Increase value added

Optimisation of the production and distribution structure

Changes in a company’s production and distribution structure are among the most important strategic decisions in an operating organisation.

In this article, we will clarify how an optimisation of the company’s production and distribution structure can support the company’s competitive power and increase the company’s value added.

The production and distribution structure is a fundamental element in the long-term strategic priorities

Changes in a company’s production and distribution structure are among the most important strategic decisions in an operating organisation. This type of decision carries considerable risks and uncertainties, as it involves significant CAPEX investments and risky transformation processes in connection with a possible relocation of production and distribution points.

The reason why it is still important to assess possible improvements in the production and distribution structure on a regular basis is that such decisions are of vital importance to a company’s future competitive power and economic value added. Therefore, considerations concerning improvement of the existing production and distribution structure should be part of a company’s strategic planning process.

This is illustrated below in the figure, in which the considerations relating to a change in the existing production and distribution structure are part of the more fundamental and strategic capacity planning and, thus, at the top of the decision-making pyramid (in the next article in this series, we will take a closer look at level 2: sales & operations planning).

Optimisation of the production and distribution structure Strategic planning structure

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Morten Søndergaard
Morten Søndergaard
+45 2338 0080

Typical catalysts for optimising the company’s production and distribution structure

Despite the complexity and the business-related and operational risks, which are associated with a change of the production and distribution structure, the company’s own strategic development or more fundamental and longterm changes in market and customer conditions may result in a need to assess the potential for structural optimisation, i.e. reductions, consolidations or geographic movements.

Many companies have a production and distribution structure, which is the result of many years of continuous adjustments and acquisitions and/or mergers with other companies. A large number of international studies have shown that only approx. one third of all mergers and acquisitions live up to expectations. An important reason for
the gap in calculated synergies created in connection with the transactions is that they have not been applied to operational procedures and daily work and thus the values have not been realised. If the operational and capitalrelated synergies are not  realised within a relatively short period of time, there is a significant risk of destroying value and causing increased complexity and reduced competitive power.

However, these are not the only conditions that catalyse an assessment of the production and distribution structure. Other significant operational conditions which cause the companies to change their production and distribution structure are, among others:

  • The need to reduce salaries and other major operating costs by relocating to low-cost countries
  • The need for additional capacity, possibly on new markets
  • A change in market conditions and the need to get closer to customers
  • The need to bring down the level of complexity by reducing the production units
  • The need to reduce tied-up capital by centralising stocks
  • Changing the company’s business model and fundamental value proposition where the production and distribution activities, to a higher extent, are allocated to strategic business partners

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Effect of the company’s economic value added by optimising the production and distribution structure

As described and illustrated in the first article in this series of articles, a company’s ability to create economic value may be expressed by its ability to generate a return on invested capital (ROIC) in the company beyond the weighted average cost of capital (WACC), which the investors have in general in relation to their invested capital in the company. The level of economic value added at a given period of time can be expressed by using the following formula:

Economic value added

A change in the production and distribution structure may potentially and quite dramatically affect the company’s economic value added, as this type of change affects both operational earnings and invested capital significantly. The areas that are typically affected are illustrated below:

Optimisation of the production and distribution structure Economic Value Creators

These are all conditions which affect the company’s ability to generate better operational earnings as well as a more efficient use of the company’s invested capital and thereby the company’s ability to create value going forward.

The process of optimising the company’s production and distribution structure typically follows four steps. As previously mentioned, changes in a company’s production and distribution structure involve significant risks and uncertainties, which is why it is critical that a structured and fact-based process is followed.

Optimisation of the production and distribution structure flow

The figure above illustrates a generic process in which the company, based on “current state mapping”, assesses various future scenarios for the production and distribution structure based on the effect on the economic value added. For further information about this process and examples of its use, please contact Morten Søndergaard.