The Mission Statement Is Dead! Long Live the Mission Narrative!

The idea for this piece was rattling around in the back of my brain when I came across an interesting blog post on the Association for Talent Development’s site: “Why I Hate Mission Statements—But Love Missions.” The writer, Brad Federman, lays out many legitimate complaints about typical declarations: They have been wordsmithed into frothy blather, are too long to be remembered, and have little use beyond adorning the lobby wall. But Federman also argues, correctly, that a compelling mission has the power to shape a workplace and inform strategic and operational decisions. So what accounts for the disconnect? More importantly, how can it be bridged?

The primary fault lies not in the “mission” but in the “statement.” A statement is a one-time aspirational exercise, which is usually crafted by an elite group of marketers or executives for customers or clients. Everyone involved feels good about the honeyed prose. And there are, of course, good mission statements. The best are crisp and straightforward—more Hemingway than Faulkner. I like Patagonia’s: “Build the best product, cause no unnecessary harm, use business to inspire, and implement solutions to the environmental crisis.”

Too often, however, the statement becomes an end in itself, disconnected from job descriptions, leadership competencies, operational policies, and the other activities that comprise the day-to-day reality of the organization. Making that connection takes work and commitment. And that’s where mission narratives come in.

The narrative is a bottom-up method for ratifying the relevance and strength of the company’s purpose while also unearthing examples, hidden best practices, and unacknowledged obstacles to success. In a healthy culture, names can be attached to the narrative because telling truth to power is not a career-ending move. In companies that are more toxic, they can be written anonymously. People who are intimidated by writing can invest in some voice recognition software that allows them to capture the narrative orally.

The mission narrative should be short and explicit—the story of how a company’s mission is actually achieved. The quality of the writing is secondary, even tertiary, to spirit and specificity. It can be half a page, a page, or even two pages. It can be written by the people who actually do the work, and it can take one of many forms, depending on who’s writing it. Here are some examples of what a team leader might write:

  • To realize our mission, I do A, B, and C as a retail team leader to build a group that delivers X, Y, and Z. An example of where we performed at our peak in the past six months is… and an example of where we fell short is… I was most proud of my team when we…
  • The criteria I use for hiring are 1, 2, and 3. The formal and informal methods that I use for development are 4, 5, and 6.
  • The policies, procedures, and tools that help me most are… and here’s why. Here are those that get most in the way… and here’s why. The changes I would make tomorrow if I could are… and here’s why.
  • Here’s what I have done over the past six months to make our store and its people embody the mission of this organization…
  • If I were to hire my replacement, I would look for these qualities and/or experiences that are not in the current job description… Here’s why they would be important for his or her success…

A product manager might write about how the company’s mission informs the way suppliers are chosen or components approved for inclusion in a product. A designer or architect could write about how materials are specified. The list goes on.

Emphasizing examples, evidence, and underlying reasoning (“Here’s why…”) bring genuine experiences to light. Storytelling—the oldest, most enduring, and one of the most powerful forms of human communication—helps individuals from the shop floor to the boardroom distill concrete meaning and expression of the company’s overarching focus. Meaning drives engagement and motivation. Meaning cannot be crafted from afar; each person must find it and feel it themselves. The narrative exercise provides a channel for that exploration.

Be careful, however, not to turn the narrative into a corporate history. This is not about memorializing the distant past but rather an opportunity to chronicle the present and co-create the future. The narratives should be part of an ongoing, open-ended dialog through which members of the enterprise learn more about themselves and the work they do while also sharing to create community.

As a collective body of knowledge, the mission narratives can inform everything from organizational structure, to reward-and-recognition programs or basic policies. The exercise can embed purpose, values, and performance measures deep into an organization (and reveal where improvements must be made). Alignment up and down within organizational units and across organizational boundaries improves when people clearly articulate why they are doing what they are doing. Interdependencies are revealed. Resilience is enhanced.

Are there companies that do this well? John Hagel has cited Nike and Appleas examples of corporate narratives that hit the mark, with their “Just do it” and “Think different” messages, respectively. These slogans are not merely catchy mission statements meant to be used as marketing tools, but they begin narratives that encapsulate a larger story at the institutional level. I’m advocating something even more holistic and expansive in its creation and iteration. Like Rob Goffee and Gareth Jones, who wrote about how to create the best workplace on Earth but who could find no company that followed all of the principles, I am still searching for the organization that takes full advantage of the power of mission narratives. If you know of one or are part of an organization that would like to try, please get in touch. In a future post, I’ll share some of the best.

Originally published at strategy + business

Why I Hate Mission Statements—But Love Missions

MissionNinety-nine percent of the mission statements out there are useless. Have you read them? Indeed, some read more like an essay than a statement.

The Global Beauty Leader. We will build a unique portfolio of Beauty and related brands, striving to surpass our competitors in quality, innovation and value, and elevating our image to become the Beauty Company most women turn to worldwide.

The Women’s Choice for Buying. We will become the destination store for women, offering the convenience of multiple brands and channels, and providing a personal high touch shopping experience that helps create lifelong customer relationships.

The Premier Direct Seller. We will expand our presence in direct selling and lead the reinvention of the channel, offering an entrepreneurial opportunity that delivers superior earnings, recognition, service and support, making it easy and rewarding to be affiliated with Avon and elevating the image of our industry.

The Best Place to Work. We will be known for our leadership edge, through our passion for high standards, our respect for diversity and our commitment to create exceptional opportunities for professional growth so that associates can fulfill their highest potential.

The Largest Women’s Foundation. We will be a committed global champion for the health and well-being of women through philanthropic efforts that eliminate breast cancer from the face of the earth, and that empower women to achieve economic independence.

The Most Admired Company. We will deliver superior returns to our shareholders by tirelessly pursuing new growth opportunities while continually improving our profitability, a socially responsible, ethical Company that is watched and emulated as a model of success.

Some say virtually nothing, like this one: “To grow profitably and provide shareholder value.” Who doesn’t want those things?

Most companies use fluffy language provided by a marketing firm or a consultant that sounds polished, but remove anything that makes them stand out as an organization.

What good are these statements? How do they help your business? The short answer: They don’t.

Whenever I walk into an organization and ask employees what the organization’s mission is, I typically get varied responses:

  1. “I don’t know.”
  2. “Let me look that up”
  3. “Let me find that for you.”
  4. The blank stare.

Basically, I get a different answer from everybody.

Mission statements hang on a wall or adorn a website page and that is about all. But a mission has the potential to guide organizations into real action.

For example, during the Cola Wars, Pepsi had one of the best missions. Simply put in just two words the mission was “Beat Coke.” (By the way, it was at a time when Pepsi made Coke a little nervous because they made strides during that time.)

Granted, there is a life expectancy to that mission, and it needs to change or be refreshed when it is no longer relevant. However, talk about, clear, concise and compelling—and real.

  1. Missions are known. Think about it: Would you send a group of soldiers into a conflict without a mission or without them knowing the mission? No way. But most organizations do just that.
  2. Missions are a rallying cry or call to action. Missions give us direction and something for which to shoot. I love St. Jude’s mission, for example. They will not settle until there is a cure for cancer. In fact, they consistently reference their success as the day they will put themselves out of business. They know why they come to work everyday!
  3. Missions are influencers of our work. When a mission is clear, concise, and compelling, it influences the way we work. Take Pepsi’s mission to “Beat Coke.” Every employee could ask themselves each day: “What am I going to do to help us beat Coke today?” What a powerful question. Try doing that with the mission statement at the top of this post.
  4. Missions are bigger than just one person. Missions bind groups of people together for a common goal or effort and help people rise above themselves. When done right, missions create pride and engagement. Homewood Suites, a consistent J.D. Powers Award winner, teaches its employees that their job is about providing a “Home away from home.” A place where extended stay travelers (a.k.a. Road Warriors) feel comfortable. Their jobs are bigger than their roles. Missions are about culture.
  5. Missions are constantly being revisited. Missions are alive and active. Whether you hold shift meetings, monthly meetings, use performance appraisals, or hold coaching sessions, missions are built in the operation and people threads of the business. We should measure how we are doing against our mission, train people on the mission and brainstorm new ways to make our mission stay fresh and alive. We should find ways to help people identify with and personalize their approach to the mission.

Missions are the glue that holds us together as an organization and connects us with our customers. Missions are the vehicle that helps us all drive in the same direction.

Bottom line: I hate mission statements. But I love missions!

Originally published in ATD

Target Employee’s Amazing Black Friday Pep Talk

Shift meetings are supposed to be fun and motivating.  But most are boring.  These meetings are a great opportunity to get feedback from your employees.  But most are one way communication tools.  Most importantly, these meetings should have a call to action.  Yet most fall flat.

The shift meeting below does not fall flat.  This manager understands what a shift meeting can do.  Enjoy.  It is one of the best!

It starts with this…”People of Target, brothers, sisters, hear me now,” he said. “They’re standing out there. Any moment now, those doors will be breached. Whatever comes through those gates, you will stand your ground with a smile on your face.” And it only gets better!

Leadership Transitions

If only 34% of U.S. workers aspire to leadership positions, with 7% aiming for senior or C-level management what will that mean for our leadership bench strength? share your thoughts and ideas.

F&H Solutions Group Hires Business Development Executive

Tom McKenzie, former principal at Capital Partners, joins human resources consulting firm to strengthen business development efforts.

F&H Solutions Group, a national consulting firm specializing in human resources and labor relations, welcomes Tom McKenzie to the company’s Washington, DC, office as business strategist. He will help expand F&H Solutions Group’s product offerings and introduce the firm’s consulting services to a wider market.

With more than 30 years in executive positions in diverse organizations, McKenzie has a very strong business development skills set. He is a proven business strategist who will help F&H Solutions Group reach new business sectors and industries.

McKenzie has worked with companies ranging from Global 500 companies to new seed capital startups. His vast experience includes selecting, hiring, growing and managing successful sales, marketing, and customer service and client teams. McKenzie’s expertise also includes managing sales and customer service operations; enterprise selling and facilitating customer relationships; measuring sales and customer service effectiveness; and launching new products and services. In addition, he has focused on redesigning sales, marketing and customer service strategies; enhancing sales and customer service roles in brand management and public relations; maximizing revenue growth while managing profit margin; and implementing global accounts and strategic account teams.

Brad Federman, chief operating officer of F&H Solutions Group, notes, “We promise our clients that we will know their business, recognize their needs and use our best resources to strengthen their company and culture. With the addition of Tom McKenzie, we are fortifying that promise. I have known and worked with him for years. No one is better at understanding a client’s needs and recognizing what will help a particular organization in a given situation become even more successful.”

Prior to F&H Solutions Group, McKenzie was a principal at Capital Partners, where he performed due diligence, analysis, acquisition/transaction negotiation, sales, operations, and financial management for private equity and venture capital projects and companies.
As a managing partner of SkillMeasure, a management consulting firm, McKenzie worked with senior executives and sales teams to perform gap analysis of sales, marketing and customer service team performance and to recommend solutions. He helped grow the business into a global sales consulting company.

His career also has included positions at Provant/Global Novations, Behavioral Technology and FedEx. These experiences afforded McKenzie firsthand knowledge of ways to structure and improve sales and customer service relationships. Some of his past clients include Apple, FedEx, Intel, Yahoo, Microsoft, Bank of America and the General Services Administration.
McKenzie says, “Joining F&H Solutions Group will enable me to leverage my past experience and knowledge to continue providing our clients with proven solutions and capabilities to help them address the challenges and opportunities that come with growth and management in our rapidly changing global economy.”

About F&H Solutions Group
F&H Solutions Group is a national consulting firm specializing in human resources and labor relations matters. Our professionals have unmatched expertise and experience in working with all types and sizes of organizations in different industries in both the private and public sectors. Since 1989 FHSG has provided clients with solutions for a better workplace. Our long-term client relationships are a testament to our commitment to improving workplaces and preparing clients for a successful future. For more information, please visit http://www.fhsolutionsgroup.com.

See original press release

Remaking the industrial economy

A regenerative economic model—the circular economy—is starting to help companies create more value while reducing their dependence on scarce resources.

Visualize, for a moment, the industrial economy as a massive system of conveyor belts—one that directs materials and energy from resource-rich countries to manufacturing powerhouses, such as China, and then spirits the resulting products onward to the United States, Europe, and other destinations, where they are used, discarded, and replaced. While this image is an exaggeration, it does capture the essence of the linear, one-way production model that has dominated global manufacturing since the onset of the Industrial Revolution.

Increasingly, however, the linear approach to industrialization has come under strain. Some three billion consumers from the developing world will enter the middle class by 2030. The unprecedented size and impact of this shift is squeezing companies between rising and less predictable commodity prices, on the one hand, and blistering competition and unpredictable demand, on the other. The turn of the millennium marked the point when a rise in the real prices of natural resources began erasing a century’s worth of real-price declines. The biggest economic downturn since the Great Depression briefly dampened demand, but since 2009, resource prices have rebounded faster than global economic output (Exhibit 1). Clearly, the era of largely ignoring resource costs is over.

Exhibit 1

Since 2009, resource prices have rebounded more quickly than global economic output.

In light of volatile markets for resources, and even worries about their depletion, the call for a new economic model is getting louder. In response, some companies are questioning the assumptions that underpin how they make and sell products. In an effort to keep control over valuable natural resources, these companies are finding novel ways to reuse products and components. Their success provokes bolder questions. Could economic growth be decoupled from resource constraints? Could an industrial system that is regenerative by design—a “circular economy,” which restores material, energy, and labor inputs—be good for both society and business? If the experience of global automaker Renault is any indicator, the answer appears to be yes.

  • Renault’s plant in Choisy-le-Roi, near Paris, remanufactures automotive engines, transmissions, injection pumps, and other components for resale. The plant’s remanufacturing operations use 80 percent less energy and almost 90 percent less water (as well as generate about 70 percent less oil and detergent waste) than comparable new production does. And the plant delivers higher operating margins than Renault as a whole can boast.
  • More broadly, the company redesigns certain components to make them easier to disassemble and use again. It also targets components for closed-loop reuse, essentially converting materials and components from worn-out vehicles into inputs for new ones. To support these efforts, Renault formed joint ventures with a steel recycler and a waste-management company to bring end-of-use expertise into product design. Together, these moves help Renault save money by maintaining tighter control of its raw materials throughout its vehicles’ life cycles—or use cycles.
  • Renault also works with suppliers to identify “circular benefits” that distribute value across its supply chain. For example, the company helped its provider of cutting fluids (a coolant and lubricant used in machining) to shift from a sales- to a performance-based model. By changing the relationship’s nature and terms, Renault motivated the supplier to redesign the fluid and surrounding processes for greater efficiency. The result was a 90 percent reduction in the volume of waste discharge. This new arrangement benefits both companies: the supplier is moving up the value chain so that it can be more profitable, while Renault’s total cost of ownership for cutting fluids fell by about 20 percent.

Renault’s experience is just one data point in a growing body of evidence suggesting that the business opportunities in a circular economy are real—and large. In this article, we’ll explore the concept of such an economy, examine the arguments and economics underpinning it, and discuss the challenges that must be overcome to make it a reality. The work, which draws on McKinsey’s recent collaboration with the Ellen MacArthur Foundation and the World Economic Forum1 1. This work is summarized in three reports: Towards the Circular Economy: Accelerating the scale-up across global supply chains, World Economic Forum, January 2014; Towards the circular economy: Economic and business rationale for an accelerated transition, Ellen MacArthur Foundation, January 2012; and Towards the circular economy: Opportunities for the consumer goods sector, Ellen MacArthur Foundation, January 2013. 

Circular thinking

A circular economy replaces one assumption—disposability—with another: restoration. At the core, it aims to move away from the “take, make, and dispose” system by designing and optimizing products for multiple cycles of disassembly and reuse.2 2.For readers interested in learning more about circular economies and the thinking behind them, we recommend two seminal books: Michael Braungart and William McDonough, Cradle to Cradle: Remaking the Way We Make Things, first edition, New York, NY: North Point Press, 2002; and Walter R. Stahel, The Performance Economy, second edition, Basingstoke, Hampshire: Palgrave Macmillan, 2010. This effort starts with materials, which are viewed as valuable stock to be used again, not as elements that flow through the economy once. For a sense of the scale involved, consider the fast-moving consumer-goods industry: about 80 percent of the $3.2 trillion worth of materials it uses each year is not recovered.

The circular economy aims to eradicate waste—not just from manufacturing processes, as lean management aspires to do, but systematically, throughout the various life cycles and uses of products and their components. (Often, what might otherwise be called waste becomes valuable feedstock for successive usage steps.) Indeed, tight component and product cycles of use and reuse, aided by product design, help define the concept of a circular economy and distinguish it from recycling, which loses large amounts of embedded energy and labor.

Moreover, a circular system introduces a strict differentiation between a product’s consumable and durable components. Manufacturers in a traditional economy often don’t distinguish between the two. In a circular economy, the goal for consumables is to use nontoxic and pure components, so they can eventually be returned to the biosphere, where they could have a replenishing effect. The goal for durable components (metals and most plastics, for instance) is to reuse or upgrade them for other productive applications through as many cycles as possible (Exhibit 2). This approach contrasts sharply with the mind-set embedded in most of today’s industrial operations, where even the terminology—value chain, supply chain, end user—expresses a linear view.

Exhibit 2

In a circular economy, products are designed to enable cycles of disassembly and reuse, thus reducing or eliminating waste. View a slideshow of this exhibit, narrated by McKinsey alumnus Markus Zils.

Since restoration is the default assumption in a circular economy, the role of consumer is replaced by that of user. For companies, this change requires a different way of thinking about their implicit contract with customers. For example, in a buy-and-consume economy, the goal is to sell the product. In a circular economy, the aspiration might be to rent it out to ensure that its materials were returned for reuse. When products must be sold, companies would create incentives to guarantee their return and reuse. While all this might sound rather utopian, a number of companies are starting to pull four (often mutually reinforcing) levers to convert theory into hard-hitting practice.

1. The power of the inner circle

Ricoh, a global maker of office machines, designed its GreenLine brand of office copiers and printers to maximize the reusability of products and components, while minimizing the use of virgin materials. Products returning from their leasing contracts are inspected, dismantled, and taken through an extensive refurbishing process that includes replacing components and updating software before the machines reenter the market. By designing the components to be reused or recycled in Ricoh facilities, the company reduces the need for new materials in production and creates a tight “inner circle” of use that allows it to employ less material, labor, energy, and capital. GreenLine products are now offered in six major European markets, where they account for 10 to 20 percent of Ricoh’s sales by volume and earn margins that are as much as two times higher than those of the company’s comparable new products—without a reduction in quality.

For products that can’t be remanufactured, refurbished, or upgraded, Ricoh harvests the components and recycles them at local facilities. The company is currently considering a plan to return some recycled materials to its manufacturing plants in Asia for use in making new components. After factoring in the price differences between virgin and recycled materials (polypropylene, for example) and the cost of Asia-bound container shipping, Ricoh estimates it could save up to 30 percent on the cost of materials for these components. Overall, the company says, it’s on track to reduce the input of new resources in its products by 25 percent below their 2007 levels no later than 2020.

2. The power of circling longer

A closely related way companies can benefit from a circular economy is to maximize the number of consecutive product cycles (cycles of reuse, repair, or remanufacture), the time products spend in each of them, or both. If designed appropriately, each additional cycle eliminates some measure of the net material, energy, and labor costs of creating a new product or component. For example, Renault leases batteries for electric cars, in large part to recover them more easily so they can be reengineered or recycled for additional duty. Keeping close control over the process helps ensure the product’s quality and gives Renault a chance to strengthen its ties to customers.

Leasing isn’t new in the automotive industry, of course: tire-maker Michelin leased automobile tires in the 1920s. In 2011, Michelin Fleet Solutions had 290,000 vehicles under contract in more than 20 European countries. The group offers tire upgrades, maintenance, and replacement to optimize the performance of trucking fleets and to lower their total cost of ownership. By maintaining control over the tires, Michelin can collect them when they wear out and can extend their technical utility by retreading or regrooving them for resale. The company estimates that retreads, for example, require half of the raw materials new tires do but deliver up to 90 percent of the performance.

Meanwhile, in a few stores, the UK-based retailer B&Q is piloting a take-back program for its power tools. Customers can exchange used ones either for cash or a charity donation. The company plans to refurbish the tools it collects in Europe for resale locally or to recycle them and thus recover raw materials that could be used to make new power tools in the company’s facilities in China. Our research suggests that the margin-improvement potential, primarily resulting from savings in the cost of materials, could be as high as ten percentage points.

3. The power of cascaded use

Another source of value creation is to take a product or component and diversify its reuse more widely across the value chain, redistributing the materials so they can substitute for inflows of virgin ones somewhere else. For example, the Australian property and infrastructure company Lend Lease uses scrapped-wood chips from timber mills to create cross-laminated timber panels for construction.

Global apparel retailer H&M launched an in-store collection program encouraging customers to bring in old clothes in exchange for discount vouchers on new H&M clothing. The company partners with I:CO, a reverse-logistics provider, to sort the clothes for a range of subsequent “cascaded” uses.3 3.Cascading is the process of putting materials and components to use, across value streams and industries, after their end of life. The majority of items collected are dispatched to the global secondhand-apparel market. Clothes that are no longer suitable to wear are used as substitutes for virgin materials in other applications—for example, as cleaning cloths and textile yarns or as inputs for damping and insulation materials in the auto industry or for pipe insulation in the construction industry. When all other options are exhausted, the remaining textiles (1 to 3 percent, according to I:CO estimates) become fuel to produce electricity.

H&M executives view the program as a way to increase in-store traffic and customer loyalty. It is also the first step in the company’s longer-term goal of recycling all of its textile fibers for additional purposes and using yarns made from collected textiles in its new products—a move that would bring greater arbitrage opportunities.

4. The power of pure inputs

The final way companies can benefit from the principles of a circular economy is by designing products and components so they are easier to separate into consumable and durable elements later on, thus helping to ensure the purity and nontoxicity of materials along the manufacturing process. Greater ease of separation also increases the efficiency of collection and redistribution while maintaining the quality of the materials—a crucial economic consideration and often a substantial challenge. In the United States, for example, less than one-third of the rubble generated during the construction and demolition of buildings is recycled or reused, though it contains high concentrations of recyclable steel, wood, and concrete.4 4. Buildings and Their Impact on the Environment: A Statistical Summary, revised April 22, 2009, US Environmental Protection Agency, epa.gov. Even in paper recycling (where the inputs are generally considered “pure” and recycling rates approach 80 percent in Europe), the difficulty of removing inks, fillers, and coatings from paper without degrading it results in a loss of materials worth $32 billion a year.

In some cases, companies work with their supply partners to create ecosystems that support circular product designs. For example, Desso, a Dutch manufacturer of carpets, operates a take-back program that collects end-of-use carpet tiles to recover their materials for further production or for sale to secondary materials suppliers. The carpet-backing material can be fully recycled in the company’s own production processes; Desso’s supplier, Aquafil, converts the Nylon 6–based top yarn back into new yarn. Because the nylon inputs are pure, they can be reused over and over again without degradation. In general, designing a product to use the purest materials possible helps maintain their residual value and supports recycling and reuse.

Squaring the circle

Given the potential of the circular economy to replace untapped value through resource arbitrage, why isn’t it taking off faster? Three barriers have slowed the realization of that potential; each holds clues about moves companies can make to convert themselves from linear to circular economics.

Geographic dispersion

The most tangible barrier for corporate decision makers is all around them, in the extensive supply and manufacturing footprints that companies have created to thrive in the linear economy. This problem is evident even in seemingly simple products. For example, B&Q estimates that its cordless drills contain up to 80 components derived from 14 raw materials sourced in as many as seven countries. A product such as a car is significantly more complex. Understandably, closing product and component loops for most products is difficult, despite attractive arbitrage opportunities.

Moreover, good standards for reusable materials require global support, which is not always present. Whether companies attempt to create closed global loops (like Ricoh) or geographically open cascades (as H&M and I:CO are attempting to do in the apparel industry), there is always a risk that an efficient and effective collection, reuse, and recycling process will break down. That is particularly true in developing countries, where the collection and recycling of valuable end-of-use materials frequently falls to the informal sector. In China, for example, the formal sector covers only about 20 percent of the “e-waste” collected.5 5. Euromonitor; expert interviews. Without adequate standards, reprocessing is inefficient and, worse, creates health and safety hazards for the workers involved.

To get a handle on the challenge of geographic dispersion, senior executives must start thinking as hard about reverse-network activities (moving from products to components to materials) as they do about the traditional inbound ones. They will have to deal with a host of thorny trade-offs. Should refurbishment take place in the region of manufacture or of usage? When is it more economical to reduce components to their constituent materials and sell them on global markets? How cost effective would it be to establish postusage loops with business partners as opposed to making new components with virgin materials?

Developing a clear picture of the economics will be crucial, as will the ability to create “win–win” partnerships. For example, in exchange for lower prices and guaranteed access to supplies, Philips Healthcare returns used components to its suppliers and lets them decide whether to reuse the components for new builds and service parts or to sell them to raw-materials suppliers as high-quality, recyclable (or even ready-to-use) feedstock. (See, “Toward a circular economy: Philips CEO Frans van Houten,” available on mckinsey.com, on February 7.)

Reverse-logistics skills (such as collection, sorting, remanufacturing, and refurbishment) will be critical. One of the success factors in Ricoh’s GreenLine operations is the company’s “take-back” system, which optimizes supply and demand for remanufactured machines. This system requires sophisticated reverse-network-management capabilities, such as tracking the location and condition of used devices and components, as well as storing bill-of-materials information.

Complex materials

The second point of leakage involves the sheer complexity and proliferation of modern product formulations, which are rarely labeled or made public and are therefore devilishly difficult to identify after the fact, even for manufacturers. In the world of plastics, for example, companies have broadened the spectrum of materials used, in creative and complex ways. Most innovations in polymer-materials science have come courtesy of new additives that act, for example, as heat stabilizers, flame retardants, pigments, or antimicrobial agents.

In addition, the proliferation of materials can come from sheer habit or even management inattention. Companies, for example, often add materials to cut costs or innovate and then later fail to revisit these decisions; in their purchasing practices, say, they might introduce 16 plastics, where 4 would cover all functional specifications and application needs. These problems have exponentially increased the complexity of materials, while making it hard to classify and collect them on the scale required to create arbitrage opportunities or to demonstrate the returns needed to attract investors.

Moreover, companies often have no cost-efficient way of using chemical or physical processes to extract embedded raw materials without degrading the product, so most of the original value is lost in current, smelter-based recycling processes. For example, only $3 worth of gold, silver, and palladium can currently be extracted from a mobile phone that, when new, contains $16 worth of raw materials.

Despite the difficulties, some companies are making progress. Veolia’s Magpie materials-sorting system, for example, uses infrared and laser technologies to sort some plastics quickly. The company’s facility in Rainham, in the United Kingdom, can separate nine grades of plastics while processing 50,000 metric tons of them a year. Nonetheless, current technologies still depend on accurate (and often manual) presorting, which must meet minimum purity requirements to ensure an economically viable yield.

As Veolia’s example suggests, tackling the problem of complex materials will ultimately come down to extracting them at scale, so that they have a marketable value. This will in turn require companies to cooperate in the precompetitive sphere. Arbitrage opportunities already exist across the value chain—from raw-materials suppliers to product manufacturers, players in end-of-use management, and suppliers of the enabling information technologies. Successful first movers could capture significant economic benefits, including an outsized influence on global standards or on the design of products and supply chains.

The curse of the status quo

The final barrier against a circular economy is the sheer difficulty of breaking ingrained habits. Many aspects of the current system reflect decisions made long ago. While some are relatively innocuous (for instance, QWERTY keyboards and the shape of power plugs), others incur higher costs.

Misaligned incentives dot the industrial landscape, making it hard to create, capture, and redistribute value. Customers, for instance, are used to evaluating the expense of products only at the point of sale, even if costlier but longer-lasting products would be more economical in the long term. Leasing models are unheard of in many industries, though they would benefit both customers and companies. Research from the Ellen MacArthur Foundation suggests, for example, that leasing high-end home washing machines would lower the cost of use for customers by one-third over five years. During that time, manufacturers would earn roughly one-third more in profits because they could lease their fleets of machines multiple times before refurbishment.6 6. For more, see Towards the circular economy: Economic and business rationale for an accelerated transition, Ellen MacArthur Foundation, January 2012, ellenmacarthurfoundation.org.

Ingrained habits within companies also thwart change. Senior executives rightly worry about the higher levels of capital needed to change products, as well as the friction of moving from familiar sales- to usage-based approaches. One of the biggest concerns for Ricoh’s executives before launching GreenLine, for example, was that it might cannibalize new products. Only after creating a control plan to monitor sales of GreenLine and other offerings was the company confident that it could guarantee strong coverage across different customer segments while not cannibalizing its products.

Misaligned incentives also exist between companies. Dividing the gains from optimized designs of more circular products or processes is tricky given the different motivations involved. For example, in the European beer industry, the closed-loop model for returnable bottles is well established. Yet in some markets, the share of bottles completing the circle back to the manufacturer dropped to one-third, from one-half, between 2007 and 2012. The reason: store owners preferred to dispose of the empty bottles themselves because that maximized the sales space available to promote new products. Addressing such challenges requires companies to develop profit-sharing models across their value chains. They should also learn how to spot “moments of truth” when it might be easier to break with the status quo—for example, when companies enter new markets, renegotiate agreements with suppliers and service providers, or face choices about big capital investments.

Toward a circular economy

Ultimately, the systemic nature of the barriers means that individual corporate actions, while necessary, won’t suffice to create a circular economy at scale. The real payoff will come only when multiple players across the business and research communities, supported by policy makers and investors, come together to reconceive key manufacturing processes and flows of materials and products. Should that happen, our research finds, the benefits would be huge. They include:

  • Net materials savings. On a global scale, the net savings from materials could reach $1 trillion a year. In the European Union alone, the annual savings for durable products with moderate lifespans could reach $630 billion. The benefits would be highest in the automotive sector ($200 billion a year), followed by machinery and equipment.
  • Mitigated supply risks. If applied to steel consumption in the automotive, machining, and transport sectors, a circular transformation could achieve global net materials savings equivalent to between 110 million and 170 million metric tons of iron ore a year in 2025. Such a shift could reduce demand-driven volatility in these industries.
  • Innovation potential. Redesigning materials, systems, and products for circular use is a fundamental requirement of a circular economy and therefore represents a giant opportunity for companies, even in product categories that aren’t normally considered innovative, such as the carpet industry.
  • Job creation. By some estimates, the remanufacturing and recycling industries already account for about one million jobs in Europe and the United States.7 7.According to the Automotive Parts Remanufacturers Association (United States) and SITA (the waste-management arm of Suez Environnement).The effects of a more circular industrial model on the structure and vitality of labor markets still need to be explored. Yet we see signs that a circular economy would—under the right circumstances—increase local employment, especially in entry-level and semiskilled jobs, thus addressing a serious issue facing many developed countries. Ricoh’s remanufacturing plant, for instance, employs more than 300 people.

Focusing a collective effort on the leverage points that would have a systemic impact is the key to unlocking this potential. Our research suggests that the place to start is materials flows, as they represent the most universal industrial assets. The ultimate objective is to close materials loops on a global level and to achieve tipping points that would bring major streams of materials back into the system, at high volume and quality levels, through established markets. Creating pure-materials stocks for companies would help jump-start that process while giving companies strong incentives to innovate.

The ubiquitous PET8 8.Polyethylene terephthalate. provides a useful analogy for how this could happen. The polymer’s strong adoption as the basic input for bottles in the beverage industry created a recycled-PET market that extended beyond bottles. This in turn created a stable platform for beverage companies to use PET for their own innovative purposes. Innovation therefore shifted from materials (new additives harder to isolate and later remove) and toward products and processes (for example, novel shapes for sports-drink bottles, new process innovations that allow hot drinks to be injected into bottles, and thinner-walled water bottles requiring lower amounts of materials to create).

Establishing de-facto standards for other materials would act as a catalyst for further action. Our research identified four types of materials, each at a different stage of maturity in its evolution toward the circular economy. These four thus represent realistic starting points where pilot projects would make the greatest difference right away (Exhibit 3).

Exhibit 3

A large-scale transformation would focus on four types of materials at different stages of maturity.

Mobilizing multiple stakeholders is always challenging, of course, and could take several forms, including industry partnerships and consortia. Nonprofits and nongovernmental organizations will also play a vital convening role.9 9.For example, the Ellen MacArthur Foundation’s Circular Economy 100 program aims to bring companies and innovators together across regions to help develop and accelerate various commercial opportunities. Similarly, the World Economic Forum has created a number of initiatives focused on circular-economy issues.Regardless of the route companies choose, by joining forces they can begin using existing science to develop the projects and enabling mechanisms that could trigger a self-reinforcing virtuous cycle. That would in turn ultimately benefit stakeholders on every level—customers, businesses, and society as a whole.

The “take, make, and dispose” model of production has long relied on cheap resources to maintain growth and stability. That world no longer exists. By applying the principles of a circular economy—a system that is regenerative by design—forward-looking companies can seize growth opportunities while laying the groundwork for a new industrial era that benefits companies and economies alike. Capitalizing on the opportunities will require new ways of working, but the benefits are well worth the cost.

Originally Published in full in McKinsey – Insights and Publications

Next-shoring: A CEO’s guide

Proximity to demand and innovative supply ecosystems will trump labor costs as technology transforms operations in the years ahead.

When offshoring entered the popular lexicon, in the 1990s, it became shorthand for efforts to arbitrage labor costs by using lower-wage workers in developing nations. But savvy manufacturing leaders saw it as more: a decisive change in globalization, made possible by a wave of liberalization in countries such as China and India, a steady improvement in the capabilities of emerging-market suppliers and workers, a growing ability to transfer proven management processes to new locales, and increasingly favorable transportation and communications economics.

Something of equal moment is occurring today. As we settle into a “new normal” catalyzed by the global financial crisis, the ensuing recession, and an uneven global recovery, traditional arbitrage models seem increasingly outmoded.1 1. See Ian Davis, “The new normal,” McKinsey Quarterly, March 2009. For some products, low labor costs still furnish a decisive competitive edge, of course. But as wages and purchasing power rise in emerging markets, their relative importance as centers of demand, not just supply, is growing.

Global energy dynamics too are evolving—not just the now-familiar shale-gas revolution in the United States, but also rising levels of innovation in areas such as battery storage and renewables—potentially reframing manufacturers’ strategic options. Simultaneously, advances stemming from the expanding Internet of Things, the next wave of robotics, and other disruptive technologies are enabling radical operational innovations while boosting the importance of new workforce skills.

Rather than focus on offshoring or even “reshoring”—a term used to describe the return of manufacturing to developed markets as wages rise in emerging ones—today’s manufacturing strategies need to concentrate on what’s coming next. A next-shoring perspective emphasizes proximity to demand and proximity to innovation. Both are crucial in a world where evolving demand from new markets places a premium on the ability to adapt products to different regions and where emerging technologies that could disrupt costs and processes are making new supply ecosystems a differentiator. Next-shoring strategies encompass elements such as a diverse and agile set of production locations, a rich network of innovation-oriented partnerships, and a strong focus on technical skills.

In this article, we’ll describe the economic forces sweeping across the manufacturing landscape and examine technologies coming to the fore. Then we’ll suggest some principles for executives operating in this new world. The picture we’re painting is of necessity impressionistic: next-shoring is still taking shape and no doubt will evolve in unexpected ways. What’s increasingly clear, though, is that the assumptions underlying its predecessor, offshoring, are giving way to something new.

Economic fundamentals

The case for next-shoring starts with the economic fundamentals of demand (since the importance of local factors is growing) and supply (as the dynamics of labor and energy costs evolve).

The importance of local demand factors

More than two-thirds of global manufacturing activity takes place in industries that tend to locate close to demand. This simple fact helps explain why manufacturing output and employment have recently risen—not only in Europe and North America, but also in emerging markets, such as China—since demand bottomed out during the recession following the financial crisis of 2008.

Regional demand looms large in sectors such as automobiles, machinery, food and beverages, and fabricated metals. In the United States, about 85 percent of the industrial rebound (half a million jobs since 2010) can be explained just by output growth in automobiles, machinery, and oil and gas—along with the linkages between these sectors and locally oriented suppliers of fabricated metals, rubber, and plastics (Exhibit 1).2 2. See Manufacturing the future: The next era of global growth and innovation, McKinsey Global Institute, November 2012, for an in-depth analysis of the economics and trends surrounding five types of manufacturing industries: global technologies (for instance, electronics) that are R&D intensive and highly traded, global innovation for local markets (autos, machinery) that are R&D intensive but tend to produce adjacent to demand, labor-intensive regional processors (food, fabricated metals) that are highly localized and locate adjacent to demand, resource-intensive commodities (metals, paper and pulp) that are energy intensive and locate near demand or resources, and labor-intensive tradables (apparel, footwear) that are highly traded and locate where labor is cheap. The automotive, machinery, and oil and gas industries consume nearly 80 percent of US metals output, for example.

Exhibit 1

In the recent US industrial rebound, about 85 percent of the job growth in manufacturing occurred in automobiles, machinery, and regional-supplier industries.

In China too, locally oriented manufacturers have contributed significantly to rising regional investment and employment. The country has, for example, emerged as the world’s largest market and producer for the automotive industry, and many rapidly growing manufacturing sectors there have deep ties to it. As automotive OEMs expand their capacity in emerging markets to serve regional demand, their suppliers have followed; the number of automotive-supplier plants in Asia has tripled in just the past decade.

The emerging markets’ share of global demand is steadily climbing, from roughly 40 percent in 2008 to an expected 66 percent by 2025 (Exhibit 2). As that share rises, it also is fragmenting into many product varieties, feature and quality levels, price points, service needs, and marketing channels. The regional, ethnic, income, and cultural diversity of markets such as Africa, Brazil, China, and India (where some local segments exceed the size of entire markets in developed nations) is raising the ante for meeting local demand. In the automobile industry, for example, fragmenting customer demand has led to a 30 to 50 percent increase in the number of models. Ninety percent of recent capital expenditures in the automotive sector have involved product derivatives worldwide and capacity expansions in new markets.

Exhibit 2

Emerging markets’ share of global demand is expected to reach 66 percent by 2025.

The limits of labor-cost arbitrage

Surging local demand helps explain why rapid wage growth in China hasn’t choked off manufacturing expansion there. Wages have nearly doubled since 2008, partly as a result of domestic minimum-wage policies.3 3. Measured in nominal dollars. (The country’s 2011 five-year plan called for 13 percent average annual minimum-wage increases, a rate some provinces have already exceeded.) True, in a few labor-intensive, trade-oriented industries, such as apparel production and consumer electronics, labor-cost changes do tend to tip the balance between different geographic regions; manufacturing employment in Bangladesh and Vietnam, for instance, has benefited from China’s wage surge, even as Chinese manufacturers are seeking to raise productivity.

But these are far from the only implications of rising wages. Just as Henry Ford’s $5 day helped create a new consuming class, so higher wages in China are increasing local demand, thus reinforcing the local-investment choices of OEMs and suppliers. At the same time, there is little evidence of a zero-sum game between China and advanced economies, such as the United States. Rather, the narrowing labor-cost gap reinforces the importance of local demand factors in driving manufacturing employment. Indeed, factor costs often have the greatest impact on location decisions within a region—for example, Airbus moving to Alabama instead of Texas or North Carolina. These costs interact with policy factors, such as infrastructure spending and tax incentives, to shape a region’s overall economic attractiveness.

The impact of energy costs

The price of natural gas in the United States has fallen by two-thirds as gas production from shale deposits rose by 50 percent annually since 2007. A narrow range of sectors—gas-intensive manufacturing, such as the production of petrochemicals, fertilizer, and steel—are benefiting most directly. Some downstream players in the energy value chain have begun shifting investments. Dow Chemical, BASF, and Methanex, for example, have announced plans for new US manufacturing capacity to take advantage of cheaper, abundant energy supplies.

These moves are important for such companies and subsectors; McKinsey Global Institute (MGI) research suggests that by 2020, lower-cost energy could boost US GDP by somewhere between $400 billion and $700 billion.4 4. For more, see the full McKinsey Global Institute report, Game changers: Five opportunities for US growth and renewal, July 2013. But do they presage a dramatic rebalancing of global manufacturing activity? Electricity costs were already lower in the United States than in many countries, including China—which, along with others, also has opportunities to boost its own energy output through hydraulic fracturing. And fossil fuels aren’t the only area where the energy-supply picture is morphing.

Consider, for example, the potential impact of energy-storage technologies, especially lithium-ion batteries and fuel cells, which are becoming more capable and less costly. At the same time, the improving economics of renewable-energy production—particularly solar and wind power—offers manufacturers an expanding range of future supply options. In some developing regions where power grids are unreliable or nonexistent, factory complexes served by distributed solar power may be feasible. Distributed generation is also growing in combined heat–power (CHP) plants, which use heat created in the production process to run steam turbines and generate electricity locally.

None of these is a silver bullet today. But as advances continue over time, more and more companies may become able to ask themselves where they would place major strategic bets if the availability and price of energy were lesser concerns. That too will probably lead back to a focus on local demand patterns. Interestingly, the country representing the greatest source of future demand growth—China—also is actively stimulating the development of a range of new energy sources and storage technologies through a focus on new strategic industries in its five-year plans.5 5. See Guangyu Li and Jonathan Woetzel, “What China’s five-year plan means for business,” July 2011.

Technology disruption ahead

Technology is affecting far more than energy dynamics. Advanced robotics, 3-D printers, and the large-scale digitization of operations are poised to alter fundamental assumptions about manufacturing costs and footprints.6 6. For more, see Disruptive technologies: Advances that will transform life, business, and the global economy, McKinsey Global Institute, May 2013. To derive value from these shifts, companies will have to make significant investments and ensure access to hubs of innovation, capable suppliers, and highly skilled workers.

Advanced robotics

Investments in industrial robots have increased by nearly 50 percent since 2008—even in emerging nations such as China—as a new generation of advanced systems develops, with greater dexterity and ability to process information. These robots can perform an expanding array of factory tasks—for instance, manipulating small electronic parts, and picking and packing individual products. They can work side by side with humans and be trained by factory-floor operators rather than programmed by teams of highly paid engineers. Improved economics and capabilities eventually may yield productivity gains that are unforeseen today, as well as better products and faster speed to market. As that happens, companies will be able to retool their manufacturing systems to provide new roles for these mechanical “workers.”

Cheaper, more proficient robots that can substitute for a wider variety of human tasks are another reason companies may locate more manufacturing closer to major demand markets, even where wage rates are higher. In developing nations, robots could speed up rates of automation and help bridge shortages of some production skills. MGI research suggests that 15 to 25 percent of the tasks of industrial workers in developed countries and 5 to 15 percent of those in developing countries could be automated by 2025.

Further out, highly robotized factories also equipped with other information technologies might shift competition to areas such as the ownership of customer networks, which should become increasingly valuable as information embedded in them starts guiding production priorities and flows. Flexible, intelligent assembly robots also should enable contract manufacturers to serve an increasingly diverse range of customers, creating new opportunities for attackers to target attractive microsegments.

3-D printing

The economics of 3-D printing are improving rapidly, as well. While still only a sliver of value in the manufacturing sector (0.02 percent), sales of 3-D printers are set to double, to $4 billion, by 2015, and prices for the equipment are declining swiftly.7 7. Wohlers Report 2013: Additive Manufacturing and 3D Printing State of the Industry, Wohlers Associates, May 2013, wohlersassociates.com. Also, 3-D printers open up the possibility of more distributed production networks and radical customization. In early manufacturing applications, some companies are using the devices to accelerate product development, since they eliminate wait times for prototyping by faraway specialists. Companies will be able to consider new supply-chain models and, in some cases, replace traditional suppliers of parts with targeted usage of in-house printers.

These printers won’t replace traditional high-volume modes of production, such as die casting and stamping. For more specialized goods, though, it’s easy to imagine the emergence of service businesses—the equivalent of copy or print shops—that would manufacture items based on design specifications provided by B2B or B2C customers. Crowdsourcing networks for new-product ideas could one day complement traditional R&D activities for some manufacturers. (For more on 3-D printing, see “3-D printing takes shape,” available on mckinsey.com, on January 31.)

Digitized operations

Significant as advanced robotics and 3-D printers are, they represent just two plot lines in a much bigger story about the digitization of operations. Cloud computing, mobile communications, and the Internet of Things8 8.The growing collection of sensors and actuators embedded in products and equipment. are beginning to combine with advanced analytics to create threads of intelligent data that link assets and stakeholders as never before. Increasingly, products will communicate with each other, with robots and advanced machines inside factories, and with customers and suppliers. Digital “DNA” for parts (including the materials, equipment, and time required to make them) will also be increasingly available.

The implication is that we are approaching a day when manufacturers will have unprecedented global visibility into who makes what, where, and how well. They’ll be able to run virtual operations “war rooms” on their phones. They’ll have new opportunities to solve plant-floor optimization problems as intelligent machines interface with each other and with people on the line. In the near future, manufacturers also will exploit opportunities for crowdsourced design and on-demand production. These opportunities will extend well beyond goods made by 3-D printers; manufacturers will pursue the buying and selling of previously underutilized production lines “by the hour” and will rely on dynamic databases to determine what every part should cost. And new forms of technology-enabled collaboration, such as the three-dimensional virtual assembly and testing of vehicles, will redefine what it means to be proximate to innovation—which may be locally generated or accessed via broadband.

Digital operations aren’t a far-off fantasy. GE already has a 400-person industrial Internet software team and its employees use iPads to run an advanced battery factory in New York State. Amazon.com is employing growing numbers of smart warehouse robots. Fiat has reduced the number of physical prototypes needed to introduce a new product; Alcoa has compressed prototyping time and costs for some products; and an auto supplier recently slashed an eight-month prototyping process to one week.

Next-shoring

Although these forces are still gathering strength, they’re already pointing toward two defining priorities for manufacturing strategy in the era of next-shoring: proximity to demand and proximity to innovation, particularly an innovative base of suppliers. In developed and emerging markets alike, both ingredients will be critical. Next-shoring isn’t about the shift of manufacturing from one place to another but about adapting to, and preparing for, the changing nature of manufacturing everywhere.

Optimizing location decisions

Being close to demand is particularly important at a time when consumption in emerging markets is growing rapidly, boosting with it the diversity of the regional preferences that manufacturers must contend with. In a 2012 interview with McKinsey, Timken CEO James Griffith explained his company’s approach: “Over the last ten years, we’ve added a very strong Eastern European, Indian, and Chinese manufacturing base,” not because wages are low there “but because those were the markets that were growing.” This expansion has been accompanied by a strategic shift away from a focus on automotive parts—“we could make a car last for a million miles, but nobody cares.” The new emphasis is on fast-growing mining, trucking, steelmaking, and cement-making customers in emerging markets. For them, Timken’s reliability is a decisive asset.9 9. See “Manufacturing’s new era: A conversation with Timken CEO James Griffith,” December 2012.

Locating manufacturing close to demand makes it easier to identify and meet local needs. It’s a delicate balancing act, though, to create an efficient global manufacturing footprint that embraces a wide range of local tastes, since economies of scale still matter in many industries. Volkswagen has coped by moving from vehicle platforms to more modular architectures that provide greater flexibility for manufacturing several product variants or derivatives.

New products, market segments, and consumer preferences are combining with perennial risks (such as seasonal variations in demand and fluctuations in wages and currency rates) to boost uncertainty in manufacturing and supply networks. That uncertainty places a premium on operational agility—the ability to adapt design, production, and supply chains rapidly to fluctuating conditions.10 10.For more on operational agility, see Mike Doheny, Venu Nagali, and Florian Weig, “Agile operations for volatile times,” McKinsey Quarterly, May 2012. This too may play into location decisions.

Take the experience of a consumer-products company that had relied on one plant to supply its major market. When the company began experiencing unaccustomed spikes in regional and seasonal purchasing patterns, shortages and lost sales ensued. To accommodate rising variations in demand, the company built a second plant, with similar cost characteristics, in a different region. This additional capacity helped ensure supplies to the prime market, where the problems were most acute, while also allowing the company to meet growing demand opportunistically in several new markets close to the new plant. Although the investment was considerable, it lowered the company’s risk exposure, eliminated damaging stockouts, and improved the bottom line.

Building supplier ecosystems

New combinations of technical expertise and local domain knowledge will become the basis for powerful new product strategies. Responsive, collaborative, and tech-savvy supplier ecosystems will therefore be increasingly important competitive assets in a growing number of regional markets. To keep up with the opportunities afforded by technological change, for example, a major manufacturer that until recently had relied on a low-cost supplier in Mexico for parts has begun working with a new supplier that has cutting-edge 3-D printing capabilities. The new relationship has lowered stocking costs (since parts are made on demand), while providing avenues for developing prototypes more quickly.

Examples like this are just a start. As information flows among partners become more robust, they will usher in a range of improvements, from surer logistics to better payment systems. These will create a virtuous cycle of collaborative benefits. The supply bases of many manufacturers thus may soon need significant upgrades and capital investments to create joint competencies in areas such as robotics. Collaboration and management investment in skill-development programs could be necessary as well. In some cases, it may be valuable to collaborate with local or national governments to create the conditions in which the manufacturing ecosystems of the future can flourish. Tighter supply networks also will foster production systems that reduce the need for virgin natural resources, a topic addressed in more detail by our colleagues in “Remaking the industrial economy,” available on mckinsey.com on February 5.

A failure to develop innovative supply ecosystems will have growing competitive implications for countries as well as companies. The competitive challenges facing the United States sometimes look more like a system failure than an economic one. US investment in advanced robotics, for example, often lags behind that of other developed economies, with trade deficits prevailing even in sectors where wage-rate differentials aren’t a big influence on location decisions.

Developing people and skills

All this will place a premium on manufacturing talent, creating a range of regional challenges. In Europe and the United States, educational institutions aren’t producing workers with the technical skills advanced manufacturers need. In developing economies, such as China, the millions of lower-cost production associates who are well adapted to routine manufacturing may find it difficult to climb to the next level. Line supervisors—often fresh out of regional universities—struggle to manage baseline operations and to coordinate teams. Organizations will need to invest more in formal training and on-the-job coaching to bridge the gaps. They must also cast a wider net, supporting local community colleges and technical institutes to shape curricula and gain access to new talent streams.

A related challenge is the need for new management muscle. As it gets harder to hide behind labor-cost arbitrage, regional manufacturing executives and midlevel managers will need to become both better at running a tight operational ship and more versatile. They should be able to grasp the productivity potential of a range of new technologies and have enough ground-level knowledge of local markets to influence product strategies and investment trade-offs. The ability to build external relationships—with suppliers, education partners, and local-government officials who can influence the development of vibrant, sophisticated supply ecosystems—will also be a source of competitive advantage.

Next-shoring will look different in different locales, of course. Europe and the United States have impressive advantages in areas such as biopharmaceuticals, automotive engineering, and advanced materials. China, meanwhile, is quickly climbing the expertise curve, with increasingly sophisticated corporate and university research facilities and growing experience in advanced processes and emerging industries.11 11.See Gordon Orr and Erik Roth, “The CEO’s guide to innovation in China,” McKinsey Quarterly, February 2012; and “China’s innovation engine picks up speed,” McKinsey Quarterly, June 2013. In the world we’re entering, the question won’t be whether to produce in one market for another but how to tailor product strategies for each and how to match local needs with the latest veins of manufacturing know-how and digital expertise. While the road map for every company, industry, and location will be different, we believe that the principles we’ve laid out here should be useful for all.

Originally Published by McKinsey & Company