For low volumes

• Reduced capital-

expenditure

investment

Network strategy

• Rely on own

footprint of brick-

and-mortar stores

close to customer

• Train store

associates to serve

both e-commerce

and store visits

Applicability

• For areas around

retail footprint

• Reduced capital-

expenditure

investment

Network strategy

• Build smaller

e-commerce

fullment centers

close to customer

Applicability

• For geographies

with high population

density

(metropolitan areas)

Consolidation in

logistics cluster

Dark

store

Store with cross-

trained workforce

E-commerce

fulllment center

Omnichannel

fulllment center

Vendor

Customer locker

or drop box

Hub and

spoke

Logistics

clusters

Retail

infrastructure

Omnichannel

infrastructure

SUPPLY CHAIN

58 Future of retail operations: Winning in a digital era January 2020

— Efficiency through scale. By serving multiple

customers, contract logistics companies build

the scale and expertise needed for warehouse

efficiency—for example, shift planning during

peak hours and seasons. For many shippers,

large and small, these capabilities were the key

reason they outsourced their warehousing.

In our view, automation is not (yet) very helpful in

delivering value-added services, which are often

quite complex. Consider what happens when a

worker checks whether a returned pair of sneakers

is ready to be reshipped. Reliably unpacking the

shipment (customers often use whatever they can

get their hands on, such as supermarket plastic

bags), recognizing the condition of the returned item,

and then selecting the correct next processing step

is not a job easily performed by a robot.

However, a lot of automation equipment is well

suited to drive efficiency, the first factor, in three

ways. Start with the jobs of putting away and picking,

especially of high-velocity items. Automation can

reduce the dependency on an ever-tightening labor

market. Second, automation can enable higher

throughput in a smaller space. Given the tight

market for warehousing real estate, especially near

city centers, the business case for automation is

improving significantly. Large manufacturers and

start-ups such as CommonSense have identified

this advantage of automation as a core value driver.

And of course, automation can help during peak

times. Business cases for automation often rely

on average throughput, or the base load. Even

on those terms, automation can succeed, but it

means that a lot of equipment sits idle much of the

year, as it is only used for one or two shifts a day.

During peak times, this idle capacity can easily be

unlocked through a third shift without adding large

numbers of part–time warehouse employees—who

are harder to find during the Christmas season, for

example. From an efficiency standpoint, automation

has a lot going for it right now.

So how can contract logistics players make the most

of this opportunity? With specialized equipment

proliferating—more than 20 logistics activities

could soon see mechanized help—almost every

logistics customer now needs guidance in picking

the optimal equipment for its purposes, procuring it,

fitting it into the warehouse layout, training workers

on it, and maintaining it. With contract logistics

companies’ scale and experience, they can meet the

need and become true partners to their customers,

offering expertise, better rates of procurement,

and deep operating knowledge. But to get there,

logistics companies must do two things:

— Be at the forefront of understanding and

deploying automation (for example, by partner-

ing with automation providers to test new equip-

ment). Scale will help with this requirement,

especially in segments that use specific types

of equipment (for example, to handle small items

or returns).

— Get sharp on the marketing strategy, including

a definition of the market segments they can

serve well, discipline in targeting clients in these

segments, and clear communication of the value

proposition to them. With the rise of equipment

comes a greater need for companies to specialize

in activities common to a given industry, as most

machinery is not as versatile as human labor. It will

become tougher to serve every client out of the

same warehouse setup. Contract logistics players

need to shape and communicate a clear benefit

for each customer industry.

Delivering the best service at the lowest cost in a

given market segment will create a strong value

proposition. The expertise gained by doing this

may also help to mitigate some of the contract

issues: the deep relationships formed by becoming

a true partner and adviser will likely also lead to

stable contracts that can accommodate longer

payoff periods. Some customers will still leave, of

59Automation in logistics: Big opportunity, bigger uncertainty

course, but when they do, the logistics company’s

expertise and market-leading role should attract

replacements, lowering the risk of equipment

obsolescence. Therefore, logistics companies

should avoid equipment that is specific to only

one customer if that customer is not willing to help

shoulder the burden.

Yet superior expertise and support may not be

enough to make all contracts profitable over their

duration. Contract logistics companies should also

get smart about pricing. The power of incentives,

such as adding attractive terms to extend contracts

or penalties if contracts are terminated before

customized equipment is paid off, is not to

be underestimated.

Parcels

For parcel companies, the strategic considerations

are a little simpler. Increasing demand is a given,

as are rising requirements for speed and reliability.

Considered that way, there can be little question

that parcel companies need to automate. And in

fact, many already have. DHL invested about €750

million in its German parcel network, and United

Parcel Service (UPS) has announced a long-term

plan to invest even more.

But within that imperative, parcel companies face

some subtler questions:

— What kind of equipment should be installed?

Parcel companies around the world have two

choices. One is to install large equipment that

can handle the vast majority of parcels, say

those up to 120 by 60 by 60 centimeters. This

approach puts a high value on flexibility to

accommodate a wide mix of parcels. Other

companies have focused on equipment

designed for smaller items, as e-commerce

fulfillment features lightweight (less than 5

kilograms) items that are typically smaller than a

shoebox. This kind of equipment is less flexible,

as it cannot handle the large items, but it is

significantly cheaper to install and often even

to operate.

To decide, companies must review two pieces

of data: the historical mix of parcel sizes and the

growth rate of each size. If the data do not yield

a definitive answer, it may make sense to create

a flexible base capacity of large equipment

and then add smaller sorters to accommodate

e-commerce peaks.

— Which process steps should be automated?

The most obvious candidate is sorting in the

hub. The labor-cost savings, especially in the

developed world, make this a relatively clear

case. Unloading and loading in the hubs are

more complicated. Over the past five years,

more equipment for these activities has been

developed. Some providers say their gear can

increase the productivity of one employee

to more than 3,000 items unloaded per hour,

from the previous 700 to 1,000 items per hour.

In our experience, however, this equipment

often struggles with the different shapes

and especially the packaging of today’s

e-commerce parcels. Plastic bags are the worst

nightmare of many parcel-hub engineers.

When it comes to to the automation of loading,

large parcels are extremely difficult. Just

imagine a 50-pound sack of dog food landing

on a small, delicate box of LEGO toys. The child

who receives the latter will not be happy with

its condition. For smaller items, automation

has been in place for years, but reviews are

mixed. Parcel companies are well advised to ask

manufacturers to showcase their solution with

the company’s parcel mix.

Apart from hubs, some parcel companies, such

as DHL, have started to automate delivery

bases. Key advantages of this model are more

SUPPLY CHAIN

60 Future of retail operations: Winning in a digital era January 2020

sorting “depth”—that is, less manual sorting—

and easier same-day deliveries that are fulfilled

close to a city and then sorted to the route in

the delivery base. Automating in this way allows

a company to outcompete some low-cost

services offered by rivals.

— How much capacity should be installed?

E-commerce growth, and the volatility of its

volumes, make this a vexed question. Many

companies seem to have chosen not to

overinvest in growth. The US operations of

FedEx and UPS as well as Japan’s Yamato

Holdings are only slowly expanding capacity.

There are two reasons, which we raised

previously, for being cautious and not rushing

to capture all the growth: e-commerce players

such as Alibaba and Amazon are investing in

their own delivery systems, and e-commerce

volumes tend to be low margin. Instead of

focusing on investing in growth, many players

are trying to get more out of their existing

automation equipment—for instance, by

introducing new products with different

speeds that allow for sorting through the entire

day. This will initially postpone the question

of installing new capacity, but ultimately, all

parcel companies need to find the right balance

between yield and growth.

Despite the uncertainty, logistics companies can

make informed decisions. We hope this article

offers clarity on a complex situation, and together

with the entire series of articles, provides logistics

executives with a useful perspective on how their

industry is changing—and how they can change

ahead of it.

Ashutosh Dekhne is a partner in McKinsey’s Dallas office, Greg Hastings is an associate partner in the Charlotte office, John

Murnane is a senior partner in the Atlanta office, and Florian Neuhaus is a partner in the Boston office.

The authors wish to thank Knut Alicke, Tom Bartman, Alan Davies, Mark Staples, Adrian Viellechner, and Markus Weidmann for

their contributions to this article.

61Automation in logistics: Big opportunity, bigger uncertainty

Next–generation supply

chain—transforming your

supply chain operating

model for a digital world

In a digital age, most supply chains run on old principles and processes.

A few leaders can show us how a new operating model can answer the

demands of today—and tomorrow.

by Manik Aryapadi, Ashutosh Dekhne, Christoph Kuntze, Tim Lange, and Andreas Seyfert

SUPPLY CHAIN

62 Future of retail operations: Winning in a digital era January 2020

Whether they choose to be faster, more innovative,

or closer to customers, it’s becoming increasingly

difficult for manufacturers and retailers to launch

new products and better services that react flexibly

to shifting demand, while still maintaining (or even

improving) their profitability.

It’s no surprise that leading players are focused on

improving their supply chain—especially when it

comes to enhancing service levels, cutting costs, or

optimizing inventory levels. An illustrative analysis

of a retailer’s income statement supports this

approach, showing that practically every element is

affected by the supply chain’s performance (exhibit).

Many companies have tried to optimize their

warehousing and shipping processes, improve

their planning, and develop other core supply chain

topics—but often with only modest success. And all

too often operational improvement initiatives have

failed to make any real impact on the P&L or balance

sheet. Why? Organizations have neglected to evolve

their supply chain operating model—its processes,

structures, and people—resulting in it being unable

to sustain changes once focus has shifted to

another area.

A next-generation model stretches far beyond

the mere organizational design of structures and

workflows—it defines the ways and means by which

a company operates its supply chain (see sidebar,

“New supply chain operating model challenges all

dimensions of the supply chain”).

New trends, new challenges

To succeed in the digital age companies need a

next-generation model for their supply chain. They

must rethink their operating model, particularly in

light of three dominant trends:

First, customer preferences have changed as the

influence of digital sales channels has increased.

Exhibit

McK Retail Compendium 2020

Next gen manufacturing

Exhibit

A close look at an income statement shows the impact of supply chain performance.

Income statement of superstore, illustrative Supply chain’s impact

Cost of goods sold.

Other operating expenses

Selling expenses

Contribution margin

Rent

Amortization, depreciation,

and write-downs

Operating prot

Personnel expenses

Net sales

COGS¹

Gross margin

Markdowns

Income from merchandise

Logistics costs

1. Supply chain’s service level largely determines

the availability of goods on store shelves

2. Good supplier relationships help reduce COGS

3. Markdown amounts are primarily determined by delivery

terms and planning accuracy

4. Shipping and warehousing are among the largest cost items

5. Delivery signicantly inuences personnel expenses for

stocking and replenishing shelves

6. Precise volume forecasts increase returns on marketing

investment

7. Branch and warehouse size can be reduced by cutting

inventories

8. Right-sizing helps optimize depreciation and write-

downs on warehouse and branch equipment, as well as

on eet vehicles

Next–generation supply chain—transforming your supply chain operating model for a digital world

New supply chain operating model challenges all dimensions of the supply chain

The strategic objective is clear: more revenue, lower costs, satised customers.

To get there, companies must align their operating model with the demands of the digital world, entailing scrutiny of all dimensions of

the supply chain: structures, processes, and people. By asking core questions along these dimensions, it is possible to determine the

cornerstones of a next–generation operating model.

Structures

— Roles and responsibilities. Who is

responsible for key processes and

individual process levels?

— Organizational structure. What

organizational form ensures stable

day-to-day operations, yet agile

development and innovation? How

should reporting lines run?

— Ecosystem. Which capabilities

are core competencies to keep

in house, and which ones can we

source from current partners or other

external providers? How should the

corresponding network be organized?

People

— Skills. What skills do our people need

to do their job and how should we

fill any gaps—M&A, recruitment, or

internal capability building?

— Corporate culture. What elements

of the corporate culture promote

willingness to change—how can

we foster openness and tolerance

of mistakes?

— Resource distribution. How many

employees and managers do we need,

where, and what qualification profiles

should they have? How can we deploy

resources systematically?

Consideration is the increasing pressure on supply

chain functions in terms of cost and productivity.

New market conditions frequently result in a growing

number of products, warehouses, and logistics

service providers, requiring more frequent and more

detailed planning. This also creates calls to scale

up personnel resources in indirect functions like

scheduling and distribution management.

Finally, the use of new digital technologies and

advanced analytics also affect supply chains

design, creating both opportunities and challenges.

Advanced analytics allow more precise planning,

and efficiency and effectiveness also rise when

planners are freed up from repetitive tasks

and can concentrate on value-adding activities.

McKinsey studies have shown that current

technologies could automate an average of

45 percent of human activities.

However, innovative technologies and methods

place new demands on the capabilities of employees,

management, and IT infrastructure along the supply

chain: all three elements need to be continually

realigned to reflect the latest trends. Companies

that do not respond to these challenges by radically

reshaping the structures and processes of their

supply chain will extract few of the benefits that the

transformation promises.

SUPPLY CHAIN

Processes

— Process design. How should we

design functional, cross-sector, and

support processes? How can we best

integrate innovations? How can we

accelerate decisions?

— Performance management. What

are our most important KPIs? How do

we set and track targets? How do

we encourage decision orientation

and collaboration?

— IT systems and technologies. What

technology infrastructure does the

company need? What is the ideal IT

organization and governance in an age

of big data and analytics?

64 Future of retail operations: Winning in a digital era January 2020

Seven steps for tomorrow’s

operating model

To realign their supply chain operating model, leading

consumer goods companies are following seven

guidelines that could be beneficial for others.

1. Challenge unconditionally. Successful

companies challenge all processes in their

planning and logistics management and are

not afraid to radically reinvent them. Predictive

methods like machine-learning forecasting or

supply-scenario planning will only reach their full

potential if the entire planning cycle is shortened.

Digitization enables a deeper integration of

planning and management steps—e.g., joint

optimization of tactical production planning and

operational scheduling: not only does that lead

to better planning results, it also makes it easier

to automate processes end to end. As part of

the review, the individual value contribution of all

processes should be challenged, removing any

steps that don’t add value.

2. Deploy cross-functional teams. For years,

tighter specialization of supply chain processes—

from requirement planning to inventory

management—was considered a determining

factor of success. However, each unit attempting

to optimize its own operations was often at the

expense of others.

Leading companies have put an end to this

overspecialization. They bundle responsibility for

all supply chain processes throughout the value

chain, from suppliers to customers, in cross-

functional teams. They aim to ensure end-to-end

responsibility for supply chain performance,

while holistically optimizing service, costs,

and inventories. Team affiliation (be it sales,

production, or supply chain management)

becomes irrelevant, as the whole group makes

autonomous decisions and performance is

assessed and incentivized as a whole.

3. Centralize. For many years, forerunners like

Procter & Gamble or Unilever have been

centralizing their planning and logistics

management at a regional, sometimes even

global, level. In more recent years consumer

electronics players have also followed this

method. Centralization efforts optimize volume

flows across countries and regions, as well as

allowing organizations to bundle resources

and build centers of excellence to introduce

advanced analytics.

4. Assign technology development to project

teams. Digital forerunners like Amazon and

Zalando have long pursued a policy of stacking

commercial process ownership and technology

development. Similarly, companies seeking

to build a next–generation supply chain

operating model should assign the development

of new technology solutions to small, high-

performance product teams, rather than central

IT departments.

With cross-functional staffing, such units can

take responsibility for driving the evolution of

innovative solutions, allowing new technologies

to be developed and implemented far more

efficiently. Using this approach, one retailer was

able to take an order management module that

had been plagued with delays, and complete it

within budget in eight weeks.

5. Accelerate decisions. The flexible testing of

digital supply chain innovations in pilot projects

requires fast decision and release processes.

Fast-track procedures are typically premised

on business cases or risk assessments

with a reduced number of criteria. In return,

implementation of agile principles is associated

with continuous control of progress made

along with clear decisions to continue or abort

the project.

6. Adopt a zero-based approach. Changing

organizational structures and redistributing

resources is not an easy undertaking;

vested interests and resistance are often

prevalent. Applying zero-based principles

helps to objectively assess which structures,

competencies, and capacities are needed. By

reducing organizational components to the

bare minimum for continued existence and

then adding on the tasks, skills, and resources

that have a clear added value and that meet

Next–generation supply chain—transforming your supply chain operating model for a digital world

the digital requirements, companies can identify

the most important roles in the company and

staff them with the right amount of talent.

7. Build up dynamic capabilities. Capabilities

and role profiles should be aligned to the

requirements of new technologies and

processes; particularly critical are data

scientists (experts in the development of

analytical solutions and algorithms) and

digital translators (employees at the interface

between business and analytics). Yet not

all capabilities can be built up internally—

partnerships can generate best-of-best

solutions, allowing internal resources to

be concentrated on company-specific

competence areas, such as the development

of forecasting software for special product

groups or markets.

Following these seven guidelines can help

manufacturers and retailers get their supply chain

operating model in good shape for the future. A next-

generation model creates the right preconditions to

optimally benefit from the opportunities associated

with digitizing the supply chain. Companies can thus

obtain a lasting competitive edge.

This article is adapted from a version that originally

appeared in Akzente.

Manik Aryapadi is an associate partner in McKinsey’s Cleveland office, Ashutosh Dekhne is a partner in the

Dallas office, Christoph Kuntze is a partner in the Miami office, Tim Lange is a partner in the Cologne office, and

Andreas Seyfert is a senior knowledge expert in the Berlin office.

SUPPLY CHAIN

66 Future of retail operations: Winning in a digital era January 2020

Beyond procurement:

Transforming indirect

spending in retail

by Stefon Burns, Ella Burroughes, Steve Homan, and Alexander Merklein

If retailers treat indirect costs as an opportunity for business

transformation rather than just a procurement matter, they can boost

return on sales by as much as 2 percent.

PROCUREMENT

67Beyond procurement: Transforming indirect spending in retail

For retailers seeking to cut costs and generate

cash for growth investments, indirect spending can

be a big untapped opportunity. Indirect costs—the

goods and services that retailers purchase but

don’t resell—are equivalent to 10 to 15 percent of

sales on average, and most retailers know that their

indirect spending is far from optimized. But while

recognizing the potential is easy, capturing it has

proven stubbornly difficult.

The challenges aren’t new. They include a lack of

spending visibility, fragmented ownership and spend

authority, a dearth of incentives to reduce indirect

spend, and a siloed approach to procurement of

not-for-resale (NFR) categories. In addition, indirect

procurement typically focuses on negotiations with

suppliers over price, rather than on higher-impact

opportunities to optimize what and how the retailer

buys. Our research has also shown that capabilities

and resourcing for NFR procurement in retail are

significantly weaker than in many other sectors:

NFR goods and services are viewed as much less

important than goods for resale, so the NFR-sourcing

staff tends to receive less management attention and

less investment in talent. Furthermore, even NFR-

sourcing professionals typically have little expertise

in NFR categories. Rare is the procurement team

that has deep knowledge of, for example, elevator

maintenance or marketing–agency overhead costs.

Visionary retailers, however, are taking a radical

new approach to indirect spending—and achieving

radical results. These retailers aren’t viewing

indirect costs as a concern only for the procurement

function. Instead, they’re looking to transform

indirect spending across the entire business. They’re

overcoming the challenges by leveraging three

new ways of working: a cross-functional approach

that incorporates category–specific demand levers,

the use of digital and analytical tools, and stronger

supplier collaboration. And they’re taking specific

actions to bring about lasting change in mind-sets

and behaviors.

In doing so, retailers are shaving as much as 10 to 15

percent off their annual indirect spend, capturing

impact worth 1 to 2 percent in return on sales, and

seeing a more than 15-fold return on the cost of their

NFR-sourcing team. We’ve found that the value at

stake is remarkably consistent across retailers—

even at those that have been working on reducing

indirect costs for a long time, whether in-house or

with external support.

A business transformation

To capture maximum value from a cost-reduction

program, retailers must be deliberate about the

program’s scope and ambition level. A broad scope

and high targets are indispensable elements of a

transformative effort.

Historically, retailers have cut costs primarily

by reducing store labor or travel expenses. Few

retailers have tapped into the full potential of

optimizing NFR spending (Exhibit 1). Furthermore,

even retailers explicitly seeking to reduce

indirect spending sometimes classify certain cost

categories as “not addressable.” For instance,

some retailers consider marketing expenditures

out of scope; their rationale is that marketing

is critical to the core business of retail. Other

retailers don’t bother trying to lower rents because

they assume that they can’t renegotiate terms

unless they’re in financial distress. Some indirect

costs—such as supplier-managed logistics—

remain unchallenged because they’re “hidden”

in cost of goods sold. And some retailers look for

cost-reduction opportunities only in operating

expenses, leaving all capital expenditures

untouched—even though the latter often has

higher savings potential (as a percentage of costs).

In bypassing these categories, retailers forfeit more

than half of the potential impact and miss out on the

synergies that a large-scale program could bring. To

achieve transformative change in indirect spending,

nothing is off limits.

PROCUREMENT

68 Future of retail operations: Winning in a digital era January 2020

Another must-do for a transformation program: set

stretch targets that inspire creativity and out-of-

the-box thinking. To set its NFR targets, one retailer

first conducted a fact-based diagnostic that was

championed by senior leaders. This exercise helped

the organization understand that the program was

a priority, adopt a transformational rather than an

incremental mind-set, and focus on how to achieve

the targets rather than on trying to change them.

New ways of working

Seeing an NFR effort as a business transformation is

a crucial first step. To maximize NFR savings, retailers

then need to adopt three new ways of working.

A cross-functional approach incorporating

category–specific demand levers

Transformation of indirect spend will require the

involvement and commitment of more than just

the procurement staff. A cross-functional team

can break down silos, pose tough questions about

what the business really needs, and make balanced

trade-offs.

A cross-functional team can pull the basic supplier-

management levers (such as competitive bids and

supplier consolidation) that affect who the retailer

buys from and at what price. The team can also pull

process-management levers, which influence how

a retailer buys: if the various functions comply with

Exhibit 1

McK Consumer and Retail Compendium 2019

Beyond procurement

Exhibit 1 of 3

By addressing the full cost base, a retailer can double the scope and savings of its

indirect-costs program.

Typical breakdown for a €10 billion retailer, € million

Typical savings, %

Typical indirect

costs scope

Marketing

Rent

Private-label

packaging

Supplier-

managed

costs

Capital

expenditure

Total scope

900

10–15 10–158–17 12–24 10–15 10–200–5

200

300

200

300

100

2,000

69Beyond procurement: Transforming indirect spending in retail

procurement policies and use only preferred vendors,

maverick spending will be reduced or even eliminated.

Savings across the organization can be more easily

tracked. The retailer can better negotiate vendor

payment terms and cycles to its benefit.

Most important, a cross-functional team will be

better placed to pull category-specific demand-

management levers, which influence what the

retailer buys. In our experience, these levers deliver

as much as half of the potential savings—or even

more for mature companies because negotiating

for lower prices yields diminishing returns over

time. The biggest opportunities are often in areas

that many retailers consider out of scope, such

as marketing (by using a return-on-investment

approach, for instance) or logistics (using levers

such as inventory reduction or network redesign).

A retailer seeking to optimize logistics spending

tasked a cross-functional team with redesigning

its distribution network. The team was able to

reduce end-to-end costs by selectively increasing

certain logistics costs. For example, it switched

some deliveries from sea to air in order to gain sales

and reduce markdowns. It also increased delivery

frequency for some products and stores while

decreasing it for others.

The use of digital and analytical tools

Digitization has revolutionized every business

process and will continue to do so; indirect sourcing

is no exception.¹ Today, leading retailers are using

digital and analytical tools in the following areas to

achieve dramatic reductions in indirect costs:

— Spend visibility. Advanced digital solutions,

machine learning, enable retailers to rapidly

and accurately map the relevant spend base

into granular categories, shedding light

on exactly who spends how much on what.

Cutting–edge digital procurement solutions

can pull purchase-order (PO) and invoice

data from multiple systems to create a “spend

cube,” automatically generating benchmarks

on pricing and specs, as well as dashboards

and reports to help category managers monitor

spending. One retailer had recently streamlined

its headquarters organization but found

through AI-supported spend mapping that

many of the costs had crept back in through

the use of contractors and temporary labor.

Once the retailer generated the spend cube

using an agreed taxonomy, it could lock down a

baseline and see how much it was spending on

contracted versus uncontracted vendors.

— Consumer insights. A retailer used digital

consumer surveys and crowdsourced competitor

benchmarks to understand, address, and retest

consumer perceptions of store cleanliness.

Which areas of the store did consumers notice

most? Which areas did they hardly notice at

all? Analysis showed that the parking lot and

the sidewalks were perceived as clean enough,

so instead of hiring a cleaner to do a thorough

cleaning multiple times a day, the retailer cut

back to once a day, with store associates doing

spot checks every few hours. The surveys

also revealed places—such as fitting rooms

and the shoe department—where the retailer

could invest in more frequent cleaning to boost

customer satisfaction. The business-insights

team then measured the exact impact of these

adjustments on the retailer’s sales.

— Design to value. A retailer reduced the cost

of its paper shopping bags by 25 percent by

redesigning them. Through digital analysis of

basket size, product dimensions, and data from

cashier surveys, the retailer determined the

ideal dimensions of a shopping bag based on

the distribution of physical volume and weight

of products. Further digital analysis—along with

input from cashiers, baggers, and vendors—

helped the retailer arrive at the substrate

composition that would give the shopping

bags the right levels of puncture strength and

tensile strength.

— Clean sheeting. Digital clean-sheeting

tools can reduce indirect costs by as much as

40 percent in a category. Such tools typically

feature algorithms for determining costs

in various NFR areas, dynamic databases

For more on digital solutions in procurement, see Pierre de la Boulaye, Pieter Riedstra, and Peter Spiller, “Driving superior value through digital

procurement,” April 2017, McKinsey.com.

PROCUREMENT

70 Future of retail operations: Winning in a digital era January 2020

of input costs (such as raw–material index

prices), and a sophisticated calculation engine.

Through a clean-sheeting exercise, one retailer

discovered that it was paying much more

than the “should cost” for water-bottle labels

(Exhibit 2).

— Spend control. Digital procure-to-pay tools

give retailers better spend control by enforcing

more discipline in how suppliers are set up and

approved, and by supporting a more rigorous

PO-approval process.

— Zero-based budgeting (ZBB). Using digital

tools (and enabled by increased spend visibility),

retailers can easily build detailed bottom-up

budgets, detect the exact drivers of variances,

and take swift action to close gaps. ZBB,

which first gained traction in consumer-goods

companies, can be powerful for retailers,

especially in store–related NFR categories.

Determining the appropriate budget for each

store and then tracking adherence to that

budget can yield significant savings.

Closer collaboration with suppliers

Retailers should work with suppliers on cost

improvements and innovations. Suppliers can

be great idea generators because they know a

retailer’s bad habits better than the retailer itself

does and would rather help change those habits

than lose the business. Retailers can also invest in

improving supplier capabilities in ways that will pay

the investment back several times over. Among the

benefits of stronger supplier relationships: better

product quality and availability, faster responses

to market needs, less administrative effort, greater

efficiency, and lower total cost.

Exhibit 2

McK Consumer and Retail Compendium 2019

Beyond procurement

Exhibit 2 of 3

Through clean sheeting, a retailer saw that it was paying more than the ‘should cost’ for labels

on its water bottles.

Label costs for 500ml bottle

l Prot of 5% included in price

l Batch size of 2 million pieces (est.)

l Yearly volume of 6 million pieces (est.)

l Manufacturing location: Eastern Europe

l Interest rate of 3%

l Selling, general, and administrative (SG&A) costs of 5%

l Range of labor rates in local currency depending on skill level

l Selling tax and value-added tax not included

Raw and

purchased

material

Landed

material

Direct

manufacturing

costs

Total

manufacturing

costs

Target price

Target

price,

including

outbound

logistics

Quoted

Inbound

logistics

Labor

Machinery

Batch

setup,

scrap,

tooling

Overhead,

other

manufactur-

ing

costs

Outbound

logistics

SG&A,

R&D

Prot

15%

Materials Value add Overhead and prot

Key assumptions

71Beyond procurement: Transforming indirect spending in retail

The elements of successful supplier collaboration

include focusing on a limited number of suppliers to

deliver the highest return on investment, establishing

a robust value-sharing agreement at the outset,

creating a dedicated supplier-collaboration team

separate from (but aligned with) category managers,

and building a disciplined performance-management

and benefits-tracking system.

One retailer, when retendering its contracts for

outsourced warehousing, required suppliers to

submit proposals for improving the joint warehousing

operation. Based partly on these proposals, the

retailer reduced its supplier count to two, allowing

for closer collaboration while maintaining some

competitive tension. The retailer built continuous-

improvement targets into the contracts, with

gainsharing incentives for the suppliers. It also

invested in a “lean warehousing” team that works

closely with the suppliers to build capabilities.

Getting it done

Retailers must embed these new ways of working

into daily tasks. To sustain behavioral change, they

must use all four parts of the “influence model”

(Exhibit 3).²

Fostering understanding and conviction

Leading retailers should lay out a clear case for

change and help each stakeholder connect to it on

a personal level. An important aspect of the change

story is communicating why savings are needed

and what they will be used for. Allowing business

units or functions to reinvest part of the savings

can increase motivation. (One initiative leader at a

retailer put it this way: “Half goes to the CFO, but

the other half we get to keep.”) The head office

should, of course, have enough visibility into the

reinvestments to ensure they align with corporate

priorities and generate strong returns.

Intelligent target setting also helps foster

understanding across the organization. Targets

should be based on detailed diagnostics, including

benchmarking against a relevant peer set.

Otherwise, stakeholders will reject the targets

as arbitrary; there’s also a risk of damaging the

business by pushing it into “slash and burn” cost

cutting. The diagnostics should yield not just

a single target—such as, $100 million in cost

savings—but also a set of quantified initiatives.

Targets should include cost ratios (for example,

logistics spending as a percent of sales) rather

than just absolute numbers to ensure that cost

efficiency genuinely improves even when the

category experiences tailwinds. (For example, a

decline in logistics costs due to a decline in sales

isn’t really an improvement.)

Because indirect sourcing is typically perceived as

a backwater and procurement staff can feel they’re

performing thankless work, external visibility can be

highly motivating. When retail CEOs publicize their

For more on the influence model, see Tessa Basford and Bill Schaninger, “The four building blocks of change,” McKinsey Quarterly, April 2016,

McKinsey.com.

To sustain behavioral change,

retailers must use all four parts of

the ‘inuence model.’

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72 Future of retail operations: Winning in a digital era January 2020

NFR initiatives and targets, the people involved in the

initiatives see that their work matters and even has

the power to influence their company’s stock price.

Along the NFR journey, there will be times when

stakeholders resist change for fear of negatively

affecting sales. A test-and-learn

culture can

overcome this. A first step can be to show mock-

ups or samples of proposed changes. One retailer’s

procurement team recommended using thinner,

cheaper paper for marketing materials. It overcame

resistance from the marketing department by

having samples printed on the thinner paper

and using blind testing to demonstrate that the

materials were just as effective.

Reinforcing with formal mechanisms

Company goals should be translated into personal

targets. One retailer created a simple timeline of

when initiatives were expected to deliver impact,

using the top end of the impact range estimated for

each initiative. The resulting quarterly figures became

targets for the relevant executives, whose bonuses

were partly dependent on hitting those targets.

To follow up on progress against targets, many

retailers instinctively go for a monthly cadence

of follow-up meetings. But, in our experience, a

weekly program-management rhythm is much

more effective for driving the pace of initiatives and

bringing about cultural change. During the weekly

Exhibit 3

McK Consumer and Retail Compendium 2019

Beyond procurement

Exhibit 3 of 3

Retailers can use a range of tactics to change mind-sets and behaviors.

The inuence model’s four building blocks of change

• Program leader

and team

• Initiative resourcing

• Category experts

• Training

• Cross–functional

steering committee

• Senior sponsorship

of initiatives

• Early wins

• Personal targets

• Weekly program-

management rhythm

• Implementation-

level tracking

• Case for change

• Intelligent target

setting

• External visibility

• Test and learn

73Beyond procurement: Transforming indirect spending in retail

meeting, the team reviews all initiatives but focuses

on only a few, either on a rotating basis or to help

those that need additional support.

Initiatives should be tracked not only against

milestones but also on progression through “imple-

mentation levels”: an initiative begins as an idea,

matures to a business case, becomes an approved

decision, gets implemented, and is ultimately

converted to “money in the bank.” The expected

impact of initiatives can be appropriately “discounted”

when they are in earlier stages. Implementation-

level tracking gives the program leader and

steering committee a more accurate picture of

when impact will be delivered and which initiatives

need what kind of support. Linking this tracking to

ongoing budgeting, forecasting, and performance-

management processes yields greater transparency

in profit-and-loss performance.

Developing talent and skills

An NFR program needs a capable program leader

and a supporting team. The program leader,

who will likely come from a line role, should know

the business well and have the respect of top

management. Given this individual’s talent and

leadership skills, it won’t be an easy decision for

senior executives to free him or her up to lead the

program. But the sacrifice will pay off.

Still, without sufficient resources for each initiative,

the program will struggle. Colleagues from each

function or cost category will need to dedicate

10 to 20 percent of their time to the effort. For one

$10 billion retailer, delivering $200 million in savings

required a program leader and about 40 full-time

equivalents (FTEs) working for 12 months. Company

leadership had to stop or pause other initiatives to

create the required capacity. While 40 FTEs might

sound like an enormous investment, the retailer

recouped the cost of those employees’ yearlong

efforts about 50 times over in recurring savings.

Neither the program leader nor the team members

can be expected to have all the relevant category-

specific expertise. Our research shows that

retailers have eight times the indirect spend per

procurement professional compared with other

sectors, which means their level of expertise in

any particular category will be relatively shallow.

Therefore, tapping into internal and external

category experts is crucial. One grocery retailer

discovered that one of its project managers

had been a refrigeration engineer for 25 years.

The company brought him into a team tasked

with reducing the life-cycle cost of refrigeration,

heating, and cooling assets by 30 percent in two

years. The team achieved the goal in six months

and did so with simple solutions—for example,

changing the type of price tags used in refrigerated

shelves so that the tags wouldn’t fall off and clog

the drain. This change saved the retailer more than

$600,000 a year.

Capability building is also key. The best companies

use a combination of classroom training, e-learning

tools, and on-the-job coaching. In our experience,

many NFR professionals who receive functional

and category-specific training and mentoring

immediately double or triple their effectiveness.

A phased train-the-trainer approach—in which

the sourcing team receives training during a pilot

Many NFR professionals who receive

functional and category-specic

training and mentoring immediately

double or triple their eectiveness.

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74 Future of retail operations: Winning in a digital era January 2020

phase, applies the learnings to an initial set of

categories, then trains others in the next phase—

has proven effective in many cases.

Role modeling

The CEO, CFO, and the rest of the management team

must work together to communicate the case for

change and role model the desired mind-sets and

behaviors. Working as a cross-functional steering

committee, they can remove roadblocks, surface and

capture cross-functional opportunities, and allocate

enough resources to them, thereby sending an

unmistakable message to the organization about the

importance of these initiatives.

Another powerful role-modeling lever is senior

sponsorship of initiatives. Senior leaders can serve

as coaches for the owners of individual category

initiatives, whether those owners are within or

outside the senior leaders’ respective functions.

Helping to secure—and then celebrate—early wins

is also a form of role modeling. It lets the entire

organization see that senior leaders are committed

to ensuring the NFR program’s success and that

they recognize its impact.

Most retailers have significant opportunities

to reduce indirect costs. The first step is to

acknowledge that the potential exists, then conduct

a thorough diagnostic to quantify it. Though

challenging, a transformation in indirect spending

can yield greater profitability, funding for growth,

and competitive advantage.

Stefon Burns is an associate partner in McKinsey’s New York office, Ella Burroughes is an associate partner in the

London office, Steve Hoffman is a partner in McKinsey’s Chicago office, and Alexander Merklein is an associate partner in

the Vienna office.

75Beyond procurement: Transforming indirect spending in retail

Rethinking procurement

in retail

For retailers, procurement is no longer solely a matter of negotiating

“A” brands. Private labels and verticalization are trending. Advanced

approaches and tools help get procurement in shape for the future.

by Patricio Ibáñez, Alexander Merklein, and Daniel Rexhausen

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76 Future of retail operations: Winning in a digital era January 2020

The days in which brick-and-mortar retail

monopolized customer touchpoints are gone.

Alongside internet retailers such as Amazon

and Zalando, and start-ups such as the

beverage-delivery service Flaschenpost, brand

manufacturers are increasingly seeking to gain

direct access to consumers—whether online or

through ultramodern flagship stores in premium

city-center locations. Aside from pioneers like

Apple, many categories are encroaching on the

final consumer business, from coffee brands

(such as Nespresso) through to cosmetic lines

such as Kiehl’s and NYX Professional Makeup by

L’Oréal. As a result, traditional retailers not only

face intensified pressure on margins but also

unrelenting pressure to innovate.

The retail sector is mounting a response. By

increasing its share of private brands, it is

endeavoring to win the loyalty of customers and set

itself apart from the growing competition. Some

retailers, among them the French sports equipment

discounter Decathlon, are already aiming to

increase their share of private labels to 100 percent.

Those who can afford it pursue verticalization

and set up in-house production facilities for their

private labels. Leading grocery retailers such as

Edeka, Migros, Morrisons, and Kroger have long

produced much of their assortment themselves—

from beverages to meat to baked goods. Even

coffee roasters, ice cream factories, or potting-soil

producers have since been added to the vertically

integrated portfolios of retail chains.

These trends do more than simply change the

face of retail: they are also making a deep impact

on procurement management. The procurement

function is now not solely fixated on annual

negotiations with manufacturers of “A” brands.

Instead, the focus is increasingly turning to the

procurement of private labels and purchasing

of raw materials for in-house production. At the

same time, this approach is changing the entire

procurement organization. New team structures

and skills are needed, as are new approaches

and tools.

Priorities are shifting

For years, procurement officers in the retail

sector primarily focused on premium brands

and their suppliers; little effort was dedicated

to the procurement of private labels, which was

sidelined as an activity of less importance. That

is fundamentally changing with the emergence of

new competitors and sales channels. Meanwhile,

the share of private labels in the portfolio of many

brick-and-mortar retailers is very close to 50

percent. Private labels have long since outgrown

their original function as entry-level products. Today,

private labels assume quality leadership positions

(take for instance REWE Feine Welt, Tesco Finest,

or President’s Choice at Loblaw), address popular

niches such as organic food and vegan cosmetics,

or serve special customer groups (consider

children’s brands at Tesco like Fred & Flo baby care

and Tesco Goodness for kid’s food, or at Asda like

Little Kids food and Little Angels baby care). In the

meantime, there is barely any market segment that

the retail sector has not conquered with its in-house

products—through to the branding of complete

categories such as EDEKA zuhause, under which

the retail chain sells its home products.

As they expand their portfolio of private labels,

retailers are not merely focusing on securing their

position in the face of often limited supply sources.

Particularly in the premium segment, their aim is

to systematically improve margins and strengthen

their negotiating position against brand suppliers. At

the same time, their high-quality in-house products

set a counterpoint to the design-to-cost programs

of many “A” brands that seek to improve their own

margins with cheaper components and packaging.

Against this backdrop, the private label is set to

become an unprecedented strategic competitive

77Rethinking procurement in retail

advantage—vis-à-vis brand manufacturers but also

other retailers.

As verticalization increases, so too does the

importance of procuring resources and raw materials.

Retailers with in–house manufacturing capacity can

no longer simply pass on prices to their customers.

Instead, they have to ensure the supply and capacity

utilization of their production facilities. Not only does

that make the task of procurement more demanding,

it also involves far more complex processes.

Agile work structures are needed

The new trends have a wide-ranging impact on the

procurement function. Established power plays

in negotiations with brand suppliers have become

more difficult. Indeed, as retailers have lost their

ability to monopolize touchpoints to customers,

they have also lost their most powerful negotiation

argument in some areas. Brand manufacturers have

known how to take advantage of this opportunity:

they have professionalized their customer

management and today have access to data–based

customer knowledge that had long been exclusively

controlled by the retail sector. In contrast, many

retailers have changed little in the way they manage

their procurement activities and are seeing their

past negotiation power dwindle. In order to restore

the level playing field with manufacturers, they

have to revolutionize their procurement functions at

multiple levels simultaneously:

— Organization. Conventional procurement

management dependent on a few core

suppliers is no longer enough. Clever retailers

set their procurement organizations on a far

broader footing and, in particular, endow them

with greater agility. Category specialists are

replaced by agile, cross-functional teams that

link procurement to other functions, such as

product development, category management,

and supply chain management, and that set the

foundations for successful procurement based

on sprints.

— Capabilities. Agile procurement teams need a

broader range of competencies. Negotiation

tactics are no longer such a decisive factor;

more important are analytical skills, especially

in the disciplines of advanced analytics and

machine learning, coupled with an extensive

understanding of products.

— Tools. Retailers have long operated with sell-

off and margin analytics that ideally also factor

in additional agreements such as advertising

subsidies. However, that’s not enough in the

current environment: procurement officers

need a detailed understanding of how much

value can be created with each product and

what prices are actually feasible in the market,

including for well-established products beyond

their “brand bonus.” Also needed are highly

professional requests for quotations for product

development, manufacturing, or collaboration

agreements with suppliers. This is only possible

with the assistance of digital processes and a

toolbox that supports procurement in the retail

sector with new procedures and technologies.

New tools for every purpose: From

the parametric cleansheet to the

negotiation cockpit

As they seek to optimize their procurement

functions, today’s retailers have at their disposal a

large spectrum of methodological approaches and

digital analytics tools—not just for the procurement

of private labels but also for products produced in

house, for nonretail goods, and for the procurement

of industrial brands. Some of these tools should

be standard equipment in every retailer’s toolbox,

given that they provide the fact base needed for

making the best possible procurement decisions.

Such tools include analytics tools for determining

spending and price variance, a supplier positioning

matrix, and the cleansheet—an essential tool

for shedding transparency on complex product

categories. Beyond that, tried-and-true tools

are also used as needed, such as guidelines for

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78 Future of retail operations: Winning in a digital era January 2020

optimizing negotiation tactics or contractual terms

and conditions, presentation playbooks, or aids for

global procurement (Exhibit 1).

A closer look at a cleansheet analysis helps

illustrate the benefits of using digital tools. It

sheds light on the dense undergrowth of product

components and specifications: it is not unusual

for categories to have an excess of 1,000 stock-

keeping units (SKUs) and a correspondingly large

number of suppliers. That said, many articles within

a category are often manufactured and assembled

in similar ways—suggesting that considerable

savings potential lurks below the surface, and a

parametric model could help uncover it. Such a

model would help combine similarly manufactured

products into clusters and transpose the cost

information on individual parts to all others within

the product cluster. In this way, the retailer can

quickly calculate the costs for hundreds of products

and thereby determine competitive pricing.

Another helpful approach to improve internally

manufactured brands in particular is the design-

to-value (DTV) method. Innovative tools such as

ethnographic consumer research or industry-wide

design trend analytics today provide even more

detailed insights into what truly drives customers’

purchase decisions and what designs are in demand

in the market. Equipped with these and other DTV

tools, retailers can boost sales, optimize prices, and

simultaneously reduce costs—thus ratcheting up

value creation for each and every product.

Generally speaking, no procurement officer

looking for the best product at the best price can

afford to bypass advanced analytics anymore.

Take for instance today’s grocery sector, where

Exhibit 1

Insights 2019

Rethinking procurement in retail

Exhibit 1 of 2

For each step in the procurement process, there are approaches and tools for optimization—

both digital and classic ones.

Overview of key tools along the purchasing value chain

●

Spend

analysis

●

Price-variance

analysis

●

Supplier

proles

●

Cleansheet

●

Supplier

positioning

matrix

●

Request for

quotation

●

E-auction

●

Dening

specications

●

Linear

performance

pricing

●

Internal idea

generation

workshop

●

Global sourcing

●

Supplier workshop

●

Global sourcing

●

Negotiating

tactics

●

Contract

terms and

conditions

●

Playbook for

presentation

●

Negotiation

notes

●

Performance

tracking

Document

and follow up

on negotiation

results

Create a fact

basis

Conduct

request for

quotation

Generate

ideas and

derive

positioning

Prepare

and conduct

negotiations

Monitor

changes and

measure

impact

79Rethinking procurement in retail

algorithm-based machine learning is used to

develop complex demand forecasts or agronomic

predictive models, compile global cost curves, or

analyze market conditions based on geodata. To

this end, the tools combine an array of data on

market trends or developments in the weather and

commodities markets that procurement officers

can use to predict the purchasing prices of wheat,

for instance.

Many tools touched on here can be used both

in contract manufacturing and in the in-house

production of private-label goods. However, they

differ in terms of their range of influence. They

Exhibit 2

Insights 2019

Rethinking procurement in retail

Exhibit 2 of 2

Cleansheet analysis reveals high cost-savings potential—especially in procurement of

commodity products.

Cleansheet cost calculation for a high-volume candle (private label), € per piece

Sales, general, and administrative expenses.

Source: McKinsey analysis

•

Prot of 5% included in the price

•

Batch size of 10,000 pieces

•

Tender volume of ~15,000 pieces

•

Manufacturing location: Germany

•

Paran cost: €0.794/kg

•

Interest rate: 2% assumed

•

SG&A¹ costs: 3%; no R&D costs

•

Labor rates: €23.6 to €27.03 depending on skill level

Material (raw/purchased)

Inbound logistics

Landed material

Labor

Machinery

Batch setup, scrap, tooling

Direct manufacturing cost

Manufacturing OH, other related cost

Total manufacturing cost

SG&A, R&D, other on-top cost

Prot

Target price

Outbound logistics

Target price after outbound logistics

Quoted

0.59

Materials

Basic

assumptions

0.03

0.61

0.05

0.01

0.02

0.69

0.04

0.73

0.02

0.04

0.80

0.01

0.80

1.13

–29%

Value add Overhead (OH) and prot

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80 Future of retail operations: Winning in a digital era January 2020

offer the greatest leverage effect for in-house

production, as they can impact the selection of raw

materials, the manufacturing process, and even

the deployment of personnel. A number of levers

are also available for the procurement of private

labels. For instance, DTV can be used to manage a

product’s exact specifications, while procurement

tools and e-auctions help find the best suppliers.

Why the effort pays: Big

savings potential

A closer look at the levers in procurement clearly

shows that private labels offer procurement officers

substantially more opportunities for influencing the

product than industrial brands. Accordingly, there

are greater opportunities for reducing costs and

widening margins. It is possible to capture quick

savings through the procurement price alone. A

cleansheet analysis again helps determine the extent

of the potential: in the procurement of a mass article—

in the illustrated example, a candle for home use—the

difference between the determined target price and

the supplier’s offer was almost 30 percent (Exhibit 2).

Cost savings can be captured in the medium term

by combining procurement sources, switching to

other suppliers, or adjusting volumes. By contrast,

changing the content or packaging requires more

time, although it can likewise prove an effective

means of long-term savings.

The effort is certainly worth it. After all, the

costs of procurement or manufacture of articles

make up as much as 75 percent of the retail

price. Professional procurement management

with advanced method-ologies and smart tools

can make a substantial contribution toward

cutting these costs—by more than 10 percent in

the case of private labels. Retailers should not

miss this opportunity to stretch their margins

and maneuver into a stronger market position—

because the competition does not sleep.

Patricio Ibáñez is a partner in McKinsey’s Cleveland office, Alexander Merklein is an associate partner in the Vienna office,

and Daniel Rexhausen is a partner in the Stuttgart office.

81Rethinking procurement in retail

Six emerging trends in

facilities management

by Stefon Burns, Ella Burroughes, Steve Homan, and Alexander Merklein

Outsourcing, workplace strategies, and technology innovations

hold immense potential for companies seeking to reduce costs and

improve productivity in facilities management.

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82 Future of retail operations: Winning in a digital era January 2020

For companies with distributed operations—

retailers, manufacturers, transportation and

logistics—facilities management can represent

10 to 25 percent of total indirect spending.

Several recent developments, including fears

of a recession, trade conflicts, tech disruption,

and rising wages, have made cost cutting a

higher priority in this area. But business leaders

must strike a tricky balance to reduce noncore

costs without affecting the performance of

core operations.

Companies have no shortage of options at their

disposal to optimize facilities-management

expenditures. Outsourcing is a well-established

strategy that’s on the rise thanks to an influx of

vendors, while integrated approaches to facilities

management, workplace strategy, and technology

all hold promise. The global market for in-house

and outsourced facilities management is estimated

to reach $1.9 trillion by 2024. The outsourced

segment accounts for more than half the total and

has attracted a growing number of vendors with

new service offerings. Still, charting a clear path

forward—one that enables companies to extract

the most value—is an increasingly complex task.

How should companies proceed? As a first step,

executives must familiarize themselves with

how six emerging trends could reduce facilities-

management costs and improve productivity.

The first three involve the application of existing

strategies and approaches; the second three

involve using technology to transform the way

companies complete tasks. However, these trends

aren’t plug and play; companies must have the right

strategy and capabilities to get the most from them.

Facilities management and sourcing leaders should

focus on several immediate steps to mobilize their

organization and pursue these trends.

The evolution of facilities

management strategy

When facing ongoing pressure to reduce operating

costs, companies tends to look for savings

without giving much thought to the long-term

repercussions. This dynamic makes facilities

management a particularly ripe target. During

challenging economic times, companies trim

facilities-management budgets; once the outlook

rebounds, spending levels often remain low. This

pattern can lead to deteriorating conditions of

buildings and equipment, potentially costing more

in the long run.

Over the years, industries have accepted outsourcing

as a viable option to noncore operations, including

facilities management. Companies typically follow

a progression that begins with outsourcing noncore

activities at individual locations (Exhibit 1). The

consolidation, standardization, and bundling of

these tasks across facilities over time results in

the outsourcing of a comprehensive set of noncore

services and management to third parties.

Several economic factors have made outsourcing

more relevant for facilities management. Growth

is slowing across several large countries as they

reach the tail end of the current economic cycle.

Far–reaching global trade conflicts have created

unexpected changes in commodity and finished

product prices. Meanwhile, increased tech

disruptions in a handful of industries are pushing

legacy companies to free up cash for technology

investments. Last, lower unemployment rates are

pushing wage rates higher for the best talent. Thanks

to these developments, the total market for facilities

management (both in-house and outsourced) is

expected to grow at more than 6 percent a year from

2018 to 2024, hitting nearly $1.9 trillion (Exhibit 2).

Companies have no shortage of

options at their disposal to optimize

facilities management expenditures.

83Six emerging trends in facilities management

Exhibit 1

Own sta

performing

noncore services

Outsourcing of

noncore tasks on

case-by-case

basis

Pooling of

volumes across

sites, which is

tendered by the

central

procurement

function

Alignment of

service levels

across sites to

lowest acceptable

level, which also

treats employees

alike

Bidding out

multiple

services in

same RFQ with

opportunity for

one supplier to

deliver more

than one service

in exchange for

extra rebate

Full outsourcing of

wide range of

noncore services

and management

One partner per site

that typically

performs major

services with own

sta

Synergies in

del

ivery and

management

Levers

In house

Outsourced

Consolidated

Standardized

Bundled

Integrated

Savings

Typical evolution of facilities management (FM) over time.

Exhibit 2

McK on Retail 2019

Six emerging trends

Exhibit 2 of 3

Companies are increasingly outsourcing facilities management (FM).

Global market outlook (in-house and outsourced FM spend),

USD billions

846

972

1,134

1,314

1,599

1,884

2009 2024E2012 2015 2018 2021E

6.2% p.a.

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84 Future of retail operations: Winning in a digital era January 2020

Facilities management is ripe for disruption: it

lags behind other functions such as production

equipment maintenance by both digital maturity

and penetration of technology. Although technology

is available for facilities management, several

obstacles have inhibited adoption, such as a lack of

digital skills within the function, other priorities for

leadership, and a focus on continuous cost cutting.

These factors have made the facilities management

outsourcing market attractive for leading vendors

that were already engaged directly or indirectly with

this function. Several incumbents have developed an

integrated facilities management offering in an effort

to capture a greater market share.

Six emerging trends

We have identified six trends that offer cost savings

or productivity-improvement opportunities now or

that could transform facilities management over

the next decade. Since the attractiveness of each

trend will depend on an organization’s needs and

capabilities, the trends are presented in a manner to

facilitate evaluation and comparison.

1. Outsourcing facilities management

Organizations are evaluating their operating model

to maximize value creation. Before they outsource

facility management to third parties, however,

they review the appropriate mix of insourcing and

outsourcing based on capability, cost, and coverage.

Several factors are altering the equation.

— Growth in outsourcing. Outsourcing has now

surpassed 50 percent of the total facilities

management market in several regions,

including Europe, the Middle East, and North

America.

— Industry-based adoption. In manufacturing

companies, soft services such as landscaping

and janitorial are preferred categories for

outsourcing. Hard services such as utility

equipment maintenance are typically still

insourced. Meanwhile, retail, banking, and other

nonmanufacturing industries are looking to first

optimize their operating model by balancing

insourcing and outsourcing. If the benefits they

achieve are not significant, some players in

these industries have opted to fully outsource

facility management.

Case study

One large retailer was seeking to prioritize

tasks that could be handled more cost-

eectively by a third-party vendor. Its

team compiled a list of categories that

should be kept in house as well as those

to outsource. In-house categories were

determined based on which tasks could

be handled through a shared-services

model with high utilization of internal labor.

Outsourced categories were dened by

current specications and, separately,

by the essential level of service for the

organization. It put out an RFP for the

outsourced categories with two types of

specications and then selected suppliers

that best matched the retailer’s needs. This

approach reduced facilities-management

spending by 15 percent, which was

reallocated to support the organization’s

investment strategy.

85Six emerging trends in facilities management

— Penetration of integrated facility management

(IFM). IFMs are capturing increased market

share in outsourcing, particularly in North

America, where IFMs are close to 20 percent of

the outsourced category.

Implications

— Cost: Is your operating model optimized, and do

still have better cost performance?

— Competitive advantage: Does facilities

management provide a competitive advantage

over peers?

— Organizational capability: Does the company

have experienced personnel in facilities

management with intrinsic knowledge of the

location as well as highly efficient internal

technicians that would be challenging for a third

party to match?

2. Integrated value and related services

Companies are exploring the integration of facilities

management and related services in an effort to

streamline management and improve performance.

This offering can include the following functions:

— Real estate. This category includes all services

related to transaction management, project

management, and other services.

— Facilities management. All of the tasks that

are involved in maintaining a facility, such as

equipment maintenance and building services.

— Energy management. Activities focus on the

conservation of energy, including retrofits and

procedural changes.

— Production maintenance. The maintenance of

production equipment comprises areas such

as assembly stations, process equipment, and

testing stations.

— Employee services. Services for employees

could include mailroom, fitness center, and

cafeteria and food.

Case study

A global nancial institution was

spending $450 million annually to maintain

its thousands of locations around the world.

Its fragmented supplier base included

more than 10,000 vendors across about a

dozen categories. To assess opportunities

for outsourcing, the institution undertook a

scoping and prioritization exercise, sought

to gain greater transparency into spending

categories, applied advanced sourcing

techniques, and invested in stakeholder

management. With the insights gained

from this process, the company was able

to consolidate its facilities-management

spending from dozens of suppliers to just

one vendor, while standardizing business

processes and service quality. Adopting

integrated facilities management helped

reduce costs by more than $150 million

over three years.

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86 Future of retail operations: Winning in a digital era January 2020

Implications

— Decision making is easier, as fewer people

are involved.

— A comprehensive view of all services with

fewer providers eases the management of

these categories.

— Suppliers that provide integrated services can

become strategic partners for organizations.

Factors to evaluate if the organization should pursue

an arrangement with an outsourcing integrator:

— Cost: Are costs higher than benchmarks

for peers?

— Geographic portfolio: Does the company have

a diverse geographic footprint?

— Property portfolio: Is the property

portfolio diverse?

— Organizational capability: Does the real estate

function have limited capacity or capability?

3. Workplace strategy

Workplace strategy is becoming a key tool to

enhance employee engagement and retention. It

includes several different categories:

— Modular work space. Work spaces can become

more modular and activity-based to increase

agility and flexibility with the changing workforce

while decreasing total square footage.

— Coworking. Coworking provides flexibility

in selecting the type of space and period of

occupancy, which can offer cost savings.

— Lifestyle amenities. Lifestyle amenities such as

yoga, meditation, day care, recreation rooms,

and nap areas have become common features to

enhance employee experience.

— Wellness designs. Companies can invest in

work spaces with appealing acoustics, lighting,

furniture, and flooring, among other features.

Case study

One energy company sought to trim

its real estate costs while implementing

workplace strategies that would maximize

its use of space and accommodate evolving

employee needs. It pursued a range of

densication initiatives, including doubling

up oces for employees of specic

positions, converting excess conference

rooms to oces, and reducing oce sizes

for certain functions, such as accounting

or reception. It also created “hoteling”

zones, where employees could secure work

spaces on an as-needed basis.

Through these approaches, it increased

the number of available seats by

nearly 60 percent without expanding

its footprint. As important, an internal

survey found that employees viewed

this reconfiguration favorably.

87Six emerging trends in facilities management

Together, these categories form options along the

continuums of space and well-being (Exhibit 3).

Notably, trends in this category can increase

facilities management costs (for companies that

choose to invest more in workspace design), but

they could also indirectly compensate for these

outlays with higher employee productivity.

Implications

— When considering workforce strategies,

companies need to balance employee

engagement and workplace investment.

— Organizations are increasingly looking for

suppliers that are capable of maintaining an

evolving workplace.

Factors to help organizations determine if revamping

the workplace is the right choice:

— Geographic portfolio: Is the geographic

portfolio of facilities fragmented and

consistently changing with customer location?

— Employee productivity: Is current employee

productivity lower than peer benchmarked

levels, and would wellness design and lifestyle

amenities have an impact?

Exhibit 3

McK on Retail 2019

Six emerging trends

Exhibit 3 of 3

Fixed

Flexible

Traditional cubicles

Modular work space

Coworking

Not explicitly considered

Addressed through REFM

Traditional setup

Lifestyle amenities

Wellbeing designs

Space

Well being

Case study

A mining company sought to increase rig

uptime and reduce maintenance spending,

which accounted for 25 percent of operating

expenses. An analysis determined that

top drive and pipe handling accounted for

40 percent of all downtime and 10 percent of

all maintenance spending. It then conducted

a thorough “digital teardown” to estimate

specic opportunities in predictive main-

tenance for each component. To support

a predictive maintenance deployment, the

company focused on ve building blocks:

— Strategy

— Technology

— Capabilities

— Organization

— Processes and procedures

Its eorts paid o handsomely: the company

created an end-to-end system with

real-time data collection, storage, and pro-

cessing to enable predictive maintenance.

These capabilities enabled it to reduce

maintenance spending by 27 percent while

increasing revenue from services thanks to

higher reliability.

PROCUREMENT

88 Future of retail operations: Winning in a digital era January 2020

Through these approaches, it increased the

number of available seats by nearly 60 percent

without expanding its footprint. As important, an

internal survey found that employees viewed this

reconfiguration favorably.

4. The Internet of Things (IoT) evolution

A number of trends and developments are

spurring the adoption of equipment enabled by

the IoT by facilities management across a range of

applications.

— Energy efficiency. The implementation of IoT

devices, such as motion sensors for lights and

automated temperature controls, enabling more

visibility into energy usage and management.

— Occupant experience. This factor could be a

contributor to the adoption of the IoT.

— Computing. Data transmission costs are

determining whether edge, cloud, or hybrid

computing approach will prevail.

— Stack ownership. Companies are trying to

own multiple layers of the IoT stack. Hardware

infrastructure and software are emerging as

preferred ownership models.

— IoT security. Security is lagging behind the

development of IoT devices and platforms.

Implications

— Companies have to upgrade or retrofit legacy

systems before facilities can benefit from the IoT.

— Lingering skepticism about the IoT’s impact

means that organizations will have to develop

multiple use cases to demonstrate the impact of

these technologies on occupant experience.

— Companies should consider partnering with

suppliers that have an end-to-end vision of the

IoT and the capabilities required to convert this

vision into reality.

Executives should consider the following factors to

determine if now is the right time to adopt the IoT for

facilities management:

— Cost: Is the cost of IoT conversion in facilities

comparable to current expense of maintenance

and operations?

— Change champion: Do IoT initiatives have C-level

sponsors beyond the CIO?

Case study

Leading companies are in the process

of integrating robotics into their facilities-

management operations for tasks such as

floor cleaning, window washing, and power

washing. Innovations in early stages of

development include robots for security

patrol, lawn mowing, and snow removal,

among other tasks. The promise of such

robots is threefold: beyond the opportunity

to reduce operating expenses, these

machines could free up existing staff to

focus on higher-value activities while

mitigating some of the risk associated with

these tasks.

89Six emerging trends in facilities management

— Device compatibility: Can systems be retrofitted

with IoT technology?

— System compatibility: Is the building-

management system (BMS) capable of

integrating with devices and software? Does the

organization have the data management and

security capabilities necessary to support devices

equipped by the IoT?

5. Advent of robots

Robotic automation is well suited to take over

repetitive and hazardous tasks. Thus far, Asian and

European companies are leading in the adoption

of robotics for services such as cleaning and

security; widespread adoption could occur within

the next decade.

— Repetitive tasks. Activities that follow the same

process every time, such as sweeping a floor,

are prime opportunities to integrate robots into

operations. Several companies are currently

designing and building robots to automate

repetitive tasks such as power washing and

lawn mowing.

— Hazardous tasks. The use of robots for certain

jobs—for example, security patrol or HVAC

duct cleaning—could enable companies to

reduce costs and risk.

Implications

— Applications of robotic process automation are

still in the early stages for facilities management.

— Repetitive and hazardous facility-management

tasks are prime for disruption by robots.

— Organizations can pilot robots for repetitive

tasks or partner with suppliers that have

expertise in the deployment and maintenance

of robots.

Factors to evaluate if now is the right time to invest

in robotic automation:

— Cost: Is the cost of owning or leasing a robot less

than current costs?

— Market support: Has a service supply chain for

the equipment been established?

— Effectiveness: Is the quality of work similar or

better than current processes?

— Technology maturity: Will current technology

change dramatically in the short term?

Case study

Companies are experimenting with

various applications of AR to support

workers in selected tasks. A remote

assisted maintenance tool kit, for example,

includes endoscopic and thermal cameras,

a microphone, and a portable computer.

With these tools, the equipment operator

can connect remotely to an expert, who

can guide him through the maintenance

procedure. AR maintenance also oers

operators support through an integrated

helmet with special glasses and software

that details proper maintenance procedures.

PROCUREMENT

90 Future of retail operations: Winning in a digital era January 2020

6. Augmented reality

Technology players are developing end-to-end

AR solutions that have the potential to transform

facilities management.

— Hardware. Smartphones and tablets are

dominant in the hardware market, while wearables

are still in low levels of market penetration.

— Content source. Information is limited to content

pulled from maintenance manuals and through

user interaction. Content sources from devices

based in the IoT are also in the early stages

and would ideally be enhanced further by data

collected from IoT sensors.

— Interaction. Information can be visual,

instructive, or interactive. Technologies are

developing across all areas, but visualization is

currently the most mature.

— Mapping. While mapping is still limited to spatial

tracking, marker-based and shape-imposition

technologies are being developed.

— Software development kit (SDK). SDKs are well

developed for consumer applications such as

gaming but are still in the early stages for facility

management applications.

Implications

— Augmented reality is still in the early stages of

development for facilities management.

— Organizations would have to coordinate across

several functions to use AR effectively.

— Companies should work with partners that

are actively engaged with AR providers and

pilot technology when the market is ready with

a solution.

Factors to evaluate if now is the right time to

implement AR:

— Market support: Has the service supply chain

of hardware, software, and content been

established?

— IT infrastructure: Has IT infrastructure been

developed to support AR on a few controlled

applications?

— ROI: Does technology have a good ROI when

considering technician time, number of visits,

safety, and ease of process use?

— Workforce skill level: Is the current workforce

sufficiently technology savvy?

Technology players are developing

end-to-end AR solutions that have

the potential to transform facilities

management.

91Six emerging trends in facilities management

Actions companies can take now

Facilities management leaders can’t simply flip a

switch to harness these trends. Some companies

will need to adjust their strategy, organizational

capabilities, and culture. And considering that a few

of these trends are still in their infancy, executives

should focus on laying the foundation. Several

actions can help.

Elevate facilities management to a C-level

priority (with a focus on COO/CFO engagement)

Many industries have traditionally kept facilities

management on the back burner, but this category

can be a gold mine of savings. One company, for

example, was under pressure to reduce costs, but

the procurement team was skeptical of addressing

facilities management because of sensitivities

within the organization. The indirect procurement

team asked for support from the CPO and COO to

back a transformation of facilities management,

and this support created an actionable pipeline of

savings for the next three years.

Establish a cross-functional team

True cross-functional collaboration between

procurement and operations is required to create

sustainable impact. Companies should form a

team that includes the COO, CIO, a facilities-

management leader, a strategic-sourcing leader

(for facilities management or innovation), and a

project–management office leader, among others.

Without alignment, facility-management initiatives

face a difficult path. One company’s procurement

team identified savings during the RFP process and

moved to adopt integrated facilities management,

but some stakeholders were not on board. During

implementation, an operations team found that

the prescribed specifications were not aligned

with its equipment. Within a few months, the IFM

contract was nullified after disagreement between

procurement and operations. In another company,

procurement leaders were adamant about pursuing

IFM. Although it was the right strategy, they first

sought to gain alignment and support from the

operations team before the process kicked off.

Assess the organizational maturity and

capabilities needed to manage vendors and

support digital technologies

Capabilities, both from a relationship and content

standpoint, are important. Vendor relationships

can be built by acting on stakeholder satisfaction

surveys, organizing joint meetings with suppliers,

and managing supplier performance as a team.

Organizations can develop content-based

capabilities by introducing supplier-led training

on digital technologies and investing in external

expert trainings. For instance, a client set up

a meeting cadence between suppliers and

stakeholders to identify and address issues

every quarter.

Build the business case for investment in

selected trends

Companies can support the adoption of emerging

technologies by doing controlled pilots. Projects

that apply AR to simple tasks and experiment

with the IoT can get the organization acclimated

to technology. Successful pilots can provide the

business case for scaling; a similar rationale can

be used for opportunities to integrate robots. The

hotel industry, for example, is adopting robots for

bell service and housekeeping through pilots in

certain hotels.

Partner with IFMs, and set up a robust

governance mechanism

A company can view IFM suppliers as a partner to

achieve savings and manage portfolio, but it must

first establish a robust governance mechanism

to maintain trust with suppliers. A regular auditing

cadence can ensure that any savings are contributing

to the bottom line. In addition, companies should

make decisions collaboratively with IFMs on

topics such as specification standardization and

computerized maintenance management system

(CMMS) technology. At one manufacturer, a factory

manager set up a regular auditing cadence to

review IFM initiatives with the finance team to ensure

that savings flowed to the bottom line.

PROCUREMENT

92 Future of retail operations: Winning in a digital era January 2020

Stefon Burns is an associate partner in McKinsey’s New York office, Ella Burroughes is an associate partner in the London

office, Steve Hoffman is a partner in the Chicago office, and Alexander Merklein is an associate partner in the Vienna office.

Design an implementation road map

Companies should develop a comprehensive, long-

term category strategy to incorporate all facilities-

management trends. A sequencing exercise can help

companies prioritize initiatives. Since technologies

will continue to evolve, facilities management leaders

should establish a regular strategy review process of

all categories to refine and hone their vision.

Traditionally overlooked, facilities management

is on the cusp of disruption. Companies that

track emerging trends and invest in the right

organizational capabilities will be well positioned

to reduce costs and increase the impact of their

facilities-management spending.

93Six emerging trends in facilities management

The end of IT?

Retailers who want to stay ahead of the pack and drive

business results through technology innovation are rethinking the

setup of their IT departments.

by Marcus Keutel, Gautam Lunawat, and Markus Schmid

TECH

94 Future of retail operations: Winning in a digital era January 2020

“The IT is the problem—as usual!” This complaint

is a constant refrain whenever retailers with

brick-and-mortar beginnings realize that

desired process improvements or (tech) product

innovations will be delayed, must take a different

form than planned, or won’t be realized at

all. Usually this statement is true and false in

equal measure. It’s true because today nearly

every change a retailer might make depends on

technological solutions—and they often fall below

expectations. But it’s false as well because the

business side often is the root cause. In fact, a joint

study by Oxford University and McKinsey of more

than 5,000 IT projects identified three reasons

behind most failures: inadequate management

of the many people involved, investment that

is not aligned to business needs, and a lack of

transparency regarding the project portfolio.

The biggest stumbling block:

Silo structures

Invisible trenches between the IT department

and the rest of the company constitute one of

the main reasons why brick-and-mortar retailers

often struggle far more with technology than

their digitally grown counterparts. Many decision

makers in traditional companies still see IT as an

administrative function positioned somewhere

below the CFO, far away from the operative

business owners. IT departments like this tend

to be places where countless people toil on large

monolithic projects and political criteria rather than

arguments that help determine how resources

are allocated. Business-side practitioners and

developers seldom share ideas directly. As a result,

this type of IT function is generally unattractive

for digital talents, and commercially successful

retailers often struggle to build the internal

technology competence that they need.

The technological shortcomings that result from

this silo structure can threaten retailers’ very

existence—especially as the demands they face

multiply dramatically in the age of digitization, and

the digital disruptors like Amazon continue to invest

and innovate aggressively. Over the last few years,

leading retailers such as Walmart, Tesco, Kroger,

and John Lewis have significantly boosted their

technology investments in response. However, many

retailers still continue to devote less than 1.5 percent

of revenue to developing their technology assets.

While higher investment is essential, stationary

retailers cannot close the gap to the industry’s

technology leaders by simply throwing more money

on the table. Choosing the right digital model and

continuously developing it in a test-and-learn

process are far more important. The company must

build a modern technology organization supporting

the delivery of the best business results. In the end,

transforming mind-sets, capabilities, and ways of

working is critical not only in classical IT areas such

as application development and infrastructure

but also in core commercial divisions like sales,

merchandising, supply chain, and marketing.

Paths to a modern technology

organization

When it comes to organizing IT, stationary retailers

might look to digital pioneers such as Amazon or

Zalando. They are good role models based on one

organizational commitment in particular: for them,

joint responsibility for commercial processes and

technology development has always been the rule.

Retailers can consider this basic idea and optimize

their technological performance in six steps:

1. Entrust responsibility to small, effective

product teams

The modern technology organization is not

a large IT department organized by systems

anymore. Instead, small teams of developers

provide technical support for specific business

processes, known as “products.” For example,

individual teams could be built around various

products, such as assortment planning (in

sales or purchasing), promotions and pricing

(marketing), or inventory management (supply

chain). The individual products are defined

95The end of IT?

Exhibit 1

at such a granular level that a small team of

developers can support the process from

beginning to end. This approach obviously

enables “tearing down the walls” between

business and IT. The granular structure also

creates an opportunity to connect each of

these products and development teams

with a counterpart from the business. This

type of connection typically increases the

effectiveness of the product teams. Thanks

to their cross-functional staff, such teams can

drive further development independently and

be measured against the concrete business

results of their work. An overview from one

retailer, which has been transforming toward

such a structure with approximately 90 product

teams, shows just how differentiated the new

structure can be (Exhibit 1).

2. Set up “tech chapters” as new structures

within IT

The establishment of product teams usually

requires a change of the classical IT structures

with leaders at the division, department, and

team levels. One option that is currently used

by many companies is to replace the classical

structure with so-called “tech chapters” that

manage the professional development of

employees in the product teams and recruit new

tech specialists. Typically, chapter leads do not

influence the content of product development

(the “what”). They focus on the methodology and

McK Retail compendium 2020

End of IT

Exhibit 1 of 2

The end of centralized IT: small, eective product teams handle technological development in

each business unit.

Allocation of product teams to a retailer’s commercial units

1st level

Customer

Acquisition

Product search and advising Product presentation

Recommendation engine

Product search

Electronic price display

Web landing pages

Product congurator

Sales forecasts

Demand planning

Replenishment

Order management

Availability management

Stocktaking

IT security

Data warehousing and

reporting

Identity management

User support

Development support

Checkout

Service

Loyalty

Products and services

Assortment management

Pricing

Supplier management

Inventory management

Supply chain

Warehousing

Transport

Service fulllment

Support

Finance

IT platform

Analytics

2nd level Allocated IT product teams (selected)

TECH

96 Future of retail operations: Winning in a digital era January 2020

technology (the “how”). In large IT organizations

(1,000 employees and more) retailers typically

break up the tech chapters, as otherwise the

resulting organizational units would become

too big and thereby the responsibilities would

become unclear. One possibility is to break

the tech chapters into domains. For example,

one doman, titled “customer,” focuses on all

customer-facing products. This is an effective

way to create meaningful groups of employees

that benefit the most from knowledge sharing.

3. Assign product ownership to the business

Instead of throwing requirements from the

business over the wall to the IT department, in

this model each product team has a product

owner in one of the business divisions, such as

purchasing, sales, or finance. He or she leads

the content of the team’s work and, in contrast to

most of today’s models, is not limited to defining

requirements. They determine what their teams

work on and initiate the development of further

technological solutions that can improve the

company’s performance in their respective

business area. In concrete terms, this means that

the head of sales, for example, is responsible

for the checkout product team or the head of

purchasing has responsibility for the demand

planning/forecasting product team. Product

owners work with their product teams using

agile methods. In such a modern technology

organization, product teams and tech chapters

work together as needed: product owners

directly drive development with a business mind-

set, while chapter leads contribute technological

know-how (Exhibit 2).

4. Specify KPIs as standards of success for

each team

Binding KPIs let product owners and their teams

know how their performance is measured and

where it needs to improve. Digital retailers have

long used this approach to steer their teams:

instead of a single target for everyone based on

an indicator like overall sales development, each

team has its own set of KPIs linked to business

performance. This ensures that developers are

incentivized in the same way as their colleagues

in the corresponding business area. For the

marketing team, for example, a KPI could be

transaction cost per website visitor, for the

search team, the share of search results that

result in a purchase, for the recommendation

team, sales due to recommendations. By setting

targets for indicators like these, retailers ensure

that the team’s objectives are in line with those

of the company as a whole. The KPIs themselves

are not new, but using them to explicitly evaluate

the content of technology development inspires

a much stronger commitment to them—they

essentially become the currency that product

teams use to both prioritize their activities and

demonstrate their usefulness.

5. Add sponsors at the top management level

Ideally, each business division will have a sponsor

on the executive board whose involvement

includes setting priorities for his or her area. This

close connection to top management helps

resolve cross-divisional conflicts regarding

development priorities early on and reduce the

need for coordination at the expert level. Another

welcome side effect: technological questions

and their prioritization become consequential

not only for product owners but for nearly every

manager in the company.

6. Implement a state-of-the-art tech stack

To realize the maximum benefit from such

a transformation, it is crucial to enable the

product teams by reviewing and updating the

tech stack in the company. Typically, the result

is a rather intensive modernization with a higher

degree of modularization. To ensure scalability

and allow for rapid change, a shift to cloud

platforms and SaaS solutions is inevitable.

Further, most companies are working on

breaking up their monolithic architecture and

moving to microservices with a clear API-first

strategy. This will at the same time decrease

97The end of IT?

the need for manual operations and pave

the way to migrate to a DevOps setup, where

most product teams are responsible not

only for developing their products but also for

running them.

In general, we see two alternatives for how

companies have implemented a modern

technology organization:

“Big bang” refers to changing the full setup all at

once. This approach has the advantage of a short

implementation timeline; however, it also requires a

huge amount of preparation and bears a high risk of

disrupting daily operations.

“Step by step” starts with selected domains and

is followed by a sequential roll out. This approach

enables a test-and-learn environment and provides

enough time for the affected employees from the

business functions to understand and adapt to the

required changes. In most cases the step-by-step

approach will be the preferred choice.

New organization, new challenges

Tearing down the walls between business and IT by

implementing the transformation steps described

here can unleash vast potential. Experience shows

that the resulting setup enables companies to

develop and use new technologies much more

efficiently (see sidebar, “Suddenly fast and reliable:

How two retailers benefit from restructuring their

IT setup”). At the same time, it frees the classical

IT function to focus exclusively on cross-cutting

technology topics. Central-expert teams therefore

coexist alongside the tech-chapter leads to

make decisions on system architecture, ensure

data security, and manage relationships with

major technology partners. Responsibility for

infrastructure, such as cloud computing and data

pipes, is another overarching concern that is an

important enabler function.

Demands on the CTO as the organization’s ultimate

technology authority increase as well. The new

model requires far greater business foresight,

since the CTO must provide the right impetus for

Exhibit 2

McK Retail compendium 2020

End of IT

Exhibit 2 of 2

The technology-driven organization lives from the close interplay between product owners,

which determine “what” development will entail, and the tech chapters, which determine “how”

it will be done.

Target structure of a technology–based retail company, illustrative example

Product teams

Agile coachTech chapter

UX¹ designer

Architect

Developer

. . .

Product owner Product owner Product owner

User experience.

TECH

98 Future of retail operations: Winning in a digital era January 2020

potential digitization initiatives in the organization.

Doing so requires not only a person with

outstanding capabilities but also one positioned

at eye level with the other business unit leaders

and top managers. That’s why retailers that move

towards this structure often decide to make the

CTO a board-level role.

The changes laid out here are immense:

decades-old structures disappear, hundreds of

employees must learn new ways of working, and

many managers on the business side become

responsible for technology development.

Implementing this takes time. Companies may

be able to set up business-led product teams

in a matter of months, but fully learning the

corresponding new behaviors and ways of working

can take years. Transformation toward modern

technology organizations will only be successful if

the top management team wholeheartedly stands

behind the journey. Transforming from a classical IT

department to a modern technology organization

can be a radical step, but taking it can mean the

difference between a retailer struggling to survive

and one that translates digitization into genuine

business success.

Key takeaways

1. For many traditional retailers, digitization

and the shift towards omnichannel requires a

change from a classical IT function to a modern

technology organization.

2. Effective technological development requires

many small teams who are responsible for

supporting individual business processes

(products) end to end.

3. Connecting development teams to the business

divisions responsible for the business process in

question, including connected KPIs, tears down

the walls between business and IT—business

and IT have to create impact together.

Suddenly fast and reliable: How two retailers benet from restructuring their IT setup

The experiences of two European retailers

show the potential that reorganizing

technology structures can set free:

— After making the organizational

changes, a housewares retailer was

able to complete an order-management

module, which had fallen months

behind schedule, within budget and in

less than two months.

— A food retailer using the new structure

managed to develop an entire

technical solution for deliveries to

end customers—from the online shop

to the management of merchandise,

inventories, and the delivery fleet—

within ten months. The solution went

live on schedule as a result.

In both cases, the key to success was

entrusting operational decision makers

from the business with the product owner

role working with their product teams.

It quickly became clear that they could

be far more targeted in identifying and

prioritizing requirements when their

responsibility expanded from

simply operating solutions to shaping

them as well. At the same time, this

put the responsibility of deciding on

potential benets and costs in one

place—an important prerequisite for

making technology decisions from

a business perspective.

Marcus Keutel is a partner in McKinsey’s Cologne office, Gautam Lunawat is a partner in the Silicon Valley office, and

Markus Schmid is a partner in the Munich office.

99The end of IT?

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