Background:

McKinsey has been engaged by a diversified manufacturing client to assist in revitalizing its steam boiler hose division. This division supplies boiler hoses to external customers as well as the client's own boiler division. Pertinent information includes:

  • Boiler hoses are sold as original equipment and replacements.
  • The industry has experienced mounting price pressures.
  • The client holds the third position out of eight industry participants.

Additional data provided:

  • Last year's Profit & Loss (P&L) breakdown, as a percentage of sales, is as follows:

    • Raw Material: 70%
    • Labor: 20%
    • Distributed Overhead: 10%
    • Selling, General, and Administrative Expenses (SG&A): 15%
    • Profit: -15%

  • Raw material consists of a commodity petrochemical.

  • At least two competitors in the industry are generating moderate profits.

Question:

How would you structure an analysis aimed at restoring profitability in this situation, and where do you foresee potential cost-saving opportunities?

Minimum Requirements:

The candidate should refrain from delving into the following areas:

  1. Discontinuing the product line (impractical due to its essential nature of boiler sales).
  2. Raw material prices (uniform across competitors).
  3. Allocation of overhead (minimal potential for cash savings).
  4. SG&A (standard industry fees for independent installers).

Final Analysis:

The Product over-design is leading to excessive raw material consumption. Such answers should address the following organizational implications:

  1. Examination of product engineering's connection with the marketplace (notable lack of interaction between engineering, marketing, and sales).
  2. Assessment of feedback from the sales force (customers are satisfied with hoses but require all product features).
  3. Exploration of similar problems in other areas of the company.
  4. Economies of scale (assessing the client's capacity for achieving scale production).
  5. Production technology (evaluating the modernity of the client's plant).
  6. Labor costs (analyzing wage rates and productivity relative to industry norms).
  7. Raw material procurement practices (investigating material procurement through long-term contracts with pricing based on the spot market minus a discount).

These insights should pave the way for a comprehensive solution to the profitability challenge.